Mercury Systems - Earnings Call - Q1 2026

Executive Summary

• Q1 FY26 revenue of $225.2M grew 10.2% YoY and materially beat S&P Global consensus by ~8.6% ($225.2M vs $207.3M*), while adjusted EPS of $0.26 beat by ~$0.17 ($0.26 vs $0.09*) as mix and accelerated deliveries drove upside. S&P Global estimates marked with *; values retrieved from S&P Global.
• Adjusted EBITDA rose 66% YoY to $35.6M with a 15.8% margin as gross margin improved to ~28%, aided by a favorable program mix, lower manufacturing adjustments, and reduced net adverse EACs; management pulled forward ~$20M of revenue and ~$10M of adjusted EBITDA from Q2 into Q1, setting a lower near‑term Q2 bar.
• Bookings of $250.2M (book‑to‑bill 1.11) and record backlog of ~$1.4B (+6.5% YoY) underpin FY26; 12‑month backlog rose to $815.6M.
• Capital allocation/liquidity catalysts: new $200M share repurchase authorization and a five‑year extension of the $850M revolver (current draw $591.5M), enhancing flexibility as execution improves.

What Went Well and What Went Wrong

• What Went Well
  • Beat on revenue and adjusted EPS as mix and accelerated deliveries outperformed internal expectations; adjusted EPS $0.26 vs $0.09* consensus, revenue $225.2M vs $207.3M*. S&P Global estimates marked with *; values retrieved from S&P Global.
  • Margin drivers improved: gross margin ~28% (+~260 bps YoY) on favorable mix; adjusted EBITDA margin 15.8% (+530 bps YoY); net adverse EACs trimmed to ~$4M, down ~51% YoY, reflecting maturing execution.
  • Demand indicators firm: bookings $250.2M (book‑to‑bill 1.11), record backlog ~$1.4B; management cited competitive takeaways and CPA momentum, plus international EW/radar follow‑ons, and potential tailwinds from Golden Dome and European re‑arm.
• What Went Wrong
  • Q2 set‑up softer: pulling forward ~$20M revenue/~$10M EBITDA into Q1 will reduce Q2 revenue YoY and drive “approaching double‑digit” Q2 EBITDA margins before re‑accelerating in 2H.
  • SG&A and litigation costs elevated: SG&A rose $12.8M YoY to $45.9M and litigation/settlement expense increased (adjusted out in non‑GAAP), pressuring GAAP results (GAAP net loss $(12.5)M).
  • Free cash flow was an outflow of $(4.4)M in Q1 (improved vs prior year), with management reiterating FCF will skew to 2H as capacity is allocated to programs with unbilled balances (cash‑friendly, little revenue).

Transcript

Operator (participant)

Good day, everyone, and welcome to the Mercury Systems First Quarter Fiscal 2026 Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the company's Vice President of Investor Relations, Tyler Hojo. Please go ahead, Mr. Hojo.

Tyler Hojo (VP of Investor Relations)

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 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 mater2ially.

All forward-looking statements should be considered in conjunction with the cautionary statements on slide two 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. I'll now turn the call over to Mercury's Chairman and CEO, Bill Ballhaus. Please turn to slide three.

Bill Ballhaus (Chairman and CEO)

Thanks, Tyler. Good afternoon. Thank you for joining our Q1 FY 2026 Earnings Call. We deliver Q1 results that were ahead of our expectations, with solid year-over-year growth in backlog revenue, Adjusted EBITDA, and Free Cash Flow. Our ability to accelerate deliveries on a number of our customers' high-priority programs once again contributed to strong results this quarter. Today, I'll cover three topics. First, some introductory comments on our business and results. Second, an update on our four priorities: Performance Excellence, Building a Thriving Growth Engine, expanding Driving Improved Free Cash Flow. And third, performance expectations for the balance of FY 2026 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 Q1 results support our expectations for robust organic growth with expanding margins and positive Free Cash Flow. Bookings of $250 million and a 1.11 book-to-bill, resulting in a record backlog of $1.4 billion. Revenue of $225 million, up 10.2% year-over-year, Adjusted EBITDA of $35.6 million, and Adjusted EBITDA margin of 15.8%. Up 66% and 530 basis points, respectively, year-over-year. And Free Cash Outflow of $4.4 million, a $16.5 million improvement in Free Cash Flow year-over-year. We ended Q1 with $305 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 6.5% year-over-year, a streamlined operating structure enabling increased positive operating leverage and significant margin expansion, and continued progress on Free Cash Flow drivers, with net working capital down $105.7 million year-over-year, or 18.8%. Please turn to slide five. Starting with our four priorities and priority one, Performance Excellence, where our efforts positively impacted our results primarily in two areas. First, in Q1, we recognized $4 million of net adverse EAC changes across our portfolio, which is in line with recent quarters and down 51% year-over-year, reflecting our maturing capabilities in program management, engineering, and operations, and sound execution on our development programs.

