Mercury Systems - Earnings Call - Q4 2025

Executive Summary

• Q4 FY25 delivered record bookings of $341.5M (book-to-bill 1.25), record backlog of $1.40B, revenue of $273.1M, GAAP diluted EPS of $0.27, adjusted EPS of $0.47, and adjusted EBITDA of $51.3M; gross margin reached 31.0% and free cash flow was $34.0M.
• Results materially beat Wall Street consensus: revenue by ~$28.7M, adjusted EPS by ~$0.25, and adjusted EBITDA by ~$16.7M, underpinned by accelerated customer deliveries (~$30M revenue, ~$15M adjusted EBITDA).
• Management reiterated margin expansion and cash conversion priorities; FY26 color: low-single-digit revenue growth, adjusted EBITDA margin approaching mid-teens, positive free cash flow, first half relatively flat with margin inflecting in H2 and strongest in Q4.
• Near-term catalysts: backlog mix improvement, continued acceleration of deliveries, CPA wins and international production agreements, plus potential tailwinds from “Golden Dome” priorities, though not embedded in FY26 commentary yet.

What Went Well and What Went Wrong

What Went Well

• Record Q4 bookings ($341.5M) and record backlog ($1.40B), with 12‑month backlog at $807.8M; book-to-bill 1.25 demonstrates healthy demand and conversion.
• Margin and cash improvements: adjusted EBITDA margin 18.8% (up >700 bps QoQ), gross margin 31% (+160 bps YoY), free cash flow $34.0M; Q4 adjusted EPS $0.47 versus $0.23 prior year.
• Management execution quote: “Focus on accelerating customer deliveries generated approximately $30M of revenue and approximately $15M of adjusted EBITDA planned for FY26,” driving top-line and margin upside in Q4.

What Went Wrong

• Operating cash flow down YoY (Q4: $38.1M vs $71.8M), and free cash flow down YoY (Q4: $33.98M vs $61.41M), as timing effects reversed exceptionally strong prior-year cash generation.
• Continued drag from older, lower-margin backlog; management expects margins to progress over “several quarters” as mix improves, not a binary step-up.
• Revenue timing: accelerated deliveries pulled ~$30M from FY26 into Q4 FY25, creating a first-half FY26 headwind and implying a relatively flat H1 before improvement in H2.

Transcript

Speaker 3

Good day everyone and welcome to the Mercury Systems fourth 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.

Speaker 0

Mr. Hojo, good afternoon and thank you for joining us. With me today is our Chairman and Chief Executive Officer Bill Ballhaus 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 is posted on the Investor Relations section of the website under Events and Presentations. Turning to slide 2 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 GAAP, during our call we will also discuss several non-GAAP 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.

Speaker 1

I'll now turn the call over to.

Speaker 0

Mercury's Chairman and CEO Bill Ballhaus. Please turn to slide three.

Speaker 2

Thanks Tyler and good afternoon. Thank you for joining our Q4 and FY25 earnings call. We delivered very strong results in Q4 that were once again in line with or ahead of our expectations, resulting in solid FY25 year over year growth in backlog, revenue, adjusted EBITDA, and free cash flow. Today I'd like to cover three: first, some introductory comments on our business and results; second, an update on our four performance excellence, building a thriving growth engine, expanding margins, and driving improved free cash flow; and third, performance expectations for FY26 and longer term. 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 4. Our Q4 and full year results reflect our expectation to deliver robust organic growth with expanding margins and positive free cash flow. Record quarterly bookings of $342 million and a 1.25 book-to-bill resulting in a record backlog of $1.4 billion, Q4 revenue of $273 million, up 9.9% year over year.

Over year and full year revenue of.

$912 million, up 9.2% year over year. Q4 adjusted EBITDA of $51 million and adjusted EBITDA margin of 18.8%, full year EBITDA of $119 million and adjusted EBITDA margin of 13.1%, all up substantially year over year, and free cash flow of $34 million resulting in record full year free cash flow of $119 million. We ended Q4 with $309 million of cash on hand. These results reflect ongoing focus on our four priority areas with highlights that include solid execution across our broad portfolio of production and development programs, backlog growth of 6% year over year, reduced operating expense enabling increased positive operating leverage, and continued progress on free cash flow drivers, with net working capital down $90 million year over year or 16.7%. Please turn to Slide 5. Starting now with our four priorities and Priority 1, Performance Excellence.

