Mercury Systems Inc (MRCY) 2004 Q4 法說會逐字稿

Good day and welcome everyone to the Mercury Computer Systems Incorporated Fourth Quarter and Yearend Fiscal 2004 Earnings Results Conference Call.

Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to the Vice President Of Investor Relations, Diane Basile.

Please go ahead.

Good morning everyone, and welcome to the Mercury Computer Systems fourth quarter 2004 earnings conference call.

If you've not received a copy of the earnings release, you can find it on our web site www.mc.com or, on the First Call Network.

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

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

For a discussion of these risks and uncertainties, we refer you to the company's reports filed with the Securities and Exchange Commission, including the company's annual report on form 10-K for the year ended June 30, 2003.

Further information regarding forward-looking statements and risk factors is included in the press release we issued last night reporting the company's fourth quarter and fiscal 2004 yearend results.

We caution listeners of today's conference call not to place undue reliance on any forward-looking statements, which speak only as of the date of this call.

We undertake no obligation to update any forward-looking statements.

I'm now pleased to turn the call over to Mercury's President and Chief Executive Officer, Jay Bertelli.

Good morning, ladies and gentlemen, and thank you for joining our fourth quarter fiscal yearend earnings conference call.

With me on the call today, is Bob Hult, our CFO, and Joe Hartnett, our Corporate Controller and Diane has already introduced herself.

At this point, I'd like to briefly review the fourth quarter and yearend results and then I'll turn the call over to Bob to provide the additional financial details for the quarter and the year.

I'll then give closing remarks before we open the call to your questions.

As you can see from the press release we issued this morning, Mercury marked its 54th consecutive profitable quarter.

Overall, the quarter revenue of 59.1 million and the full year revenue of 185.6 million are record numbers.

I'm also pleased to report that backlog increased for the fourth consecutive quarter, to 91.2 million and the book-to-bill for the quarter and for the year was greater than one.

For the quarter operating income was strong at 13.6 million or 23% of revenues.

EPS were 44 cents.

We ended the quarter with a balance of cash and marketable securities of 238.3 million.

Full year operating income was 31.6 million or 17% of revenues.

And, earnings per share of $1.05 exceeded guidance.

I'd like to take a moment to highlight the addition of George Chamillard to Mercury's Board of Directors.

George is Chairman of Teradyne, one of the world's leading producers of automatic test equipment for semiconductor, System On Ship, Field SI, analog and mixed signal devices.

He was past Chairman and, is now a Board member of both the Mass High Technology Council and the semi or Semiconductor Equipment and Materials International.

George brings lot of knowledge and strong business acumen to Mercury.

We expect to draw heavily on his business knowledge and experience and look forward to his contributions to our Board of Directors.

With that, I'll turn the call over to Bob.

Thank you, Jay.

Good morning, everyone.

As you heard from Jay, the fourth quarter results were very strong.

We executed on several of our growth initiatives, including related financing activities.

As indicated on our April conference call, today will be finalizing our outlook for fiscal '05.

Our objective here is to provide the business context and to review the assumptions behind our guidance as an AP role model development.

First let me summarize total company fourth quarter and full year results for fiscal '04 as we reported last evening.

Fourth quarter 2004 revenues were 59.1 million.

This reflects a growth of 33% over the prior year.

Operating income for the fourth quarter was 13.6 million or a strong 23.0% of revenues.

Earnings per share for the fourth quarter was 44 cents, exceeding the top end of our previous guidance by one cent.

For the year, revenues grew to 185.6 million, an increase of 3% over prior year revenues of 180.2 million.

On a full year basis, operating profit was 17% at the top end of our business model range.

Earnings per share for the 2004 fiscal year were $1.05 versus $1.03 for fiscal 2003 and above the high-end of the guidance range.

At this point, I'd like to drill down into operating performance, beginning with revenue detailed by business unit.

As you saw in our press release, fourth quarter revenues were a record 59.1 million.

