Q4 2025 Mercury Systems Inc Earnings Call

Speaker #3: Good day, everyone, and welcome to the Mercury Systems Fourth Quarter Fiscal 2025 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 Vice President of Investor Relations, Tyler Hojo.

Speaker #3: Please go ahead, Mr. Hojo.

Speaker #4: Good afternoon, and thank you for joining us. With me today is our Chairman and Chief Executive Officer, Bill Ballhaus, and our ecutive Vice President, Anne CFO, Dave Farnsworth.

Speaker #4: 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 #4: The slide presentation that we will be referencing is posted on the Investor Relations section of the website under Events and Presentations. Turning to the slide in the presentation.

Speaker #4: 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 #4: These forward-looking statements are subject to future risks and uncertainties that could cause our actual results or performance to differ materially. All forward-looking statements should be considered in conjunction with the cautionary statements on slide two in the earnings press release, and the risk factors included in Mercury's SEC filings.

Speaker #4: 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.

Speaker #4: 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.

Speaker #4: Please turn the slide three.

Speaker #5: Thanks, Tyler, and good afternoon. Thank you for joining our Q4 and FY25 earnings call. We delivered very strong results in Q4 that were once again in line with or ahead of our expectations, resulting in solid FY25 year-over-year growth in backlog, revenue, adjusted EBITDA, and free cash flow.

Speaker #5: Today, I'd like to cover three topics: first, some introductory comments on our business and results, second, an update our four priorities: performance excellence, building a thriving growth engine, expanding margins, and driving improved free cash flow.

Speaker #5: And third, performance expectations for FY26 and longer term. Then, I'll turn it over to Dave, who will walk through our financial results in more detail.

Speaker #5: 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.

Speaker #5: 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 four.

Speaker #5: Our Q4 and full-year results reflect our expectation to deliver robust organic growth with expanding margins and positive free cash flow. Record quarterly bookings of $342 million and a 1.25 book-to-build resulted in a record backlog of $1.4 billion.

Speaker #5: Q4 revenue of $273 million, up 9.9% year-over-year. And full-year revenue of $912 million, up 9.2% year-over-year. Q4 adjusted EBITDA of $51 million and adjusted EBITDA margin of 18.8%.

Speaker #5: Full-year EBITDA of $119 million and adjusted EBITDA margin of 13.1%. All up substantially year-over-year. And free cash flow of $34 million, resulting in record full-year free cash flow of $119 million.

Speaker #5: We ended Q4 with $399 million of cash on hand. These results reflect ongoing focus on our four priority areas, with highlights that include solid execution across our broad portfolio of production and development programs, backlog growth of 6% year-over-year, reduced operating expense, enabling increased positive operating leverage, and continued progress on free cash flow drivers with networking capital down $90 million year-over-year or 16.7%.

Speaker #5: Please turn to slide five. Starting now with our four priorities and priority one: Performance Excellence. In the fourth quarter, our focus on performance excellence positively impacted our results, primarily in two areas. First, in Q4, we recognized $4.7 million of net adverse EAC changes across our portfolio, which is in line with recent quarters, reflecting our maturing capabilities in program management, engineering, and operations, and progress in completing development programs.

Speaker #5: Second, our focus on accelerating customer deliveries generated approximately $30 million in revenue and approximately $15 million in adjusted EBITDA planned for FY26. This acceleration incrementally impacted our top-line growth and adjusted EBITDA margins for Q4 and FY25, and will also factor into our outlook for FY26, which I'll speak to shortly.

Speaker #5: Please turn to slide six. Moving on to priority two, driving organic growth. Q4 record bookings of $342 million resulted in a record backlog of $1.4 billion and a full-year book-to-build of $1.13.

Speaker #5: In the quarter, we received a number of significant contract awards, including two new production awards totaling $36.9 million for ground-based radar programs that leverage our common processing architecture and cybersecurity software from recently acquired StarLab.

Speaker #5: A $22 million initial production contract from a U.S. defense prime contractor for sensor processing subsystems that will upgrade existing combat aircraft. An $8.5 million contract to develop and demonstrate a next-generation RF signal conditioning solution to enhance the performance and cost of expanded active electronically steered array radars, broadly used in air, sea, and ground-based applications.

Speaker #5: Two agreements with the European defense prime contractor to expand and accelerate production of processing subsystems and components for radar and electronic warfare missions. And a new production agreement that supports a critical US military space program.

Speaker #5: 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.

Speaker #5: Please forward to slide seven. Now turning to priority three, expanding margins. In pursuit of our targeted adjusted EBITDA margins in the low to mid 20% range, we're focused on the following drivers: backlog margin expansion as we burn down lower margin backlog and replace with new bookings aligned with our target margin profile.

Speaker #5: Ongoing initiatives to simplify, automate, and optimize our operations are driving organic growth to realize positive operating leverage. Q4 adjusted EBITDA margin of 18.8% was ahead of our expectations and up sequentially over 700 basis points.