In the fourth quarter, our focus on performance excellence positively impacted our results primarily in two areas. First, in Q4 we recognized $4.7 million of net adverse EAC changes across our portfolio, which is in line with recent quarters, reflecting our maturing capabilities in program management, engineering, and operations, and progress in completing development programs. Second, our focus on accelerating customer deliveries generated approximately $30 million of revenue and approximately $15 million of adjusted EBITDA planned for FY26. This acceleration incrementally impacted our top line growth and adjusted EBITDA margins for Q4 and FY25 and will also factor into our outlook for FY26, which I'll speak to shortly. Please turn to Slide 6. Moving on to Priority 2, driving organic growth. Q4 record bookings of $342 million resulted in a record backlog of $1.4 billion and a full year book-to-bill of 1.13.

This quarter we received a number of significant contract awards, including two new production awards totaling $36.9 million for ground-based radar programs that leverage common processing architecture and cybersecurity software from recently acquired Star Lab, a $22 million initial production contract from a U.S. defense prime contractor for sensor processing subsystems that will upgrade existing combat aircraft, an $8.5 million contract to develop and demonstrate a next generation RF signal conditioning solution to enhance the performance and cost of X band Active Electronically Steered Array radars broadly used in air, sea, and ground-based applications, two agreements with a European defense prime contractor to expand and accelerate production of processing subsystems and components for radar and electronic warfare missions, and a new production agreement that supports a critical U.S. military space program. 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. Please forward to slide 7. Now turning to priority 3, expanding margins in pursuit of our targeted adjusted EBITDA margins in the low to mid 20% range, we're focused on the following: backlog margin expansion as we burn down lower margin backlog and replace with new bookings aligned with our target margin profile, ongoing initiatives to simplify, automate, and optimize our operations, and driving organic growth to realize positive operating leverage. Q4 adjusted EBITDA margin of 18.8% was ahead of our expectations and up sequentially over 700 basis points. This stronger margin performance was driven by the conversion of backlog previously contemplated to be delivered in FY26 and higher operating leverage.

Gross margin of 31%, up approximately 160 basis points year over year, was in line with our expectations and largely driven by the average margin in our backlog. We expect backlog margin to continue to increase as we bring in new bookings that we believe will be 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 as a result of fully realizing the impact of previously implemented actions to simplify, streamline, and focus our operations. Please forward to slide 8.

Finally, turning to priority 4, improved free cash flow, we continue to make progress on the drivers of free cash flow and in particular reducing net working capital, which at approximately $449 million is at the lowest level since Q2 of FY22 and down $211 million from peak net working capital levels in Q1 of FY24. Q4 free cash flow of $34 million was ahead of our expectation of break even, primarily driven by acceleration of cash receipts. Free cash flow for FY25 was approximately $119 million and net debt is down to $282 million, the lowest level since Q1 of FY22. We believe our continuous improvement related to program execution, accelerating deliveries for our customers, demand planning, and supply chain management will lead to continued reduction in working capital and net debt going forward.

In addition, as we did in FY25, we continue to expect to allocate factory capacity in FY26 to programs with unbilled receivable balances, which will help drive free cash flow, although with little impact to revenue. Please turn to slide 9. FY25 represented a year of significant progress and dramatically improved results. Looking ahead, I am optimistic about our team, our leadership position in delivering mission critical processing at the edge, the market backdrop, 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%.

Although we will not be providing specific guidance for FY26, I will provide the following color which excludes any acceleration of customer deliveries within or into FY26 and potential funding increases on existing programs driven by administration priorities such as Golden Dome. In FY26, we expect to demonstrate continued progress toward our target profile for the full year. For FY26, we expect annual revenue growth of low single digits with the first half relatively flat year over year and volume increasing sequentially as we move through the second half. This revenue outlook reflects the previously discussed approximately $30 million of accelerated deliveries into Q4 of FY25 as well as our expectation that we will allocate factory capacity to programs with unbilled receivable balances resulting in free cash flow generation with little revenue impact.

As we discussed in previous calls, our backlog margin, while up over the last four quarters, is still below our target margin profile driven primarily by older low margin programs. We expect to continue to execute those low margin programs in FY26. As a result, we are expecting full year adjusted EBITDA margin approaching mid teens with low double digit adjusted EBITDA margins in the first half and first quarter margin flat year over year. We anticipate margins to expand in the second half with Q4 adjusted EBITDA margin expected to be the highest of the fiscal year. Finally, with respect to free cash flow, we expect to be free cash flow positive for the year with second half free cash flow greater than the first.

In summary, with our momentum coming out of FY25, I expect that our performance in FY26 will represent another positive and meaningful step toward our target profile. I look forward to providing updated commentary as we progress through the year. With that, I'll turn it over to Dave to walk through the financial results for the quarter and fiscal year and I look forward to your questions.

