Mercury Systems Inc

Good day, everyone, and welcome to the Mercury Systems fourth quarter fiscal 2024 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, Dave Farnsworth. Please go ahead, Mr. Farnsworth.

Good afternoon, and thank you for joining us. With me today is our Chairman and Chief Executive Officer, Bill Ballhaus. If you have 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 Bill and I will be referring to is posted on the investor relations section of the website under events and presentations. Turning to slide two in the presentation, I'd 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, and free cash flow. 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 Chairman and CEO, Bill Ballhaus. Please turn to slide three. Thanks, Dave.

Good afternoon. Thank you for joining our Q4 and fiscal year 2024 earnings call. We exited FY24 with positive momentum. delivering results in line with or ahead of expectations, and I look forward to that momentum continuing as we enter into FY25. Today, I'd like to talk through three topics. First, some introductory comments on our business and results as we close FY24. Second, a progress update in each of our four priority areas established just over a year ago, delivering predictable performance, building a thriving growth engine, expanding margins, and driving improved free cash flow. And third, expectations for our performance as we enter FY25 and longer term. Then I'll turn it over to Dave, who will walk through our financial results. Before jumping in, I'd like to thank our customers for their collaborative partnership and the trust they put in Mercury to support their most critical programs and our Mercury team for their dedication and commitment to delivering mission critical processing at the edge. One other note, I'd like to thank Nelson Erickson for his contributions to Mercury over the years. I know many of you have interacted with Nelson on the investor relations front. Nelson is elected to pursue a new opportunity outside of Mercury, and we wish him well in his future endeavors. Please turn to slide four. In FY24, we made considerable progress addressing transient challenges in the business. As we enter FY25, I'm optimistic about our strategic positioning as a leader in mission-critical processing at the edge and our expectations on delivering predictable organic growth with expanding margins and robust free cash flow. Our Q4 in full year results were in line with or ahead of our expectations. Q4 bookings of $284 million and $1.02 billion for the full year in line with our guidance of a billion and representing a FY24 book to bill of 1.22. Q4 revenue of $249 million and $835 million for the full year above the midpoint of our guidance. Q4 adjusted EBITDA of $31 million, up 42% year over year. And Q4 free cash flow of $61 million and $26 million for the full year, keeping with or exceeding our guidance of free cash flow positive for the fiscal year. Q4 free cash flow was up $58 million year over year and represents the highest quarterly free cash flow in a company's history. We ended the fourth quarter with $181 million of cash on hand after paying down $25 million of debt. These Q4 results reflect solid progress in each of our four priority focus areas with highlights that include retiring risk across our remaining challenge programs, most notably executing the plan on the return to initial pilot production on our common processing architecture area. expanding our record backlog to over 1.3 billion, up 16% year-over-year, additional streamlining of our operations, enabling increased positive operating leverage as we return to organic growth, and reversing the multi-year trend of growth in working capital, with net working capital down 15% year-over-year and sequential reductions in inventory and unbilled receivables. With this progress in FY24, We are entering FY25 with a clear path toward delivering predictable organic growth, expanding margins, and improved free cash flow. Please turn to slide five. Following those introductory comments, I'd like to spend time on each of our four focus areas, starting with our first focus area, delivering predictable performance. In the fourth quarter, we delivered improved operating performance and were able to more effectively mitigate what we believe to be the transitory challenges that have obscured the underlying performance of the business. In Q4, we recognized approximately 16.2 million of items that we believe are transitory, down from 39 million in Q3, including 9.7 million of net EAC change impact across our portfolio. 2.9 million of inventory reserves and scrap, and 3.6 million associated with contract settlement reserves. These items impacted Q4 revenue by approximately 9.7 million, gross margin by approximately 12.6 million, with the remainder impacting operating expenses. The approximately $9.7 million of net EAC change impact is a 38% reduction from what we experienced last quarter and consisted of approximately $4.4 million from our challenge programs and approximately $5.3 million spread across the remaining programs in our portfolio. Although still greater than we would like to see, the magnitude of these items is the lowest in four quarters and reflects the progress we are making in driving toward predictable execution and steady growth. As shown on slide six, with respect to the challenge programs, since the end of the third quarter, we progressed by completing, exiting, or retiring risk on three additional of the original 19 programs. We believe we have now retired risk on 13 of the original 19 challenge programs that have materially contributed to earnings volatility in recent quarters. For the six remaining programs, two are nearing completion and represent ordinary course risk going forward. The other four remaining programs are associated with the common processing architecture. As I mentioned, we have successfully executed on our return to initial pilot production in our common processing architecture area. We're in the final phases of reliability testing with significant risk retired and are on a deliberate path to ramp up toward full rate production in the first half of the fiscal year, leveraging additional capital equipment and trained resources that we have in place. Given the progress in FY24, we will no longer separately address the challenge programs going forward, but we will keep you informed with regard to progress on our common processing architecture. Please turn to slide 7. Turning now to the second focus area, driving organic growth. Bookings for the quarter were $284 million, resulting in a 1.14 book to bill. Our backlog, now at a record $1.3 billion, is up 16% year over year. Notably, when we look at FY24 bookings, approximately 80% of our firm fixed price bookings are production in nature, which we believe is a good leading indicator that the mixed shift toward production is progressing in our firm fixed price portfolio. Some wins in the quarter worth noting. A large production order from a prime contractor for mercury processing solutions to be integrated on a key U.S. Air Force program of record. Multiple large production orders for processing solutions employed