Mercury Systems - Q2 2026
February 3, 2026
Transcript
Operator (participant)
Good day, everyone, and welcome to the Mercury Systems second quarter fiscal 2026 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, 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 materially.
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 Q2 FY 2026 earnings call. We delivered Q2 results that were ahead of our expectations, with solid year-over-year growth in backlog, revenue, and adjusted EBITDA, and robust free cash flow. Our ability to accelerate progress on a number of our customers' high-priority programs once again contributed to strong results this quarter, including record first-half revenue. 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 margins, and driving 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 Q2 results support our expectations for robust organic growth with expanding margins and positive free cash flow. Bookings of $288 million and a 1.23 book-to-bill, resulting in a record backlog approaching $1.5 billion. Revenue of $233 million, with first half revenue up 7.1% year-over-year. Adjusted EBITDA of $30 million and adjusted EBITDA margin of 12.9%, up 36.3% and 300 basis points, respectively, year-over-year.
Free cash flow of $46 million, well ahead of our expectations. We ended Q2 with $335 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 8.8% 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 $61 million year-over-year or 12.9%. Please turn to slide 5. Starting with our four priorities and priority one, performance excellence, where our efforts positively impacted our results primarily in two areas.
First, in Q2, we recognized $4 million of net adverse EAC changes across our portfolio, which is in line with recent quarters, reflecting sound execution on our development and production programs. Second, we accelerated progress across a number of programs and generated approximately $30 million of revenue, $10 million of adjusted EBITDA, and $30 million of cash, primarily planned for the third quarter. This acceleration contributed to top-line growth, adjusted EBITDA margins, and free cash flow that exceeded our expectations for Q2 and will also factor into our outlook for Q3, which I'll speak to shortly. Notably, our focus on accelerating customer deliveries led to record first-half revenue and the highest first-half point-in-time revenue since FY 2021.
Beyond the 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, and progressed on bringing online an additional 50,000 sq ft of factory space to support ramp production for our Common Processing Architecture programs and to allow for efficient scaling if potential market tailwinds materialize. This is just one of many actions we have taken, along with prior investments across a number of critical technology developments, that are driving our ability to accelerate delivery of vital capabilities to our warfighters and our allies. Please turn to Slide 6. Moving on to Priority Two: Driving Organic Growth.
We delivered another strong quarter with $288 million of bookings, resulting in a book-to-bill of 1.23 and a record backlog approaching $1.5 billion. Q2 awards reflected a mix of franchise program extensions, competitive new design wins, and follow-on production awards across both domestic and international customers. Bookings were led by a scope expansion on a long-standing cost-plus development program, supporting modernization efforts within a core missile defense platform, extending Mercury's role through additional hardware content and further strengthening our position as the program progresses toward future production. We also captured two key new design wins during the quarter in exciting growth markets.
These included a major RF and processing subsystem, supporting a leading advanced air mobility manufacturer's development of its ground control infrastructure, as well as a new design award supporting a space-based application with a leading aerospace and defense prime, expanding Mercury's capability set within the fast-growing space market. Importantly, these design wins represent new platform entry points and future production potential, positioning Mercury for continued growth as these programs mature. Follow-on production awards were another contributor, including incremental quantities on a key U.S. missile franchise, reflecting continued customer confidence as those programs ramp, along with additional awards supporting deployed naval platforms and international land-based radar and electronic warfare applications, underscoring the durability of Mercury's installed base.
Finally, the quarter included approximately $20 million of follow-on awards that leverage our Common Processing Architecture and include embedded Anti-Tamper and cybersecurity software from our recent acquisition of Star Lab, reinforcing the strategic value within this key set of capabilities. 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, customer conversations continue to progress 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 remain 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 7. 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. Q2 adjusted EBITDA margin of 12.9% was ahead of our expectations and up 300 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 26% was slightly down year-over-year, driven by an increased mix of low-margin backlog converted in the quarter. We expect average backlog margin to continue to increase as we convert lower-margin backlog and bring in new bookings that we believe will be in line with our targeted margin profile. Operating expenses 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 8. Finally, turning to Priority 4: Improve 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 $414 million, is down $61 million year-over-year and is at the lowest level since Q1 FY 2022. Net debt is now down to $257 million, also the lowest level since Q1 of FY 2022. 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 over time.... 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 9.
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 first half results reflect continued progress toward this target profile, with an aggregate 1.17 book-to-bill, 7.1% top-line growth, 14.3% Adjusted EBITDA margins, 400 basis points of margin expansion year-over-year, and $41 million of positive free cash flow over the last two quarters.
