MERCURY SYSTEMS INC Q3 FY2025 earnings call

Key Points

• Bill Ballhaus highlighted Q3 results reinforcing confidence in strategic positioning, with bookings of $200 million, revenue of $211 million, adjusted EBITDA of $25 million, and free cash flow of $24 million.
• Four priorities:
  • Delivering predictable performance: Recognized $3.7 million of net EAC change impacts, offset revenue acceleration from Q2.
  • Driving organic growth: Q3 bookings of $200 million led to backlog growth of 4%, with significant contract awards including $40 million in production contracts for common processing architecture and a $20 million follow-on production order for F-35 program.
  • Expanding margins: Q3 adjusted EBITDA margin of 11.7% was in line with expectations, with gross margin of 27% and operating expenses down year-over-year.
  • Improved free cash flow: Net working capital down $148 million year-over-year, free cash flow of $24 million in Q3, and $146 million over last four quarters.
• Acquired Star Lab from Wind River to enhance differentiation in common processing architecture products and divested manufacturing operation in Switzerland to scale operations.

In Q3, Mercury Systems reported revenue of $211 million with year-to-date revenue growth of 8.9% year-over-year. Bookings were $200 million, resulting in a trailing 12-month book to bill of 1.1. Adjusted EBITDA was $25 million with a margin of 11.7%, up substantially year-over-year. Free cash flow was $24 million, up $50 million year-over-year, and ended Q3 with $270 million of cash on hand. Backlog was $1.340 billion, up 4% year-over-year.

Guidance

• Full year FY '25: Expect annual revenue growth approaching mid-single digits, low double-digit adjusted EBITDA margins, Q4 adjusted EBITDA margins approaching mid-teens, and full year free cash flow ahead of prior expectations.
• No specific guidance for FY '26 but will provide commentary next quarter.

Risks

• Monitored tariffs but currently see no material impact in FY '25, with exclusions applying to significant bill material, and ways to address potential cost impacts from tariffs.

Q: Please give an update on LTAMDS given it's moving into initial production.

A: Bill Ballhaus stated they're pleased with the customer's milestone, working with them to ramp up consistent with schedule and excited about growth prospects.

Q: How to think about the increase in deferred revenues?

A: Dave Farnsworth explained it's due to customers wanting components upfront and paying for them, with deferred payments offsetting inventory increases.

Q: Optimal net working capital level and free cash flow conversion?

A: Dave Farnsworth said they aim for 50% free cash flow conversion from EBITDA, currently at low 50% of revenue and aiming for 35-40% in ideal world.

Q: Revenue step down sequentially due to pull forward into Q2?

A: Bill Ballhaus said Q3 revenue is normalized for the pull forward, and full year expectations remain the same with timing shifting left due to accelerated deliveries.

Q: Revenue split development vs production and changes in FY '26?

A: Bill Ballhaus said revenue split follows bookings, with over 80% of trailing 12-month bookings production, but no specific revenue split provided.

Q: $40 million production contracts for common processing architecture and backlog representation?

A: Bill Ballhaus said strategic wins and acquisitions like Star Lab have added to backlog in common processing architecture area, but specific backlog allocation not provided.

Q: EBITDA margins approaching mid-teens for Q4 and progression into 2026?

A: Bill Ballhaus and Dave Farnsworth explained it's due to backlog margin improvement and operating leverage, with progression gradual over time.

Q: Growth in free cash flow 2026 vs 2025?

A: Dave Farnsworth said focused on steady state free cash flow conversion of 50% and reducing working capital, with more color on 2026 next quarter.

Q: Time frame for burning out lower margin backlog?

A: Bill Ballhaus said based on commentary at end of FY '24, it will play out over several quarters as new bookings at targeted margins replace lower margin backlog.

Q: Definition of bringing new work into backlog at higher margin?

A: Bill Ballhaus explained it's based on rigorous startup process considering risk and opportunities in program bidding and negotiation.

Q: Book to bill ratio dipping below one and macro environment impact?

A: Bill Ballhaus said timing of bookings can vary, focusing on LTM book to bill of 1.1 and positive macro tailwinds like growing defense budget and constructive mix adjustment.

Q: Impact of tariffs on commercial chip supply chain?

A: Bill Ballhaus said no material impact in FY '25, with exclusions on bill material and ways to address potential cost impacts.