Executive Summary / Key Takeaways

• Operational Turnaround Underway: Mercury Systems is executing a significant transformation, shifting from a period of "challenged programs" and development-heavy mix to predictable execution, production-focused growth, and enhanced operational efficiency.
• Strong FY25 Financial Rebound: Fiscal year 2025 demonstrated substantial improvement, with revenue growing 9.2% to $912.0 million, adjusted EBITDA soaring by $110 million to $119.4 million (13.1% margin), and record free cash flow of $119.0 million.
• Technological Edge Driving Wins: The company's differentiated Mercury Processing Platform, particularly its Common Processing Architecture (CPA) and embedded security solutions, is a critical competitive advantage, leading to market share gains and strategic program wins.
• Positive FY26 Outlook: Management anticipates low-single-digit revenue growth, adjusted EBITDA margins approaching mid-teens, and positive free cash flow in FY26, driven by improving backlog margins and continued working capital optimization.
• Long-Term Value Creation: The investment thesis hinges on Mercury's ability to sustain this operational momentum, leverage its technological leadership in a robust defense market, and achieve its long-term targets of above-market top-line growth, low-to-mid 20% adjusted EBITDA margins, and 50% free cash flow conversion.

Setting the Scene: Powering the Edge of Defense

Mercury Systems, Inc. ($MRCY) stands as a critical technology provider in the aerospace and defense sector, with a rich history spanning over four decades. Incorporated in Massachusetts in 1981, the company has evolved to deliver "mission-critical processing to the edge," where vital signals and data are collected and rapidly converted into actionable intelligence for the most demanding defense challenges. This core mission positions Mercury at the nexus of high-tech innovation and national security.

The company's offerings are built upon its proprietary Mercury Processing Platform, a culmination of over 40 years of innovation and strategic acquisitions. This platform provides integrated processing capabilities that span the full breadth of signal processing, from radio frequency (RF) front-end to the human-machine interface. Mercury's business model encompasses both a "product model," focused on internal R&D for scalable capabilities, and a "solutions model," which involves deep customer engagement for tailored, mission-specific developments that transition into long-term production. These synergistic models leverage common resources and intellectual property to accelerate innovation across its portfolio.

Mercury's technological differentiation is a cornerstone of its competitive strategy. The company's products are engineered to be Mission-Ready, featuring advanced thermal management and rugged packaging for reliable operation in harsh environments. They are Trusted and Secure, designed and manufactured onshore with advanced cryptography and physical protection technologies like BuiltSECURE, which mitigates reverse engineering and enhances cyber resiliency. Mercury also develops BuiltSAFE processing systems for safety-certifiable applications. The platform is Software-Defined, offering flexible hardware architectures that are reconfigurable and upgradeable, extending system life and reducing costs through model-based systems engineering (MBSE). Finally, its Open and Modular approach, adhering to Modular Open Systems Architectures (MOSA) and standards like OpenVPX, maximizes technology reuse, reduces development time, and mitigates obsolescence risks.

These differentiators translate into tangible benefits for defense customers. For instance, Mercury leverages advanced commercial silicon technologies, including Altera's Agilex 9 Direct RF FPGA chips, which enable direct digitization of radio frequency signals at the antenna, eliminating complex analog down-conversion stages. This innovation significantly enhances speed and efficiency in radar, communications, and electronic warfare applications. The recent acquisition of Star Lab in April 2025 further bolstered Mercury's embedded security offerings, integrating cybersecurity software directly with its Common Processing Architecture (CPA) products. This capability is particularly crucial as embedded systems security becomes a mandatory requirement for new military programs, providing Mercury a critical edge over traditional competitors. The company's Advanced Concepts Group is also actively driving next-generation technology and design wins, exemplified by a recent win for a US Defense Department satellite program that leveraged existing products and expertise.

The market backdrop for Mercury Systems is robust, characterized by a global defense super-cycle. Renaissance Strategic Advisors (RSA) estimates the global aerospace and defense electronics market to be $157 billion in 2025, projected to grow to $197 billion by 2029. Mercury primarily operates in the Tier 2 defense electronics market, estimated at $51 billion in 2025 and expected to reach $66 billion by 2029. Key growth segments include C4I (Command, Control, Communications, Computers, and Intelligence), with dedicated communications projected to grow at a 7.0% CAGR, and Sensor and Effector mission systems, where Radar is expected to see a 6.9% CAGR and Electronic Warfare (EW) a 6.2% CAGR from 2025-2029. The U.S. Department of Defense (DoD) prioritizes C4ISR, EW, guided missiles, and microelectronics, with significant R&D funding requests ($2.5 billion for microelectronics in FY25). Trends like the increasing electronification of defense systems, DoD's push for outsourcing ($25 billion addressable market for Tier 2 embedded computing and RF), and the adoption of AI algorithms further fuel demand for Mercury's specialized capabilities. The "Golden Dome" architecture, a strategic priority for the administration, presents near-term volume opportunities on existing programs where Mercury already has a strong footprint.

