Mercury Systems Inc

Good day, everyone, and welcome to the Mercury Systems Third 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. Please go ahead, Mr. Hojo.

Good afternoon, and thank you for joining us. With me today is our Chairman and Chief Executive Officer, Bill Ballhouse, and our Executive Vice President and CFO, Dave Farnsworth. If you have not received a copy of the earnings press release we issued earlier this afternoon, you can find it on our website at mrcy.com. The slide presentation that we will be referencing to is posted on the investor relations section of the website under events and presentations. Turning to slide 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. All forward-looking statements should be considered in conjunction with the cautionary statements on slide 2 in the earnings press release. and the risk factors included in mercury's sec filings 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-gap financial measures specifically adjusted income, adjusted earnings per share, adjusted EBITDA, and free cash flow. A reconciliation of these non-GAAP metrics is included as an appendix to today's slide presentation and in the earnings press release. I'll now turn the call over to Mercury's Chairman and CEO, Bill Ballhouse.

Please turn to slide three. Thanks, Tyler. 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. 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 cash flow. And third, performance expectations for FY25 and longer term. Then I'll turn it over to Dave, who will walk through our financial results in more detail. Before jumping in, I'd like to thank our customers for their collaborative partnership and the trust they put in Mercury to support their most critical programs. I'd also like to thank our Mercury team for their dedication and commitment to delivering mission-critical processing at the edge. Please turn to slide four. 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. 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%. Please turn to slide 5. 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. 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. 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 F-35 program. 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 US national security mission, a $7 million development contract with the US 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 mix shift toward production. 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. First, we announced the acquisition from Wind River 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. 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 operations. 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 operations. 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. 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. 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. 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. 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. 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 cash flow conversion of 50%. As we discussed last quarter, although we will not be providing specific guidance for FY25, 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 impact 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. We continue to expect Q4 adjusted EBITDA margins to be the highest level of the fiscal year approaching mid-teens. 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. 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. 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. 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 EBITDA margins to improve over those in the first three quarters. 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. 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 million and 33 cents respectively as compared to gap net loss and loss per share 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. 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 6 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. Free cash flow for the third quarter was approximately 24 million as compared to an outflow of approximately 26 million in the prior year. 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. 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. Inventory increased slightly year over year and sequentially by approximately 10 million and 8 million respectively. We continue to see increases in deferred revenues. which in many cases provides an offset to a portion of our unbilled and inventory balances. 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 as sequentially by approximately 72 million and 7 million respectively as a result of additional milestone billing events achieved during the period. 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% of trailing 12 month revenue to 51%. Net working capital remains a primary focus area, and we believe we can continue to deliver improvement. 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. 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. With that, I'll now turn the call back over to Bill.

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

Absolutely. We will now begin the question and answer session. 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're welcome to return to the queue to ask follow-up questions. And your first question comes from the line of Peter Arment with Baird. Peter, please go ahead.

Yeah, thanks. Good afternoon, Bill, Dave, Tyler. Nice results. Hey, Bill, could you? Bill, 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 kind of that production stage. So what's the latest on that?

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. 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 LTAMs.

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 make 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 customers 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. So we've been, you know, getting through those milestones on schedule and, and the payments results. 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, 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.

Got it. I'll jump back in queue. Thanks, guys. Okay. Thanks, Peter.

And your next question comes from the line of Michael Cermoli with TruViz Securities. Michael, please go ahead.

Hey, good evening, guys. Thanks for taking the question. Nice results. Maybe just really good free cash flow performance. 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, Mike, thanks for the comments starting out. No, we've looked at it and we've talked about 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 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. 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 going to continue to work on that. Got it. That's helpful.

And just to follow up, 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 every quarter we've been, 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. 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. I'll jump back in the queue. Thanks, guys.

Okay. Thanks, Dwayne.

And your next question comes from the line of Seth Seifman with JPMorgan. Seth, please go ahead.

Hi. Good afternoon. This is Rocco on for Seth. Was the revenue stepped down 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. 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 deliveries.

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.

Great. Thank you. And your next question comes from the line of Pete Skibitsky with Olympic Global. Pete, please go ahead.

Yeah, good evening, guys. Nice corner. Maybe to follow up on Mike's question, you guys mentioned the 12-month trailing bookings were 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, you know, in fiscal 26?

Yeah, we, we haven't talked about, uh, the, the split out of the revenue that way. Um, 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, uh, in our financials exactly how much of the revenue is production versus development. But definitely, you should look at the bookings as an indicator.

