Mercury Systems, Inc. (MRCY) Earnings

Management highlights

- Core Strategic Priorities * Performance Excellence: Focused on development program execution, customer delivery, and scaling production for transitioning programs. Q4 generated record quarterly revenue, with overtime revenue up 23.6% year-over-year (the highest in 15 quarters), driven by improved material receipt and better supply chain alignment with organic growth. The company expanded capacity, increased automation, and consolidated subscale sites to improve scalability and efficiency, and announced a new strategic agreement with Palantir to use AI software for improved material planning and factory operations to boost backlog conversion. * Organic Growth: Near-term growth is expected to come from higher volume on existing production programs and transition of development programs to production, with additional upside from broader industry demand tailwinds and new development program wins. Record Q4 bookings were broad-based, with large production awards across common processing architecture, effectors, airborne applications, space, and missile defense. Multi-year customer commitments are increasing in response to rising global defense budgets, with strong demand visible across space, munitions, missile defense, and CPA. * Margin Expansion: Management targets an adjusted EBITDA margin profile in the low to mid 20s, driven by conversion of lower-margin legacy backlog, new bookings aligned with target margins, operational optimization, and positive operating leverage from organic growth. FY26 gross margin improved 70 basis points year-over-year to 28.6%, and operating expenses as a percentage of revenue declined year-over-year, reflecting ongoing efficiency gains. * Free Cash Flow Conversion: Net working capital decreased 4% year-over-year to ~$431 million (a $18 million year-over-year reduction), representing a $229 million (34.8%) total reduction from the Q1 FY24 peak. Full year FY26 net debt was reduced by $55 million year-over-year to $227 million, leaving the balance sheet with strong flexibility for growth investments. - Operational Summary * Ended Q4 FY26 with record total backlog of over $1.9 billion (up 38.4% year-over-year) and record next 12-month backlog of $1 billion (up 23.3% year-over-year), providing enhanced visibility into FY27 and beyond. A few recent large orders included consolidated quantities that would otherwise have been booked and recognized in FY27, leading to higher-than-typical next 12-month backlog coverage.

Guidance

- Management increased its long-term targeted organic revenue growth outlook to low double digits, up from prior lower guidance, while maintaining targets of low to mid 20% adjusted EBITDA margin and 50% free cash flow conversion. - For FY27: Management expects total revenue approaching $1.1 billion, with revenue growth approaching double digits year-over-year. Q1 FY27 revenue is expected to be the lowest of the year, growing high single digits year-over-year, with revenue accelerating through the remainder of the year. - For FY27 adjusted EBITDA: Management expects full year adjusted EBITDA approaching 200 billion yen, with adjusted EBITDA margin in the high teens, growing through the year to align with target margins by year-end. Q1 FY27 adjusted EBITDA margin is expected to be in line with Q1 FY26. - For FY27 free cash flow: Full year free cash flow conversion is expected to approach 35% (below the 50% long-term target), with higher free cash flow in the second half than the first. Q1 FY27 (typically the weakest cash flow quarter) is expected to have a larger than normal cash outflow, driven by advance material purchases to support growth. - FY28 reference points (not formal guidance): Management expects low double digit top-line organic growth, adjusted EBITDA margin at the low end of the target range, and free cash flow conversion returning to the 50% target. - The current FY27 and FY28 outlook does not include potential upside from unbooked market tailwinds across key portfolio segments, or benefits from the new Palantir AI partnership or other automation initiatives to improve backlog conversion.

Segment performance

The call does not break out separate financial performance for distinct product segments with explicit absolute revenue and revenue contribution percentage data. Overall company aggregate results for Q4 FY26 include: record revenue of $290 million, record bookings of $660 million (up 93.1% year-over-year), adjusted EBITDA of $49 million (16.7% adjusted EBITDA margin), and free cash flow of $29 million. Full year FY26 aggregate results: total revenue of $984 million (up 7.9% year-over-year), total bookings of $1.5 billion (up 49.8% year-over-year, book-to-bill of 1.57), gross margin of 28.6% (up 70 basis points year-over-year), adjusted EBITDA of $150 million (up 25.7% year-over-year, 15.3% adjusted EBITDA margin, up 217 basis points year-over-year), and full year free cash flow of $68 million. Domestic revenue represented 85.8% of FY26 total revenue and grew 13% organically year-over-year, while international revenue declined ~15% year-over-year. Q4 FY26 saw record quarterly bookings for Common Processing Architecture (CPA), and full year FY26 also delivered record annual CPA bookings.

Risks & headwinds

- Forward-looking statements, including FY28 reference points, are subject to risks and uncertainties that could cause actual results to differ materially from projections, including failure to convert backlog to revenue and failure to secure additional new orders beyond current backlog. - Current visibility depends on government defense budget allocation to customer programs, and potential tailwinds from increased defense budgets have not yet materialized in firm bookings. - International operations faced temporary delivery headwinds in FY26 from the transition of international manufacturing to a new contract manufacturer, though management expects these issues to resolve within the next two quarters. The 15% year-over-year decline in international revenue in FY26 is attributed to this temporary disruption. - Achieving target margin and growth relies on continued successful resolution of supply chain constraints and successful execution of operational efficiency and automation initiatives, including the Palantir partnership, which is still in early stages with unproven benefits.

Analyst Q&A

• Q: What are the key drivers of projected sequential margin expansion throughout FY27, and can you update full year CPA booking performance following the record Q4? /

  A: Margin expansion throughout FY27 is driven by the ongoing burn down of lower-margin legacy backlog, with margins expected to hit the company's target profile by the end of the fiscal year. CPA delivered a record full year of bookings in FY26, in line with the multi-year progression of ramping up production for the segment. Strong Q4 and full year CPA demand was broad-based across the entire portfolio, not tied to a single large award, confirming strong growth prospects for the segment.

• Q: How much of the upgraded FY27 organic growth outlook reflects existing large framework agreements vs. core business improvements, and what financial benefits are expected from the new Palantir partnership? /

  A: The upgraded outlook reflects the company's current record backlog and high visibility into FY27, and almost no unbooked market tailwinds from large potential agreements (like UCA missile frameworks or European defense growth) are included in the current guidance. The Palantir partnership is focused on speeding up backlog conversion to deliver technology to warfighters faster, and it could potentially positively impact top-line revenue, margins, and free cash flow, though the partnership is still early and benefits are not included in current guidance.

• Q: Why is international revenue down 15% year-over-year in FY26, and what is the outlook for that segment? /

  A: The decline is a temporary impact from transitioning international manufacturing to a new contract manufacturer, a shift that caused expected delivery delays that management projects will be resolved within the next couple of quarters. International demand and backlog remain strong, so the delivery slowdown is not a reflection of underlying market fundamentals for the segment.

• Q: What is the growth and margin outlook for CPA ruggedized servers, and what opportunity exists for smaller form factor CPA products? /

  A: CPA growth is already outperforming prior expectations, with a growing pipeline of new program opportunities emerging. New smaller form factor CPA products open up additional total addressable market for integration onto smaller mobile platforms (like armored ground vehicles and unmanned vessels), and Mercury's unique position providing secure CPA technology gives it strong share gain potential in these new markets. Management does not disclose specific margin data for individual product lines.