Mercury Systems Inc

NASDAQ:MRCY

Earnings Call Transcript 2021-Q4

[Operator]

Good day everyone and welcome to the Mercury Systems fourth quarter fiscal 2021 conference call. Today's call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to the company's Executive Vice President and Chief Financial Officer, Mike Ruppert. Please go ahead, sir.

[Mike Ruppert]

Good afternoon and thank you for joining us. With me today is our President and Chief Executive Officer, Mark Aslett. If you have not received a copy of the earnings press release we issued earlier this afternoon, you can find it on our website at mrcy.com. The slide presentation that Mark and I will be referring to is posted on the Investor Relations section of the website under Events & Presentations.

Please turn to slide two in the presentation. Before we get started, I would like to remind you that today's presentation includes forward-looking statements, including information regarding Mercury's financial outlook, future plans, objectives, business prospects and anticipated financial performance as well as Mercury's new value creation initiative which we call 1MPACT. These forward-looking statements are subject to future risks and uncertainties that could cause our actual results or performance to differ materially. All forward-looking statements should be considered in conjunction with the cautionary statements on slide two, in the earnings press release and the risk factors included in Mercury's SEC filings.

I would also like to mention that in addition to reporting financial results in accordance with Generally Accepted Accounting Principles, or EBITDA, during our call, we will also discuss several non-GAAP financial measures, specifically, adjusted income, adjusted earnings per share, adjusted EBITDA, free cash flow, organic revenue and acquired revenue. A reconciliation of these non-GAAP metrics is included as an appendix to today's slide presentation and in the earnings press release.

I will now turn the call over to Mercury's President and CEO, Mark Aslett. Please turn to slide three.

[Mark Aslett, President, Chief Executive Officer]

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

Our results for Q4 and fiscal 2021 was strong led by robust design wins and double digit growth in revenue and adjusted EBITDA. It was, however, a more challenging than we anticipated and we believe that fiscal 2022 could be similar. That said, the team is doing an outstanding job of managing, derisking and growing the business and we are beginning the year with over $900 million of backlog.

The secular growth trends benefiting Mercury also remained favorable and we are well-aligned with the national defense strategy. The government continues to push for modernization, speed and affordability in both sensor and effector mission systems and C4I. As a result, our five-year plan remains intact, that is to deliver high single digit to low double digit organic revenue growth averaging 10% over time, coupled with M&A and margin expansion.

Since fiscal 2014, we have completed 13 acquisitions, multiplying the size of the company, delivering significant synergies and creating substantial value for shareholders. As we cross the $1 billion dollars revenue threshold in fiscal 2022, we are taking proactive steps with an eye towards repeating what we found over the past seven years.

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

Before talking more about 1MPACT, let's take a quick look at our financial results on slide four. We delivered strong fourth quarter results, as anticipated. Bookings came in as 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 were 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 bottomline, 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 2020. 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 a point where we are participating in more than 300 different programs, which continue to serve us well.

We designed a lot of top programs, with the majority being in sole-source position. 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 2021. Looking ahead to the next five 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 2021 design wins totaled $1.5 billion in estimated lifetime value. We had 74 design wins during the year. We received an award for the next generation deceptive jammer to arm Filthy Buzzard, which is one of our top programs. We won by leveraging the EW capabilities we acquired with KOR Electronics and our partnership with a leading Silicon Valley semiconductor company. This design win has an estimated lifetime value of $260 million and possibly more.

We made significant capital investments in our trusted microelectronics business in Phoenix. Leveraging the investments in partnership with another leading semiconductor firm, we are producing 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 2021 design win relates to the Army 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 aircrafts. 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 two acquisitions in fiscal 2021, 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 are excited about its 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 have also made significant investments to consolidate and build out our facilities. So, all-in-all, fiscal 2021 was a very strong year in a challenging environment.

Turning to slide five. Throughout fiscal 2021 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 CR3 and a delay in a large foreign military sale. In addition to lowering bookings, these issues combined reduced our organic revenue growth by approximately five percentage points for the year.

On our call last quarter, we previewed fiscal 2022 expecting mid to high single digit organic growth leading to total company revenue growth in the mid teens. Given our experience in fiscal 2021, we have taken a more conservative stance on organic growth for fiscal 2022. This includes reducing our expected fiscal 2022 revenues from SEWIP and other Nasal fleet upgrades, F-35 and certain FMS programs.