Second, we accelerated customer deliveries across a number of high-margin programs, generating approximately $20 million of revenue and $10 million of Adjusted EBITDA previously planned for the second quarter. This acceleration, partially driven by a $26 million year-over-year increase in point-in-time revenue, contributed to top-line growth and Adjusted EBITDA margins that exceeded our expectations for Q1 and will also factor into our outlook for Q2, which I'll speak to shortly. Beyond this solid performance across our portfolio of programs, we progressed on a number of actions in the quarter to increase capacity, add automation, and consolidate subscale sites in our ongoing efforts to drive scalability and efficiency. Notably, we continued to build out our highly automated manufacturing footprint in Phoenix, Arizona.

We expect to bring online over 50,000 sq ft of factory space in Q3 of FY 2026 to support ramped production for our Common Processing Architecture programs and to allow for more efficient scaling if potential market tailwinds materialize. Please turn to slide six. Moving on to Priority Two, Driving Organic Growth. Following record bookings in Q4, we delivered another solid quarter with $250 million of awards, resulting in a record backlog of $1.4 billion and a book-to-bill of 1.11. Notable Q1 awards reflected a healthy mix of competitive wins, follow-on production awards, and new design programs that continue to strengthen our position across key franchises. $26 million in competitive takeaways, including a major RF subsystem win supporting a ramping U.S. missile program.

Multiple follow-on production awards, including an order from a leading European defense prime for an electronic warfare application that reinforces our strong international positioning, and a follow-on for RF modules supporting a major U.S. fighter aircraft. Several follow-on orders that leverage our Common Processing Architecture and include embedded anti-tamper and cybersecurity software from our recent acquisition of Starlab. And on the development front, we saw continued momentum with new design wins across mission computing, RF, and processing technologies, expanding Mercury's role on next-generation defense platforms. 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 with our proven capabilities and latest innovations.

Beyond our backlog growth, we continue to have customer conversations on the potential for higher demand on multiple programs across our portfolio, driven by increased defense budgets globally and domestic priorities like Golden Dome. Although these potential opportunities are still in early pipeline phases, I am optimistic that they may have a positive impact on our demand environment if funding is allocated across certain program priorities to our customers over the next several quarters and beyond. Please forward to slide seven. Now turning to Priority Three, Expanding Margins. In our efforts to progress toward our targeted Adjusted EBITDA margins in the low-to-mid-20% range, we are focused on the following drivers. Backlog margin expansion as we convert lower margin backlog and add new bookings aligned with our target margin profile, ongoing initiatives to further simplify, automate, and optimize our operations, and driving organic growth to realize positive operating leverage.

Q1 Adjusted EBITDA margin of 15.8% was ahead of our expectations and up 530 basis points year-over-year. This margin performance was driven by the conversion of backlog previously contemplated to be delivered later in FY 2026 and higher operating leverage. Gross margin of 28%, up approximately 260 basis points year-over-year, was driven by a favorable mix of backlog margin converted in the quarter. We expect average 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, as a percent of revenue, are down year-over-year as a result of fully realizing the impact of previously implemented actions to further simplify, streamline, and focus our operations, and ongoing initiatives to drive efficiency. Please forward to slide eight. Finally, turning to Priority Four, 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 $458 million is down $106 million year-over-year. Q1 Free Cash Flow represented a $16.5 million improvement over Q1 of last year. 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, we continue to expect to allocate factory capacity in FY 2026 to programs with unbilled receivable balances, which will help drive Free Cash Flow, although with little impact to revenue. Please turn to slide nine.

