Mercury Systems Inc (MRCY) 2017 Q4 法說會逐字稿

Good day, everyone, and welcome to the Mercury Systems Fourth Quarter Fiscal 2017 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 Executive Vice President and Chief Financial Officer, Gerry Haines.

Please go ahead, sir.

Good afternoon, and thank you, everyone, for joining us.

With me today is our President and Chief Executive Officer, Mark Aslett.

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.

We'd like to remind you that remarks that we may make during this call about future expectations, trends and plans for the company and its business constitute forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995.

You can identify these statements by the use of the words may, will, should, could, would, plans, expects, anticipates, continue, estimate, project, intend, likely, forecast, probable, possible, potential, assumes and other similar expressions.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated.

Such risks and uncertainties include, but are not limited to, continued funding of defense programs; the timing of such funding; general economic and business conditions, including unforeseen weakness in the company's markets; effects of continued geopolitical unrest and regional conflicts; competition; changes in technology and methods of marketing; delays in completing engineering and manufacturing programs; changes in customer order patterns; changes in product mix; continued success and technological advances in delivering technological innovations; changes in or in the U.S. government's interpretation of federal procurement rules and regulations; market acceptance of the company's products; shortages in components; production delays or unanticipated expenses due to performance quality issues with outsourced components; inability to fully realize the expected benefits from acquisitions and restructurings or delays in realizing such benefits; challenges in integrating acquired businesses and achieving anticipated synergies; changes to export regulations; increases in tax rates; changes to generally accepted accounting principles; difficulties in retaining key employees and customers; unanticipated costs under fixed-price product, service and system integration engagements; and various other factors beyond our control.

These risks and uncertainties also include such additional risk factors as are discussed in the company's filings with the U.S. Securities and Exchange Commission, including in our annual report on Form 10-K for the fiscal year ended June 30, 2016.

The company cautions readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made.

The company undertakes no obligation to update any forward-looking statement to reflect events or circumstances arising after the date on which such statement is made.

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 or EPS, adjusted EBITDA and free cash flow.

Adjusted income excludes the following items from GAAP net income: amortization of intangible assets, restructuring and other charges, impairment of long-lived assets, acquisition and financing costs, fair value adjustments from purchase accounting, litigation and settlement income and expense, and stock-based compensation expense, along with the tax impact of those items.

This yields adjusted income, which is expressed on a per-share basis as adjusted EPS calculated using weighted average diluted shares outstanding.

Adjusted EBITDA excludes interest income and expense, income taxes and depreciation in addition to the exclusions for adjusted income.

Free cash flow excludes capital expenditures from cash flows from operating activities.

A reconciliation of these non-GAAP metrics is included in the earnings press release we issued this afternoon.

I'll now turn the call over to Mercury's President and CEO, Mark Aslett.

Thanks, Gerry.

Good afternoon, everyone, and thanks for joining us.

I'll begin today's call with a business update.

Gerry will review the financials and guidance.

And then we'll open it up for your questions.

Mercury finished the fiscal year with a great fourth quarter.

We came in at the high end of our guidance for revenues and exceeded guidance on adjusted EBITDA, both of which were at record levels.

Bookings for the fourth quarter were also very strong.

We ended the year with a record backlog, which positions us for another year of above industry average growth in fiscal '18.

The team continues to execute extremely well.

Our integration activities are on track, and our acquired and organic businesses are delivering solid results.

We continue to see lots of opportunity in the marketplace, and we feel that we're well positioned given our capabilities set.

Two growth areas that we're focusing on are safety-certifiable avionics and platform management computing.

Acquiring CES, now fully integrated and operating as Mercury Mission Systems International, provided us with an international foothold in both areas.

The acquisition of RTL completed in early July continues that theme with a domestic focus.

Although RTL was a relatively small deal, it provides us with some interesting new capabilities in line with our strategy, while enabling us to build our U.S. team.

Turning now to the metrics for fiscal 2017 as a whole, including the Microsemi Carve-Out, CES and Delta Microwave acquisitions, Mercury's consolidated total revenues grew 51% year-over-year to record levels.

GAAP income from continuing operations increased 27% and adjusted EBITDA was up 64% and also a record.

Our fiscal '17 bookings grew 49% and the year-end backlog increased 24% to $357 million.

International bookings, including foreign military sales, were up 97% year-over-year.

Our 12-month forward revenue coverage remains strong, positioning us well for FY '18.

Fiscal 2017 was a strong year for us organically also.

Our organic revenue grew 10% year-over-year, and we continued our success in accelerating the growth of the business we acquired.

Overall, we were delighted to deliver above industry average growth and profitability in line with our target business model.

Moving to Q4 and starting at the bottom line, adjusted EBITDA on a consolidated basis was up 52% year-over-year and 24% of revenue, well within our recently updated target model.

Total revenues for Q4, including the acquired businesses, were up substantially year-over-year.

Our largest revenue programs in the quarter were a large ground-based radar, SEWIP, Filthy Buzzard, Patriot and Aegis.

Total bookings for Q4 were also up substantially.

Our largest bookings programs were Small Diameter Bomb II, Filthy Buzzard, F-35, PGK, Aegis and AMRAAM missile.

Turning now to new business.

