Mercury Systems Inc (MRCY) Q1 2027 Earnings Call Transcript

Good day, everyone, and welcome to the Mercury Systems First Quarter Fiscal 2027 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 Senior Vice President of Strategy and Corporate Development, Tyler Hojo. Please go ahead, Mr. Hojo.

Good afternoon, and thank you for joining us. With me today is our Chairman and Chief Executive Officer, Bill Ballhaus, and our Executive Vice President, CFO, and COO, Dave Florensworth. If you have not received a copy of the earnings press release we issued earlier this afternoon, you can find it on our website at MRCY.com. The slide presentation that we will be referencing to is posted on the Investor Relations section of the website under Events and Presentations. Turning to slide 2 in the presentation, I'd like to remind you that today's presentation includes forward-looking statements, including information regarding Mercury's financial outlook, future plans, objectives, business prospects, and anticipated financial performance. These forward-looking statements are subject to future risks and uncertainties that could cause our actual results or performance to differ materially. All forward-looking statements should be considered in conjunction with the cautionary statements on slide 2 in the earnings press release and the risk factors included in Mercury's SEC filings. We will also be providing fiscal year 28 reference points today, which along with our target profile should not be construed as financial guidance and speak only as of today. They illustrate the financial profile the business could achieve based on the factors referenced above, including our ability to convert backlog to revenue and gain additional orders beyond current backlog. These factors may materially affect whether we reach these reference points or target profile. I'd also like to mention that in addition to reporting financial results in accordance with generally accepted accounting principles, or GAAP, during our call we will also discuss several non-GAAP financial measures, specifically adjusted income, adjusted earnings per share, adjusted EBITDA, and free cash flow. A reconciliation of these non-GAAP metrics is included as an appendix to today's slide presentation and in the earnings press release. I'll now turn the call over to Mercury's Chairman and CEO, Bill Ballhaus. Please turn to slide three.