Speaker 1

Dave, thank you, Bill. Our fourth quarter results reflect solid progress toward our goal of positioning the business to deliver performance excellence characterized by organic growth, expanding margins, and robust free cash flow. We still have work to do, but we are encouraged by the progress we have made and expect to continue this momentum in fiscal 2026. With that, please turn to slide 10, which details our fourth quarter results. Our bookings for the quarter were $342 million, up $57 million or 20% year over year, with a book-to-bill of 1.25. Our backlog of $1.4 billion is up $79 million or 6% year over year. Revenues for the fourth quarter were $273 million, up approximately $25 million or 9.9% compared to the prior year. During the fourth quarter, we were able to accelerate customer deliveries worth approximately $30 million of revenue from fiscal 2026 into the fourth quarter.

Gross margin for the fourth quarter increased approximately 160 basis points to 31% as compared to the same quarter last year. Gross margin improvement during the fourth quarter was primarily driven by favorable program mix and a reduction in net EAC change impacts of approximately $5 million or 51% year over 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 through our continued focus on building a thriving growth engine, coupled with further expected progress toward completion of lower margin activities. Operating expenses decreased approximately $20 million or 25% year over year. The decrease was primarily driven by the actions taken in fiscal 2024 and 2025 to improve our performance by simplifying, automating, and optimizing our operations and aligning our team composition with our increased production mix.

As we previously discussed, GAAP net income and earnings per share in the fourth quarter were approximately $16 million and $0.27, respectively, as compared to GAAP net loss and loss per share of approximately $11 million and $0.19, 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 fourth quarter was $51 million, up $20 million or 65% as compared to the same quarter last year. Adjusted earnings per share were $0.47 as compared to $0.23 in the prior year. The year over year increase was primarily related to net income of $16 million in the current period as compared to net loss of $11 million in the prior year.

Free cash flow for the fourth quarter was approximately $34 million as compared to approximately $61 million in the prior year. This reflects the third consecutive quarter of positive free cash flow. Turning to our full year results on.

Slide 11, our bookings for fiscal 2025 were approximately $1 billion, marking another solid year of bookings. Our book-to-bill was 1.13, yielding.

Record backlog of $1.4 billion, which is up 6% from fiscal 2024. Fiscal 2025 revenues were $912 million, up approximately $77 million or 9.2% compared to the prior fiscal year. Gross margin was 27.9% for fiscal 2025, an increase of approximately 440 basis points from the 23.5% gross margin realized during fiscal 2024. During fiscal 2025 we had net EAC change impacts of $21 million, a reduction of $51 million or 71% as compared to the prior year. Our gross margin improvement in fiscal 2025 was also impacted by lower manufacturing adjustments including inventory reserves and warranty expense. Operating expenses decreased approximately $70 million or 20% in fiscal 2025 as compared to the prior year. The decrease was primarily due to the organizational realignment activities taken in fiscal 2024 and 2025.

As previously discussed, GAAP net loss and loss per share in fiscal 2025 were approximately $38 million and $0.65, respectively, as compared to GAAP net loss and loss per share of approximately $138 million and $2.38, respectively, in the prior year. The improvement in year over year earnings is primarily a result of increased gross margins coupled with reduced operating expenses. Adjusted EBITDA for fiscal 2025 was $119 million or $110 million as compared to the prior year. Adjusted earnings per share were $0.64 as compared to adjusted loss per share of $0.69 in the prior year. The year over year increase was primarily related to lower net losses of approximately $100 million in fiscal 2025 as compared to the prior year. Free cash flow for fiscal 2025 was a record of $119 million as compared to $26 million in the prior year.

Slide 12 presents Mercury Systems' balance sheet for the last five quarters. We ended the fourth quarter with cash and cash equivalents of $309 million, sequentially driven primarily by approximately $38 million in cash provided by operations in the fourth quarter, which were partially offset by investments of approximately $4 million in capital expenditures. Over the last five quarters, we generated approximately $180 million of free cash flow. Receivables decreased slightly year over year while unbilled receivables decreased approximately $26 million. 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. As Bill previously noted, we continue to expect to allocate factory capacity in fiscal 2026 to programs with unbilled balances, which will help drive free cash flow.

Inventory decreased slightly year over year and sequentially by approximately $2 million and $20 million, respectively. Accounts payable increased $6 million sequentially, driven by the timing of payments to our suppliers. Accrued expenses decreased approximately $2 million sequentially, primarily due to lower restructuring and other accrued expenses. Accrued compensation increased approximately $16 million sequentially, primarily due to bonus and payroll expenses. Deferred revenues increased year over year by approximately $53 million as a result of additional milestone billing events achieved during the period. Sequentially, deferred revenues decreased approximately $16 million, primarily due to additional point in time revenue. During the fourth quarter of fiscal 2025, working capital decreased approximately $90 million year over year, or 17%. This demonstrates the progress we've made in reversing the multi-year trend of growth in working capital, 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 twelve months revenue to 49%. Net working capital remains a primary focus area for us, and we believe we can continue to deliver improvement. Turning to cash flow on slide 13, free cash flow for the fourth quarter was approximately $34 million as compared to $61 million in the prior year. This exceeded our expectation of break even for the fourth quarter. We believe our continuous improvement in 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 for the fiscal year and the higher level of predictability in the business.