Coming out of Q2, we maintain our full year view on FY 2026, which excludes any further accelerations 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. Given our Q2 and first half overperformance of approximately $30 million, we expect Q3 revenue to be down year-over-year, absent any additional accelerations, followed by a ramp in Q4. We continue to expect full year adjusted EBITDA margin approaching mid-teens. Given the accelerations into the first half and positive impact on first half margins, we expect Q3 adjusted EBITDA margin approaching double digits as we convert low-margin backlog and realize lower operating leverage. We continue to expect Q4 adjusted EBITDA margin to be the highest of the fiscal year.
Finally, with respect to free cash flow, we continue to expect free cash flow to be positive for the year. As discussed, we pulled forward approximately $30 million of cash receipts into Q2, which impacts Q3 and we expect will result in free cash outflow for the quarter. In summary, with our momentum coming out of Q2 and the first half, 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. 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 second quarter results continue to reflect solid progress toward our goal of delivering organic growth, expanding margins, and robust free cash flow. We still have work to do to reach our targeted profile, but we are encouraged by the progress we have made and expect to continue this momentum going forward. With that, please turn to Slide 10, which details our second quarter results. Our bookings for the quarter were approximately $288 million, with a book-to-bill of 1.23. Our record backlog of nearly $1.5 billion is up $119 million or 8.8% year-over-year. Revenues for the second quarter were $233 million, up approximately $10 million or 4.4% compared to the prior year.
During the second quarter, we were again able to accelerate progress on a number of customers' high-priority programs, worth approximately $30 million of revenue, primarily planned for Q3 fiscal 2026. Gross margin for the second quarter decreased approximately 130 basis points to 26% as compared to the same quarter last year. The gross margin decrease during the second quarter was primarily driven by execution on lower-margin programs. 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 and through our continued focus to simplify, automate, and optimize our operations. We expect average backlog margin to continue to increase as we convert lower-margin backlog and bring in new bookings that we believe will be in line with our targeted margin profile.
Operating expenses decreased approximately $2 million or 2.4% year-over-year. The decrease in research and development costs of approximately $6 million or 28% was driven by efficiency improvements and headcount reductions initiated in fiscal 2025 to align our team composition with our increased production mix, as we previously discussed. We also saw a decrease in amortization expense of over $1 million related to various customer relationship intangibles that were fully amortized in fiscal 2025. These decreases were partially offset by an increase in restructuring and other charges of $4 million as we progress on driving scale and efficiency in our operations. Decreases in operating expenses were also partially offset by increased selling, general, and administrative costs of approximately $2 million, primarily related to litigation and settlement costs.
GAAP net loss and loss per share in the second quarter were approximately $15 million and $0.26, respectively, as compared to GAAP net loss and loss per share of approximately $18 million and $0.30, respectively, in the same quarter last year. The improvement in year-over-year earnings is primarily a result of increased operating leverage and lower non-operating expenses. Adjusted EBITDA for the second quarter was approximately $30 million, up $8 million or 36.3% as compared to the same quarter last year. Our adjusted EBITDA during the second quarter was also partially driven by the acceleration of customer deliveries, as previously mentioned by Bill. Adjusted earnings per share was $0.16, as compared to $0.07 in the prior year. The year-over-year increase was primarily related to our increased operating leverage in the current period as compared to the prior year.
Free cash flow for the second quarter was an inflow of approximately $46 million, as compared to $82 million in the prior year. The inflow from the current period was primarily driven by progress made in reducing our net working capital by approximately $61 million or 12.9% year-over-year. As Bill previously noted, free cash flow during the second quarter benefited from the progress we accelerated primarily from the third quarter. Slide 11 presents Mercury's balance sheet for the last 5 quarters. We ended the second quarter with cash and cash equivalents of $335 million, sequentially driven primarily by approximately $52 million in cash provided by operations in the second quarter, which was partially offset by investments of nearly $6 million in capital expenditures and $15 million of shares repurchased and retired from our share repurchase program.
