Mercury Systems, Inc. Price & Performance (MRCY)

Good afternoon, and thank you for joining us. With me today is our Chairman and Chief Executive Officer, Bill Balhouse 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 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 Mercury, Bill Balhouse. Please turn to Slide three. Thanks, Tyler. Good afternoon. Thank you for joining our Q2 FY twenty twenty five earnings call. We delivered solid results in Q2 that were once again in line with or ahead of our expectations. And I'm optimistic about our ongoing efforts to improve performance as we move through the fiscal year. Today, I'd like to cover three topics. First, some introductory comments on our business and results. Second, an update on our four priorities. Delivering predictable performance, building a thriving growth engine, expanding margins, and driving improved free cash flow. And third, performance expectations for FY 2025 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 to support the most critical programs and our Mercury team for their dedication and commitment to delivering mission critical processing at the edge. Please turn to Slide four. Our Q2 results reinforce my confidence in our strategic positioning and our expectations in delivering predictable or organic growth with expanding margins and robust free cash flow.

Bookings of $242,000,000 and a trailing book to bill of 1.12 revenue of $223,000,000 up 13% year over year. Adjusted EBITDA of 22,000,000 and adjusted EBITDA margin of 9.9% both up substantially year over year. And record free cash flow of $82,000,000 up $44,000,000 year over year.

We ended Q2 with $243,000,000 of cash on hand.

These results reflect continued progress in each of our four priority areas.

With highlights that include solid execution across our broad portfolio production and development programs a record backlog of $1,400,000,000 reduced operating expense enabling increased positive operating leverage and continued progress on free cash flow drivers with net working capital down $115,000,000 year over year or 19.5%. Please turn to Slide five. Starting now with our four priorities and priority one, delivering predictable performance. In the second quarter, our focus on predictable performance positively impacted our results primarily in three areas. First, we continue to make progress mitigating what we believe to be predominantly transitory impacts as discussed over the last several quarters. In Q2, we recognized approximately $4,400,000 of net EAC change impacts across our portfolio which is the lowest in the last few years, and reflects the progress we are making in maturing our processes and program management engineering and operations. Second, we continue to make progress in the quarter ramping production in our common processing architecture product area. We expect to have our full capacity become available as we move through the second half of the year. This progress is enabling follow on production awards as we discussed last and led to a notable takeaway in Q2 from a processor board competitor wasn't able to meet the security requirements provided by our common process and architecture This reflects our ability to take share in this attractive market segment based on our technology, leadership [indiscernible] And third, our focus on accelerating customer deliveries generated a $29,000,000 or 31% year over year increase in point in time revenue.

The majority of which was driven by pull forward deliveries and revenue from Q3. Please turn to Slide six. Moving on to Priority two, driving organic growth. Solid Q2 bookings of $242,000,000 resulted in a record backlog of $1,400,000,000 In line with our expectations, over 80% of trailing twelve month bookings were production in nature, which has driven a mix shift toward production. In line with this shift, we recently announced a workforce restructuring to align our team composition with this increased production mix, Some wins in the quarter are worth noting. A development contract from a U. S. Defense prime contractor where we will replace and upgrade a competitor's existing processing capabilities with a solution leveraging our common processing architecture. Our additional protection features enable the system to be eligible for export to allied nations to support forward deployed operations. A $24,500,000 contract to develop a data processing and storage subsystem for a U. S. Defense Department satellite program.

Under this contract with an innovative space systems prime contractor, we will deliver a number of subsystems that leverage our commercial products and deep expertise in data recording, data processing, and subsystem integration for defense applications. Two awards with Naval Air Systems Command a $16,500,000 delivery order for data transfer units and a $14,000,000 contract option for high definition video recorders that support U. S. And allied military aircraft. And following production awards for two long running U. S. Navy programs of record Supported by multiple lines of business, and two key U. S. Air Force programs of record where Mercury is the sole source provider of memory modules. 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 [indiscernible] We know from engagements with our customers that our unique capabilities providing mission critical processing at the edge aligned well with their priorities and what we believe is strong demand in growth markets. Including sensors and effectors, electronic warfare, avionics, C4I and Space. All in all, Q2 was a good booking quarter with multiple competitive wins where we believe we are growing share based on our technical differentiation.