Speaker #5: This stronger margin performance was driven by conversion of backlog previously contemplated to be delivered in FY26 and higher operating leverage. Gross margin of 31%, up approximately $160 basis points year-over-year, was in line with our expectations and largely driven by the average margin in our backlog.

Speaker #5: We expect backlog margin to continue to increase as we bring in new bookings that we believe will be in line with our targeted margin profile and accretive to the current average margin in our backlog.

Speaker #5: Operating expenses are again down year-over-year as a result of fully realizing the impact of previously implemented actions to simplify, streamline, and focus our operations.

Speaker #5: Please forward to slide eight. Finally, turning to priority four, improved free cash flow. We continue to make progress on the drivers of free cash flow, and in particular, reducing networking capital which, at approximately $449 million, is at the lowest level since Q2 of FY22, and down $211 million from peak networking capital levels in Q1 of FY24.

Speaker #5: Q4 free cash flow of $34 million was ahead of our expectation of break-even, primarily driven by acceleration of cash receipts. Free cash flow for FY25 was approximately $119 million, and net debt is down to $282 million, the lowest level since Q1 of FY22.

Speaker #5: We believe our continuous improvement related to program execution, accelerating deliveries for our customers, demand planning, and supply chain management will lead to continued reduction in working capital and net debt going forward.

Speaker #5: In addition, as we did in FY25, we continue to expect to allocate factory capacity in FY26 to programs with unbilled receivable balances, which will help drive free cash flow, although with little impact on revenue.

Speaker #5: Please turn to slide nine. FY25 represented a year of significant progress and dramatically improved results. Looking ahead, I am optimistic about our team, our leadership position in delivering mission-critical processing at the edge, the market backdrop, 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 cash flow conversion of 50%.

Speaker #5: Although we will not be providing specific guidance for FY26, I will provide the following color, which excludes any acceleration of customer deliveries within or into FY26, and potential funding increases on existing programs driven by administration priorities such as Golden Dome.

Speaker #5: In FY26, we expect to demonstrate continued progress toward our target profile. For full-year FY26, we expect annual revenue growth of low single digits with the first half relatively flat year-over-year and volume increasing sequentially as we move through the second half.

Speaker #5: This revenue outlook reflects the previously discussed approximately $30 million of accelerated deliveries into Q4 of FY25. As well as our expectation that we will allocate factory capacity to programs with unbilled receivable balances resulting in free cash flow generation with little revenue impact.

Speaker #5: As we discussed in previous calls, our backlog margin, while up over the last four quarters, is still below our target margin profile, driven primarily by older, low-margin programs.

Speaker #5: We expect to continue to execute those low-margin programs in FY26. As a result, we are expecting full-year adjusted EBITDA margin approaching mid-teens, with low double-digit adjusted EBITDA margins in first half and first-quarter margin flat year-over-year.

Speaker #5: We anticipate margins to expand in the second half, with Q4 adjusted EBITDA margin expected to be the highest of the fiscal year. Finally, with respect to free cash flow, we expect to be free cash flow positive for the year, with second-half free cash flow greater than the first.

Speaker #5: In summary, with our momentum coming out of FY25, I expect that our performance in FY26 will represent another positive and meaningful step toward our target profile.

Speaker #5: I look forward to providing updated commentary as we progress through the year. With that, I'll it over to Dave to walk through the financial results for the quarter and fiscal year, and I look forward to your questions.

Speaker #5: Dave?

Speaker #6: Thank you, Bill. Our fourth-quarter results reflect solid progress toward our goal of positioning the business to deliver performance excellence characterized by organic growth, expanding margins, and robust free cash flow.

Speaker #6: We still have work to do, but we are encouraged by the progress we have made and expect to continue this momentum in fiscal 26.

Speaker #6: With that, please turn to slide 10, which details our fourth-quarter results. Our bookings for the quarter were $342 million, up $57 million or 20% year-over-year, with a book-to-build of 1.25.

Speaker #6: Our backlog of $1.4 billion is up $79 million, or 6% year-over-year. Revenues for the fourth quarter were $273 million, up approximately $25 million, or 9.9% compared to the prior year.

Speaker #6: During the fourth quarter, we were able to accelerate customer deliveries worth approximately $30 million of revenue from fiscal 2026 into the fourth quarter. Gross margin for the fourth quarter increased approximately 160 basis points to 31%, as compared to the same quarter last year.

Speaker #6: Gross margin improvement during the fourth quarter was primarily driven by favorable program mix and a reduction in net EAC change impacts of approximately $5 million, or 51% year-over-year.

Speaker #6: 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 through our continued focus on building a thriving growth engine, coupled with further expected progress toward completion of lower margin activities.