The biggest change since our last call related to LTAMDS. Raytheon at their recent Investor Day said the LTAMDS awards will likely be in their next fiscal year. We have been expecting a large booking in the second quarter of fiscal 2022. This booking has now moved to our fiscal 2023, 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 2023 and over the course of the next five years and beyond.

As Michael will share some detail, as a result of these changes, we are now expecting flat organic growth in fiscal 2022. We are expecting approximately 10% total company revenue growth prior to future M&A approaching $1 billion for the first time and record adjusted EBITDA.

We are expecting a number of programs to drive growth in fiscal 2022. 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 2021 and expect additional bookings in fiscal 2022.

In addition, we are involved with several radar upgrades. We expect to see growth in the EW domain and we have seen strong demand across multiple programs in C2 and platform and mission management. Over time, we expect Mercury's totaled company revenues continue growing faster than overall defense spending. We focused the business on large and faster growing parts in the defense market. Looking ahead to fiscal 2022, we are expecting a significant rebound in growth in bookings versus fiscal 2021 with a positive book-to-bill for the year and a substantial growth in our backlog.

Over the past two months, we have 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 of our customers in the government returning to on-site work. We also believe that 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 2022, we expect our design wins to again total more than $1 billion in estimated lifetime value. We expect these programs as well as prior design wins to convert into increased bookings and backlog as they transition into production over time.

Looking farther ahead to fiscal 2023, 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 2022 and finally, the substantial expected revenue growth on F-35, LTAMDS, Filthy Buzzard and other programs.

Turning to slide six. Since fiscal 2014, we have completed 13 acquisitions, deploying $1.2 billion of capital. As a result of these investments, we dramatically scaled and transformed the business. We have grown the estimated lifetime volume of Mercury's top 30 programs into two, from $4.6 billion to more than $11 billion. We also achieved a pipeline that's greater than 10X the size of our backlog and represents the foundation for our future growth.

Over this period, we have successfully grown total company revenue 4.4 times and adjusted EBITDA more than nine times, resulting in a 10X increase in our market cap. As demonstrated by the more rapid growth in adjusted EBITDA, we have extracted substantial costs and revenue synergies from our acquisitions over time. This has significantly reduced our gross purchase price to net multiple to the deals that we have 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 2023. In addition, we are in an extremely active period of 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 2023, combined with M&A, we believe that we have the opportunity over time to replicate what we have done so successfully since fiscal 2014. As a result, we have 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 five years.

Since fiscal 2014, driven by our acquisitions, we have substantially changed the company. We have expanded the scope of our offerings and capabilities, leading to a nearly eight-fold increase in subsystems revenue. Within source manufacturing, our headcount has increased 3.5 times. Our footprint has grown from 10 to 27 locations and our external 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 scale in mind.

Turning into slide seven, 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 of 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 are anticipating $22 million net benefit in total for fiscal 2022 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 two to three years, in addition to growth, we will be focusing on six 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 that planning stages and we will have more to say about them over the time.

At this point, we think it's reasonable to target $30 million to $50 million of incremental adjusted EBITDA by fiscal 2025 as a result of this activity. Again, this includes the $22 million dollars net benefit in fiscal 2022. Going forward, we will continue to reinvest some of the gross savings in people and business systems with an eye towards future scalability. Overall 1MPACT is about enabling that future. Doing what we have done since fiscal 2014, but doing it efficiently and effectively at greater scale.

The way to think about this and to use an analogy, two of our large customers that recently merged with other defense clients are going through similar value creation programs. We have effectively acquired a company greater than two times our size over the course of the past seven years. It just so happens that we have done so via 13 acquisitions as compared to the single merger vehicles, like our customers.

In addition today and 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 will begin serving as a strategic advisor 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 sincerest thanks and wish him well in retirement.

Turning to slide eight. The expected 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 pursuits and diligence as well as integration. The integrations of the POC and Pentek are on track and both businesses are performing well. Looking forward, we believe that we are well-positioned to continue supplementing Mercury's organic growth with accretive acquisitions.