Please forward to Slide seven. Now turning to priority three, expanding margins. As we've discussed in prior calls, in our efforts to achieve our targeted adjusted EBITDA margins in the low to mid-twenty [indiscernible] We are focused on the following levers. Executing on our development programs and minimizing cost growth impacts, getting back toward a more historical 2018 mix of development to production programs, driving organic growth to generate positive operating leverage and achieving cost efficiencies. Q2 adjusted EBITDA margin of 9.9% was in line with our expectations and indicative of progress on each of these levers in our effort to reach our targeted margins over time. Gross margin of 27% was in line with our expectations and largely driven by the average margin in our backlog coming into FY 2025. As we've discussed over the last two quarters, our backlog margin coming out of FY 2024 was lower than what we expect to see on a go forward basis driven primarily by a small number of low margin development programs, and programs that incurred adverse net EAC change impacts in FY 'twenty four. We expect backlog margin to increase going forward as we continue to bring in new bookings, as we did once again in Q2 that we believe will be in line with our targeted margin profile in accretive to the current average margin in our backlog.

Operating expenses, specifically R and D and SG and A, are down significantly year over year as a result of prior and ongoing actions to streamline and focus our operations. As expected, R and D levels increased sequentially Please forward to Slide eight. Finally, turning to priority four, improved free cash flow. We continue to make significant progress on the drivers of free cash flow, and in particular in reducing net working capital, which at $475,000,000 is at the lowest level since Q3 of FY Notably, combined free cash flow over the last three quarters is approximately $122,000,000 and net debt is down to $349,000,000 the lowest level since Q2 of FY twenty twenty two. We believe our continuous improvement related to program execution and hardware delivery just in time material and appropriately timed payment terms will lead continued reduction in working capital and improved free cash flow performance going forward. Please turn to Slide nine. Looking ahead, I am optimistic about our team, our leadership position in delivering mission critical processing at the edge, 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-twenty percent range, and free cash flow conversion of 50%.

As we discussed last quarter, although we'll not be providing specific guidance for FY 2025, I will update the color we previously discussed. First half revenue up 13% year over year exceeded our expectation that the first half would be in line with last year. The overperformance was largely driven by the acceleration of about $30,000,000 in customer deliveries and revenue into Q2 from Q3. For full year FY 2025, we now expect revenue growth approaching mid single digits year over year versus our prior expectation that revenue growth would be relatively flat. As we discussed last quarter, our current backlog margin is lower than what we expect to see on a go forward basis Driven primarily by a small number of low margin development programs and programs that incurred adverse net EAC change impacts in FY 'twenty four. Although we are encouraged that our recent quarter bookings are accretive to our overall backlog margin, we continue to expect low double digit adjusted EBITDA margins overall for FY 2025 as we complete lower margin development efforts and continue to shift our mix toward production. We expect Q4 adjusted EBITDA margins to be the highest level of the fiscal year Finally, with respect to free cash flow, we continue to expect to be cash flow positive in FY 2025.

Given the large acceleration of cash from Q3 into the first half, and first half free cash flow of $61,000,000 which is well ahead of our prior we expect free cash flow to be around breakeven in the second half. In summary, given the operational improvements over the last several quarters and our recent momentum I expect that our performance in FY 2025 in particular our exit run rate will represent a positive step toward our target profile. Given our progress in the first half and our momentum heading into the second half, I look forward to providing additional insights relative to our expectations for full year performance as we progress through the back half of the year. With that, I'll turn it over to Dave to walk through the financial results for the second quarter, and I look forward to your questions. Dave?

Thank you, Bill. Our second quarter results reflect solid progress toward our goal of positioning the business to deliver predictable performance characterized by organic growth, expanding margins and robust free cash flow.

There is still work to be done, but we are encouraged by the progress we have made in expect the second half of fiscal twenty twenty five revenue and adjusted EBITDA margins to improve over the first half.

Our continued progress in our priority areas is highlighted by a few key milestones that we achieved during the second quarter. This includes delivering improved operating performance making additional progress in ramping production in our common processing architecture product area and continuing to expand our record backlog. With that, please turn to Slide 10, which details our second Our bookings for the quarter were $242,000,000 with a book to bill of 1.09 yielding a backlog of 1,400,000,000.0 of $77,000,000 or 6% year over year. Revenues for the first quarter were $223,000,000 up 26,000,000 or 13% compared to the prior year.

