Good day everyone and welcome to the Mercury Systems fourth quarter fiscal 2021 conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would 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 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 Mark and I will be referring to is posted on the Investor Relations section of the website under Events & Presentations. Please turn to slide two 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 as well as Mercury's new value creation initiative which we call 1MPACT. 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 would also like to mention that in addition to reporting financial results in accordance with Generally Accepted Accounting Principles, or EBITDA, 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 will now turn the call over to Mercury's President and CEO, Mark Aslett. Please turn to slide three.

Thanks Mike. Good afternoon everyone and thanks for joining us. I will begin with a business update. Mike will review the financials and guidance. And then, we will open it up for your questions. Our results for Q4 and fiscal 2021 was strong led by robust design wins and double digit growth in revenue and adjusted EBITDA. It was, however, a more challenging than we anticipated and we believe that fiscal 2022 could be similar. That said, the team is doing an outstanding job of managing, derisking and growing the business and we are beginning the year with over $900 million of backlog. The secular growth trends benefiting Mercury also remained favorable and we are well-aligned with the national defense strategy. The government continues to push for modernization, speed and affordability in both sensor and effector mission systems and C4I. As a result, our five-year plan remains intact, that is to deliver high single digit to low double digit organic revenue growth averaging 10% over time, coupled with M&A and margin expansion. Since fiscal 2014, we have completed 13 acquisitions, multiplying the size of the company, delivering significant synergies and creating substantial value for shareholders. As we cross the $1 billion dollars revenue threshold in fiscal 2022, we are taking proactive steps with an eye towards repeating what we found over the past seven years. This afternoon, we announced a company-wide effort which we call 1MPACT to lay the foundation for our next phase of value creation at scale. The goal is to achieve Mercury' full growth, margin expansion and adjusted EBITDA potential over the course of the next five years. Before talking more about 1MPACT, let's take a quick look at our financial results on slide four. We delivered strong fourth quarter results, as anticipated. Bookings came in as…

Thank you Mark and good afternoon again everyone. As usual, I will start with our Q4 and fiscal 2021 results and then move to our guidance for Q1 and full year fiscal 2022 I will conclude with some details on the magnitude and timing of potential financial benefits from the 1MPACT effort that Mark just discussed. We finished fiscal 2021 with a strong fourth quarter and delivered record revenue, adjusted EBITDA and adjusted EPS for the year. As Mark mentioned, entering fiscal 2022, we are expecting flat organic growth but double digit total growth, strong results on the bottomline and a substantial rebound in our bookings. As a result, we believe that we are well-positioned for a return to high single digit, low double digit organic growth in fiscal 2023. In addition, we expect adjusted EBITDA margins to expand in fiscal 2023, driven by positive operating leverage in addition to benefits of the 1MPACT program. Turning now to slide ten. Mercury delivered solid results in Q4. Total revenue, adjusted EBITDA and adjusted EPS all met or exceeded our guidance. Our Q4 bookings and book-to-bill were strong as the bookings environment began to improve from this slowdown we experienced through the first three quarters of fiscal 2021. Bookings for Q4 were $260 million, down 7% compared to Q4 2020 when we had a record bookings quarter. Bookings were up 24% compared to last quarter as we saw a rebound in activity. Q4 book-to-bill was 1.04. Revenue for Q4 increased 15% from Q4 2020 to $251 million, which is above the top end of our guidance range of $236.5 million to $246.5 million. Organic revenue was $210 million and acquired revenue, which included Physical Optics Corporation and Pentek, was $40.8 million. Our acquisitions continued to perform well as we integrate them into…

[Operator Instructions]. And our first question is going to come from the line of Sheila Kahyaoglu, Jefferies. Sheila, your line is open.

We would like to go to the next question.

I think we will skip that question. Sheila, if you can requeue. Our next question is going to come from the line of Seth Seifman with JPMorgan. Ladies and gentlemen, stand by.

Sorry. Hold on. Can you hear me?

Yes. We can hear you now.

