Mercury Systems Inc (MRCY) 2021 Q4 法說會逐字稿

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'd 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'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 Mark and I will be referring to is posted on the Investor Relations section of the website under Events & Presentations.

Please turn to Slide 2 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 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, Mark Aslett. Please turn to Slide 3.

Thanks, Mike. Good afternoon, everyone, and thanks for joining us. I'll begin with the business update. Mike will review the financials and guidance, and then we'll open it up for your questions.

Our results for Q4 and fiscal '21 was strong, led by robust design wins and double-digit growth in revenue and adjusted EBITDA. It was, however, a more challenging year than we anticipated, and we believe that fiscal '22 could be similar. That said, the team is doing an outstanding job managing, derisking and growing the business and we're beginning the year with over $900 million of backlog.

The secular growth trends benefiting Mercury also remained favorable, and we're well aligned with the national defense strategy. The government continues to push for modernization, speed and affordability in both sensor and effective mission systems and C4I. As a result, our 5-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 '14, we've completed 13 acquisitions multiplying the size of the company, delivering significant synergies and creating substantial value for shareholders. As we crossed the $1 billion revenue threshold in fiscal '22, we're taking proactive steps with an eye towards repeating what we've done over the past 7 years.

This afternoon, we announced a company-wide effort, which we called 1MPACT to lay the foundation for our next phase of value creation and scale. The goal is to achieve Mercury's full growth, margin expansion and adjusted EBITDA potential over the course of the next 5 years.

Before talking more about 1MPACT, let's take a quick look at our financial results on Slide 4. We delivered strong fourth quarter results as anticipated. Bookings came in as expected, down slightly from a very strong Q4 last year, but up substantially from Q3, resulting in a positive book-to-bill of 1.04. Our largest bookings programs in the quarter were SEWIP, Filthy Buzzard, F-16 SABR, PGK and P-8.

Total revenue exceeded the high end of our guidance, up 15% year-over-year and down 3% organically. Our largest revenue programs in the quarter was SEWIP, CPS, F-35, Filthy Buzzard and Aegis. Our new business pipeline is robust, and our design wins in Q4 totaled more than $500 million in estimated lifetime value.

On the bottom line, we delivered another record quarter for adjusted EPS and adjusted EBITDA. We also announced and completed the Pentek acquisition.

For the full 2021 fiscal year, we delivered strong results across all our key metrics, highlighted by year-end backlog of over $900 million, which grew 9% from fiscal '20. Total revenue increased 16%, including 5% organic growth. We delivered record adjusted EBITDA, which was up 15% year-over-year.

We diversified the business to the point where we now participate in more than 300 different programs, which continue to serve us well. We designed in on our top programs with the majority being sole-source positions. Our largest revenue programs for the year were a classified radar program, LTAMDS, F-35, SEWIP and E-2D Hawkeye. No single program is more than 5% of total company revenue in fiscal '21. Looking ahead to the next 5 years, no single program is expected to be more than 6% of total revenue.

Design win activity remains very strong and activity levels elevated. Our fiscal '21 design wins totaled $1.5 billion in estimated lifetime value. We had several important design wins during the year. We received an award for the next-generation deceptive Jammer beyond Filthy Buzzard, which is one of our top programs. We won by leveraging the EWK capabilities we acquired with Core Electronics and our partnership with the leading Silicon Valley semiconductor company. This design win is an estimated lifetime value of $260 million and possibly more.

We made significant capital investments in our trusted microelectronics business in Phoenix. Leveraging this investment in partnership with another leading semiconductor firm will produce a next-generation RF system in package. We believe this device will outperform existing commercially available products. The estimated lifetime value of this win is around $100 million.

Potentially, our most important fiscal '21 design win relates to the Army's Airborne Mission Common Server or AMCS program. The initial award is small. However, we believe that the estimated lifetime value could approach $1 billion should the Army deploy AMCS across its fleet of aircraft. This opportunity would not have been possible without the acquisitions of CES, RTL, GECO and most recently, Physical Optics Corporation It's an amazing win by the team.