The increase is primarily driven by higher point in time revenue of $29,000,000 dollars largely accelerated from Q3 as we continue to focus on delivering for our customers. Gross margin for the second quarter increased to 27.3% from 16% in the same quarter last year. The increase in gross margin during the current quarter was primarily driven by a reduction in the net EAC change impact on our programs recognized over time. To $4,000,000 as compared to 31,000,000 in the same quarter last year.

And lower inventory reserves of approximately $12,000,000 These improvements in gross margin were partially offset by higher manufacturing dollars As Bill previously noted, expect to see an improvement in our gross margin for as the average margin in our backlog improves resulting from newer awards at targeted margins. Operating expenses decreased and A expenses.

These decreases were driven by the actions taken in fiscal twenty twenty four to improve our performance by consolidating and simplifying our operations. GAAP net loss and loss per share in the second quarter were approximately $18,000,000 and $0.3 respectively as compared to GAAP net loss and loss per share of $460,000 and $0.79 respectively in the same quarter last year. The improvement in year over year earnings is primarily a result of increased revenue and the associated gross margin coupled with reduced operating expenses adjusted EBITDA for the second quarter was approximately $22,000,000 compared to negative $21,000,000 in the same quarter last year. Adjusted earnings per share were $0.07 as compared to adjusted loss per share of $0.42 in the prior year. The year over year increase was primarily related to lower net losses in the current period as compared to the prior year period.

Free cash flow for the second quarter was a record dollars as compared to approximately $38,000,000 in the prior year. The significant increased cash flow was primarily driven by the improvement in cash provided by operating activities of approximately $40,000,000 in the current year as compared to the prior year. Slide 11 presents Mercury's balance sheet for the last five quarters. We ended the second quarter with cash and cash equivalents of approximately $243,000,000 driven primarily by approximately $85,000,000 in cash provided by operations and investments of approximately $4,000,000 in capital expenditures.

Bills receivables decreased approximately $20,000,000 or 16% sequentially.

Unbilled receivables decreased year over year and sequentially by approximately 72,000,000 or 21 percent and $20,000,000 or 7% respectively.

These decreases reflect the incremental progress we've made by delivering on programs to our customers, which significantly drove our cash flow performance during the current quarter. Inventory decreased slightly year over year and sequentially by approximately $10,000,000 and $7,000,000 respectively.

The current quarter balance also included approximately $15,000,000 of material receipts supporting milestone invoicing, which largely drove the increase in our deferred revenue of nearly $40,000,000 These material receipts partially offset our decrease in inventory from accelerated point in time revenue. This increase in milestone invoicing activity reflects the progress we've made to better align the payment structure of our contracts to match the corresponding cash outflows of these arrangements. Accounts payable decreased approximately $10,000,000 sequentially driven by the timing of payments to our suppliers.

Accrued expenses decreased approximately $2,000,000 sequentially primarily due to payments under our restructuring taken in fiscal twenty twenty four.

Deferred revenues increased year over year and sequentially by approximately $55,000,000 and $40,000,000 respectively as a result of additional milestone billing events achieved during the period. Working capital decreased in the second quarter approximately $115,000,000 year over year or 20% and decreased by $89,000,000 or 16% sequentially.

This demonstrates the progress we've made in reverse highlighted by five quarters of sequential reductions in unbilled receivables, resulting in the lowest net working capital since Q3 fiscal twenty twenty two. Percent. Net working capital remains a primary focus area and we believe we can continue to deliver improvement. Turning to cash flow on Slide 12. Free cash flow for the 2nd quarter was a approximately $82,000,000 as compared to $38,000,000 in the prior year. We believe our continuous improvement related to program execution and hardware delivery just in time material and appropriately timed payment terms will lead to continued reduction in working capital, improved free cash flow performance going forward. In closing, we are pleased with the first half performance for the fiscal year and the higher level of predictability in the business. We believe continuing to execute on our 4 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. Thanks, Dave. With that, operator, please proceed with the Q and A. [indiscernible] If you are a member of the press, we ask that you submit your questions via the web.

