Mercury Systems, Inc. (MRCY) Earnings Call Transcript & Summary

Good morning, everyone. This is Sheila Kahyaoglu, with the Jefferies Aerospace and Defense Equity Research team, and we're Day 2 of our Industrials Conference, Virtual, once again, unfortunately, but we're very lucky to have the Mercury team with us, Mark Aslett, President and CEO; and Mike Ruppert, Executive Vice President and CFO. I'm going to hand it over to Mark with a few prepared remarks, and then we'll head off to questions. Mark, go ahead, please.

Okay. Great. Well, good morning, everyone, and welcome to the conference, and thanks for joining us here today. With me here today is our Chief Financial Officer, Mike Ruppert. Let me just go through a few slides and then we'll move into the Q&A. So the presentation does contain some forward-looking statements. And due to risks and uncertainties, the actual results may differ materially from what you see out here today. So a little bit about the company. Mercury was actually founded in 1981. So we're actually in our 40th year of being in business. Today, we kind of positioned the company at the intersection of both the high-tech world and defense. And our goal is to make commercially available technology, profoundly more accessible in terms of speed and affordability to our defense prime customers. From a vision perspective, our goal is to be able to provide all of the different types of processing solutions that go onboard military platforms, in particular, those very high-performance compute solutions that require the concepts of trust and security. As you'll see, we deployed on some of our nation's most important programs and platforms, working with our major defense prime customers. And today, we enjoy the defense industry's highest current employee Glassdoor ratings. Just a quick overview of Mercury by the numbers. Approximately 2,400 employees today, 1/3 of which hold DoD security clearances, approximately 25 facilities around the world, the majority of those been here in the U.S. We've been in the defense industry for over 35 years. Really at the heart of our success is our investment model. And so we're spending significantly more in terms of internally funded R&D to develop the technologies that our customers need to solve some of the most difficult compute challenges in the defense industry. We've got a great bunch of programs that are well aligned with National Defense Strategy and again, working with all of the major primes. From a financial perspective, we just completed our fiscal year '21. So we had a very strong financial performance, 16% revenue growth year-over-year, 5% organic growth over the course of the last 5 years, and we've averaged 10% organic growth. Our EBITDA margins are very strong at 22%, and we've even grown our revenues -- sorry, our EBITDA margins plus revenues. We're a highly acquisitive company. So we've completed 13 transactions over the course of the last 7-or-so years, growing our revenues 4.4x over that same period and our adjusted EBITDA, 9x. So looking at Mercury's financial profile, it really does demonstrate the uniqueness of the strategy. Our goal, as you can see here in the inverted pyramid, is to generate strong margins, shown as greater than 20%. We're looking to grow our business, organically, over a multiyear period at high single digits to low double digits, and then looking to supplement that high level of organic growth with M&A to grow the business on an annual basis greater than 20%. So you can see our actual results on the right-hand side. So in fiscal '20, we met our goals. In fiscal '21, we're a little short in terms of just organic growth that led to -- our total company growth being slightly less than the 20% target. That being said, our actual results are still in the top 8% of all publicly traded companies when you compare our actual results with all companies of the similar size trading between $1 billion and $5 billion. Moving to the next slide. We are a very innovative growth company, again, mentoring -- sitting at the intersection of these 2 worlds. We focused the business on large and bust a great parts of the market. We have proven that a high-tech company can operate successfully at scale on behalf of all investors and stakeholders through the investments that we're making in internally funded R&D. We're benefiting from outsourcing by our customers, supply chain delayering as well as reshoring the microelectronics. And we believe that we've developed a low-risk content expansion strategies that, over the course of the last 5 years, is delivering well above the industry levels of organic growth. And finally, we continue to acquire and integrate companies to continue to gain capabilities as well as scale. On the call, yesterday evening, we announced the impact program. This is to allow Mercury to continue on our journey. And so the goal here is to basically take a step back and look at the things that we need to do in the business today for us to become a multiple of our current size, like we have done over the course of the last 7-or-so years. We engaged a Tier 1 consulting firm early this calendar year, who took a fundamental look at the business in terms of how we should be organizing to -- for us to continue to scale. We began that work in the fourth quarter with the actions accelerating in Q1. And as a result, we're expecting a $22 million benefit in FY '22, with additional benefits over time. The areas that we're focused in on, you can see here on the fourth pull down so organizational efficiency and scalability, streamlining procurement, optimizing our facility footprint, looking at improved efficiency on both the income statement around R&D and G&A, capital asset efficiency on the balance sheet as well. And then continue to invest in scalable processes and systems. We're expecting a $30 million to $50 million incremental improvement to adjusted EBITDA by FY '25. And this is on top of the margin expansion that we were previously anticipating. The gross benefits, we'll be selectively reinvesting back in the business, again, with an eye towards future scalability. So with that, why don't I hand it over to Sheila to begin the Q&A.