The level of pursuits and design win activity remains the highest I have seen since joining Mercury.

We believe it's a unique time in the industry driven by several underlying trends.

The first is that our customers are outsourcing more.

Along with seeking affordability, they're looking to do business with commercial suppliers that are able to deliver meaningful innovation, an area where Mercury excels.

The second is our customers' flight-to-quality as they seek to do business with a smaller number of trustworthy, scalable suppliers who can deliver affordability and innovation.

The major primes have encountered a range of issues with competing suppliers that are faltering, and we've taken share displacing both smaller and larger competitors.

The third trend is what we see as an active focus by the government and the primes to delayer their supply chains.

The primary intent is to gain direct access to innovative commercial suppliers whose solutions are affordable and can be delivered more quickly.

We believe this is a significant opportunity for us longer term given that Mercury's moved up the value chain from a Tier 3 to the mid-Tier 2 level.

Our achieving Tier 2 status is largely the result of the capabilities we've developed or recently acquired.

It also reflects our strong positioning in secure sensor and mission processing, our commercial business model as well as our trusted manufacturing capabilities.

These factors were reflected in our bookings, revenue and the strength of our design win pipeline.

In terms of our Q4 design wins, we're seeing a lot of activity in radar, EW and C4I modernization, secure processing and in weapon systems.

Last quarter, I talked about design win pursuits related to 2 large secure airborne processing opportunities.

We received an initial purchase order for one of those during Q4.

We believe this could be an important piece of business in the secure rack-mount server domain over the longer term.

In the second pursuit, we were selected by an additional competitor, meaning we now own 2 of the 3 teams.

We're also making progress on opportunities in the guided missiles and precision munition space.

We're seeing increased spending in those areas based upon the needs to replenish low stocks as well as continued usage.

Our new business pipeline reflects the fact that our customers want to do business with outsourcing partners who have the capacity to co-invest by internally funded R&D.

We've steadily increased our R&D investments on the dollar basis over the past few years and sustained one of the highest internal R&D spend to revenue ratios in the defense industry.

We may actually increase R&D spending further this fiscal year, beyond our initial full-year guidance, given the magnitude of the opportunity set we see.

The goal of any additional spend will be to capture new design wins to maintain or increase the long-term compounded organic growth rate we have enjoyed since fiscal 2013.

As I said earlier, we believe it's a unique time in the industry.

We're also making significant investments in our manufacturing assets, with 2 current priorities over the next 12 months.

The first priority is the ongoing build out of our trusted manufacturing facility in Phoenix.

We expect the Phoenix plant to be an important competitive advantage for us in the production of trusted devices and in the secure processing domain.

The second priority is to create a scalable RF facility on the West Coast, like we did in Hudson, New Hampshire.

This will involve the facility's expansion and investing in greater levels of manufacturing and test automation at the recently acquired Delta Microwave Oxnard location.

We expect the Phoenix and Oxnard facilities to make important contributions to our above-industry average growth in the future as well as margin expansion over time as a result of the expected synergies.

The build-out in Phoenix is on time and on budget.

Planning for the expansion and subsequent consolidation at 2 other facilities into Delta is now underway, and we are aiming for completion this fiscal year.

Mercury is strongly positioned for continued growth as we begin fiscal 2018.

We positioned ourselves on franchise programs that appear to be well funded and are currently in or moving into production.

We're winning important new designs, and our backlog is much larger than in prior years.

We continue to expand and diversify our basic programs and more of our programs that are producing at a high rate than in the past.

This reflects expanded content on many of those programs, prime examples being Aegis, SEWIP and F-35.

Broadening our program portfolio reduces risks and leads to future growth.

Going forward, we intend to remain active and disciplined in our approach to M&A as we work to extend our record of organic and acquisition-driven growth above the industry average.

We've completed 3 deals in the past 12 months.

In the past 20 months, we've successfully deployed approximately $400 million of capital on 5 strategic transactions.

This makes us one of the most active acquirers in both deal volume and deal value within the defense electronics sectors, including the primes.

We continue to look for deals that are strategically aligned, have the potential to be accretive in the short term and promise to drive long-term shareholder value.

We will continue to target acquisitions that expand our addressable market in aerospace and defense electronics, domestically and internationally and that's scaled the technology platform that we've built.

We'll remain focused on the key pillars of the business, RF and secure processing, while also continuing to assemble critical and differentiated solutions for secure sensor and mission processing.

We plan to continue acquiring smaller capability led tuck-ins like RTL, while capitalizing on larger strategic opportunities as they present themselves.

In addition, we've positioned ourselves extremely well from a capital structure perspective.

The equity offering in January and debt refinancing in June put us in a net cash position with a significant access to low-cost debt.

As well, we eliminated any short-term negative carry.

Moving to the industry conditions.

We expect to begin government fiscal 2018 with another budget-continuing resolution as we've seen in the past.

We view the President's recent budget submission and committee mark-ups as a positive.

But given the scope of the congressional agenda, including health care and tax reform as well as the partisan environment in Washington, we recognize the potential for continued challenges associated with the timing of budget approvals this coming government year.

Nonetheless, we believe that we'll see an increase in defense spending and our initial fiscal 2018 guidance reflects these expectations.