Please ensure you are not on speakerphone and that your phone is not on mute when called upon. Your first question comes from the line of Pete Skibitski with Alembic Global. Your line is open.

Hey, good evening guys. Great quarter. It looks like even excluding the pull forward revenue was still a strong quarter.

Especially on the cash flow side. So Bill, I'll ask a question I've asked before, but maybe this is the last time I need to ask it. Just can you talk about the progress in the second quarter on the CPA kind of processes and programs in terms of the maturity there? Are there any kind of technical risks that remain at this point or is it just a matter of slowly kind of ramping from LRIP to full rate production on the programs?

Yes, Pete. Well, first of all, thanks for the comments upfront. And I would characterize our progress on CPA as as planned and consistent with what we discussed previously, we are ramping the full rate production. We expect to get our capacity to be fully available as we move through through the back half of the year. And of course, how we use that capacity will benefit the business in a number of ways. We've already seen as we've brought production online that we've received significant production awards. We talked about that in Q1. We had a really nice takeaway from a competitor based on our technical differentiation this quarter, that's been another benefit. And as we progress through the second half, we'll be able to allocate that capacity to drive revenue performance and deliver for our customers on new awards. And continue to burn down unbilled balances where we have receivables on older contracts. So continued progress, all sort of normal course at this point and very much progressing to plan and consistent with what we've discussed previously.

Okay. That's great. Just one more for me. As you guys build confidence in that system, I'll call it, could you talk about order flow Your backlog is kind of inched upward in the first half of the year, you know what we can say, I think. How are you expecting order flow to trend in the second half of the year? Should that accelerate or kind of in conjunction, how is the continuing resolution been impacting order flow?

Thanks. Yes. I don't get too granular in focusing in on orders by quarter because like cash, it can be a little bit lumpy. I do think that our trip trailing 12 months book to bill of 1.12 is reflective of solid performance. And as we're looking forward, we still feel really confident about not only our strategic positioning, which we've talked about consistently but also the enduring demand drivers and the need for mission critical processing at the edge. So all in all, I feel very optimistic about that outlook. Our trailing 12 month book to bill, I think, is solid at one point 1.2 and I think it positions us well for the second half of the year. Great.

Thank you very much. Your next question comes from the line of Peter Arment with Baird. Your line is open.

Yes. Good afternoon, Bill, Dave, Tyler, welcome to the call. Congrats on the quarter. Obviously, a lot of progress being made here. Guess I just want to understand the back half of the year free cash flow kind of breakeven commentary because I think you've made a tremendous amount of progress of bringing the unbilled down. And again, you saw evidence that this quarter but now you've also got this deferred revenue growth and then I just want to understand how how whether that's tied to the new contract structure and on receiving the milestones or could you maybe just Dave walk us through a little bit of dynamics of why there isn't positive still cash being generated in the second Yes. And as we said, Peter, when we looked at the first half, our cash was ahead of where we were at expecting and some of that was driven by the milestones that we were able to achieve and drove, as you saw, based on the timing of those milestones. So those milestones as we work through the second half will be will be performing effort against that cash that we've already received. So we expect to see the deferred revenue come down as we get through the back half of the year.

It does not mean that unbilled won't continue to be something that we're we're working aggressively on. But we do expect to see material drawdown of that that deferred revenue that was brought in those milestones that were completed earlier.

Appreciate that. I'll jump back in the queue. Thanks.

Jim comes from the line of Ken Herbert with RBC Capital Markets. Your line is open.

Hey, good afternoon, Bill and Dave. You consistently talked now about sort of the longer term opportunity to get adjusted EBITDA margins back into the 20% [indiscernible] can you provide without getting maybe too specific on timing, but how does the business look when you get to that level? I mean, is there a way we should think about that from a revenue standpoint, from an efficiency standpoint, can you provide any more sort of parameters around how you think about that maybe from a timing standpoint you think about the business moving forward?