Thanks, Tyler. Good afternoon. Thank you for joining our Q1 FY27 earnings call. The Mercury team delivered strong Q1 results with record Q1 bookings, record backlog, record Q1 revenue, and record Q1 adjusted EBITDA. Based on this solid execution, we are raising our outlook for FY27. Today, I'll cover three topics. First, some introductory comments on our business and results. Second, an update on our four priorities, performance excellence, growth, margin expansion, and free cash flow. And third, expectations for FY27 and longer term. Then I'll turn it over to Dave, who will walk through our financial results in more detail. Before jumping in, I'd like to thank our customers for their collaborative partnership and the trust they put in Mercury to support their most critical programs. I'd also like to thank our Mercury team for their dedication and commitment to delivering high-performance processing and enabling mission dominance for the warfighter at the edge. Please turn to slide four. Our Q1 results reflect robust organic growth and margins that are in line with our target profile. Record Q1 bookings of $370 million, up 48% year-over-year, a 1.46 book-to-bill, record backlog of $2.1 billion, and record next 12-month backlog of over $1 billion. Record Q1 revenue of $253 million. Record Q1 adjusted EBITDA of $56 million and adjusted EBITDA margin of 22.3%. And free cash outflow of $24 million, better-than-expected performance. We ended Q1 with $232 million of net debt, down 19.2% year-over-year. These Q1 results reflect relentless focus on our four priority areas, with highlights that include solid execution across our portfolio, leading to Q1 year-over-year organic revenue growth of 12.4%, and adjusted EBITDA growth of 58.6%, year-over-year growth in backlog and next 12-month backlog of 44.7% and 27.9%, respectively. An increase of 648 basis points year-over-year in adjusted EBITDA margin, and continued progress on free cash flow drivers with net working capital down 60 basis points year-over-year as a percent of trailing 12-month revenue. Please turn to slide five. Starting with our four priorities in priority one, performance excellence, where we are focused on sound execution on development programs, delivering for our customers, and scaling efficiently on numerous programs transitioning to higher volume production. In Q1, we ramped up across a number of programs generating record Q1 revenue and record trailing 12-month revenue of just over $1 billion. We believe Q1 revenue reflects increased linearity in the business enabled by an improving material posture. Our progress in scaling efficiently, combined with strong bookings and record backlog, have resulted in organic growth above our prior expectation for Q1 and a raised outlook for the full year, which I'll speak to shortly. Beyond this solid performance, we continue efforts to expand capacity and increase automation to drive scalability and efficiency. Please turn to slide six. Moving on to priority two, driving organic growth. We believe that our near-term organic growth will be driven by increased volume on existing production programs and the ongoing transition of a number of development programs to production. Additionally, we see possible upside tied to potential tailwinds from increased customer demand and quantities across a broad set of production programs in our portfolio. Lastly, we are excited about new development programs, both in the works and in our pipeline, and the potential of the production volume associated with those development efforts over time. In Q1, we delivered a record first quarter with $370 million of bookings, up 48% year-over-year, and a book-to-bill of $1.46 for the quarter. Our trailing 12-month bookings of $1.7 billion is the highest in the company's history, and our record total backlog of over $2 billion is providing enhanced visibility as we progress through FY27 and into FY28. The strength in Q1 bookings reflected demand across multiple areas of our portfolio. Importantly, we are also beginning to see some of the defense spending tailwinds we've discussed on past calls materialize in the form of earlier-than-expected bookings. Effectors were a particular area of strength, with bookings increasing meaningfully year-over-year, including a significant production award for advanced weapons systems that expand Mercury's role on the program. We also received a follow-on production order supporting an established missile defense platform. Radar bookings also increased year over year, supported by awards across multiple programs. Electronic warfare was another area of strength, with bookings increasing significantly year over year, including a competitive takeaway on the F-35 program, driven in part by improvements in our operational execution. We also received notable awards across our common processing architecture and space-based tracking applications, including follow-on orders supporting existing satellite programs and additional funding associated with early-stage, Golden Dome-related missile tracking capabilities. Looking ahead, we remain optimistic about the bookings environment, given our portfolio's strong alignment with priority defense investment areas. Please turn to slide 7. Now turning to priority 3, margin expansion. In our efforts towards consistently delivering adjusted EBITDA margins in the low to mid-20s, we are focused on the following drivers. Backlog margin expansion as we convert legacy lower margin backlog and add new bookings aligned with our target margin profile. Ongoing initiatives to further simplify, automate, and optimize our operations. And driving organic growth to increase positive operating leverage. Gross margin for Q1 of 35.2% was up 730 basis points year-over-year, reflecting a favorable mix in the quarter and improved average backlog margin. Q1 FY27 operating expenses are flat on an absolute basis and down year-over-year as a percent of revenue, reflecting our ongoing focus to drive efficiencies and enable positive operating leverage with top-line growth. Quarterly adjusted EBITDA margin of 22.3% was ahead of our expectation and up 640 basis points year-over-year, driven by the favorable mix in the quarter. We are encouraged by Q1 adjusted EBITDA margin, which we believe is an early indication of our ability over time to consistently deliver results within our target margin profile. Please forward to slide 8. Finally, turning to priority four, free cash flow conversion. We continue to make progress on the drivers of free cash flow. Networking capital at approximately $491 million, while up $33 million year-over-year, is down 60 basis points as a percent of trailing 12-month revenue. Net debt of $232 million at the end of the quarter is down $55 million year-over-year. With $100 million debt repayment in Q1, we have paid down $250 million in debt over the last two quarters, reflecting confidence in our expected ability to generate robust free cash flow on an ongoing basis. We believe our continuous improvement related to program execution, demand planning, and supply chain management, along with strong balance sheet flexibility, positions us well to drive organic growth efficiently and to capitalize on any additional potential market tailwinds. Please refer to slides 9 and 10. Our Q1 results reflect significant progress toward consistently delivering on our target financial profile of top-line growth above our estimated market growth rate of 9.9%, adjusted EBITDA margins in the low-to-mid-20s, and free cash flow conversion of 50%. Based on our Q1 performance, we are raising our FY27 outlook for revenue, adjusted EBITDA, and free cash flow conversion. For FY27, we now expect revenue growth of double digits year-over-year, up from approaching double digits, with total revenue approaching $1.1 billion. We anticipate Q2 revenue to be up 10% year-over-year, with revenue increasing through the balance of the year. We expect FY27 adjusted EBITDA margin in the high teens and adjusted EBITDA around $210 million, reflecting 40% year-over-year growth, up from our prior view of approaching $200 million and nearly 30% year-over-year growth. We expect Q2 adjusted EBITDA margin to expand roughly 500 basis points year-over-year and adjusted EBITDA margin to increase quarterly through the balance of the year. As mentioned in our last call, amid increased demand, we are making targeted investments in inventory, automation, and factory optimization to drive organic growth. For the full year, we are now anticipating FY27 free cash flow conversion approaching 40%, up from approaching 35%, with positive Q2 free cash flow and second half free cash flow expected to be higher than in the first. Although our revised FY27 outlook incorporates a limited set of tailwinds that have materialized in firm bookings, it does not incorporate the benefit of potential tailwinds that could occur on a number of production programs across our portfolio, including our common processing architecture, effectors, airborne applications, space, and missile defense. Additionally, this outlook does not incorporate benefits from automation efforts across our organization to improve backlog conversion. We believe any such improvements may translate into higher organic growth and adjusted EBITDA margin, representing potential upside to our outlook. Finally, while we are not updating today the FY28 reference points that we provided last quarter, our record Q1 performance, record backlog, and improving visibility gives us increasing confidence in our outlook beyond FY27. We expect to revisit and update these reference points as we progress through the back half of FY27. In summary, with our positive momentum coming out of a record Q1, we look forward to executing well for our customers, enabling high-performance processing and mission dominance for the warfighter at the edge, and delivering on what we believe is a significant value creation opportunity in front of us. In addition, today, we announced the formalization of Dave Farnsworth's role as Mercury's Chief Financial Officer and Chief Operating Officer. Dave's extensive operational experience has been invaluable to the company, and he has been effectively serving in this capacity for quite some time. With that, I'll turn it over to Dave to walk through the financial results for the quarter, and I look forward to your questions. Dave?