Billed receivables remained relatively flat, and unbilled receivables decreased by approximately $5 million year-over-year. As Bill previously noted, we continue to expect to allocate factory capacity in fiscal 2026 to programs with unbilled receivable balances, which will help drive free cash flow with minimal impact to revenue. Inventory increased year-over-year by approximately $5 million. The increase was driven primarily by work in process as we bring product to its final state in support of our increased proportion of point-in-time revenue on many of the company's production programs. Prepaid expenses and other current assets increased year-over-year by approximately $46 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 approximately $41 million and $8 million, respectively, driven by the timing of payments to our suppliers. Accrued expenses increased approximately $3 million sequentially, primarily due to restructuring and other charges in the second quarter. Accrued compensation increased approximately $12 million sequentially, primarily due to our incentive compensation plans. The amount due to our factoring facility increased sequentially by approximately $27 million, primarily due to the timing of payments from our customers due back to our counterparty. Deferred revenues increased sequentially by approximately $11 million as a result of additional milestone billing events achieved during the period. Working capital decreased approximately $60 million year-over-year or 12.7%. Working capital also decreased by nearly $44 million or 9.5% sequentially.
This continues to demonstrate the progress we've made in reversing the multi-year trend of growth in working capital, resulting in a reduction of $246 million or 37.3% from the peak net working capital in Q1 fiscal 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 second quarter was an inflow of approximately $46 million, as compared to $82 million in the prior year. We continue to expect free cash flow to be positive for the year, with an outflow in the third quarter, as Bill previously noted. We believe our continuous improvement in program execution, hardware deliveries, 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 second 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. 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)
Thank you, sir. Everyone, if you would like to ask a question, please press star one on your telephone keypad. Again, that is star one to ask a question. We'll take the first question today from Peter Arment from Baird.
Peter Arment (Managing Director)
Hey, good evening, Bill and Dave, and Tyler. Nice results. Hey, Bill, Bill, can you give us a little a bit of a, like, kind of a handicap? How do we think about how much is left of the lower margin backlog that you've got to kind of convert and pull through? It sounds like, excuse me, it sounds like it's gonna be still with us for Q3, but obviously, it sounds like Q4 is gonna be the highest margin of the year. How should we think about just kind of the, how that, how that exits the system?
Bill Ballhaus (Chairman and CEO)
Yeah, I mean, it's the same progression that we've been talking about for several quarters now, where at the end of FY 2024, we talked about that the backlog margin, the average of backlog margin being lower than what we expected to see on an ongoing basis, driven by a number of factors, and that that would need to flow through over time. And if you look at the duration of our backlog, it wasn't a 4-quarter period of time, wasn't necessarily a 12-quarter period of time, somewhere in between. So as we work our way through 2026 and through 2027, we expect to see most of the impact tied to the low margin distribution, our backlog start to burn through and get behind us. I think the good news on this front, you know, our gross margin in the quarter was down.
It's actually a good thing because it reflects that we are burning down that lower margin distribution in our backlog, and we continue to replace that part of our backlog with higher margin bookings that we expect to be in line with our target profile. So no change from what we said before. It's a continuation. If anything, we made great progress this quarter in burning down the low margin distribution, as well as bringing in solid bookings in the quarter.
Peter Arment (Managing Director)
Thanks for that call, Bill. Just a quick follow-up. Just when we think about the pull forward, is that something that's also tied to this low margin backlog? Or is this just, you know, something that you're calling out just because I think there's some confusion about what's pull forward or what's growth, et cetera?
Bill Ballhaus (Chairman and CEO)
Yeah, I mean, you've seen over the last several quarters that we've been successful in accelerating deliveries, and it's had an impact in us delivering results that were ahead of our expectations. And that's exactly what happened again this quarter. We had about $30 million of revenue that we pulled forward. It impacted EBITDA positively by about $10 million. That gives you a sense for where that backlog sits in our distribution because it basically flows through a gross margin. There's not much OpEx. There isn't any OpEx that we add associated with it. So I would say this, this quarter was just a continuation of, of what we've been delivering over the last several quarters.
Peter Arment (Managing Director)
Appreciate the call out. Jump back in the queue. Thanks, Bill.
Bill Ballhaus (Chairman and CEO)
Thanks, Peter.
Operator (participant)
Up next is Ken Herbert from RBC.
Ken Herbert (Senior Aerospace and Defense Analyst)
Yeah. Hi, good afternoon, Bill, Dave, and Tyler. Hey, maybe Bill, I just wanna start first on the capacity you called out that you're adding in terms of the CPA. Can you level set us in terms of where you are with, with capacity today on that product line, maybe from a revenue standpoint, if possible, and how we should think about how much more capacity you need to continue to bring on to support, you know, the order activity and the demand pull?
Bill Ballhaus (Chairman and CEO)
Yeah, and I wanna just a reminder that the capacity that we're bringing online in Phoenix, the cost associated with that is already in our OpEx, and so the investment that we're making is a little bit of CapEx to bring additional lines on board. We are continuing to ramp up production in our CPA area. That has gone basically per plan. Feeling very good about how we're delivering for our customers. We continue to grow our backlog. You saw in the quarter, we had another $20 million of orders associated with CPA. And we remain confident that as time goes on and we continue to execute on our programs, that we'll continue to see increased demand over time for that product line, and that's behind bringing on the additional space.