From an M&A perspective, we completed 2 acquisitions in fiscal '21, deploying $375 million of capital, strengthening both our C4I and sensor and effector mission systems capability. The acquisition of POC was the company's largest to date, and we're excited about the future potential as part of Mercury.

At the same time, we made record investments in the business, including internal R&D to drive innovation and secure processing, trusted microelectronics and mission computing. We've also made significant capital investments to consolidate and build out our facilities. So all in all, fiscal '21 was a very strong year in a challenging environment.

Turning to Slide 5. Throughout fiscal '21 and as we discussed, our organic revenues were impacted by COVID-related modernization delays on SEWIP and other naval surface programs. Customer execution issues on the F-35 TR3 and a delay in a large foreign military sale. In addition to lowering bookings, these issues combined reduced our organic revenue growth by approximately 5 percentage points for the year. On our call last quarter, we previewed fiscal '22, expecting mid- to high single-digit organic growth, leading to total company revenue growth in the mid-teens.

Given our experience in fiscal '21, we've taken a more conservative stance on organic growth for fiscal '22. This includes reducing our expected fiscal '22 revenues from SEWIP and other naval fleet upgrades, the F-35 and certain FMS programs. The biggest change since our last quarter relates to LTAMDS. Raytheon at their recent Investor Day said that the next LTAMDS award will likely be in their next fiscal year. We have been expecting a large booking in the second quarter of fiscal '22.

This booking has now moved to our fiscal '23 with revenue spread over several years. Like SEWIP and F-35, LTAMDS is an important well-funded program. It's the largest single design win in the company's history to date and will be a significant driver of growth beginning in fiscal '23 and over the course of the next 5 years and beyond.

As Mike will discuss in detail, as a result of these changes, we're now expecting flat organic growth in fiscal '22. We're expecting approximately 10% total company revenue growth prior to future M&A, eclipsing $1 billion for the first time and record adjusted EBITDA. We're expecting a number of programs to drive growth in fiscal '22. These include revenue associated with the large FMS order that was delayed in Q1 last year.

The good news is that we received an initial award for this program in the fourth quarter of fiscal '21 and expect additional bookings in fiscal '22. In addition, we're involved with several radar upgrades. We expect to see growth in the EW domain, and we're seeing strong demand across multiple programs in C2 and platform and mission management. Over time, we expect Mercury's total company revenue to continue growing faster than overall defense spending. We focused the business on large and faster-growing part of the defense market.

Looking ahead to fiscal '22, we're expecting a significant rebound in growth in bookings versus fiscal '21, with a positive book-to-bill for the year and the substantial growth in our backlog. Over the past 2 months, we've seen an improvement in customer activity levels and the speed at which things are moving. We believe this could be attributed to vaccination rates and employees at our customers and the government returning to on-site work.

We also believe the Biden administration's budget release has given program offices more clarity around priorities, which could further reduce program delays. In addition, our design win activity remains strong. For fiscal '22, we expect our design wins to gain total more than $1 billion in estimated lifetime value. We expect these programs as well as prior design wins to convert into increased bookings in backlog as they transition into production over time.

Looking further ahead to fiscal '23, we currently expect our organic growth to accelerate back to more normal high single-digit to low double-digit levels. This growth is expected to be driven by: one, the improving environment; two, the anticipated growth in bookings in fiscal '22; and finally, the substantial expected revenue growth on F-35, LTAMDS, Filthy Buzzard and other programs.

Turning to Slide 6. Since fiscal '14, we've completed 13 acquisitions deploying $1.2 billion of capital. As a result of this investment, we've dramatically scaled and transformed the business. We've grown the estimated lifetime value of Mercury's top 30 programs and pursuits from $4.6 billion to more than $11 billion. This opportunity pipeline is greater than 10x the size of our backlog and represents the foundation for our future growth.

Over this period, we've successfully grown total company revenue 4.4x and adjusted EBITDA more than 9x, resulting in a 10x increase in our market cap. As demonstrated by the more rapid growth in adjusted EBITDA, we've extracted substantial cost and revenue synergies from our acquisitions over time. This has significantly reduced our gross purchase price to net multiple for the deals that we've done.