Yes. We can hear you now.

Okay. Thanks. Sorry. Yes, so a question about growth and I know you discussed it. But I wonder if, I am still having a little bit of trouble understanding the pace of growth, why it has slowed so much, I guess? We don't see necessarily your customer on F-35 having the same issues in the relevant segment. And taken all together, what accounts, especially for the reduction that we are going to see in the September quarter, when the Q comes out in October, what subsegments of your sales will we see the most impact? And then sort of what gives you confidence in this point in the kind of, it looks like apparently very sharp increase in sales that we are going to see the rest of the year?

Sure. So a lot of questions there, Seth. Let me kind of just maybe unpack it and try and recap what happened in fiscal 2021 in terms of revenue and bookings. So as we tried to say in the prepared remarks, what we really saw during the year was that orders were progressively delayed beginning in the first quarter as a result of really three things, COVID, customer execution issues on various programs and the change in the administration. All those things actually resulted in more than a five point reduction in organic growth, ended up being around about 6.5 points actual reduction spread across the F-35, SEWIP and other naval programs as well as the FMS. And so if you kind of simplify it without those pressures, the FY 2021 organic revenues would have been ended up being consistent with historical organic revenue growth rates of high single digit to low double digits. Peeling back the onion a little bit, so the naval and SEWIP upgrades had an approximately three point impact, international FMS sales, the large order that moved or the large program that moved from the first quarter ended up being around about 1.5 points. And then F-35 Intel was around about two points. Now if you look at those programs, right, they are all really good programs and they actually, in the main, performed pretty well. So revenue was up double digits on F-35. We were up double digits on LTAMDS. We are up double digits on Filthy Buzzard. But just some of the growth that we experienced maybe wasn't necessarily as high as what we thought coming into the year. SEWIP was down a little bit for the year. So those programs that I just mentioned are really all great programs for us and expect it to continue to grow over the course of the next five years because we believe that they are well aligned with the overall national defense strategy. o big picture, that's kind of what happened and from a revenue perspective and it's a very similar story with respect to the impact on organic growth and bookings. So F-35 had a three point decline in organic bookings. The large FMS contracted a 3.5 point impact on organic bookings and Filthy Buzzard was around about a point. So it was really all related to the timing of the awards and we do expect that things kind of both bookings will rebound in fiscal 2022, accelerating in fiscal 2023.

Thank you. And our next question will come from the line of Peter Arment with Baird.

Yes. Good afternoon Mark and Mike.

Hi Peter.

Hi Mark. Mark, maybe just to come at it a different way. Maybe just can you talk a little bit outside of those programs? I mean the diversity you kind of highlighted within your revenue mix, but yet you are still kind of forecasting a downtick in flat overall growth, mid single digit to high single digit down to kind of flat growth. So maybe what are you seeing on a broader aspect that's maybe harder to call out for us to see because it's not one big program as you first stated? Thank you.

Yes. So I mean we have got a pretty significant base of programs, as we have discussed in the past. And no single program has accounted for 5% to 6% of total company revenue and we expect that to continue going forward. Part of the challenge that we have had, though, Peter, I think it's part of the impact that we are seeing is that when you have movement concentrated in your, call it, top five programs, which is really what we experienced last year, it does have an impact. And that's, in essence, what we have seen. And the impact that is a result of the reduction in organic growth in fiscal 2022 versus what we thought last quarter, many of it is us being just more conservative in the programs that I just mentioned, really as a result of the impacts that we saw throughout fiscal year 2021. So in essence, we are taking a more conservative approach to the year. And then probably the biggest change that we had since last quarter or since the last call was on LTAMDS. And on LTAMDS, we were expecting a significant order in the second quarter. And now as a result of some changes that Raytheon had discussed, we have taken LTAMDS, that large award, out of our fiscal year 2022 and into our fiscal 2023. We will still have bookings and revenues associated with that program, but we just won't have as much as what we had previously. So it really does come down to just the major impacts that we are seeing on some of these programs that are affecting the overall growth. We are still expecting significant growth from our top 20 programs in fiscal 2022. We are expecting that growth in bookings will accelerate substantially in the second half. And again, we are expecting very significant growth across these programs. So F-35, Filthy Buzzard, F-18, which is a new program for us, SEWIP and then the large FMS programs are all expecting to grow substantially on a year-over-year basis.