After that our record backlog and the high level of activity we're seeing in our business, we're confident that Mercury will achieve our fiscal '18 financial goals.

This means, continue to deliver above-industry average growth in revenue and profitability.

At the same time, we're continued to add depth to our board.

I'd like to welcome Mercury's newest directors, Lisa Disbrow and Mary Louise Krakauer, who were elected to the board on July 25.

Lisa recently retired as Under Secretary of the Air Force with responsibilities for the readiness and welfare of approximately 660,000 Airmen and their families and an annual budget of more than $132 billion and a range of executive functions across a global enterprise.

ML recently retired as Executive Vice President and Chief Information Officer at Dell Corporation.

She brings us extensive business experience across the broad set of domains, including HR, IT and Global Services, drawn from senior roles in high-tech companies, including Dell, EMC and Hewlett-Packard.

We're delighted to have Lisa and ML on the Mercury board where their respective expertise in the defense and technology industries will be key assets.

We look forward to benefiting from their counsel and experience as we continue to execute on our growth strategies in the years ahead.

Wrapping up our look forward.

We're anticipating continued strong performance in the first quarter fiscal '18, both organically and in our acquired businesses.

Our business model is working extremely well.

We're taking share and we're seeing high levels of activity based upon the investments that we've made and the capabilities set that we've created.

Our planned integration in manufacturing synergies are materializing as we anticipated.

And finally, our balance sheet is strong, enabling future acquisitions.

Gerry will take you through the outlook in more detail.

So with that, I'd like to turn the call over to Gerry.

Gerry?

Thank you, Mark, and good afternoon, again, everyone.

Before we go through the financial results, I'll note that unless otherwise stated, we'll be discussing the company's financial results, comparison to prior periods and guidance on a consolidated basis.

These results include the Creative Electronics Solutions or CES and Delta Microwave acquisitions -- businesses we acquired in the second and fourth quarter of fiscal 2017, respectively.

Richland Technologies or RTL, which we acquired very early in the first quarter fiscal '18 is not included in any of our fiscal '17 results.

Mercury's fourth quarter was a positive finish to another strong and very successful fiscal year.

Once again, we delivered progressively stronger, profitable growth over the course of the year, ultimately achieving record bookings, backlog, revenue and adjusted EBITDA for the year.

We acquired Delta Microwave and meaningfully amended our revolving credit facility.

At the same time, we finalized negotiations for the RTL acquisition, which is now added to our capabilities in safety critical avionics.

For the full fiscal year 2017, on a consolidated basis, Mercury's revenue of $408.6 million was up 51% from the prior year, marking a new record.

GAAP net income for fiscal 2017 increased over 26% to $24.9 million.

And adjusted EBITDA was up nearly 64% to $93.9 million, setting company records in both dollar and percentage terms.

Total bookings for the year grew 49% and our book-to-bill ratio was 1.09 for the year, driving record year-end backlog of $357 million, up 24% from $287.7 million a year ago.

Mercury also continued to deliver strong growth on a organic basis in fiscal 2017, with organic revenue growing 10% year-over-year.

Organic revenue is defined as revenue attributed to those businesses that have been a part of Mercury for more than 4 full fiscal quarters.

Acquired revenue, a new category we're introducing this quarter, also added significantly to our aggregate results.

Acquired revenue is defined as revenue associated with businesses that have been a part of Mercury for 4 full quarters or less.

After the completion of 4 full fiscal quarters, acquired businesses will be treated as organic for current and comparable historical periods.

For Q4, businesses contributing to acquired revenue include the Microsemi Carve-Out businesses, CES and Delta Microwave.

Turning to our financial results for the fourth quarter of fiscal '17.

Mercury's total revenue increased 35% from Q4 last year to $115.6 million, very near the top end of our guidance range of $112 million to $116 million.

Organic revenue was $71.2 million, up 4% over Q4 of fiscal '16.

International revenue, including foreign military sales was 15.8% of total revenue compared with 17.6% in Q4 of last year.

Revenue from radar and Electronic Warfare together accounted for 55% of consolidated total revenue, compared with 67% in Q4 a year ago.

Once again, the lower proportion versus Q4 last year reflects the overall much larger and more diverse revenue mix for the most recent quarter.

This reflects the addition of several new businesses and the associated expansion of our addressable market and revenue base.

Radar revenue for Q4 was down 3% year-over-year, while Electronic Warfare revenue increased 35%.

Total bookings for the fourth quarter were up 27% year-over-year, driving a 1.14 book-to-bill ratio.

Of our $357 million total year-end backlog, approximately $290.8 million or 81% of it is expected to ship within the next 12 months.

Mercury's bookings and revenue growth also continued to drive solid profitability for the quarter.

Gross margin for Q4 fiscal '17 was 46.6%, slightly above the top end of our Q4 guidance and close to the midpoint of our target business model.

Fourth quarter gross margin was down slightly on a sequential basis due to mix, but up substantially from 44.7% in Q4 of last year.

The year-over-year improvement in gross margin in Q4 was driven by several factors.

These include production cost efficiencies and acquisition integration synergies as well as the continuing ramp-up of our in-sourced U.S. manufacturing operations.

In Q4, there was also a $0.5 million negative gross margin impact from an inventory valuation step up from purchase accounting related to the Delta Microwave acquisition.