Thank you, Bill. Our first quarter results exemplify the progress we've made toward delivering robust, organic growth and margins in line with our target profile. As Bill noted, our first quarter results were in line with our targeted financial profile, and our focus remains on building toward consistently delivering results within that profile over time. With that, please turn to slide 11, which details our first quarter results. Our bookings for the quarter were approximately $371 million with a book-to-bill of 1.46. Our record backlog of over $2 billion is up $637 million, or 44.7% year-over-year. Revenues for the first quarter were $253 million, up approximately $28 million, or 12.4% organically compared to the prior year. Gross margin for the first quarter was 35.2%, up 730 basis points as compared to 27.9% for the same quarter last year. The gross margin during the first quarter was primarily driven by our program mix and lower inventory reserves of approximately $5 million as compared to the prior year. We also saw lower net EAC change impacts of $1 million as compared to the same quarter last year. Operating expenses slightly decreased by a million year-over-year. The decrease in operating expenses was driven primarily by lower selling, general, and administrative expenses, and amortization of intangible assets of approximately $3 million and $1 million, respectively. The decrease to selling, general, and administrative expense was primarily driven by fewer litigation and settlement expenses in the current quarter. The decrease in amortization of intangible assets was driven by certain intangibles being fully amortized in prior years. The decreases to our operating expenses were partially offset by higher research and development expense of approximately $3 million, driven by increased spending on internal R&D projects. Gap net income and earnings per share in the first quarter were approximately $13 million and $21 cents, respectively, as compared to gap net loss and loss per share of approximately $13 million and $21 cents, respectively, in the same quarter last year. Adjusted EBITDA for the first quarter was approximately $56 million, which is up $21 million or 58.6% as compared to nearly $36 million in the same quarter last year. Our adjusted EBITDA as a percentage of revenue was 22.3% as compared to 15.8% for the same quarter last year. Adjusted earnings per share for the first quarter was $0.52 as compared to $0.26 in the prior year. Free cash flow for the first quarter was an outflow of approximately $24 million as compared to an outflow of $4 million in the prior year. Slide 12 presents Mercury's balance sheet for the last five quarters. We ended the first quarter with cash and cash equivalents of $110 million, which represents a sequential decrease of approximately $105 million. This decrease was primarily driven by $100 million payment against our revolving credit facility and a free cash outflow of $24 million. The decrease to cash and cash equivalents was partially offset by proceeds from stock-option exercises of nearly $20 million in the current period. We've made cumulative payments of $250 million over the past two quarters, reducing our net debt to $232 million. Billed and unbilled receivables increased sequentially by approximately $12 million and $5 million, respectively, during the first quarter. The increase in receivables was driven by the timing of receipts from our customers as we continue to make progress delivering on programs to our customers. Inventory increased sequentially by approximately $32 million. As we noted last quarter, the increase was driven by targeted investments to drive organic growth, which was evidenced by our record first quarter revenue for the company. Prepaid expenses and other current assets increased by less than a million sequentially. Accounts payable increased sequentially by approximately $5 million, primarily driven by the timing of payments to our suppliers. Accrued expenses decreased approximately $18 million sequentially, primarily due to payments under our incentive compensation plans. The decrease was partially offset by an increase in the amount due to our factoring facility of nearly $7 million, driven by the timing of payments from our customers due back to our counterparty. Deferred revenues increased sequentially by less than a million, primarily driven by additional milestone billing events achieved during the period. Networking capital increased approximately $33 million year-over-year, or 7.2%, driven by targeted investments in inventory to drive organic growth. As we have previously discussed, our focus on networking capital improvements has enabled us to make $250 million in payments against our revolver over the past two quarters. These payments, coupled with our last 12 months free cash flow of approximately $48 million, results in a year-over-year reduction to net debt of $55 million, or 19.2%. This continues to demonstrate the progress we've made in reversing the multi-year trend of growth in networking capital. We believe our strong balance sheet provides sufficient flexibility for us to pursue and capture potential market tailwinds. Turning the cash flow on slide 13. Free cash flow for the first quarter was an outflow of approximately $24 million as compared to an outflow of $4 million in the prior year. Our free cash flow performance in the first quarter was largely driven by the increase in inventory, which, as we noted last quarter, was a deliberate investment to drive organic growth in fiscal 27. We still believe our continuous improvement in program execution, hardware deliveries, and appropriately timed payment terms will lead to continued reduction in working capital. In closing, we are pleased with the performance in the first quarter, and our increased confidence is reflected with our revised outlook for fiscal 27 and beyond. We believe continuing to execute on our four priority focus areas will not only drive revenue growth and profitability, but will also result in further margin expansion and cash conversion, demonstrating the long-term value creation potential of our business. With that, I'll now turn the call back over to Bill.