For the fiscal 2004-year, revenues were 185.6 million, up 3% over fiscal '03.

Reported revenue included a 1.3 million contribution from the acquisition of TGS, which closed in May of 2004.

Our defense electronics business unit reported revenue of 42.8 million or 72% of total revenues for the fourth quarter, up approximately 32% from the same period last year.

For the full year, the DEG business unit revenues were 126 million, representing 68% of total corporate revenues.

Within the three application areas, radar, signals intelligence and defense technologies, the group experienced particular strength in signals intelligence.

Our imaging and visualization business unit revenues for the fourth quarter were 8.9 million, representing 15% of total revenues and up 22% from the same quarter last year.

This includes a $1.3 million contribution from the acquired TGS business.

During the fourth quarter, sales from digital X-ray modality were particularly strong.

For the full year, our IVS unit reported revenue of 32.9 million or 18% of total corporate revenues.

Our OEM solutions business unit fourth quarter revenues were 7.4 million or 13% of total revenues, up 60% from the same quarter last year.

Growth was primarily driven by applications serving the semiconductor market, which accounted for approximately 86% of the OEM solutions group's revenues.

For the full year, the OEM solutions business unit revenues grew to 26.7 million or 14% of the total company revenue compared to 20.4 million or 11% for the same period of fiscal 2003.

This 31% year-over-year growth was driven by design wins moving into production and the strength of the semiconductor market.

As a result, we experienced increased shipments of our systems to semiconductor capital equipment OEMs for integration into semiconductor inspection and mass generation systems.

Total company book-to-bill ratio was greater than one for the fourth quarter and for the full fiscal year.

Total backlog at the end of the fourth quarter was 91.2 million, a 9.6 million increase from the end of the third quarter and an increase of 33.9 million from the beginning of the fiscal year.

Of the ending backlog, approximately 89% or 80.9 million relates to shipments expected within the next 12 months.

Gross margin was 71.5% for the quarter, an exceptional result, which is higher than the ongoing company business model.

The strength of defense revenues coupled with the favorable mix impact of certain programs within defense were the primary drivers of the quarterly gross margin results.

For the full year, gross margins were 67.4%, which again is at the high-end of our business model.

Total operating expenses comprised of selling, G &A, research and development expenses in the amortization of intangibles were 28.6 million for the quarter and 93.5 million for the full year.

For the full year operating expenses remained essentially flat on a percentage of revenue basis at 50.4% in 2004 from 51.2% in 2003.

Within operating expenses, selling, general and administrative expenses were 16 million for the quarter and 53.2 million for the year.

Fourth quarter SG&A expenses included the impact of performance bonuses and acquisition-related expenses.

R&D expenses were 11.9 million for the quarter and 38.6 million for the year.

R&D approximated 21% of revenues for the full year.

Amortization of intangibles and in-process technology charges related to recent acquisitions were 0.8 million for the quarter and 1.6 million for the full fiscal 2004.

Operating income of 13.6 million represented 23% of revenue for the quarter and was 31.6 million for the fiscal year.

For the full year, operating income was 17%, up from 14.3% in 2003.

Net income of 22.9 million was 12.3% of revenue, up slightly from 22.7 million in fiscal 2003.

To the balance sheet, cash flows.

Before I address the yearend balance sheet, I would like to take a minute to talk about the financing activity, which occurred during April.

In late April, we issued a $125 million convertible debenture instrument.

The rationale behind this offering is very straightforward.

In support of our previously disclosed acquisition strategy and, ahead of the anticipated interest rate increases, we determined that the convertible instrument would be a more efficient financing alternative to straight debt or equity financing.

In the final analysis, we were able to raise debt at a 2% coupon, positioning us well to execute on our acquisition strategy.

Turning to the balance sheet, operating cash flow for the quarter was 5.4 million.

Operating cash flow was comprised of 9.6 million in net income and 2.1 million of depreciation and amortization offset by increases in working capital.