As far as, you know, additional capacity and investments required beyond that, one of the nice things about where we sit right now is when we look at all of the potential tailwinds that are out there, and we talked about what's driving those. For us to be positioned to execute and deliver on those tailwinds, the investment profile is really incremental, and it's graceful, and we don't have to invest ahead of the demand in order to be able to deliver on it. For the most part, we're running at single shifts across all of our factories, and so the first step for us to increase capacity to meet tailwinds would be to add additional shifts.
Now with this capacity coming online in Phoenix later this year, we'll be in the same position with CPA that we can very efficiently meet increased demand associated with tailwinds just by moving to an additional shift. I think that's a really good place for us to be.
Ken Herbert (Senior Aerospace and Defense Analyst)
Hey, I appreciate the cover. And if I could, I just wanted to ask a question on the guidance. I mean, I think you've demonstrated a pattern here to be able to outperform, and it seems like there's, you know, recurring, you're able to pull revenues to the left relative to expectations. You've obviously set up here today with this call a fairly soft fiscal third quarter within a strong fourth quarter, and I can appreciate the seasonality, but maybe what kept you back from pushing up the guide or having a little bit more confidence in the full year numbers, because you've got multiple quarters now of being able to obviously outperform and exceed expectations and continue to over deliver relative to sort of the near term setup.
Bill Ballhaus (Chairman and CEO)
Yeah, and it has been pretty consistent quarter-over-quarter for the last several quarters. If we think about the setup to FY 2026, coming into the year, we pulled forward about $30 million of accelerated deliveries and revenue from 2026 into 2025, which really set the stage for expectation for the year to be low double-digit growth on top of high single digits last year. If it weren't for that pull forward, we would have been looking at mid-single digit growth last year and high single digit growth this year. So it just shows how the movement between quarters can really impact the optics around growth in a period. Now, as we've come through the first two quarters of FY 2026, we're well ahead of plan.
If you look at our top line, if you look at our EBITDA, and if you look at free cash flow, all of that is ahead of plan. So our expectations for the year are the same now as they were coming into the year. What we've done is we've overperformed, and we shifted the profile to the left.... Now, the expectations and the commentary that we gave for Q3 is absent any further accelerations from Q4 into Q3 or any accelerations from FY 2027 into FY 2026. The reason why we're giving our commentary that way is, for the most part, our ability to accelerate deliveries is largely driven by our ability to accelerate material. So if you think about what just happened in Q2, in the last few weeks of Q2, we were able to pull in material so that we could deliver more units in Q2.
You heard that our point-in-time revenue in Q2 was the highest that it's been in five years. That's a reflection of us moving hardware through our factories and shipping it. In order to do that, it's based on accelerating material from our suppliers, and we can't be certain that we're going to be able to accelerate until that material is in-house. I don't want to give commentary and set expectations based on things that, we don't have 100% confidence around. Now, for the last several quarters, we have demonstrated the ability to exercise that muscle across our entire operation, and every quarter we've been able to accelerate $20 million-$30 million in deliveries into the quarter.
But we're not setting our expectations based on that because we're going to work through the quarter on the next set of constraints and the next set of material that we're trying to accelerate. And, you know, based on prior quarters, we've been able to do that, but we don't want to set expectations, assuming that that's going to happen. So hopefully that provides a little bit of clarity on that commentary.
Ken Herbert (Senior Aerospace and Defense Analyst)
Thanks, Bill. I appreciate the context.
Operator (participant)
The next question comes from Sheila Kahyaoglu from Jefferies.
Kyle Baker (Investment Banking Analyst)
Hi, guys. This is Kyle on for Sheila. Thanks for taking my question. On an extension of the question that Peter asked about low margin backlog and your response that sort of persists through FY 2027, you know, how do we think about the puts and takes as we think about mid-teen margins this year, and what FY 2027 could ultimately look like if you're still burning through some of that past backlog and in light of potentially pulling forward growth and what you're seeing in the bookings trends? Thanks.
Bill Ballhaus (Chairman and CEO)
Yeah, Kyle, thanks, thanks for the question, and I think just a point of clarification. You know, we may have lower margin backlogs still in our backlog as we're working our way through FY 2027, but it becomes increasingly smaller as time goes on. And so, you know, as we move forward, the impact of our low margin backlog on our EBITDA margins continues to drop over time because the volume comes down. So, you know, as every quarter that progresses, we expect that impact to continue to come down. Because what we're doing is we're burning down that low margin backlog. It's going away, and we're replacing it with new bookings that are coming in with higher margins, and that's what's giving us the increase in our average backlog margin as time goes on. So hopefully that helps clarify the point.
