Mercury Systems Inc

in customer activity levels and the speed at which things are moving. We believe this could be attributed to vaccination rates and employees that are customers in the government returning to onsite work. We also believe the Biden administration's budget release has given program offices more priority around priorities, which could further reduce program delays. In addition, our design and activity remains strong. For fiscal 22, we expect our design wins to gain total more than a billion dollars in estimated lifetime value. We expect these programs, as well as prior design wins, to convert into increased bookings and backlog as they transition into production over time. Looking farther ahead to fiscal 23, we currently expect our organic growth to accelerate back to more normal high single digit to low double digit levels. This growth is expected to be driven by, one, the improving environment, two, the anticipated growth in bookings in fiscal 22, and finally, the substantial expected revenue growth on S35, LTAMs, filthy buzzers, and other programs. Turn to slide six. Since fiscal 14, we've completed 13 acquisitions, deploying $1.2 billion of capital. As a result of this investment, we've dramatically scaled and transformed the business. We've grown the estimated lifetime value of Mercury's top 30 programs and pursuits from $4.6 billion to more than $11 billion. This opportunity pipeline is greater than 10x the size of our backlog and represents the foundation for our future growth. Over this period, we've successfully grown total company revenue 4.4 times and adjusted EBITDA more than nine times, resulting in a 10x increase in our market cap. As demonstrated by the more rapid growth in adjusted EBITDA, we've extracted substantial cost and revenue synergies from our acquisitions over time. This has significantly reduced our gross purchase price to net multiple for the deals that we've done. Looking forward, crossing the billion-dollar revenue threshold is both a milestone to be celebrated and, we believe, an inflection point for Mercury. I mentioned that we expect organic growth to rebound in fiscal 23. In addition, we're in an extremely active period for M&A right now. Our pipeline is very robust, with multiple opportunities of varying sizes, all in line with the core of our strategy. With the acceleration of organic growth expected in fiscal 23, combined with M&A, we believe that we have the opportunity over time to replicate what we've done so successfully since fiscal 14. As a result, we've launched impact to determine what we need to do today to enable us to become a multiple of our current size. Our goal is to achieve our full growth and adjusted EBITDA potential organically and through M&A over the course of the next five years. Since fiscal 14, driven by our acquisitions, we've substantially changed the company. We've expanded the scope of our offerings and capabilities, leading to a nearly eight-fold increase in subsystems revenue. We've in-sourced manufacturing. Our headcount has increased three and a half times. Our footprint has grown from 10 to 27 locations. And our Excel supply chain spend has increased nearly 3x. Despite achieving significant synergies, as I mentioned, we believe there's additional value to be had. We proactively began contemplating impact earlier this calendar year with capturing that value and our future scaling in mind. Turn to slide 7. Early in Q3, we engaged a Tier 1 consulting firm to do a full assessment of the company. Working with them, we took a fresh look at the business from an organizational structure and value creation perspective. Based on that assessment, the first opportunity is to consolidate and streamline our organizational structure. This will improve visibility, speed of decision-making, and accountability. These actions started in the fourth quarter with the effort accelerating in Q1. We're anticipating a $22 million net benefit in total for fiscal 22 related to these actions. The Q1 action alone accounts for $14 million of that total. Impact will be led by a new Chief Transformation Officer reporting to me. As it progresses over the course of the next two to three years, in addition to growth, we'll be focusing on six major areas. Organizational efficiency and scalability, procurement and supply chain, facilities optimization, R&D investment efficiency, capital and asset efficiency, and scalable common processes and systems. These actions are still in their planning stages and we'll have more to say about them over time. At this point, we think it's reasonable to target $30 to $50 million of incremental adjusted EBITDA by fiscal 25 as a result of this activity. Again, this includes a $22 million net benefit in fiscal 22. Going forward, we'll continue to reinvest some of the gross savings in people and business systems with an eye towards future scalability. Overall, the impact is about enabling our future. fiscal 14, but doing it efficiently and effectively at greater scale. A way to think about this and to use an analogy, two of our large customers that recently merged with other defense primes are going through similar value creation programs. We've effectively acquired a company greater than two times our size over the course of the past seven years. It just so happens that we've done so via 