Looking forward, crossing the $1 billion revenue threshold is both a milestone to be celebrated, and we believe an inflection point for Mercury. I mentioned that we expect organic growth to rebound in fiscal '23. In addition, we're in an extremely active period for M&A right now. Our pipeline is very robust with multiple opportunities of varying sizes all in line with the core of our strategy.

With the acceleration in organic growth expected in fiscal '23, combined with M&A, we believe that we have the opportunity over time to replicate what we've done so successfully since fiscal '14. As a result, we've launched 1MPACT to determine what we need to do today to enable us to become a multiple of our current size. Our goal is to achieve our full growth in adjusted EBITDA potential organically and through M&A over the course of the next 5 years.

Since fiscal '14, driven by our acquisitions, we've substantially changed the company. We've expanded the scope of our offerings and capabilities, leading to a nearly eightfold increase in subsystems revenue. We've in-sourced manufacturing. Our headcount has increased 3.5x. Our footprint has grown from 10 to 27 locations, and our excelled supply chain spend has increased nearly 3x. Despite achieving significant synergies, as I mentioned, we believe there is additional value to be had. We proactively began contemplating 1MPACT earlier this calendar year with capturing our value and our future scaling in mind.

Turning to Slide 7. Early in Q3, we engaged a Tier 1 consulting firm to do a full assessment of the company. Working with them, we took a fresh look at the business from an organizational structure and value-creation perspective. Based on that assessment, the first opportunity is to consolidate and streamline our organizational structure. This will improve visibility, speed of decision making and accountability. These actions started in the fourth quarter with the effort accelerating in Q1.

We're anticipating a $22 million net benefit in total for fiscal '22 related to these actions. The Q1 action alone accounts for $14 million of that total. 1MPACT will be led by a new Chief Transformation Officer reporting to me. As it progresses over the course of the next 2 to 3 years, in addition to growth, we'll be focusing on 6 major areas: organizational efficiency and scalability; procurement and supply chain; facilities optimization; R&D investment efficiency; capital and asset efficiency; and scalable common processes and systems.

These actions are still in their planning stages, and we'll have more to say about them over time. At this point, we think it's reasonable to target $30 million to $50 million of incremental adjusted EBITDA by fiscal '25 as a result of this activity. Again, this includes a $22 million net benefit in fiscal '22. Going forward, we'll continue to reinvest some of the gross savings in people and business systems with an eye towards future scalability.

Overall, 1MPACT is about enabling our future, doing what we've done since fiscal '14, but doing it efficiently and effectively at greater scale. A way to think about this and to use an analogy, 2 of our large customers that recently merged with other defense primes are going through similar value creation programs. We've effectively acquired a company greater than 2x our size over the course of the past 7 years. It just so happens that we've done so via 13 acquisitions as compared with a single merger of equals like our customers.

In addition today, but unrelated to 1MPACT, we announced that our Executive Vice President, Didier Thibaud, has decided to retire from the company. Didier will rejoin his family in France after 26 years at Mercury. In September, he'll begin serving as a strategic adviser to me while also working closely with the leadership team for a smooth and orderly transition. Didier's contributions and counsel have been instrumental to our growth and success. We extend to him our sincere thanks and wish him well on retirement.

Turning to Slide 8. We expect that 1MPACT will also accelerate value creation as we apply the new processes and methodologies to future M&A activity, which remains an integral part of our strategy. The M&A environment is extremely active right now, as I mentioned, and our pipeline is strong. We remain disciplined in our approach, both in terms of deal disputes and diligence as well as integration. The integrations of POC and Pentek are on track and both businesses are performing well. Looking forward, we believe that we're well positioned to continue supplementing Mercury's organic growth with accretive acquisitions.