Dave Farnsworth (EVP and CFO)
Bill, if I might, and, you know, for Kyle, it's becoming every quarter that goes by, it's a smaller percentage because of the aggregate. Because as Bill said, we're not adding new things at low margin. You know, so every quarter that we've had a bit of a lower than our expected margin, that number comes in the backlog. That number starts coming down, and when Bill said, you know, "Hey, you know, we expect that to some of that to go through FY 2027," it, you know, it's shrinking every quarter, and that's getting closer and closer to nothing as we go through. So I don't think people should build an expectation that we're going to have the same level of low margin activity every quarter as we go through 2027. We're not saying that at all.
Yeah. As a reminder, this isn't a situation where it looks like we have a part of our business that's consistently running at lower margins. We have legacy programs, development programs, programs where we took EAC impacts in FY 2024 and FY 2025, that have resulted in that, you know, lower margin distribution in our backlog, and we're just converting that and burning it through over time, and it's not being replaced. We're replacing it with higher margin bookings.
Kyle Baker (Investment Banking Analyst)
Understood. Very helpful. If I could just ask one follow-on about the net EACs. Obviously, they're much-
Bill Ballhaus (Chairman and CEO)
Yeah
Kyle Baker (Investment Banking Analyst)
... lower than they have been in the past, but have still been a little sticky at that $4 million-$5 million a quarter. Can you just talk about what you're... You know, where we are in the inning, what-- you know, what inning we are in terms of kind of scrubbing that portfolio and getting more towards a, a normal baseline? Thanks, guys.
Dave Farnsworth (EVP and CFO)
I'm not good at the baseball questions because I was a track guy, so innings are hard for me. You know, maybe we're on the last leg of the relay race, you know? So, you know, largely, those EAC adjustments are a reflection, as we talked about, as we're going through and completing some of these programs at the very end. There are not that many programs left. They're very small adjustments compared to what they were in the past. We're seeing solid positive adjustments at the same time. So, you know, this quarter it was $3.5 million, roughly. You know, could I see, and we've been asked, you know, many times, could we see that being positive in a quarter? Yeah, we could see that. You know, could it be slightly negative in a quarter?
You know, it's within a range that is not unexpected for us. It's consistent with what we've considered in our outlook, you know, and, you know, we keep every time we finish one of these programs, put it behind us, you know, it lessens the opportunity for those adjustments to happen in the future. So, you know, I guess, kind of like we're getting there, you know, you know, it's things that happen within the quarter as we're completing these things, largely as we've talked about in the past, on developing programs, but they're older programs that we're just completing as we go through the final kind of qualification on these things.
Bill Ballhaus (Chairman and CEO)
Yeah, and I would just say very succinctly that we think they're kind of in a normal course range right now, and, you know, we're confident in our ability to get to our target margin profile with the EACs and the zip code that they've been running over the last several quarters.
Operator (participant)
The next question today will come from Seth Seifman from JPMorgan.
Seth Seifman (VP and Equity Research Analyst)
Hey, thanks very much, and good evening, everyone. Nice quarter. Wanted to ask, the Common Processing Architecture in terms of ramping up. I know you—I'm sure you don't want to give an exact number, but you know, if we think about kind of a rough proportion of what that comprises in the sales mix, is there any way for you to kind of speak to, A, where that is, and B, you know, where it should be going as we think, you know, a year or two out?
Bill Ballhaus (Chairman and CEO)
Well, we haven't quantified the percentage of the business or the sales mix, et cetera. I will say that we have been successful over the last year in ramping up to meet our program demands. The good news is the team has been executing very well in this area since we went through and implemented our root cause corrective action and started bringing the production line back up, and we've seen the follow-on orders coming in. We do see good growth potential in this part of the business. We see healthy demand, and it's an area where we're technically differentiated. And so we have, you know, a lot of optimism about this part of our business and continue to have that.
Dave Farnsworth (EVP and CFO)
Yeah, and I think, you know, we don't talk about, you know, kind of where we are in individual programs, but I think there are programs that we're, you know, that are fully ramped up in the production within the Common Processing Architecture. There are other programs that are still ramping up.