Speaker #6: Operating expenses decreased approximately $20 million or 25% year-over-year. The decrease was primarily driven by the actions taken in fiscal 24 and 25 to improve our performance by simplifying, automating, and optimizing our operations and aligning our team composition with our increased production mix as we previously discussed.

Speaker #6: GAAP net income and earnings per share in the fourth quarter were approximately $16 million and $0.27, respectively, as compared to GAAP net loss and loss per share of approximately $11 million and $0.19, respectively, in the same quarter last year.

Speaker #6: The improvement in year-over-year earnings is primarily a result of increased gross margins coupled with reduced operating expenses. Adjusted EBITDA for the fourth quarter was $51 million, up $20 million, or 65%, compared to the same quarter last year.

Speaker #6: Adjusted earnings per share were $0.47, as compared to $0.23 in the prior year. The year-over-year increase was primarily related to net income of $16 million in the current period, as compared to a net loss of $11 million in the prior year.

Speaker #6: Free cash flow for the fourth quarter was approximately $34 million, as compared to approximately $61 million in the prior year. This reflects the third consecutive quarter of positive free cash flow.

Speaker #6: Turning to our full-year results on slide 11. Our bookings for fiscal 25 were approximately $1 billion, marking another solid year of bookings. Our book-to-build was $1.13, yielding record backlog of $1.4 billion, which is up 6% from fiscal 24.

Speaker #6: Fiscal 25 revenues were $912 million, up approximately $77 million or 9.2% compared the prior fiscal year. Gross margin was $27.9% for fiscal 25. An increase of approximately $440 basis points from the 23.5% gross margin realized during fiscal 24.

Speaker #6: During fiscal 25, we had net EAC change impacts of $21 million, a reduction of $51 million or 71% as compared to the prior year.

Speaker #6: Our gross margin improvement in fiscal 25 was also impacted by lower manufacturing adjustments including inventory reserves and warranty expense. Operating expenses decreased approximately $70 million or 20% in fiscal 25 as compared to the prior year.

Speaker #6: The decrease was primarily due to the organizational realignment activities taken in fiscal 24 and 25, as previously discussed. GAAP net loss and loss per share in fiscal 25 were approximately $38 million and 65 cents, respectively, as compared to GAAP net loss and loss per share of approximately $138 million and $2.38 cents, respectively, in the prior year.

Speaker #6: The improvement in year-over-year earnings is primarily a result of increased gross margins coupled with reduced operating expenses. Adjusted EBITDA for fiscal 25 was $119 million, up $110 million as compared to the prior year.

Speaker #6: Adjusted earnings per share were $0.64 as compared to an adjusted loss per share of $0.69 in the prior year. The year-over-year increase was primarily related to lower net losses of approximately $100 million in fiscal 2025 as compared to the prior year.

Speaker #6: Free cash flow for fiscal 2025 was a record of $119 million, compared to $26 million in the prior year. Slide 12 presents Mercury's balance sheet for the last five quarters.

Speaker #6: We ended the fourth quarter with cash and cash equivalents of $39 million, sequentially driven primarily by approximately $38 million in cash provided by operations in the fourth quarter.

Speaker #6: Which were partially offset by investments of approximately $4 million in capital expenditures. Over the last five quarters, we've generated approximately $180 million of free cash flow.

Speaker #6: Billed receivables decreased slightly year-over-year, while unbilled receivables decreased approximately $26 million. The decrease in unbilled receivables reflects the incremental progress we've made by delivering our programs to our ustomers, which significantly drove our cash flow performance during fiscal 25.

Speaker #6: As Bill previously noted, we continue to expect to allocate factory capacity in fiscal 2026 to programs with unbilled balances, which will help drive free cash flow.

Speaker #6: Inventory decreased slightly year-over-year and sequentially by approximately $2 million and $20 million, respectively. Accounts payable increased $6 million sequentially, driven by the timing of payments to our suppliers.

Speaker #6: Accrued expenses decreased approximately $2 million sequentially, primarily due to lower restructuring and other accrued expenses. Accrued compensation increased approximately $16 million sequentially, primarily due to bonus and payroll expenses.

Speaker #6: Deferred revenues increased year-over-year by approximately $53 million as a result of additional milestone billing events achieved during the period. Sequentially, deferred revenues decreased approximately $16 million, primarily due to additional point-in-time revenue during the fourth quarter of fiscal 25.

Speaker #6: Working capital decreased approximately $90 million year-over-year, or 17%. This demonstrates the progress we've made in reversing the multi-year trend of growth in working capital.

Speaker #6: Resulting in the lowest net working capital since Q2 of fiscal 22. As a reference point, in the last four quarters, we have driven our net working capital from a high of $72% of trailing 12 months' venue to 49%.

Speaker #6: Net working capital remains a primary focus area for us, and we believe we can continue to deliver improvement. Turning cash flow on slide 13, free cash flow for the fourth quarter was approximately $34 million as compared $61 million in the prior year.