During the quarter, working capital was significantly impacted by customer order patterns, driving a backend revenue skew for the quarter.

As a result, fourth quarter DSOs, day sales outstanding, came in at 63.

The impact of the revenue skew is evidenced by utilizing the count-back method of calculating DSO, which would yield a day sales outstanding of only 36 versus the reported 63.

Another way to look at this is 99% plus of our aged receivables are collectible within 60 days.

This metric, I believe, is an indication of strength of both our customer collections and the absolute AR balances.

Inventory turns of 6.3 for the quarter were up from 5.6 turns from last year, for the full year, we were able to improve inventory turns by two full terms to 6.9.

For the full year, cash provided by operating activities was 25.9 million.

Capital expenditures were 2.3 million for the quarter and 5.6 million for the full year.

Cash and cash equivalents were 238.3 million at the end of the year, up 109.5 million from the third quarter, primarily as a result of the $125 million convertible debt-offering offset by the cash utilized by the completion of the TGS and Advanced Radio Corp. acquisitions within the quarter.

At the end of the fourth quarter, total employee population was 652.

The increase of 77, from the end of the last quarter, was primarily a result of the TGS and Advanced Radio Corporation acquisitions.

As you read in our press release last evening, the board of directors has authorized an additional $10 million to the previously authorized share repurchase program.

We expect to continue to utilize our stock repurchase program to purchase shares to offset dilution from our employee stock option and purchase plans.

That wraps up the overview of the fourth quarter in 2004.

I'd now like to move on to the 2005 outlook.

I'll first go through the full-year guidance and then I'll speak specifically to the first quarter.

The important data point that I would ask you to keep in mind when developing your own models is that our historic revenue patterns are lumpy.

Quarterly patterns are mostly dependants upon specific program timing and customer order patterns and quarterly revenue assumptions are important determinant of quarter operating profit and earnings.

On the top line, we have built our operating plan under the assumption of revenue growth to a range of 225 to 230 million or 21 to 24% growth relative to 2004.

This range of revenue is supported by business unit program level details to which we have visibility during our planning process.

As we noted on our previous call, this will represent the first time in several years that we are planning for a substantive revenue growth.

The assumptions behind this growth include relatively consistent investment levels into the department of defense transformational programs, the integration of our TGS acquisition into our new imaging and visualization solutions group, modest interest rate increases, and no drag changes in the current semiconductor capital equipment market cycle.

By business unit, we project the full-year revenue mix as follows: The defense electronics business unit will approximate 60% of total corporate revenues.

The imaging and visualization business unit will approximate 20% of revenues.

And the OEM solutions business unit will also approximate 20% of revenues.

In total, this would represent a mix of approximately 60% defense and 40% commercial applications.

Moving through the P&L, we anticipate '05 gross margins to be in the 66 to 67% range.

This assessment is based upon the projected program and business unit mix.

Mercury remains committed to our continuing investment in research and development and we expect that R&D will remain within historical levels of 20 to 21% of sales.

At these levels, we expect that operating margins should approximate 17% for 2005.

With a 30% tax rate and no change to average shares outstanding, we would therefore expect earnings per share to be in the 120 to $1.25 range.

In terms of working capital improvements, we expect improvements in our DSOs to 45 days and improving inventory turns to eight times.

CapEx for '05 is projected to be approximately 8 million compared to 6 million spent in '04.

Depreciation and amortization will be approximately 10 million due to the increase in amortization from intangible assets associated with our acquisition.

OK, first quarter outlook.

We expect the first quarter revenue for 2005 to be in the range of between 51 and 54 million.

At this level, the company is projecting its second largest revenue quarter in its history having just reported its firmest revenue quarter.

For the first quarter, we project operating expenses of 28 million or approximately flat relative to the just-ended fourth quarter as a result of three factors.

First factor, the full quarter impact of recent acquisitions.

Second factor, hiring related to projected growth.

Third factor, uneven program related R&D expenses.