Turning to Slide 9. In summary, we believe that the current environment is transitory, and we'll begin to see signs of improvement. Although organic growth may be lower in FY '22 versus what we thought last quarter, we believe that the secular growth trends that benefit Mercury is still in place. We're expecting substantial growth in bookings and backlog in fiscal '22. As a result, fiscal '23 is shaping up to be a strong year as organic growth returns to normal levels and margins expand as a result of recent 1MPACT actions taken.

Our longer term outlook remains intact, and our strategy remains the same. That is to deliver strong margins while growing the business organically and supplementing this organic growth with disciplined M&A and full integration. This strategy has worked extremely well for us for nearly a decade. As we crossed the $1 billion revenue threshold, we've launched 1MPACT to achieve Mercury's full growth and adjusted EBITDA potential over the course of the next 5 years.

With that, I'd like to turn the call over to Mike. Mike?

Thank you, Mark, and good afternoon again, everyone. As usual, I'll start with our Q4 and fiscal '21 results and then move to our guidance for Q1 and full year fiscal '22. I'll conclude with some detail on the magnitude and timing of potential financial benefits from the 1MPACT effort that Mark just discussed.

We finished fiscal '21 with a strong fourth quarter and delivered record revenue, adjusted EBITDA and adjusted EPS for the year. As Mark mentioned, entering fiscal '22, we're expecting flat organic growth, but double-digit total growth, strong results on the bottom line and a substantial rebound in our bookings. As a result, we believe that we're well positioned for a return to high single-digit, low double-digit organic growth in fiscal '23. In addition, we expect adjusted EBITDA margins to expand in fiscal '23, driven by positive operating leverage in addition to benefits of the 1MPACT program.

Turning now to Slide 10. 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 the slowdown we experienced through the first 3 quarters of fiscal '21.

Bookings for Q4 were $260 million, down 7% compared to Q4 '20 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 '20 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 continue to perform well as we integrate them into Mercury.

GAAP net income and GAAP EPS were down 34% and 35%, respectively, from Q4 '20. This was driven primarily by nonoperating income, discrete tax benefits, amortization expense and restructuring and other charges. Adjusted net income and adjusted EPS, which exclude most of these items, were up year-over-year. We recorded $7 million of restructuring and other charges in Q4, reflecting a workforce reduction in the quarter as well as third-party consulting costs associated with our 1MPACT program.

Adjusted EBITDA for Q4 increased 19% to a record $59.1 million compared to $49.6 million last year. Our adjusted EBITDA margins were 23.5% for the quarter, up from 22.8% in Q4 fiscal '20. This margin expansion included a 110 basis point dilutive impact from the POC acquisition.

Turning to our full year results on Slide 11. We managed through COVID and market conditions to deliver record revenue, adjusted EBITDA and adjusted EPS in fiscal '21. The volume of new design wins remained high at $1.5 billion. We continue to position the business for future growth through investments in R&D and CapEx. We also completed 2 acquisitions, deploying $375 million of capital.

Total bookings for fiscal '21 were $881 million. This was down 8% from fiscal '20 when we had a record bookings year. As Mark mentioned, our bookings during the year were impacted by a variety of market and program dynamics. Our book-to-bill for fiscal '21 was slightly below 1 at 0.95. We ended the year with backlog of $910 million, up 9% year-over-year.

Revenue in fiscal '21 increased 16% year-over-year to a record $924 million, exceeding our guidance of $910 million to $920 million. No single program represented more than 5% of our revenue in fiscal '21, and our top 5 programs represented less than 20% of revenue.

Total GAAP net income on a consolidated basis for fiscal '21 was $62 million or $1.12 per share. The decrease was driven primarily by nonoperating income, discrete tax benefits, amortization expense, COVID expenses and restructuring and other charges. Adjusted net income and adjusted EPS were both up year-over-year. Adjusted EBITDA for fiscal '21 increased 15% to a record $201.9 million compared to $176.2 million last year. Our adjusted EBITDA margins were 21.9% compared to 22.1% in fiscal '20. POC had a dilutive impact of 30 basis points on adjusted EBITDA margins for the 6 months following the acquisition.

