Q3 2025 Mercury Systems Inc Earnings Call
Yeah.
Operator: Good day, everyone, and welcome to the Mercury Systems' third quarter fiscal 2025 conference call. Today's call is being recorded.
Tyler Hojo: At this time, for opening remarks and introductions, I'd like to turn the call over to the company's vice president of investor relations, Tyler Hojo. Please go ahead, Mr. Hojo.
Speaker Change: At this time, for opening remarks and introductions, I'd like to turn the call over to the company's Vice President of the Professor of Relations. Tyler Hojo, please go ahead, Mr. Hojo.
Tyler Hojo: Good afternoon and thank you for joining us. With me today is our Chairman and Chief Executive Officer, Bill Ballhaus, and our Executive Vice President and CFO, Dave Farnsworth.
Good afternoon and thank you for joining us.
Speaker Change: With me today is our Chairman and Chief Executive Officer, Bill Ballhaus, and our Executive Vice President and CFO Dave Farnsworth.
Tyler Hojo: 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.
Speaker Change: 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 This live presentation that we will be referencing to is posted on the Investor Relations section of the website under events and presentations.
Tyler Hojo: 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 two 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.
Speaker Change: Turning this slide to 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.
Speaker Change: 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.
Tyler Hojo: 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'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.
and the risk factors included in Mercury's SEC violence.
Speaker Change: I'd also like to mention that in addition to reporting financial results in accordance with generally accepted accounting principles or gap during our call, we will also discuss several non-GAAP financial measures.
Tyler Hojo: A reconciliation of these non-GAAP metrics is included as an appendix to today's slide presentation and in the earnings press release.
Bill Ballhaus: I'll now turn the call over to Mercury's chairman and CEO, Bill Ballhouse. Please turn to slide three. Thanks, Tyler.
Tyler Hojo: I'll now turn the call over to Mercury's Chairman and CEO , Bill Ballhaus. Please turn us live to Ray. Thanks, Tyler. Good afternoon. Thank you for joining our Q3 FY25 earnings call.
Bill Ballhaus: Good afternoon. Thank you for joining our Q3 FY25 earnings call. We delivered solid results in Q3 that were, once again, in line with or ahead of our expectations. And I'm optimistic about our ongoing efforts to improve performance as we move through the fiscal year.
Tyler Hojo: We delivered solid results in Q3 that were once again in line with or ahead of our expectations and I'm optimistic about our ongoing efforts to improve performance as we move through the fiscal year.
Bill Ballhaus: Today, I'd like to cover three topics. First, some introductory comments on our business and results. Second, an update on four priorities, delivering predictable performance, building a thriving growth engine, expanding margins, and driving improved free cashflow. And third, performance expectations for FY25 and longer term.
Today I'd like to cover three topics.
Tyler Hojo: First, some introductory comments on our business and results. Second, an update on four priorities, delivering predictable performance, building a thriving growth engine, expanding margins, and driving improve free cash flow. And third, performance expectations for FY25 and longer term.
Bill Ballhaus: 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 mission-critical processing at the edge. Please turn to slide 4. Our Q3 results reinforce my confidence in our strategic positioning and our expectations to deliver predictable organic growth with expanding margins and robust free cash flow. Bookings of $200 million and a trailing 12-month book-to-bill of $1.1 million.
Tyler Hojo: 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
Tyler Hojo: I'd also like to thank our Mercury team for their dedication and commitment to delivering mission critical processing at the edge. Please turn to slide 4.
Tyler Hojo: RQ3 results reinforce my confidence in our strategic positioning and our expectations to deliver predictable organic growth with expanding margins and robust free cash flow, bookings of 200 million and a trailing 12 months booked a bill of 1.1.
Bill Ballhaus: Revenue of $211 million and year-to-date revenue growth of 8.9% year-over-year. Adjusted EBITDA of $25 million and Adjusted EBITDA margin of 11.7%, both up substantially year over year. And free cash flow of $24 million, up $50 million year over year, resulting in $146 million of free cash flow over the last four quarters. We ended Q3 with $270 million of cash on hand. These results reflect continued progress in each of our four priority areas with highlights that include solid execution across our broad portfolio of production and development programs. backlog growth of 4% year-over-year, reduced operating expense enabling increased positive operating leverage, and continued progress on free cash flow drivers with net working capital down 148 million year-over-year or 24.6%.
Tyler Hojo: Revenue of 211 million, and year-to-date revenue growth of 8.9% year-over-year [inaudible]
Tyler Hojo: Adjusted EBITDA of $25 million, and adjusted EBITDA margin of 11.7%.
Tyler Hojo: both up substantially year-over-year, and free cash flow of $24 million, up $50 million year-over-year, resulting in $146 million of free cash flow over the last four quarters. We end at Q3 with $270 million of cash on hand.
Tyler Hojo: These results reflect continued progress in each of our four priority areas with highlights that include solid execution across our broad portfolio of production and development programs.
Backlog growth of 4% year-over-year [inaudible]
Tyler Hojo: Produced Operating Expense, Enabling Increased Positive Operating Leverage, and Continued Progress on free cash flow drivers with networking capital down 148 million year over year, or 24.6 percent. Please turn to Slide 5.
Bill Ballhaus: Please turn to slide five. Starting now with our four priorities and priority one, delivering predictable performance. In the third quarter, our focus on predictable performance positively impacted our results primarily in two areas.
Tyler Hojo: Starting now with our four priorities and priority one, delivering predictable performance.
Tyler Hojo: In the third quarter are focused on predictable performance, positively impacted our results primarily two areas.
Bill Ballhaus: First, in Q3, we recognized approximately 3.7 million of net EAC change impacts across our portfolio, which is again down sequentially to the lowest level in several quarters, reflecting our maturing capabilities in program management, engineering, and operations, and progress in completing development programs. And second, our focus on accelerating customer deliveries allowed us to largely offset the $29 million of revenue that we accelerated into Q2, as discussed in our last call.
Tyler Hojo: First, in Q3, we recognized approximately 3.7 million of net EAC change impacts across our portfolio, which is again down sequentially to the lowest level in several quarters.
Tyler Hojo: Reflecting our maturing capabilities in program management, engineering, and operations, and progress in completing development programs.
Tyler Hojo: And second, our focus on accelerating customer deliveries allowed us to largely offset the 29 million of revenue that we accelerated into Q2 as discussed in our last call. Please turn to slide 6.
Bill Ballhaus: Please turn to slide six. Moving on to priority two, driving organic growth. Q3 bookings of $200 million resulted in a backlog of $1.34 billion, up 4% year over year. In the third quarter, we received a number of significant contract awards, including a total of $40 million in production contracts for our common processing architecture, adding to our backlog in this area. And a $20 million fall on production order associated with the F35 program.
Moving on to Priority 2, Driving Organic Growth
Tyler Hojo: A total of $40 million in production contracts for our common processing architecture adding to our backlog in this area and a $20 million fall on production order associated with the F-35 program.
Bill Ballhaus: It's also worth noting that in the month of April, we had several meaningful bookings, including a $20 million follow-on production agreement with an innovative commercial space company that supports a U.S. national security mission, a $7 million development contract with the U.S. Navy for an electronic warfare capability, and a $6 million follow-on production order for a classified avionics program that leverages our commercial memory products and advanced packaging expertise. In line with our expectations, over 80% of trailing 12-month bookings were production in nature, which continues to drive a makeshift toward production.
Tyler Hojo: It's also worth noting that in the month of April, we had several meaningful bookings, including a $20 million follow-on production agreement with an innovative commercial space company that supports a U.S. national security mission.
Tyler Hojo: A $7 million development contract with the U.S. Navy for an electronic warfare capability and a $6 million follow-on production order for a classified avionics program that leverages our commercial memory products and advanced packaging expertise.
Tyler Hojo: In line with our expectations, over 80% of trailing 12 month bookings were production in nature, which continues to drive a mixed shift toward production.
Bill Ballhaus: These awards are important not only because of their value and impact on our growth trajectory, but also because they reflect those customers' trust in Mercury to support their most critical franchise programs. In addition to this bookings progress, in early Q4, we entered into two agreements that we believe will enhance our competitive position going forward.
