Good day, everyone, and welcome to the Mercury Systems Second Quarter Fiscal 2025 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 Vice President of Investor Relations, Tyler Hojo. Please go ahead, Mr. Hojo.

Good afternoon, and thank you for joining us. With me today is our Chairman and Chief Executive Officer, Bill Ballhaus; and our Executive Vice President and CFO, Dave Farnsworth. 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 we 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, Tyler. Good afternoon. Thank you for joining our Q2 FY 2025 earnings call. We delivered solid results in Q2 that were once again in line with or ahead of our expectations, and I'm optimistic about our ongoing efforts to improve performance as we move through the fiscal year. Today, I'd like to cover three topics; first, some introductory comments on our business and results. Second, an update on our four priorities; delivering predictable performance, building a thriving growth engine, expanding margins and driving improved free cash flow; and third, performance expectations for FY 2025 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 the 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. Our Q2 results reinforce my confidence in our strategic positioning and our expectations in delivering predictable organic growth with expanding margins and robust free cash flow. Bookings of $242 million and a trailing book-to-bill of 1.12, revenue of $223 million, up 13% year-over-year, adjusted EBITDA of $22 million and adjusted EBITDA margin of 9.9%, both up substantially year-over-year and record free cash flow of $82 million, up $44 million year-over-year. We ended Q2 with $243 million of cash on hand. These results reflect continued progress in each of our four priority areas with highlights that include solid execution across our broad portfolio of production and development programs, a record backlog of $1.4 billion, reduced operating expense, enabling increased positive operating leverage and continued progress on free cash flow drivers with net working capital down $115 million year-over-year or…

Thank you, Bill. Our second quarter results reflect solid progress toward our goal of positioning the business to deliver predictable performance characterized by organic growth, expanding margins and robust free cash flow. There is still work to be done, but we are encouraged by the progress we have made and expect the second half of fiscal 2025 revenue and adjusted EBITDA margins to improve over the first half. Our continued progress in our priority areas is highlighted by a few key milestones that we achieved during the second quarter. This includes delivering improved operating performance, making additional progress in ramping production in our common processing architecture product area and continuing to expand our record backlog. With that, please turn to Slide 10, which details our second quarter results. Our bookings for the quarter were $242 million with a book-to-bill of 1.09, yielding a backlog of $1.4 billion, up $77 million or 6% year-over-year. Revenues for the first quarter were $223 million, up $26 million or 13% compared to the prior year. The increase is primarily driven by higher point-in-time revenue of $29 million, largely accelerated from Q3 as we continue to focus on delivering for our customers. Gross margin for the second quarter increased to 27.3% from 16% in the same quarter last year. The increase in gross margin during the current quarter was primarily driven by a reduction in the net EAC change impact on our programs recognized over time to $4 million as compared to $31 million in the same quarter last year and lower inventory reserves of approximately $12 million. These improvements in gross margin were partially offset by higher manufacturing adjustments of approximately $4 million. As Bill previously noted, we expect to see an improvement in our gross margin performance over time as the average margin…

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

Thank you. [Operator Instructions] Your first question comes from the line of Pete Skibitski with Alembic Global. Your line is open. Q – Pete Skibitski: Hi, good evening, guys. Great quarter. Its -- I mean it looks like even excluding the pull forward revenue was still a strong quarter, especially on the cash flow side. So Bill, I'll ask a question I've asked before, but maybe this is the last time I need to ask it. Just can you talk about the progress in the second quarter on the CPA kind of processes and programs in terms of the maturity there? Is there any kind of technical risk that remain at this point? Or is it just a matter of slowly kind of ramping from low rate [ph] to full rate production on the programs?