in air and missile defense systems for U.S. and international customers, including some which are actively engaged in Ukraine and others which will provide critical capability in support of NATO ongoing operations in Europe and elsewhere. multiple production orders for f-35 related electronics content cutting across various subsystems in both our processing technologies and signal technologies business units and a 13.2 million cost plus development award from the office of naval research to advance sensor processing technologies which will enable radar and ew capabilities to be designed on much shorter timelines by increasing the modularity of components at the chip level and leveraging the latest commercial chips from major semiconductor providers within a smaller and lighter footprint. These awards are important not only because of their value and impact on our growth trajectory, but also because they reflect our customers' trust in Mercury to support their most critical franchise programs. We know from engagements with our customers that our unique capabilities providing mission-critical processing at the edge align well with our customers' priorities and strong demand in growth markets, including sensors and effectors, electronic warfare, avionics, and C4I. Please turn to slide eight. Now turning to our third priority focus area, expanding margins. We believe FY24 was an unusual transitory year where we delivered margins well beneath our targets. These shortfalls were primarily driven by the previously discussed impacts that we view as transitory and negative operating leverage from relatively low production volume largely tied to development program delays. Looking forward, to achieve our adjusted EBITDA margin targets, we are focused on the following levers. executing on our development programs in minimizing cost growth impacts, getting back toward a more historical 2080 mix of development to production programs, driving organic growth to generate positive operating leverage, and achieving cost efficiencies. I've discussed on this call our program execution and cost growth containment efforts along with our organic growth efforts. Regarding cost efficiencies, As mentioned in prior calls, we implemented a series of cost reduction actions during FY24 as we streamlined and realigned our organization structure, resulting in significant cost savings previously announced. In Q4, we completed top-to-bottom leadership selection for the corporate reorganization initially announced in January, organizing our US-based business units into two product business units and an integrated processing solutions business unit, and centralizing our engineering, operations, and mission assurance functions. Additionally, we stood up an advanced concepts group that's focused on advanced technologies, innovation, and strategic growth pursuits. With this significant effort behind us, we exited FY24 with a streamlined cost structure, an integrated organizational construct, and a strong leadership team that is well poised to build on our momentum coming out of FY24 and drive improved performance toward our targeted business profile. Please turn to slide nine. Finally, turning to our fourth priority focus area, improved free cash flow. We continue to make progress in reducing net working capital, which is down 93.3 million year over year after years of expansion. Inventory is down sequentially by 8 million from 343 million in Q3 to 335 million in Q4. Notably, While inventory is flat year-over-year, WIP is up 44% year-over-year from $82 million to $118 million, reflecting an increased mix of the inventory progressed toward delivery. Unbilled receivables are down year-over-year 79 million, or 21%, driven by Q2, Q3, and Q4 billings, which were the three highest billing quarters on overtime revenue contracts in the company's history. This record level of billings reflects our relentless focus on progressing our programs in order to deliver for our customers and in turn, invoice and collect cash, leading to the free cash flow record performance in Q4. We believe the operational process rigor we've implemented in FY24 related to program execution and hardware delivery, just-in-time material, and appropriately timed payment terms will lead to continued reduction in working capital and improve free cash flow performance going forward. Please turn to slide 10. Entering FY25, I have high confidence in our team, our leadership position in delivering mission-critical processing at the edge, and our expected ability over time to deliver results in line with our target profile of above-market top-line growth, adjusted EBITDA margins in the low-to-mid 20% range, and free cash flow conversion of 50%. Although we will not be providing specific guidance this early in the year for FY25, I will provide the following color. In FY25, we expect to make further progress on the two primary challenges we have been tackling over the last year, specifically high working capital and the high mix of development programs, which we expect to see reflected in our FY25 financials in the following two ways. First, As we continue to focus on bringing down working capital, we expect to allocate meaningful operational capacity to advance programs with large unbilled receivable balances, which generates cash, but relatively low revenue, given that on many of these programs, a large percentage of revenue has been previously recognized. As a result, we expect our top line for FY25 to be relatively flat year over year, with the first half in line with last year and an increase in run rate as we exit the fiscal year and begin to allocate more operational capacity away from legacy programs with high unbilled balances toward production programs. Second, while we have made significant progress on development programs across our portfolio, Our current backlog margin is lower than what we expect to see on a go-forward basis, driven primarily by a small number of low margin development programs and programs that incurred adverse EAC adjustments in FY24. Given that a large percentage of our backlog converts over the next 12 months, although we expect low double-digit adjusted EBITDA margins overall for FY25, We expect adjusted EBITDA margins to start off in the high single digits for the first half of the year and then expand in the second half as we complete these lower margin development efforts and continue to shift our mix toward production. Finally, given our recent strong free cash flow performance in Q4, we're expecting to be cash flow positive again in FY25 with second half free cash flow higher than the first half. In summary, given the operational improvements over the last 12 months and our momentum coming out of Q4, I expect that our performance in FY25, in particular our exit run rate, will represent a positive step toward our target profile. As we progress through the first half of the year, I look forward to providing additional insights relative to our expectations for second half and full year performance. With that, I'll turn it over to Dave to walk through the financial results for the fourth quarter and fiscal year 2024, and I look forward to your questions. Dave?