Speaker #6: This exceeded our expectation of break-even for the fourth quarter. We believe our continuous improvement in program execution, hardware delivery, just-in-time material, and appropriately timed payment terms will lead to a continued reduction in working capital.

Speaker #6: In closing, we are pleased with the performance for the fiscal year and the higher level of predictability in 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.

Speaker #6: With that, I'll now turn the call back over to Bill.

Speaker #5: Thanks, Dave. With that, operator, please proceed with the Q&A.

Speaker #3: Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star one on your telephone keypad to raise your hand and join the queue.

Speaker #3: And if you would like to withdraw your question, again, press star one. We also ask that you limit yourself to one question and one follow-up.

Speaker #3: For any additional questions, please re-queue. Your first question comes from the line of Peter Arment with Baird. Please go ahead.

Speaker #7: Yeah. Good afternoon, Bill, Dave, Tyler. Nice results. Hey,

Speaker #5: Hey, Peter.

Speaker #7: Bill. Can I ask a estion regarding the factory capacity that's being allocated to programs tied to the unbilled receivable? Does that really, does that wash out of the system when we think about fiscal 26, or how do ou handicap that?

Speaker #5: Yeah. I an, it's hard for us to be real precise on the timing, but I think we're working ourselves into a time period where that won't be something that we talk with respect to our organic growth.

Speaker #5: You know, as Dave and I have discussed, we think we still have pretty significant room to improve on working capital and make great progress.

Speaker #5: In 2024 and 2025, we expect to make good progress. In 2026, a piece that will come from burning down the programs with the unbilled balances, and of course, as we push those through the factory, it's good free cash flow, but it doesn't help with revenue.

Speaker #5: It's very little impact on revenue. So I don't, without being too precise about it, I think we get significantly through this headwind as we work our way through 2026.

Speaker #7: Great. That's very lear. And just regarding the networking and working capital comment, you ow Dave mentioned you know I think you guys peaked at 72% of sales, now down to 49%.

Speaker #7: Is there a way to think about what should be a normalized level for a like Mercury?

Speaker #5: Yeah. I think, Peter, this is Dave. I think you know we pretty consistently said, you know, depending on the mix of business, that could be in the 35% range.

Speaker #5: And as we think longer term, that's that's still kind of our target to go and and continue to attack that. And you ow bringing it down, and we're down 200 or so million, that you know obviously the next dollar gets harder than the previous dollar, but you know, but we still feel we have room to to run in that direction.

Speaker #7: Appreciate it. I'll ump back in the queue. Thanks, guys.

Speaker #5: Good. Thank ou.

Speaker #3: Your next question comes from the line of Ken Herbert with RBC Capital Markets. Please go head.

Speaker #8: Yeah. Hey, good afternoon, guys. Nice quarter.

Speaker #5: Thanks. Hey, Ken. Thanks.

Speaker #8: Yeah. Bill or Dave, maybe as you think about the pull forward of the revenues from a, sounds e, first half 26 into the fourth quarter, is can you maybe elaborate on what's behind that?

Speaker #8: Because is obviously the second or third quarter of this year. You've been le to do this. Is it is it just better execution? Is it is it maybe customers really sort of pushing things to go faster?

Speaker #8: I'm just trying to a sense as to sort of repeatability of this, if that makes sense. Because obviously, it's a it's a really nice surprise and reflects certainly well on the execution.

Speaker #5: Yeah. I mean, first of all, we're really happy with the performance in Q4. If you just go top to bottom with you know record quarterly bookings, our venue was the second highest revenue quarter that we've in the company's history.

Speaker #5: What drove that was a large percentage of point-in-time revenue. Which implies delivery. And so you ow what we're underneath the hood, what we're ing in order to accelerate these deliveries, is work through our supply chain and our factory capacity to look at what in our expanding and record backlog we can pull you know forward into current periods and try and accelerate deliveries for our ustomers.

Speaker #5: Because the reality is they want the benefits of our technologies into their programs and into their customers' hands as fast as we can get it there.

Speaker #5: So that's what we're working on. I think you know where we are right now with the magnitude of what we pulled into Q4, which again, we think is a very good thing because it's demonstrating performance that's getting really close to our target profile when you think about organic growth, margins, and free cash flow conversion.

Speaker #5: Now we're working through, okay, with the impact to the first half and what we're originally planned deliveries that are now we're now in Q4, working through the same constraints.

Speaker #5: And so that's working through our supply chain, looking at kits that are you know ready to approach the factory floor, where are we short, how can we work those shortages so that we can complete kits, accelerate deliveries, etc.

Speaker #5: I mean, that's literally the process that we've been going through. I think the good news is is we've demonstrated in FY25 the ability to build and execute that muscle.

