Mercury Systems Inc (MRCY) 2008 Q1 法說會逐字稿

Good day and welcome to the Mercury Computer Systems, Incorporated first quarter fiscal 2008 earning results conference.

Today's call is being recorded.

(OPERATOR INSTRUCTIONS) At this time for opening remarks and introductions, I would like to turn the program over to the Manager of Financial Planning and Analysis, Ms.

Leslie Schaefer.

Please go ahead, ma'am.

Good afternoon, everyone, and welcome to the Mercury Computer Systems earnings conference call.

With me are Jay Bertelli, President and Chief Executive Officer, Bob Hult, Senior Vice President and Chief Financial Officer and Alex Braverman, Vice President, Controller and Chief Accounting Officer.raver man.

If you have not received a copy of the earnings release you can find it on our Website www.MC.com, or on the First Call Network.

We would like to remind you that remarks that we make during this call about future expectations, trends, and plans for the Company and business constitute forward-looking statements which involves risks and uncertainties that could cause actual results to differ materially from those projected or anticipated.

Additional information regarding forward-looking statements and risks is included in the press release we issued this afternoon.

Reporting the Company's first quarter fiscal year 2008 results and the Company's periodic reports filed with the SEC.

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.

In addition to reporting financial results in accordance with Generally Accepted Accounting Principles or GAAP, we will also be discussing non-GAAP financial measures adjusted to exclude certain charges which we will specifically identify.

Managers believes this non-GAAP financial measures assist in providing a more complete understanding of the Company's underlying operational results and trends and management uses these measures along with their corresponding GAAP financial measures to manage the Company's business, to evaluate its performance compared to prior periods in the market place and to establish operational goals.

However, they are not meant to be considered in isolation or substitute for financial information provided in accordance with GAAP.

The reconciliation of GAAP to non-GAAP financial results discussed in today's conference call is contained in the Company's first quarter fiscal year 2008 earnings result.

I am now pleased to turn the call over to Mercury's Senior VP and Chief Financial Officer, Bob Hult.

Thank you, Leslie.

Good afternoon everyone.

I will review revenue for the first quarter of fiscal year 2008, including details by business, discuss company operating performance, balance sheet and cash flow results.

And then finish with a discussion regarding the outlook for the next quarter and the remainder of the fiscal year.

I will discuss the numbers of both the GAAP and non-GAAP basis.

First quarter revenues were $49.2 million, slightly above our guidance of approximately $48 million and about flat with last year's first quarter.

Gross margin was 64%, well above our guidance of 67% due primarily to a favorable customer and product mix.

Lower excess and inventory reserve expense driven by improvements in our supply chain management also contributed to this improved gross margin.

In addition, the operating margin was favorably effected by the restructuring actions we took last year which has significantly reduced operating expense.

GAAP operating loss was $3.3 million.

This includes stock based compensation expense of $2.7 million and amortization of acquired intangibles of $1.8 million.

The GAAP net loss for the first quarter was $3.3 million.

Resulting in a loss per share of $0.15 versus our guidance of a loss of approximately $0.33 .

On a non-GAAP basis we recorded an operating profit of $1.3 million for the quarter.

The non-GAAP operating profit excludes stock based compensation expense and amortization of acquired intangible assets.

Non-GAAP net income was $2 million, our non-GAAP earnings diluted earnings per share for the first quarter were $0.09.

Above our guidance, previous guidance of a loss of $0.08.

The book-to-bill ratio for the quarter was 1.1 driven primarily by our Defense business.

Backlog including deferred revenue was $84.2 million.

A $5.6 million sequential increase from the fourth quarter of last fiscal year.

Of the ending backlog, $63.4 million or about 75% relates to shipments expected within the next 12 months.

As we announced last quarter, we have reorganized the Company along new reporting segments.

This new business unit structure was designed to facilitate operational benefits that we believe will spur innovation, drive revenue, and help us contain costs.

Our new Advanced Computing Solutions Business Unit or ACS, consists of our Aerospace and Defense, Semiconductor, Teleconference and Legacy Life Sciences Businesses.

For the first quarter ACS reported revenues of $42.2 million or 86% of total revenues for the quarter.

A 2% decline from the year ago period.

The slight decline is the result of a year-over-year drop in ACS Commercial revenues of $20.9 million to $14.1 million or approximately 33%.

This drop was offset by an increase in year-over-year defense revenues from $22.3 million to $28.1 million or approximately 26%.