Tyler Hojo: These awards are important not only because of their value and impact on our growth trajectory, but also because they reflect those customers' trust in Mercury to support their most critical franchise programs.
Tyler Hojo: In addition to this bookings progress, in early Q4 we entered into two agreements that we believe will enhance our competitive position going forward.
Bill Ballhaus: First, we announced the acquisition from WinRiver of Starlab, a long-time partner and provider of cybersecurity software that integrates with our common processing architecture products, adding to our overall differentiation in this area.
Tyler Hojo: First, we announce the acquisition from WinRiver of StarLab, a longtime partner and provider of cybersecurity software that integrates with our common processing architecture products adding to our overall differentiation in this area.
Bill Ballhaus: Second, we announced an agreement to divest and outsource our manufacturing operation in Switzerland, which we believe will enhance our ability to scale and increase capacity with improved efficiency as we pursue continued growth of our international operation.
Tyler Hojo: Second, we announce an agreement to divest and outsource our manufacturing operation in Switzerland, which we believe will enhance our ability to scale and increase capacity with improved efficiency as we pursue continued growth of our international operations.
Bill Ballhaus: please forward to slide seven. Now turning to priority three, expanding margins. As we've discussed in prior calls, to achieve our targeted adjusted EBITDA margins in the low to mid 20% range, we are focused on the following two drivers. Backlog margin expansion as we burn down lower margin existing backlog and replace with new bookings aligned with our target margin profile. And driving organic growth to realize positive operating leverage given our streamlined operation. Q3 adjusted EBITDA margin of 11.7% was in line with our expectations, up sequentially 180 basis points, and indicative of progress on each of these levers in our effort to reach our targeted margins over time.
Please forward to slide seven.
Now turning to Priority 3, Expanding Margins.
Tyler Hojo: As we've discussed in prior calls, to achieve our targeted adjusted EBITDA margins in the low to mid-20% range, we are focused on the following two drivers
Tyler Hojo: Backlog margin expansion as we burn down lower margin existing backlog and replace with new bookings aligned with our target margin profile and driving organic growth to realize positive operating leverage given our streamlined operations.
Tyler Hojo: Q3 adjusted EBITDA margin of 11.7% was in line with our expectations, up sequentially 180 basis points, and indicative of progress on each of these levers in our effort to reach our targeted margins over time.
Bill Ballhaus: Gross margin of 27% was in line with our expectations and largely driven by the average margin in our backlog coming into FY25. We expect backlog margin to continue to increase as we bring in new bookings that we believe will be both in line with our targeted margin profile and accretive to the current average margin in our backlog.
Tyler Hojo: Gross Margin of 27% was in line with our expectations and largely driven by the average margin in our backlog coming into FY25.
Tyler Hojo: We expect backlog margin to continue to increase as we bring in new bookings that we believe will be both in line with our target of margin profile and a creative to the current average margin in our backlog.
Bill Ballhaus: Operating expenses are again down year-over-year and down significantly year-to-date as a result of prior and ongoing actions to streamline and focus our operations.
Tyler Hojo: Operating expenses are again down your year and down significantly year-to-date as a result of prior and ongoing actions to streamline and focus our operations.
Bill Ballhaus: Please forward to slide 8. Finally, turning to priority four, improved free cash flow. We continue to make significant progress on the drivers of free cash flow, and in particular, reduced networking capital, which at $453 million is at the lowest level since Q2 of FY22, and down $207 million from peak networking capital levels in Q1 of FY24.
Please forward to slide 8.
Finally, turning to Priority 4, improved free cash flow.
Tyler Hojo: and down 207 million from peak networking capital levels in Q1 of FY24.
Bill Ballhaus: Notably, combined free cash flow over the last four quarters is approximately $146 million, and net debt is down to $322 million, the lowest level since Q1 of FY22. We believe our continuous improvement related to program execution and hardware delivery, just-in-time material, and appropriately timed payment terms will lead to continued reduction in working capital and net debt going forward.
Tyler Hojo: Notably, combined free cashflow over the last four quarters is approximately 146 million, and net debt is down to 322 million, the lowest level since Q1 of FY22.
Tyler Hojo: We believe our continuous improvement related to program execution and hardware delivery just in time material and appropriately time payment terms will lead to continued reduction in working capital and net debt going forward.
Bill Ballhaus: Please turn to slide nine. Looking ahead, I am optimistic about our team, our leadership position in delivering mission critical processing at the edge, and our expected ability over time to deliver results in line with our target profile of above market top line growth, adjusted EBITDA margins in the low to mid 20% range and free cashflow conversion of 50%.
Please turn to Slide 9.
Tyler Hojo: Looking ahead, I am optimistic about our team, our leadership position in delivering mission-critical processing at the edge and our expected ability over time to deliver results in line with our target profile of above-market top-line growth
Tyler Hojo: Adjusted EBITAM margins in the low-to-mid 20% range and free cash flow conversion of 50%.
Bill Ballhaus: As we discussed last quarter, although we will not be providing specific guidance for FY 25, I will update the color we previously discussed. For full year FY25, we continue to expect annual revenue growth approaching mid-single digits with timing positively impacted by our enhanced execution and accelerated deliveries earlier in the year. As we discussed last quarter, our current backlog margin is lower than what we expect to see on a go-forward basis driven primarily by a small number of low-margin development programs and programs that incurred adverse net EAC change impacts in FY24. Although we are encouraged that our recent quarter bookings are accretive to our overall backlog margin, we continue to expect low double-digit adjusted EBITDA margins overall for FY25.
Tyler Hojo: As we discuss last quarter, although we will not be providing specific guidance for FY25, I will update the color we previously discussed.
Tyler Hojo: For full year FY25, we continue to expect annual revenue growth approaching mid-single digits with timing positively impact by our enhanced execution and accelerated deliveries earlier in the year.
Tyler Hojo: As we discussed last quarter, our current backlog margin is lower than what we expect to see on a go-forward basis driven primarily by a small number of low-margin development programs and programs that incurred adverse net EAC change impacts in FY 24.
Tyler Hojo: Although we are encouraged that our recent quarter bookings are accretive to our overall backlog margin, we continue to expect low double digits adjusted EBITOM margins overall for FY 25.
Bill Ballhaus: We continue to expect Q4 adjusted EBITDA margins to be the highest level of the fiscal year approaching mid-teens.
Tyler Hojo: We continue to expect Q4-adjusted EBITAM margins to be the highest level of the fiscal year approaching mid-teens.
Bill Ballhaus: Finally, with respect to free cash flow, our year-to-date free cash flow of $85 million is above our previous expectations. Even with this acceleration of cash year to date, we expect free cash flow to be a round break even for Q4, resulting in full year free cash flow that is ahead of our prior expectations.
Tyler Hojo: Finally, with respect to free cash flow, our year-to-date free cash flow of 85 million is above our previous expectations.
Tyler Hojo: Even with this acceleration of cash year to date, we expect free cash flow to be around break even for Q4, resulting in full year free cash flow that is ahead of our prior expectations.
Bill Ballhaus: In summary, given the operational improvements over the last several quarters and our recent momentum, I expect that our performance in FY25 will represent a positive step toward our target profile, and I look forward to providing commentary on expectations for FY26 in our call next quarter.
Tyler Hojo: In summary, given the operational improvements over the last several quarters and our recent momentum, I expect that our performance in FY25 will represent a positive step toward our target profile. And I look forward to providing commentary on expectations for FY26 in our call next quarter.
David Farnsworth: 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 third quarter results reflect solid progress toward our goal of positioning the business to deliver predictable performance characterized by organic growth, expanding margins, and robust free cash flow.
Tyler Hojo: 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
Dave Farnsworth: Thank you, Bill. Our third quarter results reflect solid progress toward our goal of positioning the business to deliver predictable performance characterized by organic growth, expanding margins, and robust free cash flow.
David Farnsworth: There is still work to be done, but we are encouraged by the progress we have made and expect the fourth quarter fiscal 2025 revenue and adjusted even the margins to improve over those in the first three quarters.
