Mercury Systems Inc

Good day, everyone, and welcome to the Mercury Systems first quarter fiscal 2022 conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the call over to the company's executive vice president and chief financial officer, Mike Rupert. Please go ahead, sir.

Good afternoon, and thank you for joining us. With me today is our president and chief executive officer, Mark Aslett. If you've not received a copy of the earnings press release we issued earlier this afternoon, you can find it on our website at mrcy.com. The slide presentation that Mark and I will be referring to is posted on the investor relations section of the website under events and presentations. Please turn to slide two in the presentation. Before we get started, I would like to remind you that today's presentation includes forward-looking statements. including information regarding Mercury's financial outlook, future plans, objectives, business prospects, and anticipated financial performance. These forward-looking statements are subject to future risks and uncertainties that could cause our actual results or performance to differ materially. All forward-looking statements should be considered in conjunction with the cautionary statements on slide two in the earnings press release and the risk factors included in Mercury's SEC filings. I'd also like to mention that in addition to reporting financial results in accordance with generally accepted accounting principles, or GAAP, during our call we will also discuss several non-GAAP financial measures, specifically adjusted income, adjusted earnings per share, adjusted EBITDA, free cash flow, organic revenue, and acquired revenue. A reconciliation of these non-GAAP metrics is included as an appendix to today's slide presentation and in the earnings press release. I'll now turn the call over to Mercury's President and CEO, Mark Aslett. Please turn to slide three.

Thanks, Mike. Good afternoon, everyone, and thanks for joining us. I'll begin with the business update. Mike will review the financials and guidance, and then we'll open it up for your questions. Our results for the first quarter of fiscal 22 were in line with our expectations. Total revenue exceeded our guidance, and adjusted EBITDA came in above the midpoint. Our impact transformation efforts are progressing well and we continue to execute strategically. During the quarter, we signed an agreement to acquire Avalex Technologies while continuing to invest in the business organically. Our outlook for fiscal 22 remains unchanged. Reflecting the lower bookings and backlog exiting last fiscal year, we continue to expect flat organic revenue growth versus fiscal 21. We expect total company revenue to grow 10% in fiscal 2022, eclipsing $1 billion for the first time. Due to the timing of the expected close, our Q2 and fiscal 2022 guidance excludes RLX, as well as only future M&A. We also anticipate margin expansion and record adjusted EBITDA. We expect to deliver substantial year-over-year growth in bookings in fiscal 22, weighted towards the second half and especially Q4. This should lead to a positive book-to-bill for the year and solid growth in our backlog, setting the stage for strong results in fiscal 23. That said, the risk levels have become elevated in three areas since last quarter. First, the potential for a prolonged defense budget continuing resolution. Second, the White House vaccination mandate for the defense industry and the resulting impact on our employees and operations. And third, inflation and supply chain constraints in the semiconductor industry. We're working diligently to mitigate risk wherever we can and anticipate a return to high single-digit to low double-digit organic growth in fiscal 23. This growth, coupled with margin expansion driven by improved operating leverage and our impact efforts, should lead to strong fiscal 2023 results overall. We're optimistic about our growth prospects over the longer term. We believe that mercury is well aligned with the national defense strategy. The government continues to push for modernization, speed, and affordability in both sensor and effect emission systems and C4I. The needs for secure processing, trusted microelectronics, and open mission systems are increasing. We're well positioned to benefit from the longer-term secular growth trends that we've discussed in the past. Supply chain delaying by the government and the primes, the flight to quality suppliers, the shift to outsourcing by our customers at the subsystem level, and the government's increased focus on supply chain reshoring for microelectronics. Our vision of being the leading commercial provider of trusted and secure devices to systems is what our customers are seeking. They're looking to partner more with companies like Mercury and buy less from traditional suppliers. As a result, our engagements are becoming larger and more strategic for our customers and for us. Our five-year plan remains intact, that is, to deliver high single-digit to low double-digit organic revenue growth, averaging 10% over time, coupled with M&A and margin expansion. Taking a quick