Turning to slide nine. In summary, we believe that the current environment is transitory and we will begin to see signs of improvement. Although organic growth may be lower in FY 2022 versus what we thought last quarter, we believe that the secular growth trend that Mercury is still in place. We are expecting substantial growth in bookings and backlog in fiscal 2022. As a result, fiscal 2023 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 cross the $1 billion revenue threshold, we have launched 1MPACT to achieve Mercury's full growth and adjusted EBITDA potential over the course of the next five years.

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

[Mike Ruppert]

Thank you Mark and good afternoon again everyone. As usual, I will start with our Q4 and fiscal 2021 results and then move to our guidance for Q1 and full year fiscal 2022 I will conclude with some details on the magnitude and timing of potential financial benefits from the 1MPACT effort that Mark just discussed.

We finished fiscal 2021 with a strong fourth quarter and delivered record revenue, adjusted EBITDA and adjusted EPS for the year. As Mark mentioned, entering fiscal 2022, we are expecting flat organic growth but double digit total growth, strong results on the bottomline and a substantial rebound in our bookings. As a result, we believe that we are well-positioned for a return to high single digit, low double digit organic growth in fiscal 2023. In addition, we expect adjusted EBITDA margins to expand in fiscal 2023, driven by positive operating leverage in addition to benefits of the 1MPACT program.

Turning now to slide ten. Mercury delivered solid results in Q4. Total revenue, adjusted EBITDA and adjusted EPS all met or exceeded our guidance. Our Q4 bookings and book-to-bill were strong as the bookings environment began to improve from this slowdown we experienced through the first three quarters of fiscal 2021. Bookings for Q4 were $260 million, down 7% compared to Q4 2020 when we had a record bookings quarter. Bookings were up 24% compared to last quarter as we saw a rebound in activity. Q4 book-to-bill was 1.04.

Revenue for Q4 increased 15% from Q4 2020 to $251 million, which is above the top end of our guidance range of $236.5 million to $246.5 million. Organic revenue was $210 million and acquired revenue, which included Physical Optics Corporation and Pentek, was $40.8 million. Our acquisitions continued to perform well as we integrate them into Mercury.

GAAP net income and GAAP EPS were down 34% and 35% respectively from Q4 2020. This was driven primarily by non-operating income, discrete tax benefits, amortization expense and restructuring and other charges. Adjusted net income and adjusted EPS, which excludes most of these items, were up year-over-year.

We recorded $7 million of restructuring and other charges in Q4, reflecting a workforce production 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 2020. This margin expansion included 110 basis points dilutive impact from the POC acquisition.

Turning to our full year results on slide eleven. We managed through COVID and market conditions to deliver record revenue, adjusted EBITDA and adjusted EPS in fiscal 2021. 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 two acquisitions deploying $375 million of capital.

Total bookings for fiscal 2021 were $881 million. This was down 8% percent from fiscal 2020 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 2021 was slightly below one at 0.95. We ended the year with backlog of $910 million, 9% year-over-year.

Revenue in fiscal 2021 increased 16% year-over-year to a record $924 million, exceeding our guidance of $900 million to $920 million. No single program represented more than 5% of our revenue in fiscal 2021. And our top five programs represented less than 20% of revenue.

Total GAAP net income on a consolidated basis for fiscal 2021 was $62 million or $1.12 per share. The decrease was driven primarily by non-operating 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 2021 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 2020. POC had a dilutive impact of 30 basis points on adjusted EBITDA margins for the six months following the acquisition.

Slide twelve presents Mercury's balance sheet for the last five 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 thirteen. 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 Pentek acquisition as well 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 2022, we expect free cash flow conversion to increase compared to fiscal 2021.

I will now turn to our financial guidance, starting with the full year fiscal 2022 on slide fourteen. Our guidance for Q1 and for full fiscal year reflects the market conditions and potential impact from the fiscal 2021 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 2022, we currently expect total company revenue of $1 billion to $1.03 billion, an increase of 8% to 11% compared to fiscal 2021. This is prior to any additional acquisitions.

As Mark discussed, we expect headwinds from last year's delays in major programs like SEWUP, F-35 CR3 and a large foreign military sale. We expect those to be off debt 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 2022 organic revenue to be approximately flat compared to fiscal 2021. We expect bookings to rebound in fiscal 2022, driving a book-to-bill above one for the year.