Yes. Thanks for the question. Let me just is Bill. I'll take it. We've talked pretty consistently for the last several quarters about the main levers that we're focused on. And we've made progress on each of the levers And I think as we're sitting here looking forward and think about the path to our target margins, I think there's really 2 primary things that we're focused on. One is the conversion of our backlog margin that we've talked about The fact that coming out of FY24, our backlog margin was lower than what we expect to see on a go forward basis impacted by a small number of low margin development programs and a number of programs that were impacted by EAC adjustments in FY24. And as we're progressing, each quarter and we're bringing in new bookings, we're really pleased to see that the margin on those bookings are coming in line with our target margins. Associated with our targeted EBITDA margins that were working to get to. So that's the dynamic that will play out over time. We haven't been specific around the timing where we expect the backlog margin to be at a place where it's consistent with our target margins.

But we have a duration associated with our backlog. So you could do some thinking around how that might turn over over time. But that's the first the first driver. And then the second is around our operating expense. So that we can get positive operating leverage as we continue to drive volume. And I feel like at this place where we are with our operating expense, we've made significant progress over the last 18 months on that part of our cost structure. And while we said before and it will continue to be a focus that will drive efficiencies into the business as we go forward on an ongoing basis. But I feel good about where our operating expenses relative to the positive operating leverage that we [indiscernible] So those are really the 2 pieces and I feel like we're in a pretty good place in terms of understanding where we are and being able to see those two moving pieces work together to get us to our targeted margins.

Thanks for all the detail Bill.

The next question comes from Seth Seifman of JPMorgan. Your line is open.

Thanks very much and good afternoon and nice quarter. I guess just in thinking about the the growth rate, you talk about above market. Maybe just to put some parameters around that, when you when you think about what market is, do you think about it kind of as the defense budget, which I think a lot of people think about maybe low to mid single digit growth over time. Do you think about it as a more as a certain subset of the defense market that that might be growing faster. And then the second part of that question is, the common processing architecture and when you're fully ramped up there kind of what role that plays in the mix and how that plays into your thoughts about the overall growth rate of the business? As we look out over, let's say, 1 to 3 year period?

Yes. So as we've discussed before, we're focused on delivering top line growth that represents a growth rate above market growth rate. And specifically the market that we're focused in on is the defense electronics, Tier 3 defense electronics market with growth rates that are historically in the 5% to 6% range.

And we believe for a number of reasons, in particular [indiscernible] where we're well positioned and we've focus and in particular that's around delivering processing power and capability to the edge those sub segments tend to grow a little bit fast and we feel like we're very well positioned based on our technical differentiation to deliver growth that exceeds those market growth rates. So that's really what we mean by we talk about our targeted growth rates. With respect to the common [indiscernible] As we work through the technical challenges in that area and gotten those behind us and then ramp to full rate production it impacts our business in a number of different ways positively. First, it unlocks bookings because a number of customers were holding back follow on development and production awards until we had demonstrated we got to root cause eliminated the technical risk, and then ramped up production. So it's opened up new production awards It also now gives us the opportunity with capacity becoming available to allocate that capacity in the way that makes the most sense. And that could be either burning down backlog and delivering new units and revenue that goes with it.

Or allocating the capacity to more legacy programs that represent our unbilled balances that when we deliver those units, there's less revenue associated with those units because they the revenue has been recognized in prior periods. But it allows us to deliver the units, invoice our customers and collect cash. So having that capacity online gives us a number of different degrees of freedom to drive performance and how have it flow through RP and L into our cash flow statement and into the balance sheet. Hopefully that's helpful. Yes, absolutely. Thank you. The next question comes from Jonathan Ho with William Blair. Hi. Let me echo my congratulations as well.

I just wanted to get some additional color on what drove the $30,000,000 in pull forward contract activity. Was this concentrated in a handful or single program? And was there sort of a customer impetus or government directive to drive earlier deliveries? Thank you.

Yes. Thanks, Jonathan. Thanks for the comment upfront and the question. For 18 months, we've been very consistent in the prioritized focus of the business with priority 1 being a focus on delivering predictable performance. Looking backward, a lot of that effort was focusing on completing the large mix of development programs in our portfolio But it also includes a relentless focus on delivering for our customers. So a lot of what we've you've seen in our results for both Q1 and in Q2 is a byproduct of our team being relentless on delivering for our customers. And that shows up in 2 ways. It's delivering out of our backlog on new awards delivering hardware associated with that backlog, getting it out the door, as well as working down our unbilled balances. In this quarter, really the over performance was tied to point in time revenue and those were on programs and for products where based on that focus on delivering for our customers, we're able to pull to the left from our initial and that's what really drove the shift into the quarter.