look at the financial highlights on slide four, Q1 is typically our seasonally weakest quarter. Bookings were down slightly year-over-year as expected, and our book-to-bill for the quarter was 0.89%. We feel confident that Q1 represents the low watermark for bookings in fiscal 22. Our largest bookings programs in the quarter were F35, a classified EW program, a classified C2 program, F18, and F16. Total revenue was up 9% year over year, above the high end of our guidance. Organic revenue was down 11%, slightly better than anticipated. Our largest revenue programs in the quarter were MH60, a classified C2 program, a classified radar program, P8, and F35. We continue to see high levels of new business activity. Our pipeline remains strong with design wins in Q1 totaling nearly $500 million in estimated lifetime value. Free cash flow for the quarter was slightly negative. On the bottom line, however, adjusted EPS came in at higher end of our Q1 guidance and adjusted EBITDA at the midpoint, down 20% and 10% year-over-year, respectively. Turning to slide five, we expect Mercury's total company revenue to continue growing faster than overall defense spending over time. We focus the business on large and faster-growing parts of the defense market. and we now participate in more than 300 different programs. We're designed in on our top programs with the majority being sole source positions. No single program is more than 5% of total company revenue in fiscal 21. Looking ahead to the next five years, no single program is expected to be more than 6% of total revenue. For fiscal 22, we expect bookings and revenue to increase as we move through the year. As I said earlier, risk levels have increased related to the defense budget CR, COVID vaccine mandates, and the supply chain. We successfully manage COVID-related risks throughout the pandemic. During the second quarter, we intend to comply with the White House vaccine mandates. This should enhance the resiliency of the business by protecting our employees and strengthening our ability to deliver on our commitments. In the short term, however, it may result in higher employee turnover and impacts to our operations. Beyond the challenges associated with COVID, we continue to see the effects of inflation and semiconductor supply chain constraints. The team is working daily with our suppliers to address these challenges. Over time, we believe the vaccine mandates will help alleviate programmatic delays as our employees, our customers, and the DoD ultimately return to on-site work. The vaccines could also have a positive effect on some of the supply chain issues we're facing. As a result, we're cautiously optimistic that bookings will grow substantially year over year in fiscal 22, leading to a positive book to bill and growth in backlog. We anticipate double-digit growth in bookings in the second half of fiscal 22, driven by our top 20 programs. This growth should be led by programs such as S35, LTAMS, which is now called Ghost Eye, Filthy Buzzard, CWIP, and various FMS programs. In addition to these franchise program bookings, we expect growth from recently acquired programs to accelerate in the second half also. Looking ahead to fiscal 23, we expect bookings from our top 20 programs to ramp yet again. We anticipate seeing fewer delays in key programs, among them F35, TR3, and Block 4, as well as naval and airborne upgrades such as CWIP and Silky Bossard. As I've said, this should lead to strong results in fiscal 23, driven by a return to high single-digit to low double-digit organic growth. Turning to slide six, since fiscal 14, we've completed 13 acquisitions, deploying $1.2 billion of capital, dramatically scaling and transforming the business as a result. We've grown total company revenue 4.4 times, and through synergy, adjusted EBITDA more than nine times over that period. This has resulted in substantial value creation for shareholders. we believe there's additional value to be had going forward. As we discussed last quarter, early this calendar year, we proactively launched a company-wide effort, which we called Impact, to lay the foundation for our next phase of value creation at scale. The goal is to achieve Mercury's full growth, margin expansion, and adjusted EBITDA potential organically and through M&A over the course of the next five years. The first opportunity is to streamline and simplify our organizational structure, which we began in Q4 and have now largely completed. We're anticipating a $22 million net benefit in total for fiscal 22 related to this impact activity. The Q1 actions alone accounted for $14 million of that total. To lead the impact, during the first quarter, we hired Thomas Hoover, previously with Boston Consulting Group, McKinsey, and Bain, as our Chief Transformation Officer. As impact progresses over the course of the next two to three years, in addition to growth, we'll be focusing on six major areas aimed at incremental EBITDA uplift, leading to margin expansion over time. We're beginning to move from planning into the execution phase in several of these areas. We continue 