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%. We believe our strong Q1 results, combined with the solid Q4 results of FY 2025, reflect continued progress toward this target profile with an aggregate 1.2 book-to-bill, 10% top-line growth, 17.4% Adjusted EBITDA margins, and positive Free Cash Flow over the last two quarters. Coming out of Q1, we maintain our full year view on FY 2026, which excludes any further acceleration of customer deliveries within or into FY 2026 or upside bookings to our plan tied to domestic priorities like Golden Dome or increased global defense budgets.

We continue to 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. Given our Q1 overperformance, we expect Q2 revenue to be down year-over-year, absent any additional acceleration of deliveries. We continue to expect full-year Adjusted EBITDA margin approaching mid-teens, with low double-digit Adjusted EBITDA margins in the first half. Given the accelerated delivery of high-margin backlog into Q1, we expect Q2 Adjusted EBITDA margin approaching double digits as we convert low-margin backlog. We continue to 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 half.

In summary, with our momentum coming out of Q1, I expect FY 2026 performance to represent another positive step toward our target profile. Additionally, I'm gaining optimism regarding the potential for tailwinds associated with increased global defense budgets and domestic priorities like Golden Dome to materialize in upside bookings to our plan over time. I look forward to providing updated commentary as we progress through the year. Before I hand it over to Dave, I wanted to touch on a new $200 million buyback authorization that was announced in our Earnings Press Release. This authorization underscores our confidence in the business, our improving fundamentals, and the multiple opportunities we see ahead to drive long-term shareholder value. 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?

Dave Farnsworth (EVP and CFO)

Thank you, Bill.

Our first quarter results continue to 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 throughout fiscal 2026. With that, please turn to slide 10, which details our first quarter results. Our bookings for the quarter were $250.2 million, with a book-to-bill of 1.11. Our record backlog of $1.4 billion is up $86.4 million, or 6.5% year-over-year. Revenues for the first quarter were $225.2 million, up approximately $21 million, or 10.2% compared to the prior year. During the first quarter, we were again able to accelerate customer deliveries worth approximately $20 million of revenue previously planned to be delivered in Q2 FY 2026.

Gross margin for the first quarter increased approximately 260 basis points to nearly 28% as compared to the same quarter last year. Gross margin improvement during the first quarter was primarily driven by favorable program mix, lower manufacturing adjustments of $7.4 million, and a reduction in net EAC change impacts of approximately $4 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 ongoing initiatives to simplify, automate, and optimize our operations. Operating expenses increased $6.3 million, or 9.6% year-over-year. The increase was primarily driven by higher compensation costs and incremental litigation and settlement expenses within selling, general, and administrative costs of $7.3 million and $6 million, respectively.

These increases were partially offset by a reduction in research and development costs of $5.2 million, or 28.3%, driven by headcount reductions initiated in fiscal 2025 to align our team composition with our increased production mix, as we previously discussed. We also incurred $1.6 million of restructuring and other charges during the quarter as we progress on driving scale and efficiency in our operations. GAAP net loss and loss per share in the first quarter were $12.5 million and $0.21, respectively, as compared to GAAP net loss and loss per share of $17.5 million and $0.30, respectively, in the same quarter last year. The improvement in year-on-year earnings is primarily a result of increased gross margins, partially offset by increased operating expenses previously discussed. Adjusted EBITDA for the first quarter was $35.6 million, up $14.1 million, or 65.8% as compared to the same quarter last year.

Adjusted earnings per share was $0.26 as compared to $0.04 in the prior year. The year-over-year increase was primarily related to our increase in revenue and the associated gross margin in the current period as compared to the prior year. Free Cash Flow for the first quarter was an outflow of $4.4 million as compared to an outflow of $20.9 million in the prior year. This reflects a $16.5 million, or 79% reduction, to our outflow as compared to the prior year. Slide 11 presents Mercury's balance sheet for the last five quarters. We ended the first quarter with cash and cash equivalents of $304.7 million, sequentially driven primarily by $2.2 million in cash provided by operations in the first quarter, which was offset by investments of $6.5 million in capital expenditures. Over the last four quarters, we generated approximately $135.6 million of Free Cash Flow.