Dave Farnsworth: There is still work to be done, but we are encouraged by the progress we have made and expect the fourth quarter fiscal 2025 revenue and adjusted even the margins to improve over those in the first three quarters With that, please turn to slide 10, which details our third quarter results
David Farnsworth: With that, please turn to slide 10, which details our third quarter results. Our bookings for the quarter were $200 million with a book-to-bill of $0.95. Our bookings on a trailing 12-month basis reflect a book-to-bill of $1.1. Our backlog of $1.34 billion is up $51 million or 4% year over year. Revenues for the third quarter were approximately $211 million, up $3 million or 1.5% compared to prior years. Our revenues grew approximately $52 million or 8.9% on a year-to-date basis. Gross margin for the third quarter increased to 27% from 19.5% in the same quarter last year. As Bill previously noted, we expect to see an improvement in our gross margin performance over time as the average margin in our backlog improves.
Dave Farnsworth: Our bookings for the quarter were 200 million with a book to bill of 0.95. Our bookings on a trailing 12 month basis reflect the book to bill of 1.1. Our backlog of 1.34 billion is of 51 million or 4% year over year.
Dave Farnsworth: Revenues for the third quarter were approximately $211 million of $3 million or $1.5% compared to prior years Our revenues grew approximately $52 million or $8.9% on a year-to-date basis
Dave Farnsworth: Bruce Margin, for the third quarter, increased to 27% from 19.5% in the same quarter last year.
Dave Farnsworth: As Bill previously noted, we expect to see an improvement in our gross margin performance over time as the average margin in our backlog improves. This is the result of our expectation that newer awards will be at targeted margins coupled with further expected progress towards completion of lower margin activities.
David Farnsworth: This is the result of our expectation that newer awards will be at targeted margins coupled with further expected progress toward completion of lower margin activities. Operating expenses decreased approximately $12 million year-over-year, primarily due to lower R&D expense and restructuring and other charges. These decreases were driven by the actions taken in fiscal 2024 and 2025 to improve our performance by consolidating and simplifying our operations and aligning our team composition with our increased production mix, as we discussed last quarter. Gap net loss and loss per share in the third quarter were approximately $19,033,000 respectively as compared to gap net loss and loss per share of approximately $45,077,000 respectively in the same quarter last year.
Dave Farnsworth: Operating expenses decreased approximately 12 million year-over-year, primarily due to lower R&D expense and restructuring in other charges.
Dave Farnsworth: These decreases were driven by the actions taken in fiscal 2024 and 2025 to improve our performance by consolidating and simplifying our operations and aligning our team composition with our increased production mix as we discussed last quarter.
Dave Farnsworth: Gapnet loss and loss per share in the third quarter were approximately 19 million and 33 cents respectively as compared to Gapnet loss and loss per share [inaudible]
Dave Farnsworth: of approximately 45 million and 77 cents respectively in the same quarter last year. The improvement in year-over-year earnings is primarily a result of increased gross margins coupled with reduced operating expenses.
David Farnsworth: The improvement in year-over-year earnings is primarily a result of increased gross margins coupled with reduced operating expenses. Adjusted EBITDA for the third quarter was $24.7 million compared to negative $2.4 million in the same quarter last year. Adjusted earnings per share were $0.06 as compared to adjusted loss per share of $0.26 in the prior year. The year-over-year increase was primarily related to lower net losses in the current period as compared to the prior year. free cash flow for the third quarter was approximately $24 million as compared to an outflow of approximately $26 million in the prior year.
Dave Farnsworth: Adjusted even up for the third quarter was 24.7 million compared to negative 2.4 million in the same quarter last year.
Dave Farnsworth: Adjusted earnings per share were six cents as compared to adjusted loss per share of 26 cents in the prior year. The year-over-year increase was primarily related to lower net losses in the current period as compared to the prior year.
Dave Farnsworth: Three cash flow for the third quarter was approximately 24 million as compared to an outflow of approximately 26 million in the prior year
David Farnsworth: The significantly increased cash flow was primarily driven by the improvement in cash provided by operating activities, which was approximately $48 million higher as compared to the same quarter in the prior year.
Dave Farnsworth: The significantly increased cash flow was primarily driven by the improvement in cash provided by operating activities, which was approximately 48 million higher as compared to the same quarter in the prior year.
David Farnsworth: Slide 11 presents Mercury's balance sheet for the last five quarters. We ended the third quarter with cash and cash equivalents of nearly $270 million, driven primarily by approximately $30 million in cash provided by operations, which were partially offset by investments of approximately $6 million in capital expenditures. Billed receivables remained relatively flat sequentially, while unbilled receivables decreased approximately $7 million. Unbilled receivables decreased year-over-year by approximately $54 million, or 17%. The decrease in unbilled receivables reflects the incremental progress we've made by delivering on programs to our customers, which significantly drove our cash flow performance during fiscal 2025.
Dave Farnsworth: Slide 11 presents Mercury's balance sheet for the last five quarters
Dave Farnsworth: We ended the third quarter with cash and cash equivalents of nearly 270 million driven primarily by approximately 30 million in cash provided by operations, which were partially all set by investments of approximately 6 million in capital expenditures.
Dave Farnsworth: The decrease in on-build receivables reflects the incremental progress we've made by delivering on programs to our customers, which significantly drove our cash flow performance during fiscal
David Farnsworth: Inventory increased slightly year over year and sequentially by approximately $10 million and $8 million, respectively. We continue to see increases in deferred revenue, which in many cases provides an offset to a portion of our unbilled and inventory balance. Accounts payable increased approximately $9 million sequentially, driven by the timing of payments to our suppliers. accrued expenses increased approximately $5 million sequentially, primarily due to increased litigation and settlement-related expenses. Deferred revenues increased year-over-year sequentially by approximately $72 million and $7 million, respectively, as a result of additional milestone billing events achieved during the period.
Dave Farnsworth: Inventory increased slightly year over year and sequentially by approximately 10 million and 8 million respectively We continue to see increases in deferred revenue which in many cases provides an offset to a portion of our unbuilt and inventory balances
Dave Farnsworth: Accounts payable increased approximately 9 million sequentially driven by the timing of payments to our suppliers.
Dave Farnsworth: Accrued expenses increased approximately 5 million sequentially, primarily due to increased litigation and settlement related expenses.
Dave Farnsworth: Deferred revenues increased year-over-year as sequentially by approximately 72 million and and seven million respectively as a result of additional milestone-dilling events achieved during the period.
David Farnsworth: working capital decreased in the third quarter approximately 148 million year over year or 25% and decreased by 22 million or 5% sequentially. This demonstrates the progress we've made in reversing the multi-year trend of growth in working capital, highlighted by six quarters of sequential reductions in unbilled receivables, resulting in the lowest net working capital since Q2 of fiscal 2022. As a reference point, in the last four quarters, we have driven our net working capital from a high of 72 percent of trailing 12-month revenue to 51 percent. Networking capital remains a primary focus area and we believe we can continue to deliver improvement.
Dave Farnsworth: Working capital decreased in the third quarter approximately 148 million year over year, or 25% and decreased by 22 million or 5% sequentially [inaudible]
Dave Farnsworth: As a reference point, in the last four quarters, we have driven our networking capital from a high of 72% of trailing 12-month revenue to 51%.
Dave Farnsworth: Networking Capital remains a primary focus area and we believe we can continue to deliver improvement.
David Farnsworth: Turning the cash flow on slide 12. Free cash flow for the third quarter was approximately $24 million as compared to an outflow of $26 million in the prior year. We believe our continuous improvement related to program execution, hardware delivery, just-in-time material, and appropriately timed payment terms will lead to continued reduction in working capital.
Dave Farnsworth: Free cash flow for the third quarter was approximately 24 million as compared to an outflow of 26 million in the prior year.
Dave Farnsworth: We believe our continuous improvement related to program execution, hardware delivery, just in time material, and appropriately time payment terms will lead to continued reduction in working capital.
