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 Ruppert. 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 2 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 2 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 3.

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 2022 were in line with our expectations. Total revenue exceeded our guidance and adjusted EBITDA came in above the midpoint. Our 1MPACT 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 2022 remains unchanged. Reflecting the lower bookings and backlog exiting last fiscal year we continue to expect flat organic revenue growth versus fiscal 2021. 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 Avalex as well as any 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 2022 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 with strong results in fiscal 2023. 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 2023. This growth coupled with margin expansion driven by improved operating…

Thank you, Mark, and good afternoon, again everyone. As usual, I'll start with our first quarter results, and then move to our Q2 and fiscal 2022 guidance. As Mark said, Mercury's Q1 results were in line with our expectations. Total revenue exceeded our guidance, while adjusted EBITDA exceeded the midpoint, and adjusted EPS came in at the high end of guidance. We remain on track towards achieving our previously announced revenue and adjusted EBITDA guidance for full year fiscal 2022. We expect a double-digit increase in bookings versus fiscal 2021, a positive book-to-bill for the year and strong growth in our backlog. We continue to expect the year to be weighted towards H2, and especially Q4. We expect margins to expand in the second half of the year and free cash flow to begin to normalize. Looking further ahead to fiscal 2023, we expect a return to high single-digit low double-digit organic revenue growth driven by bookings and backlog growth in fiscal 2022. We expect this organic growth coupled with improved operating leverage and the 1MPACT initiative, to result in strong margin expansion and EBITDA growth in fiscal 2023 versus fiscal 2022. Turning to our Q1 results on slide 10. Bookings in Q1 were $199 million, down 1% compared to Q1 2021. Our book-to-bill was 0.89. Our backlog at the end of the quarter was $884 million, up 7% from Q1 2021, and down 2.8% compared to Q4 2021. While our total backlog declined from last quarter, our 12-month backlog was up 4.5% compared to last quarter, as a result of bookings shifting in the near-term revenue. As a result, we have better visibility into the second half of fiscal 2022. Coupled with bookings on key programs that we expect to receive in Q2, we're optimistic about our results for…

Thank you, sir. [Operator Instructions] And our first question is going to come from the line of Peter Skibitski with Alembic Global.

Hi. Good evening Mark and Michael. Thanks for all the color. I guess just a quick one I guess for me. Nice revenue quarter. You hit your adjusted EBITDA guidance here for the first quarter. Michael, you touched on the adjusted EBITDA margin below your expectation. But was that just the incremental revenue that came through? Was just maybe a little bit more CRAD revenue than expected? Is that kind of what you meant by program mix?

Yes. That's the right way to think about it Pete. It's -- it really is just program mix and the higher revenue was associated with the lower margin development programs or CRAD.

Okay.

CRAD was up 13% year-over-year.

Okay, okay. That's great. And if I can sneak one last one in. But looking into the second quarter, Mark, what are you kind of most concerned about? Is it the CR, or is it the semi shortage? Is it the vaccine mandate? Is there a way to kind of rank kind of what you guys are most concerned about?

Yes, it's a good question. It's actually all of those things. So, as I said on the call, in the prepared remarks, the risk level has elevated across all of those areas. Now, I think we still feel pretty good that Q1 is the low watermark for bookings this fiscal year, and we're going to see progressive growth in both bookings and revenue as the year progresses. But we're very mindful of the risk in those three areas and we'll see how things evolve, Pete.

Thank you. Our next question will come from the line of Seth Seifman with JPMorgan.

Hey. Thanks very much. Good afternoon. Maybe just a follow-up there digging in on the question of the CR. If it gets pumped out through the first calendar quarter of fiscal or I guess, if it gets funded out through the first calendar quarter of 2022, what does that mean in terms of the bookings you expect in your second half? And to what degree is your bookings target reliant upon an appropriations bill? And what time period do you need that?

Sure. So, in our guidance Seth, we've actually assumed a one quarter CR. We don't have that many new program starts and much of the bookings growth in the second half, is actually tied to growth in our existing core markets and largely around our top 20 programs, which were existing programs. So, it's hard to say for sure what the risk could be, because there are unknown unknowns, but we've assumed one level -- sorry, one quarter of CR in the guidance.