Our new Visage Imaging Business Unit, focuses on the treating medical imaging market.

Concentrating on visualization and PAC software solutions.

Visage Imaging is a wholly-owned subsidiary with the majority of its operating activities such as R&D and sales functioning on a stand-alone basis.

For the first quarter, Visage Imaging reported revenues of $3.9 million or 8% of total revenues, flat with the year ago period.

In the first quarter, Visage experienced a product release delay and continued extended sales cycles with several major customers.

This business is still in start up mode working on refining its products and forging relationship with customers.

Despite the flat revenues, we are encouraged by the signs of customer attraction at Visage and we expect it to help drive the better comparisons we have been forecasting for the Company during the second half of this fiscal year.

Our Visualization Sciences Group or VSG, is also primarily a software business.

Selling development toolkit and visualization applications to geoscience, engineering, and manufacturing, material sciences and other industrial and scientific markets.

VSG reported a $2.6 million in revenues for the first quarter of fiscal 2008 versus $1.6 million for the same period of fiscal 2007, up about 63%.

This is still a small business but growing rapidly from a small base.

Our emerging businesses consists of new business opportunities that benefit the Mercury's capabilities across markets.

Current area of focus include computing and visualization in biotech and aircraft navigation.

These businesses had revenues of 500 K ($0.5 million) in the quarter up 200 K ($0.2 million) in the first quarter of last year.

Also included in this segment is the new Mercury Federal Business which is a start up effort aimed at Design Services, Systems Engineering , and Associated Product sales to Intelligence and Homeland Security agencies.

We do not expect Mercury Federal to have a material impact on fiscal 2008 results.

Turning to the balance sheet and cash flow statement, cash, cash equivalents and marketable securities at the end of the first quarter of fiscal 2008, we are $158.6 million.

Representing a $1.5 million increase from the end of the fourth quarter of fiscal year 2007.

This small increase includes a net operating cash inflow of $4 million, an out flow of 800 K for capital expenditures and 2.4 million out flow for the acquisition of the remainder of the Biotech venture we invested in last year.

First quarter day sales outstanding were 63 days, inventory turns 3.0 for the quarter.

The days were adversely impacted by end of quarter shipment SKUs and the turns were unfavorably impacted by lower revenue in the first quarter as compared to the fourth quarter of last year.

At the end the quarter, the total employee population excluding contractors was 737 employees.

I would now like to move to second quarter and full year 2008 guidance.

For the full year fiscal 2008, we continue to expect revenues to approximate 225 million with acceleration in the second half of the year.

We continue to project a full year revenue mix of approximately 50% defense and 50% commercial applications.

Despite a relatively flat top line on a year-over-year basis, the Company continues to expect significant improvement in the bottom line as a result of the restructuring actions taken in the fourth quarter of 2007.

And in addition, we believe our gross margin will continue to be stronger than we anticipated when we gave guidance last quarter.

For the full year fiscal 2008, we currently expect our gross margin to approximate 59% versus our previous expectation of 57%.

Due to the favorable customer product mix and continued favorable inventory reserve provisions.

For the fiscal year, operating expenses are currently expected to approximate 128 million.

This excludes stock based compensation and amortization expense.

We are improving our GAAP full year 2008 EPS guidance from a loss of $0.63 to a loss of $0.54.

A GAAP tax provision is estimated at 3.5 million for the fiscal year.

Diluted shares for the year are projected to be approximately 21.5 million.

The impact of stock based compensation costs for the full year will be approximately 11 million.

The amortization of acquired intangibles will be approximately 7 million.

But non-GAAP effective tax rate will be 30% and the non-GAAP shares are projected to be approximately 21.7 million.

As a result of these adjustments, we currently expect fiscal year 2008, non-GAAP earnings per share to be approximately $0.33 versus our previous guidance of $0.17.

CapEx for 2008 will be approximately 7 million, depreciation approximately 9 million.

The second quarter we currently expect revenues of 51 million.

Currently anticipate the gross margin to be approximately 58% in the second quarter.

Operating expenses approximately 32 million, again, this excludes stock based compensation and amortization expenses.

Based on gross margin and operating expense expectations we are forecasting lower EPS in the second quarter than we reported in the first quarter with the expectation that EPS will improve in the second half of the year.

GAAP tax provision is estimated at 1.8 million for the second quarter.

Diluted shares, 21.5 million.

The result in GAAP losses per share, currently expected to approximate $0.37 for the second quarter of fiscal 2008.