David Farnsworth: In closing, we are pleased with the performance through the third quarter of the fiscal year and the higher level of predictability in the business. 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.
Dave Farnsworth: In closing, we are pleased with the performance through the third quarter of the fiscal year and the higher level of predictability in the business.
Dave Farnsworth: 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.
Bill Ballhaus: With that, I'll now turn the call back over to Bill. Thanks, Dave.
Dave Farnsworth: With that, I'll now turn the call back over to Bill. Thanks, Dave. With that operator, please proceed with the Q&A.
Operator: With that, operator, please proceed with the Q&A. Absolutely. We will now begin the question and answer session.
Operator: If you would like to ask a question, simply press star followed by the number one on your telephone keypad. And if you would like to withdraw your question, press star one again. And please limit yourself to one question and one follow-up. You are welcome to return to the queue to ask follow-up questions.
Absolutely. We will now begin the question and answer session.
Speaker Change: If you would like to ask a question, see the pair of stars followed by the number one on your telephone
Dave Farnsworth: And if you would like to withdraw your question, press par one again. And please leave me yourself the one question and one follow-up. You're welcome to return to the queue to us follow-up questions.
Peter Arment: And your first question comes from the line of Peter Arment with Baird.
Speaker Change: And your first question comes on the line of Peter Arment with Beard. Peter, please go ahead.
Bill Ballhaus: Peter, please go ahead. Yeah, thanks. Good afternoon, Bill, Dave, Tyler. Nice results.
Yes, thanks. Good afternoon, Bill Dave, Tyler, nice results. Thank you, Bill. Thank you.
Bill Ballhaus: Bill, could you maybe give us a little bit of a, you know, an update on ALTAMS, given just recent developments of that kind of program moving into kind of initial production, and I know that was always going to be considered one of your larger programs as we get into kind of that production stage. So, what's the latest? Yeah, thanks for asking the question. And we've talked about this before as one of the major programs that has, you know, that we worked our way through the development has tremendous potential for us in terms of long-term production.
Speaker Change: Phil, could you maybe give us a little bit of an update on LTAMS, given just recent developments of that kind of program moving into kind of initial production, and I know that was always going to be considered one of your larger programs as we get into that production stage. So, what's the latest on that?
Speaker Change: Yeah, thanks for asking the question, and we've talked about this before as one of the major programs that has, you know, that we worked our way through the development has tremendous potential for us.
Bill Ballhaus: And we're really pleased to see our customer achieve their significant milestone, which was critical to the program moving forward. And we continue to work with them to ramp up consistent with their schedule and their needs and are excited about the growth prospects for LTAM.
Speaker Change: In terms of long-term production, we are really pleased to see our customer achieve their significant milestone, which was critical to.
Speaker Change: The program moving forward and we continue to work with them to ramp up consistent with their schedule and their needs and are excited about the growth prospects for L-Tams.
David Farnsworth: Okay, and then just maybe as my follow-up, Dave, could you just maybe just give us a little more color on the increase in deferred? I know you guys are making a lot of progress on unbilled receivables, and that's been great to see, but just how do we think about the deferred revenues kind of jumping the way it's been over the last few quarters? Yeah, I think Peter goes back to and we've talked about, you know, really focused on the terms that we have with our with our customers. And, and being in a position where we can set milestones we go and as long as we're achieving those milestones, you know, we have a we have solid payment terms associated with that.
Peter Arment, David Farnsworth, David Farnsworth, David Farnsworth, David Farnsworth,
Speaker Change: Okay, and then just maybe as my follow-up, Dave, could you just give us a little more color on the increase in deferred? I know you guys make a lot of progress on unbuilt receivables, and that's been great to see, but just how do we think about the deferred revenues kind of jumping away from the last few quarters?
Speaker Change: Yeah, I think Peter goes back to and we've talked about, you know, really focused on the terms that we have with our customers.
Speaker Change: and being in a position where we can set milestones we go and as long as we're achieving those milestones, we have a solid payment terms associated with that so we've been you know. Thank you very much.
David Farnsworth: So we've been, you know, getting through those milestones on schedule and the payments results.
Speaker Change: Getting through those milestones on schedule and the payments resolved. And again, one of the things we talked about in the past and you see this in our inventory is where customers will come and say, hey,
David Farnsworth: And again, one of the things we've talked about in the past, and you see this in our inventory, is where customers will come and say, hey, we'd like you to go buy a bunch of end of life components for us so we can have production for several years and not have to worry about it, and we say, we're absolutely willing to do that, and they're willing to pay us to do that, you know, upfront so that we can go out and get those things and have them in stock for them. So you see a little bit of inventories pick up because of that, but at the same time, the deferred payments, that offset.
Speaker Change: We'd like you to go buy a bunch of end-of-life components for us so we can have production for several years and not have to worry about it and we say we're absolutely willing to do that and they're willing to pay us to do that.
Speaker Change: you know, up front so that we can go out and get those things and have them in stock for them. So you see a little bit of inventories tick up because of that, but at the same time the deferred payments that offset that.
Peter Arment: I'll jump back in queue. Thanks, guys. Okay, thanks, Peter.
Speaker Change: Todd, I'll jump back in cute. Thanks, guys. Okay, thanks, Peter
Michael Ciarmoli: And your next question comes from the line of Michael Ciarmoli with Trubis Securities. Michael, please go ahead. Good evening, guys. Thanks for taking the question. Nice results. Maybe just really good free cash flow performance.
Speaker Change: And your next question comes from the line up Michael Ciarmoli with two insecurities, Michael, please go ahead
Hey, you're giving you guys. Thanks for taking the question. Nice results.
Speaker Change: maybe just a really good free cash flow performance. Dave, what sort of the optimal networking capital level is a percent of revenues and as you're kind of continuously driving or taking out costs and improving efficiencies, is anything changing with your expectation of free cash conversion?
David Farnsworth: Dave, what's sort of the optimal net working capital level as a percent of revenues? And as you're kind of continuously driving or taking out costs and improving efficiencies, is anything changing with your expectation of free cash conversion? Yeah, no, I, you know, Mike, thanks for, thanks for the comments starting out. No, you know, we've looked at it, and we've talked about, you know, kind of ultimately looking at a 50% free cash flow conversion from EBITDA. And that still makes sense to us. I mean, we're running significantly ahead of that, as you said, because we're bringing down our working capital to a more level that would be commensurate with our business.
Speaker Change: Yeah, you know Mike, thanks for the comments starting out. No, you know we've looked at it and we've talked about you know kind of ultimately looking at a 50 percent.
Speaker Change: Free Cash Flow Conversion from EBITDA, and that still makes sense to us. I mean, we're running significantly ahead of that as you said.
Speaker Change: because we're bringing down our working capital to a more level that would be commensurate with our business and as we've talked about, we were as high as the 70-plus percent.
David Farnsworth: And, you know, as we've talked about, we were as high as the 70 plus percent of revenue. That's just not the right model for this business, where we're down in the low 50% now, and still have room to go. We've talked about a model in the future, kind of in an ideal world, we'd love to get to 30 or 35%. But more 35 to 40 is probably the right range for us. So we have room to go, as Bill and I have both said before, and we're gonna continue to work on that. Got it. That's helpful.
Speaker Change: of Revenue. That's just not the right model for this business. We're down in the low 50% now and still have room to go. We've talked about a model in the future, kind of an ideal world. We'd love to get to 30 or 35%.
Speaker Change: But more 35 to 40 is probably the right range for us [inaudible]
Speaker Change: So we have, we have Ruffle Gauwis, Bill and I have both said before and we're going to continue to work on that [inaudible]
David Farnsworth: And just to follow up, this low, the low margin backlog that you're burning off, does that drag continue or have an impact as we start fiscal 26? Or should we think of the EBITDA margins you're going to generate in the fourth quarter as sort of a launching point for 26? Yeah, I think the way I would think about it is, you know, every quarter, we've been, you know, as we've talked about, we've been adding new bookings that are at our targeted margins are better, so higher than what the existing margin and backlog is, and we're burning off those lower margin things.