We believe continuing to execute on our four priority focused 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.

Speaker 2

Thanks Dave.

With that, operator, please proceed with the Q&A.

Speaker 3

Thank you. We will now begin the question and answer session. If you would like to ask a question, please press Star one on your telephone keypad to raise your hand and join the queue. If you would like to withdraw your question, press Star one. We also ask that you limit yourself to one question and one follow-up. For any additional questions, please re-queue. Your first question comes from the line of Peter Arment with Baird. Please go ahead.

Speaker 2

Yeah.

Good afternoon, Bill, Dave, Tyler. Nice results.

Speaker 1

Hey, Peter.

Speaker 2

Hey, Bill.

Speaker 1

Can I ask a question regarding you?

The factory capacity that's being allocated, programs tied to the unbilled receivable.

Speaker 2

Does that really wash out of the system when we think about it.

Fiscal 2026 or how do you, how.

Do you handicap that? Yeah, I mean, it's hard for us to be real precise on the timing, but I think we're working ourselves into a time period where that won't be something that we talk about with respect to our organic growth. You know, in 2026, as Dave and I have discussed, we think we still have pretty significant room to improve on net working capital, make great progress in 2024 and 2025. We expect to make good progress in 2026. A piece of that will come from burning down the programs with the unbilled receivables. Of course, as we push those.

Through the factory, it's good for free.

Cash flow, but it doesn't help with revenue. It's very little impact on revenue. I don't, without being too precise about it, I think we get significantly through this headwind as we work our way through 2026. Great. That's very clear.

Regarding the net working capital comment, Dave mentioned, I think you guys peaked at 72% of sales and now down to 49%.

Speaker 1

Is there a way to.

Speaker 2

Think about what it is.

Should be a normalized level for a business like Mercury?

Speaker 1

Yeah, I think, Peter, this is Dave. I think, you know, we pretty consistently said, you know, depending on the mix of business, that could be in the 35% range. As we think longer term, that's still kind of our target to go and continue to attack that and, you know, bringing it down. We're down $200 million or so. Obviously, the next dollar gets harder than the previous dollar, but we still feel we have room to run in that direction.

Appreciate it.

Speaker 2

I'll jump back in the queue.

Thanks, guys.

Thank you.

Speaker 3

Your next question comes from the line of Ken Herbert with RBC Capital Markets. Please go ahead.

Yeah.

Hey, good afternoon, guys.

Speaker 2

Nice quarter. Thanks. Thanks.

Yeah, Bill or Dave, maybe as you think about the pull forward of the revenues from, it sounds like first half 2026 into the fourth quarter, can you maybe.

Speaker 1

Elaborate on what's behind that?

Because this is obviously the second or third quarter of this year you've been able to do this. Is it just better execution? Is it maybe customers really sort of pushing things to go faster? I'm just trying to get a sense as to sort of repeatability of this, if that makes sense. Because obviously it's a really nice surprise and reflects certainly well on the execution.

Speaker 2

Yeah, I mean, first of all, we're really happy with the performance in Q4. If you just go top to bottom with, you know, record quarterly bookings. Our revenue was the second highest revenue quarter that we've had in the company's history. What drove that was a large percentage of point in time revenue, which implies delivery. You know, what we're underneath the hood. What we're doing in order to accelerate these deliveries is work through our supply chain and our factory capacity to look at what in our expanding and record backlog we can pull forward into current periods and try and accelerate deliveries for our customers. The reality is they want the benefits of our technologies into their programs and into their customers' hands as fast as we can get it there. That's what we're working on.

I think where we are right now with the magnitude of what we pulled into Q4, which again we think is a very good thing because it's demonstrating performance that's getting really close to our target profile. When you think about organic growth and margins and free cash flow conversion. Now we're working through okay with the impact to the first half and what were originally planned deliveries that are now, we're now in Q4 working through the same constraints. That's working through our supply chain, looking at kits that are, you know, ready to approach the factory floor. Where are we short, how those shortages so that we can complete kits, accelerate deliveries, et cetera. I mean, that's literally the process that we've been going through. I think the good news is we've demonstrated in FY25 the ability to build and execute that muscle.