Billed receivables decreased year-over-year and sequentially by $31.9 million and $16.9 million, respectively. Unbilled receivables decreased year-over-year and sequentially by $23.4 million and $3.6 million, respectively. The decrease in both billed and unbilled receivables reflects the progress we've made by delivering on programs to our customers. As Bill previously noted, we continue to expect to allocate factory capacity in fiscal 26 to programs with unbilled receivable balances, which will help drive Free Cash Flow with minimal impact to revenue. Inventory decreased year-over-year by $10.8 million. Prepaid expenses and other current assets increased sequentially by $43.2 million, primarily due to our settlement in principle on the securities class action complaint. This settlement in principle is recorded as a receivable within prepaid expenses and other current assets, and a corresponding accrual was recorded in accrued expenses.

Accounts payable increased year-over-year and sequentially by $23.1 million and $18.7 million, respectively, driven by the timing of payments to our suppliers. Accrued expenses increased $32.2 million sequentially, primarily due to our settlement in principle on the securities class action complaint previously mentioned. Accrued compensation decreased $27.8 million sequentially, primarily due to payments under our incentive compensation plans. Deferred revenues increased year-over-year by $29.2 million as a result of additional milestone billings achieved during the period. Sequentially, deferred revenues decreased slightly by $1.3 million. Working capital decreased $105.7 million year-over-year, or 18.8%. This demonstrates the progress we've made in reversing the multi-year trend of growth in working capital, resulting in a reduction of $202.3 million, or 30.6%, from the peak net working capital in Q1 FY 2024. 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 12. Free Cash Flow for the first quarter was an outflow of $4.4 million as compared to $20.9 million in the prior year. We still expect to be Free Cash Flow positive for the year, with second-half Free Cash Flow greater than the first half, as Bill previously noted. 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 in the first quarter 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.

Lastly, as you saw in our filing, we've announced that we've entered into an amendment to our revolving credit facility. This amendment extends the maturity date of the credit facility by five years, with a facility size of $850 million. This amendment enhances our financial flexibility and provides continued access to a strong source of liquidity, allowing us to execute our strategic priorities and invest in our long-term growth. With that, I'll now turn the call back over to Bill.

Bill Ballhaus (Chairman and CEO)

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

Operator (participant)

At this time, if you would like to ask a question, please press star one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Ken Herbert with RBC. You may go ahead.

Ken Herbert (Managing Director)

Yeah, hi. Nice results, Bill and Dave.

Maybe just to start off, when we back out sort of the pull forward on the revenues, you're sort of basically flat in terms of the growth with 12% EBITDA margins, sort of in line, I think, with how you were initially guiding for the first quarter. Can you just talk about your ongoing ability to continue to pull the revenues forward as we think about that through the rest of the fiscal year? And I know, obviously, it's hard to predict that and depending upon a lot of factors. But how do we think about that, and how do we think about that from a potential to really drive sort of incremental upside as we go through the rest of the fiscal year?

Bill Ballhaus (Chairman and CEO)

Yeah, Ken, thanks. This is Bill. I'll take that.

If I think about the last few quarters, we have been successful as we've worked our way through the quarters at looking at the constraints on delivering to our customers and for their high-priority programs, being able to work through the constraints and accelerate deliveries. The challenge with doing that is we really don't have good line of sight on how we're working through those constraints until we get toward the middle or the end of the quarter. And so as we think about Q2 and our commentary for the balance of the year, that's the primary reason why we haven't factored any future accelerations into it. That said, we're continuing across our portfolio every day and every week to work on constraints and trying to accelerate for our customers.

And we hear loud and clear from our customers that in today's environment, in general, if we can deliver early, that's a very good thing for them and for their customers. So we continue to work through it. The kinds of things that we're working through are largely tied to trying to accelerate material from our suppliers. In some cases, we have some factory constraints that we need to try and work our way through as material comes in. And those are the kinds of things that we're working on on a day-to-day basis. So again, we haven't factored it into our outlook for Q2 or for the rest of the year. We do continue to work it. And as we're successful in accelerating deliveries, then obviously we pull that into our updated view on the current period and the fiscal year.