Slide 12 presents Mercury's balance sheet for the last 5 quarters. In Q4, we completed the $65 million acquisition of Pentek, which we financed with $25 million of cash on hand and $40 million of debt under our revolver. We ended Q4 with cash and cash equivalents of $114 million compared to $122 million in Q3. The reduction was driven by the cash used for the Pentek acquisition, partially offset by the cash generated in the business. We ended Q4 with $200 million of debt, up $40 million related to the funding of the Pentek acquisition.

From a capital structure perspective, Mercury remains well positioned with continued flexibility and great access to capital. We still have significant capacity to invest in M&A, and our pipeline of M&A opportunities continues to be strong.

Turning to cash flow on Slide 13. Free cash flow for Q4 was in line with our expectations at $16.3 million, representing 28% of adjusted EBITDA. During the quarter, we had cash outflows related to COVID, acquisition-related expenses, primarily related to the Pentek acquisition, as well as for consulting costs associated with our 1MPACT program.

For the year, free cash flow was $51.6 million, representing approximately 26% of adjusted EBITDA, in line with expectations. In fiscal '22, we expect free cash flow conversion to increase compared to fiscal '21.

I'll now turn to our financial guidance, starting with the full year fiscal '22 on Slide 14. Our guidance for Q1 and for full fiscal year reflects the market conditions and potential impacts from the fiscal '21 bookings delays that Mark discussed. Our guidance assumes no acquisition-related expenses as well as an effective tax rate of 25%. Our guidance includes restructuring and other charges of $9.4 million in Q1 related to the 1MPACT initiative. For fiscal '22, we currently expect total company revenue of $1 billion to $1.03 billion, an increase of 8% to 11% compared to fiscal '21. This is prior to any additional acquisitions.

As Mark discussed, we expect headwinds from last year's delays in major programs like SEWIP, F-35 TR3 and a large foreign military sale. We expect those to be offset by increases in other electronic warfare and radar programs as well as C2 and platform and mission management programs. As a result, we expect our fiscal '22 organic revenue to be approximately flat compared to fiscal '21. We expect bookings to rebound in fiscal '22, driving a book-to-bill above 1 for the year.

Similar to fiscal years '19 through '21, we expect our total revenue in fiscal '22 to progressively increase by quarter throughout the year, weighted heavily towards the second half. Total GAAP net income on a consolidated basis for fiscal '22 is expected to be $60 million to $65.2 million or $1.07 to $1.16 per share. Adjusted EPS for fiscal '22 is expected to be in the range of $2.45 to $2.55 per share, an increase of 1% to 5% compared to fiscal '21. Adjusted EBITDA for fiscal '22 is expected to be in the range of $220 million to $227 million, up 9% to 12% from fiscal '21. This guidance includes $22 million of savings from the 1MPACT-related organizational efficiencies that Mark discussed.

Adjusted EBITDA margins are expected to be approximately 22% despite a 100 basis point dilution due to a full year of POC, which has lower EBITDA margins. Like revenue, we expect adjusted EBITDA and adjusted EBITDA margins to progressively increase from quarter-to-quarter, with Q1 being the low point for the year. As revenue ramps throughout the year, we expect operating leverage to lead to margin expansion.

Looking further ahead, we believe the investments that we've made over the last few years will result in further adjusted EBITDA margin expansion in future years. We believe this will be driven by program mix and operating leverage as well as operating efficiencies and with the 1MPACT initiatives accelerating margin expansion in fiscal '23 and beyond.

From a free cash flow perspective, we're targeting approximately 40% free cash flow to adjusted EBITDA in fiscal '22. We expect the COVID cash outflows we saw in fiscal '21 to diminish, and we expect capital expenditures for the year to return closer to maintenance levels. We do anticipate cash outflows associated with 1MPACT, including $6.8 million of separation costs and $4.7 million of third-party consulting fees.

Turning now to our first quarter fiscal '22 guidance on Slide 15. We're forecasting total revenue in the range of $210 million to $220 million, an increase of approximately 2% to 7% year-over-year. On an organic basis, we expect Q1 revenue to be down approximately 15% year-over-year, driven by the bookings slowdown in fiscal '21. We expect to incur a GAAP net loss in the first quarter of $4.4 million to $2.3 million or $0.08 to $0.04 per share. The net loss is a result of the $9.4 million of restructuring and other charges previously discussed.