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

Hi. Good afternoon. I guess the one thing I wanted to ask on the 1MPACT program is, can you give us a sense of how this maybe goes above and beyond your typical sort of streamlining efforts when you are doing acquisition integration? And what sort of led you to go down the path of, I guess, wanting to deliver more of that operating leverage this year as you think about structuring for 2023 and beyond? Thank you.

Sure. Good question, Jonathan. So if you think about the journey that we are on and we tried to outline some of that in the prepared remarks, since 2014 we have completed thirteen acquisitions. We have had a greater than 4X increase in revenues over that period and greater than 9X increase in EBITDA. So we have extracted substantial revenue synergies that's resulted in us basically reducing our net to gross purchase price multiple. However, along the way, if you step back, there's been some very substantial changes in the company overall. So we have had a 3.5X increase in our headcount. We have seen an eight-fold increase in our subsystems revenue. The number of locations that we have, have increased from 10 to 27. And our external supply chain spend has increased 3X. So in that period, we have really optimized for growing the business. And with growth slowing a little bit organically this year, earlier in the year we figured that there was an opportunity for us to kind of go back, take a look at what other opportunities existed to further consolidate the businesses that we have acquired to extract even greater cost and revenue synergies. That being said, 1MPACT is really all about laying the foundation for future growth. We think that we have the potential to be a multiple of our current size. But in essence, crossing the $1 billion revenue threshold is a milestone, but it's also a turning point. And we know that there are certain things that we need to focus in on to continue for us to grow and scale the way in which we would like to. So we have basically taken a pretty comprehensive look, kind of top to bottom, left to right, across the business. And the six areas that we are focusing in on that we really began the efforts in the first quarter was around org efficiency and scalability. So we saw an opportunity of streamlining the business, consolidating where appropriate. Those activities began in the fourth quarter and they have accelerated in Q1 with the numbers that Mike announced. Beyond that, the areas that we are going to focus in on are continued improvements around procurement and supply chain. We see the opportunity as we continue to streamline and optimize the business to also optimize our facility footprint. We are going to continue to look at investing in R&D, but looking at ways in which we can maybe doing it more efficiently. And similarly, across the capital base and balance sheet are the ways in which we can be more efficient there also. But again, to reiterate, it's all about future scalability and for Mercury to achieve its full growth potential both organically as well as through M&A and maybe even accelerating and expanding margins over time.

And our next question will come from the line of Michael Ciarmoli with Truist Securities.

Hi. Good evening guys. Thanks for taking the questions. Maybe, Mark, I think you called this may be transitory. But organic growth has been sliding here for a couple of years. Gross margin has been declining for several years. You guys are looking at 1MPACT, I mean, in thinking about structural changes versus the transitory changes. How are you contemplating that? And I guess, just to be clear for housekeeping, without the $22 million in 1MPACT savings, I mean, there would be some significant margin compression at the EBITDA level next year. So is anything else, from a mix perspective, changing on you guys?