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

We will now begin the question and answer session. Please limit yourself to one question and one follow-up. If you would like to ask a question, please press star 1 to raise your hand. To withdraw your question, press star 1 again. We ask that you pick up your handset when asking a question to allow for optimum sound quality. If you are muted locally, please remember to unmute your device. Please stand by while we compile the Q&A roster. Your first question comes from the line of Patrick McCarthy with Oppenheimer. Your line is now open.

Hey, good afternoon, and thank you very much for taking my call. Congratulations on the call. Thank you. I was wondering if I could touch on the margins and the backlog for a moment. Just first on the backlog, could you characterize the backlog and the order flow between new orders, follow-on orders, and maybe follow-on orders that have more content?

Yeah, we haven't broken it out that way. I think what we've been talking about is... We're seeing a significant move over the last 12 months, as we expected when we completed development programs, into production orders, and some of those production orders are brand new production orders, some of them are follow-on production orders, and some of are increasing quantities on production orders as we move into fuller rate production. So, it's really across Across the board, I wouldn't say one particular area is driving it.

Yeah, I would just add that I think... The makeup of our backlog really does reflect this progression of the business from a heavy concentration of development programs a few years ago to a portfolio that's transitioning to fuller rate production. And as Dave alluded to, there's a spectrum. For the production activities, where some of the production is initial low rate production following the development programs. And in some cases, we're ramping the full rate on programs where we've been in production for a long time.

Okay, great. Thank you. And then just very quickly as a follow-up, can you give us a sense as to how much of maybe the low margin legacy work still exists within the backlog, or you pretty much run through that at this point?

Yeah, I mean, we have made incredible progress over the last nine quarters since we first started talking about that. And while we haven't gotten specific about it, we're clearly burning down that tail. And what we've said is that as we work our way through FY27, we don't expect to be talking about that dynamic any further. And I think if you look at... Not only this quarter, EBITDA margins of 22.3, but also look at Q4 of last year where our margins were 16.7%, but we talked about a couple of unusual elements in our cost structure were adjusted for those two items. One was around comp, another was around sort of increased EACs year over year. Adjusted for those two items, we're right at about 20% in Q4. So I think that progression is reflecting the fact that our average margin in our backlog continues to move in the right direction, reflecting that we're burning down those low margin legacy programs.

Your next question comes from the line of Jonathan Ho with William Blair. Your line is now open.

Jonathan, can you hear it?

Yeah, can you hear me okay? Yeah, we got you.

Yep.

Okay, perfect. Can you give us a sense? You talked a little bit about increased demand for production quantities. Can you maybe give us a sense of what those programs are? And, you know, do you have the capacity to sort of rapidly scale to produce some of these higher volumes?