13 acquisitions, as compared with a single merger of equals like our customers. In addition today, but unrelated to impact, we announced that our Executive Vice President, Didier Thibault, has decided to retire from the company. Didier will rejoin his family in France after 26 years of mercury. In September, he'll begin serving as a strategic advisor to me, while also working closely with the leadership team for a smooth and orderly transition. Didier's contributions in council have been instrumental to our growth and success. We extend to him our sincere thanks and wish him well in retirement. Turning to slide eight. The expected impact will also accelerate value creation as we apply the new processes and methodologies to future M&A activity, which remains an integral part of our strategy. The M&A environment is extremely active right now, as I mentioned, and our pipeline is strong. We remain disciplined in our approach, both in terms of deal pursuits and diligence, as well as integration. The integrations of POC and Pentac are on track, and both businesses are performing well. Looking forward, we believe that we're well positioned to continue supplementing mercury's organic growth with accretive acquisitions. Turn to slide 9 in summary. We believe that the current environment is transitory and we'll begin to see signs of improvement. Although organic growth may be lower in FY22 versus what we thought last quarter, we believe that the secular growth trends that benefit mercury is still in place. We're expecting substantial growth in bookings and backlog in fiscal 22. As a result, fiscal 23 is shaping up to be a strong year as organic growth returns to normal levels and margins expand as a result of recent impact actions taken. Our longer-term outlook remains intact and our strategy remains the same. that is, to deliver strong margins while growing the business organically and supplementing this organic growth with disciplined M&A and full integration. This strategy has worked extremely well for us for nearly a decade. As we crossed the billion-dollar revenue threshold, we've launched Impact to achieve Mercury's full growth and adjustability with our potential over the course of the next five years. With that, I'd like to turn the call over to Mike. Mike?

Thank you, Mark, and good afternoon again, everyone. As usual, I'll start with our Q4 and fiscal 21 results and then move to our guidance for Q1 and full year fiscal 22. I'll conclude with some detail on the magnitude and timing of potential financial benefits from the impact effort that Mark just discussed. We finished fiscal 21 with a strong fourth quarter and delivered record revenue adjusted EBITDA and adjusted APS for the year. As Mark mentioned, entering fiscal 22, we're expecting flat organic growth, but double-digit total growth, strong results on the bottom line, and a substantial rebound in our bookings. As a result, we believe that we're well positioned for a return to high single-digit, low double-digit organic growth in fiscal 23. In addition, we expect adjusted EBITDA margins to expand in fiscal 23, driven by positive operating leverage in addition to benefits of the impact program. Turning now to slide 10, Mercury delivered solid results in Q4. Total revenue, adjusted EBITDA, and adjusted EPS all met or exceeded our guidance. Our Q4 bookings and book-to-bill were strong as the bookings environment began to improve from the slowdown we experienced through the first three quarters of fiscal 21. Bookings for Q4 were $260 million, down 7% compared to Q4-20 when we had a record bookings quarter. Bookings were up 24% compared to last quarter as we saw a rebound in activity. Q4 booked a bill with 1.04. Revenue for Q4 increased 15% from Q4-20 to $251 million. which is above the top end of our guidance range of $236.5 to $246.5 million. Organic revenue was $210 million, and acquired revenue, which included Physical Optics Corporation and Pentec, was $40.8 million. Our acquisitions continue to perform well as we integrate them into Mercury. GAAP net income and GAAP EPS were down 34 percent and 35 percent, respectively, from Q420. This was driven primarily by non-operating income, discrete tax benefits, amortization expense, and restructuring and other charges. Adjusted net income and adjusted EPS, which exclude most of these items, were up year over year. We recorded $7 million of restructuring and other charges in Q4. reflecting a workforce reduction in the quarter, as well as third-party consulting costs associated with our impact program. Adjusted EBITDA for Q4 increased 19% to a record $59.1 million compared to $49.6 million last year. Our adjusted EBITDA margins were 23.5% for the quarter, up from 22.8% in Q4 fiscal 20. This margin expansion included 110 basis point dilutive impact from the POC acquisition. Turning to our full year results on slide 11, we managed through COVID and market conditions to deliver record revenue adjusted EBITDA and adjusted EPS in fiscal 21. The volume of new design wins remained high at $1.5 billion. We continued to position the business for future growth through investments in R&D and CapEx. We also completed two acquisitions, deploying $375 million of capital. Total bookings for fiscal 21 were $881 million. This was down 8% from fiscal 20 when we had a record bookings year. As