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 2 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 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 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 3.

Thanks, Dave. Good afternoon. Thank you for joining our Q1 FY '25 earnings call. We started FY '25 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 FY '25 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 4. 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…

Thank you, Bill. As Bill previously noted, our first quarter results were in line with or ahead of our expectations, and reflects solid progress toward our goal of transitioning the business to deliver predictable performance characterized by organic growth, expanding margins and robust free cash flow. There is still a lot of work to be done, but we are encouraged by the progress we have made so far, and we continue to expect our transition efforts to become more apparent in our financial results during the second half of fiscal year 2025. Our continued progress in our priority areas is highlighted by a few key milestones that we achieved during the first quarter. This includes delivering improved operating performance, making additional progress in our ramp toward full rate production in our common processing architecture and continuing to expand our record backlog. With that, please turn to Slide 10, which details our first quarter results. Our bookings for the quarter were $248 million with a book-to-bill of 1.21, yielding a backlog of $1.3 billion, up $188 million or 16% year-over-year. Revenues for the first quarter were $204 million, up $23 million or 13% compared to the prior year of $181 million. The increase was primarily driven by higher point-in-time revenue of $16 million, largely accelerated from Q2 as we have continued to improve our operational performance. As Bill noted, we experienced approximately $8 million of net EAC change impact in the quarter as compared to approximately $16 million in the first quarter of fiscal 2024, which was the lowest net EAC change impact in the last five quarters. Gross margin for the first quarter decreased to 25.3% from 27.9% in the prior year. The decline in gross margin during the current quarter was primarily driven by higher manufacturing adjustments and inventory…

Thanks, Dave. With that, operator, please proceed with the Q&A.

[Operator Instructions] Your first question comes from the line of Pete Skibitski with Alembic Global. Please go ahead.

Hi, good evening, guys.

Hi, Pete.

Hi, Bill, could you give more color on the common processing architecture programs? I'm just trying to get a feel for what challenges remain on those programs, if you're just trying to get yields up in the second quarter before you go into full-rate reduction. Just maybe give us some more of a feel there? And do you still call them challenge programs or are we past using that term?

Yes. I mean, I'll start with the second part of your question first. We've really moved away from using that term. And I think that's just reflective of the progress that we made over the last five quarters. We talked about it pretty much quarter-over-quarter how we made pretty methodical and systematic progress in closing out those programs. And when we left it last year, we had a couple left where we felt like the risk was in line with ordinary course risk, and then we had some programs associated with the CPA. So we feel like we've made progress such that we don't need to talk about those programs. On the common processing architecture and our production, I'd say from the time that we initiated the root cause corrective action, we halted the line, we put a plan in place and this is going back a few quarters now. We've pretty much executed to that plan. And we're in the progress of ramping up toward full-rate production. As I've mentioned before, we have the resources trained and in place. We have our capital in place. We are just being very methodical and rigorous in how we ramp this up. I think another positive sign in the quarter and we alluded to the possibility of this in prior quarters was once we got closer to full rate production in demonstrating that our corrective action was in place and working, we felt like there was the potential for follow on awards to become unlocked. And we saw that happen in the quarter, which I think is another positive indicator of the progress that we made on that front. Hopefully, that's some helpful color on the topic.

Yes. I appreciate it. And just one last one for me. Just was wondering on the cadence here in the first half, it sounds like you had some revenue get pulled forward in the first quarter. So the second quarter will probably be down sequentially, probably year-over-year. Does the gross margin take a step-down in the second quarter as well before it ramps in the second half? I was just wondering if you could clarify that for us? That's it. Thanks.

Yes. I'll let Dave address the gross margins and then maybe I can come back and provide a little color on the on the volume.

Yes. I think what you see is and we had talked last quarter about our expectations being in the high-single digits. And we were slightly higher than that in Q1. And I think what you would find is as a result of the volume that got pulled in, we were able to have a bit of a higher operating leverage and which resulted in EBITDA being higher even though gross margin was not. And so we would expect that with -- if the volume ends up being lower in Q2, we wouldn't have as much of an impact from operating leverage, but it would still be in the same realm from a gross margin standpoint.

Okay, great. Very helpful. Thank you.

Yes. Thanks, Pete.

Your next question comes from the line of Peter Arment with Baird. Please go ahead.

Yes, thanks. Good afternoon, Bill and Dave.

Hi, Peter.

Hi, Bill. Thanks for all the color on the common processing architecture. It sounds like that's kind of tracking your plan. But you've always talked about I think when you retired the risk on all these other kind of programs that are no longer challenged, that eventually you had to wait for them to get into kind of production before you could be able to start to see that unbilled unwind. And obviously, you've made progress on the unbilled, but how do we think about it? It sounds like the CPA will start to ramp in the second half. But how about all those other programs? How do we think about kind of how they layer in?