Yes, Pete. Thanks. Well, first of all, thanks for the comments upfront. And I would characterize our progress on CPA as planned and consistent with what we discussed previously, we are ramping the full rate production. We expect to get our capacity to be fully available as we move through the back half of the year. And of course, how we use that capacity will benefit the business in a number of ways. We've already seen as we brought production online that we've received significant production awards. We talked about that in Q1. We had a really nice takeaway from a competitor based on our technical differentiation this quarter. That's been another benefit. And as we progress through the second half, we'll be able to allocate that capacity to drive revenue performance and deliver for our customers on new awards and continue to burn down unbilled balances where we have receivables on older contracts. So continued progress all sort of normal course at this point and very much progressing to plan and consistent with what we've discussed previously. Q – Pete Skibitski: Okay. That's great. Just one more for me. As you guys build confidence in that system, I'll call it, can you talk about order flow? Backlog is kind of inched upward in the first half of the year, what we can say, I think. How are you expecting order flow to trend in the second half of the year? Should that accelerate? Or kind of in conjunction, how is the continuing resolution impacting order flow? Thanks.

Yes. I don't get too granular in focusing in on orders by quarter because like cash, it can be a little bit lumpy. I do think that our trailing 12-month book-to-bill of 1.12 is reflective of solid performance. And as we're looking forward, we still feel really confident about not only our strategic positioning, which we've talked about consistently, but also the enduring demand drivers and the need for mission-critical processing at the edge. So, all-in-all, I feel very optimistic about that outlook. Our trailing 12-month book-to-bill, I think it's solid at 1.12, and I think it positions us well for the second half of the year. Q – Pete Skibitski: Great. Thank you very much.

Your next question comes from the line of Peter Arment with Baird. Your line is open.

Yes, good afternoon Bill, Dave. Tyler, welcome to the call. Congrats on the quarter. Obviously, a lot of progress being made here. I guess I just want to understand the back half of the year free cash flow kind of breakeven commentary because I think you've made a tremendous amount of progress of bringing the unbilled down. And again, you saw evidence of that this quarter. But now you've also got this deferred revenue growth. And I just want to understand how -- whether that's tied to the new contract structure and on receiving the milestones? Or could you maybe just, Dave, walk us through a little bit of the dynamics of why there isn't positive still cash being generated in the second half?

Yes. And as we said, Peter, when we looked at the first half, our cash was ahead of where we were expecting and some of that was driven by the milestones that we were able to achieve and drove, as you saw, a significant increase in our deferred revenue. based on the timing of those milestones. So, those milestones as we work through the second half will be performing effort against that cash that we've already received. So, we expect to see the deferred revenue come down as we get through the back half of the year. It does not mean that unbilled won't continue to be something that we're working aggressively on. But we do expect to see a material drawdown of that deferred revenue that was brought in those milestones that were completed earlier.

Appreciate that. I'll jump back in the queue. Thanks.

The question comes from the line of Ken Herbert with RBC Capital Markets. Your line is open.

Hey good afternoon Bill and Dave. You consistently talked now about sort of the longer-term opportunity to get adjusted EBITDA margins back into the 20% -- low 20s range. Is what -- can you provide without getting maybe too specific on timing, but how does the business look when you get to that level? I mean is there a way we should think about that from a revenue standpoint, from an efficiency standpoint? Can you provide any more sort of parameters around how you think about that maybe from a timing standpoint or just operationally as you think about the business moving forward?

Yes. Thanks for the question. Let me -- this is Bill, I'll take it. We've talked pretty consistently for the last several quarters about the main levers that we're focused on. And we made progress on each of the levers. And I think as we're sitting here looking forward and thinking about the path to our target margins, I think there's really two primary things that we're focused on. One is the conversion of our backlog margin that we've talked about. The fact that coming out of FY 2024, our backlog margin was lower than what we expect to see on a go-forward basis, impacted by a small number of low-margin development programs and a number of programs that were impacted by EAC adjustments in FY 2024. And as we're progressing each quarter and we're bringing in new bookings, we're really pleased to see that the margin on those bookings are coming in, in line with our target margins associated with our targeted EBITDA margins that we're working to get to. So that's a dynamic that will play out over time. We haven't been specific around the timing where we expect the backlog margin to be at a place where it's consistent with our target margins. But we have a duration associated with our backlog. So you could do some thinking around how that might turnover over time. But that's the first driver. And then the second is around our operating expense so that we can get positive operating leverage as we continue to drive volume. And I feel like at this place, where we are with our operating expense, we've made significant progress over the last 18 months on that part of our cost structure. And while we said before, and it will continue to be a focus that will drive efficiencies into the business as we go forward on an ongoing basis, but I feel good about where our operating expense is relative to the positive operating leverage that we expect to see as part of our game plan to get to our targeted margins. So those are really the two pieces. And I feel like we're in a pretty good place in terms of understanding where we are and being able to see those two moving pieces work together to get us to our targeted margins.