Speaker #5: And you saw in multiple quarters that we were able to continue to pull forward, and you know as a result, we took an outlook that was low single digits for the year and converted it into high single digits, almost double digits for the year.

Speaker #5: So we're we're executing those same muscles again in FY26. Obviously, in the color commentary around 26, we haven't accounted for any accelerations within the year or into the year from FY27.

Speaker #5: But we are working on that every day. And as we make progress, as we put those plans in place, and as we execute those plans, we'll continue to update our commentary as we move through the year.

Speaker #8: Great. Thank you. And if I could, just a quick follow-up on the bookings in the quarter. You obviously continue to call out that they are supportive of sort of the near-term margin targets.

Speaker #8: Can you can you give any more granularity in s of where you're seeing the bookings in terms of maybe you ow capabilities, how many are with you know the the CPA, and what you're seeing in terms of real demand on from a booking standpoint?

Speaker #5: Well, I think in just the small number of select bookings that we referred to in the call, you can see a pretty good distribution.

Speaker #5: Across end markets, a mix of production with some development awards that we think have the potential to lead to really significant future scale on those new developments.

Speaker #5: So I think we have a good mix of bookings and a good representation of the health of our end markets. On the margin point that you mentioned, I feel really good about the progress that we made.

Speaker #5: So you know we we talked about the status of our backlog margin, where it's at at the end of FY24, the fact that we expected it to come up over time as we burned down the lower margin and replace it with bookings that are in line with our targeted margin.

Speaker #5: We've done that for four quarters, and so we feel very good about that. When we look at sort of the rest of the runway, we haven't been specific about the timing as to when that transition would complete itself.

Speaker #5: But we've you know if you do the math on our backlog duration, it's clearly wasn't going to happen in a year. And it's not going to take three years.

Speaker #5: It's somewhere in between. And as I think I think as we get toward the end of FY26, we should have a very crisp picture of where we are in completing that transition.

Speaker #5: And be able to give you ow I think a more precise update.

Speaker #8: Yeah. And Ken, this is Dave. I would add it with specific reference to your question on the bookings around the common processing architecture. We did note in our remarks that two of the bookings that that came in in the quarter for 36.9 million dollars were related to common processing architecture.

Speaker #8: You know adding more to our backlog in that area. Yep. Perfect. Thanks, Bill. Thanks, Dave.

Speaker #5: Yep.

Speaker #3: Your next question comes from the line of Pete Skibinski with Olympic Global. Please go head.

Speaker #8: Yeah. Really nice quarter, guys.

Speaker #5: Thanks, Pete.

Speaker #8: Yeah. Maybe just to beat the drum more on the unbilled receivables, just because Bill, you mentioned that they've declined really nicely. You talked about accelerating the $30 million in the quarter so you can do quick turnaround stuff.

Speaker #8: So, I just wanted to understand better why the balance of these unbilled programs is sort of giving you schedule risk and why they're taking up so much capacity.

Speaker #8: Are they basically all you know integrated subsystems as opposed to components? Is that why they're kind of taking longer and taking up more capacity?

Speaker #5: Well, I think it's a couple of things. One is some of those programs are what we talked about over the last couple of years, development programs that transitioned into production etc.

Speaker #5: But I ink the main point is that with the programs that have some of the larger unbilled balances, when they consume factory capacity to move out the door, we're able to deliver invoice and collect cash.

Speaker #5: But most of the revenue on those programs have been recognized. So there's very little incremental revenue that comes with it. That's the main point that we're trying to get across.

Speaker #5: So as we have to allocate capacity to these programs, we get the benefit of the free cash flow, but we don't get significant revenue impact because a lot of the revenue has been previously recognized in those programs.

Speaker #5: And it's what drives those unbilled balances.

Speaker #8: And I would add that you know when you look at those programs that are largely older programs that were bid and and contracted before we were really focused on the terms we have around these contracts.

Speaker #8: So that's why the unbilled balances build up as well. Because we weren't billing and collecting along the way as we are now. You can see examples of how that's changed in our deferred revenue buildup, for instance.

Speaker #8: But those older contracts, as Bill said, didn't have that. So, hey, a larger unbilled balance we have to complete the contracts in order to get there.

Speaker #5: Yeah. So Pete, opefully that addresses the estion. But if not, please follow up.

Speaker #8: Sure. Sure. And just one follow-up on that point. Just your 26 free cash guy, you're just speaking to kind of positive free cash flow.

Speaker #8: It seems like if you're dedicating capacity to these unbilled programs that aren't going to generate revenue, it seems like your free cash conversion should be really strong.

Speaker #8: You know, maybe, I an, you did one time this year, right? So it seems like you know with more to go on the unbilled that you would be in that in that neighborhood.

Speaker #8: Is that the right way to think about it?

Speaker #5: Yeah. I think the way we're putting it is we expect to be positive. This is a business that should be generating positive cash.

