Good day, everyone. Welcome to the Mercury Systems Second 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 of Mark Aslett. If you've not received a copy of the earnings press release we issued earlier this afternoon, you can find it at [ph] 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. Mercury delivered solid results for the second quarter of fiscal '22. Bookings were up substantially from what we believe was the low watermark in Q1, resulting in the 1.08 book-to-bill. We remain confident in achieving even stronger bookings in the second half, leading to substantial growth for the year. As a result, we expect to exit fiscal '22 well positioned for return to our normal levels of growth and margin expansion. This should lead to a strong performance overall in fiscal '23 as planned. Looking further ahead at our 5-year plan, the 1MPACT program we launched in fiscal '21 is providing the foundation for our next phase of value creation at greater scale. We expect to deliver high single-digit to low double-digit organic revenue growth over time, coupled with margin expansion and M&A. Our long-term model sitting at the intersection of the high-tech industry and defense has positioned Mercury exceptionally well. Our strategy and investments in pure processing, trusted microelectronics and open mission systems are serving as the engines of growth in the business. Turn to the numbers on Slide 4. Total revenue for Q2 was up 5% year-over-year, reflecting the anticipated challenging industry conditions. Our largest revenue programs in the quarter were a classified C2 program, MH-60, P8, CDS, Autumn [ph] and F-16. We continue to see high levels of new business activity, and our pipeline remains strong. Design wins in Q2 totaled more than $160 million in estimated lifetime value. Through the first half of fiscal '22, we've won 30 new designs with an estimated lifetime value of more than $580 million. Free cash flow for…

Thank you, Mark. And good afternoon, again, everyone. As usual, I'll start with our second quarter results and then move to our Q3 and fiscal '22 guidance. The team worked in Q2 to deliver solid financial results despite the external challenges that Mark discussed. We saw a significant rebound in bookings from Q1 and finished the quarter with a book-to-bill above 1. The bookings momentum in Q2 is expected to accelerate, resulting in a strong second half of the fiscal year. For full fiscal '22, we're maintaining our prior guidance for revenue, adjusted EBITDA and adjusted EPS. Our updated guidance incorporates the acquisitions of Avalex and Atlanta Micro as well as a more cautious organic revenue outlook, primarily due to elevated supply chain risk. We continue to expect fiscal '22 to be weighted towards H2 and especially Q4 as margins expand and free cash flow begins to normalize. Given our backlog at the end of Q2 and forecasted Q3 bookings, we expect to exit Q3 with strong visibility into Q4. Looking ahead to fiscal '23, we continue to anticipate a return to above industry average organic revenue growth driven by the strong bookings and backlog growth in fiscal '22. We expect this organic growth, coupled with improved operating leverage and our impact initiatives to result in margin expansion and increased adjusted EBITDA versus fiscal '22. Turning to our Q2 results on Slide 9. Bookings were up 13% compared to Q2 '21 and up 19% from last quarter. During the quarter, we had over $25 million of bookings moved from Q2 into Q3 as a result of contracting delays. We've already received a majority of those orders in Q3. Despite these delays, our book-to-bill was still strong at 1.08. Our backlog at the end of the quarter was $954 million, up…

Turning to Slide 16. Q2 was a strong quarter for Mercury. We're confident this will lead to a strong year in fiscal '23 as organic growth returns to normal levels and impact drives margin expansion. Looking ahead longer term, our model sitting at the intersection of the high-tech industry in defense is exceptionally well positioned. We believe that our strategy and investments in secure processing, trusted microelectronics and open mission systems will continue to drive growth in the business. While we're mindful of the potential risks associated with the defense budget and industry headwinds, we expect to continue to benefit from key secular trends such as outsourcing, delayering and reshoring. We're well aligned with our customers in the DoD. Our design win cadence is strong, and new business activity remains robust. Our strategy is to deliver strong margins while growing the business organically and supplementing this organic growth with disciplined M&A and full integration. By executing on this strategy, we've created significant value for shareholders for nearly a decade, and we expect to continue doing so. In closing, I'd like to extend my appreciation to the entire Mercury team for the outstanding work they've done during this challenging time, my sincere thanks to all of you. Before we move to questions, I'd like to address the recent public disclosures by two of our shareholders, Jana Partners and Starboard Value. At Mercury, we frequently engage and maintain an ongoing dialogue with shareholders and have a history of seeking, considering and incorporating their feedback where appropriate. As we've communicated today, we're focused on executing our strategic plan, and we'll continue to evaluate opportunities to enhance value for all shareholders as we do so. The purpose of today's call is to discuss our second quarter earnings results and outlook, and we ask that you please keep your questions focused on these topics. With that, operator, please proceed with the Q&A.