Total Q4 operating expenses were $40.9 million compared to $30.5 million for the same period last year.

The increase was due primarily to the incremental addition of a full quarter of the Microsemi Carve-Out businesses acquired during Q4 of last fiscal year, plus the subsequent acquisitions of CES and Delta Microwave during fiscal '17.

In addition, Q4 OpEx includes 2 types of incremental R&D investments.

First, we often ramp-up investment in newly acquired businesses to align them with the level of R&D invested in the organic business.

In effect, working to move the acquired businesses up the integrated solutions value chain from Tier 3 to Tier 2. At the same time, we're investing targeted R&D dollars to develop new technology capabilities, specifically aimed at capturing design wins from our increasingly robust pipeline of new business opportunities.

Returning to the financial results.

GAAP net income for the fourth quarter of fiscal '17 was $8.8 million or $0.19 a share.

This compares with $7.5 million or $0.19 a share in Q4 of last year.

Adjusted EPS for the fourth quarter increased to $0.32 a share compared with $0.29 a share in Q4 of fiscal '16 and well above our Q4 guidance range of $0.26 to $0.29 a share.

Reflecting Mercury's strong growth and improved profitability, adjusted EBITDA for Q4 of fiscal '17 increased 52% to a record $27.8 million from $18.3 million a year ago.

This exceeds our Q4 guidance of $24.8 million to $26.7 million and at 24% of revenue is midway into our long-term target range of 22% to 26% and a company record as well.

Turning to the balance sheet.

Mercury ended the fourth quarter of fiscal '17 with cash and cash equivalents of $41.6 million compared with $81.7 million a year earlier.

The change in cash primarily reflects the repayment of the outstanding term loan near the end of Q4 as part of the realignment of our debt into an all revolver credit facility.

This materially increased our access to capital even as we improved the economic and other terms of the facility.

From a cash flow perspective, Mercury's operating cash flow of $9.7 million for Q4 of fiscal '17 was partially offset by $6.1 million of capital expenditures.

This yielded $3.7 million of free cash flow compared with $10.8 million in Q4 of fiscal '16.

The cash flow decrease primarily reflects the linearity and timing of invoices and collections for certain large program activities.

We expect this timing issue to normalize over the coming quarters and for fiscal 2018 to be a strong year for cash flow.

Actual Q4 net capital spending came in below our guidance of $7 million to $8 million and, as anticipated, was substantially lower than in Q3.

The relocation of our headquarters is complete and the expansion of our DMEA certified facility in Phoenix is well underway.

As Mark mentioned, we're also making good progress on our plans for consolidating, integrating and expanding the Delta Microwave business in Oxnard, California.

Overall, we're beginning to see the benefits associated with an increasingly integrated and capable business.

Our Microsemi Carve-Out integration plan remains on track, well within the time frame laid out in our initial plans.

As we indicated when the transaction was first announced, we expect approximately 2/3 of the run rate synergies to be realized within the first 2 years.

The integration of CES is also on plan.

In terms of Mercury's financial position, we continue to maintain a conservative approach to the balance sheet.

As I mentioned near the end of Q4, we amended the company's existing revolving credit agreement, increasing it into a $400 million 5-year revolving credit facility, extending until June of 2022 and adding a $150 million accordion feature.

The new revolver significantly enhances our ability to invest as and when we see appropriate opportunities align with Mercury's strategy.

In connection with the amendment, we repaid the remaining principal on our existing term loan using cash on hand.

This eliminated the negative carrying cost associated with having large simultaneous cash and debt balances, while preserving and increasing our access to lower-cost capital.

As a result, we've significantly optimized our financial structure, eliminating the interest cost of the term loan and the mandatory amortization of debt principal provides us with much greater financial agility and flexibility.

We remain well positioned to continue executing on our capital deployment strategy supporting future growth, both organically and through acquisitions.

I'll turn now to our financial guidance for the first quarter and full 2018 fiscal year.

For purposes of modeling and guidance, we've assumed no restructuring and no acquisition or nonrecurring financing-related expenses and an effective tax rate of 35% in the periods discussed.

The guidance also assumes weighted average, fully diluted shares outstanding of approximately 47.6 million shares for Q1 and 47.8 million shares for the full fiscal year.

Our guidance reflects the outlook that Mark discussed, highlighted by continuing strong performance, both organically and in our acquired businesses.

We expect to continue delivering growth and profitability at rates higher than the industry average, driven by a record backlog, growth in our major product lines and across many of our programs as well as through our enhanced manufacturing capabilities.

We're planning to remain aggressive in our approach to R&D investment.

We expect to see ongoing improvement in our free cash flows as our CapEx continues to taper from the high levels associated with the important investment projects undertaken in fiscal '17.

With that as background, for the first quarter of fiscal '18, on a consolidated basis, we're forecasting total revenue in the range of $102 million to $107 million, an increase of 16% to 22% over Q1 of fiscal '17.

Gross margin for Q1 is expected to be approximately 46% to 47%.

Q1 GAAP net income is expected to be in the range of $3.6 million to $4.9 million or $0.07 to $0.10 a share.

Adjusted EPS for Q1 is expected to be in the range of $0.24 to $0.26 per share.