And Jonathan, I would add, it was not a single contract or a single customer. It was multiple different products and customer said, and again, as Bill said, as we're improving our capacity in our operational facilities, we were able to pull some things that we thought we would not get delivery on and as a point in time revenue is on delivery. We would knock out revenue on and deliver in Q2. We were able to pull them forward out of Q3 and Q2, deliver them early get them to our cost earlier than expected and get them to our customers. So [indiscernible] I think one of the things that was encouraging in the quarter is as we really focused our capacity, we were able to demonstrate both the pull forward of deliveries to drive revenue and at the same time finish off programs and drive down our unbilled receivables. And I think that's really a credit to our team the improvement in our management system and our focus on delivering for our customers.

Excellent. Thank you. The next question comes from Michael Ciarmoli with Turis Securities.

Hey, good evening guys. Thanks for taking the question. Nice results.

Bill or Dave, maybe just to stay on that topic and get some more clarity. I mean, it sounds like the pull forward was just basic blocking and tackling and delivering.

I mean, because if I when I hear pull forward, probably want to strip it out and your revenues would have been down year over year and down sequentially.

Sequentially, but that doesn't seem like the way we should interpret this. And then I guess the pull forward and thinking about the back half of the year, so you've got mid single digit revenue growth kind of implies a flattish sequential trajectory But what would drive in that flattish revenue environment for the rest of the year, what drives the margins higher, especially in the Q4? Is that kind of what you were referencing with the bookings coming in at that targeted margin rate?

Yes. So let me start with top line and the revenue movement within the period. And again, I don't want to get too granular on the revenue per everyone that in Q1, we had some pull forward from Q2 into Q1. And then again from Q3 into Q2. Now if you kind of normalize the volume and where it sits, It does sort of spread out the growth throughout the year to get a more balanced and consistent growth between the first half and the second half. And I think if you adjust that 30,000,000 in your thinking, you'll see a more balanced growth rate across the full year. As far as the margin uplift in the 4th quarter, I think there's 2 things that are that are happening, it's yes, the dynamics in the backlog So we are seeing the roll forward of the lower margin backlog being replaced with the new awards that are coming in line with our target margins. But as we saw last year, in the Q4, we would expect to see some positive operating leverage with the increased volume that would be additive to our margins and that's why we're expecting a Q4 to be the highest margins in the year, hopefully that makes sense.

Yes. And I I think there are 2 things that impact that backlog margin as Bill discussed. 1 is of course the new bookings coming in. And the margin rate on those bookings and we said that it's been accretive as we've been going forward, the level of the margin on the contracts that we're actually performing executing on And we've talked about some of the contracts that we're completing and moving past are were some of the lower margin contracts. So those two phenomena act in concert with each other to naturally start to raise that backlog margin.

Got it.

Helpful. Thanks, guys.

Thank you.

The next question comes from Brian Chesch with Raymond James. Hey, nice quarter.

And thank you for taking my questions. I wanted to maybe just delve into this journey you're taking to remix the business away from not away from, but this natural shift from development to production work you talk about where we're at in that journey? And then maybe give us a little bit of sensitivity how the margins shift higher as development moves every 500 or 1,000 basis points Yes. We have we've talked about this in the past kind of the difference between margin rates typically on development versus production contract and the way we think about that model and what we've talked about in the past is the differences in 1,000 basis points kind of range the difference between those two.

And so we are and we talked about that the bookings we're seeing are in line with our targeted margins. As Bill talked about, when we look at our bookings for the last trailing 12 months they've been in 80% range production. So we're seeing that happen. It's some of that is as a consequence of finishing these development programs, We had a large number of development programs that were we've been working through. I want to make sure that people don't take the amount of production happening as a natural phenomenon finishing those development programs and getting the follow on production awards. We still are focused on new development and and the right kinds of new development and we still are moving innovation along in the company, but this is a natural [indiscernible] move of how we see the business proceeding. We expect this level of kind of bookings to to be the case for some phase, some period of time?