Thanks so much for that, Mark. So just to kick it off, you reported earnings, last night, initiated '22 guidance. A bit disappointing or not your normal high single digit, low double-digit organic growth. I think you're flattish for the year, down maybe close to double digits for the Q1. What are you kind of seeing? I noticed there's some program-specific items in there and how that changes over the next 4 quarters?

Okay. Yes. So we did try to outline the impacts that we've seen during fiscal year '21. And it can really be kind of grouped into a number of different categories. The first is that we saw some COVID-related impacts on naval upgrade programs that, for us, didn't just impact one program. It impacted a number of programs. That affected organic growth in fiscal year '21 by approximately 3 points, or lowered our organic growth by approximately 3 points. We had impacts in certain international FMS programs, in particular, we had a large order with a customer that moved from Q1 into our fiscal year '22 that was around about 1.5 points of impact. And then finally, we saw some delays on the F-35 program as our customer, Lockheed, has wrestled with a supplier delivery issue on the F-35 TR3 program, that affected our organic growth by an additional 2 points. So absent, really those 3 areas, our organic growth would have been substantially higher than the 5 points that we delivered. And so we believe that growth, overall, was impacted between 5 to 6.5 points for the last fiscal year. That being said, the Naval programs that we're involved in and the F-35 are critical programs and F-35, EW and ELTA -- sorry, and Filthy Buzzard as well as the other programs were all up year-over-year. They just weren't up as much as what we were anticipating. So big picture, that's kind of what happened in '21, Sheila.

No, that's a helpful bridge. And then how do we think about that bridge from fiscal 2022 where you're guiding flattish on the organic side into '23?

Yes. So we -- what we said on the call last night is that we're expecting flat organic growth for fiscal year '22, with approximately 10 points total company growth prior to any future M&A. And the reason that we took the organic growth rate down is really because of the experience that we had during fiscal year '21 in these certain areas as well as the new information that really came out from Lockheed on the TR3 program, and most recently, with Raytheon on LTAMDS. And so as a result of the experience and the new information, we decided to be really more conservative in those 3 areas that we mentioned. So, in particular, we think that with LTAMDS moving from our fiscal year '22 and now into fiscal year '33 -- '23, sorry, that had a close to a 2-point impact on organic growth. We were more conservative around SEWIP and these other naval programs to the point of -- around about 3 points of growth, 1 point of organic growth on the F-35 and then some additional in both FMS and EW. Now -- so we think that we're taking a more conservative approach, just basically based on our experience last year. That said, these areas are also the areas where we think that there's upside to the guidance that we've given. And we expect that, for fiscal year '22, although, we're forecasting organic growth to be flat from a revenue perspective year-over-year, we are expecting substantial growth in bookings, both at the year level, driven by a strong second half with additional growth in '23.

Yes. And Sheila, just to add on to that. I think fiscal '23 programs are the same ones. The rebound are the same ones that Mark just discussed. It is F-35, it is LTAMDS, it is Filthy Buzzard. And then what we're also seeing one of the reasons like why we like the POC acquisition in terms of the programs they're on, we expect to see a rebound there in fiscal '23, some nice growth.

I guess, 1 question I get from investors, which I'm sure you guys are dealing with this morning is, how do you have confidence in the '23 outlook, given there's no fit up? So some of these programs are long term and here to stay, F-35, LTAMDS. How are you thinking about growth will return to normalized growth, whenever it might be, whether that's from outsourcing or design, to future design wins?

Yes. So I think the longer-term trends for us are still very much intact, right? I think outsourcing has been a big driver of our growth. We see that continuing really across our different market areas. In the platform and mission management area, which is part of C4I, which is all about avionics and mission computing, we see that delayering is picking up. So I mentioned on the call last night, probably the most exciting design win that we had during our fiscal year '21 is on a program called AMCS. It's the Army's Common Mission Server. This is a mission computer that has huge potential across Army aviation, and potentially the Naval aviation as well. So -- and then we're continuing to see themes around reshoring and purchasing capabilities that are both designed and developed here in the U.S., and that's really where our trusted microelectronics strategy comes into play. If you look at the part of the market that we have focused on, we believe that they will continue to grow faster than the overall defense budget. And as we look at the 2 major market categories, Sensor and Effector Mission Systems as well as C4I, both are expected to grow at double-digit rates over the course of the next 5 years, with faster growth likely being driven in C4I just based upon some of the programs that we're involved with. Programmatically, the programs that are affecting our organic growth in the short term, we believe, are transitory in nature, and those programs are well aligned with the natural defense strategy. And we think it's the top 20 programs that will really drive the growth in the business over time. Programs such as the F-35, LTAMDS, Filthy Buzzard, SEWIP are all top programs for us and are expected to continue to be so over the course of the next 5 years.