In this competitive landscape, Mercury Systems holds a specialized niche. While larger prime contractors like Raytheon Technologies (RTX), Northrop Grumman (NOC), Lockheed Martin (LMT), and L3Harris Technologies (LHX) operate at a broader system-integration level, Mercury excels in delivering high-performance, purpose-built embedded technologies. For instance, Mercury's specialized embedded processing modules offer superior efficiency and faster prototyping for radar simulations compared to the broader offerings of RTX. Similarly, in signals intelligence for UAVs, Mercury's modules provide notably better performance under challenging conditions than NOC's more integrated systems. Against LMT, Mercury's components can offer significantly greater efficiency in embedded applications like EO/IR technologies. While these larger competitors generally exhibit stronger net profitability (e.g., RTX at 6% TTM Net Profit Margin, NOC at 10%, LMT at 8%, LHX at 7%, compared to Mercury's -4.16% TTM Net Profit Margin), Mercury's competitive moats lie in its rapid innovation cycles, advanced packaging for Size, Weight, and Power (SWaP) optimization, and its "Deliver Uncompromised" commitment, ensuring trusted domestic supply chains and secure solutions. These advantages allow Mercury to capture specific, high-value subcomponent roles and differentiate itself through technical superiority and adaptability, aligning with the DoD's increasing focus on Modular Open Systems Architectures (MOSA) and outsourcing to specialized commercial technology providers.

The Turnaround: From Volatility to Predictability

The period leading into fiscal years 2023 and 2024 was marked by significant challenges for Mercury Systems. The company experienced stock price volatility, shareholder activism, and the resignation of its former CEO in June 2023, which led to an ongoing legal dispute. Operationally, Mercury grappled with "challenged programs" and incurred adverse Estimate at Completion (EAC) adjustments, particularly in fiscal year 2024, when product complexity led to manufacturing delays, including a multi-month halt in secure computing programs. These issues impacted financial results and customer confidence.

In response, William L. Ballhaus was appointed President and CEO in August 2023 and Chairman in October 2023, initiating a comprehensive operational overhaul. This transformation included embedding the 1MPACT value creation initiative into core operations, streamlining the organizational structure, and implementing multiple workforce reductions (approximately 350 positions in FY24 and 145 in January 2025, expected to yield $15 million in annualized savings). The Mission Systems and Microelectronics divisions were consolidated into a single integrated structure in January 2024 to enhance efficiency and accountability.

Entering fiscal year 2025, Mercury demonstrated significant progress in mitigating these challenges. The Common Processing Architecture (CPA) programs, previously a source of operational headwinds, are now "ramping production" towards full capacity in the second half of FY25, moving away from the "challenged programs" designation. This progress has already translated into tangible competitive wins, including a "notable takeaway" from a processor board competitor in Q2 FY25, directly attributed to Mercury's CPA security requirements and technical differentiation. Furthermore, in April 2025, the company strategically divested its Swiss manufacturing operations to Cicor Group, entering a long-term supply agreement designed to enhance international scalability and efficiency. These actions underscore a disciplined focus on operational excellence and strategic alignment, laying a solid foundation for future growth.

Financial Performance: A Clear Path to Recovery

The strategic and operational shifts initiated by management have yielded a compelling financial turnaround in fiscal year 2025. The company reported total net revenues of $912.0 million, marking a robust 9.2% increase from $835.3 million in fiscal year 2024. This growth was driven by a strategic pivot to program execution and progress in common processing architecture programs. The revenue mix saw a significant shift, with point-in-time revenue increasing by $112.3 million, while over-time revenue decreased by $35.5 million, reflecting the successful transition of development programs into production.

Bookings remained strong, with a record $342 million in Q4 FY25, resulting in a 1.25 book-to-bill ratio for the quarter and a full-year book-to-bill of 1.13. This propelled the backlog to a record $1.4 billion, up 6% year-over-year. Notably, over 90% of Q1 FY25 bookings were production in nature, signaling a sustained shift towards higher-margin business. Key wins in FY25 included $36.9 million for ground-based radar programs leveraging CPA and Star Lab software, a $22 million production contract for sensor processing subsystems for combat aircraft, and a five-year, $131.3 million contract for secure data transfer systems for naval aircraft.

Profitability metrics showed dramatic improvement. Gross margin expanded by 440 basis points to 27.9% in fiscal 2025, up from 23.5% in the prior year. This was primarily due to a positive net EAC change impact of $21.1 million (a $52.2 million improvement year-over-year) and $16.4 million in lower manufacturing adjustments. Operating expenses were significantly reduced, with Selling, General, and Administrative (SG&A) expenses decreasing by $12.4 million (7.4%) and Research and Development (R&D) expenses falling by $33.7 million (33.3%) to $67.6 million. These reductions, stemming from workforce realignments and streamlined operations, enabled substantial operating leverage.