Similar to fiscal years 2019 through 2021, we expect our total revenue in fiscal 2022 to progressively increase by quarter throughout the year, weighted heavily towards the second half. Total GAAP net income on a consolidated basis for fiscal 2022 is expected to be $60 million to $65.2 million or $1.07 to $1.16 per share. Adjusted EPS for fiscal 2022 is expected to be in the range of $2.45 to $2.5 per share, an increase of 1% to 5% compared to fiscal 2021. Adjusted EBITDA for fiscal 2022 is expected to be in the range of $220 million to $227 million, up 9% to 12% from fiscal 2021. This guidance includes $22 million of savings from the 1MPACT-related to organizational efficiencies that Mark discussed.

Adjusted EBITDA margins are expected to be approximately 22% despite 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 ramp throughout the year, we expect operating leverage to lead to margin expansion.

Looking further ahead, we believe the investments that we have 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 with the 1MPACT initiatives accelerating margin expansion in fiscal 2023 and beyond.

From a free cash flow perspective, we are targeting approximately 40% free cash flow to adjusted EBITDA in fiscal 2022. We expect that COVID cash outflows we saw in fiscal 2021 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 2022 guidance on slide fifteen. We are 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 revenues to be down approximately 15% year-over-year, driven by the bookings slowdown in fiscal 2021. 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 remain 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 margins 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 sixteen. Given our significant growth over the last few years and our outlook for accelerated organic and acquisition driven growth in fiscal 2023 and beyond, we have 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 sixteen summarizes our preliminary estimate of the potential savings related to 1MPACT and the timing for realizing those savings. We are still in the planning phase for the 1MPACT work streams in the six focus areas that Mark outlined. Once they have 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 are still refining our views, our preliminary estimates are that we can generate approximately $35 million to $55 million of gross savings by fiscal 2025. 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 are expecting $30 million to 450 million benefit to adjust to EBITDA.

From a timing perspective, at the midpoint of the savings range, our preliminary estimate is that we will be able to recognize cumulatively approximately 425 million of savings by the end of fiscal 2023. We expect to realize $35 million by the end of fiscal 2024 and 100% of the gross savings or $45 million, at the midpoint, by fiscal 2024. As I discussed, we have already included approximately $22 million of savings in our fiscal 2022 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 2022 guidance assumes margins expand by 10 basis points compared to fiscal 2021 despite 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 2023. 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 that $30 million to $50 million of estimated net benefits of 1MPACT as being additive to this previously expected margin expansion. We are optimistic about the potential for the 1MPACT program and we will continue to provide updates as it progresses.

Turning to slide seventeen. In summary, Mercury delivered strong financial performance in Q4 and fiscal 2021, 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 are expecting fiscal 2022 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 are optimistic as we look towards the second half of fiscal 2022 and into fiscal 2023. We believe we are 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 will be happy to take your questions. Operator, you can proceed with the Q&A now.

[Operator]

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

[Mark Aslett, President, Chief Executive Officer]

We would like to go to the next question.

[Operator]

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

[Seth Seifman, JPMorgan]

Sorry. Hold on. Can you hear me?

[Operator]

Yes. We can hear you now.

[Mark Aslett, President, Chief Executive Officer]

Yes. We can hear you now.

[Seth Seifman, JPMorgan]

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

[Mark Aslett, President, Chief Executive Officer]

Sure. So a lot of questions there, Seth. Let me kind of just maybe unpack it and try and recap what happened in fiscal 2021 in terms of revenue and bookings. So as we tried to say in the prepared remarks, what we really saw during the year was that orders were progressively delayed beginning in the first quarter as a result of really three things, COVID, customer execution issues on various programs and the change in the administration.

All those things actually resulted in more than a five point reduction in organic growth, ended up being around about 6.5 points actual reduction spread across the F-35, SEWIP and other naval programs as well as the FMS. And so if you kind of simplify it without those pressures, the FY 2021 organic revenues would have been ended up being consistent with historical organic revenue growth rates of high single digit to low double digits.

Peeling back the onion a little bit, so the naval and SEWIP upgrades had an approximately three point impact, international FMS sales, the large order that moved or the large program that moved from the first quarter ended up being around about 1.5 points. And then F-35 Intel was around about two points. Now if you look at those programs, right, they are all really good programs and they actually, in the main, performed pretty well.