So let me talk a little bit about the rebound in growth in 2023 and maybe kind of what's driving the five-year outlook. And then Mike can maybe touch upon the margins that you mentioned. So we do have really increasing confidence that our growth will return, based upon an expected accelerated bookings throughout fiscal 2022, in particular, in the second half as well as substantial growth in FY 2023. The growth is likely going to come from our top 20 programs, which we expect to accelerate in the second half of 2022. We expect the growth to be up greater than 20 points. And we are expecting an acceleration of bookings from those programs, again, as we head into 2023. It's many of the same programs that we have talked about. So substantial ramp on the F-35. LTAMDS, we are expecting to more than double in 2023. Filthy Buzzard will grow substantially. And then beyond those key franchise programs, there's other programs that we expect, new programs for Mercury, either acquired programs or new design wins, that are also poised to contribute to additional growth in the 2022, 2023 time frame. Programs such as the V-22, F-18 as well as T-45. So we have won some great programs, all aligned with the national defense strategy, we believe. And the reason that we are saying the things are transitory is because we believe that speaking to our customers that it's literally been the timing of specific orders. If you look out farther in time, Mike and you consider kind of our strategy over the five years, it really hasn't changed. We are still expecting that over the course of the five years that we are expecting to be able to grow the business at high single digit, low double digit…

Yes. Hi Mike. And I think we can talk about two things. Talk about the EBITDA margins, just to give a little color on that. And then we can talk about gross margins too. But let me just start with EBITDA margins. And I would start by saying, overall, the profitability of the base business hasn't materially changed over the last couple of years. You do have to look at our EBITDA margins, with and without POC acquisition in it, because it does have a dilutive impact which is important to point out. If you look at where we were in fiscal 2020 from an EBITDA margin perspective, we were 22.1%. We came down a little in fiscal 2021 to 21.9%. But again, POC, as I mentioned, had about a 30 basis point dilutive impact. So we would have been at 22.2%. So slightly up from fiscal 2020. And then when you look at fiscal 2022, the midpoint of our guidance is 22%. But again, as I mentioned in my prepared remarks that POC acquisition, now that we will have it for a full year, has a 100 basis point dilutive impact. So it would have been 23% otherwise. And what we are seeing there is that we have some negative operating leverage because of the flat organic growth in fiscal 2022 and that's being offset by some of the 1MPACT initiatives that we talked about. And when you look at it just on the base of 21.9% compared to 22%, which is the midpoint of our guidance, think about it like this, is that we have got dilutive impact from POC year-over-year. We have got production programs pushing to the right, like Mark discussed and then some of the negative operating leverage that I mentioned. But looking forward to fiscal 2023 is important because as we go into fiscal 2023 and we return to organic growth, we are going to have the programs transitioning into production, which is going to lead to gross margin expansion and EBITDA margin expansion. We are not going to have the headwinds from negative operating leverage and then we will see the benefits associated with the 1MPACT program. So we are expanding margins in 2022, but we think there's a lot of benefit when we start looking at EBITDA margins in fiscal 2023. And gross margin is a similar story.

Yes. So if you go back to it, Mike, what I said, right, I mean, if you look at for the year, organic bookings were impacted throughout the year which impacted organic revenue. And at the end of the day, it was three points on SEWIP and various naval surface program upgrades. We had 1.5 points on international FMS, which is the large order that moved revenue-wise from the first quarter. And then approximately two points of impact on the F-35. Absent those, our organic growth rate would have been absolutely in line with what our goals and objectives are, which is to deliver high single digit, low double digit organic growth coupled with M&A. So it's unfortunate. But when you boil it down, it comes down to just some delays associated with various programs.

And our next question will come from the line of Sheila Kahyaoglu with Jefferies.

Hi. Good afternoon guys. Can you hear me now?

Yes, we can.

We can, Sheila, yes. Yes.

Sorry about that. First time, first question in a decade and I have screwed up. So I wanted to ask about 1MPACT a little bit more and I apologize, but I just don't often hear about 22% margin companies talking about realigning their cost structure. So Mark, you mentioned some facility rationalization. You just went through a CapEx upgrade. So is this going to be like a gross margin target area? And I understand some of your commentary around R&D and utilizing it better, just given how much you have expanded. But how do we kind of expect that to trend as a percentage of sales?