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. Complementing impact, we've also strengthened the leadership team. In addition to Thomas Huber, Mitch Stevenson joined Mercury from Raytheon as Chief Growth Officer early last month. Yesterday, we announced that Roger Welles has joined us from FLIR Teledyne as president of our microelectronics division. We're very pleased to have Thomas, Mitch, and Roger aboard. Turn to slide seven. Over the past seven years, our acquisitions and integration processes have generated significant cost and revenue synergies, creating tremendous value. We believe that deploying impact will accelerate and increase the value we create through M&A going forward. Impact could also allow us to increase our deal cadence and potentially the size of our transactions. Combined with the synergies generated, this could have a compounding effect on future value creation. The M&A environment continues to be extremely active, and our pipeline is strong. We remain disciplined in our approach in terms of deal pursuits, diligence, pricing, and integration. We were very busy from an M&A perspective in Q1, resulting in the acquisition of Avilex, which we expect to close early this month. Avilex continues to build out our avionics and mission computing business, complementing our recent acquisition of Physical Optics Corporation. As we discussed last quarter, potentially our most important fiscal 21 design win related to the Army's AMCS program, a win that was enabled by POC as well as prior acquisitions. Like those transactions, we expect Avilex to leverage supply chain de-layering and further strengthen our position in platform and mission management. We look forward to welcoming the Avilex team to Mercury. Turning to slide eight, We remain strategically committed to delivering strong margins while growing the business organically and supplementing this organic growth with disciplined M&A and full integration. This strategy is working extremely well. We believe it will continue to generate significant value for our shareholders over the longer term as we execute our plans in five areas. The first is to grow our revenues organically at high single digits to low double digits, averaging 10% over time, supplemented by growth from acquisitions. The second is to invest in new technologies, our facilities, manufacturing assets and business systems, as well as in our people. Third is manufacturing insourcing, as well as driving stronger operating performance across our manufacturing locations and supply chain. Fourth, we're seeking to grow revenues faster than operating expenses. This should allow us to continue investing in organic growth while maintaining strong operating leverage in the business. And finally, we're fully integrating the businesses we acquire to generate cost and revenue synergies over time. These synergies, combined with impact and other areas of the plan, should produce attractive returns for our shareholders. Turning to slide nine, We're expecting substantial growth in bookings and backlog in fiscal 22. This should lead to a stronger year in fiscal 23 as organic growth returns to more normal levels and margins expand as a result of impact. In the short term, risks have increased related to the defense budget, COVID vaccine mandates and the supply chain. However, looking ahead longer term, we remain very optimistic. We've aligned our business with the national defense strategy in the industry's key market trends. Our model, sitting at the intersection of the high-tech industry and defense, is exceptionally well positioned. Our strategy and investments in secure processing, trusted microelectronics, and open mission systems are serving as the engines of growth in the business. Our M&A pipeline is robust, positioning us for continued acquisition-related growth. We've streamlined our organizational structure, strengthened our leadership team, and launched impact. As a result, we believe that we can replicate what we've done successfully since fiscal 14 and achieve Mercury's full growth and adjust the potential organically and through M&A over the next five years. Before I turn the call over to Mike, I'd like to welcome Mercury's newest director, Deborah Plunkett. Deborah was elected to the board at our annual meeting, October the 27th. Her extensive experience in cyber, national security and information assurance will be a significant asset to Mercury. In addition, as planned, Vince Vito has retired from the board. Vince has contributed valuable insight and counsel as a director for more than 15 years, the last 10 of them in his role as chairman. On behalf of all of us at Mercury, I extend our deep appreciation to Vince for his dedicated service and leadership. At the same time, I'd like to welcome Director Bill O'Brien as our new chairman. I look forward to working with Bill to achieve Mercury's full potential in the years ahead. Finally, I'd like to recognize the entire Mercury team for a tremendous effort during these challenging times. My sincere thanks for your outstanding work and all of your contributions. With that, I'd like to turn the call over to Mike. Mike?