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, you know, for the first three quarters. Some of the other areas are 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, and we've talked about before the, you know, when we talked about some of the significant adjustments that we saw in the CUME catch-up on EACs that had a large piece of that was in that radar area. And, you know, 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 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.

Okay, okay. Yeah, to complement that, I'm just wondering why the others 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. Okay.

Okay. Sounds great. Thank you. Yep.

Thanks, Pete. And your next question comes from the lineup, Ken Herbert with RBC Capital Markets. Ken, please go ahead. Yeah. Hi. Good afternoon, everybody.

Hi, Ken. Maybe Bill or Yeah, 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, you know, through the first through 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. 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-sized 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. 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. 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 recompete or new wins. Can you give any commentary on the competitive landscape, maybe, and how you see the opportunity 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. 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.

Great. Thank you very much. I'll pass it back to Eric.

Okay. Thank you.

And your next question comes from the line of Connor Walters with Jefferies. Connor, please go ahead. Hi, guys. Thanks so much for taking the question.

Hey, Connor. On the quarter. Hey, Connor. Thank you. Yeah. So maybe on the EBITDA margins approaching mid-teens for Q4, It's a nice sequential step up. I was hoping to dive into that a little bit. You 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, to provide some color on how to think about that progression into Q4 and to what degree we can think of that as a fair launching point in 2026.

I mean, I can take a cut at it and then Dave can jump in. 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. And, you know, 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. 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 what's driving the Q4 expectations.

Yeah, and I would just 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 op expense, and you can see that in our financials, and you've seen that as we've gone through the year. And at the same time, again, every quarter that we're making more progress as we 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. 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.

Okay. That's great. Thanks so much. I'll leave it there.

Okay, thanks, Connor.

And your next question comes from the line of Noah Poponak with Goldman Sachs. Noah, please go ahead.

Hey, good evening, everyone. Hey, good evening, Noah.

Could you grow free cash flow full year 2026 versus 2025?

Yes, 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. 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 cashflow 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. 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. 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 sort of directionally 50% of EBITDA, and then it sounds like multiple years still of improving working capital. So 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 what's left to go and the time associated with it.

Okay. Excellent. In terms of the burning out of the backlog, the older legacy, lower margin contracts, what's the timeframe in the future at which that is 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 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, since we made that comment, have been in line with what we expect to be our targeted margin profile associated with the EBITDA margin profile we've discussed of low to mid 20s 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 fy 24. okay that makes a lot of sense and again it's a matter of it's a matter of several quarters where that will play out um and the good news is we're seeing that progression happen

Okay, great. 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 over time, everything you bring into the backlog has an assumed margin, and then that can change over time based on cost and execution. So I was 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 conservatism or something else in the assumptions you make on the front end versus you know what what's happened in the past yeah so when you think about you know how how companies in in our business in 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. 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 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 line up the program and go through that analysis and pressure test that as to what we use as the backlog margin.

I understand. Okay. Thank you so much.

Okay. Thank you. And your next question comes from the line of Jonathan Ho with William Blair. Jonathan, please go ahead.

Hi, this is Garrett Burke. I'm on for Jonathan Ho. Thanks for taking my question. Just the book, the 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 happening.

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 the LTM book-to-bill of 1.1, which we think is in a good zip code. 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 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, you know, all in all, good about the bookings performance in Q3. Okay, got it.

That makes sense. 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?

Um, not, not so much a disruption associated with those. 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. Um, uh, 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 right at the center of some of the existing systems, and so we feel really good about the opportunity to participate there. 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. Got it. Got it.

Thank you.

Again, if you would like to ask a question, hit the press star followed by the number one on your telephone keypad. And your next question comes from the line of Pete Skibitski again from Olympic Global. Pete, please go ahead.

Yeah, thanks, guys. And a question, guys, we've been asking everyone, but didn't ask you yet. Tariffs, just because of your commercial chip supply chain, have you seen, do you expect to see any impact from the tariffs?

Yeah, certainly no material impact in FY25. And when we look at country exposure, 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 material. So, you know, like everybody else, we're monitoring the situation 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.

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, you know, address any potential cost impacts that may emerge associated with tariffs.

Okay.

Thank you.

Mr. Ballhouse, it appears there are no further questions. Therefore, I would like to turn the call back over to you for any closing remarks.

Okay. 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.

That concludes today's call. You may now disconnect.