Thank you. Our next question will come from the line of Peter Arment with Baird Equity Research.

Hi. Yes, good evening, Mark and Mike. Mark, maybe if you could just circle back a little bit to Pete's question about the second half, the EBITDA margins that you're having in the first half, obviously below your historical, what you've enjoyed and the second half, obviously implies kind of a big step-up. So maybe if you could just highlight a couple of the key things that are going to drive that. I know you talked about maybe less few ad or some of the development programs. Thanks.

Yes. Let me kind of go through just a little bit H2 versus H1, kind of overview from a high level and then maybe kind of Mike could kind of dig in a little and tease things apart. So, for the second half from a revenue perspective, as we said, we're expecting double-digit growth in revenue versus the first half and year-over-year. Pretty much like the growth that we're expecting for the full year, we're expecting that the growth will be driven sequentially by the two major market segments in which we're participating, which is sensor and effector mission systems as well as C4I. And the growth is going to come primarily from our top 20 programs, which are largely expected to grow at a much higher rate, and it's really this that I think is the primary driver of the margin expansion. So, taking it down a level, if we look at it in the second half from a programmatic perspective, the growth, what the programs that are going to drive growth are LTAMDS F-18, SEWIP, F-16, SABR F-35 and not large FMS program that moved from Q1 of last year. Other programs or large programs in the second half or ALR-56, a classified C2 program as well as T-45. So, it's kind of in line with what Mike said, right? It's really the program mix H1 versus H2. Do you want to add anything?

Yes, yes. And Peter, I think Mark just went through all the programs. I think as you look at the EBITDA for the year, the midpoint of our guidance is still 22% between our Q1 and our Q2 kind of midpoint of our guidance, we're running at about 17.5%. So we clearly expect to pick up in the second half, and as I said in the prepared remarks in Q4, specifically as well and that's going to be driven by a couple of things. Number one is the gross margin expansion, and Mark just talked about some of the specific programs. But at high level, the program mix between the development programs that we had in H1 compared to production programs in H2 is going to drive a lot of that. The second thing is operating leverage, and we're continuing to invest in R&D in H1 at levels that are consistent with what we've done in the past. Because of that, we're seeing some negative operating leverage which is putting pressure on margins. We expect that to reverse in the second half and really drive margins as well. So those are the two big things; program mix and operating leverage driving the EBITDA margins in H2.

Thank you. Our next question will come from the line of Sheila Kahyaoglu with Jefferies.

Hey, good afternoon, guys and thanks for the time. Just staying on the implied margin ramp. When we think about the first half, how much of the margin pressure is coming from new program mix? Is it like 500 bps? Is it 100 bps? And you also talked about elevated supply chain risk and inflation as a watch item. How are you kind of thinking about that into the second half?

So, why don't I hit on the margin question first? The preponderance of the lower gross margin Sheila in H1 is related to the program mix and the new development programs. And as we go through the second half of the year, we're going to see a ramp up in gross margins. I think, when we get to Q4, we're going to see gross margins that can look back at where we were in fiscal '20 for the year around 40%, 45%. I think that's where we'll be around Q4. And again, we don't specifically guide gross margins. But at the year level, I think we're going to be slightly above where we were in fiscal 2021, which implies that ramp-up in gross margins in H2, which is related to the programs that Mark went through.

Yes. And then on the supply chain side of things Sheila, yes, we clearly are seeing what many other companies have talked about right in this earnings season with substantial increases in lead times and price inflation. I would say the team to date has done a very, very good job in navigating around that. We missed very little revenue in the first quarter associated with it, but we do expect that the inflationary environment and the risk associated with revenue will be around for quite some time. That was one of the reasons that in the first quarter, we did make additional raw material purchase commitments, that was tied to revenue in the second half, that also was able to take advantage of some better pricing. So, the team is doing a great job. It's challenging and we're managing through it.