Adjusted EPS, which excludes restructuring and other charges, is expected to be $0.38 to $0.41 per share. Adjusted EBITDA for Q1 is expected to be $36.8 million to $39.6 million, representing approximately 17.5% to 18% of revenue. The adjusted EBITDA margins in Q1 are impacted by the negative operating leverage due to lower revenue while recurring operating expenses remained stable. We expect to continue to invest in R&D in H1 to position ourselves for continued growth in H2 and beyond. As a result, we expect to see lower margins in H1 with expansion in H2.

As I mentioned, for the full fiscal year, we expect our adjusted EBITDA margin to be approximately 22% of revenue. We expect free cash flow to adjusted EBITDA for Q1 to be approximately 25% of adjusted EBITDA. Our conversion will be impacted by cash outflows associated with the restructuring and other charges previously mentioned.

Turning to Slide 16. Given our significant growth over the last few years and our outlook for accelerated organic and acquisition-driven growth in fiscal '23 and beyond, we've launched 1MPACT to set the stage for becoming a multiple of our current size over time. 1MPACT also aims at realizing our full adjusted EBITDA potential.

Slide 16 summarizes our preliminary estimate of the potential savings related to 1MPACT and the timing for realizing those savings. We're still in the planning phase for the 1MPACT work streams in the 6 focus areas that Mark outlined. Once they've been completed, each will include detailed savings and timing estimates. We currently expect to complete the planning phase in Q1 and begin actioning the work streams in Q2.

Although we're still refining our views, our preliminary estimates are that we can generate approximately $35 million to $55 million of gross savings by fiscal '25. The 1MPACT effort is primarily focused on scalability. As such, we expect to reinvest approximately $5 million of the savings into the new organizational structure. On a net basis, we're expecting a $30 million to $50 million benefit to adjusted EBITDA.

From a timing perspective, at the midpoint of the savings range, our preliminary estimate is that we'll be able to recognize cumulatively approximately $25 million of savings by the end of fiscal '23. We expect to realize $35 million by the end of fiscal '24 and 100% of the gross savings or $45 million at the midpoint by fiscal '25. As I've discussed, we've already included approximately $22 million of savings in our fiscal '22 guidance related to the actions taken in Q4 and Q1.

We expect to see margin expansion during the year as a result of these actions. Our fiscal '22 guidance assumes margins expand by 10 basis points compared to fiscal '21, despite a 100 basis point dilutive impact from a whole year of POC. As mentioned earlier, we expect organic revenue growth to return to our target high single-digit, low double-digit range in fiscal '23. We expect adjusted EBITDA margins to expand at the same time, driven by positive operating leverage as well as our 1MPACT efforts.

Looking further ahead, we expect to see continued margin expansion, driven by programs transitioning to production, operating leverage as revenues grow faster than expenses and continued acquisition integration. We see the $30 million to $50 million of estimated net benefits of 1MPACT as being additive to this previously expected margin expansion. We're optimistic about the potential for the 1MPACT program, and we'll continue to provide updates as it progresses.

Turning to Slide 17. In summary, Mercury delivered strong financial performance in Q4 and fiscal '21, including record revenue, adjusted EBITDA and adjusted EPS for the year and more than $900 million of year-end backlog. New business activity is returning to more normalized levels, and we're expecting fiscal '22 to be a strong year for bookings. Additionally, we believe that launching 1MPACT will enable us to accelerate adjusted EBITDA margin expansion over time.

As a result, we're optimistic as we look toward the second half of fiscal '22 and into fiscal '23. We believe we're in a strong position to continue executing on our long-term value creation strategy of high single-digit, low double-digit organic revenue growth, coupled with EBITDA margin expansion, supplemented with strategic and accretive M&A.

With that, we'll be happy to take your questions. Operator, you can proceed with the Q&A now.