Thanks for all the detail, Bill.

The next question comes from Seth Seifman of JPMorgan. Your line is open.

Hey, thanks very much and good afternoon, and nice quarter. I guess just in thinking about the growth rate, you talk about above market. Maybe just to put some parameters around that. When you think about what market is, do you think about it kind of as the defense budget, which I think a lot of people think about maybe a low to mid-single-digit growth over time? Do you think about it as a more -- as a certain subset of the defense market that might be growing faster? And then the second part of that question is, the common processing architecture and when you're fully ramped up there, kind of what role that plays in the mix and how that plays into your thoughts about the overall growth rate of the business as we look out over, let's say, a one to three year period?

Yes. So as we've discussed before, we're focused on delivering top line growth that represents a growth rate above market growth rate. And specifically, the market that we're focused in on is the defense electronics, Tier 3 defense electronics market with growth rates that are historically in the 5% to 6% range. And we believe for a number of reasons, in particular, when we focus in on the subsegments of that market where we're well positioned and we focus, and in particular, that's around delivering processing power and capability to the edge, those subsegments tend to grow a little bit faster, and we feel like we're very well positioned based on our technical differentiation to deliver growth that exceeds those market growth rates. So that's really what we mean by when we talk about our targeted growth rate. With respect to the common processing architecture, as we've worked through the technical challenges in that area and gotten those behind us and then ramp to full rate production, it impacts our business in a number of different ways positively. First, it unlocks bookings because a number of customers were holding back follow-on development and production awards until we had demonstrated we got to root cause, eliminated the technical risk and then ramped up production. So it's opened up new production awards. It also now gives us the opportunity with the capacity becoming available to allocate that capacity in the way that makes the most sense. And that could be either burning down backlog and delivering new units and revenue that goes with it, or allocating the capacity to more legacy programs that represent our unbilled balances that when we deliver those units, there's less revenue associated with those units, because the revenue has been recognized in prior periods, but it allows us to deliver the units, invoice our customers and collect cash. So having that capacity online gives us a number of different degrees of freedom to drive performance and have it flow through our P&L into our cash flow statement and into the balance sheet. So hopefully, that's helpful.

Yes, absolutely. Thank you.

The next question comes from Jonathan Ho with William Blair. Your line is open.

Hi. Let me echo my congratulations as well. I just wanted to get some additional color on what drove the $30 million in pull-forward contract activity. Was this concentrated in a handful or a single program? And was there sort of a customer impetus or government directive to drive earlier deliveries?

Yes. Thanks, Jonathan. Thanks for the comment upfront and the question. For 18 months, we've been very consistent in the prioritized focus of the business with priority one being a focus on delivering predictable performance. Looking backward, a lot of that effort was focusing on completing the large mix of development programs in our portfolio, but it also includes a relentless focus on delivering for our customers. So a lot of what you've seen in our results for both Q1 and in Q2 is a byproduct of our team being relentless on delivering for our customers. And that shows up in two ways. It's delivering out of our backlog on new awards, delivering hardware associated with that backlog, getting it out the door as well as working down our unbilled balances. In this quarter, really the overperformance was tied to point-in-time revenue, and those were on programs and for products where based on that focus on delivering for our customers, we're able to pull to the left from our initial expectations. And that's what really drove the shift into the quarter.

And Jonathan, I would add, it was not a single contract or a single customer. It was multiple different products and customer set. And again, as Bill said, as we're improving our capacity in our operational facilities, we were able to pull some things that we thought we would not get delivery on. And at this point in time, revenue is on delivery. We would not get revenue on and deliver in Q2. We were able to pull them forward out of Q3 and Q2, deliver them early, get them to our earlier than expected and get them to our customers. So a positive all around.

