Mercury Systems Inc

Good day, everyone, and welcome to the Mercury Systems third 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, Michael 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. Mercury continued to perform well in Q3, delivering strong results across the board. As expected, it was a challenging quarter due to order delays, as well as supply chain and labor market constraints, but our team continues to successfully manage these headwinds. It was a record quarter for bookings, leading to a 1.17 book-to-bill and record backlog. As a result, we expected to deliver a strong Q4, positioning Mercury for a return to organic growth in fiscal 23. This organic growth, coupled with margin expansion driven by our impact initiatives, as well as our M&A program, should lead to strong performance overall next year. Looking ahead longer term, our five-year plan continues to target high single-digit to low double-digit organic revenue growth over time, coupled with margin expansion and M&A. We're on track to achieve these goals. We're dismayed by the unprovoked attack and humanitarian crisis unfolding in the Ukraine and hope for a speedy resolution. Our confidence in our longer-term growth outlook has increased since the invasion, given the broader implications for Europe. We believe that over the course of the next 10 years, we'll see substantial growth in incremental defense spending, both domestically and internationally. We don't anticipate an impact on our revenues in the short term due to the nature of the military assistance provided to Ukraine. However, we do expect to see an increase in bid and proposal activity, resulting in higher bookings in the midterm and over the next five years. Turning to our Q3 results on slide four, we saw substantial bookings growth in the third quarter. Bookings increased 41% year-over-year and were up 25% sequentially. Our largest bookings programs were LTAMs, CH53K, F16, P1171, and a classified radar program. Despite its very strong performance, we did face Booking's challenges in Q3. The largest impact was the further delay in the award for the FMS program that began seeing delays in Q1 of last year. Our customer currently expects to receive their award in May, resulting in an award to Mercury in late June. The majority of the products are currently in inventory. Additionally, the F35 TR3 Lot 16 order that we received earlier in the year was partially funded in the third quarter, with the remainder expected in Q4. The biggest upside this quarter was LTAMs. In Q2, we reported that our next LTAMs booking for domestic and international production had likely moved to fiscal 25. This delay created headwinds for fiscal 23, as well as our five-year plan. That said, our customers are seeing increased demand signals associated with missiles and missile defense. In Q3, we were pleased to receive two awards for L-Towns totaling $27 million. The larger of the two awards was for long lead time materials associated with future production. These awards contributed to our strong total bookings for the quarter and helped to partially mitigate the large FMS order delay. This quarter, we expect to receive an RFP from Raytheon for additional LRIP systems, which may partially reverse the delay we reported in Q2. Mercury's total revenue for Q3 was down 1.5% from our prior year record as anticipated, reflecting the orders that slipped, as well as the supply chain and labor market challenges. Our largest revenue programs in the quarter were F35, LTAM, MH60, F16, and CDS. We'll continue to see high levels of new business activity, and our pipeline remains strong. Design wins in Q3 total more than $360 million in estimated lifetime value. Through the first three quarters, we received 22 new design wins with an estimated lifetime value of more than a billion dollars. Year to date, The total estimated lifetime value of our design wins is up 14% from the same period a year ago. Adjusted EPS and adjusted EBITDA were in line with our Q3 guidance. Free cash flow was negative and down from Q2, primarily due to the impact of supply chain headwinds on working capital. Turning to slide five, following record bookings in Q3, we expected an acceleration in Q4. leading to record bookings, a positive book-to-bill, and record backlog in revenue for fiscal 22 as a whole. Despite the industry headwinds and order delays, we anticipate total company revenue growth of approximately 8% to 10% for fiscal 22, exceeding $1 billion for the first time, together with record adjusted EBITDA. We've been largely successful in our efforts to mitigate the supply chain, labor market, and COVID-related disruptions. That said, we continue to see in-quarter supplier decommits and long lead times for semiconductor components and materials. We're also seeing the impact of inflation, some of which we can pass on and some we can't. The team is staying in close contact with our suppliers and placing orders for accelerated material procurement. Nonetheless, during Q3, the supply chain constraints increased revenue churn pushing revenue linearity to the back end of the quarter. This resulted in lower in-order cash collections, which affected free cash flow. All our manufacturing facilities have remained open and productive throughout the pandemic. Early in Q3, we did, however, see some labor productivity impacts as a result of Omicron, which peaked in January, also affecting cash flow. We expect the tight labor market, as well as supply chain constraints, to remain headwinds for some time. We're pleased that, effective yesterday, Steve Ratner joined the Mercury