Speaker #5: And you know we have a couple of things that are working for us, of course. Like you just said, we did accelerate a significant amount of cash into Q4.

Speaker #5: You know, we expected to be about break-even, and we were $30-plus million ahead of that. And so, that's a little bit of a challenge early on in the year.

Speaker #5: And at the same time, as I said, we have a significant deferred revenue balance, which is cash we've collected, you know, in advance already.

Speaker #5: So, we'll be working that off over time. We expect to continue building it up; it's dependent on the terms we can negotiate with our customers.

Speaker #5: So, you know more to come as we go through the year on that. But for now, I think that’s the way we’re looking at it: we expect to be positive.

Speaker #5: Yeah. I mean, there's no mystery to those moving pieces. It starts with the 50% free cash flow conversion, and there's what we free up off the balance sheet if there's anything we accelerated into a prior period, then that would be impacted.

Speaker #5: So I think, Pete, you're thinking about it consistent with how we're thinking about it.

Speaker #8: Okay. Fair enough. Thanks, guys.

Speaker #5: Yep. Thanks, Pete.

Speaker #3: Your next question comes from the line of Seth Seefman with JPMorgan. Please go ahead.

Speaker #9: Hey. Thanks very much. Good afternoon and good results.

Speaker #5: Hi, Seth.

Speaker #9: Hi. I have two questions about margin. Given that you talked about the average margin and the backlog kind of driving this 31% gross margin that we saw in the quarter, is there any reason that the margin should step back down into the 20s going forward?

Speaker #9: And then on the OPEX, you know, very low levels of SG&A and R&D as a percentage of sales, how do we think these Q4 run rates in dollars?

Speaker #9: And what will they apply for next year?

Speaker #8: Yeah, this is Dave. I'll start with that. You know, as we go through and over time, yes, we expect our gross margins to increase as our margin and backlog increases.

Speaker #8: Does that mean that there couldn't be a single event in a quarter that might change it slightly? You know, I would never say it couldn't.

Speaker #8: It's impossible for it to go down. But over the year, over the longer term, we expect it to continue to increase. So, you know, from that standpoint, Seth, the other thing when you look at the operating expense, you see a significant decline in operating expense year-over-year in the fourth quarter and year-over-year in the aggregate.

Speaker #8: You know, I would note that a couple of things in the year-over-year and in the fourth quarter, when you look, you see a decline in restructuring.

Speaker #8: You know, so that's not impacting EBITDA, obviously. But you know, you can see that that went from $20 million, a change last year versus this year.

Speaker #8: And you know, there’s a $20 million difference. If you look at some of the notes, you can see there was a significant difference in the SG&A in the fourth quarter. However, when I consider that consistent with last year, the difference is all in stock-based compensation.

Speaker #8: Which, again, doesn't impact EBITDA. I think I think I would I would say from an SG&A standpoint, we feel like we're in the right range as we've said a few times.

Speaker #8: I think that if you look at our R&D in the fourth quarter, I think that was a little bit lower than we expect to be on a run rate basis.

Speaker #8: I think you know Bill's talked the level we saw kind of as we were going through the balance of the year is about the level we expect to see, give or take, depending on what contract activities we're working on in a given period.

Speaker #8: Yeah.

Speaker #5: Yeah, Bill, if you have any. I just wrap it up by saying I think we're in the right zip code for the near term in our OPEX.

Speaker #5: And it's a result of the things that we've talked about over the last couple of years in you really streamlining our organization and focusing on areas like IRAD, for instance.

Speaker #5: So I feel like we're in the right zip code for the near-term and and that's really a good place for us to be to start generating more operating leverage as we start to scale.

Speaker #9: Okay. Excellent. Thanks. Thanks very much.

Speaker #5: Yep. Thanks, Seth.

Speaker #3: Your next question comes from the line of Jonathan Ho with William Blair. Please go ahead.

Speaker #10: Hi. Good afternoon and congrats on the strong results. Just given your strong next 12 months' backlog, I just wanted to understand sort of the rationale behind not providing sort of annual guidance and you know where do you maybe see the most potential for uncertainty or what's giving you pause?

Speaker #10: You know, just given the framework that you've laid out.

Speaker #5: Yeah. I think you know, with respect to our commentary on the outlook for the year, you know obviously we said we didn't account for any of the acceleration of deliveries within the year or into the year.

Speaker #5: And in FY25, we demonstrated that we're focused on doing that, and we were successful in doing it. But given that we just recently accelerated $30 million, which is a pretty significant amount of deliveries into Q4, we're still working our way through the constraints on accelerating deliveries within the year.

Speaker #5: And we're working on that. We're addressing it every day and going through risks and opportunities, trying to identify the choke points. So, I wouldn't say there are any concerns there.

Speaker #5: It's a matter of working through those plans. We're trying to, you know, address the constraints and figure out what we will be able to accelerate in the year.