Sure. So I will talk again just in a little bit more depth about the areas, right. So to be clear, I see, this 1MPACT activity was contemplated really not related to some of the challenges, I guess, that we faced on the timing of various orders during fiscal year 2021. We see that crossing our $1 billion revenue threshold is a milestone, but it is an inflection point. And with all of the change in the business, effectively acquiring a company two times our size, but doing it through 13 acquisitions, we have extracted a lot of synergies, but we knew that there was probably more value to be had and we have been very, very focused in optimizing for growth. We see the opportunity, really, I guess, in fiscal 2022 is organic growth rate really just takes a bit of a pause to go attack that. And so we have already done a lot of manufacturing consolidation, right. So we moved from five RF manufacturing locations on the East Coast down to one major site. We just completed a similar activity from three to one on the West Coast, kind of building in scalability. But we have still gone from 10 to 27 locations. And I think there's an opportunity for us to continue to optimize our facility footprint while us continuing to improve delivery to customers at the same time. The actions that we began to take in Q4 and Q1 was really about streamlining and optimizing the org structure, again, as a result of the cumulative acquisitions that we have done. We have been fully integrating them. But because the structure itself and the way in which we are organized actually drives the cost footprint of the business, we took an opportunity to kind of step back and take another look at it to drive additional savings. So Mike, do you want to talk a little bit about what you might see happening with respect to overall margins, over and above the planned margin expansion that we are anticipating as a result of 1MPACT?

Yes. So Sheila, first of all, we are still in the planning phases of 1MPACT. And so we will have more information and more detail as we move along. In terms of, you asked about R&D as a percentage of revenue, where that might trend. Stepping back pre-1MPACT, we had always talked about as you look over a five-year period margin expansion. And we thought that was going to come from a handful of areas. That was program, product mix as programs transition from start-up phases into full rate production that has higher margins. We thought it was going to come from operating leverage. And we thought it was going to come from R&D leverage as well as we have been investing heavily and we can leverage some of the R&D investments we are making in areas like security and safety across more of our products. So we expected R&D as a percentage of sales to come down, driving margin expansion over our five-year plan. We still expect all of that. And what 1MPACT is in the numbers that we threw out in terms of $30 million to $50 million potential EBITDA improvement is above that margin expansion that we already expected. Now the amount in each of the areas that Mark discussed, we are still working through that in terms of what's going to be the amount around direct procurement and the amount around R&D and other areas. So we will provide more information as we go on that. I think that if you look in the out years, though, the margin expansion opportunity on top of where we already were is 200 to 300 basis points.

Yes. So the way in which we are thinking about 1MPACT, Sheila and this was kind of the primary focus when we were contemplating the activity, was related to M&A. And so as you know, we are a highly acquisitive company, 13 acquisitions over the course of the last seven or so years. Serial acquirers, fully integrating those businesses. And we have done a really good job, again, extracting cost and revenue synergies with EBITDA growing at twice the rate or twice the multiple that revenue has over that time frame. But as we look forward, the idea was to basically transform the way in which we are doing things to try and improve the scalability, the efficiency of the work and simplifying things along the way. And so we are applying 1MPACT on ourselves to begin with, which we think that will allow that two to three points of incremental margin expansion over and above what we have been previously anticipating over time. But the goal is stand up this transformation office and then to use the processes and the methodologies associated with 1MPACT to all future acquisitions. If we do this right, we think that we should be able to extract even greater synergies from the deals that we do going forward and we should be able to extract those synergies more quickly. So it's about the future. It's about Mercury kind of achieving its full growth and EBITDA potential, both organically as well as through M&A.

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

Hi guys.

Hi Austin.

Hi. Just my first question here. Do you anticipate any future acquisitions in fiscal year 2023 or beyond once this 1MPACT restructuring is completed? Or is Pentek sort of it for a while?

No. It's a good question, Austin. So we don't see 1MPACT actually slowing down our M&A activities. So the M&A market is very, very active right now. Deals of various sizes, kind of all in line with the core of our strategy. And you will continue to see us acquire businesses that fit with the core of the strategy. So we are not expecting 1MPACT to stall M&A. That's not the intent at all.

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

Okay. Well, thank you very much everyone, for joining the call today. We look forward to speaking to you again next quarter. Thank you.

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