Impact to stock based compensation cost for the second quarter will be 3 million and the amortization of acquired intangibles will be approximately 1.8 million.

Non-GAAP tax rate is 30% and the non-GAAP diluted shares are approximately 21.5 million.

As a result second quarter fiscal 2008, non-GAAP losses per share are currently expected to approximate a loss of $0.05.

At this point I would like to turn the call back over to Jay for his Industry currents and

Thank you, Bob.

Good day, everybody.

I have a question for you.

How many of you are wearing red socks?

I am.

The only thing I am more excited about the Red SOX is the first quarter performance.

The positive book-to-bill ratio of 1 to 1 for the Company is very encouraging.

While a few more quarters with simular results must be achieved before we can forecast a trend.

We believe we are on a track based on the design wins over the past several quarters plus the robust sales pipeline and our Advance Computing Solutions Business Unit.

We have transitioned through the acquisition integration phase and are achieving the positive results we anticipated from the IP we acquired which has been turned into leading edge products for our markets.

We have also transitioned through the organization restructuring phase with the new ACS organization producing the forecasted cost savings as evidenced by the quarter's results and the Visage Imaging organization structured to focused on Advanced Visualization applications primarily in the microdiagnostic imaging markets.

Our traditional value proposition based on our ultimate performance multicomputer platforms has been challenged.

Consequently, we've had to reinvent the Company and to a lot more market specific value propositions.

In the defense markets, we have modular products that start at the sensor or antenna, extend through the processing chain and the visualization of the output.

These marginal products, ...

I E, RF tuners, Data conversion products, ADDs, combined with preprocessing capabilities are traditional high performance multicomputers, signal board multicomputers with extensive I/O capabilities, and visualization software enhanced with GPU capabilities are also being delivered as integrated systems solutions.

Our extensive software expertise ties these modules together to bring significant value to the customer.

We believe we now have the broadest range of the product offerings in the industry to provide our customers one-stop shopping for all their computing needs, for modules, to fully integrated systems..

The investments we have made in new products and our traditional high-end space, plus the investments in our acquisitions that we have made over the past three years are starting to pay off.

Seven of the eight design wins in Q1 achieved by our ACS business unit includes products originating from our acquisitions.

Our next generation single board computer product and the data conversion NRF products enable us to capture the seven design wins in defense.

With a potential combined value of $75 million to $100 million over the next three to five years.

Another design win in the commercial space for a satellite communications based station is based on the ensemble 2ATCA based product line.

Initial estimates for revenue when the system goes into production are $10 plus million over the next couple of years.

With regards to ACS, I would like to make a few comments about the [AEGIS] program.

Some of you may have red the October 15 edition of Defense News.

The article entitled, quote, improving AEGIS, end of quotes.

Speaks to the plans to expand the upgrade effort to modernize the ballistic missle defense capabilities of the fleet.

While we are currently primarily focused on eradicating terrorists we can't ignore road nations with nuclear capabilities.

The premodernization or interim program for 18 ships is underway.

When the AEGIS BMD 4.0.1 system is inserted into the program, it will include our power station, our power stream 7000 system.

Several of our systems have shipped for test and evaluation purposes.

Direction orders are expected in the second half of calendar year '08.

The value of the systems is estimated in the low single-digit millions per ship.

We anticipate 10 to 18 ship sets for the premodernization phase of this program.

The current modernization program which then succeeds the premodernization is scheduled for EGIS to begin upgrading 62 destroyers and 22 cruises, starting in 2012.

Many, if not all this ships will be equipped with the BMD multi mission signal processors which includes our power stream 7000s.

Our Visage Imaging, we have reinvented our medical business moving from a hardware based imagery reconstruction focus to advanced visualization for Life Sciences with a software business model.

We have launched the Visage brand to signify the separation from Mercury and to generate the market specific focus internally and externally.

Visage Imaging was recently selected by Frost and Sullivan to receive the award of quote, Product Line Strategy Leadership, end of quotes, in medical.

The thin client server model with the advanced 2-D and 3-D visualization applications is the platform of choice.

The North America Advanced 3-D and 4 D visualization market report from Frost and Sullivan sites a market of 575 million in 2007 growing to 1.3 billion in 2013.

The development of 3-D visualization is in the early adopted market stage.

We believe we are entering the market at the right time with the right products which have been designed to address the deficiencies in the products currently in use.

The chasm will be crossed when we sign a few of the major players.

We believe we can exit Q4 FY '08 with bookings that would suggest a 5 to 8% market share.