You saw in multiple quarters that we're able to continue to pull forward and as a result took an outlook that was low single digits for the year and converted it into high single digits, almost double digits for the year. We're executing those same muscles again in FY26. Obviously in the color commentary around 26, we haven't accounted for any accelerations within the year or into the year from FY27. We are working on that every day. As we make progress, as we put those plans in place and as we execute those plans, we'll continue to update our commentary as we move through the year. Great, thank you.

If I could just a quick.

Speaker 1

Follow up on the bookings.

In the quarter, you continue to call out that they are supportive of the longer term margin targets. Can you give any more granularity in terms of where you're seeing the bookings, in terms of maybe capabilities, how many are with the CPA and what you're seeing in terms of real demand from a booking standpoint?

Speaker 2

I think in just the small number of select bookings that we referred to on the call, you can see a pretty good distribution across end markets, a mix of production with some development awards that we think have the potential to lead to really significant future scale on those new developments. I think a good mix of bookings and a good representation of health of our end markets. On the margin point that you mentioned, I feel really good about the progress that we made. We talked about the status of our backlog margin where it sat at the end of FY2024, the fact that we expected it to come up over time as we burn down the lower margin and replace it with bookings that are in line with our targeted margin. We've done that for four quarters and we feel very good about that.

When we look at sort of the rest of the runway, we haven't been specific about the timing as to when that transition would complete itself, but if you do the math on our backlog duration, it clearly wasn't going to happen in a year and it's not going to take three years.

It's somewhere in between.

As we get toward the end of FY2026, we should have a very crisp picture of where we are in completing that transition and be able to give, you know, I think a more precise update.

Speaker 1

Ken, this is Dave. I would add with specific reference to your question on the bookings around the common processing architecture, we did note in our remarks that two of the bookings that came in in the quarter for $36.9 million were related to common processing architecture, adding more to our backlog in that area.

Speaker 2

Yep, perfect.

Speaker 1

Thanks, Bill.

Speaker 2

Thanks, Dave.

Speaker 3

Your next question comes from the line of Pete Skibitski with Alembic Global. Please go ahead.

Yeah, really nice quarter, guys.

Speaker 2

Hey, thanks.

Yeah, maybe just to beat the drum more on the unbilled receivables. Just because, Bill, you mentioned that they've declined really nicely and you talked about accelerating the $30 million in the quarter so you can do quick turnaround stuff. I just wanted to understand better why the balance of these unbilled programs are sort of giving you schedule risk and why they're taking up so much capacity. Are they basically all, you know, integrated subsystems as opposed to components? Is that why they're kind of taking longer and taking up more capacity?

I think it's a couple of things. One is some of those programs are what we talked about over the last couple of years. Development programs had transitioned into production, et cetera. I think the main point is that with the programs that have some of the larger unbilled balances, when they consume factory capacity to move out the door, we're able to deliver, invoice, and collect cash. Most of the revenue on those programs has been recognized, so there's very little incremental revenue that comes with it. That's the main point that we're trying to get across. As we have to allocate capacity to these programs, we get the benefit.

Of the free cash flow, we.

Don't get significant revenue impact because a lot of the revenue has been previously recognized in those programs, and it's what drives those unbilled balances.

Speaker 1

I would add that, you know, when you look at those programs, they're largely older programs that were bid and contracted before we were really focused on the terms we have around these contracts. That's why the unbilled balances build up as well, because we weren't billing and collecting along the way as we are now. You can see examples of how that's.

Speaker 2

Change in our deferred revenue buildup, for instance.

Speaker 1

Those older contracts, as Bill said, didn't have that, so have a larger unbilled balances. We have to complete the contracts in order to get there.

Speaker 2

Yeah, Pete, hopefully that addresses the question. If not, please follow up.

Sure. Just one follow-up on that point. Just your 2026 free cash guide. You're just speaking to kind of positive free cash flow. It seems like if you're dedicating capacity to these unbilled programs that aren't going to generate revenue, it seems like your free cash conversion should be really strong. I mean, you did one times this year, right? It seems like, with more to go on the unbilled, that you would be in that neighborhood. Is that the right way to think about it?

Speaker 1

I think the way we are putting it is we expect to be positive. This is a business that should be generating positive cash. You know, we have a couple of things that are working for us. Of course, like you just said, we did accelerate a significant amount of cash into Q4. You know, we expected to be about break even and we were $30 million plus ahead of that. That is a little bit of a challenge early on in the year. At the same time, as.

I said we have a significant deferred.

Revenue balance, which is cash we've collected in advance already. We'll be working that off over time. We expect to continue building it up, but it's dependent on the terms we can negotiate with our customers. More to come as we go through the year on that. For now, I think that's the way we're looking at it is we expect to be positive.