Speaker Change: Got it, that's helpful. And just to follow up, the low margin backlog that you're burning off the set.
Speaker Change: Drag continue or have an impact as we start fiscal 26 or should we think of the EBITDA margins? You're going to generate in the fourth quarter as sort of a launching point for 26. Let's go back.
Speaker Change: Yeah, I think the way I would think about it is, you know, every quarter we've been, you know, as we've talked about, we've been adding new bookings that are at our targeted margins are better so higher than what the existing margin and backlog is and we're burning off those lower margin things.
David Farnsworth: It's not a binary activity that all of a sudden it's going to jump in one quarter to the final number. It's going to go gradually up there over time, so I would not think of it as, hey, we're going to wake up one morning, and it's going to be, you know, completely different. It's going to gradually move up, and Bill's talked about approaching that line over time. Got it. Helpful.
Speaker Change: It's not a binary activity that all of a sudden it's going to jump in one quarter to the final number. It's going to go gradually up there over time. So I would not think of it as...
Speaker Change: Hey, we're going to wake up one morning and it's going to be, you know, completely different. It's going to gradually move up and Bill's talked about approaching that line over time [inaudible]
Michael Ciarmoli: I'll jump back into Q.
Michael Ciarmoli: Thanks, guys.
Got it. Helpful. I'll jump back in the cute thanks guys.
Seth Seifman: And your next question comes from the line of Seth Seifman with J.P. Morgan. Seth, please go ahead. Hi, good afternoon.
Okay, thanks for me.
Speaker Change: And your next question comes from the line of Seth Seifman, the JP Morgan, Seth, please go ahead.
Rakhwan: This is Rakhwan for Seth. Was the revenue stepped up sequentially due to the pull forward into Q2? Yeah, we talked about it last quarter that, you know, our focus on accelerated deliveries for our customers trying to get the benefits of our technology into their hands sooner, we've been really focused on the operations of the business, and we had a significant pull forward from Q3 into Q2, I think we characterized it as around $30 million. And so, you know, in thinking about the Q3 revenue, I think there's an opportunity to think about it as normalized for that pull forward.
Hi, good afternoon. This is Rock one for Seth.
Speaker Change: Was the revenue step down sequentially due to the pull-forward in the Q2?
Yeah, we talked about it last quarter, that-
Speaker Change: You know, our focus on accelerated deliveries for our customers trying to get the benefits of our technology into their hand sooner. We've been really focused on the operations of the business and we had a significant pull forward from. [inaudible]
Speaker Change: Q3 and Q2, I think we characterized it as around 30 million.
Speaker Change: And so, you know, in thinking about the Q3 revenue, I think there's an opportunity to think about it as normalized for that.
Rakhwan: And then for our full year commentary, as we indicated, our expectations for the full year remain the same, the timing profile within the year shifting to the left because of the acceleration of delivery. Right, so that acceleration of deliveries is what's driving the flat revenue year over year in Q4, that's implied, which would be a deceleration versus the first half. Correct. Consistent with our prior expectations.
Speaker Change: Pull Forward. And then for our four-year commentary as we indicated our expectations for the full year remain the same, the timing profile within the year shifting to the lot because of the acceleration of deliveries.
Speaker Change: Right, so that acceleration delivery is what's driving the revenue year over year in Q4 that's implied which would be a acceleration version of the first half.
Correct, consistent with our prior expectations.
Rakhwan: Great, thank you.
Great. Thank you.
Pete Skibitski: And your next question comes from the line of Pete Skibitski with Alembic Global. Pete, please go ahead. Good evening, guys. Nice corner. Bill, maybe to follow up on Mike's question, you guys mentioned the 12-month trailing bookings were greater than 80% production.
Speaker Change: And your next question comes from the line of Peter Skibitski with Olympic Global. Pete, please go ahead.
You're good evening guys, nice corner.
Speaker Change: Maybe to follow up on Mike's question, you guys mentioned the 12 month trailing bookings.
Bill Ballhaus: I'm just wondering if we switch to revenue, what's the revenue split development versus production this year and how do you expect that changes in fiscal 26? Yeah, we haven't talked about the split out of the revenue that way. You know, suffice it to say that, you know, over time, it follows our bookings for sure. So, you know, we expect it to continue moving in that direction, but we haven't we haven't broken out for on in our financials, exactly how much of the revenues production versus development, but definitely, you should look at the bookings as an indicator.
Speaker Change: or I don't know, greater than 80% production. I'm just wondering if we switch to revenue. What's the revenue split development versus production this year and how do you expect that changes in fiscal 26?
Speaker Change: Yeah, we haven't talked about the split out of the revenue that way, you know, suffice it to say that, you know, over time it follows our bookings for sure.
Speaker Change: So, you know, we expect it to continue moving in that direction, but we haven't broken out in our financials exactly how much of the revenue is production versus development. But definitely, you should look at the bookings as an indicator.
Bill Ballhaus: Okay, okay, and then just one follow-up. You know, if I look at the 10Q and some of your revenue by program area, the radar area has really, you know, grown nicely year-to-date for the first three quarters. Some of the other areas, though, like, you know, Electronic Warfare, C4I, they still seem to be kind of sort of flattish, I guess. Is there anything going on that is, you know, driving that improved radar performance revenue-wise, and it's causing the other couple of areas to kind of lag? Yeah, we and we've talked about before the, you know, when we talked about some of the significant adjustments that we saw in the cube catch up on EACs, that a large piece of that was in that radar area.
Speaker Change: Okay, okay, and then just one follow-up. You know, if I look at the 10Q in some of your revenue by program area
Speaker Change: The radar area has really grown nicely year to date for the first three quarters [inaudible]
Speaker Change: Some of the other areas, like electronic warfare, C4I, they still seem to be kind of sort of flatish I guess Is there anything going on that is driving that improved radar performance revenue wise and is causing other couple of areas to kind of lag?
Speaker Change: Yeah, and we've talked about before, you know, when we talked about some of the significant adjustments that we saw in the CUM catch up on EACs at a large piece of that was in that radar area.
Bill Ballhaus: And, you know, that that had to do with some of our common processing architecture activities, and that now you're seeing that's not as big an impact. That was a negative. So that was naturally going to rise. That's, you know, if you think about the programs we have, and, you know, we don't we don't talk about the individual programs and how much revenue they are, but you guys have a good sense of the programs, you know, we're working on and which ones are in that radar area. So it'll give you an idea of what's driving that.
Speaker Change: and that had to do with some of our common processing architecture activities.
Speaker Change: and now you're seeing that's not as big an impact. That was a negative, so that was naturally going to rise. That's, you know, if you think about the programs we have, and...
Speaker Change: We don't talk about the individual programs and how much revenue they are, but you guys have a good sense of the programs you know we're working on and which ones are in that radar area so it'll give you an idea of what's driving that.
Bill Ballhaus: Okay, okay.
Bill Ballhaus: Yeah, to complement that, I'm just wondering, you know, why the other seem to be kind of lagging a bit. Yeah, I think there's not so much lagging. There's a little bit of timing involved in some of those things. So, you know, and again, remember, we're in a situation where we've been very cognizant of ensuring that material is just in time. And we've talked about, you'll see some as we go up that curve a little bit slower than we have in the past, some timing impact in some of those areas. But overarching, the revenue will be identical for the programs, just a little bit of a different timing situation.
Speaker Change: Okay, okay. Yeah, as I compliment that, I'm just wondering why the others seem to be kind of lagging a bit.
Speaker Change: Yeah, I think there's not so much lagging, there's a little bit of timing involved in some of those things so...
Speaker Change: You know, and again, remember we're in a situation where we've been very cognizant of ensuring that materials just in time and we've talked about
Speaker Change: You'll see some as we go up that curve a little bit slower than we have in the past some timing impact in some of those areas but overarching the revenue will be identical for the programs just a little bit of a different timing situation.
Bill Ballhaus: Okay, okay.
Pete Skibitski: Sounds great. Thank you. Yep.
Pete Skibitski: Thanks, Pete.
Jeff, thanks, Peter.
