Good day, everyone, and welcome to the Mercury Systems First Quarter Fiscal 2024 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 President and Chief Executive Officer, Bill Ballhaus. 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 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, 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, Bill Ballhaus. Please turn to Slide 3.

Thanks, Dave. Good afternoon, everyone. Thank you for joining our Q1 FY 2024 earnings call. Today I'd like to talk through three topics: first, some introductory comments on our business and results. Second, an update on the progress we are making in each of our four priority areas that we outlined in our last call: delivering predictable performance, building and thriving growth engine, expanding margins and driving improved free cash flow. And third, expectations for our performance both for FY 2024 and longer-term. Then I'll turn it over to Dave, who will walk through our financial results and guidance in more detail. Please turn to Slide 4. Since our last quarter's call and during my first full quarter in the business, I've had the opportunity to meet with a number of customers, visit our Mercury teams and facilities domestically and abroad and deepen my understanding of the underlying opportunities and challenges in the business. As I said last quarter, I am optimistic and confident in our strategic positioning as a leader in mission-critical processing at the edge, the attractiveness of our business model and our outlook over time to deliver predictable organic growth with expanding margins and robust free cash flow. In the near term however, we are addressing two transitory dynamics in our business that are impacting our financial results. First, a high mix of low-margin development programs that we expect to eventually transition into a portfolio of predictably performing production programs; and second, an increase in working capital over the last few years, namely in unbilled receivables and inventory that will convert over time into significant free cash flow. I'd like to provide a little color on these two transients, before turning to our priorities including how we are addressing these dynamics. Please turn to Slide 5. With…

Thanks Bill. I'll start with our first quarter fiscal '24 results and then discuss our full year fiscal '24 guidance. As Bill mentioned in our first full quarter at Mercury, we have spent considerable time visiting our facilities meeting many of our employees and deepening our understanding of the capabilities and challenges in the business. I continue to be impressed by the breadth of innovation throughout our program offerings as well as the unwavering commitment of our employees to deliver mission-critical processing to the edge. It has also become increasingly evident that our near-term focus on developing a mature integrated management operating system is the anchoring point from which we can achieve predictable performance and deliver differentiated end-to-end processing solutions that our customers demand. Turning to our first quarter fiscal 2024 results. As expected our financial performance was below that of the prior year across all P&L metrics. As discussed in our last earnings call, fiscal 2024 is a transition year, where the organization is dedicated to executing on our challenged programs, most of which are development in nature and then progressing to the follow-on production awards. Through that transition, we will recognize the small proportion of remaining revenues on the challenge program contracts. But more importantly, we will move toward releasing the significant working capital balances that have accumulated, particularly within unbilled receivables. We will then shift our resources to execute on the follow-on production awards, which will begin to rebalance our program portfolio more heavily towards higher-margins predictable production programs, as well as consume existing inventories. We expect this transition to occur throughout fiscal 2024 and into fiscal 2025. In Q1, we made progress towards this rebalance through the complication of two additional challenge programs and are on track to complete at least five challenged programs in the…

Thanks Dave. With that operator let's proceed with the Q&A.

Thank you. Ladies and gentlemen, at this time, we would like to open up today's call for the question-and-answer session. [Operator Instructions] Our first question comes from the line of Ken Herbert with RBC Capital Markets. Your line is live.

Yes, hi, good afternoon gentlemen.

Hi Ken. Good afternoon.

Maybe Bill or Dave I just want to make sure I've got this correctly. So, it sounds like you've you're targeting sort of five of the programs of the 20 programs to be complete by the first half, which if I understand properly, you did two in the fourth quarter and two this quarter, so that implies one in the second quarter? And then you've said a majority is so implying sort of at least five to six in the second half of the year. Is that the right way to think about the pacing of these? And is there any opportunity to maybe accelerate the completion of those programs in the second half of the year?

Yes Ken, this is Bill. First of all, I think that is the right way to think about it or at least that's how we're thinking about it in terms of pacing. And while that is the majority of the programs, I think it puts us on a good track to unlock a significant amount of bookings and that's what we're really focused on. We want to get the development programs done. We want to execute predictably on them so that we can mitigate any EAC impact or gross margin impact tied to our mix. And what we're really interested in is as we complete these development programs pull that margin mix pressure and uncertainty out of our results unlock the bookings that lead to the attractive production programs and with that free up unbilled and generate cash. So, that's why we're so focused on it from a pacing standpoint. I think what you articulated is consistent with our expectations.

Okay, great. And Bill on those programs it looks like there was a little bit of cost creep especially with one particular program in the first quarter, is the run rate of sort of the $6 million for the development programs at $12 million for the other sort of programs, which sounds like that $12 million was initially contemplated in the guidance. But that $6 million on these programs, is that something that should significantly step down in the second quarter? Or how should we think about that from a modeling perspective?