Ken Herbert (Managing Director)

Great. Thanks, Bill. And if I could, the additional capacity that you're bringing online in Phoenix, what's the timing, and can you help maybe us help us quantify sort of what that could add in terms of either capacity or ultimately what it could add from a revenue standpoint?

Bill Ballhaus (Chairman and CEO)

Yeah. I mean, I think to answer the question, I'd like to take a step back and answer it in the broader context of how we're thinking about our approach to scaling up, not only to meet our anticipated ramp, but also any potential tailwinds across a broad number of programs in our portfolio where we're having active conversations with our customers today about increased quantity.

And I would say our general outlook is that our investment profile, in order to meet the anticipated ramp up in front of us and the potential tailwinds, I would categorize as an elegant profile, meaning incremental investment when we have line of sight to the demand. And the kinds of places that we would be investing would be adding multiple shifts. Most of our locations are operating on a single shift or an extended shift. So we have capacity to add multiple shifts. And on certain lines, we might increase automation with additional test equipment so that we could accelerate our processing and shrink our cycle time. So in general, what we see are incremental investments like that that are tied to firm demand and typically not in advance of that demand.

I'd say the one exception to what I just described is the capacity that we're bringing online in Phoenix that is currently and has been in our cost structure, in our operating expense in terms of the rent. We are making some incremental investments in terms of CapEx to bring additional lines up in that factory. And it's intended in the near term to meet the anticipated demand increase for Common Processing Architecture programs. I won't dimension the capacity that we could potentially bring online because it's really tied to the number of shifts, do we work extended weeks, those kinds of things. And right now, we're not forecasting or anticipating the need to do that across the board in Phoenix.

Dave Farnsworth (EVP and CFO)

I think, Bill, I would just add that it gives us additional flexibility to be able to flex up.

Bill Ballhaus (Chairman and CEO)

Absolutely.

Dave Farnsworth (EVP and CFO)

Yep. Great. Thanks, John.

Bill Ballhaus (Chairman and CEO)

To be clear on that.

To be clear on that point, we will have the ability to ramp up and scale up efficiently on other programs in that space should some of the tailwinds that I've mentioned materialize in bookings.

Ken Herbert (Managing Director)

Perfect. Thanks. And nice results.

Bill Ballhaus (Chairman and CEO)

Thanks, Ken. Thank you. Thanks, Ken.

Operator (participant)

Your next question comes from the line of Peter Arment with Baird. You may go ahead.

Peter Arment (Managing Director)

Thanks, Bill, Dave, Tyler. Nice results here.

Bill Ballhaus (Chairman and CEO)

Peter, you're a little stopped. Yeah, Peter, we can't hear you. Yeah. It's a little quiet.

Peter Arment (Managing Director)

Can you hear me now?

Bill Ballhaus (Chairman and CEO)

It's a little bit better. But I think if Dave puts his ear really close to the speaker, we should be able to pick up.

Dave Farnsworth (EVP and CFO)

Go ahead, Peter.

Peter Arment (Managing Director)

I'm sorry. Can you?

Bill Ballhaus (Chairman and CEO)

There we go. You sounded like you had a lot on this.

Peter Arment (Managing Director)

On the CPA, you guys have had a couple of good bookings quarters coming into this first quarter. And it sounds like you've had some other follow-on orders. Could you give us the latest on how that production is ramping up?

Bill Ballhaus (Chairman and CEO)

Yeah. And this has been a multi-quarter progression going back to when we first brought back up the line and went through a very methodical approach to initial production. And our commentary all along has been that we had confidence that once we started to produce again and increase production, we would start to see bookings follow. And that has been the progression that we've seen. And we believe that as we continue to ramp up production and deliver, that will unlock future demand.

So this is one of the parts of the business where we're continuing to focus on what we call ramp-to-rate, higher-rate production because we can see the potential demand, customer demand for our existing CPA products. We're also focused on how we can expand that TAM and investments that we can make in different form factors with a similar kind of CPA architecture and approach that over time, we think could expand the TAM to additional platforms where we could sell this technology into. So we're excited about the progress that we're making on our programs, the increases in production that we've been able to achieve. And this is obviously a part of the business that we're very committed to, we're excited about, and we see significant growth potential.