Great. And then maybe just a quick follow-up So if you think about how that backlog naturally progresses towards your target margin work, How do you How much of that margin bridge from 10% to 20 percent or 10% to 20% plus comes from this natural mix shift. As opposed to some of the other levers that Bill alluded to earlier.

Yes, I don't think we've broken out the individual components of that. So I wouldn't want to try and detail that. Okay. Fair enough. Your next question comes from the line of [indiscernible] Of Jefferies. Your line is open. And great quarter guys. Thanks for taking the time. Want to maybe start on free cash flow and just ask $82,000,000 of free cash flow in the quarter. I think was your all time high free cash flow in a quarter in a year, let alone a quarter. So can we talk about how we bridge that free cash flow to what true free cash flow is given you're implying breakeven in the second half. There was obviously some factoring in there and some benefit from other items. So maybe if you could just talk about how we should be thinking about the second half being breakeven and as we head into fiscal twenty twenty six?

Yes. I think Sheila, this is Dave. I think that the way to think about it is we were able to accelerate cash in essence into the second quarter. Largely when you look at our deferred revenue, you see our deferred revenues up around $40,000,000 That's milestones that we achieved. That are ahead of all of the effort being completed.

So as we go through the second half, we expect to be seeing that deferred revenue come down. As we get the work done around those things or complete work around those things. And so we expect that will have It will lower the deferred revenue resulting in an offset the cash that we're bringing in on the other programs. So net $40 ish million is almost a pull forward a piece of that out of the second half of the year.

So we're not looking at it as a pure, hey, it's a break even back half of the year. We're looking at it as [indiscernible] running to offset that activity. We still are focused on our net working capital been in several years. I mean, we're headed in the right direction. Obviously, that's not at the exclusion of revenue or or margin, but it's something we're working in concert So I think I think the way we're thinking about cash is consistent with what we said in the in the past. We expect to be a consistent positive cash flow generator and we expect to have positive cash as we exit the year. Obviously, we're with where we are today, a little bit ahead of where we thought we'd be through the first half.

Got it. And then maybe if we could just talk about it's been asked a few different ways of profitability profile too. Any sort of you could give on production versus development margins? And then if you could just talk about the competitive wins you mentioned in the slides what are those and how do we think about the stability of those?

Yes, I'll start and then Bill, life's even talk about the wins. As we just said, I think that what we said historically is that production margins and development margins because of the different profile [indiscernible] the targets we see for those are roughly 1,000 basis points different We've seen that consistently in our bookings that that's about right. The bookings we're bringing in are absolutely consistent, as Bill has said, with the target model that we have. And so we see the bookings that are coming in at the margins we need to step towards our ultimate business model.

And I'll just make a comment on the competitive on the competitive wins. We had a number of head to head competitive wins in the quarter. I think a couple worth mentioning. One is on U. S. Defense Department satellite program. With an innovative space systems provider I think what's interesting about this pursuit is it was led by our advanced Concepts Group, which is a group we launched last year to focus on our next generation technology and position us for next generation type pursuits, came up with a very innovative solution that actually leveraged existing products and work that we had done for other customers. And so we think it's right in line with an innovative development program with the right risk profile that will lead to production runs down the road. So it's exactly what we wanted to do with the Advanced Concepts Group in a really good success story. And then the second is the takeaway associated with our common processor architecture product line And as we've said before, this is an area where we see emerging demand and we feel like we've got solid technical differentiation. And this takeaway was a perfect example of that.

It was a relatively entrenched competitor and incumbent providing a processing capability The end customer was looking to upgrade the capability to include the functionality consistent with our common processing architecture the incumbent couldn't meet those requirements, we could and that was the basis of the takeaway and the development award. So I think those are very notable They're worth mentioning and I think they're evidence of our ability to compete head to head and win based on the technical differentiation associated with the Mercury processing platform.

Got it. Thank you. Mr. Balhais, it appears there are no further questions. Therefore, I would like to turn the call back to you for closing remarks.

Okay. Well, thanks everybody for participation. I would like to thank the Mercury team because it's people and teams that deliver the results that we talked through today. And the team had an outstanding quarter. We appreciate your participation and we look forward to the next quarter. Thank you. Thank you.

This concludes today's conference call. We thank you for joining. You may now disconnect.