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

Hey. Good afternoon everyone. I just wanted to get a better sense with regard to this big ramp in the fourth quarter. It sounds -- I guess I'm trying to figure out to what degree you're predicating this fourth quarter revenue ramp on a kind of a timely end to the current CR. In other words, if we get a full year CR, what kind of revenue chunk might we expect shift to fiscal '23?

Sure. Let me take a crack at that, Pete. So we don't believe that there's a lot of risk associated with the CR itself. I think we've gone through the programs, and we feel pretty good. The ramp in Q4, I think although there's no forecast without risk, we've got a significant amount of Q4 revenue already in backlog. And I think this backlog combined with the expected ramp in Q3 bookings is what really gives us the visibility and the comfort to the implied Q4 revenue and EBITDA that Mike discussed in the plan. So Quarter3 bookings is an important quarter for us, and we’re expecting continued momentum based on what we delivered in Quarter2.

Thank you. Our next question is going to come from the line of Seth Seifman with JPMorgan.

Thanks very much. Good evening. I wonder if you guys could talk a little bit more about the risk on the execution side, on the manufacturing side. You talked about sort of, I guess, you think about headcount, you think about the supply chain challenges that you mentioned and those are still ongoing through much of the economy and will probably be ongoing in the June quarter as well. And so to what degree does that level of kind of operational cadence or execution need to return to something like normal for you to deliver on the Q4 target and kind of what gives you confidence in that?

Yeah. So few things there, Seth. So clearly, I think we've seen a pretty turbulent environment. And right now, we're not anticipating that things will be fully resolved likely until next calendar year. That said, I think we've been very, very proactive, working with our suppliers wherever we possibly can to minimize the risk going forward. And we don't currently expect that the uncertainties around the supply chain will actually grow materially in the second half. We've been very, very focused on in doing whatever we can. We mentioned in the prepared remarks that we've purchased an additional $10 million of materials that is linked to second half revenue, those materials are flowing in. We flowed down DPS ratings where appropriate. We're in daily contact with the suppliers. And obviously, we've taken into account what we believe to be the highest risks from both the supply chain as well as the labor perspective in the current guidance. So the team is doing a pretty good job overall, but it is quite challenging out there.

Thank you. Our next question is going to come from the line of Sheila Kahyaoglu with Jefferies.

Hi. Good afternoon, guys. Thanks for the time. Obviously, a lot going on this quarter. Hey, guys. And you talked about this in your prepared remarks a lot in terms of opportunities in your M&A pipeline, both historically and going forward. What impact going on as well? Maybe can you give us a quantitative and qualitative outlook on your historical and going forward M&A on how Mercury's added value both from a revenue and EBITDA perspective because when we look at it, the growth is great. It's up 20%, both on the top line and the bottom line. So I guess maybe can you talk about the potential opportunities you have going forward, whether it's through 1MPACT or on future opportunities?

Yeah. Look, great question. I think as we said, we've built, I would say, an enviable M&A organization, our ability to source diligence, close and then integrate deals is very, very strong. To me, 1MPACT about leveraging proven ability that we have to integrate and grow future acquired businesses. We're doing a greater scale going forward. I think as we said in the prepared remarks, since fiscal '14, we've now acquired 15 businesses, deploying $1.4 billion in capital. That's dramatically scaled Mercury as a business transformed the capability set that we have as well as the importance to our customers. And as a result of the acquisitions, but more importantly through the synergies that we've generated through integration, we've been able to actually grow total company revenues by over 4.4x over the course of the last 7 or so years. And because integration and full integration is such an important element of the strategy and 1MPACT about taking that to the next level, we've been able to actually grow adjusted EBITDA at 9x or twice the growth in revenues. And I think it's really this organic growth strategy that we have. It's been driven by the shift to subsystems, coupled with M&A and full integration is what's delivered the value creation over the course of the period where we've been very, very active. 1MPACT to me is about taking it to the next level. And so it’s about Mercury kind of achieving its full growth and adjusted EBITDA potential, doing what we’ve been doing, but doing it at a greater scale and potentially even better than what we’ve done in the past.

Thank you. Our next question is going to come from the line of Peter Arment with Baird.

Good evening, Mark and Mike. Mark, obviously, there's questions about kind of the timing and how this is all going to kick into the kind of the fourth quarter and you have a lot of confidence around that. You've in the past, I guess, talked about kind of returning to high single-digit or low double-digit growth. And I wanted to see maybe just more qualitatively, do you think that's still possible in '23, just given the lingering effects of a CR, Pete's right about that full year CR or whether you get just lingering effects from the supply chain. Just how you're thinking about kind of the return to the growth model?