Peter Arment (Managing Director)

That's great, color. And then if you could also just comment on kind of the European defense environment, it sounds like you're getting favorable follow-on production awards there and seeing that mix continue to ramp.

Bill Ballhaus (Chairman and CEO)

Yeah. It's interesting. As we think about just the market broadly. The general tailwinds that we're seeing fall into a couple of different categories. I'd say first, it's the growth in the domestic budgets. And it's not just the size of the defense budget. It's also the percent that's being allocated to the acquisition of technology and capabilities like we delivered. And there's also some interesting tailwinds with executive orders around the use of commercial technology and certain priorities like Golden Dome.

And then another major driver, which you mentioned, is the tailwinds in Europe tied to the ReArm Europe initiative where defense budgets look like in aggregate, they're tripling over the next few years towards a trillion dollars in aggregate. We have very strong channels to market to that European defense budget growth. If we look at our trailing 12 months, the growth of that part of the business has been about 15% when we look at direct to European primes and via FMS. And I would say that that's largely before the tailwinds have really kicked in. Now, the conversations that I alluded to earlier that we're having with our primes domestically are mirrored with the European primes where we're talking about increased quantities, accelerating rates, things like that. In areas primarily associated with EW and radar processing.

Now, those are conversations that are early in the pipeline, but I do think they're healthy and reflective of what could be a healthy demand environment internationally where, again, we have good exposure and we have a demonstrated growth rate in the 15% range over the last 12 months.

Peter Arment (Managing Director)

Appreciate it, Color. Nice results, guys. Thanks.

Bill Ballhaus (Chairman and CEO)

Thanks, Peter.

Operator (participant)

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

Hi. Good evening. This is Russel on for Seth. As expected, gross margins took a bit of a step back in Q1. How should we be thinking about the margin progression through the year? Are volumes the key to expanding margins, or are there other focus pieces to watch?

Bill Ballhaus (Chairman and CEO)

Well, I'd say year-over-year, our gross margins are up about 260 basis points.

And that was really a key enabler to our EBITDA margin expansion of over 500 basis points year-over-year. So we feel really good about the progression of our margins toward our target profile. And as we said before, we've got. Clear line of sight to our target profile that consists of improvements to our average backlog margin as we convert low-margin backlog and replace it with bookings that are in line with our target margin. Increased initiatives to drive automation and efficiency, and then positive operating leverage. Those are really the three components of our bridge from where we are today that, again, over the last two quarters, our EBITDA margin has been 17.4%. And we feel like we're on our way towards the target profile of low- to mid-20s% focused on those three components.

Dave Farnsworth (EVP and CFO)

And also, I know I think your question, you were looking sequentially?

Yes. Looking sequentially.

Yeah. So sequentially, of course, there's a little bit of mix in there from the margin standpoint. So, Q4, and when we talked about this on the earnings call, we talked about it had a very favorable mix for us during that quarter, and so our expectation was not that Q1 would approximate that same mix.

Right. That makes sense. Then how should we think about Free Cash Flow conversion this year? Should we expect it to come in below the target of 50% following the strong conversion last year, or is there additional cash to pull out in the near term?

As Bill said, and we've been talking about, we're focused on getting our working capital to the level it should be and what we feel like the model gets us to.

Of course, that takes time, and there's quarter-to-quarter kind of perturbations around that because of timing of billings and shipments. We do expect over the long run that we'll be at that 50% level. But in any given quarter, we're not saying our expectation is this quarter or next quarter that it'll be that way, but over time, and what we said for FY 2026 is we expect to be Free Cash Flow positive.

Great. Thank you.

Bill Ballhaus (Chairman and CEO)

Free Cash Flow positive with the second half higher than the first half. And I think as we progress through FY 2026, over time, we'll be able to provide an updated view on that. Yeah.

Thanks, Russell.

Your next question comes from the line of Austin Moeller with Canaccord Genuity. You may go ahead.

Austin Moeller (Director of Equity Research)

Hi. Good afternoon. Just my first question here.

Can you walk us through the delivery timeline for LTAMDS based on what's currently in your backlog and the contract that was recently received by Raytheon for the next batch?

