Executive Summary / Key Takeaways

• Mercury Systems is strategically positioned as a critical technology provider in the defense electronics market, leveraging its proprietary Mercury Processing Platform and Common Processing Architecture (CPA) to deliver mission-critical solutions at the edge.
• The company demonstrated strong operational execution in Q1 FY26, exceeding expectations with 10.2% year-over-year revenue growth to $225.2 million and a 66% increase in adjusted EBITDA to $35.6 million, driven by accelerated deliveries and improved program management.
• Mercury is making significant progress towards its long-term target profile of above-market top-line growth, low to mid-20% adjusted EBITDA margins, and 50% free cash flow conversion, supported by backlog margin expansion and streamlined operations.
• Key growth drivers include increasing global defense budgets, domestic priorities like "Golden Dome," and strong international channels, with the company actively expanding its highly automated manufacturing footprint to meet anticipated demand.
• While the company faces risks from legal proceedings and the conversion of legacy low-margin backlog, its robust backlog of $1.4 billion and enhanced financial flexibility from a recently extended $850 million revolving credit facility provide a solid foundation.

The Foundation: Mission-Critical Processing at the Edge

Mercury Systems, Inc. (NASDAQ:MRCY) stands as a pivotal technology company within the aerospace and defense sector, specializing in delivering mission-critical processing capabilities to the "edge"—where signals and data are collected and transformed into actionable intelligence. Incorporated in 1981 and rebranded in 2012, Mercury has, over four decades, cultivated a unique advantage through its Mercury Processing Platform. This platform integrates innovative technologies, spanning from radio frequency (RF) front end to the human-machine interface, enabling rapid conversion of data from hostile environments into critical decisions. The company's offerings range from silicon to system scale, encompassing components, modules, subsystems, and complete integrated solutions, deployed in over 300 programs across 35 countries.

The broader defense electronics market, Mercury's primary focus, historically exhibits growth rates in the 5% to 6% range. However, Mercury targets subsegments within this market that are growing even faster, particularly those demanding advanced processing power and capabilities at the edge. This strategic focus, coupled with a commitment to leveraging commercial technology for defense applications, positions Mercury to outpace overall market growth. The company's strategy is underpinned by four core priorities: delivering predictable performance, building a thriving growth engine, expanding margins, and driving improved free cash flow.

Technological Edge: The Mercury Processing Platform and CPA

At the heart of Mercury's competitive differentiation is its proprietary Mercury Processing Platform, a culmination of over 40 years of development and strategic acquisitions. This platform is designed to handle compute-intensive, high-bandwidth, and high-throughput applications, often under stringent size, weight, and power (SWaP) constraints and in harsh environments. The platform's ability to transform massive digital data streams into real-time usable information is crucial for modern defense applications.

A cornerstone of this platform is the Common Processing Architecture (CPA). CPA is not merely a product line; it is a strategic differentiator, particularly in meeting stringent security requirements for defense programs. Mercury's CPA products offer enhanced security features, such as embedded anti-tamper and cybersecurity software, a capability significantly bolstered by the early Q4 FY25 acquisition of Star Lab from Wind River. This integration provides a notable advantage over competitors, as demonstrated by a Q2 FY25 competitive win where an incumbent processor board competitor could not meet the security requirements provided by Mercury's CPA. The company is actively focused on "ramp to rate" for CPA, aiming to expand its total addressable market (TAM) to additional platforms. This technology's ability to enable secure, high-performance processing is critical for next-generation defense platforms and is expected to drive significant future growth.

Mercury's R&D efforts, guided by its Advanced Concepts group, are focused on next-generation technologies and design wins that expand its footprint beyond the current portfolio. These initiatives aim to develop innovative solutions, often leveraging existing products and work for new applications, ensuring a strong pipeline of future production opportunities. The company's investments in critical capabilities and intellectual property, particularly in processing and leveraging open standards for data-intensive applications like artificial intelligence (AI), are key to maintaining its technological lead.

Competitive Landscape and Strategic Positioning

Mercury Systems operates in a competitive environment alongside major defense contractors and specialized technology providers. Its primary publicly traded direct competitors include Raytheon Technologies (RTX), Northrop Grumman (NOC), and L3Harris Technologies (LHX).

Compared to these larger players, Mercury Systems holds a specialized niche. While RTX, NOC, and LHX offer broad integrated systems and benefit from immense scale and extensive government relationships, Mercury focuses on modular and subsystem-focused solutions. This specialization allows Mercury to offer significantly higher efficiency and agility in specific applications, such as its integrated radio frequency assemblies for electronic warfare or its onboard UAV processors. For instance, Mercury's specialized digital radio frequency memory units can achieve notably better performance under challenging conditions in electronic warfare applications, a key differentiator against broader portfolios like NOC's.

However, Mercury's smaller scale compared to these giants can lead to higher operating costs and potentially slower market share growth in broader segments. Its supply chain, while managed for efficiency, could face vulnerabilities that larger, more diversified competitors might mitigate more easily. Despite these challenges, Mercury's established relationships, with products deployed in over 300 programs across 35 countries, foster strong customer loyalty and provide a stable revenue base. The company's strategic acquisitions, like Star Lab, and divestitures, such as outsourcing its Swiss manufacturing operations, are aimed at enhancing its competitive position by improving scalability, efficiency, and technological differentiation in key areas.

Financial Performance and Operational Momentum

Mercury Systems has demonstrated significant operational improvements and a positive shift in its financial trajectory. In the first quarter of fiscal year 2026, the company reported robust results, with net revenues increasing 10.2% year-over-year to $225.2 million. This growth was partially fueled by the acceleration of approximately $20 million in revenue from Q2 FY26 into Q1 FY26, driven by accelerated customer deliveries on high-priority programs.