Thank you. Our next question will come from the line of Jonathan Ho with William Blair & Co.

Good afternoon. I just wanted to maybe understand a little bit more about your comments around sort of the vaccine mandate and potentially, how that could impact your business. Can you give us a sense of how much additional churn you're looking at, and maybe your thoughts around sort of skill shortages and difficulty hiring workers, how do you think about managing that process? Thank you.

Yes. So, as you know Jonathan, I think we did a very good job kind of managing through the initial stages of the pandemic. We're obviously now in a different phase with the White House mandating the vaccines. So, we're working through that. A very large majority of the population is vaccinated currently, but there's still a portion that is not. So, we're working to educate those and cajole and coax then to actually get the vaccine. It's unclear at this stage, exactly how many of those choose not to get vaccinated and it's still a little unclear, just given some of the change in the turn coming out of the White House as to what companies are going to be able to do and what flexibility that they have with respect to the mandate themselves. So, we know how employees that we intend to comply. We're communicating with them in a two-way dialogue. But at this point it's unclear as to the exact impact it will have. We are preparing mitigants to actually offset any disruptions that we may have, which includes overtime and temporary labor like other people. We haven't had any issues with respect to hiring. I think time to hire is still pretty strong and we have the labor that we need. So right now, we're doing okay, but this is an important quarter with respect to those potential changes.

Thank you. Our next question will come from the line of Michael Ciarmoli with Truist Securities.

Hey, guys. Good evening. Thanks for taking the question. So, I guess, Mark and Mike, maybe what was the thought process? I mean, we've obviously seen the larger defense peers here report, call out these risks, lower their guidance. You guys are still calling for substantial strength. Your fiscal year doesn't exactly align well with some of these risks. I mean, it would seem like you're a bit more vulnerable, but you've obviously decided to keep the stake in the ground and not maybe account for some of these risk factors and maybe reducing the guidance. I mean, can you walk us through kind of the confidence level and calling out these risks, but not maybe reflecting them in the guidance?

Sure. Let me kind of step back and just do a little bit of a recap in terms of kind of how we ended up here. So as we said on the call, I think, overall, we're pretty encouraged by the defense budget trends and the longer-term effects associated with the vaccine mandates. Notwithstanding that, as we said in the prepared remarks, I think, in the short term risk levels have increased due to the potential of the prolonged CR, the impacts of the vaccine mandates could have on employee turnover and operations, as well as the supply chain constraints and inflation that we just discussed. As we reflected coming out of 2021 and as we built the forecast, what we did Mike, as you know, is we examined the areas that impacted organic growth the most last year and believe that as we came into this year, we've planned more conservatively. Now, that doesn't mean that our plan has zero risk, as the year is clearly back-end loaded and the environment is more challenging. But to recap what happened in 2021, we saw really a 6-point reduction in organic growth last year. This was led by a 3-point reduction in organic revenue growth due to delays in naval modernization, particularly programs like SEWIP. We saw a 2-point reduction due to the now well-publicized Lockheed supply delays on the F-35 TR3 and Block 4, as well as a greater than a 1-point reduction to various FMS programs. So to risk adjust these, as well as other areas, coming into this year we lowered organic revenue growth expectations by 8 points. And this decline resulted in the guidance that we currently have, which is flat organic revenue growth for the year. But I believe that bookings will grow as the year…

Thank you. Our next question will come from the line of Austin Moeller with Canaccord Genuity.

Good evening, Mark and Mike. Just on the note about the impact of inflation. I know there's a lot of expectation here that organic growth will manage to remain strong in fiscal year 2023. But, are you concerned about the impact of inflation on either the current defense budget or the future defense budget and that cost growth leading to a reduction in procurement quantities for key weapon systems? Or alternatively, do you think that that will benefit Mercury by driving DoD to further engage in delayering of the supply chain and allow you to negotiate with them directly, as opposed to through the prime?