team, as our Senior Vice President and CHRO reporting to me. Steve was previously at Raytheon Technologies, where he led human resources for a 16,000-person, $16 billion division. Adding Steve's expertise and proven leadership couldn't be more timely. Core to our growth is having a world-class team in place. C will help lead our efforts to attract, retain, and develop the talent we need to continue growing and scaling the business. Turning to slide six, we proactively launched our IMPACT program a year ago. IMPACT's goal is to achieve Mercury's full growth and adjusted EBITDA potential organically and through M&A over the course of the next four years, and it's progressing well. we anticipate a $27 million net benefit related to impact actions taken and planned in fiscal 22. These actions have been key to our success in managing the industry headwinds and continuing to achieve strong financial results this fiscal year. As we move towards more normal conditions, we expect the benefits of impact to be additive to the savings we've been able to deliver to date. We continue to expect impact to generate $30 to $50 million of incremental adjusted EBITDA by fiscal 25. We're on track to meet this target with upside opportunities that would allow us to potentially deliver greater value earlier than originally anticipated. Impact is aimed at improving our organic growth as well as the fundamentals of the business. It's enabling us to better align with our customers' priorities and to partner with them on larger opportunities. As a result, we expect to continue to take share and grow faster than the industry over time. Impact is also aimed at optimizing our balance sheet by improving our working capital and asset efficiency. In addition, we see substantial potential through impact to expand our margins. We're focusing on five major areas. First, organizational efficiency and scalability. Second, procurement and supply chain. Third, facilities optimization. And fourth, scalable common processes and systems. The fifth area is R&D investment efficiency and returns. Mercury's investment in R&D outpaces our customers in the competition. We believe this investment is in line with where the defense industry is headed. It's allowing us to deliver innovations more quickly and more affordably, and we're taking share as a result. We've proven that a high-tech investment model can operate successfully at scale on behalf of all stakeholders. Turning to slide seven as it relates to M&A, impact is about leveraging our proven ability to integrate and to grow acquired businesses, but at a greater scale going forward. Including our recent Avalanche and Lantern micro-acquisitions, both of which are performing well, We have deployed $620 million in capital since December of 2020. Looking ahead, we believe that impact will allow us to increase our deal cadence and potentially the size of our transactions, compounding the impact on value creation. In addition to impact, we strengthened our balance sheet this quarter, and we believe that we can continue to execute successfully on our M&A strategy going forward. The environment continues to be active, and we remain focused on our existing M&A themes, secure sensor processing, open mission systems, C3, and trusted microelectronics. We intend to remain disciplined in terms of deal pursuits, diligence, pricing, and integration. Turning to slide eight, we expect Mercury's revenue to continue growing faster than overall defense spending over time, driven primarily by organic growth. We focused the business on larger and faster-growing parts of the defense market and now participate in more than 300 different programs. We designed in on our top programs with the majority being source positions. Congress has passed the FY22 Defense Appropriations Bill, which was 6% higher than the $715 billion initial request. The DOD top line submitted for FY23 is $773 billion. This represents approximately 8% growth over the original FY22 request and 2% over the appropriations bill. This growth is intended to address the effects of inflation and modernization needs, as well as the war in Ukraine. That said, we believe the FY23 budget will likely be revised upwards as the bill moves through the appropriations process later this year. Despite the expectation of a CR as a result of the midterm elections, there appears to be strong bipartisan support for increased defense spending. We believe we're experiencing a potential sea change in defense spending and priorities with profound implications for the U.S., Europe, and our allies, both in the short and long term. This is due to the war in Ukraine and the Russian threat to NATO and non-NATO countries as well as the risk associated with China and Taiwan. Our advisors estimate the U.S. growth combined with potential increases in NATO and allied partner defense spending to 2% of GDP could drive more than $1.5 trillion of additional defense spending over the course of the next decade. We don't see Mercury's revenues benefiting from this incremental spending in the short term, given the nature of our offerings. However, over time, we do expect to see increased Britain proposal activity. This should lead to higher bookings in the electronics associated with missiles and munitions, air and missile defense systems, unmanned systems, fixed-wing and rotorcraft, ground vehicles, and electronic warfare. This activity should further support the achievement of our high single-digit to low double-digit organic growth goals over the course of the next five years. With that, I'd like to turn the call over to Mike. Mike?