Seth Seifman (VP and Equity Research Analyst)
Okay. So there's still a still runway, I guess. Okay. And then just when we think about you know cash up to over $300 million, you bought back a little bit of stock in the quarter. You know, how do we think about where that cash balance sorta should be over time and you know what you guys are gonna do with the cash?
Dave Farnsworth (EVP and CFO)
Yeah. No, no, good question. I mean, we, we've said, and, you know, kind of still validate and think about that, you know, around $100 million-$150 million is probably the, you know, the right kind of balance for us. It's higher than that as we've generated significant cash in the last year and a half. You know, you know, that's the right level. You know, over the last two or three quarters, you know, kind of, you know, probably felt like the prudent approach to, to cash was to, was to keep cash on our books as we were going through a little bit of uncertainty around government shutdowns, not shutdowns, you know, what, what was gonna happen in terms of payment. You know, our emphasis is still on delevering.
You know, that's something we're looking at, obviously, as we go through the next, you know, couple of quarters.
Bill Ballhaus (Chairman and CEO)
Yeah, I'd say the priorities are on delevering and continuing to drive down that debt state. That, that remains the focus.
Seth Seifman (VP and Equity Research Analyst)
Okay, great. Thanks very much.
Operator (participant)
Up next, we'll take a question from Michael Ciarmoli from Truist.
Michael Ciarmoli (Senior Research Analyst)
Hey, good evening, guys. Thanks for taking the questions, good results.
Bill Ballhaus (Chairman and CEO)
Hey, Mike.
Michael Ciarmoli (Senior Research Analyst)
Bill, Bill or Dave, just, I mean, looking at your top line, and I can appreciate all the commentary. You're growing slower than some of your mid-cap peers and even some of your customers, and I think maybe you kind of alluded to it. But can you help us with exactly how much capacity is being allocated to the unbilled and maybe tease out that drag? I mean, is it kind of $10 million, $15 million a quarter? Just to try and get a sense of kind of how much is flowing through the P&L at no revenue recognition, but obviously it's, you know, you're tying up capacity executing on that.
Dave Farnsworth (EVP and CFO)
Yeah, Mike, that... You know, we hadn't talked about that. You know, we haven't put out, you know, this is how much revenue, how much higher revenue would be if we stopped doing that. You know, it's a focus of ours to continue to burn down our net working capital. We're still not where we think our net working capital should be. We still think the unbilled balances are too high. You know, certainly there's some drag for that. We've talked about that, but we haven't quantified it.
Michael Ciarmoli (Senior Research Analyst)
Okay, okay. That's fair. We'll maybe we'll take that offline. Just maybe back to Ken's question as well, you know, on kind of the choke points and why you can't consistently see some of this acceleration, you know, we're one month into the quarter. As you, you know, kind of gauge your suppliers and look at maybe potential choke points, are there certain items that are you know, giving you less confidence? Is it semiconductors? Is it circuit boards? Can you just maybe is it discrete components? What is sort of the potential watch items on that material list that's giving you reason for pause?
Bill Ballhaus (Chairman and CEO)
Like, literally every week with the teams across every program, we're going through every bill of material line by line and looking at what does it take for us to get kit complete. And that, you know, that can vary by program. But we're literally working across all of our programs to figure out how we can accelerate kit completion so that we can move hardware through our factories. And the reality is, while we're pushing on our suppliers to close out kits, we don't know that the material will be here until the day that it shows up. Because literally, a supplier could tell us that the material will be here on Friday, and then on Friday tell us that it's delayed by 60 days for one reason or another.
So that's the reason why we're not incorporating any further accelerations into our outlook, but we're working it very aggressively every day across the business. And I think the good news is, the last several quarters, we have demonstrated that we have built the muscle in the company to do this, fairly consistently. We're just not baking it into our commentary.
Dave Farnsworth (EVP and CFO)
I wouldn't say, you know, Mike, I wouldn't characterize it as, you know, something's lessening our confidence. You know, we go into the quarter, as Bill said, with, you know, "Hey, what would we need to do to be able to accelerate this?" And then we work on those constraints all quarter long to build our confidence that we can get it done. So, you know, I wouldn't suggest that anything's lessening our confidence and our ability to do it. It's a process we work through.
Michael Ciarmoli (Senior Research Analyst)
Okay. Okay, that's fair. Good stuff. Thanks, guys. I appreciate it.
Bill Ballhaus (Chairman and CEO)
Thanks.
Dave Farnsworth (EVP and CFO)
Thanks, Mike.
Operator (participant)
Austin Moeller from Canaccord Genuity has the next question.