Bill Ballhaus (Chairman and CEO)

Yeah. Thanks for the question. I don't think we'll comment on the current deliveries and the current timeline associated with option year one with respect to what you referenced. There's typically a time constant from the time that primes, in general, get awarded their funding until we get our funding. And we're working through the progressions associated with that time constant. And as those conversations materialize in bookings, then I think we'll be able to give an updated view on our commentary.

Austin Moeller (Director of Equity Research)

Okay. And. How do you view the revenue growth rate and backlog opportunity for your US versus international customers?

Dave Farnsworth (EVP and CFO)

I mean, we feel good about both. Potentials for growth.

I don't think we've quantified one versus the other, but certainly the tailwinds that Bill talked about make us feel good about the long-term prospects for growth in both of those marketplaces.

Bill Ballhaus (Chairman and CEO)

Yeah. I agree. I mean, both domestically, internationally, and as we look across our portfolio in general, we see a number of different growth drivers and potential tailwinds above getting to our target profile, which we've spoken to.

Austin Moeller (Director of Equity Research)

Great. I'll pass it back there. Thank you.

Bill Ballhaus (Chairman and CEO)

Thank you.

Dave Farnsworth (EVP and CFO)

Thanks.

Operator (participant)

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

Jonathan Ho (Research Analyst)

Hi. Good afternoon and congratulations on the strong results. Just wanted to ask quickly on Golden Dome and maybe what you're seeing there. Is there any sort of update in terms of timing or potential opportunities just given your ability to participate in all the theaters?

Bill Ballhaus (Chairman and CEO)

Well, thanks, Jonathan.

Thanks for the comment and for the question. I'd say it's still early in terms of specifics on where funding will be allocated and the timing with which it will be allocated. I will say, though, I feel like we are well-positioned with respect to how that opportunity could materialize. And specifically, when you think about the different layers associated with a Golden Dome, a space layer, an airborne layer, tracking layer, interceptor, ground-based processing, shipboard processing, etc., and the administration's commitment to having capabilities in place over a three-year timeframe, it really points to existing capabilities in those layers. And we participate across that entire architecture.

And so while there's some uncertainty around the specifics and the timing, we do believe that over time, as the funding priorities are clear and the funding is allocated to programs, eventually, that's going to translate into increased demand for mission-critical processing at the edge on the platforms in those different layers. And we feel very positioned to capture those tailwinds. So. There's uncertainty around the specifics. We do expect things to unfold over time, but we are very confident and believe we're well-positioned to be able to capture those tailwinds because of our broad exposure across that architecture.

Jonathan Ho (Research Analyst)

Thank you. And just as a quick follow-up, I just want to make sure. I didn't completely hear one of the questions, but in terms of the U.S. government shutdown, are you seeing any impact either to funding or to program starts or contract awards?

Just wanted to make sure that there was no impact there. Thank you.

Bill Ballhaus (Chairman and CEO)

Yeah. I would say that so far, the any impact associated with the shutdown, we'd say it's very minimal. And there's a couple of factors behind that response. One is we have very good backlog coverage as we look at our outlook for the fiscal year. Most of our funding comes through the primes, and most of our awards come from the primes. I would say that if there's an extended shutdown over time, we could see some timing-related impacts associated with new bookings. But at this point, we haven't seen anything that is beyond minimal.

Jonathan Ho (Research Analyst)

Thank you.

Bill Ballhaus (Chairman and CEO)

Thanks, Jonathan.

Operator (participant)

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 Michael Ciarmoli with Truist Securities.

Bill Ballhaus (Chairman and CEO)

Hey, Mike. Good evening.

Sam Philpott (VP of Asset Securitization Group)

This is actually Sam on for Mike. Congrats on the quarter.

Bill Ballhaus (Chairman and CEO)

Hey, Sam.

Sam Philpott (VP of Asset Securitization Group)

I was curious, obviously, last quarter, you guys talked to kind of trying to work down some of the lower-margin older backlog that you guys have. I was curious if you could just give a general update on how you feel like you're progressing with that and kind of thoughts for the rest of the year, and if there's any relationship between the pull forward on the higher-margin work and execution on that lower-margin portfolio.