General comments.

We lost our momentum a few years ago for a few reasons.

Most of which were attributable in my view to poor execution.

My opinion is the strategy was mostly right but the jury is still out on some of the initiatives.

The nature of our business being OEM and prime based with the long time period to production, it take as few years to regain the momentum we lost.

I had players on the field who had not produce.

We were not working together as a team.

The personnel changes we have made over the past 12 to 18 months are starting to produce positive results.

The Q1 results demonstrate that we could be profitable and generate cash with little or no revenue growth in FY '08 over FY '07.

The investment initiatives in new products, in new markets are beginning to produce results.

As a designs wins move to production, we believe we will return to operating income in the 15 plus % range when the top line starts growing.

I would like to mention the investor day we have scheduled for November 13.

Most of you hopefully have already received invitations to that date.

There will be a reminder going out sometime later this week and for those of you who have not received the information yet.

As a guest speaker we have Dr.

Elliott Siegel.

Professor and Vice-Chairman, University of Maryland Department of Diagnostic of Radiology and the Chief of Imaging at the Veterans Affairs Merlin Health Care System.

He is going to be obviously addressing the imaging market place which is of interest to all of us.

So, in conclusion, today I borrowed a theme from the Red SOX Nation.

We believe.

And I used it several times in my comments.

So I leave you with this statement and a question.

I believe, do you believe?

We will open up the call for questions.

Are you ready for questions sir?

We are, operator.

(OPERATOR INSTRUCTIONS) .

Our first question will be from Brian White with Jeffries.

Please go

Good afternoon.

When we look at the defense business, will this business grow sequentially in the December quarter?

The, Brian, Bob here.

The ACS business, let me back up even further.

Our guidance at 51 for the December quarter is coming off a quarter of 49.

So total is not not that much growth sequentially and as you can see from the information I shared around Q1, we had growth, significant growth in the defense business and our commercial business did fall off a bit from previous quarters.

Both of those businesses are characterized by lumpy orders and lumpy situations with customers.

So, I don't think it is going to be too, too much different from what we saw in Q1.

But for the full year, we are expecting 50% defense.

50% commercial.

Maybe a little bit stronger in favor of defense based on what we could see right now so I don't think it is going to be too dramatically different from Q1 if terms of mix.

Little less defense percentage wise than we just experienced in Q1 because it was very strong due to certain programs, drawing orders down.

Okay.

So how do you gross margin go from 64% to 58% in one quarter.

How do they go down?

Yes, how do they go down.

Well, we have a couple of moving parts here.

I will take the easiest one first.

The improvements we have made and continue to make in the supply chain are our ability to really cap the gross inventories and do a much better job of demand forecasting and working with our supply chain partners our EMS partners and really seeing the benefit in the need for inventory, excess and absolute inventory reserve provisions.

We had a pretty good pick up on Q1 on that.

Approximately 2 points of the improvement that you saw in the 64% versus the previously guided 57%.

So maybe a third of that was in the inventory provision space.

And we believe that that is a permanent improvement or at least a portion of it.

So we are thinking we got a solid point to sew there and we are not quite ready to say we got the full 2 points.

The rest is customer and product mix.

As I said, we will arguably have a little less defense in favor of commercial in Q2 and that does come with a lower gross margin and then inside of the defense business we are depending on specific product mix.

So, it is going to come down to, well, we will say 59% and we just did 64, so,.

Okay.

And how -- .

One thing you want to remind everybody, yourself included.

Last year the company performed at approximately 56% for the full year with a high degree of regularity quarter-to-quarter so this is a huge step up for us.

Taking last year from 56 to guiding this year at 59, and you saw it in Q1.

There is the potential to do better than that.

And we are not ready to commit yet to that to you guys.

Okay.

Wen we look at the four operating units how should we think about the gross margins here for the four operating units.

It is not something we really broken out in the past.

The big operating unit is ACS and it is 85% or better of the company.

And that's the big moving part.

The other operating unit that has revenues, two other units.

VSG and VI, are both software oriented business units.

Now, VI, the tool kit business, if you will, the business we acquired a few years back, it is fairly mature.

We get a gross margin there that reasonably looks like a software company.

When you come to VI, the new Visage Imaging business, focused on Life Sciences, there is a mix of software and hardware in there.

And it is more software than hardware, but of course that moderates the gross margin.

So VI has a gross margin of 80, 90%.

Is that what we are looking at?

No, it is above 70% and below 80, VI.

Okay.