These estimates assume approximately $4.1 million of depreciation, $5.6 million of amortization of intangible assets, $0.5 million of fair value adjustments from purchase accounting and $5.0 million of stock-based and other noncash compensation expense.

Adjusted EBITDA for the first quarter of fiscal '18 is expected to be in the range of $21.4 million to $23.5 million, representing approximately 21% to 22% of revenue at the forecasted revenue range for the quarter.

For the full fiscal year '18, we expect Mercury's total revenue to increase to between $453 million and $468 million or approximately 11% to 15% year-over-year.

Total GAAP net income for fiscal '18 is expected to be in the range of $26.4 million to $30.3 million or $0.55 to $0.63 per share.

Adjusted EPS is expected to be in the range of $1.15 to $1.23 per share.

We currently expect total adjusted EBITDA for fiscal '18 to be approximately $103 million to $109 million, an increase of 10% to 16% from fiscal '17 and at approximately 23% of revenue for the year, well within the range established by our current target business model.

Over the past several years, Mercury's second half has been stronger than its first half.

A pattern we believe is generally related to the timing and cadence of defense budget approvals and associated contracting activity.

Given the way current events are unfolding in Washington, we expect to see this phenomenon repeat again in fiscal '18.

After a typical start to the year, we're anticipating another year of strong overall results.

Our content and market expansion growth strategies have positioned us well.

Our bookings, order flow and new business pipeline are strong.

We're harvesting the acquisition integration synergies that we anticipated in terms of both dollars and time.

And finally, we're expanding Mercury's addressable market and driving profitable growth through disciplined M&A.

As a result, we expect Mercury to deliver another year of strong growth and solid financial performance in fiscal 2018.

With that, we'll be happy to take your questions.

Operator, you can proceed with the Q&A now.

(Operator Instructions) Our first question comes from Jason Gursky of Citi.

Just a couple of housekeeping questions to get started here.

Can you talk a little bit about what's assumed in the guidance as far as organic growth is concerned?

So maybe you start there?

Yes.

So we didn't, Jason, break out the specific growth rates for organic versus acquired.

We don't do that on a forecast basis.

Part of the reason is that, over time, when you get into the mark beyond the 4 full fiscal quarters, what were -- for example, of the Microsemi businesses that we acquired a little over 4 quarters ago, next quarter will flip into organic as will the historical periods.

And that'll give you -- you and everyone a good way to get apples-to-apples comparisons.

So that said, we continue to see what we believe are robust performance in both the organic and the acquired businesses.

Okay.

And then you mentioned a little bit about free cash flow and CapEx going forward.

But can you talk a little bit about more specifically what your goals are for free cash flow conversion in the current fiscal year?

Yes.

So we should see better free cash flow conversion in '18 relative to '17.

We don't, as you know, give specific cash flow forecast, so none of those metrics are within what we give as guidance metrics.

But we really haven't seen any fundamental change in the cash-generating capability of the business.

The overall profit margins are pretty consistent.

We've seen that for multiple periods including through '17.

Of course, we do have the increase through the course of the year.

So if you look back at '17, the delivery in the second half was better than the delivery in the first half.

But over the course of the year, remained pretty strong.

Operating cash flow in '17 was actually good and strong, up about 60% year-over-year, even though Q4 was a little lighter than we expected based on the timing issue that I highlighted in the earlier remarks.

That's really just a temporary perturbation, quarter-to-quarter that can happen, but over the, sort of, rolling 4-quartered view, we don't think there is any fundamental change in the business.

So all in all, we expect it to be a good strong year.

Okay.

And then Mark just one bigger picture question for you.

You guys kind of break down your capabilities into 6 sets, right, as acquire, digitize, process, store, exploit and then disseminate.

Can you just maybe pick 2 or 3 where you're most excited at this point, either because of the products and capabilities that you've developed or that where you're seeing some demand pool across those kind of 6 capabilities at this point?

And then I'll get off at this point.

Sure.

So as you know that the center of the strategy has been around what we call the sensor processing chain, which is encompassing RF technology on the front end, which we had call acquire, digitalization capability, the traditional processing that Mercury is known for, on-board storage, the ability to be able to exploit or extract information from vast quantities of data that is generated and then to be able to disseminate that in the form of information or countermeasures.

So the area is that we are seeing significant growth in really 2 main areas: it's the acquire phase, which is related to our capabilities in RF; and then finally in processing.

And processing has really got a couple of different drivers to it.

The first is the significant shift towards embedding security into the processing architecture.

And then as a company and as we have discussed openly, we are moving beyond just providing the processing associated with the sensor into other mission-critical compute areas such as C2.

So if you tie that back up at a market segmentation level, what we are seeing is very strong growth in our EW business, year-over-year EW revenues were up 48%.

We also had strong growth in our radar business, and we've got emerging growth areas in both C4I and missiles and munitions.

Our next question comes from Seth Seifman of JPMorgan.

Maybe to follow-up and ask a similar question about next year's revenue growth a different way.

Instead of thinking about capabilities, there are some major programs that you guys traditionally call out, and you mentioned some of their contribution during the quarter.

When you think about the contribution of those programs to the growth next year, what are some of the main drivers?

Sure, it's a great question, Seth.

We -- I think as I said in my prepared remarks, we've got more programs that are producing at higher rates than we've seen in the past.