Yeah. Look, it's a great question. Thanks for that. So obviously, notwithstanding the elevated industry risks that we're facing for fiscal '22. I think we continue to expect very substantial growth in bookings year-over-year. Our bookings and backlog expectations for the year have actually improved since last quarter. And we continue to remain pretty confident for the second half, just given the timing of the deals that we see. The expected growth in bookings, as we see it right now, should lead to a positive book-to-bill for the year as a whole as well as double-digit growth in total and 12-month backlog. And it's really these bookings and the increase in backlog exiting this fiscal year that we believe positions us for a return to our more normal levels of growth organically in fiscal '23. And this organic growth, coupled with the margin expansion that we expect associated with the impact of initiatives really do sell us well for pretty substantial value creation next year. So I think right now, we feel pretty confident in the second half. We're seeing the bookings momentum coming out of Q2. As we said, we thought that Q1 was the low watermark. We're pleased with the progress, and we're expecting even faster growth in the second half.

And Peter, I would just add to that. We just went through our update to our 5-year forecast as of our midyear strategic plan exercise. And Mark just talked about fiscal '23, but when you look at the 5-year, it's very strong as well. And that growth is supported by the major programs we're on, the markets that we've been investing in. So a clear path to return to the organic growth model. And then on top of that is impact ramping up not just in fiscal '23, but margin expansion over the 5-year period.

Thank you. Our next question is going to come from the line of Ken Herbert with RBC.

Hey. Good afternoon, Mark and Mike. 2-part question, if I could. First, when you look market the new business opportunities today, your business development pipeline how has that changed relative to maybe a year or 2 ago? Is it possible to quantify that as we think about the impact maybe of the budget on some of the new program starts and your organic investment opportunities? And then second, I was just wondering if you could put a finer point on sort of how much of the fourth quarter revenues are currently in backlog with the $25 million? It sounds like you've largely booked it slipped out of second, third quarter and sort of what you expect to book in the third quarter? Thank you.

Sure. So Mike, I don't know if you want to take the Q4 backlog one. And then I can talk a little bit about the -- what we see over the 5 years and why we feel confident.

Yeah. So Ken, as we talked about in the prepared remarks, if you look at Q4, it's really driven by the key programs that were designed into. They're well supported. So this really is about timing. If you look historically, we've had about 50% to 60% of the next 12 months in 12-month backlog entering a year. We haven't given out guidance on how much backlog covered we have entering a quarter because it can typically range anywhere from 70% to the mid-80% range. It depends on contract mix et cetera. As we look at our Q4 right now and why we're comfortable with the guidance we put out, we currently have about 70% of our Q4 in backlog today. And if you look at the bookings that we see in Q3, we anticipate having over 80% of Q4 in backlog by the end of Q3. So even though we're forecasting a very big Q4, the coverage we expect going into Q4 is at the high end of the range that we normally see. So we've got a lot of insight into the programs. And we feel like we've got a lot of insight into the timing, as I said in our prepared remarks that we're staying close with our customers on that.

Thanks, Mike. So let me kind of just talk a little bit about the longer term. So we've been investing heavily for growth and we've grown the business significantly organically over a multiyear period. And so despite the headwinds that we're experiencing now in the latter half of '21 and '22 to date, we absolutely believe that our long-term business model is in fact, as Mike said we've just updated our 5-year plan at the midyear mark and continue to believe in our ability to grow the business at high single digit to low double-digit rates on average over time, as we have done for many, many years now. And the reason that we believe though is that to begin with, I mean, we're positioned in large and well-funded high-priority programs of record that we believe are very much aligned with the National Defense Strategy as well as DoD priorities. We're designed in on many of these programs. And by far, the majority are actually sole-source supply positions. None of our programs have been canceled. And I think, in fact, as we look forward, we think that the funding associated with the programs is -- remains strong. We continue to out invest our competition from an internally funded R&D which we believe is in line with the direction that the industry is headed. And this is allowing us to deliver innovations far more quickly, far more affordably than what we're seeing other companies doing, which in turn means that we're taking share. Our largest secular growth driver, which we've been focused on for quite some time now which is outsourcing at the subsystem level is occurring by our traditional customers as well as the they are seeking to delayer the supply chain to gain access to innovative tech oriented mid-tier such as Mercury. And so although clearly, we may be a leading indicator one of the challenges that we’re seeing more broadly across the industry, we do believe that many of those are temporary in nature and that we can continue to grow the business, the way in which we have in the past. And again, probably the biggest driver of that is outsourcing.