Ken Herbert: And your next question comes from the line of Ken Herbert with RBC Capital Markets.
unknown: And your next question comes from the lineup, Ken Herbert, with RBC Capital Markets. Can please go ahead.
Ken Herbert: Ken, please go ahead. Yeah, hi, good afternoon, everybody. Bill or Dave, you called out $40 million, I think, of production contracts for the common processing architecture in the quarter. Just to help put that in context, can you talk about maybe sort of how did that trend across through the first two, third quarters? Was that a relatively high number that you called it out? And then maybe, if you can, what percent of the backlog does the CPA represent, or can you give any sort of scale as to how that is represented in the backlog? Yeah, no, thanks for the question, Ken.
Yeah, hi. Good afternoon, everybody.
unknown: I can. Yeah, Bill or Dave, you called out 40 million, I think, a production contract for the common processing architecture in the quarter.
Speaker Change: Just to help put that in context, can you talk about maybe what sort of how did that trend across?
Speaker Change: You know, through the first two-third quarters, was that a relatively high number that you called it out? And then maybe if you can, what percent of the backlog does the CPA represent or can you give any sort of scale as to how that is represented in the backlog?
Bill Ballhaus: I don't think we've given specifics on the magnitude of the backlog associated with CPA. I will point out, though, that we referenced early in the year some strategic wins, good size wins, along with the wins that we discussed on this call, which has added pretty substantially to our backlog in that area. And, of course, we feel very good about that. It's an area where we see demand. We have differentiation. We added to the differentiation this quarter with the acquisition of Starlab, so we're feeling really good about the progression associated with CPA. I would add that, you know, although we don't break out the allocation of our bookings into the individual kind of categories, and, you know, we have pointed out in the past when there's been a significant booking that was impactful to the backlog in that area.
Speaker Change: The winds that we discussed on this call which has added pretty substantially to our backlog in that area. And of course we feel very good about that. It's an area where we're going to talk about.
Speaker Change: We see demand. We have differentiation. We added to the differentiation this quarter with the acquisition of...
Speaker Change: Star Lab, so we're feeling really good about the progression associated with CPI.
Speaker Change: and you know, we have pointed out in the past when there's been a significant booking that was impactful to the backlog in that area so the fact that we pointed out that that $40 million is an indication that it's impactful, that that's significant.
Bill Ballhaus: So the fact that we pointed out that $40 million is an indication that it's impactful, that that's significant. Yeah. That's helpful. Thanks.
Bill Ballhaus: And I know it's been over the last few quarters, you've been able to call out some nice share gains on some specific re-competes or new wins. Can you give any commentary on the competitive landscape, maybe, and how you see the opportunity to to maybe outgrow the industry here in these areas, especially with what looks like to be a host of new, you know, program starts coming out of the DoD as part of the maybe the 25 supplemental or into 26. Yeah, I mean, those dynamics are still shaping up. But I think in general, we feel pretty good about the tailwinds, at least as they've been discussed to date.
Recompete, or new wins. Can you give any commentary on-
Speaker Change: The competitive landscape may be in how you see the opportunity to, to maybe outgrow the industry here in these areas, especially with what looks like to be a host of new, you know, program starts coming out of the DOD as part of the, maybe the 25 supplemental or into 26.
Bill Ballhaus: And, you know, more specific to us, I think we feel well positioned. I think it's backed up by our LTM book to bill of 1.1. Already in this quarter, we had some nice wins and a volume of awards that, you know, in the first month of the quarter is the highest that we've seen in any quarter in our history. I don't want to make too much of that because the first month of a quarter is, you know, usually a low volume month, but we did have a good month of April and, you know, feel good about where we sit in some of those tailwinds.
Speaker Change: Discussed Today, and more specific to us. I think we feel well positioned. I think it's backed up by our LTM book to Bill of
Speaker Change: 1.1. Already in this quarter we had some nice wins in a volume of awards that you know in the first month of the quarter is the highest that we've seen in any quarter in our history. I don't want to make too much of that because the first month of a quarter is [inaudible]
Speaker Change: You know, usually a low volume month, but we did have a good month of April , and you know, feel good about where we said in some of those tailwinds [inaudible]
Bill Ballhaus: Great. Thank you very much.
Operator: I'll pass it back to Eric. Okay, thank you.
Speaker Change: Great. Thank you very much. I'll pass it back to her.
Connor Walters: And your next question comes from the line of Connor Walters, whichever is Connor, please go ahead. Hi, guys. Thanks so much for taking the question on the quarter. Thank you. Yeah, so maybe on the EBITDA margins approaching... for a nice sequential step up. I was hoping to dive into that a little. previously pointed to some OPEX, mainly SG&A steadily rising, which we're seeing, but maybe on the gross margin level, things have been a little bit flattish quarter over quarter despite the EAC improvement. So I was hoping on, like, you guys could provide some color on how to think about that progression into Q4 and to what degree we can think of that as a fair look.
Okay. Thank you.
Speaker Change: And your next question comes from the line of Conor Walters, which I for risk Conor, please go ahead.
Conor Walters: Hi guys, thanks so much for taking the question on the quarter.
Thank you.
Speaker Change: Yeah, so maybe on the EBITDA margins approaching mid-teens for Q4, the nice sequential step-up, I was hoping to dive into that a little bit, he previously pointed to some op-x mainly SG&A steadily rising, which we're seeing.
Speaker Change: But maybe on the gross margin level, things have been a little bit flat as a quarter of a recorder despite the EAC improvement. So, was hoping on, like you guys could provide some color, how to think about that progression in the Q4 and what degree we can think of that as a fair launching point in the 2026.
Bill Ballhaus: And I can, I can take a cut at it and then Dave can jump in. I, you know, at least for us. In terms of our path to our targeted margins, which we discussed in the low to mid-20s, it's now really clear what the drivers of that progression are, and it's the two things that we've mentioned. It's this dynamic associated with our backlog margin and how that's improving over time as we burn down the low margin and replace with bookings that are at or above our targeted margins. Again, in Q3, the margin associated with the bookings that we brought in in the quarter were at or above our targeted margins, and Dave, I think we would say, you know, very strong relative to the last several quarters.
Speaker Change: I mean I can I can take a cut at it and then Dave can jump in I you know at least for us
Dave Farnsworth: It's now really clear what the drivers of that progression are, and it's the two things that we've mentioned. It's this dynamic associated with our backlog margin, and how that's improving over time as we burn down the low margin and replace.
with bookings that are at or above our target of margins and...
Again, in Q3, the margin associated with
Dave Farnsworth: The bookings that we brought in in the quarter or at or above our target of margins in a day, but I think we would say...
Dave Farnsworth: very strong relative to the last several quarters, so we feel very good about how that dynamic is playing out. And in Q4,
David Farnsworth: So we feel very good about how that dynamic is playing out. And in Q4, what I think you're seeing is those two things, that plus the operating leverage associated with our OPEX being sort of in the zip code of where we think it needs to be, all starting to play out. And hopefully, that gives a sense of the timing and the progression of how the backlog margin dynamic is starting to play out in conjunction with the operating leverage, and that's really driving the Q4 expectations.
Dave Farnsworth: What I think you're seeing is those two things. That plus the operating leverage associated with our op-ex being sort of in the zip code of where we think it needs to be.
Dave Farnsworth: all starting to play out, and hopefully that gives a sense of the timing and the progression of how the backlog margin dynamic is starting to play out in conjunction with the operating leverage, and that's really what's driving the Q4 expectations.
David Farnsworth: Yeah, and I would just, you know, echo what Bill said. When you look at EBITDA and the expectations that Bill outlined for EBITDA, it is a function largely of exactly those two things, and we've made the progress on the OPEX expense, and you can see that, you know, in our financials, and you've seen that as we've through the year. And at the same time, again, every quarter that we're making more progress as we both finish off or get to the lower levels on some of the lower margin activities, and we're adding to our backlog, you know, at higher margins.
Dave Farnsworth: Yeah and I would just you know echo what Bill said when you when you look at EBITDA and the expectations that Bill outlined for EBITDA it is
Dave Farnsworth: It is a function largely of exactly those two things and we've made the progress on the op expense and you can see that.