Yeah, I mean, the first... First thing I'd say is we've talked about tailwinds, potential tailwinds in the market across a broad swath of our portfolio that would reflect increased quantities and increased demand. And we really haven't seen that materialize yet. We had one booking in the quarter that we said reflects some of the tailwinds, but it wasn't so much increased quantities. It was an acceleration of the order granted on a program where we've earned increase. But so far, we really haven't seen impacts associated with the potential tailwinds that we still see progressing through our pipeline. What we're seeing is predominantly a reflection of our portfolio transitioning from development to low rate to higher rate production. And it's something that we've expected to see for a few years. And it's just a natural evolution of Mercury's portfolio. When it comes to capacity. In general, across our sites right now, we're operating on one shift. And so from a scalability standpoint, the first step that we would take to meet increasing demand would be to move to two shifts. And it's a very elegant way to scale the business and a way to scale the business following the demand so that we don't have to make significant investments ahead of the demand. But right now, we feel like we're in a really good position with our footprint to be able to scale up, scale up efficiently and handle any of the potential tailwinds that we see.

And just a quick follow-up, you know, when we think about sort of, you know, the geopolitical landscape, is there any impact or perspective impact to some of your programs, just given, you know, some of the changes that have taken place and from an electoral standpoint recently, you know, any shifting in the priority there, either accelerating or decelerating? Thank you.

Yeah, we don't think so. I mean, we feel like our Portfolio and the programs that we're on align with the top priorities from a national security standpoint, and we don't see that changing. And we feel like we're in a really good position with respect to the budget and the priorities and specifically, you know, in the near term, who knows how the budgets are going to play out from a timing standpoint. But given our $2 billion backlog, the next 12-month backlog that's now up 5% sequentially and over a billion. We've got really good visibility through 27 and into 28. Again, we feel like our programs are well aligned with the top priorities. So if the budget comes out at $1 trillion, $1.1 trillion, we feel like our prioritization will be well above where the waterline is. And of course, from a long-term standpoint, we're really confident. And then during demand drivers associated with our business and specifically the demand for high performance processing distributed throughout a networked battle space. So we feel really good about our strategic positioning.

Your next question comes from the line of Sheila Kayagaloo with Jeffries. Your line is now open.

Hi, and good afternoon, Bill, Dave, and congratulations, Dave. Thank you so much for the time. As you think about programs ramping into production, how should we think about the margin delta of the current revenue run rate versus your backlog? As programs move into production, are there any dynamics or ramps we should be thinking about in terms of the margin trajectory? Thank you.

Yeah, I, I think, and we've talked about before, certainly as programs have been transitioning to production, it's helped lift the margin that we've got in our backlog because development programs tend to be lower margin than production programs. We've talked about that in the past. But in addition to that, we've continued to work up our total margin in backlog. So, and we've talked about this after for. Three or four quarters now that the margin that we're adding into our backlog is consistent with the margin we expect in order to be able to meet the target profile we've got out there. And I think Q1 was a good example of that, that the mix of programs we executed on put us in a position where we were able to, you know, execute at 22.3%, even the margins. Which is right in line with our target profile, and I think that as we move forward, our goal is to ensure that we can get to a position where we can consistently deliver those margins within that profile so that the mix of contracts in our profile will be in such a place that that will make sense.

And if I can just ask one follow-up, clearly you're seeing strong underlying demand, but how should we think about revenue capacity of the business today, and can you talk about the investments you're making to meet strong customer demand faster?

Yeah, I mean, from a capacity standpoint, we feel like we've got significant capacity that's untapped right now. And again, we're primarily running at one shift across our factories. And if necessary, and if the demand were materialized, we could go to two shifts. And, you know, that wouldn't require any additional capital. The one significant capital investment we've made already, and that was expanding our footprint in Phoenix. We brought online about $50,000. Square feet. So we feel very good about our ability to be able to scale and do it efficiently within our existing footprint.

Your next question comes from the line of Seth Safeman with J.P. Morgan. Your line is now open.

Thanks very much. Good afternoon and nice results. I just wanted to ask on the – when we think about the margin progression, you know, The implication for the rest of the year is that, you know, we'll see a step down in C2 and then some improvement, but, you know, perhaps Q1 is kind of then the high watermark for the year. You know, what are some of the specific things that, you know, you're kind of that we should be aware of from a mixed perspective that kind of don't carry forward from here as we think about the rest of the year?