So revenue was up double digits on F-35. We were up double digits on LTAMDS. We are up double digits on Filthy Buzzard. But just some of the growth that we experienced maybe wasn't necessarily as high as what we thought coming into the year. SEWIP was down a little bit for the year. So those programs that I just mentioned are really all great programs for us and expect it to continue to grow over the course of the next five years because we believe that they are well aligned with the overall national defense strategy.

o big picture, that's kind of what happened and from a revenue perspective and it's a very similar story with respect to the impact on organic growth and bookings. So F-35 had a three point decline in organic bookings. The large FMS contracted a 3.5 point impact on organic bookings and Filthy Buzzard was around about a point. So it was really all related to the timing of the awards and we do expect that things kind of both bookings will rebound in fiscal 2022, accelerating in fiscal 2023.

[Operator]

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

[Peter Arment, Baird]

Yes. Good afternoon Mark and Mike.

[Mark Aslett, President, Chief Executive Officer]

Hi Peter.

[Peter Arment, Baird]

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

[Mark Aslett, President, Chief Executive Officer]

Yes. So I mean we have got a pretty significant base of programs, as we have discussed in the past. And no single program has accounted for 5% to 6% of total company revenue and we expect that to continue going forward. Part of the challenge that we have had, though, Peter, I think it's part of the impact that we are seeing is that when you have movement concentrated in your, call it, top five programs, which is really what we experienced last year, it does have an impact. And that's, in essence, what we have seen.

And the impact that is a result of the reduction in organic growth in fiscal 2022 versus what we thought last quarter, many of it is us being just more conservative in the programs that I just mentioned, really as a result of the impacts that we saw throughout fiscal year 2021. So in essence, we are taking a more conservative approach to the year.

And then probably the biggest change that we had since last quarter or since the last call was on LTAMDS. And on LTAMDS, we were expecting a significant order in the second quarter. And now as a result of some changes that Raytheon had discussed, we have taken LTAMDS, that large award, out of our fiscal year 2022 and into our fiscal 2023. We will still have bookings and revenues associated with that program, but we just won't have as much as what we had previously.

So it really does come down to just the major impacts that we are seeing on some of these programs that are affecting the overall growth. We are still expecting significant growth from our top 20 programs in fiscal 2022. We are expecting that growth in bookings will accelerate substantially in the second half. And again, we are expecting very significant growth across these programs. So F-35, Filthy Buzzard, F-18, which is a new program for us, SEWIP and then the large FMS programs are all expecting to grow substantially on a year-over-year basis.

[Operator]

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

[Jonathan Ho, William Blair & Co.]

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

[Mark Aslett, President, Chief Executive Officer]

Sure. Good question, Jonathan. So if you think about the journey that we are on and we tried to outline some of that in the prepared remarks, since 2014 we have completed thirteen acquisitions. We have had a greater than 4X increase in revenues over that period and greater than 9X increase in EBITDA. So we have extracted substantial revenue synergies that's resulted in us basically reducing our net to gross purchase price multiple.

However, along the way, if you step back, there's been some very substantial changes in the company overall. So we have had a 3.5X increase in our headcount. We have seen an eight-fold increase in our subsystems revenue. The number of locations that we have, have increased from 10 to 27. And our external supply chain spend has increased 3X. So in that period, we have really optimized for growing the business. And with growth slowing a little bit organically this year, earlier in the year we figured that there was an opportunity for us to kind of go back, take a look at what other opportunities existed to further consolidate the businesses that we have acquired to extract even greater cost and revenue synergies.

That being said, 1MPACT is really all about laying the foundation for future growth. We think that we have the potential to be a multiple of our current size. But in essence, crossing the $1 billion revenue threshold is a milestone, but it's also a turning point. And we know that there are certain things that we need to focus in on to continue for us to grow and scale the way in which we would like to. So we have basically taken a pretty comprehensive look, kind of top to bottom, left to right, across the business. And the six areas that we are focusing in on that we really began the efforts in the first quarter was around org efficiency and scalability.