Yes. I think about it in terms of just a transition that's happening over-time as we're completing the developments, there's then a transition into production. And on many of those development programs, that's the phase that we're in. I'd also point to our operating expense, which reflects an allocation of our engineering and our technical resources to closing out the development programs and ramping up production. So the status varies program-by-program, but I would say that we're generally in that phase where we're ramping down on the developments and beginning the process of transitioning to production.

Okay. That's super helpful. And just a quick follow-up. Just your R&D obviously, as you mentioned, ticked down this quarter and then you said it's going to incrementally come back. Is it -- is it going back to kind of your historical 12% of revenues or is that not a good guide?

Yes. I don't expect any major swings, but I do expect some incremental movement on that front. Just as we make progress on ramping down on the development programs and then have the capacity to increase in an incremental way our investment in innovation across our Mercury processing platform.

Got it. I'll jump back in the queue. Thanks, guys.

Thank you.

Your next question comes from the line of Seth Seifman with JPMorgan. Please go ahead.

Hi, thanks very much and good afternoon. I just wanted to ask when the CPA program programs get ramped up, how do we think about the kind of portion of the mix that programs related to common processing architecture will comprise at that point when they're at full-rate production?

Yes. I think we haven't specifically spoken about exactly what percentage of the portfolio any of these things are. Nothing is -- they're not a majority of the portfolio, everything we have a breadth of 300 plus programs across the portfolio. So you know, and no program in and of itself contributes 10% of revenue. So it is a bunch of programs across various capabilities. So it is as you saw last year a significant contributor to revenue. And as Bill talked about, we did see increased production booking activity around this and we expect that to be impactful as we move throughout the second half of the year.

Right. Okay. Okay. So I guess you said was it you said $50 million of follow-on orders?

Correct.

In Q1, right? So that's about 250. So that was about 20% of the bookings. But it sounds like when we think about where future revenues are going forward, it's a -- it's not 20% of future revenues going forward, it's something much lower than that in terms of CPA based programs?

Yes. I think we're not specifically calling out how much that it is of the total. And I would not conclude that it's, you know, much less than or much more than. I mean, I think that I don't think that there's enough that we've commented on for you to make that conclusion.

Okay. Okay. That sounds good. And then just as a follow-on on the SG&A in the quarter, definitely down meaningfully from the levels we saw in the second-half of last year. Q1 of '24 was also kind of low and then it kind of popped up for the remainder of the year. Do we think about a similar profile there or is that kind of low '30s kind of number sustainable quarterly on a go-forward basis?

Yes. Seth, there is some cyclicality in the SG&A as you've seen historically from us. It's just timing of some of the expenses that happened. But we do expect our operating leverage to improve throughout the second half.

Okay. Excellent. Thanks very much.

Your next question comes from the line of Michael Ciarmoli with Truist Securities. Please go ahead.

Hi, good evening, guys. Thanks for taking my question.

Hi, Michael.

Hi, Michael.

Hi, good progress, good results here. Just a point of clarification back to Pete's first question. The first half flat and I always appreciate the conservatism, but should we expect revenues to be down kind of in that 15% sequential range, I mean from a -- just to think flat year-over-year?

Well, I think what we said is for the full year, we expect our revenue to be roughly in line in the first half. The thing that we're really focused on is the exit run-rate coming out of the year. You know, with the things that we're focused on our four priorities, the progress that we make in the first half of the year and coming out of the first half. We're really, really focused on the impacts of that focus and how it drives our run-rate coming out of '25 leading into '26. So that's really where our focus is right now. But what we said is, first half roughly in line with last year and we did have a little bit of pull forward from Q2 into Q1, but I appreciate that our focus is really on driving the exit run-rate coming out of the year.

Got it. Got it. And then I guess just on that exit run rate, is there any way to quantify? I mean, if you get to full capacity on the common processing architecture, I mean, can you maybe help us out with kind of the overhead absorption, what the drag on gross margins are now just and getting full volume through on the end of the year?

Yes. I mean, I'll comment on the things that we're thinking about as the drivers on that exit run rate and it aligns with our priority focus. So first, it's continuing to drive down the volatility in the business, getting the common processing architecture line up to full rate production. Second, it's on our bookings and our organic growth focus. It's on the mix of bookings. And in this case, it's also on the margin in our bookings based on the dynamic that we talked about of our backlog margin being a little bit lower than what we'd expect to see on a go-forward basis driven by some low-margin development programs and EAC impacts from last year. And we are feeling good about the new bookings coming in and being accretive to our backlog margin and in line with our target margins aligned with our target profile. And also the progress that we make, on the working capital front and how we're able to allocate increased capacity away from deliveries on the large unbilled balances that have very little revenue with them and over to programs that do have a higher revenue content. So I mean that there's nothing new in what I just said, that's what we've been focused on for the last year plus. And those are the areas that really are going to drive our velocity and our run rate coming out of the year, both top-line and on the bottom-line.