Yeah, I think as we looked at the year, just looking at how we think things will play out through the factories through the rest of this fiscal year, and we're just in Q1 of this year. That, you know, we can see the mix in Q1 was towards a little bit towards the higher end of our margin in backlog. So, you know, we've always talked about there's a range, there's an average in the backlog, but there's a range around that. And some of the programs that we happen to execute and deliver on in the first quarter, there was a higher percentage of those that were above that line. And right now, our expectation is that that's going to normalize a little bit for the rest of the year, but we're going to continue to work every day at doing everything we can to exceed those margins and to exceed our, you know, our stake that we put in the ground. Yeah, and I would just add, I mean, first of all, I'll emphasize that point that hopefully.

You've seen a consistent pattern over years now where we put a stake in the ground and then we leverage every degree of freedom possible to outperform where we put the stake in the ground. A little bit more color around Q1, the 22.3%. I think Dave and I would be the first to tell you that nothing really extraordinary happened in the quarter. And we are nowhere near our potential as a business in terms of the things that we're focused on to drive performance improvement. And we see a lot of headroom from where we're operating today to our potential. So hopefully that's helpful in putting a little context around that outlook.

Yeah, it absolutely is. That was going to be kind of my follow-up was, you know, you're kind of reached your target profile for the quarter, but if we think about what's ahead, there's still, you know, a maturing set of production programs. There's still, you know, some lingering legacy contracts. There's still leverage on the OPEX outside of cost of goods sold. I would imagine all of those things and maybe others provide, you know, upside to that profile.

Yeah, I mean, literally, and we've talked about this from a math standpoint, you can model our business in a very simple four-line model and tweak the different lines to see what the resulting math would be. And specifically, there's the top line growth rate. There's the progression of our backlog margin continuing to tick up. There's the OPEX of the business, which we've said our goal is to keep it flat, and we demonstrated in the quarter that actually it was down on an absolute basis and down as a percent of revenue. And so, to your point, any incremental improvement in the top line is going to flow through and generate positive operating leverage because of the OPEX. Any further improvement in our backlog margin? As we said, there are a number of areas where we see the opportunity to improve how we're executing, to your point, around the progression of our programs from development to production. And as that matures, the efficiency goes up and the margin has the potential to go up. So if you just tweak those three lines and see how it flows through the bottom, I think the math would say we've got room to run. And as we keep, you know, improving performance and consistently demonstrate an ability to deliver within our target margin profile, we'll, you know, take a look at what our expectations might be beyond that.

Your next question comes from the line of Austin Moeller with Concord Genuity. Your line is now open.

Hi, good afternoon. So I was just wondering if you could comment on where you see steady state EBITDA margins settling out in the next 12 months, if revenue growth remains primarily organic here.

Yeah, I mean, look, I think it's a combination of factors. It's our top line growth rate and what happens there. It's the continued progression of our backlog margin, and it's the operating leverage in the business. You know, we're constantly working on driving each of those things because that's going to end up driving our margin expansion, and that is our focus right now. Our primary focus is on scaling the business and scaling efficiently, and we're not out of degrees of freedom to drive improvement in those areas.

And we did talk, we talked about, you know, we see our EBITDA increasing by closing close to 40% this year over FY26.

Okay, and I was wondering what your thoughts are on the fiscal year 27 appropriations bill, and if it is passed versus a full year CR, how that might impact the upgrade cycle for ruggedized servers on weapons platforms.

Well, I think, you know, what we see is first really good visibility in our business through FY27 and into FY28, primarily driven by what's already in our backlog and the coverage that we have over the next 12 months. And that's what gives us really good confidence and visibility around the outlook that we've provided.

Your next question comes from the line of Ken Herbert with RBC. Your line is now open.

Hey, good evening, guys. This is Steve Trackhouse on for Ken Herbert. Over the last couple quarters, we've talked a lot about the progression in volume from development to low rates. Can you maybe touch on the pricing opportunity you might see across your electronic components business? As I think about credit circuit boards, we heard a lot of commentary in USA, for example, around the consistent supply constraints there. So maybe can you talk about the pricing opportunity across your portfolio?