Speaker #5: And at the same time, with respect to the market and conversations that we're having with our customers, I would say that those are all very positive.

Got it, got it. And just, just a quick follow-up. And, and building on the question, I, I just wanted to understand your thoughts around design, when Cadence, and the pipeline progression, particularly around areas like golden dome and the new budget, you know, how do we sort of see that that playing out over the course of the year? And, you know, do you need these design wins ahead of, you know, sort of bookings programs, uh, to sort of accelerate the business? Thank you. Well, interestingly, I think some of the bigger opportunities that we're talking about in terms of near-term volume is actually on existing programs that could fit within a golden dome type architecture. That wouldn't look like a design 1, but it would look like an increase in quantity or an acceleration of deliveries. So, I'd say that.

That's one point to the response. But I'd say secondly, since we've stood up our advanced concepts group over the last year, we've really tightened up our focus on the next set of developments in Next Generation Technologies and design wins.

That can expand our footprint and really drive and accelerate our growth beyond our current portfolio. So I think those are the two things that we're really focused on. But I think the near-term opportunities that could really drive volume are more tied to existing customer relationships and existing systems where we have a footprint.

Thank you.

Your next question comes from the line of Connor Walters with Jeff. Please, go ahead.

Hi, guys. Congrats on the great quarter, and thanks for taking my question.

Um, thanks for

I want to circle back on margins. I'm curious what played out better than anticipated in Q4, given the earlier commentary that was pointing to something nearing the mid-teens. I’m hoping you could offer some puts and takes as we think about that deceleration to the low double-digit range in the first half of 2026. Now that Opex is in the right ballpark and you're executing well on the EACs, this is just a read on program mix that’s expected to come down the pipeline.

Impacted us in Q4 and drove us to that higher-than-expected Eva margin rate.

Great, and maybe just one more capex. We took a step back this year. How should we be thinking about that in 2026 and beyond as you continue to invest in additional automation across the facility footprint?

Yeah, I think there might be an opportunity for it to tick up a little bit in, uh, in 2026. Just tied to any investments we make to further automate or down the road that we make to.

You know, really accelerate our capacity and ability to accelerate deliveries. But I say tick up; I don't, you know, I don't see anything at this point that would be significant.

Great. Thanks so much.

Yep, your next question comes from the line of Sam's, True Sticker with Truist Securities. Please go ahead.

Hi. Good evening, guys. Nice quarter on for Mike and Troy this evening. Um, I guess just kind of circling back, I'm curious what operational improvement levels do you guys have left to pull? I don't know if you guys are thinking about maybe any more facility consolidation, just anything on that front. And kind of building off of that, how should we think about potential operational improvement versus the lower margin backlog working out of the system in terms of...?

The margin expansion profile going forward.

Yeah, I think you know, as we think about the drivers of our margin going forward, there are three pieces to it. One is the backlog margin that we talked about. The second is continuing to drive efficiencies to automate and streamline our operations, and then the third is the positive operating leverage that we get with.

Increased volume. Um I'd say we're we're focused on all 3. The backlog margin is progressing and playing out the way we thought. And I think the fourth quarter is a you know a great illustration that when we deliver a higher mix of higher margin backlog it's math it translates into better Evita margin so as we move through 26 and we're seeing a little bit in 26 of a higher mix of lower margin programs working their way through in 26. I think Q4 showed what happens when we have less, slow margin mix more, high margin mix that all flows through to higher evi down margin. So we're focused on continuing that progression. And then we said it before in in Prior calls, we'll work for, you know, continuously for the rest of our lives on driving efficiency into the organization and then it becomes a decision around what we

Do with those efficiencies either to, you know, create additional capacity for innovation investment, etc. But that's something that we'll work on continuously and will never be done.

Got it. That's great. And I guess if I could just sneak in one more, you guys spoke to a couple noteworthy contracts in the quarter in the backlog. But could you maybe just give us a little more detail on where you're seeing the most demand, either by sort of general product category or even end market? Kind of land where you're seeing that. And then I guess obviously international has been doing well, but if you have any additional color there, that would be great too. Thanks.

Yeah, I guess you can see in the K where, you know, where we're growing by customer and by, you know, by segment, and that does move around quarter to quarter. And sometimes it's just driven by mix and program activity in in a current period.

But I will say that across our business right now.

We are engaged in conversations that look like increased production quantities and acceleration, along with questions from our customers and primes around providing rough order of magnitude bids if we were to accelerate or increase production. This is tied to our domestic primes and spans across our areas of land, sea, and space.

Um, and we're also seeing it with the European primes as well. Now, again,

you know, until those

Conversations manifest into bookings. It's really hard to put any certainty into our outlook, but those conversations are happening. Um, again, we feel very good about the market and the tailwinds in the market.

Um, going forward.

Noah Popernack with Goldman Sachs, please go ahead.