Mark mentioned, our bookings during the year were impacted by a variety of market and program dynamics. Our book to bill for fiscal 21 was slightly below one at 0.95. We ended the year with backlog of 910 million, up 9% year over year. Revenue in fiscal 21 increased 16% year over year to a record 924 million, exceeding our guidance of 910 to 920 million. No single program represented more than 5% of our revenue in fiscal 21. and our top five programs represented less than 20% of revenue. Total gap net income on a consolidated basis for fiscal 21 was $62 million, or $1.12 per share. The decrease was driven primarily by non-operating income, discrete tax benefits, amortization expense, COVID expenses, and restructuring and other charges. Adjusted net income and adjusted EPS were both up year over year. Adjusted EBITDA for fiscal 21 increased 15% to a record 201.9 million compared to 176.2 million last year. Our adjusted EBITDA margins were 21.9% compared to 22.1% in fiscal 20. POC had a dilutive impact of 30 basis points on adjusted EBITDA margins for the six months following the acquisition. Slide 12 presents Mercury's balance sheet for the last five quarters. In Q4, we completed the $65 million acquisition of Pentec, which we financed with $25 million of cash on hand and $40 million of debt under our revolver. We ended Q4 with cash and cash equivalents of $114 million compared to $122 million in Q3. The reduction was driven by the cash used for the Pentec acquisition partially offset by the cash generated in the business. We ended Q4 with $200 million of debt, up $40 million related to the funding of the Pentec acquisition. From a capital structure perspective, Mercury remains well positioned with continued flexibility and great access to capital. We still have significant capacity to invest in M&A, and our pipeline of M&A opportunities continues to be strong. Turning to cash flow on slide 13, free cash flow for Q4 was in line with our expectations at $16.3 million, representing 28% of adjusted EBITDA. During the quarter, we had cash outflows related to COVID, acquisition-related expenses primarily related to the PENTEC acquisition, as well as for consulting costs associated with our impact programs. For the year, free cash flow was $51.6 million, representing approximately 26% of adjusted EBITDA in line with expectations. In fiscal 22, we expect free cash flow conversion to increase compared to fiscal 21. I'll now turn to our financial guidance, starting with the full year fiscal 22 on slide 14. Our guidance for Q1 and the full fiscal year reflects the market conditions and potential impact from the fiscal 21 bookings delays that Mark discussed. Our guidance assumes no acquisition-related expenses, as well as an effective tax rate of 25%. Our guidance includes restructuring and other charges of $9.4 million in Q1 related to the impact initiative. For fiscal 22, We currently expect total company revenue of $1 to $1.03 billion, an increase of 8% to 11% compared to fiscal 21. This is prior to any additional acquisitions. As Mark discussed, we expect headwinds from last year's delays in major programs like CWIP, F-35TR-3, and a large foreign military sale. We expect those to be offset by increases in other electronic warfare and radar programs, as well as CQ and platform and mission management programs. As a result, we expect our fiscal 22 organic revenue to be approximately flat compared to fiscal 21. We expect bookings to rebound in fiscal 22, driving a book-to-bill above one for the year. Similar to fiscal years 19 through 21, we expect our total revenue in fiscal 22 to progressively increase by quarter throughout the year, weighted heavily towards the second half. Total GAAP net income on a consolidated basis for fiscal 22 is expected to be $60 to $65.2 million or $1.7 to $1.16 per share. Adjusted EPS for fiscal 22 is expected to be in the range of $2.45 to $2.55 per share, an increase of 1% to 5% compared to fiscal 21. Adjusted EBITDA for fiscal 22 is expected to be in the range of $220 to $227 million, up 9% to 12% from fiscal 21. This guidance includes $22 million of savings from the impact-related organizational efficiencies that Mark discussed. Adjusted EBITDA margins are expected to be approximately 22% despite 100 basis point dilution due to a full year of POC, which has lower EBITDA margins. Like revenue, we expect adjusted EBITDA and adjusted EBITDA margins to progressively increase from quarter to quarter, with Q1 being the low point for the year. As revenue ramps throughout the year, we expect operating leverage to lead to margin expansion. Looking farther ahead, We believe the investments that we've made over the last few years will result in further adjusted EBITDA margin expansion in future years. We believe this will be driven by program mix and operating leverage, as well as operating efficiencies, with the impact initiatives accelerating margin expansion in fiscal 23 and beyond. From a free cash flow perspective, we're targeting approximately 40% free cash flow to adjusted EBITDA in fiscal 22. We expect the COVID cash outflows we saw in fiscal 21 to diminish, and we expect capital expenditures for the year to return closer to maintenance levels. We do anticipate cash outflows associated with impact, including $6.8 million of separation costs and $4.7 