(Operator Instructions) And our first question is going to come from the line of Sheila Kahyaoglu, Jefferies.

We'd like to go to the next question.

We'll skip that question, Sheila, if you can requeue. Our next question is going to come from the line of Seth Seifman with JPMorgan.

Sorry, hold on. Can you hear me?

Yes, we can hear you now.

Yes, we can hear you now.

Sorry, sorry. Yes. So a question about growth. And I know you discussed it. But I wonder if -- I'm 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're 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're going to see the rest of the year?

Sure. So a lot of questions there, Seth. Let me kind of just maybe on pocket and try and recap what happened in fiscal '21 in terms of revenue and bookings. So as we try 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 3 things: COVID, customer execution issues on various programs and the change in administration. That -- all those things actually resulted in more than a 5-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 '21 revenues would have actually been -- 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 3-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 SEWIP -- sorry, F-35 Intel was around about 2 points.

Now if you look at those programs, right, they're 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're 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've just mentioned are really all great programs for us and expect it to continue to grow over the course of the next 5 years because we believe that they're well aligned with the overall national defense strategy. So 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 3-point decline in organic bookings. The large FMS contracted a 3.5 point impact on organic bookings, and Filthy Buzzard was around about 1 point. So yes, 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 '22, accelerating in fiscal '23.

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

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're 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.

Yes. So I mean we have got a pretty significant base of programs, as we've 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've had, though, Peter, I think it's part of the impact that we're seeing is that when you have movement on concentrated in your, call it, top 5 programs, which is really what we experienced last year, it does have an impact. And that's, in essence, what we've seen. And the impact that is a result of the reduction in organic growth in fiscal '22 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 '21.

So in essence, we're 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've taken LTAMDS, that large award out of our fiscal year '22 and into our fiscal '23. We'll 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're seeing on some of these programs that are affecting the overall growth. We're still expecting significant growth from our top 20 programs in fiscal '22. We're expecting that growth in bookings will accelerate substantially in the second half. And again, we're 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 & Company.

I guess 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're 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 '23 and beyond?

Sure. Good question, Jonathan. So if you think about the journey that we've won and we tried to outline some of that in the prepared remarks. Since 2014, we've completed 13 acquisitions. We've had a greater than 4x increase in revenues over that period and greater than 9x increase in EBITDA. So we've 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've had a 3.5x increase in our headcount. We've seen an eightfold 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've 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've 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'd like to. So we've basically taken a pretty comprehensive look kind of top to bottom left to right across the business. And the 6 areas that we're focusing in on that we really began the efforts in the first quarter was around all efficiency and scalability.

So we saw an opportunity of streamlining the business, consolidating where appropriate. Those activities began in the fourth quarter, and they've accelerated in Q1 with the numbers that Mike announced. Beyond that, the areas that we're 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're 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.

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. How -- 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'd 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 '23 and maybe kind of what's driving the 5-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 '22, in particular, in the second half as well as substantial growth in FY '23.

The growth is likely going to come from our top 20 programs, which we expect to accelerate in the second half of '22. We expect the growth to be up greater than 20 points. And we're expecting an acceleration of bookings from those programs, again, as we head into '23. It's many of the same programs that we've talked about. So substantial ramp on the F-35. LTAMDS, we're expecting to more than double in '23. 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 '22, '23 time frame. Programs such as the V-22, F-18 as well as T-45. So we've won some great programs, all aligned with the national defense strategy, we believe. And the reason that we're saying the things that transitory is because we believe they're 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 5 years, it really hasn't changed. We're still expecting that over the course of the 5 years that we're expecting to be able to grow the business at high single-digit, low double-digit rates. We're well positioned with the national defense strategy. And the key drivers of growth, both from a DoD perspective, around modernization, speed and affordability. But then also with the key industry trends that we've discussed in the past such as outsourcing, supply chain delayering as well as reshoring. We have positioned the business in what we believe to be the faster growing part of the market, in particular, sensor and effector mission systems and C4I.