Profitability saw a substantial uplift, with adjusted EBITDA reaching $35.6 million, a 66% increase year-over-year, and the adjusted EBITDA margin expanding to 15.8%, up 530 basis points from the prior year. This margin expansion was primarily attributed to a favorable program mix, lower manufacturing adjustments of $7.4 million, and a significant 51% year-over-year reduction in net adverse Estimate at Completion (EAC) changes to $4 million. This reduction in EAC changes reflects maturing capabilities in program management and operations, a key aspect of the company's "predictable performance" priority.

Operating expenses, while increasing in some areas like selling, general, and administrative (SG&A) due to higher compensation and litigation expenses, saw a notable 28.3% decrease in research and development (R&D) expenses to $13.2 million. This R&D reduction was primarily due to headcount reductions initiated in fiscal 2025, aligning the team with an increased production mix. The company expects to incur an additional $2.4 million in restructuring charges in Q2 FY26 related to further workforce reductions.

Liquidity and cash flow generation have also seen significant improvement. As of September 26, 2025, Mercury held $304.7 million in cash and cash equivalents. Net working capital stood at approximately $458 million, down $106 million (18.8%) year-over-year. This marks a substantial reversal of a multi-year trend, with net working capital down $211 million from its peak in Q1 FY24. The company's long-term target for normalized net working capital is in the 35% to 40% range of revenue, indicating further room for improvement. Free cash flow for Q1 FY26 was an outflow of $4.4 million, a $16.5 million improvement year-over-year. This progress is driven by enhanced program execution, accelerated deliveries, and strategic management of demand and supply chains.

Outlook and Growth Trajectory

Mercury Systems maintains an optimistic outlook, projecting continued progress toward its 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, the company anticipates low single-digit annual revenue growth, with the first half expected to be relatively flat year-over-year due to prior revenue accelerations, and volume increasing sequentially in the second half.

Adjusted EBITDA margins are expected to approach mid-teens for the full year, with low double-digit margins in the first half. Q2 FY26 adjusted EBITDA margin is projected to approach double digits as the company converts lower-margin backlog, but margins are anticipated to expand in the second half, with Q4 FY26 expected to be the highest of the fiscal year. This progression is tied to the strategic burn-off of older, lower-margin backlog and its replacement with new bookings that align with Mercury's target margin profile. Management notes that the difference between production and development contract margins is typically around 1,000 basis points, and recent bookings are consistently coming in at targeted margins.

Free cash flow is expected to be positive for FY26, with the second half generating more cash than the first. This will be supported by the allocation of factory capacity to programs with unbilled receivable balances, driving cash flow with minimal revenue impact. This strategy addresses older contracts where revenue was recognized earlier, but cash collection is tied to delivery.

Strategic growth initiatives include a significant ramp-up in production for the Common Processing Architecture (CPA), supported by a new 50,000-square-foot highly automated manufacturing footprint in Phoenix, Arizona, expected to be online by Q3 FY26. This expansion will support CPA production and allow for efficient scaling to meet potential market tailwinds. The company is also seeing increased demand for programs like LTAMDS (Lower Tier Air and Missile Defense Sensor), which holds "tremendous potential" for long-term production.

Broader market tailwinds are also a significant factor. These include increasing global defense budgets, particularly the "ReArm Europe" initiative, which could see European defense budgets triple to $1 trillion in aggregate over the next few years. Mercury, with its strong international channels, has already seen its international business grow by about 15% over the trailing 12 months. Domestic priorities, such as "Golden Dome," also present substantial opportunities. While specifics are still developing, Mercury believes it is "well positioned" to participate across the various layers of such architectures, potentially leading to increased quantities or accelerated deliveries on existing programs.

To enhance financial flexibility, Mercury's Board of Directors authorized a new share repurchase program of up to $200 million on November 3, 2025. Furthermore, on November 4, 2025, the company extended its revolving credit facility by five years to November 4, 2030, with a facility size of $850 million.

Risks and Challenges

Despite the positive momentum, Mercury Systems faces several risks. The ongoing U.S. federal government shutdown, which began on October 1, 2025, could lead to delays in customer orders, suspension of work, or payment delays, although management currently views the impact as "minimal" due to strong backlog coverage. Legal proceedings, including a dispute with its former CEO (with a potential exposure of $3 million to $12 million plus fees) and a $32.5 million securities class action settlement expected to be covered by insurance, could divert resources and attention. Environmental claims related to a former site also present an unquantified potential liability. The company's efforts to convert its legacy low-margin backlog will continue to be a focus, as this process could impact near-term profitability.

Conclusion

Mercury Systems is executing a clear and focused strategy to capitalize on its technological leadership and favorable market dynamics within the defense electronics sector. The company's Mercury Processing Platform and Common Processing Architecture provide a strong competitive moat, enabling it to secure competitive wins and expand its role in critical programs. Recent financial performance, marked by robust revenue growth, significant EBITDA margin expansion, and substantial improvements in free cash flow and working capital, underscores the effectiveness of its operational excellence initiatives.

As Mercury progresses through fiscal year 2026, its ability to convert lower-margin backlog, integrate new high-margin bookings, and leverage its streamlined operations for positive operating leverage will be crucial. The company's proactive investments in manufacturing capacity and its strong positioning in high-growth areas like Golden Dome and European defense markets suggest a compelling trajectory for long-term value creation. While legal and operational challenges persist, Mercury's enhanced financial flexibility and commitment to its strategic priorities position it as a compelling investment opportunity for those seeking exposure to a technologically differentiated player in the evolving aerospace and defense landscape.