million of third-party consulting fees. Turning now to our first quarter fiscal 22 guidance on slide 15, we're forecasting total revenue in the range of $210 to $220 million, an increase of approximately 2% to 7% year over year. On an organic basis, we expect Q1 revenue to be down approximately 15% year over year, driven by the bookings slowdown in fiscal 21. We expect to incur a gap net loss in the first quarter of $4.4 to $2.3 million, or $0.08 to $0.04 per share. The net loss is a result of the $9.4 million of restructuring and other charges previously discussed. Adjusted EPS, which excludes restructuring and other charges, is expected to be $38 to $41 per share. Adjusted EBITDA for Q1 is expected to be $36.8 to $39.6 million, representing approximately 17.5 to 18% of revenues. The adjusted EBITDA margins in Q1 are impacted by the negative operating leverage due to lower revenue while recurring operating expenses remain stable. We expect to continue to invest in R&D in H1 to position ourselves for continued growth in H2 and beyond. As a result, we expect to see lower margins in H1 with expansion in H2. As I mentioned, for the full fiscal year, we expect our adjusted EBITDA margin to be approximately 22% of revenue. We expect free cash flow to adjusted EBITDA for Q1 to be approximately 25% of adjusted EBITDA. Our conversion will be impacted by cash outflows associated with the restructuring and other charges previously mentioned. Turning to slide 16. Given our significant growth over the last few years and our outlook for accelerated organic and acquisition-driven growth in fiscal 23 and beyond, we've launched IMPACT to set the stage for becoming a multiple of our current size over time. IMPACT also aims at realizing our full adjusted EBITDA potential. Slide 16 summarizes our preliminary estimate of the potential savings related to IMPACT and the timing for realizing those savings. We're still in the planning phase for the impact work streams in the six focus areas that Mark outlined. Once they've been completed, each will include detailed savings and timing estimates. We currently expect to complete the planning phase in Q1 and begin actioning the work streams in Q2. Although we're still refining our views, our preliminary estimates are that we can generate approximately $35 to $55 million of gross savings by fiscal 25. The impact effort is primarily focused on scalability. As such, we expect to reinvest approximately $5 million of the savings into the new organizational structure. On a net basis, we're expecting a $30 to $50 million benefit to adjusted EBITDA. From a timing perspective, at the midpoint of the savings range, our preliminary estimate is that we'll be able to recognize cumulatively approximately $25 million of savings by the end of fiscal 23. We expect to realize $35 million by the end of fiscal 24 and 100% of the gross savings or $45 million at the midpoint by fiscal 25. As I've discussed, we've already included approximately $22 million of savings in our fiscal 22 guidance related to the actions taken in Q4 and Q1. We expect to see margin expansion during the year as a result of these actions. Our fiscal 22 guidance assumes margins expand by 10 basis points compared to fiscal 21, despite 100 basis point dilutive impact from a whole year of POC. As mentioned earlier, we expect organic revenue growth to return to our target high single-digit, low double-digit range in fiscal 23. We expect adjusted EBITDA margins to expand at the same time, driven by positive operating leverage as well as our impact efforts. Looking further ahead, we expect to see continued margin expansion driven by programs transitioning to production, operating leverage as revenues grow faster than expenses, and continued acquisition integration. We see the $30 to $50 million of estimated net benefits of impact as being additive to this previously expected margin expansion. We're optimistic about the potential for the impact program and will continue to provide updates as it progresses. Turning to slide 17, in summary, Mercury delivered strong financial performance in Q4 and fiscal 21. including record revenue, adjusted EBITDA, and adjusted EPS for the year, and more than $900 million of year-end backlog. New business activity is returning to more normalized levels, and we're expecting fiscal 22 to be a strong year for bookings. Additionally, we believe that launching impact will enable us to accelerate adjusted EBITDA margin expansion over time. As a result, we're optimistic as we look toward the second half of fiscal 22 and into fiscal 23. We believe we're in a strong position to continue executing on our long-term value creation strategy of high single-digit, low double-digit organic revenue growth, coupled with EBITDA margin expansion, supplemented with strategic and accretive M&A. With that, we'll be happy to take your questions. Operator, you can proceed with the Q&A now.

Thank you, sir. As a reminder, to ask a question, you will need to press star then one on your telephone keypad. To withdraw your question, press the pound key. In order to allow as many callers as possible to ask a question, management requests that you limit yourself to one question only. Thank you. And our first question is going to come from the line of Sheila Coaglu Jeffries. Sheila, your line is open.