So we saw an opportunity of streamlining the business, consolidating where appropriate. Those activities began in the fourth quarter and they have accelerated in Q1 with the numbers that Mike announced. Beyond that, the areas that we are going to focus in on are continued improvements around procurement and supply chain. We see the opportunity as we continue to streamline and optimize the business to also optimize our facility footprint.

We are going to continue to look at investing in R&D, but looking at ways in which we can maybe doing it more efficiently. And similarly, across the capital base and balance sheet are the ways in which we can be more efficient there also. But again, to reiterate, it's all about future scalability and for Mercury to achieve its full growth potential both organically as well as through M&A and maybe even accelerating and expanding margins over time.

[Operator]

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

[Michael Ciarmoli, Truist Securities]

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

[Mark Aslett, President, Chief Executive Officer]

So let me talk a little bit about the rebound in growth in 2023 and maybe kind of what's driving the five-year outlook. And then Mike can maybe touch upon the margins that you mentioned.

So we do have really increasing confidence that our growth will return, based upon an expected accelerated bookings throughout fiscal 2022, in particular, in the second half as well as substantial growth in FY 2023. The growth is likely going to come from our top 20 programs, which we expect to accelerate in the second half of 2022. We expect the growth to be up greater than 20 points. And we are expecting an acceleration of bookings from those programs, again, as we head into 2023.

It's many of the same programs that we have talked about. So substantial ramp on the F-35. LTAMDS, we are expecting to more than double in 2023. Filthy Buzzard will grow substantially. And then beyond those key franchise programs, there's other programs that we expect, new programs for Mercury, either acquired programs or new design wins, that are also poised to contribute to additional growth in the 2022, 2023 time frame. Programs such as the V-22, F-18 as well as T-45.

So we have won some great programs, all aligned with the national defense strategy, we believe. And the reason that we are saying the things are transitory is because we believe that speaking to our customers that it's literally been the timing of specific orders. If you look out farther in time, Mike and you consider kind of our strategy over the five years, it really hasn't changed. We are still expecting that over the course of the five years that we are expecting to be able to grow the business at high single digit, low double digit rates. We are 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 have 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 parts of the market, in particular sensor and effector mission systems and C4I. And as you know, over the course of the last seven years, we have more than doubled 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 have been doing so successfully for the next five 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 2022, per your question.

[Mike Ruppert]

Yes. Hi Mike. And I think we can talk about two things. Talk about the EBITDA margins, just to give a little color on that. And then we can talk about gross margins too. But let me just start with EBITDA margins. And I would start by saying, overall, the profitability of the base business hasn't materially changed over the last couple of years. You do have to look at our EBITDA margins, with and without POC acquisition in it, because it does have a dilutive impact which is important to point out.

If you look at where we were in fiscal 2020 from an EBITDA margin perspective, we were 22.1%. We came down a little in fiscal 2021 to 21.9%. But again, POC, as I mentioned, had about a 30 basis point dilutive impact. So we would have been at 22.2%. So slightly up from fiscal 2020.

And then when you look at fiscal 2022, the midpoint of our guidance is 22%. But again, as I mentioned in my prepared remarks that POC acquisition, now that we will have it for a full year, has a 100 basis point dilutive impact. So it would have been 23% otherwise. And what we are seeing there is that we have some negative operating leverage because of the flat organic growth in fiscal 2022 and that's being offset by some of the 1MPACT initiatives that we talked about.

And when you look at it just on the base of 21.9% compared to 22%, which is the midpoint of our guidance, think about it like this, is that we have got dilutive impact from POC year-over-year. We have got production programs pushing to the right, like Mark discussed and then some of the negative operating leverage that I mentioned. But looking forward to fiscal 2023 is important because as we go into fiscal 2023 and we return to organic growth, we are going to have the programs transitioning into production, which is going to lead to gross margin expansion and EBITDA margin expansion.

We are not going to have the headwinds from negative operating leverage and then we will see the benefits associated with the 1MPACT program. So we are expanding margins in 2022, but we think there's a lot of benefit when we start looking at EBITDA margins in fiscal 2023. And gross margin is a similar story.

[Mark Aslett, President, Chief Executive Officer]

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

[Operator]

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

[Sheila Kahyaoglu, Jefferies]

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

[Operator]

Yes, we can.

[Mark Aslett, President, Chief Executive Officer]

We can, Sheila, yes. Yes.