Yes. Obviously, our goal is to see that step down over time. If we look at the $18 million, and just unpack, that I'd say that about one-third of that is ordinary course that we would expect to see. And as we said in our remarks, we saw it targeted it identified it early. And over time, the $12 million the other $12 million we would like to see that come down over time. And we've mentioned in our last call and reiterated this call, we've really increased the rigor and scrutiny that we're putting into these development programs. I think a big difference from how we're executing today is, we've got a weekly rhythm in place on our development programs and our production programs, so that something comes up from either a technical standpoint or a production standpoint, we can jump on it early and mitigate the impact. We put increased rigor in our monthly processes around EACs, et cetera. So, over time we would expect to see the impacts be mitigated from what we've experienced this quarter and historically and that's certainly our goal.

Yes. And I think one of the things, certainly for us was that we didn't -- that we said -- we saw growth, but it was largely nontechnical in nature. So it wasn't because there was new technical challenges that we had to go solve. So the risks we identified around those things are -- seem like they're the right risk still, and we're working our way through them. I think ideally as Bill said, I'd love to be in a mode, as we go forward where we get down the road and we don't see this kind of change in some of these EACs. But frankly, the fact that on the challenged programs it was one EAC that was that grew by about $5 million and the balance of that the roughly 20 programs was only $1 million was really a positive fund.

Yes. So those 20 programs, just over the course of the last 90 days, we've seen a lot more stability. And as Dave mentioned on the one program, where we did see cost growth it was primarily bill and material related and there were shifts in assumptions around quantities that drove pricing, et cetera. So without getting into too much detail, it's something that wasn't technical in nature in the balance of the 20 programs, we saw a lot more stability than we've seen historically.

Great. Appreciate all the color. I’ll pass it back there. Thank you.

Okay. Thanks, Ken

Thanks for your question.

[Operator Instructions] Our next question is from the line of Michael Ciarmoli with Truist Securities. Your line is live. Q – Michael Ciarmoli: Hi, good evening, gentlemen. Thanks for taking the questions here.

Hi, Michael. Q – Michael Ciarmoli: Bill you obviously, you gave a lot of detail there. And I guess to put it maybe simplistically I mean you laid out the $18 million of cost growth. You talked about more run rate savings, I think to the tune of $24 million. You kept the guidance. I mean there was a lot of information. I mean are you guys on plan tracking, better than planned, worse than planned? I mean what's the quick simple assessment of where you are right now?

Yes. I'd say look, when it comes to the challenged programs we talked to the fact that we put a pretty detailed scrub, across those programs as we went through the first quarter. So personally for me, I was disappointed to see the magnitude of the impact that we saw on the development programs. The $18 million about one-third of it I think we would consider expected. But for me seeing cost growth on one of the 20 programs, I don't feel great about that. And we saw about $6 million across a number of other programs that it was just like one small thing after another. I do expect to see the impact from these programs go down with time. As we just keep driving increased rigor, putting attention on these programs, program by program and when something comes up jumping on it quickly. So I'd say from that standpoint probably beneath our expectations. That said, as we look ahead we've got pretty good line of sight on follow-on production programs and bookings coming as we're completing and making progress on these development programs. And just based on that line of sight we feel good about the back half of the year as we articulated in our guidance. But I'd say the one area where I was a little bit disappointed in ourselves was the amount of EAC growth that we saw. But other than that pretty much within our expectations.

I think Mike that we recognize and I think we said, initially when Bill and I did the last call that we saw still risk but the risk was largely first half weighted. So not – I mean frankly, we're both expect a lot from folks. So it would have been – it wasn't perfect for sure. From a – Bill talked about the cost growth but from a revenue standpoint, we absolutely entered in our minds with a plan that the first half would be lower and I think we talked about that. And as we were looking towards not trying to pull a bunch of costs onto the balance sheet we talked about that. And to position ourselves for growth in the second half and to get these programs done and we spent a huge amount of the capacity of the firm working towards getting these programs done. And making sure we're ready at the – when we get into the second half and we expect as we said some significant awards in Q2 that we're ready to produce on those contracts as we go one of the things that was actually really strong and was good to see was on the production side of the business, which is 60-plus percent. I mean we absolutely – the team nailed it that the margins were right in line with what our expectations were. And so that gives us a really good sense of the strength we have in the back half of the year.

And as Dave said, we came into the year expecting that the first half will be down. The first quarter would be down. And if you just look at Slide 11 and walk top to bottom on that chart, it's pretty understandable as to where we are versus last year. We talked for instance about the large booking that we got in the year and we only recognized a portion of it. We talked about the revenue differential and the fact that the bulk of the revenue change year-over-year is tied to our overtime contracts and we are deliberately timing material to be much more efficient and linking it to the just-in-time need of our hardware. And then when you look at the gross margin differential, we talked about the impact of the development programs and adjusting back for the impact of the development programs the gross margins were largely consistent with our expectations. So I think that should be a pretty good indication that our results in the quarter, while they're down year-over-year, we expected them to be down. And I think we've got good line of sight around those variances. And as we look forward, we can see how driving execution on these development programs is going to lead the bookings. It's going to take variability out of our performance as we mitigate the impacts of the EACs and cost growth et cetera. And as we move hardware through the factory and time material more closely to hardware delivery, we're going to improve dramatically the free cash flow of this business. So it may sound odd, but I think we feel pretty good about where we sit right now. Q – Michael Ciarmoli: Got it. Thanks guys. I will keep it to just one. Thanks.