Speaker 2

Yeah, I mean, there's no mystery to those moving pieces. It starts with the 50% free cash flow conversion, and there's what we free up off the balance sheet. If there's anything we accelerated into a prior period, then that would be impacted. I think, Pete, you're thinking about it consistent with how we're thinking about it.

Okay, fair enough. Thanks, guys.

Yep, thanks, Pete.

Speaker 3

Your next question comes from the line of Seth Seifman with JPMorgan. Please go ahead.

Speaker 1

Hey, thanks very much.

Speaker 2

Good afternoon and good results. Hi, Seth. Hi.

Speaker 1

I guess two questions about margin.

Speaker 2

Given that you talked about the average margin and the backlog kind of driving this 31% gross margin that we saw in the quarter, is there any reason that the margin should step back down into the 20% going forward? On the OpEx, very low levels of SG&A and R&D as a percentage of sales. How do we think about these Q4 run rates in dollars and what they imply for next year?

Speaker 1

Yeah, this is Dave. I'll start with that. As we go through and over time, yes, we expect our gross margins to increase as our margin and backlog increases. Does that mean that there couldn't be a single event in a quarter that might change it slightly? I would never say it couldn't. It's impossible for it to go down. Over the year, over the longer term, we expect it to continue to increase. From that standpoint, Seth, the other thing on when you look at operating expense, you see a significant decline in operating expense year over year in the fourth quarter and year over year in the aggregate.

I would note that a couple of things in the year over year and in the fourth quarter when you look, you see a decline in restructuring, so that's not impacting EBITDA obviously, but you can see that that went from $20 million, a change last year versus this year and a $20 million difference. If you look at some of the notes, you can see there was a significant difference in the SG&A in the fourth quarter. When I consider that consistent with last year, the difference is all in stock-based comp, which again doesn't impact EBITDA. I think I would say from an SG&A standpoint, we feel like we're in the right range, as we've said a few times. If you look at our R&D in the fourth quarter, I think that was a little bit lower than we expect to be.

On a run rate basis.

I think Bill's talked about the level we saw as we were going through the balance of the year is about the level we expect to see, give or take, depending on what contract activities we're working on in a given period.

Speaker 2

Yeah, Bill, if you have any, I just wrap it up by saying I think we're in the right zip code for the near term in our OpEx, and it's a result of the things that we've talked about over the last couple years and really streamlining our organization and focusing in areas like IRAD, for instance. I feel like we're in the right zip code for the near term, and that's really a good place for us to be to start generating more operating leverage as we start to scale. Okay, excellent. Thanks. Thanks very much. Thanks, Seth.

Speaker 3

Your next question comes from the line of Jonathan Ho with William Blair. Please go ahead.

Speaker 1

Hi, good afternoon, and congrats on the strong results.

Given your strong next 12 months backlog, I just wanted to understand sort of.

The rationale behind not providing sort of annual guidance and where do you maybe.

See the most potential for uncertainty.

Speaker 2

What's giving you pause just given the.

Speaker 1

Framework that you've laid out?

Speaker 2

Yeah, I think with respect to our commentary on the outlook for the year, obviously we said we didn't account for any of the acceleration of deliveries within the year or into the year. In FY2025 we demonstrated that we're focused on doing that and we were successful in doing it. Given that we just recently accelerated $30 million, which is a pretty significant amount of deliveries into Q4, we're still working our way through the constraints on accelerating deliveries within the year. We're working that every day and going through risks and opportunities and trying to identify the choke point. I wouldn't say there are any concerns there. It's just a matter of working through those plans. We're trying to address the constraints and figure out what we will be able to accelerate in the year.

At the same time, with respect to the market and conversations that we're having with our customers, I would say that those are all very positive. I mean, when you consider the overall outlook and size of the defense budgets and allocation, increased allocation toward acquisition of technology and capabilities, you look at some of the executive orders that are focused on the use of commercial technology, which is right in our wheelhouse, the executive orders around Golden Dome, and then what's happening with European defense budgets. You can see in our K how our international operations has really grown over the last 12 months. We feel great about those tailwinds, the conversations that we're having with our customers across our business, where there's interest in additional quantities, looking for ways to accelerate, identify production and capacity constraints. Those all feel like very positive tailwinds.

Until they get quantified and until we see those conversations translate into bookings, it's really hard for us to pull that into our outlook and be definitive about it. Like we did last year, we'll go through the year, we'll work on the accelerations, we'll convert the bookings, and as we work through the year, we'll continue to provide an update.

Speaker 1

Got it. Just as a quick follow up and building on the question, I just—

Wanted to understand your thoughts around design.

Win cadence and the pipeline progression, particularly.