Therefore, first quarter operating profits are projected in the range of 12 to 13%.

At these levels, the company projects a range of 18 to 22 cents for earnings per share for the first quarter.

In summary, for the full year we project revenue in the range of 225 to 230 million or 21 to 24% growth over fiscal '04.

We project gross margins of 66 to 67% and operating expenses to remain relatively flat throughout the year resulting in a full-year guidance for operating profit of 17%.

Our balance sheet is strong.

We have the cash reserves to support our strategic growth initiatives and to finance organic growth in our target application areas.

The strong 2004 performance, again, demonstrated the Mercury capability to turn revenue into profit.

We remain focused on leveraging this skill set and we are committed to maintaining appropriate levels of spending relative to our growth projections.

We are driving ourselves to a more aggressive operating model and, are increasing the operating profit objective reflected in our timeless business model to 16 to 18%, up from the previous operating profit goal of 15 to 17%.

On a quarter-to-quarter basis, we expect continued lumpiness in revenue patterns.

We therefore anticipate that on a quarter-to-quarter basis, there could be variability in profit measured as a percentage of revenue.

However, we are firm believers in our business model and our ability to consistently drive strong operational performance for the long run.

At this point I'd like to turn the call back over to Jay for industry comments and additional context regarding our business outlook.

Thanks, Bob.

Fiscal year 2004 now in the books we can look back at our fourth quarter as evidence of the success of our investment strategies.

We see clear indications of our strategy open innovation is gaining traction as we move ahead into the New Year.

We closed out the year with record revenues.

We have a very strong backlog, the best in our history.

Our defense business logged 35 design wins in '04.

And during the fourth quarter, we finalized two acquisitions.

TGS Group and Advanced Radio Corp.

That will extend our ability to make our customers successful.

Each of these acquisitions provides Mercury with significant strategic resources to broaden our product offerings and serve markets as well as to enter new ones.

TGS, as you may recall, is a leading provider of advanced 3D image processing and visualization software for life sciences, geosciences and simulation applications.

These are new markets for Mercury.

Advanced Radio Corporation or ARC provides radio frequency or RF products for enhanced communications capabilities in both military and commercial applications.

We continue to evolve the expertise that customers need from Mercury as we continue to provide more of a solution to better enable the success of our customers.

With the TGS products, for example, we expect to help our customers to manipulate and exploit the information that their systems generate, extracting more usable information for the radiologist, the geologist, and scientists who are designing drugs.

Today TGS is best known for its Amira and Open Inventor software programs.

We expect to continue developing, supporting and selling these products in their current markets as well as, to leverage the technology in new and enhanced offerings for OEMs in medical and scientific imaging.

The technology underlying Open Inventor and Amira is fundamental to Mercury's ability to solve these problems for our customers.

Our image and visualization solutions team, is currently developing products that integrate this expertise with the XR family of rack-mount service solutions combining with Mercury's professional services and support.

The result will be a new family of products that address the imaging understandings requirements in hospitals, laboratories and research institutions.

We are moving closer to the position, the caregiver.

We anticipate the announcement of some of these products during the remaining months of the calendar year.

We can always say -- already say that these plans have gained traction with key prospects in targeted growth markets.

Similarly, in the Defense space, our investment in Advanced Radio Corp. is enabling us to make new inroads to communications and signals intelligence in order to provide more of a solution to our customers.

The ARC acquisition extends our capabilities in two important ways: first, the need for portable signals and communications intelligence solutions is growing dramatically.

And the technology that ARC brings to Mercury is instrumental in allowing us to serve this expanding market.

ARC's superior synthesizer and tuner products are applicable in our space today and future products that combine ARC's radio frequency expertise with Mercury's signals intelligence processing capabilities will prove attractive to solution integrators in the coming months and years ago.

Secondly, as assets near the battle space assume the task of gathering information, the quality and quantity of data collected grows just as dramatically.