Dave Farnsworth: in our financials, and you've seen that as we've gone through the year.
Dave Farnsworth: and at the same time, again, every quarter that we're making more progress as we both finish off or get to the lower levels.
on some of the lower margin activities. [inaudible]
Dave Farnsworth: and we're adding to our backlog. You know, at higher margins, so that backlog margin is increasing and we expect to see that start playing out, as I said earlier, it'll play out over time, but you know, we do expect to see benefit from both of those things in the fourth quarter to benefit the EBITDA.
Connor Walters: So that backlog margin is increasing, and we expect to see that start playing out. As I said earlier, it'll play out over time, but, you know, we do expect to see benefit from both of those things in the fourth quarter to benefit the EBITDA. That's great. Thanks so much. Okay, thanks, Connor.
Thank you.
Okay, that's great. Thanks so much. I'll leave it there
Okay, thanks Connor.
Noah Poponak: And your next question comes from the line of Noah Poponak with Goldman Sachs.
David Farnsworth, David Farnsworth, David Farnsworth
Speaker Change: And your next question comes from the line of Noah Poponak with Goldman Sachs. Noah, please go ahead.
Noah Poponak: Noah, please go ahead. Good evening, everyone. Hey, good evening all.
Hey, good evening, everyone.
Hey, good evening, Noah.
Noah Poponak: Could you grow free cash flow for year 2026 versus 2025? That's a good question. The way we're thinking about cash in 2026 is continuing to, you know, as we think about in general, as we go forward, we're not providing any color or guidance around 2026. But I think I would talk to the longer term model that, you know, Bill had talked about in his remarks, is we expect to get to a point where there's a kind of a recurring, you know, 50% of EBITDA, you know, cash flow, and we expect to continue as we go through time until we get to the right working capital level to reduce working capital.
uhm
Speaker Change: Could you grow free cash flow for year 2026 versus 2025?
Speaker Change: Yes, a good question. Well, way we're thinking about cash in 2026 is continuing to...
Speaker Change: You know, as we think about in general as we go forward, we're not providing any color or guidance around 2026
Speaker Change: but I think I would talk to the longer term model that Bill had talked about in his remarks.
Speaker Change: is we expect to get to a point where there's a kind of recurring, you know, 50% of EBITDA.
Speaker Change: You know, Castlow, and we expect to continue as we go through time until we get to the right working capital level to reduce working capital. I think as Bill talked about when we get to at the end of next quarter. [inaudible]
David Farnsworth: I think as Bill talked about, when we get to at the end of next quarter, you know, we'll have a little more color around FY26. But right now, you know, we're just focused on getting through this year and, you know, completing strong and then working towards the model that we've talked about. Yeah, and I think there's two pieces to, you know, coming up with the answer to that question. One is our kind of our steady state free cash flow conversion that we think we can deliver. And Dave spoke to that earlier around 50%. And we feel good about how we're honing in to that part of the model.
Speaker Change: You know, we'll have a little more color around FY26, but right now, you know, we're just focused on...
Speaker Change: getting through this year and, you know, completing strong and then working towards the model that we've talked about. Yeah, and I think there's two pieces to, you know, coming up with the answer to that question.
Speaker Change: One is kind of our steady state-free cash flow conversion that we think we can...
Delivering Day's book to that earlier, around 50%
Speaker Change: and we feel good about how we're honing in to that part of the model.
Bill Ballhaus: And then I think the other contributor is the cash that's still available to be freed up of our balance sheet driving towards the working capital targets that Dave mentioned. And we still see a really good opportunity on that front. So it'll be a matter of how those two things play together in 26.
Speaker Change: And then I think the other contributor is the cash that's still available to be freed up of our balance sheet driving towards the working capital targets that they've mentioned. And we still see a really good opportunity on that front. So it'll be a matter of how those two things play together.
Bill Ballhaus: And as I said earlier, I look forward to coming back in our next call and giving some commentary on how we think 26 is going to shape up. Okay, great. So the framework is is sort of directionally 50% of EBITDA. And then yeah, you know, it sounds like multiple years still of improving working capital. So, you know, that can be lumpy. So we'll sort of just see how that layers on top. Yes, sir. And I think you could look at the progression that we've made and the timing associated with that, and that can inform a view of, you know, what's left to go and the time associated with it.
Speaker Change: 26. And as I said earlier, I look forward to coming back in our next call and giving some commentary on how we think 26 is going to shape up.
Speaker Change: Okay, great. So, the framework is sort of, directionally, 50% of either duh, and then, you know, it sounds like multiple years still of...
Speaker Change: improving working capital. So, you know, that can be lumpy. So we'll sort of just see how that layers on top.
Speaker Change: Yes, sir. And I think you could look at the progression that we've made in the timing associated with that and that can inform a view of, you know, what's left to go and the time associated with it.
Bill Ballhaus: Okay.
Bill Ballhaus: Excellent.
Take care.
Bill Ballhaus: In terms of the burning out of the backlog, the older legacy, lower margin contract, Yeah, what what's the what's the timeframe in the future at which that is, you know, close to entirely gone from your revenue? Yeah, I mean, if I were to just think about the answer to that question from a math standpoint, I would think about, you know, our commentary on the backlog at the end of FY24 being lower than what we expect to see on a go-forward basis and the timing for that aggregate backlog to burn off and the number of quarters it would take for it to be replaced by the bookings that, you know, to be our targeted margin profile associated with the EBITDA margin profile we've discussed of low to mid-20s.
Speaker Change: What's the time frame in the future at which that is close to entirely gone from your revenue?
Speaker Change: If I were to just think about the answer to that question from a math standpoint, I would think about our commentary on the backlog at the end of FY 24.
Speaker Change: Being lower than what we expect to see on a go-for basis.
Speaker Change: and the timing for that aggregate backlog to burn off and the number of quarters it would take for it to be replaced by the bookings that, you know, since we made that comment, have been in line with what we expect to be our targeted margin profile associated with the
Speaker Change: the EBITAM margin profile we've discussed of the load of mid-20s. So I think you can create an estimate for what that time frame looks like based on our duration and the commentary at the end of FY-24.
Bill Ballhaus: So, I think you can, you know, create an estimate for what that time frame looks like based on our duration and the commentary at the end of FY24.
Bill Ballhaus: Take care. That makes a lot of sense. It's a matter of several quarters where that will play out, and the good news is we're seeing that progression happen.
Take care.
That makes a lot of sense.
Speaker Change: and again it's a matter of it's a matter of several quarters where that will play out I'm in and the good news is we're seeing that progression happen
Bill Ballhaus: You prepared great.
Bill Ballhaus: And just last thing related, how do you define bringing new work into the backlog at a higher margin. Obviously, the simple definition is it has a higher margin, but you know, over time, everything you bring into the backlog has a assumed margin and then that can change over time based on cost and execution. So I'm just curious to hear you talk about how you're defining that if it's just purely the initial price cost assumptions or if it's also, you know, some version of https://www.mercurysystems.com Yeah, so when you think about, you know, how companies in our business and the aerospace and defense kind of business think about these things, so, you know, you propose, you bid, you negotiate, you know, you get awarded, and then you go through a startup process.
Speaker Change: Okay, great. And just last thing related, how do you define...
Speaker Change: bringing new work into the backlog at a higher margin. Obviously the simple definition is we have a higher margin but...
Speaker Change: You know, over time, everything you bring into the backlog has an assumed margin, and then that can change over time based on...
Cost, and Execution, and...
Speaker Change: So I'm curious to hear you talk about how you're defining that if it's just purely the initial price cost assumptions or if it's also some version of
Speaker Change: conservatism or something else in the assumptions you make on the front end versus you know what what's happened in the past.
Speaker Change: Yeah, so when you think about how companies in our business, in aerospace and defense kind of business, think about these things
Speaker Change: So, you know, you propose, you bid, you negotiate, you know, you get awarded and then you go through a startup process.