And I think one of the things that was encouraging in the quarter is as we really focused our capacity, we were able to demonstrate both the pull forward of deliveries to drive revenue and at the same time, finish off programs and drive down our unbilled receivables. And I think that's really a credit to our team, the improvement in our management system and our focus on delivering for our customers.

Excellent. Thank you.

The next question comes from Michael Ciarmoli with Truist Securities. Your line is open.

Hey. Good evening, guys. Thanks for taking the question. Nice results. Bill or Dave, maybe just to stay on that topic and get some more clarity. I mean it sounds like the pull forward was just basic blocking and tackling and delivering. I mean, because if I -- when I hear pull forward, I probably want to strip it out and your revenues would have been down year-over-year and down sequentially, but that doesn't seem like the way we should interpret this. And then I guess the pull forward and thinking about the back half of the year, so you've got mid-single-digit revenue growth kind of implies a flattish sequential trajectory. But what would drive in that flattish revenue environment for the rest of the year, what drives the margins higher, especially in the fourth quarter? Is that kind of what you were referencing with the bookings coming in at that targeted margin rate?

Yeah. So let me start with the top line and the revenue movement within the period. And again, I don't want to get too granular on the revenue between quarters. But I do want to remind everyone that in Q1, we had some pull forward from Q2 into Q1 and then again from Q3 into Q2. Now if you kind of normalize the volume and where it sits, it does sort of spread out the growth throughout the year to get a more balanced and consistent growth between the first half and the second half. And I think if you adjust that $30 million in your thinking, you'll see a more balanced growth rate across the full year. As far as the margin uplift in the fourth quarter, I think there's two things that are happening, it's -- yes, the dynamics in the backlog. So we are seeing the roll forward of the lower-margin backlog being replaced with the new awards that are coming in, in line with our target margins. But as we saw last year, in the fourth quarter, we would expect to see some positive operating leverage with the increased volume that would be additive to our margins, and that's why we're expecting the fourth quarter to be the highest margins in the year. Hopefully, that makes sense.

Yeah. And I think there are two things that impact that backlog margin, as Bill discussed. One is, of course, the new bookings coming in and the margin rate on those bookings, and we said that it's been accretive as we've been going forward. And the other is the level of the margin on the contracts that we're actually performing, executing on. And we've talked about some of the contracts that we're completing and moving past were some of the lower-margin contracts. So those two phenomena act in concert with each other to naturally start to raise that backlog margin.

Got it. Helpful. Thanks, guys.

Thank you.

The next question comes from Brian Gesuale with Raymond James. Your line is open.

Hey, nice quarter. And thank you for taking my questions. I wanted to maybe just delve into this journey you're taking to remix the business away from -- not away from, but this natural shift from development to production work. Can you talk about where you're at in that journey? And then maybe give us a little bit of sensitivity how the margins shift higher as development moves every 500 or 1,000 basis points?

Yes. We have -- we've talked about this in the past, kind of the difference between margin rates typically on development versus production contracts and the way we think about that model. And what we've talked about in the past is the difference is in the 1,000 basis points kind of range, the difference between those two. And so we are -- and we've talked about that the bookings we're seeing are in line with our targeted margins. As Bill talked about, when we look at our bookings for the last trailing 12 months, they've been in the 80% range production. So we're seeing that happen. It's -- some of that is as a consequence of finishing these development programs. We had a large number of development programs that we've been working through. I want to make sure that people don't take the amount of production happening as a natural phenomenon of finishing those development programs and getting the follow-on production awards. We still are focused on new development and the right kinds of new development, and we still are moving innovation along in the company, but this is a natural move of how we see the business proceeding. We expect this level of kind of bookings to be the case for some period of time.

Great. And then maybe just a quick follow-up. So if you think about how that backlog naturally progresses towards your target margin, how do you -- how much of that margin bridge from 10% to 20% or 10% to 20-plus percent comes from this natural mix shift as opposed to some of the other levers that Bill alluded to earlier?