Yeah, I think it's very circumstantial. You know, you see in some instances, certainly where we're entering into new or next stage contracts, we're pricing in the things that we see in the market. We've talked before about in some instances, we're including clauses in contracts for potential escalation in price if the prices change. Over the near term. In a lot of cases, we have inventory on hand already, so that's not affecting the current activities. But as we, you know, we're bidding what we see out there. We're working with our customers, so it's not something we're not surprising our customers. We're revising prices on a slightly more regular cadence than it was two years ago. And at the same time, we're getting from our customers an indication, or in some cases, actually orders, that are asking us, go buy all these things now, so you can lock in the prices for the next year, two years, three years, whatever it may be, and they're paying us up front to do that kind of activity. So it's really a combination of things. That go across, in some cases, it's pricing, but it's not that in all cases.

It's a lever for us, but I think the punchline is, as we're transitioning from development to production, we see a lift in our margins just tied to the, you know, pretty significant shift in mix to production, and production that's maturing over time, in which case we get more efficient and have the potential to expand margins.

Thank you. And then maybe just as a quick follow-up, we've talked about a lot of different moving pieces of the revenue guide, but maybe what's the one or two pieces that could really drive the organic growth higher in the backup of this year?

Well, I think, you know, we've talked about this on a number of calls. We are on a daily, weekly basis working through the constraints on our programs that will enable us to accelerate backlog conversion. One of the big moves that we've made over the last few quarters has been around material and pulling our supply chain to the left, and we're now seeing the impact of that. We saw it in the first quarter. You can see it in our commitments that we have outstanding, and that has tended to be the primary constraint. And it's not a constraint because there are particular products that are hard to get outside of maybe memory, but really what we self-inflicted about three years ago when we pushed all of our material to the right because we had a large volume of networking capital tied up in the business. But as we pulled the supply chain to the left over the last few quarters, we're now seeing a significant number of degrees of freedom in order to accelerate backlog conversion. And that's something that we're working on on a continuous basis. But you could see how it flowed through to the hard results in Q1.

Yeah, and I would add that, and we've talked about this quite a bit, We've not incorporated in our outlook any of the tailwinds from things like some of these framework agreements that have already been funded. With some of the primes, we always talked about, hey, there's going to be a delay in timing as they flow that down to the supply chain, and we weren't sure enough about what the timing would be to incorporate that in our outlook, so I think that's something that will Still have an impact as we move further into the year. And what we said is, hey, as we get stronger clarity on that, we'll talk about that on these calls.

And I'd add one last degree of freedom that isn't factored into the outlook is the impact of the automation initiatives that we have underway across our organization to include our partnership with Palantir. And we're really excited about what we're seeing on that front. We haven't quantified it yet or reflected any of the potential benefits in our outlook, but those efforts are squarely focused on addressing the critical path to accelerating backlog conversion. So any positive impact from those initiatives could represent upside to the outlook that we described.

Your next question comes from the line of Alexandra Mandry with Truist. Your line is now open.

Hey, guys. Nice results, and thanks for taking my questions. You highlighted an electronic warfare competitive takeaway on the F-35, driven partly by improved operational execution. Can you frame the scope and timing of that opportunity?

Well, in terms of the timing, it's something that we booked last quarter and we'll be delivering over the next, I'd say, several quarters. And I don't think there's much more to quantify other than that.

Great, and I guess I have a follow-up to that. So on the F-35, how durable is the expansion in Mercury's content, and what further share gain opportunities could follow for the F-35 program or other programs across the business?

Well, I mean, in general, what we're seeing is the opportunity for us to compete for content on a number of different programs and platforms, and F-35 is just one, but again, we have hundreds of programs and a number of platforms that we support.

Yeah, and we have a strong position on F-35, we feel good about. What we provide there and, you know, certainly the announcement on the on the quantities that are that are coming was very positive and and we certainly appreciate it here.

Your next question comes from the line of Pete Skibitzky with Alembic. Your line is now open.

Hey, good evening, guys. Great way to start off the fiscal year.

Thanks.

Yeah. Can we – how are you guys expecting how bookings are going to trend this year? I'm just wondering if you expect the second quarter will be a little bit lighter because of the CR, and then maybe we pick up at the second half. How are you thinking about that?

Well, you know, in general, bookings can be a little bit lumping, and the timing can move around from quarter to quarter. If, you know, literally a booking slips a week, it can impact what things look like over a given quarter. So, you know, we're not... We're not hyper-focused on bookings over a quarterly window. We really look at it over like an LTM basis. And right now, I mean, you look at our LTM bookings of $1.7 billion, it's by far the highest volume in the company's history. So I think it's a reflection of where we sit right now and the demand across our portfolio. It's not concentrated or isolated. It's very... Very broad-based. So we'll see what happens with the CR and the budgeting process. But as I said earlier, we feel really well positioned based on the backlog that we have, and in particular, the backlog that we have over the next 12 months.