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

Hey. Good evening, guys. Thanks for taking the questions. Just -- Mark or Mike, not sure which one you guys want to take this. But just to you talked about sort of the industry related risks. And I guess just at the programmatic level, we've seen some press about some SEWIP Block 2 shortfalls. And then I guess even thinking about your comments on LTAMDS and kind of that first booking order sliding out. I mean just knowing how big that program was? Has that changed? Or has anything changed on the programmatic side? I mean 6-8 months ago as we were looking to '23 for a reacceleration of organic growth. Presumably, LTAMDS was going to be a part of that. Is it -- was that the case? Is it easy to backfill that? Or just if you can talk about some of these big programs? And how they're trending, given what we're seeing, I guess, a slide out and maybe some operational shortfalls there?

Yeah. So the changes that we've talked about, right -- or the outlook, Mike actually is encompasses what we've seen programmatically based upon the best possible information today. SEWIP as we said, we started to see some impact last fiscal year here in the second half is based on the impact of COVID on the ship upgrade cycles. And we're seeing that again this year in terms of lower numbers, which is encompassing our numbers. LTAMDS, we were originally expecting to get a large booking this year that now, again, has moved out. That is also encompassed in both our outlook for this year as well as over the 5 years. And we do think that actually LTAMDS, even though it's nowhere near as large as what we thought it was going to be for fiscal -- for this fiscal year, the bookings are still going to be up 3x compared to what it was last year. So fundamentally, I don't believe anything has changed. I think we've got some great -- we're on some great programs. We're seeing ramps in a number of those over the 5-year period, and it's really the growth in the top 20 programs as well as some of the new design wins transitioning into production over time that gives us the confidence in the outlook. So we feel pretty good that we've done the work and that we're well positioned, Mike.

And our next question is going to come from the line of Jonathan Ho with William Blair & Company.

Hi, good afternoon. I just wanted to, I guess, maybe get a sense for whether you've heard anything from your customers. I think you've referenced you're staying in close contact with them. But has anything changed? Or is there anything that's maybe giving you some additional confidence as we start to look at sort of this Q4 ramp and going into 2023. I just want to get a sense from you Mark on how to think about what the customers are saying.

Yeah. So I mean, we spent a fair amount of time, obviously, with customers just looking at our major programs and just diligencing them as we continue to look at the ramp in H2. I think -- and yes, I think the major programs, right, the feedback that we've been -- that we've given support to the forecast and the guidance that we've just given overall. So I think when we look at the forecast for H2 from a bookings perspective, Jonathan, I think it's really been driven by double-digit growth across our 2 major market segments, which as you know, C4I and Sensor and effect and Mission Systems. And the growth in both those markets are really again being driven by our top 20 programs. In the top 20 programs, we're actually expecting the bookings from them are likely going to more than double versus H1 primarily because there's actually more of them producing and the ones that are producing at the higher rate. And so when I look at those programs, we've got the large FMS program that moved from Q1 of last year. We've got a substantial ramp in the F-16, which -- that was one of the orders that moved from Q2 -- sorry, Q1 into Q2 and we've already received that order. We've got F-18, we've got a ramp on LTAMDS. SEWIP, although it's lower is in the second half as well. So I think our program -- we feel good about it. I mean the stable well-funded programs that we don't expect them to be affected by the CR. And we have got the best possible information from the customers as we look at the second half.

Our next question comes from Austin Moeller with Canaccord Genuity.

Good evening, Mark and Mike. I just have a question here. If Russia launches an invasion into Ukraine, do you anticipate that we could have an expansion of about 35 sales towards some of our NATO allies? And if we see an increase in F-35 sales and the number of customers that are already are assigned to the F-35 as well as a large amount of electronic warfare and radar equipment being sent to Eastern Europe for use by NATO allies and DoD, do you anticipate that could yield upside in your fiscal year '23?

So it's hard to say exactly what obviously is going to happen in the Ukraine and specifically relating to the F-35. But if I just kind of talk a little bit about what we see happening with our program. Overall, we are expecting double-digit growth in bookings this fiscal year, greater than 40% as opposed to a 50% decline that we saw last year. So we do think that as a result of the TR3 and kind of getting through the reprogramming, we're seeing a pretty substantial uptick. Year-to-date on the program, we've booked as much as what we did throughout the whole of last year. And we're expecting a strong second half as well as a substantial increase in bookings next fiscal year. So that was one of the major programs that obviously there's now a lot of information out in the public domain around what happened with TR3 and Block IV and the production reprogramming. But from what we can see right now, things are -- appear to be back on track. And we're seeing it in our bookings and our revenue, and we feel pretty good about the growth in the program longer term, just given some of the design wins that we've already won that TR3 and Block IV will enable. So overall, I think it’s a really important program for us and for the industry, and we’re seeing a substantial pickup this year compared to last.