Around areas like Golden Dome and the new budget.

How do we sort of see that playing out over the course of the year?

Speaker 2

Do you need these design wins ahead of, you know, sort of bookings programs to sort of accelerate the business?

Speaker 1

Thank you.

Speaker 2

Interestingly, I think some of the bigger opportunities that we're talking about in terms of near term volume is actually on existing programs that could fit within a Golden Dome type architecture that wouldn't look like a design win, but it would look like an increase in quantity or an acceleration of deliveries. I'd say that that's one point to the response. I'd say secondly, since we've stood up our Advanced Concepts group over the last year, we've really tightened up our focus on the next set of developments and next generation technologies and design wins that can expand our footprint and really drive and accelerate our growth beyond our current portfolio. I think those are the two things that we're really focused on. I think the near term opportunities that could really drive volume are more tied to existing customer relationships and existing systems where we have a footprint.

Speaker 1

Thank you.

Speaker 3

Your next question comes from the line of Conor Walters with Jefferies. Please go ahead.

Hi guys, congrats on the great quarter and thanks for taking my question.

Speaker 2

Thank you.

Wanted to circle back on margins. Curious what played out better than anticipating Q4 given the earlier commentary. It was pointing to something nearing the mid teens, and then hoping you could offer some puts and takes as we think about that deceleration to the low double digit range in 1H2026. Now that OpEx is in the right ballpark, you're executing well on the eats. Is this just a read on program mix expected to come down the pipeline?

Speaker 1

Certainly the increased volume because of the pull in helped us with our operating leverage because, as you saw, OpEx wasn't going to grow because of that. There definitely was a mix phenomena going on there. As Bill talked about, we were able to accelerate $30 million worth of activity that was a higher mix of higher margin activity. Those things impacted us in Q4 and drove us to that higher than expectation EBITDA margin rate.

Speaker 2

Great.

CapEx took a step back this year. How should we be thinking about that in 2026 and beyond as you continue to invest in additional automation across the facility footprint?

I think there might be an opportunity for it to tick up a little bit in 2026, just tied to any investments we make to further automate or down the road that we make to really accelerate our capacity and ability to accelerate deliveries. I say tick up. I don't see anything at this point that would be significant.

Great, thanks so much.

Speaker 3

Your next question comes from the line of Sam Struesecker with Truist Securities. Please go ahead.

Hi, good evening guys. Nice quarter on for Michael Ciarmoli this evening. I guess just kind of circling back, I'm curious, what operational improvement levers do you guys have left to pull at the, if any. I don't know if you guys are thinking about maybe any more facility consolidation, just anything on that front and kind of building off of that. How should we think about potential operational improvement versus the lower margin backlog working out of the system in terms of the margin expansion profile going forward.

Speaker 2

I think, you know, as we think about the drivers of our margin going forward, there's three pieces to it. One is the backlog margin that we talked about. The second is continuing to drive efficiencies and to automate and to streamline our operations. The third is the positive operating leverage that we get with increased volume. I'd say we're focused on all three. The backlog margin is progressing and playing out the way we thought. I think the fourth quarter is a great illustration that when we deliver a higher mix of higher margin backlog, it's math, it translates into better EBITDA margin. As we move through 2026 and.

We're seeing a little bit in 2026.

Of a higher mix of lower margin programs working their way through in 2026, I think Q4 showed what happens when we have less low margin mix, more high margin mix, that all flows through to higher EBITDA margin. We're focused on continuing that progression. We've said it before in prior calls, we'll work continuously for the rest of our lives on driving efficiency into the organization. It becomes a decision around what we do with those efficiencies, either to create additional capacity for innovation, investment, et cetera. That's something that we'll work on continuously and will never be done.

Got it.

That's great. I guess if I could just.

Speaker 1

Sneak in one more.

You guys spoke to a couple noteworthy contracts in the quarter in the backlog, but could you maybe just give us a little more detail on where you're seeing the most demand, either by general product category or even end market, kind of land, air, where you're seeing that. Obviously, international has been doing well, but if you have any additional color there, that would be great too.

Speaker 2

Thanks. Yeah, I guess you can see in the K where, you know, where we're growing by customer and by, you know, by segment, and that does move around quarter to quarter, and sometimes it's just driven by mix and program activity in a current period. I will say that across our business right now, we are engaged in conversations that look like increased production quantities and acceleration and questions from our customers and primes around, you know, providing rough order of magnitude bids if we were to accelerate or increase production. It's tied to our domestic primes and it's across air, land, sea, space, and we're also seeing it with the European primes as well. Now, again, you know, until those conversations manifest into bookings, it's really hard to put any certainty into our outlook.

Those conversations are happening and again, we feel very good about the market and the tailwinds in the market going forward.