Now that locations at once gather this information of becoming the hubs for synthesizing data collected inside the battle space, so they need more processing power to help better commanders develop the overall picture and direct their forces accordingly.

Our current involvement in platforms such River Joint, AWACS and Joint Stars positions us well for supporting these emerging needs.

During the quarter, we announced three important defense program wins, all of which demonstrates the value that Mercury brings to our customer.

In May, we announced the Lockheed Martin Maritime Systems and Sensors division, selected Mercury's conduction cooled multi computer systems towards Portable Search and Target Acquisition Radar, extended range program or P-star.

Innovative packaging and cooling solutions are increasingly important to the Defense space as harder processors and related components are deployed in rugged environments.

Adoption of Mercury's conduction cool programs for the P-star program is one more demonstration of the traction that Mercury has developed in this important field.

The second of these important announcements also relates to packaging.

Our selection for the design and development phase of the Joint Common Missiles, sensor unit validates our advantage RT, FPGA solution, which provides PCI based products to package to withstand forces common to the missile environment.

Our ability to adapt the latest processing technology to the requirements of this program demonstrates our expertise in packaging high performance solutions for deployment in challenging environments.

Another important win, which we recently announced is the multi platform radar technology insertion program or MP-RTIP.

The MP-RTIP program will upgrade the radar processing systems on several US Air Force platforms with Mercury's RapidIO-based PowerStream 7000 computers.

The platforms include the Global Hawk UAV and the new E-10 Multi Sensor Command and Control aircraft also known as MC2A.

Once again packaging is a key consideration because the PowerStream 7,000 includes several different innovations that allow it to deliver the extreme performance density required for these high performance airborne applications.

In our OEM Solutions Group, reported excellent results this year as it demonstrates the traction that it's gained in markets.

The group reported excellent revenue growth in part from the movement of semiconductor industry design wins into production.

The other side of the OEM Solutions Group is communications computing, which is focused on solutions for the telecommunications industry.

We recently introduced a product referred to as Ensemble, a serial RapidIO Advanced Telecom Computing Architecture or AdvancedTCA, as a development system.

AdvancedTCA and RapidIO are key technology requirements for the telecommunications industry and the Ensemble system is the first test bed that lets them qualify and characterize RapidIO system performance before committing to a production platform architecture.

This helps telecom to reduce integration costs, improve efficiency, and minimize risks in design and test of next generation applications.

In conclusion, fiscal 2004 in the fourth quarter particularly, has been a time of growth and development at Mercury.

We've laid a foundation that will continue to support our growth in the coming years.

We've increased our resources in several key growth areas and are seeing very positive results.

We continue to see strong results from our traditional markets and to explore acquisition opportunities will further strengthen and expand our business core.

Our strategy is sound, our team is solid, and we remain very confident in Mercury's continuing growth and profitability.

We'll now open it up for questions.

Thank you. [OPERATOR INSTRUCTIONS] And, we'll go to William Benton with William Blair.

Good morning, guys, congratulations on a strong quarter.

Just a couple quick ones.

I know they wanted me to limit it to one but, I just have to follow up on your comment with regard to the first quarter operating margin expectations.

I just want to make sure I understand, where are you at in terms of your aggressive hiring plan so far this quarter?

And, how much in the last quarter would you say was kind of catch-up?

Obviously you guys exceeded -- I would guess you exceeded your internal targets and you had to catch up for bonus accruals at year end and I'm just kind of curious how much that was in there.

Bill, it's Bob Hult.

We've got an OPEX step up over those two quarters that you can see takes us from approximately 22 to 28, something like that.

About half of what you saw in the fourth quarter would fall into the category that you're labeling catch up.

I'm not sure I'd quite call it that, we had some bonuses, significant bonuses and comp charges that were not accrued for in the fourth quarter because we had such a strong quarter.

Right.

The other half of the step up from 22 to 28 falls into the three categories -- kind of spreads across the three categories that I outlined before.