Okay, got it. And then for Bill, you are Dave, you guys obviously paid a lot of debt down the past two quarters. It looks like net leverage will be pretty de minimis by the end of the fiscal year. So it seems like, you know, capital deployment opportunities will be, you know, the opportunity is just rising, I think, going forward. Can you give us a sense of what your priorities are?

Well, I mean, you've heard from us consistently that the organic value creation opportunity in front of us, that's 99.99% of our focus because it is so significant. And we've just been... Focused on improving the free cash flow of the business, continuing to de-lever, and now we're just building up flexibility. And, you know, we're actually very appreciative of you asking that question. And at this point, we'll continue to pay down debt, and then we'll see what other opportunities we think about in the future.

Yeah, and you're right. Our leverage, we're sub-1-4, so we feel good about the strength of our balance sheet. And we're constantly looking at, hey, what's the right thing? You know, we talked about, let's go ensure we're lined up to be able to capture the value that we have in front of us.

Okay, fair enough. Thanks, guys. Yep, thanks, Pete.

Your next question comes from the line of Michael Charmoli with Guggenheim Securities. Your line is now open.

Hey, good evening, guys. Thanks for taking the question. Nice results. Hey, I guess, Bill, Dave, I'm sure you have a three to five-year strategic plan, and you're not going to give that to us, but I think it was a senior 10Q you laid out. You know, your total addressable market growing close to 10%. Does anything change here in terms of that growth rate in your end market or your planning based on the election results? I'm just trying to figure out maybe the sensitivity to your your programs and your growth trajectory based on some of these potential budget outcomes.

Yeah, I mean, the outlook, I mean, obviously, we haven't given a three year outlook and certainly not a five year outlook, but we did give some commentary. At the beginning of 27, on 27 and 28. What underpins our commentary and our outlook is the evolution of our portfolio, and most of what's driving our outlook in the organic growth and the margin expansion is follow-on production, where we're largely sole source, and it reflects the ongoing transition of our portfolio from a high development mix to a high production mix. So that's one. One data point. We also believe that our portfolio and where we sit is very closely aligned with the top priorities of the Department of War. And so whether the budget ends up at a trillion or $1.1 trillion and also recognizing that a bigger percentage of the budget is going toward the acquisition of technology and capabilities like we provide, We feel like the drivers of the programs and our outlook are going to sit well above the waterline. So we feel like we're in a really good spot with respect to the budgetary environment.

Got it. I'll keep it to one. Thanks, guys. Okay. Thanks, Mike.

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

Hey, thanks. Good afternoon, Bill, Dave, Tyler. Really nice results. I'm sorry if I missed this on the Golden Dome Award, but could you talk a little bit about, is this more like you see this as early development work and eventually can transition to production, or how do we think about the phasing of this?

Yeah, the way you characterize it is how we're thinking about it. It's relatively small, early development work, has some potential that we're excited about, but we're in the early stages right now.

Got it. And just as a follow-up, really strong margin performance. Bill, you spent a lot of time and Dave talking about OpEx kind of being locked in. Is this evidence of that, is where you're starting to layer in more top-line volume in OpEx? Is we're really seeing the benefit on the margin side or anything else?

Yeah, I mean, that's clearly the case in the quarter, but I think what really drove the – I mean, obviously, our OpEx was down. Year over year, despite the growth in the business. But what really drove the EBITDA margin expansion this quarter was the 700-ish basis points improvement in gross margin. And more than anything, I think that reflects how the average backlog margin has progressed over time. Yes, there was a little bit of favorable mix, but I think it really reflects how our average backlog margin has moved over time. And, you know, we're... Right within the zip code of where we want to be to consistently deliver in the target margin profile. But not done yet. Not done yet. Lots of room for improvement.

Great to hear. Thanks, guys. I'll leave it there. Thanks.

All right. Thanks, Peter.

If there are any remaining questions, please press star 1 to raise your hand. Mr. Ballhouse, it appears there are no further questions. Therefore, I would like to turn the call back over to you for any closing remarks.

Okay. Thanks, Operator. I would just like to thank everyone for their time and participation and look forward to catching up again next quarter. Thank you.

This concludes today's call. Thank you for attending. You may now disconnect.