Mercury Systems Inc

Good day, everyone, and welcome to the Mercury Systems first quarter fiscal 2025 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 Q1 FY25 earnings call. We started FY25 with positive momentum, delivering results in line with or ahead of our expectations and I look forward to our continued focus on performance improvement as we move through the fiscal year. Today I'd like to discuss three topics. First, some introductory comments on our business and results. Second, an update in each of our four priority areas, delivering predictable performance, building a thriving growth engine, expanding margins, and driving improved free cash flow. And third, performance expectations for FY25 and longer term. Then I'll turn it over to Dave, who will walk through our financial results in more detail. 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. Please turn to slide four. Coming out of Q1, I am optimistic about our strategic positioning and our expectations on delivering predictable organic growth with expanding margins and robust free cash flow. Our Q1 results were generally as expected. Q1 bookings of 247.7 million, up 29% year over year, and a book to bill of 1.21. Q1 revenue of $204.4 million, up 13% year over year. Q1 adjusted EBITDA of $21.5 million and adjusted EBITDA margin of 10.5%, both up substantially year over year. And Q1 free cash flow of negative $20.9 million, up $26.2 million year over year. We ended the first quarter with $158.1 million of cash on hand. These Q1 results reflect solid progress in each of our four priority focus areas with highlights that include improved execution across our portfolio and most notably in our common processing architecture area with progress toward full rate production. Expanding our record backlog to over 1.3 billion of 16% year over year. Reduced operating expense enabling increased positive operating leverage. and continued progress on free cash flow drivers with net working capital down 97 million year over year or 14.6%. Please turn to slide five. Turning to each of our four priorities and starting with the first, delivering predictable performance. In the first quarter, our focus on delivering predictable performance positively impacted our results primarily in three areas. First, we continue to make progress on mitigating what we believe to be predominantly transitory impacts that we have discussed over the last several quarters. In Q1 FY25, we recognized approximately 11 million of items down 31% from 16 million in Q4 FY24, including 8 million of net EAC change impact across our portfolio, and $3 million of inventory reserves. These items impact the Q1 revenue by approximately $8 million and gross margin by approximately $11 million. Although still greater than we would like to see, the magnitude of these items is the lowest in five quarters and reflects the progress we are making in driving toward predictable execution by maturing our processes in program management, engineering, and operations. Second, we continue to make progress in the quarter, ramping toward full rate production in our common processing architecture product area. We expect to have our full capacity online as we move through the second half of the year. Notably, this production progress contributed to receiving over 50 million in follow on orders in the quarter. And third, our focus on improved operational performance and delivering for our customers generated an acceleration of deliveries in the quarter as reflected in the 21% year-over-year increase in point-in-time revenues. The $16 million of year-over-year point-in-time revenue increase was a primary driver of our year-over-year revenue growth, the majority of which was driven by accelerated deliveries from Q2. Please turn to slide six. Turning now to the second focus area, driving organic growth. Q1 bookings of 247.7 million resulted in a record backlog of over 1.3 billion, up 16% year over year. In line with our expectations, over 90% of Q1 bookings were production in nature, which we believe is a good leading indicator that our mixed shift toward production is continuing. Some wins in the quarter worth noting. A follow-on award in our common processing architecture area, which was facilitated by the continued progress we made in Q1 in ramping up toward full-rate production. A production order for heads-up displays used in the Navy's T-45, a trainer aircraft, which is instrumental to preparing Navy and Marine Corps aviators to fly off of aircraft carriers. A large follow-on order from a prime contractor for FPGA processor boards to be integrated on a key US Air Force program of record, where Mercury has already delivered hundreds of boards for developmental testing. Under the new contract, Mercury will deliver approximately 1,500 production boards. A large follow-on production order for a multi-chip module that will be employed in a key U.S. Air Force program of record where Mercury is the sole source provider of this device. A large production order for RF solutions employed in a critical missile defense system that is being used in multiple regions to provide a defensive umbrella against hostile threats. And a five-year contract worth as much as $131.3 million from the U.S. Naval Air Systems Command to continue providing secure data transfer systems for naval aircraft, which enable the transfer of data between planners on the ground and aircraft, significantly improving operational readiness of airborne assets. These awards are important not only because of their value and impact on our growth trajectory, but also because they reflect those 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 their priorities and what we view as strong demand in growth markets, including sensors and effectors, electronic warfare, avionics, and C4I. Please turn to slide seven. Now turning to our third priority focus area, expanding margins. As we've discussed in prior calls, in our efforts to achieve our targeted adjusted EBITDA margins in the low to mid 20% range, we are focused on the following levers, executing on our development programs and 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. Q1 adjusted EBITDA margin of 10.5% was in line with our expectations and indicative of progress on each of these levers we're pursuing in our effort to reach our targeted margins over time. Gross margin of 25.3% was in line with our expectations and largely driven by the average margin in our backlog coming into FY25. As we discussed last quarter, our backlog margin coming out of FY 24 was 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 adjustments in FY 24. We expect backlog margin to increase going forward as we continue to bring in new bookings as we did in Q1 that we believe will be in line with our targeted margin profile and accretive to the current average margin in our backlog. Operating expenses, specifically R&D and restructuring and other charges, are down significantly year over year as a result of the actions implemented in FY24 to streamline and focus our operations. Additionally, Q1 R&D reflects the completion and streamlining of internally funded efforts and an increased allocation of resources toward customer-funded activities to drive development contracts to completion and to accelerate customer deliveries. Going forward, I expect R&D levels to increase incrementally as we progress on customer funded activities and ramp up targeted efforts in our advanced concepts group to fuel innovation across the mercury processing platform. Please turn to slide eight. Finally, turning to our fourth priority focus area, improved free cash flow. We continue to make progress on the drivers of free cash flow and, in particular, in reducing networking capital. Although our networking capital balance and free cash flow in Q1 were partially impacted by timing, with an expected Q1 cash inflow of $19 million occurring in early Q2, networking capital is down year-over-year 96.6 million or 14.6%. Inventory is down 11.8 million year over year. Notably, WIP is up 23% year over year from 101.1 million to 124.3 million, and raw materials is down 12.3% from 235.9 million to 207 million, reflecting an increased mix of inventory progressed toward delivery. While inventory is up sequentially, this increase is offset by an increase in deferred revenue, which reflects our focus on improved contract terms. Unbilled receivables are down year-over-year 90.3 million, or 23.2%, and down sequentially 5.8 million, reflecting our focus on progressing our programs in order to deliver for our customers and, in turn, invoice and collect cash. We believe our continuous improvement 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 9. Looking ahead, I am optimistic about 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%. As we discussed last quarter, although we will not be providing specific guidance this early in the year for FY25, I will reiterate the color we previously discussed. Although we are pleased with the acceleration of customer deliveries and revenue into Q1 largely from Q2, we continue to expect that revenue for the first half will be approximately in line with last year. For FY25, we continue to expect revenue to be relatively flat year over year with an increase in run rate as we exit the fiscal year. With respect to gross margin, as we discussed last quarter, Our current backlog margin is lower than what we would 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. Although we are encouraged that our recent quarter bookings are accretive to our overall backlog margin, we continue to expect low double digit adjusted EBITDA margins overall for FY25, with adjusted EBITDA margins in the high single digit range for the first half of the year and then expanding in the second half as we complete lower margin development efforts and continue to shift our mix toward production. Finally, with respect to free cash flow, we are expecting to be cash flow positive in FY25 with second half free cash flow higher than the first half. In summary, given the operational improvements over the last several quarters, and our recent momentum, 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 first quarter, and I look forward to your questions. Dave?