Austin Moeller (Director of Equity Research)
Hi, good afternoon. Nice quarter. Are you able-
Dave Farnsworth (EVP and CFO)
Hi, Austin
Austin Moeller (Director of Equity Research)
... to comment, and I know it's small, but are you able to comment on the revenue impact to Mercury of the stop work order on the SDA program? If that were to be resumed, when you might expect task orders or long leads to come in on delivering components for that?
Dave Farnsworth (EVP and CFO)
Yeah, Austin, we don't quantify individual contracts or programs. You know, we have literally 300 different programs, and one of the strengths we have is the broadness of our portfolio and the revenue across it. There's no single contract that we have that approaches 10% of our revenue. And, you know, we're working closely with our customer here and, you know, have thought through with them and, you know, understand where we are in terms of funding, where they are, you know, what they're doing in terms of that stop work. And, you know, it's incorporated in our outlook, but it has been, there's not, you know, there's nothing that we would change at this juncture.
Austin Moeller (Director of Equity Research)
Okay. And I understand the dynamic of the contract shift towards higher margin production contracts in the near term here, but is there a specific mix of component product types that you expect to be bridging you to your long-term gross margin and EBITDA margin expectations of low- to mid-20s%?
Dave Farnsworth (EVP and CFO)
Yeah. No, not specifically. You know, Bill's talked about the production versus development mix and, you know, whether 80/20 is an ideal number, there probably isn't. You know, we're in the range kind of we expect to be in. You know, the margins that we're bringing into our new bookings are consistent with our longer term model of what we expect. You know, so it is across the portfolio. You know, we feel good across the portfolio about the margin profile we're seeing in all our new bookings.
Austin Moeller (Director of Equity Research)
Understood. Thanks for all the color there. Great.
Dave Farnsworth (EVP and CFO)
Yep.
Operator (participant)
Next up is a question from Jonathan Ho, William Blair.
Jonathan Ho (Technology Analyst)
Hi, good afternoon. Just wanted to see if there's any additional color you can offer regarding updates to both Golden Dome and those international orders that you're perhaps getting a little bit more visibility towards?
Bill Ballhaus (Chairman and CEO)
Yeah, you know, it, it's interesting because when we think about the growth drivers in our business right now, we have a number of different growth vectors. I mean, obviously, at the core, it's the ramp to rate from our development programs to production, and that's largely what is the driver behind us achieving our target profile of above-market growth, top-line growth, EBITDA margins in the low-to-mid 20% range and free cash flow conversion of 50%+. And then on top of that, which you don't really factor into that outlook, are a number of different tailwinds in the market associated with the larger U.S. defense budget, a larger percentage of that budget being allocated to the acquisition of capabilities like ours.
The executive orders that we feel like really play to our sweet spot, things like mandating the use of commercial technology, which is right in the center of our value proposition. Of course, Golden Dome, significant tailwinds there, and the growth of the international defense market. So that's kind of the landscape of growth drivers that are out there. I would say that for both-
Dave Farnsworth (EVP and CFO)
...Golden Dome and for the international opportunities, we're having numerous conversations. They continue to progress across our portfolio on a large number of programs. So it's not one or two opportunities that we're tracking. There's a dozen plus programs where we're having conversations with customers around significant increases in quantities. And I would say that if any of those tailwinds were to hit, that would, that would shift our expectations around our ability to hit our target profile and exceed our target profile. So still in the pipeline phases, conversations are still progressing, and the best leading indicator that we'll have is when those conversations materialize into bookings, and we'll keep you posted as, as those conversations progress.
Jonathan Ho (Technology Analyst)
Excellent. Then just in terms of your cost savings and facilities consolidation initiatives, can you give us a sense of, you know, how far along we are there and, you know, maybe some of the incremental margin opportunities that are, that are still remaining? Thank you.
Dave Farnsworth (EVP and CFO)
Yeah. I mean, we've made a lot of progress as we've talked about the savings that we've already recognized. And you can certainly see that when you look at the kind of the run rate we have on our OpEx now versus what it was two years ago. You know, we continue to identify everything. You know, we continue to work on the things that make the most sense to make us more efficient to some of the automation Bill talking about, you know, simplifying the process, looking at our facilities.
You know, obviously, the facilities, you know, take a longer time frame to recognize those kind of savings, but and, you know, Bill said many times, this is a long-term, you know, life - always part of your life is looking for savings, how can you do things better? So, so we still see it going for a long time. You know, Bill talked about the operating leverage and how you can see, you know, as we've been able to accelerate activity, we haven't increased our OpEx expense associated with those activities. So it kind of flows right through. That's the kind of impact that we expect to keep seeing as we build the business going forward.