Bill Ballhaus: And in that startup process, you review the risk opportunity set around programs, and you establish, this is what I'm going to start at in terms of a margin rate. And so, you know, we put a great deal of additional rigor around that process in the last year. You know, 12 or 18 months since, you know, since we started. So it's reflective of that startup process, which is taking into account the risk and opportunities and how we're going to work through them. So, you know, it's not, oh, we won this and we bid X rate. It's what we believe when we, when we line up the program and go through that analysis and pressure test that as to what we use as the backlog mark.
Speaker Change: And in that startup process you review the risk opportunity set around programs and you establish this is what I'm going to start at in terms of a margin rate and so you know we put a great deal of additional rigor around that process in the last.
Speaker Change: you know, 12 or 18 months since, you know, since we started.
Speaker Change: So, it's reflective of that startup process, which is taking into account the risk and opportunities
Speaker Change: and how we're gonna work through them. So, you know, it's not, oh, we won this and we bid X rate. It's what we believe when we line up the program and go through that analysis.
Speaker Change: and pressure test status is to what we use as the backlog margin.
Bill Ballhaus: I understand. Okay.
Bill Ballhaus: Thank you so much.
I understand. Okay. Thank you so much.
Bill Ballhaus: Okay, thank you.
Jonathan Ho: And your next question comes from the line of Jonathan Ho with William Blair. Jonathan, please go ahead.
Okay. Thank you.
Speaker Change: And your next question comes from the line of Jonathan Ho, with William Blair. Jonathan, please go ahead
Garrett Berkelman: Hi, this is Garrett Berkelman for Jonathan Ho. Thanks for taking my question. Just the book-to-bill ratio dipping below one this quarter. Can you just help us understand why that is? And it looks like it's been trending lower for two quarters in a row now. So maybe just some color on why that's happened. Yeah, I think the timing of bookings can move around a little bit. So I don't get too hung up on it on a quarter by quarter basis. And that's why we're really pointing at, you know, the LTM book-to-bill of 1.1, which we think is, you know, in a good zip code.
Speaker Change: Hi, this is Garrett Burkhamon for Jonathan Ho. Thanks for taking my question. Just a Garrett book, the book to Bill Ratio, they'll dig in below on this quarter. Can you just help us understand why that is? And it looks like it's been trending lower for two quarters in a row now, so maybe just some color on why that's happening.
Speaker Change: Yeah, I think the timing of hookings can move around a little bit, so I don't get too hung up on it on a quarter by quarter basis, and that's why I'm really pointing at the LTM BookDeville of 1.1, which we think is...
Speaker Change: in a good zip code. Also look at the quality of the bookings and we've talked about production versus development mix.
Bill Ballhaus: Also look at the quality of the bookings. And we've talked about production versus development mix. And also this quarter, the margin at which we brought those bookings in that we feel very good about. And as I said, in Q4, we're off to a really good start with a lot of activity, already had some new awards, some of which that slipped out of Q3 into early Q4, which can also, you know, help inform a view of like an adjusted book-to-bill for the quarter. So we feel great about our position, feel really good about our pipeline, the activity in Q4.
and also this quarter, the margin at which we…
Speaker Change: Some of which that slipped out of Q3 into early Q4
Speaker Change: which can also help inform a view of an adjusted book-to-bill for the quarter. So, we feel great about our position, feel really good about our pipeline, the activity in Q4, and all in all good about the bookings performance in Q3.
Bill Ballhaus: And, you know, all in all good about the bookings performance in Q3. Okay, got it. That makes sense.
Bill Ballhaus: And then, maybe just on the macro environment, is there anything notable to call out there? And particularly, are you seeing any disruption from the federal space from DOGE at all? Not so much a disruption associated with DOJ. I'm sure that our customers' customers are dealing with, you know, some dynamics associated with that, but I think, you know, we're focused on the macros that, you know, early on sound like a growing overall defense budget. What we think is a constructive mix adjustment, specifically away from services and into acquiring technologies and capabilities. There are some systems and priorities that have been discussed in executive orders like Golden Dome where our technology is, you know, right at the center of some of the existing systems, and so we feel really good about the opportunity to participate there.
Speaker Change: Okay, got it. Let me explain. Maybe just on the macro environment. Is there anything notable to call out there? And particularly, are you seeing any disruption from the federal space from Doge at all?
Speaker Change: Not so much a disruption associated with DOJ. I'm sure that our customers' customers are dealing with, you know, some dynamics associated with that. But I think, you know, we're focused on the macros that, you know, early on sound like a growing overall defense budget.
What we think is a constructive mix adjustment.
specifically away from services and into acquiring technologies and capabilities.
Speaker Change: There are some systems and priorities that have been discussed in executive orders like Golden Dome where our technology is right at the center of some of the existing systems and so we feel
Bill Ballhaus: So, you know, all in all, as we step back and look at those dynamics, I'd say, you know, for me personally, I have a positive overall bias on those dynamics and the tailwinds that they present. Got it, got it.
Speaker Change: really good about the opportunity to participate there. So all in all, as we step back and look at those dynamics, I'd say, for me personally, I have a positive overall bias on those dynamics and the tailwinds that they present.
Bill Ballhaus: Thank you.
Thank you.
Got it, got it. Thank you.
Operator: Again, if you would like to ask a question, simply press star followed by the number one on your telephone.
Speaker Change: Again, if you would like to ask a question, see the press star followed by the number one on your telephone keypad.
Pete Skibitski: And your next question comes from the line of Pete Skibitski again from Alembic Global. Pete, please go ahead. Yeah, thanks, guys. And a question, guys, we've been asking everyone, but didn't ask you yet, tariffs, any just because of your commercial chip supply chain? Have you seen are you do you expect to see any impact from the tariffs? Yeah, certainly no material impact in FY 25. And when we look at country exposure, you know, we don't see any direct impact from tariffs on China or Mexico or Canada, there are a number of exclusions to your point that apply to a significant piece of our bill of materials.
Pete Skibitsky: And your next question comes from the line of Pete Skibitsky again from Alembic Global. Pete, please go ahead.
Pete Skibitsky: Yeah, thanks, guys. And a question, guys, we've been asking everyone, but didn't ask you yet. Tariffs, any, just because of your commercial chip supply chain.
Pete Skibitsky: have you seen, do you expect to see any impact from the tariffs?
Yeah, certainly no material impact in FY25.
Pete Skibitsky: And when we look at country exposure, you know, we don't see
Pete Skibitsky: any direct impact from tariffs on China or Mexico or Canada. There are a number of exclusions, to your point, that apply to a significant piece of our bill of materials. So, you know, like everybody else, we're monitoring the situation and
Bill Ballhaus: So, you know, like everybody else, we're monitoring the situation and, and paying attention to it. But, but at this point, we feel like, you know, we feel good about where we sit relative to tariff exposure. Okay, and that's both from a cost perspective, but also just from a sourcing perspective, you think sourcing will be okay? I think from a sourcing standpoint, yes, and also from a cost perspective, we have a number of different ways that we can address any potential cost impacts that may emerge associated with tariffs. Okay.
Pete Skibitsky: and paying attention to it, but at this point we feel like, you know, we feel good about where we sit relative to tariff exposure.
Speaker Change: Okay and that's both from a cost perspective also just from a sourcing perspective you think sourcing will be okay?
Speaker Change: I think from a sourcing standpoint yes and also from a cost perspective we have a number of different ways that we can you know address any potential cost impacts that may emerge associated with tariffs.
Bill Ballhaus: Thank you. Mr. Ballhaus, it appears there are no further questions.
Okay, thank you.
Bill Ballhaus: Therefore, I would like to turn the call back over to you for any closing remarks.
Speaker Change: Mr. Ballhaus, it appears there are no further questions. Therefore, I would like to turn the call back over to you for any closing remarks.
Operator: Okay, well thank you very much and I appreciate everybody joining the call this evening and I look forward to our next update next quarter. Thank you very much.
Speaker Change: Okay, well thank you very much and I appreciate everybody joining the call this evening and I look forward to our next update next quarter. Thank you very much.
Operator: That concludes today's call. You may now...
That concludes today's call. You may now disconnect.