The most striking improvement was in adjusted EBITDA, which surged by $110 million to $119.4 million in fiscal 2025, compared to $9.4 million in fiscal 2024, resulting in an adjusted EBITDA margin of 13.1%. The company's net loss narrowed significantly to -$37.9 million from -$137.6 million in the prior year, and adjusted EPS turned positive at $0.64 compared to -$0.69.

Liquidity and cash flow also saw a remarkable turnaround. Mercury generated a record $119.0 million in free cash flow for fiscal 2025, a substantial increase from $26.1 million in fiscal 2024. This was driven by a $138.9 million cash inflow from operating activities and aggressive working capital management. Net working capital decreased by $90.1 million year-over-year, reaching its lowest level since Q2 FY22, and as a percentage of trailing 12-month revenue, it improved from a high of 72% to 49%. The company's net debt was reduced to $282 million by Q4 FY25, the lowest since Q1 FY22. Growth in deferred revenue, up $53 million year-over-year, reflects improved contract terms and upfront customer payments, further bolstering cash. The shift in inventory composition, with Work in Process (WIP) up 23% and raw materials down 12.3% year-over-year in Q1 FY25, indicates efficient progression of inventory towards delivery.

Outlook: Sustained Progress Towards Long-Term Targets

Looking ahead, Mercury Systems is poised for continued progress towards its ambitious long-term target profile of above-market top-line growth, adjusted EBITDA margins in the low-to-mid 20% range, and 50% free cash flow conversion. For fiscal year 2026, management expects annual revenue growth of low-single digits. The first half is projected to be relatively flat year-over-year, with volume increasing sequentially in the second half. This outlook accounts for approximately $30 million of revenue accelerated into Q4 FY25 from FY26, and the strategic allocation of factory capacity to programs with unbilled receivable balances, which generates free cash flow but has minimal revenue impact.

Adjusted EBITDA margin for FY26 is expected to approach mid-teens, with lower margins in the first half and Q4 projected to be the highest of the fiscal year. This expansion will be driven by the continued burn-down of older, lower-margin programs in the backlog, replaced by new bookings that are accretive to the overall backlog margin. Ongoing initiatives to simplify, automate, and optimize operations, combined with positive operating leverage from organic growth, are also key drivers. Free cash flow is anticipated to be positive for the year, with a stronger second half, as the company continues its focus on program execution, accelerating deliveries, demand planning, and supply chain management to further reduce net working capital towards its target of the 35% range.

The underlying assumptions for this outlook include the successful mitigation of transitory impacts like EAC changes, continued ramp-up of CPA to full-rate production, and a sustained mix shift towards production in new bookings. The favorable market backdrop, including growing defense budgets, a constructive shift towards technology acquisition, and opportunities from initiatives like Golden Dome, are expected to provide positive tailwinds, though their quantitative impact is not yet fully factored into the formal FY26 outlook.

Key Risks and Investor Considerations

Despite the positive momentum, investors should be mindful of several inherent risks. Mercury's heavy reliance on defense electronics programs, with 97% of FY25 revenues derived from government contracts, exposes it to funding uncertainties, program delays, and terminations. Economic headwinds, including potential recessionary conditions and persistent inflation, could impact demand and profitability, particularly on existing fixed-price contracts where cost pass-through is limited.

Customer concentration remains a factor, with RTX Corporation, Lockheed Martin Corporation, and the U.S. Navy each accounting for 10% or more of FY25 revenues. The loss or significant reduction of key programs like F-35, LTAMDS, or THAAD could materially affect results. While operational execution has improved, product complexity and dependence on sole-source suppliers for critical components still pose risks of manufacturing delays or supply chain disruptions. The company has experienced past cyber intrusions and faces ongoing threats, necessitating continuous investment in cybersecurity and adherence to stringent DoD security protocols.

Legal and regulatory risks include ongoing securities class action lawsuits and a dispute with the former CEO, with potential liabilities up to $14.1 million plus costs. Furthermore, the company carries significant goodwill ($938.1 million) and intangible assets ($210.6 million), which are subject to impairment if future operating performance or market conditions deteriorate.

Conclusion

Mercury Systems is in the midst of a compelling transformation, successfully pivoting from a period of operational challenges and financial underperformance to a trajectory of predictable growth and enhanced profitability. The company's deep-rooted expertise in mission-critical processing at the edge, underpinned by its differentiated Mercury Processing Platform and a strategic focus on trusted, secure, and open architectures, positions it favorably within a robust and growing defense technology market.

The significant financial improvements in fiscal year 2025, marked by strong revenue growth, a dramatic rebound in adjusted EBITDA, and record free cash flow, provide clear evidence of the effectiveness of management's turnaround strategy. As Mercury continues to optimize its working capital, burn off lower-margin legacy backlog, and secure new, higher-margin production contracts, its competitive standing, particularly in specialized embedded technologies, is strengthening. While risks inherent to the defense sector persist, the company's demonstrated operational rigor and technological leadership suggest a clear path towards achieving its ambitious long-term financial targets, making Mercury Systems an intriguing investment proposition for those seeking exposure to the evolving defense technology landscape.