Got it. Got it. Just last one, I'll jump-off. Just on those production bookings that you're getting, especially if it's kind of a core legacy program, I'm not talking about the new CPA bookings. I mean do you see that line-of-sight to gross margins maybe at or above the 40% level?

We -- Michael, it's Dave. We do see that you know and have spoken about, we expect those margins to be in line with what our target model is for production. So -- and we have been seeing that, as Bill indicated in Q4 and Q1 bookings on those production activities.

Okay. Perfect.

Yes. I think the other add here that I -- I'd emphasize is just the mix too. We're seeing in this quarter, an even heavier mix toward production, which I think is helpful to the margin story going forward as well.

Got it. Very helpful. Thanks, guys.

Yes. Thank you.

Your next question comes from the line of Conor Walters with Jefferies. Please go ahead.

Hi, guys. Thanks for taking my question and congrats on a great quarter.

Hi, Conor.

Hi, Conor.

Maybe sticking with the bookings, you're clearly making great progress here, given the 90% production mix in the first quarter. This seems to be much-improved from the 80% on fixed-price programs you mentioned throughout fiscal year '24. So curious if this provides any clarity or better line-of-sight on that timing for mix normalization of that 80/20 mix you've talked about previously?

Yes. I think this quarter our bookings overall were greater than 90% production. And I think we had a pretty heavy mix of firm fixed price this quarter. So you can -- last quarter we did say that of our firm fixed price bookings, a certain amount were production, but in this case, it was 90% of our overall bookings, which I just think is further an indication the shift in the mix.

And I think from the standpoint of you know of when is our magic point where the 80/20 is crossed, I think we've seen a significant shift, as Bill said, in those production activities that should really be manifesting itself in the second half of the year. So we absolutely see ourselves moving in the direction we've been discussing.

Okay, great. That's very clear. And then just one more from me. As we look at the R&D spend, much-improved this quarter. And as we think about the progress you've made since standing up the advanced concept groups recently, just trying to make sense if this is whether you have truly more efficient spending with customer funds or how we should be thinking about that over the duration of the year into next.

Yes. I think it's a combination of factors. We have completed some internal projects. We have definitely streamlined our focus. And in Q1, you could see the increased allocation toward customer-funded development programs and production programs. I do think we'll see an incremental lift in R&D as we move through the year and we're able to free-up some resources and target it back on internally funded innovation. But as I said earlier, I don't expect major swings. These are more incremental adjustments.

Perfect. Thanks so much.

Thank you.

[Operator Instructions] Your next question comes from the line of Ronald Epstein with Bank of America. Please go ahead.

Hi, guys. Good evening.

Hi, Ron, good evening.

Hi, Ron.

A couple of quick ones. What are you seeing in your supply-chain and your suppliers? You didn't talk about that too much. And I mean, are there still challenges or not? How is that going? And maybe as a follow-on to that, what's going on with your own workforce in terms of having enough folks and retaining them and so on and so forth, because it seems like kind of across the industry, workforce and supply-chain have been an issue?

Yes. I mean, I'll start with the workforce first. I mean, they're central to everything that we do and we're very focused on our talent in the organization. I would say that at the current point, I don't see significant constraints on our performance tied to either workforce or supply-chain right now, but we are always focused on those two areas, but not seeing any significant constraints.

Yes, I think I would -- Ron, this is Dave again. I would add from a supply-chain suspect perspective, we haven't seen an elongation of lead times beyond kind of where we've been. We haven't felt that. I mean, are there occasional things that pop-up and we got to go figure out, hey, can we accelerate that? How do we get that? Yes. But I would not say there's a systemic thing that we've seen at this point.

Got it. Got it. Got it. And then maybe one more if I can. How should we think about free cash flow generation as we go out over time? And when would we expect that kind of more in line with your EBITDA or your net income, that kind of thing?

Yes. We did have -- as you recall, we had a very significant positive cash flow for the fourth quarter. The first quarter, as Bill discussed, we were negative, but much-improved from a year-ago. There were a couple of things that timing-wise just fell into the very start of the second quarter and we would have been breakeven or positive in Q1. We expect to be positive for the year and we expect to have a stronger second-half than a first-half. And we've talked about there -- we believe that this business is -- should be and will be a consistent positive free cash flow generator.

Got it. Okay. Thank you very much.

Yes. Thank you.

Mr. Ballhaus, it appears there are no further questions. Therefore, I would like to turn the call back over to you for any closing remarks.

Okay. Thanks, Krista. Well, thanks, everyone. Appreciate you taking the time to join us for our Q1 FY '25 Earnings Call, and we look forward to another update a quarter from now. Take care.

This concludes today's conference call. Thank you for your participation, and you may now disconnect.