[Sheila Kahyaoglu, Jefferies]

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

[Mark Aslett, President, Chief Executive Officer]

Sure. So I will talk again just in a little bit more depth about the areas, right. So to be clear, I see, this 1MPACT activity was contemplated really not related to some of the challenges, I guess, that we faced on the timing of various orders during fiscal year 2021. We see that crossing our $1 billion revenue threshold is a milestone, but it is an inflection point. And with all of the change in the business, effectively acquiring a company two times our size, but doing it through 13 acquisitions, we have extracted a lot of synergies, but we knew that there was probably more value to be had and we have been very, very focused in optimizing for growth.

We see the opportunity, really, I guess, in fiscal 2022 is organic growth rate really just takes a bit of a pause to go attack that. And so we have already done a lot of manufacturing consolidation, right. So we moved from five RF manufacturing locations on the East Coast down to one major site. We just completed a similar activity from three to one on the West Coast, kind of building in scalability. But we have still gone from 10 to 27 locations. And I think there's an opportunity for us to continue to optimize our facility footprint while us continuing to improve delivery to customers at the same time.

The actions that we began to take in Q4 and Q1 was really about streamlining and optimizing the org structure, again, as a result of the cumulative acquisitions that we have done. We have been fully integrating them. But because the structure itself and the way in which we are organized actually drives the cost footprint of the business, we took an opportunity to kind of step back and take another look at it to drive additional savings.

So Mike, do you want to talk a little bit about what you might see happening with respect to overall margins, over and above the planned margin expansion that we are anticipating as a result of 1MPACT?

[Mike Ruppert]

Yes. So Sheila, first of all, we are still in the planning phases of 1MPACT. And so we will have more information and more detail as we move along. In terms of, you asked about R&D as a percentage of revenue, where that might trend. Stepping back pre-1MPACT, we had always talked about as you look over a five-year period margin expansion. And we thought that was going to come from a handful of areas. That was program, product mix as programs transition from start-up phases into full rate production that has higher margins.

We thought it was going to come from operating leverage. And we thought it was going to come from R&D leverage as well as we have been investing heavily and we can leverage some of the R&D investments we are making in areas like security and safety across more of our products. So we expected R&D as a percentage of sales to come down, driving margin expansion over our five-year plan. We still expect all of that.

And what 1MPACT is in the numbers that we threw out in terms of $30 million to $50 million potential EBITDA improvement is above that margin expansion that we already expected. Now the amount in each of the areas that Mark discussed, we are still working through that in terms of what's going to be the amount around direct procurement and the amount around R&D and other areas.

So we will provide more information as we go on that. I think that if you look in the out years, though, the margin expansion opportunity on top of where we already were is 200 to 300 basis points.

[Mark Aslett, President, Chief Executive Officer]

Yes. So the way in which we are thinking about 1MPACT, Sheila and this was kind of the primary focus when we were contemplating the activity, was related to M&A. And so as you know, we are a highly acquisitive company, 13 acquisitions over the course of the last seven or so years. Serial acquirers, fully integrating those businesses. And we have done a really good job, again, extracting cost and revenue synergies with EBITDA growing at twice the rate or twice the multiple that revenue has over that time frame.

But as we look forward, the idea was to basically transform the way in which we are doing things to try and improve the scalability, the efficiency of the work and simplifying things along the way. And so we are applying 1MPACT on ourselves to begin with, which we think that will allow that two to three points of incremental margin expansion over and above what we have been previously anticipating over time. But the goal is stand up this transformation office and then to use the processes and the methodologies associated with 1MPACT to all future acquisitions.

If we do this right, we think that we should be able to extract even greater synergies from the deals that we do going forward and we should be able to extract those synergies more quickly. So it's about the future. It's about Mercury kind of achieving its full growth and EBITDA potential, both organically as well as through M&A.

[Operator]

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

[Austin Moeller, Canaccord Genuity]

Hi guys.

[Mark Aslett, President, Chief Executive Officer]

Hi Austin.

[Austin Moeller, Canaccord Genuity]

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

[Mark Aslett, President, Chief Executive Officer]

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

[Operator]

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

[Mark Aslett, President, Chief Executive Officer]

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

[Operator]

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