Dave Farnsworth (EVP and CFO)

Yeah. I think. As— Sorry. As was pointed out earlier, we did accelerate some high-margin activity from Q2. We were able to complete it in Q1. So when you kind of normalize for that, we were very close to the range we were thinking about or had communicated.

So I think we made good progress on burning down or expending some of the lower-margin activity. Still have some to go. We talked about we're going to be working on that throughout the year, but made good progress. And the higher margin was a result of the mix of high-margin things that we were able to bring into the quarter.

Sam Philpott (VP of Asset Securitization Group)

Great. And if I could just do one follow-up on Free Cash Flow, obviously, you guys mentioned kind of second half will be the stronger generation for the year. But should we kind of think about a steady sequential progression through Q2 into the second half, or should we think about it maybe more as a bit of a step function increase once we get closer to the end of the year? Thanks.

Dave Farnsworth (EVP and CFO)

Yeah. I think we only talk about cash for the year and talk about it being stronger in the second half. Cash can vary quarter to quarter based on just timing.

Sam Philpott (VP of Asset Securitization Group)

Got it. Appreciate it. Nice quarter, guys.

Bill Ballhaus (Chairman and CEO)

Thank you.

Dave Farnsworth (EVP and CFO)

Thank you.

Operator (participant)

Your final question comes from the line of Sheila Kahyaoglu with Jefferies. You may go ahead.

Sheila Kahyaoglu (Managing Director of Equity Research)

Thanks so much. Good evening, guys. Maybe if I could just start off on your margin— Hi. You talked about margin improvement from the 16% we saw in the quarter to your target of low- to mid-20s, and that's based on visibility in your bookings, positive operating leverage, and increased automation. Can you maybe talk about how we should think about the timing of those?

And then maybe as a follow-up to that, how we should think about the backlog margin composition as you think about your core business and the order momentum you've seen in recent quarters?

Dave Farnsworth (EVP and CFO)

Yeah. So as far as the timing goes, it really depends on how we convert over the next few quarters. If you think back to when we made the comment about our backlog margin being lower than what we would typically expect to see, it was at the end of FY 2024. And since that time, we've commented that we've been able to bring in bookings that are in line with our targeted profile. So the low-margin programs in our backlog distribution at the end of FY 2024 will burn off over some period of time from the end of FY 2024. Now, our backlog duration isn't a year, but it also isn't two-plus years.

So somewhere between, I don't know, eight quarters-ish, that low-margin backlog should pretty much all convert. And so that would put us in the FY 2027 timeframe. So we want to see how we progress through FY 2026, the progress we make in Q2, Q3, and Q4 before we get any more precise around how we expect to converge on the target profile. Your second question, our backlog progression has been in line with our expectations. We've seen an increased mix towards production, which we think is just healthy in general given the heavy mix of development programs that we had going back to two years ago. And the margin profile of our backlog is converging on what we believe is consistent with our targeted margin profile.

Sheila Kahyaoglu (Managing Director of Equity Research)

Can I actually ask one more question on the buyback? Why now on the share repurchase agreement? And just how do we think about the buyback program using the revolver balance to fund the buyback?

Bill Ballhaus (Chairman and CEO)

Thanks, Sheila. I'll take that one. We've made a lot of progress on deleveraging, which has been our focus over the last couple of years. And we've seen significant Free Cash Flow. I think over the last four quarters, our Free Cash Flow has been just north of $130 million. And while our primary focus is on the organic value creation opportunity in front of us, and that's primarily tied to the top-line ramp as we transition toward production and the margin expansion that we've talked about, we also want to make sure that we've got all the appropriate degrees of freedom available to us so that we can drive long-term shareholder value.

So we haven't talked any more about our plans for capital deployment beyond that, other than our primary focus is the organic value creation opportunity in front of us. But we want to have access to all the levers and degrees of freedom.

Sheila Kahyaoglu (Managing Director of Equity Research)

Got it. Thank you.

Dave Farnsworth (EVP and CFO)

Thanks, Sheila.

Operator (participant)

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

Bill Ballhaus (Chairman and CEO)

Racey, thank you. Thank you to all of you who participated today. We look forward to getting together to discuss our results next quarter. Thank you.