Yes. I don't think we've broken out the individual components of that. So I wouldn't want to try and detail that.

Okay. Fair enough. Thank you.

[Operator Instructions] Your next question comes from the line of Sheila Kahyaoglu of Jefferies. Your line is open.

Great quarter, guys. Thanks for taking the time. I wanted to maybe start on free cash flow and just ask the $82 million of free cash flow in the quarter, I think it was your all-time high free cash flow in a quarter -- in a year, let alone a quarter. So can we talk about how we bridge that free cash flow to what true free cash flow is given you're implying breakeven in the second half. There was obviously some factoring in there and some benefit from other items. So maybe if you could just talk about how we should be thinking about the second half being breakeven and as we head into fiscal 2026.

Yes. I think, Sheila, this is Dave. I think that the way to think about it is we were able to accelerate cash in essence, into the second quarter. Largely, when you look at our deferred revenue, you see our deferred revenue is up around $40 million. That's milestones that we achieved that are ahead of all of the effort being completed. So, as we go through the second half, we expect to be seeing that deferred revenue come down, as we get the work done around those things or complete work around those things. And so, we expect that will have -- it will lower the deferred revenue, resulting in an offset to the cash that we're bringing in on the other programs. So, that $40-ish million is almost a pull-forward, the piece of that out of the second half of the year. So, we're not looking at it as a pure, hey, it's a breakeven back half of the year. We're looking at it as running to offset that activity. We still are focused on our net working capital and bringing it down. Our net working capital is the lowest it's been in several years. I mean, we're headed in the right direction. Obviously, that's not at the exclusion of revenue or margin, but it's something we're working in concert. So, I think the way we're thinking about cash is consistent with what we've said in the past. We expect to be a consistent, positive cash flow generator. And we expect to have positive cash as we exit the year, obviously, with where we are today, a little bit ahead of where we thought we'd be through the first half.

Got it. And then, maybe if we could just talk about -- it's been asked a few different ways-- the profitability profile, too. Any sort of color you could give on production versus development margins? And then, if you could just talk about the competitive wins you mentioned in the slides, what are those? And how do we think about the profitability of those?

Yeah. Hi. I'll start, and then, Bill, I'll let you talk about the wins. As we just said, I think that what we said historically is that production margins and development margins, because of the different profile of those things, are roughly -- the targets we see for those are roughly 1,000 basis points different. We've seen that consistently in our bookings, that that's about right. The bookings we're bringing in are absolutely consistent, as Bill has said, with the target model that we have. And so, we see the bookings that are coming in at the margins we need to step towards our ultimate business model. A – Bill Ballhaus: And I'll just make a comment on the competitive wins. We had a number of head-to-head competitive wins in the quarter. I think a couple worth mentioning. One is on US Defense Department satellite program with an innovative space systems provider. I think what's interesting about this pursuit is it was led by our Advanced Concepts group, which is a group we launched last year to focus on our next-generation technology and position us for next-generation type pursuits, came up with a very innovative solution that actually leveraged existing products and work that we had done for other customers. And so we think it's right in line with an innovative development program with the right risk profile that will lead to production runs down the road. So it's exactly what we wanted to do with the Advanced Concepts Group and a really good success story. And then the second is the takeaway associated with our common processor architecture product line. And as we've said before, this is an area where we see emerging demand, and we feel like we've got solid technical differentiation. And this takeaway was a perfect example of that. It was a relatively entrenched competitor and incumbent providing a processing capability. The end customer was looking to upgrade the capability to include the functionality consistent with our common processing architecture. The incumbent couldn't meet those requirements, we could, and that was the basis of the takeaway and the development awards. So I think those are very notable, they're worth mentioning, and I think they're evidence of our ability to compete head-to-head and win based on the technical differentiation associated with the Mercury processing platform.

Thank you.

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

Okay. Well, thanks, everybody for your participation. I would like to thank the Mercury team because it's people and teams that deliver the results that we talked through today, and the team had an outstanding quarter. We appreciate your participation, and we look forward to the update next quarter. Thank you.

Thank you.

This concludes today's conference call. We thank you for joining. You may now disconnect.