Okay. Thank you.

Thank you for your question. Our next question comes from the line of Sheila Kahyaoglu with Jefferies. Your line is live.

Hi. Good afternoon, guys. How are you?

Hi, Sheila.

Hi, Sheila.

Doing well.

Thanks. Good afternoon.

So I just wanted to go over a few things as possible on the top line and the bookings. Maybe if you could square away, what's happening with the top line a little bit more? I know you guys talked extensively, but are you kind of accounting for it in a different way? Does overtime revenues that are kind of what happens to how you account for it based on a material and labor way? And are you also saying that the revenue recognition left to do on the challenged programs is very small? So what part of the top line is driving the organic decline I guess I would...

Yeah. This is Dave, Sheila. I would not say -- we're not accounting for anything differently. It's the same accounting obviously and we're recognizing the material and the labor as we progress. And the one thing that's happened to the business in the past is we brought in a bunch of that material and Bill talked about this. We brought in a bunch of material and applied labor to it early on in the process. And for lots of reasons some of those reasons were go back way in time when supply chains were completely going haywire because of COVID which is long behind us. And -- but some of that practice was -- would bring it in as early as possible and start progressing it and then get to a stage, it would sit on the balance sheet until it was ready to be progressed further. And so we intentionally said, let's not do that. We don't need to do that. Supply chain stable enough now there's some long lead stuff that still freaks everybody out in the industry and we all know that. But let's make sure we're not bringing it early. We're not trying to progress it ahead of when it's needed. And so that really did lead to a significant decline in the overtime revenue. We expect that we'll still have that material and be able to progress it with the labor we need to and largely that's going to happen in the second half and we'll be able to bring it in. At the same time, as we get the new programs you'll see, a bunch of the inventory we've got progressed too into those projects and products so that that will show up as revenue where today it does not. But I thought one of the things that was a positive. If you look at our inventories and you look at the 10-Q, you can see that the inventories grew $26 million, but $21 million of that growth in the quarter was work in process not raw materials. So it's activities that we're progressing towards final product, so that we can ship it. So it's stuff that's making its way through the pipeline. So I don't think Sheila, there's been a big change other than us trying to be more just in time and trying to get ourselves in a better position from a working capital standpoint which I think is critical to the business.

Well, I would say that our focus on working capital really has two pieces to it that are really important. One is our focus on hardware delivery, so not just progressing hardware, but actually completing hardware, getting it out the door so that we can invoice and collect cash. Now, because we've recognized revenue on a number of programs that have the large unbilled balances and in many cases its most of the contract revenue, completing the hardware may have very little revenue associated with it in many cases, but it's what we have to do in order to invoice and collect cash. So part of the dynamics that you're seeing is us being focused on allocating factory capacity to hardware that we need to get out the door, so that we can collect cash that may have a small amount of remaining revenue to be recognized. Hopefully, that additional color is helpful.

Yeah. It does. Maybe just switching a little bit of gears, can you then talk about how you're thinking about some of the bookings element of it just down 30%, you mentioned a big component of that is system orders you're waiting for, complete the development program. But how should we sort of think about that timing disconnect that you're only going to go complete 11 of the programs this year. So kind of when bookings front I guess?

Yeah. Well, I'll tell you, we expect to see the bookings improve as we go through the year, starting in Q2. And we've got pretty good line of sight to a small number of good-sized bookings that we expect to see coming in starting in Q2. And I'd also point to the large award that we mentioned where we only recognized a fraction of it in Q1. So those are a couple of the dynamics that are happening on the bookings front.

And I think …

Thank you.

And I think, Sheila one of the things -- this is Dave again. One of the things you'll see as a significant ramp up our backlog to set ourselves up for the second half of the year. Bill talked about a couple of the programs. Just generically we don't go through programs, individually and talk about bookings before they're coming in, but we definitely have line of sight on a couple of those significant bookings. We're not intending. And don't need all of the challenged programs to finish. The ones that are driving the most significant bookings are largely in the realm of the programs we will be finished with.

Okay. Thank you.

Yeah. Thank you.

Thank you for your question. At this point, I'd like to turn the call back over to Mr. Ballhaus, for closing comments.

Okay. Thanks Aaron, and thanks everybody for joining our Q1 call. And we look forward to connecting with you soon, to talk through our Q2 results. Thanks for your time, this evening.

Thank you gentlemen, and ladies and gentlemen, this does conclude the Mercury Systems First Quarter Fiscal 2024 Conference Call. Have a great evening.