Hey, good evening, everyone.

Um, hey, Noah. Thanks for taking the question. I was just thinking about the pacing, the quarterly pacing on the top line from here.

Um, I hear you on the relatively flat in the first half.

And identifying the $30 million pool forward into 4 key from Q1, I guess, you know, $30 million on a flat year just as a starting point. So if I was using Q1, $25 million revenue would be 15% of revenue.

and so,

To grow, I guess to get back to flat, you know, you'd have to be growing 15%, excluding any other, you know, all else equal. If there was no other movement in revenue, so is one Q down and then two Qs up to get you to flat for the first half.

Or am I missing something in that thinking?

I think without, you know, getting too specific or caught up in quarter to quarter, we're thinking relatively flat for the first half.

I think that's the simplest way to articulate our.

Our commentary.

Okay, fair enough.

Um,

On the margin commentary. Um, and maybe this is also...

splitting hairs too much, but

I guess, you know, you calling it approaching mid-teens? I would interpret that as.

You know, you're still working your way up towards mid-teens.

And you just finished a year: $13 watt.

And you've talked about not needing that much more time to be at the longer-term framework.

So I guess help me think through

How does 26 progress versus 25, and to what extent does 27 achieve the low to mid-20s versus needing more time than that?

Yeah, I think if I step back and don't get too caught up in the quarter-to-quarter movements,

And I think about the 30,000—approximately $30 million—in Q4 that we, you know, really just time-shifted to the left.

If I looked at the mass, if that didn't happen, I think it shows a progression of growth rates on the top line, in a progression of margins. That looks a little bit different than after we pulled it forward and then with the commentary that we gave. I mean, we could all stand up at a whiteboard and do that math. But I think the math is pretty self-evident that, you know, at least on the top line.

A mid-single-digit growth rate in 2025, leading to a high single-digit growth rate in 2026, would be impacted by the shift of $30 million from 2026 into 2025, and I think that's part of the phenomenon in our...

You know, in our Outlook—and it also applies to margins. So I don't think I need to do the math for anybody, but at least that's how I think about it.

I understand on Golden Dome. Um,

any any ability to frame?

What would that mean for Mercury on a run-rate basis? And I guess, you know, given the time frame they've talked about for...

Fully operational. Um, when do you think they'll start to make awards?

Great question.

Um, I think if I take just a step back in order to deliver capabilities on the time frame that has been discussed.

I would think that largely those capabilities would be derived from existing systems that, you know, make up different layers of what a golden dome architecture can look at.

and as we look,

At those layers and the existing systems, today we really like our footprint.

and so,

You know, there is an opportunity we think for us to see an acceleration of deliveries on existing programs and increases in quantities.

When that happens for me right now it's TBD and that's why you know we've been pretty clear that in our FY 26 Outlook which ends next you know end of next June we're not in incorporating any impact from golden dome driven acceleration of deliveries. So we'll see how it plays out and we'll make sure to keep everybody you know everybody informed.

Where should normal unbilled receivables be in dollars or as a percentage of revenue? And then why are you building deferred revenue? What is the contracting mechanism that's driving that?

Yeah, so the way to think about it, let me give you an example for deferred revenue that maybe will help. And we've talked about this before.

Customer comes in and says, "Hey, I want you to go buy all the end-of-life components for these programs so that we can order them for the next five years. And I want you to hold those in inventory or, you know, as a, you know, on your balance sheet."

And they say, you know, and we say to them, "Okay? We're willing to do that. Good deal for us, right? Because we want to guarantee that production for the next five years," and we say, "But oh, by the way, we'd like you to pay us now for that."

And so they'll pay us upfront in advance of us placing, you know? So we can go place the orders in advance of those things coming in.

So you would see that creates itself as a deferred revenue asset, meaning, you know, we've got the cash; we have something we need to do in the future.

And so that impacts us, you know, significantly. It can be long lead or can be end of life; either one of those things. And that's what we've seen really go up. Where we've asked customers, rather than putting it on our balance sheet, we've said, "Hey, can you pay us for that?"

And, uh, they've been receptive to that. Um, at this, that impacts both the inventory and the unbilled. And so, some of that $127 million you see in deferred revenue is actually, you know, think of it as a counter to the unbilled balance and the inventory balance.

And so you know, we've done some math around what the ideal rates are for each one of the categories. And as Bill said, you know, we've got...

You know, a $100 million to get to the 35% kind of range. And as we look at it, it's across all of those categories. It's some in unbilled, it's some inventory. You know? We don't think we're at the ideal level for either of those things at this point.

Thanks for all the detail. I appreciate it.

Yeah, yeah, thanks. No, thanks, Noah.

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.

Okay. Well, thank you very much. Thanks for your time this afternoon, and we look forward to updating everybody in our next quarterly call.

Thank you for your participation, and you may now disconnect.

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