The full quarter impact of recent acquisitions, that alone is in excess of a couple million dollars.

OK

So hiring related the projected growth, it's measurable but it's not the largest category and then of course what I labeled uneven program-related R&D expenses, we're not just getting ready for growth.

Jay and I were discussing, we just had the largest quarter in the history of the company and number two coming up here so we're feeling like we're experiencing growth right now and we've got some R& D expenses that accompany that.

Right.

So across hiring, acquisitions and R&D activities directly associated with revenue growth.

OK.

And then the question on the current quarter, I know things are lumpy between quarters.

You guys had a huge third quarter in the IVS and OEM Solutions Group and, I know you had year-over-year growth in those segments but, sequentially they had dropped a little bit and, I just want to make sure from your point of view, has anything changed in that business at all?

How was the, I guess, TGS acquisition going so far?

And I'm kind of curious, are there any inventories you see at those customers?

The answer is no, no, no.

No inventory issues.

The acquisition integration, and for both TGS and ARC are going extremely well.

We have the senior management team consisting of Bob, Bob Becker, Craig Saline and myself that review on a monthly basis the activities relative to the integration.

We're out visiting the sites, meeting the people.

A lot of excitement with regards to the new people that have come on board.

So, everything is going extremely well there.

And, just one more comment about your, catch-up question.

Last year, in anticipation of maybe not such a great year, we in fact had put in a salary freeze.

And, so everybody here was operating without any salary increase last year.

And the commitment I made to them was that if we hit certain goals that we would make up -- try to make up for some of that and that's what we did.

OK.

Great quarter, guys, thanks.

Thank you, Bill.

We'll go next to Rob Stone, SG Cowen and Company.

I wonder if you could comment, Jay or Bob, on what drives the increase in your longer term operating margin goals.

Does that relate at all to the increase in the mix of software, for instance, through TGS or is there something else behind it?

Rob, you're referring to the increase in the range?

Yes, that is -- you slightly raised the range for your operating margin target.

We did, we moved it from a range 15 to 17 to 16 to 18.

I think I want to relate that one to -- to one thing.

And that's growth.

You know, the kind of growth that we believe is in front of the company is going to give us a leverage opportunity here.

I think you also saw that we're holding fairly firm with our gross margin guidance or range from a model standpoint.

And, I think you'll always see that operating expenses at Mercury are going to slightly lag the revenue growth.

So, I think when you push that all together, we're coming with a -- with a modest degree of confidence that we've got a very solid operating margin opportunity here in front of Mercury, we're currently assessing in the 16 to 18% range.

Having said that we just did 17 and we're out there early with 17% for '05.

Great.

Along those lines, how much of the 21 to 24% growth that you're looking for this year is related to the two recent acquisitions?

I'll take a stab at that and then we'll let Jay put some color on that.

But the largest acquisition was TGS in the medical space.

But of course we've repositioned the whole business unit.

We now call it IVS Imaging and Visualization Solutions, and that unit, as we said, would be approximately 20% of our revenues in '05.

So the IVS unit is going to experience growth in '05 over '04.

The big driver in there is the TGS acquisition.

So, I'd say that that's primary to the growth that we're going to experience in IVS.

Without it, we would not be seeing growth.

We in all likelihood be experiencing modest decline.

The Advanced Radio Corp. acquisition, you know, much smaller, it was a pre-revenue company.

I think we indicated that backlog was -- orders backlog was starting to materialize for ARC, but, you know, the leverage point there for ARC is Mercury's account relationships and our go-to-market resources, our sales team.

So, I'm kind of viewing ARC as an extension of our product line.

We're clearly planning on revenues coming from most technologies, most products but, you know, they're quickly getting integrated into what we do in defense.

So that was a bit tough to specifically break out.

Just to add a couple of comments.

As Bob suggested, while we'll be -- the ARC products, while we'll be selling them separately, the goal is primarily to integrate them into an overall processing system and so we're not going to be necessarily tracking or reporting it on it we'll be tracking but we're not going to be reporting on revenues separately for the ARC operation.