And as you know, over the course of the last 7 years, we've more than doubled the estimated value of our life -- the estimated lifetime value of our top programs and pursuits. And it's really these programs as they transition into production over time that will drive future growth.

Finally, again, we think that the M&A pipeline is very, very active. And these organic growth combined with M&A is what makes us believe that we can continue to do what we've been doing so successfully for the next 5 years to come. On top of that, we obviously announced 1MPACT and 1MPACT is about enabling our future growth, but then also having the opportunity of expanding our margins over time. So on that point, why don't I hand it over to Mike, who can kind of talk about the benefits of the 1MPACT program in fiscal '22 for your question.

Yes. Mike, and I think we can talk about 2 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'd 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 '20 from an EBITDA margin perspective, we were 22.1%. We came down a little in fiscal '21 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 '20. And then when you look at fiscal '22, the midpoint of our guidance is 22%. But again, as I mentioned in my prepared remarks, that POC acquisition, now that we'll have it for a full year, has a 100 basis point dilutive impact. So it would have been 23% otherwise.

And what we're seeing there is that we have some negative operating leverage because of the flat organic growth in fiscal '22. 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've got a dilutive impact from POC year-over-year. We've 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 '23 is important because as we go into fiscal '23 and we return to organic growth, we're going to have the programs transitioning into production, which is going to lead to gross margin expansion and EBITDA margin expansion. We're not going to have the headwinds from negative operating leverage, and then we will have -- see the benefits associated with the 1MPACT program. So we're expanding margins in '22, but we think there's a lot of benefit when we start looking at EBITDA margins in fiscal '23, 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 3 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 2 points of impact on the F-35. Absent those, our growth -- organic growth rate would have been absolutely in line with what our goals and objectives are, which is 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.

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've expanded, but how do we kind of expect that to trend as a percentage of sales?

Sure. So I'll talk again just in a little bit more depth about the areas, right? So the -- to be clear, I see, this 1MPACT activity was contemplated really not related to the -- some of the challenges, I guess, that we faced on the timing of various orders during fiscal year '21. 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 2x our size, but doing it through 13 acquisitions, we've extracted a lot of synergies, but we knew that there was probably more value to be hard. And we've been very, very focused in optimizing for growth.

We see the opportunity, really, I guess, in fiscal '22 is organic growth rate really just takes a bit of a pause to go attack that. And so we've already done a lot of manufacturing consolidation, right? So we moved from 5 RF manufacturing locations on the East Coast down to 1 major site. We just completed a similar activity from 3 to 1 on the West Coast kind of building in scalability. But we've still gone from 10 to 27 locations. And I think there's an opportunity for us to continue to optimize our facility footprint whilst continuing to improve delivery to customers at the same time.

The actions that we took in -- 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've done. We've been fully integrating them. But because the structure itself and the way in which we've 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 about a little bit about what you might see happening with respect to overall margins over and above the planned margin expansion that we -- that we're anticipating as a result of 1MPACT?

Yes. So Sheila, first of all, we're still doing the -- in the planning phases of 1MPACT. And so we'll 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'd always talked about as you look over a 5-year period, margin expansion. And we thought that was going to come from a handful of areas. That was program, product mix as we -- 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've been investing heavily and we can leverage some of the R&D investments we're 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 5-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're 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'll 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're thinking about 1MPACT, Sheila, is also -- 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're a highly acquisitive company, 13 acquisitions over the course of the last 7 or so years, serial acquirers, fully integrating those businesses. And we've 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're doing things to try and improve the scalability, the efficiency of the work and simplifying things along the way. And so we're applying 1MPACT on ourselves to begin with, which we think that will allow that 2 to 3 points of incremental margin expansion over and above what we've been previously anticipating over time. But the goal is to 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.

Just for my -- just my first question here. Do you anticipate any future acquisitions in fiscal year '23 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 on 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'll continue to see us acquire businesses that fit with the core of the strategy. So it's not -- we're not expecting 1MPACT to stall M&A. That's not the intent at all.

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'd like to thank you for your participation on today's Mercury Systems conference call. You may now disconnect.