Yeah. So I think it's probably going to be a little bit of both. We're clearly seeing the delayering trends particularly in the open mission systems arena. We're also seeing a flight to quality supply in particular in RF as well as secure processing where our customers are seeking to deal with those companies that have automated or modernized their manufacturing capabilities, as well as those that are willing and have the capacity to invest in new technologies and capabilities. So it's a little bit of both.

Our next question will come from the line of Noah Poponak with Goldman Sachs.

Hi, good evening.

Hi, Noah.

Hi, Noah.

Mark I just wanted to follow-up on all that detail you just gave on some of your largest programs that have had the delays. I guess, it seems concentrated into SEWIP and then F-35 TR3 and the LTAMDS. Notwithstanding, the fact that you already gave a lot of detail there, what's actually transpired with those programs? Like have there been meaningful stake in the ground hard milestones you can point us to? Have you had conversations with the prime about the order timing that you can point us to, because otherwise it feels a little bit like we're still just guessing on the timing and you don't know if it will slip out of your 4Q and your 1Q. Are there concrete things that have transpired that you can point us to that get us a little more comfortable?

So I'd kind of just reiterate to some extent know what we basically said, right? I think there's been a tremendous amount of disclosure that was previously maybe not out in the public domain around the delays on TR3 and block four that resulted in substantial cost increases delays to the program and potentially a change in the production levels. Maybe we were a leading indicator, right to seeing the effects of that, hard to tell. I think many of the updates that I think has been discussed publicly suggest that the TR3 development and integration efforts are actually doing better than what they were. There's still some important milestones to go. One of those is, obviously, the integration of the capabilities and the flight safety certification testing that is likely going to begin or occur early in the new calendar year, which would bode well for our revenues in the second half. So that's kind of new information. On SEWIP, I think it's again generally understood that there's been a pretty significant impact to the ship modernization upgrade cycle that affected both SEWIP as well as other naval programs. We have taken that into account in our forecast, the fact that we typically get the order in the third quarter, which our customers still intends to do. We've been even more conservative pushing it into Q4, again kind of derisking the plan. On LTAMDS, that shift moved the next production order into our next fiscal year. However, we're still expecting significant bookings associated with LTAMDS around certain upgrades and other development efforts that should lead to substantial growth in bookings year-over-year. So, yes, we've been having dialogues with customers. Yes, it's a very dynamic environment and we've tried to reflect those changes and to communicate the latest information in the remarks that I've just said.

[Operator Instructions] Our next question comes from Pete Skibitski with Alembic Global.

Yes. Thanks, guys. I just want to go forward on the F-35 outlook just because Lockheed put out that updated production kind of profile. And Mark you talked at length about TR3. But it sounds like as we head into maybe fiscal 2023 you have 35 revenue it will be a fairly easy comp for you given the delays in the TR3. So -- but how should we think about with the new production profile? Excuse me, how should we think about the profile for you guys through the mid-term? In other words is the F-35 is going to be a growth program for you guys for quite a long time, or will you in the nearer term, let's say, run into kind of this production flattening profile that some of the bigger guys are running into?

So we think that F-35 is going to be obviously, continue to be a really important program for us. Unlike say Lockheed right that the growth is obviously dependent upon the growth in the production rate there's a few things going on with Mercury. So the first is obviously getting beyond the issues that we've experienced around TR3. TR3 becomes an enabler for Block 4 and Block 4 for us enables content expansion across different parts of the system that should lead to growth in both processing as well as RF content. The second thing is that the -- it's likely that the existing systems both T1 and T2 will be retrofitted over time which could be a pretty substantial opportunity for us as well. And then obviously over time there's likely going to be continued tech refreshes. So we're not a platform provider. Our business is really tied to both the electronic systems on new platforms as well as the ongoing modernization of existing systems and F-35 is a great example. It's already on the third tech refresh of the underlying processing and memory subsystem which will benefit from. So hopefully that answers your question.

Thank you. That's all the time we have for our question-and-answer session. I'd like to turn the call back to Mark Aslett for closing comments.

Okay. Well, thanks very much everyone for joining us this evening. We look forward to speaking to you again next quarter. Take care.

Once again, we would like to thank you for participating on today's conference call. You may now disconnect.