Speaker 3

Again, if you would like to ask a question, please press star one on your telephone keypad. Your next question comes from the line of Noah Poponak with Goldman Sachs. Please go ahead.

Hey, good evening everyone. Thanks for taking the question. Just thinking about the pacing, the quarterly pacing on the top line from here, I hear you on the relatively flat in the first half and identifying the $30 million of pull forward into Q4 from Q1. I guess $30 million on a flat year just as a starting point. If I was using Q1, 2025, revenue would be 15% of revenue. To grow, I guess to get back to flat, you'd have to be growing 15%, excluding any other, you know, all else equal if there was no other movement in revenue. Is Q1 down and then Q2s up to get you to flat for the first half or am I missing something in that thinking?

Speaker 2

I think, without getting too specific or caught up in quarter to quarter, we're thinking relatively flat for the first half. I think that's the simplest way to articulate our commentary.

Okay, fair enough. On the margin commentary, and maybe this is also splitting hairs too much, but I guess, you know, calling it approaching mid teens, I would interpret as, you know, you're still working your way up towards mid teens and you just finished a year at 13.1, and you've talked about not needing that much more time to be at the longer term framework. I guess help me think through how 2026 progresses versus 2025, and then to what extent does 2027 achieve the low to mid 20% versus it needs more time than that.

I think if I step back and don't get too caught up in the quarter to quarter movements and I think about the $30 million, approximately $30 million and $15 million that we really just time shifted to the left. If I looked at the math, if that didn't happen, I think it shows a progression of growth rates on the top line and a progression of margins that looks a little bit different than after we pulled it forward. With the commentary that we gave, we could all stand up at a whiteboard and do that math, but I think the math is pretty self-evident that at least on the top line, a mid single digit growth rate in 2025 leading to a high single digit growth rate in 2026 would be impacted by the shift of $30 million from 2026 into 2025.

I think that's part of the phenomenon in our outlook and it also applies to margin. I don't think I need to do the math for anybody, but at least that's how I think about it.

I understand on Golden Dome, any ability to frame what that could mean to Mercury on a run rate basis. I guess, given the time frame they've talked about for fully operational, when do you think they'll start to make awards?

Great questions. I think take just a step back. In order to deliver capabilities on the timeframe that has been discussed, I would think that largely those capabilities would be derived from existing systems that, you know, make up different layers of what a Golden Dome architecture can look like. As we look at those layers and the existing systems today, we really like our footprint. There is an opportunity, we think, for us to see an acceleration of deliveries on existing programs and increases in quantities. When that happens, for me, right now it's TBD. That's why we've been pretty clear that in our FY26 outlook, which ends next, you know, end of next June, we're not incorporating any impact from Golden Dome driven acceleration of deliveries. We'll see how it plays out and we'll make sure to keep everybody, you know, everybody informed.

Okay, last thing, Dave, is, is there a way to frame where normal unbilled receivables should be in dollars? There's a % of revenue, and then why are you building deferred revenue? What is the contracting mechanism that's driving that?

Speaker 1

Yeah, the way to think about it, I'll give you an example for deferred revenue that maybe will help. We've talked about this before. Customer comes in and says, hey, I want you to go buy all the end of life components for these programs so that we can order for the next five years. I want you to hold those in inventory or, you know, on your balance sheet. They say, you know, and we say to them, okay, we're willing to do that. Good deal for us, right? We want to guarantee that production for the next five years. We say, but oh, by the way, we'd like you to pay us now for that. They'll pay us upfront in advance of us placing, you know, so we can go place the orders in advance of those things coming in.

You would see that creates itself as a deferred revenue asset, meaning we've got the cash, we have something we need to do in the future. That impacts us significantly. Can be long lead, can be end of life, either one of those things. That's what we've seen really go up where we've asked customers, rather than putting it on our balance sheet, we've said, hey, can you pay us for that? They've been receptive to that. That impacts both the inventory and the unbilled. Some of that $127 million you see as deferred revenue is actually, you know, think of it as a counter to the unbilled balance and the inventory balance. We've done some math around what the ideal rates are for each one of the categories. As Bill said, we've got $100 million to get to the 35 kind of range.

As we look at it, it's across all of those categories. It's some in unbilled, it's some in inventory. We don't think we're at the ideal level for either of those things at this point.

Thanks for all the detail. I appreciate it.

Yep.

Speaker 2

Thanks, Noah. Thanks, Noah.

Speaker 3

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

Speaker 2

Thank you very much. Thanks for your time this afternoon. We look forward to updating everybody in our next quarterly call.

Speaker 3

This concludes today's conference call. Thank you for your participation. You may now disconnect.