To touch on a few that we think are important for 2018, SEWIP, we're expecting rapid growth next fiscal year associated with a strong set of order activity.

We received literally 2 full-rate production orders during fiscal year '17.

So that particular program will continue to grow.

We continue to expand our content, literally winning a new piece of business with Northrop Grumman on Block 3 of this quarter.

We're also expecting a significant increase in both bookings and revenue on Aegis.

As you know, that's a missile defense program, very important program with critical technologies and capabilities where we're well positioned.

The F-35 has been a strong program for us.

It's obviously continuing to ramp.

We also expect to see continued double-digit bookings and revenue growth as we look forward into fiscal '18.

Filthy Buzzard is another program that we continue to talk about.

That should also be a strong driver of growth for us year-over-year.

Great.

And then maybe as a follow-up, the step-up in the acquisition contribution have been running about $30 million per quarter, you stepped up to $44 million.

I know we added the Delta Microwave business during the quarter.

Was that the real driver of the step-up or was it some of the businesses you bought earlier, maybe Microsemi since it's the biggest stepping up in terms of the contribution?

Yes.

So year-over-year, a part of it was that we own the Microsemi business for only roughly 2/3 of Q4 last year, and then there is the incremental addition of both CES and Delta within '17.

So they don't give you the comparison to the prior year.

That being said, Seth, I think we feel very good about the fact that we've been able to inflect northward the businesses that we've acquired.

I think when we acquired Microsemi, I think we said at the outset that we thought that this was a business that was better as having Mercury as an owner just given the strength of our channel and that is absolutely turned out to be the case.

So we're very pleased with the performance of that business as well as CES, and we got high hopes for the Delta folks.

Our next question comes from Jonathan Ho of William Blair & Company.

I just wanted to go back to the investments that you are making on the R&D side.

Could you maybe quantify for us the magnitude of those investments on an incremental basis that you want to make this year?

Maybe qualitatively talk about what this could mean in terms of the top line and bookings acceleration?

Yes.

So while we don't give specific projection numbers for R&D or any of the smaller line items in the P&L, we do have a target range of 11% to 13%.

We essentially think that we're going to be at or even slightly above the high end of that for the year in '18 as we continue to lean in, if you will.

It doesn't necessarily accelerate the revenue picture.

But over time, what it does is, broaden the aperture in terms of our ability to capture and maintain those growth rates.

That's one of the ways in which, as Mark mentioned just a moment ago, we've been able to inflect the growth rates, for example, of the acquired businesses up to close or matching the organic growth rate of the business, which is exactly what we're trying to do, sustain that organic rate.

You can see that, that was 10% this year.

The consolidated growth rate was also very strong as we've been successful in incrementally moving up those growth rates of the acquired businesses.

So exactly what those kinds of incremental investments are aimed at to make sure that we're staying ahead of that development curve on all fronts.

And with the pipeline of opportunities that we've seen growing over time as our capabilities have grown, we're quite targeted on where we can get the best yield on those investments.

I would say, Jonathan, that at a year-to-year level, R&D is probably the only line item expense that actually will be -- is expected to grow faster than the rate at the top line.

And that's the conscious decision that we're making because we see a tremendous amount of opportunity that we're looking to take advantage of.

And our commercial business model is working extremely well, and we're partnering with our customers to, for the capabilities set that they need going forward.

Got it.

Got it.

And then in your prepared remarks you said that you were seeing some of the smaller players struggle and that you're able to take some share.

Can you give us a little bit more color in terms of what you're seeing there?

And what that's resulted in, in terms of incremental share gains?

Yes.

So we actually -- I said that we're taking share in both smaller as well as larger companies.

And particularly in the RF domain, where there are several companies that are struggling to either meet deliveries of the technologies that they promised or to meet customers' affordability goals or even the time lines associated with the delivery of product.

As a result of that and the fact that we're able to invest in R&D in next-generation capabilities and the fact that we built out scalable and modern manufacturing facilities, we're taking share in a few different domains.

One of those particular quarters that we continue to actually win additional content on the F-35, not just in the processing domain, but now in the RF domain.

So we think that's a trend that will likely continue as our customers take a flight-to-quality suppliers.

Our next question comes from Peter Arment of Baird Equity Research.

Gerry, I know just to circle back on this organic growth or the outlook for fiscal '18, just because I want to get -- make sure we got the numbers roughly right.

So you did 10% organic growth in '17.

Are you implying that your organic growth is stepping down?

Or should we -- because I think expectations are that we should be able to see high single-digit organic growth?

How do we frame that?

Yes.

So I think that the growth rates that we're seeing obviously are a little slower into Q1.

So -- and that's again consistent with a pattern that we've seen ever since '13, the sequestration year, where the years seem to get off to a slower start and then you capture that over the balance of the year.

As we have in the past, we're staring into the future and looking at it and saying "Well, nobody knows exactly how the year unfolds." So our range for the year is in that 5% to 8% total growth mode.

We've got a couple of new acquisitions that we've just brought into the fold.

So we're investing there.

And over time, again, we think that we can maintain good strong growth rate.

So we don't see any fundamental change in our business either on the organic side or in the acquired side.

The Microsemi businesses have performed extremely well in our view and very much to plan.