With regards to TGS, I think we've said before that their revenues are in the $7 million to $8 million range prior to the acquisition.

We see some growth in TGS as a standalone entity, if you will.

But the real benefit there is coming from the introduction that it's giving us into new markets and the understanding that we're having -- we have now as to how to build platforms that can take that TGS software and work the Mercury magic, if you will, in terms of accelerating the performance because the customers that TGS has had, many of them are looking for cost effective ways to increase the performance of that software.

So, we're going to be marrying that TGS software on to traditional Mercury platforms, some of which will be Intel based, that's what I was talking about when I announced or talked about that XR system.

And that is going to, we believe, provide significant growth for these markets that require 3-D visualization, that requires a lot of compute power.

That's not going to happen in the next couple of months.

It's going to take us a few months to get those products together and introduce them into the marketplace.

I'll turn it back to you, Rob.

It sounds like if I parcel that correctly, just approximately, of 21 to 24%, probably somewhere in the mid to high teens is organic growth of the business and the balance is the acquisitions?

Yes, that's probably about right.

I mean, I'll come at it differently.

You know, $10 million is coming from TGS and Advanced Radio Corp.

I think you and I end up at the same point there.

All right, thanks very much.

Yes.

Just a reminder, if you do have a question please press the "star" key followed by the digit "one" and we'll go to Steve Levenson with Advest.

Good morning Jay and Bob.

Good morning, Steve.

Specifically in relation to Advanced Radio, how do you think that's going to affect your average selling price, not necessarily in dollars but in percentage to your signal intelligence customers?

Do you see them spending more per unit and in addition, do you see them expanding their number of units with the demands for their products?

Well, we certainly expect that the capability is going to get us into markets that we are -- I shouldn't call them markets because it's all signals intelligence marketplace but, it's going to get us into new application areas and new customers with that capability.

And, then those that they require the processing power of course we'll be selling Mercury's standard products into that in addition to the RF front end.

OK, but as an integrated product, as you mentioned before, do you see the price increasing substantially per unit or is this something that's going to be offered just -- I'm not going to say as a convenience, an add on?

No, we're not going to sell the combined products for the same price that we sell the current one for if that's what you're asking.

There's a hell of a lot of value in the RF front end products that ARC is producing.

OK.

Secondly, in relation to UAVs and of course this morning there was an announcement that the aerial common sensor program has been awarded, do you have some exposure there?

I know it's out in the future but obviously they're going to be beginning work on that program pretty quickly.

Well, we've been working with the primes who were bidding on that.

So I would expect that there will be some benefit to us from that but I can't tell you short-term what that's going to be worth.

That's a long-range program, as you know.

OK, I guess that's it.

Thank you very much.

And we'll go with a follow-up with William Benton with William Blair.

Hey, guys.

Just to go back, I mean, I know I always ask this question but you guys reported obviously 23% operating margins this quarter, which is fantastic.

If you annualize out this quarter you'd be at 236.

I look at your target, I'm -- I'd actually like to see it raise.

But, I look at it actually as you having more opportunity.

Is that a fair assessment of the situation, that you're kind of looking at the model as kind of saying, OK, middle of the operating margin, the traditional -- or the new model is about 17% so you're just using that or it would seem that there's upside potential there at least.

Jay is pointing at me, Bill.

So I'll take the first crack at it.

You know, we know what we're looking at and that's what we're sharing.

What you're looking at and what you're thinking about is certainly fair.

OK.

Can you just update us on -- Jay, you talked a little bit about how you're still looking at acquisitions, obviously.

Maybe if you could just update us on the acquisition efforts and then also maybe offer some perspective on some of the news accounts recently, which have been a little conflicting on transformation efforts and defense spending in general, I was wondering if you could just comment on that.

Well, I'm not -- well, let me address the transformation question first.

I don't know what you're referring to specifically, Bill.