Jonathan Ho (Technology Analyst)
Thank you.
Operator (participant)
As a reminder, everyone, it is star one, if you have a question today. We'll go next to Noah Poponak with Goldman Sachs.
Noah Poponak (Managing Director of Equity Research)
Hey, good evening, everyone.
Dave Farnsworth (EVP and CFO)
Hey, Noah.
Noah Poponak (Managing Director of Equity Research)
Could you level set us on the percentage of your revenue that is international? And I don't know if you could estimate or if you have the number on what's direct versus you know eventually ends up outside of the U.S., but it's through a U.S. customer. And then same question on missile and munition just as we all kind of recalibrate for growth rates in those two segmentations.
Dave Farnsworth (EVP and CFO)
Yeah. So first, I would tell you, you know, that we don't break out, you know, if you're asking about FMS versus, you know, non-FMS, we don't actually break that out in our financials. You know, and to a large degree, we follow our customer set. So as we're going through, we're working with our customers on what that breakout is. But if you look at the queue, you can see the international and FMS revenue, and for the second quarter, that was $38 million. So that's percentage, real quick.
Bill Ballhaus (Chairman and CEO)
15% range, something like that.
Noah Poponak (Managing Director of Equity Research)
Okay.
Dave Farnsworth (EVP and CFO)
Yeah.
Noah Poponak (Managing Director of Equity Research)
Do you have an approximation for how much revenue you generate from the category of missiles and munitions?
Dave Farnsworth (EVP and CFO)
We don't break that out separately.
Noah Poponak (Managing Director of Equity Research)
Okay. Um-
Bill Ballhaus (Chairman and CEO)
You'll be able to see in the queue the breakout between FMS and international and/or domestic business. And, you know, as we know, with our business, programs and revenue can be kind of lumpy. The international FMS business has been growing nicely. Its growth rate is down a little bit this quarter. But of course, that highlights that our domestic business, when you look at the first half, year-over-year, is up low teens, which I think speaks to some of the inherent growth of our domestic business right now, which is pretty exciting. So there's a little bit of detail that you'll see in the queue. We remain very bullish about the international opportunity where our backlog is.
Dave Farnsworth (EVP and CFO)
And you could look at it. We do break out sensors and effectors, but, you know, to break it into just specifically how much is missile, you know, would, you know, you can look at that, but it would be something we don't show.
Noah Poponak (Managing Director of Equity Research)
Understood. That is helpful. I appreciate it. Question on margins. Could you speak to, even if directionally, in the medium-term framework, what do you expect for the gross margin and then R&D and SG&A as a percentage of revenue to walk to that EBITDA margin? It'd be helpful to understand, just given those percentages have been moving around as you've taken on your strategy.
Bill Ballhaus (Chairman and CEO)
Yeah. I don't think we've spoken to gross margins explicitly when it comes to our target margin profile. But what we said about our targeted EBITDA margins in the low- to mid-20% range, basically the elements of the bridge from where we are to get to that target range involve the backlog margin progressing the way we've talked about. So, burning off the low margin programs and continuing to bring in new bookings in line with our target margins, and we've been doing that consistently for several quarters, and we continue marching down that path. Continuing to streamline and focus, automate, drive efficiencies into the business.
And then third, positive operating leverage, because we feel like we've got our OpEx in a very good place, and as we continue to grow the top line, we don't expect to see meaningful growth in our OpEx. So those three elements really provide the bridge from where we are to that, you know, that targeted margin profile.
Noah Poponak (Managing Director of Equity Research)
Okay, that's helpful. And just one last one I had, the step back up in restructuring to the $4 million. Just curious what you're doing there and what it does for the future?
Bill Ballhaus (Chairman and CEO)
Yeah, that's when we took an action in the quarter, you know, and you can see this when you look in the Q. You know, that affected, you know, about 100 folks and, you know, and some facilities. So, you know, we do expect to see some lift of that as we go through the, you know, get the full impact of that over the next year or so.
Noah Poponak (Managing Director of Equity Research)
Okay. All right, thank you.
Operator (participant)
Mr. Ballhaus, it appears there are no further questions at this time. Therefore, I would like to hand the call back to you for any additional or closing remarks.
Bill Ballhaus (Chairman and CEO)
Okay. Well, thank you very much, and thanks, everyone, for joining us for our quarterly call, and we look forward to meeting again next quarter. Thank you very much.
Operator (participant)
Again, everyone, that does conclude today's conference. We would like to thank you all for your participation today. You may now disconnect.