So we're kicking the year off just the way we typically do.

Right, okay.

That, something similar happened last year.

So just unrelated on the cash flow side, CapEx finished $32 million.

What's the plan this year?

I know you mentioned it's tapering down, but...

Yes.

So we don't, again, give specific CapEx numbers, but it should normalize into a range that as it has traditionally been in the past is well inside of 5% of revenue.

Our next question comes from Michael Ciarmoli of SunTrust.

Just on the EBITDA margins, at the midpoint of the guidance, it assumes flat from next year.

I know Gerry you just said the R&D runs probably at the high end of the model.

Is there anything else maybe impacting I would've thought there might have been a little bit more leverage or is the mix of products that you are seeing based in the backlog that's going to ship.

I mean, how are we thinking about the EBITDA margins here?

Just, I guess, maybe is R&D the only headwind to the margins or anything else out there?

Yes.

It's really -- as Mark said, the inflection on R&D is running a little more in our view than the growth rate.

But really the way I think to think about it is, when we lifted our model to the 22% to 26% range a year ago, we thought we could enter the year and hit 22% for fiscal '17.

Obviously, what ended up happening is, we're actually able to pull that performance in a little bit early.

So rather than a smoother glide path to 23%, we just hit it a little bit early based on some acceleration of investment.

So we've got a little bit of breathing to do as we continue to build out the U.S. manufacturing operations that we have in Phoenix.

And over time, we think we will be able to harvest some additional benefit to that.

So -- But again, that's over time and it was more the lean in and getting to the 23% early as opposed with diminishing.

Got it.

And any color on the gross margins?

I mean, Mark you talked about SEWIP, Aegis at 35%, seems like consistent programs being the main driver.

Should we think about margins being sort of in a similar range or is it more towards the lower end of your longer-term target next year?

The margins will be in line with kind of the midpoint of the range plus/minus a little bit per what we're seeing.

So I think, as Gerry said, we did slightly better than, I think, our plan for fiscal '17.

We are purposely leaning in on an internal R&D spend perspective in fiscal '18.

We see some large potential opportunities that we're going to go after.

Got it.

And then just maybe the one last one.

Bookings environment, you guys have been driving this north of onetime book-to-bill.

Anything changing in your view?

And I'm not really asking for guidance on a book-to-bill, but you guys see anything in the landscape that?

Certainly, it sounds like there is no real change.

It seems like there's lot opportunities.

But you think you can continue to see this booking strength?

So that's obviously a focus area for us, and I think we've delivered a positive book-to-bill several years in a row.

I don't anticipate that changing.

If you look at the markets in which we're participating, I think we expect a strong underlying growth based upon the business model, the investments that we're making.

And for all of the reasons that I described in my prepared remarks, which is greater outsourcing, delayering the supply chain, the flight to quality, et cetera.

So we feel pretty good about fiscal '18 and our position with respect to achieving the goals that we've outlined.

And I think just to add one other point to that Mike, the thing I think that we take a lot of pride in is just as we have on the revenue side inflecting up the aggregate bookings and book-to-bill has been very important to us.

And I think we take a lot of pride in the fact that we've been able to maintain that consistent bookings performance even with the introduction of multiple entities and their various capabilities and so on.

So I think that's a pretty good barometer of what we've been able to achieve and why we think we can continue to achieve those kinds of things.

Our next question comes from Sheila Kahyaoglu of Jefferies & Company.

So just on the international bookings, they were very good once again.

Is that -- can you elaborate on what's driving that?

Is that mostly Patriot once again?

Sorry, I couldn't really hear your question.

Sorry, Mark.

The international bookings, they were pretty good.

Was it Patriot or what other programs are sort of driving the strength there?

Actually, it wasn't Patriot in the fourth quarter.

It was actually a number of other programs.

In the year -- for the year F-16 SABR was a large contributor.

Patriot was a large contributor at the year level, but not the quarter level as well as other programs, so.

Okay.

And then on Delta, I know you guys are not going to get specific, but I'm backing into something of about $10 million in revenue contribution for the quarter in Q4.

So that seems about 4x what they were running at in 2016.

Yes, that number is high.

It is high, okay.

I was just wondering what's driving sort of the growth in their backlog, if it's one program that's supposed to be shipped in '18 or it's just continuous new business wins.

They actually had a high ending backlog when we acquired them, and we were anticipating strong growth over the next 4 quarters.

They're off to a great start.

We really like the team.

They've got some great capabilities.

And as outlined in my prepared remarks, we've got a plan to basically expand that facility as well as consolidating other locations that we have on the West Coast to generate cost savings and margin improvement along the way.

So good team.

We're going to try and look to replicate what we've done on the East Coast.

Got it.

And then -- so the Delta contribution at $10 million is way too high, it's closer to maybe half.

That's correct.

Okay.

And then just last question.

You mentioned you launched a few new products over the quarter.

Can you maybe talk about, identify 1 or 2 of them?

And are they contributors to '18 or are these longer-term programs?

Yes.

So we continually deliver new capabilities.

I think in the RF domain as other companies, some of our customers have alluded to, we're seeing strength in missiles and munitions with respect to capabilities that we have in RF.

The secure processing product capabilities that we've introduced in both the embedded domain as well as for C2 applications, we're seeing some good growth opportunities there.