Thank you. Our next question comes from Christopher Rieger with Berenberg Capital Management.

Hi, guys. Thank you very much for taking the question. Just with regard to the elevated supply chain risk that you've been seeing in the lengthening lead times. Could you talk about sort of where you're seeing the pinch the most? Like which programs are more or less affected than others? Any color you could provide there would be appreciated. Thanks.

Yeah. So really not necessarily at a specific program level, but I think the biggest challenges that we faced was delays and in quarter decommits from suppliers and distributors. And a lot of that was around semiconductors and in particular FPGAs. And so I think Mike said, we saw greater than a $5 million revenue impact in the second quarter associated with that. But we also saw revenue churn as suppliers were kind of decommitting and we're ending up -- to push some of the revenue towards the back end of the quarter which in turn impacted some of our cash collections. So it's a very dynamic environment. It's the reason that we've -- this past quarter committed another $10 million in component buys to derisk the revenue in the second half and we're already getting those materials in. And that's on top of what we previously did. So most of what we're seeing the issues around are in semiconductors. And again, most of that is FPGA-based.

And our next question will come from Ron Epstein with Bank of America.

Thanks. Good evening, guys. Could you walk through why do you see yourself as a leading indicator? What about your business would make you a leading indicator?

Yeah. To some extent, Ron, I think it's just the -- where we sit in the tier from an industry perspective and the fact that we've got a relatively short cycle business. And so when we started to see the impacts associated with F-35, right on TR3, that's a significant program for us. And it wasn't until really 9 months after that we start to see the impact did a lot of the other companies start to describe what was happening and then demonstrate the impact that was having on them as well. So it's largely due to I think, where we sit in the supply chain, some of the program concentration that we have in short-cycle business.

Thank you. And our final question for the day will come from the line of Noah Poponak with Goldman Sachs.

Hey, everyone.

Hi, Noah. Mark, I wanted to ask a similar question, and so I'll try it again, which is everybody in the industry is seeing a continuing resolution in supply chain and labor hurdles. And the order of magnitude of decline in your revenues organically is much larger than pretty much every other company in the industry. And if you could spend a little bit more time on why that is. I mean is being short cycle with a commercial model and a lack of multiyear contracts, does that mean when there's a delay on the program that the prime can just kind of almost turned you off completely and then pick it back up a year down the road? And if you could just get a little more specific on LTAMDS, too, the length of delay you're talking about there is quite long. I'd love to be able to better understand what's going on in that program.

Yeah. So look, I think when we kind of assess kind of what happened in fiscal '21, the biggest challenge that we had last fiscal year from a bookings perspective. And remember, the bookings slowdown that we saw in the second half of fiscal '21 and in the first half of this fiscal year, which we expect to ramp is largely what has driven the slowdown in organic revenue growth. So the largest bookings impact that we had last year was on the F-35. And as I mentioned, our bookings on the F-35 were down 50% year-over-year compared with the prior year, which caused a 3 points decline in organic bookings overall. We have that large FMS contract that was delayed from Q1 which we now expect in the second half that had a roughly 3.5 point impact as well. So literally, just there in 2 programs, we saw some pretty substantial impacts overall that has affected the growth in fiscal year '22, and I could go on with a few others. As it relates to LTAMDS, I think -- it's based upon the information that we got from our customer to date. I think our understanding is that the next LTAMDS reduction award for will be in '24. That's based on what we're hearing from PEO space and missile and that is what's currently in the Army plan. Because we didn't get a fit up last year, we don't know for sure how the budget has moved out of '22 based upon the army's portfolio and decisions around that. So we'll have more information hopefully, in the next few months as to what the actual plans for LTAMDS are. I would say, however, that I think the U.S. Army continues to stress the importance of LTAMDS as a cornerstone of next-generation air and missile defense. And it's one of the army's 6 priority areas. So although we've kind of moved it out again in time, and we're expecting a substantial ramp in bookings in this fiscal year compared to last. We're not going to see the big ramp in production orders, we believe until our fiscal '25. So the time that it takes Raytheon to get the order get it to us and the difference in the timing in fiscal years put it out into our fiscal ‘25 versus fiscal ‘24. So that’s what we know right now.

Thank you. I would now like to turn the call over to Mr. Mark Aslett for closing comments.

Okay. Well, it's been great to speak to everyone. Thank you very much for joining the call. We look forward to speaking to you again soon.