So I can't comment on that.

But, suffice to say that the efforts that have been under way for the last few years, everybody believes will continue regardless of if there's a change in administrations because it's what must happen in order for the US to be successful and have a strong military in the future.

So, you know, there's always the potential of short-term impacts on some of the spending, but all the projections I've seen would indicate that continued spending in that area specifically for intelligence, surveillance and reconnaissance.

So you're not seeing any changes, obviously?

No, what you may have -- what you may be referring to was something that came out, I think I saw it on future combat systems, that talked about some of that being extended out, nothing that we didn't anticipate and certainly no impact on any near-term prospects for us.

OK.

I forgot the first part of the question.

The acquisition, kind of update on acquisition efforts.

Yes, well, we're working very closely with two different banking teams to, you know, help us uncover opportunities.

We've got a reasonably good pipeline that we're working today.

We're looking in all three of our business areas, if you will, trying to find ways to continue the growth there.

And, we're also looking in what we would refer to as the technology vector to see if there are opportunities for us to find software companies such as TGS that would have products that are applicable across markets.

So we're looking both ways.

We're looking for cross-market and, we're also looking within the existing markets for ways to strengthen those business units.

OK.

Great, guys.

Thanks again.

Just a reminder, if you do have a question, please press "star", "one".

And we'll go next to Chris Recky (ph) with Tenner Capital (ph).

Good morning.

Just wondering if you could comment on the impact of the potential accounting change regarding contingent convertibles and whether you have any plans to offset the dilutive effects of that.

Thank you.

Sure.

I may need to ask you to clarify the second part of the question.

I'm not -- it didn't come through that clearly on this side but...

I'm sorry, just if you could -- if you have any plans to offset the dilutive effects of the rule change if it goes through.

Sure, OK.

So, first, the proposed rule change;

I think simplistically, when and if it becomes GAAP, you know, we'll comply immediately.

There's no option there.

And, you know, we'll see how it develops.

It looks like this particular modification is on a relatively fast track.

So, we're watching it carefully along, I think, with the other 305 corporations that offered contingent convertibles in the last two or three years.

The, you know, underlying it is approximately 4.1 million shares.

So, that would figure into the calculation should there be a change here.

Right now it's not in.

So, I think that's a stay-tuned.

The second part of your question was if the rule was changed, would we buy back, I guess, 4.1 million shares to offset the dilution.

And I've learned over a few or many years now, never say never.

But, I'll try to answer your question in the spirit it was asked, and probably not.

These convertible debentures did price with a very nice premium, 38%, to where we were trading when we offered them and I think, you know, we offset as much of the dilution according to perhaps new rules that way as is possible.

So, no, we would not do that.

We raised that money to support our strategic initiatives looking forward over a multi-year horizon.

And, I think we're also very careful to say that yes, we did have $130 million in the bank when we put an additional 120 in.

But, the best way to look at that is we're not going to spend the other guy's money, the convertible debenture but it certainly freed up the 130 that we had and made it a lot more flexible in terms of supporting the strategic agenda, and I'm speaking specifically there to the acquisitions.

OK.

Thanks.

And there are no further questions at this time.

I'll turn the conference back to you for any closing remarks.

Thank you all for your questions and, the opportunity for us to have this dialog today.

We hope that what you take away from our call today were two strong messages.

First, the anticipation of the top line revenue growth is a very exciting piece of news, we believe.

Today, we confirm with additional details the revenue growth projections we sketched out for you in the April conference call.

We see clear indications that our strategy of open innovation is gaining traction and project 2005 revenues in the range of 225 to 230 million.

Second, and very significantly, we are reaffirming our commitment to the wise investment of this incremental revenue.

Mercury has demonstrated a core competency in delivering profits.

We're confident of the ability to execute this strategy.

Again, we thank you for attending this call today and, for your interest in Mercury.

Look forward to talking to you three months from now.

That concludes today's conference call.

Thank you for your participation.