And again, as I said in my prepared remarks, during the quarter, we announced or received, sorry, an order for that secure rack mount, so that we're pretty excited about longer term.

So just a couple of examples.

Our next question comes from Brian Ruttenbur of Drexel Hamilton.

Lot of my questions have been asked and answered.

But I want to know if you had any headwind besides the CR that you can address?

And what have you assumed in terms of your outlook, your guidance for a CR?

Is that a 90-day CR or something longer?

And then if there's any specific programs that you see as a headwind coming up in the first or second quarters of this fiscal year?

Yes.

So with respect to headwinds, not really.

I think the Mercury team performed extremely well as kind of shown by the numbers that we continue to deliver.

With respect to our fiscal year '18, we do anticipate that we're going to begin the year with another continuing resolution.

Right now, we believe that, that could extend through the end of the calendar year.

But we do believe there will be an appropriation for GFY '18 that will result in growth in defense spending.

With respect to programs, I kind of went through some of our major programs earlier in terms of SEWIP, Aegis, F-35, Filthy Buzzard expecting strong growth.

We're also expecting strong growth in F-16 SABR.

That hasn't been a program that we've talked about -- that we've spoken about for a while.

But Northrop recently announced that the Air Force had selected SABR for its F-16 upgrades, and that's on top of several international awards that they've received, and they're currently in the EMD phase of the U.S. National Guard upgrade as well.

At Northrop, we're also expecting that the E-2D Hawkeye program will ramp, and we're expecting significant growth with respect to that program also.

(Operator Instructions) Our next question comes from Mark Jordan of Noble Capital.

I'd like another question relative to CapEx.

I think, Gerry, in your previous comments you said you're seeing normalized longer-term CapEx going down to 5% or less of revenue, which would imply on this year's revenue $20 million to $23 million.

If you went back to fiscal '16, your CapEx was $7.9 million.

Is there fundamentally higher capital investment -- ongoing capital investment needs in the acquired companies like Microsemi than they were -- was on average in legacy Mercury?

So we -- as I think, both Mark and I highlighted in some of our earlier remarks, we are doing some investment in modernization.

So it's not just consolidation or expansion.

We're doing some of that as well.

But we use the opportunity when we're consolidating the business to do some upgrading to the level of automation and so on across the business.

But the most fundamental change is, remember, we're roughly twice the size that we were back in, certainly, the early days of '16.

So the most significant impact is that.

So if you're looking at it in dollar terms, you can expect a unitary increase that is quite substantial in dollars.

But as I said on a percentage basis, it'd ought to be in the same general ballpark again under 5% and that was relatively consistent.

So the fundamental capital intensity of the business hasn't changed much.

There is periodic equipment buying and so on and so forth in the ordinary course.

But often we are focusing on that as and when we are doing some of the integration work.

Okay.

Gerry, you did mention a gross margin assumption for the first quarter, but did not for the full year.

Do you have any comment as to what might be a reasonable expect or what you've built into your model for gross margin assumption for the full year?

And how is that compared to sort of your target model?

Yes.

So we didn't give a specific guidance, but as Mark said in response to one of the questions, we estimate that it's going to be somewhere in the neighborhood of the middle of our target range, which is the target range being 45% to 50% gross margin (inaudible).

We tend to hover around the midpoint of that plus or minus 1 point from time-to-time.

Okay.

Final question for me.

You had a significant amount of tax benefits flow through the P&L in '17.

You're guiding as you had last year at the start of the year, a 35% normalized rate.

Would it not be unreasonable to assume that, that in your operation when you're booking your taxes you are rather conservative and that there's a reasonable assumption that there might be periodic benefits as the year evolves?

Yes.

So one of the things is, of course, we don't incorporate discrete items into our guidance because they can be unpredictable both as to time and quantity.

And so they can vary quite a lot from period to period.

That's the issue.

We remain profitable.

We expect to remain very profitable.

And so 35% as an applicable rate is pretty good modeling assumption.

In Q4, we mostly benefited from and, in fact, it was the lion share of the discrete benefit that we enjoyed was from the effect of stock compensation deductions.

So -- and some of those will continue certainly.

Okay.

Final question for me is on the M&A opportunities that you face.

Obviously, Delta was a good -- well-regarded company, but there seems to be not a lot of companies of that quality out there.

Is it reasonable to assume that significant acquisitions that you make going forward are probably going to have to be of the Carve-Out nature like the Microsemi transaction?

Well, that's certainly an area that we've looked at and continue to look at and have actually been successful executing against.

As we've seen -- as we've said in the past, we'll also explore other areas.

There are companies that are owned by private equity, there are companies that are privately held, both large and small.

Longer term, we do expect our customers to potentially divest some of their assets at the Tier 3 or maybe even at the mid-Tier 2 level.

So we've got pretty active pipeline of opportunities, and we've got a team that's pursuing them, Mark.

Mr. Aslett, it appears there are no further questions.

Therefore, I would like to turn the call back over to you for any closing remarks.

Okay.

Well, thank you all very much for listening in today.

We look forward to speaking to you again next quarter.

Thank you.

Thank you, ladies and gentlemen, for attending today's conference.

This concludes the program.

You may all disconnect.

Good day.