Then VSG has a gross margin of, where do you think that is about?

I am sorry, VSG?

Yes.

Yes, I was actually answering your first question as VSG and that's in the 70% plus range.

Okay.

VI is not at that level because of the hardware software mix.

Okay.

Is it a corporate average?

The VI business?

Yes.

VI, is actually is a little bit better than corporate average.

Not much but a little bit better.

Improving as the software content increases, it has got to move.

It will move up.

Okay.

Thank you.

Yes.

Our next question will come from Rob Stone with Cowen & Company.

Hello, Rob.

With respect to the market wise and share you mentioned for the Visage business, you suggested that this was I think 500 million market, right.

There's a recent report that came out from Frost and Sullivan that suggest the not American market is about 575 million for advanced visualization.

So, you also said that this is an early adopter market but it is my understanding that PAC systems has been around for a few years already and if the market is that large, I wonder who are the leading market share players and how large for example are the respective shares of the biggest competitors that you face?

The confusion Rob, that always seems to creep into this is the understanding of what constitutes PACs.

And PACs is the basic infrastructure within the hospitals that consist of the combination of the image database and the database if you will, the medical records and the infrastructure to store and communicate that information throughout the hospital.

It is not the high performance advanced visualization part of it that we are talking about it.

You absolutely right, PACs has been around for a long time.

I can remember back in, the early 90s we were supplying a component to Siemen's when they were installing the first PAC system for the U.S.

Army.

And they were using our systems to do some compression work on the imagery.

But in any event, PACs you could argue is a mature market and what we are suggesting and for what Frost and Sullivan I think is suggesting is that the visualization applique on top of the PACs 3-D visualization is what is emerging and the numbers that I quoted there, from Frost and Sullivan's report 575 million form the North American market.

Coming back to the question of competitors though, is this a concentrator or fragmented market or how big is the biggest competitor?

The, I don't want him to speak here, it is a data, and it is about two thirds, I believe of the market or 60% of the market.

So, it has gone to the big guys, the big OEMs and 20% to a number of smaller independent companies, if you will.

And the large company that we track and follow, that we think we are more akin to, is Vital Imaging, it's a public company, revenues in the 70, $80 million range.

AirRecon is another one.

They are a private company.

Not clear what their revenues are.

We suspect that it's north of 50.

From the point of the positioning vis-a-vis of the large OEMs which is in medical imaging generally have been among your customers, what is the differentiation strategy?

The, we have got a 2-pronged distribution strategy, one is to go after the OEMs which we have been doing and the other is to have a both a distribution network and a district sales force which we are just starting to ramp up to go after the smaller hospitals and the imaging clinics directly where there is less competition from the big guys and we are branding the product in such a way as to try and recreate some demand pull through the system by our ability to install in existing, the smaller hospitals and clinics and we have got several installations if you will at-- at the clinical sites that are considered to be luminary sites in order to get the feedback from those folks and get that publicized and the big differentiator and was the reason for the Frost and Sullivan award is this thin client server model that we have that nobody else has out there.

I am sorry I was talking when were you talking, Rob and I missed it.

You noted there the differentiation is primarily around the thin client server approach so what architecture topology are the competitors all using?

Work stations.

Rob, I would hope that you would be able to come to the investor day and listen to Dr.

Siegel, because he is going to be giving an industry overview and you will get firsthand information, if you will, that will help you understand this market and our opportunity for us a lot better.

Thank you.

(OPERATOR INSTRUCTIONS) We move now to Liz Defreitas with Stifel.

Hi.

My questions with regard to the Synthetic Vision system, how much do you think that opportunity could grow other the next couple of years for you?

Well, I think we said or I believe I said in my comments that we think we can exit Q4 with a bookings rate that would give us somewhere between 5 and 8% of the market share and if the, if you believe the Frost and Sullivan number of 575 million as the size of the market for 2007, it would give you some idea of what we are talking about.

I hesitate to give you the number.

All right.

Thank you.

The next question would come from Jim Mackery with David J.

Green.

Jay, Bob, one aside, my son is rooting for the red SOX and I think you answered my sales mix question previously so if you could talk about, there were few little acquisitions on the cash side.

Anything of note to point out there?

We took a minority position with, I would call it a biotech startup a year ago, 18% was the position we took.

And we had our rights to the other 82% if you will and we took those down in August during this just completed quarter.

So we now own the whole operation, if you will, and that was the payment I was referring to.

Just over $2 million, the total price we paid was roughly $3 million.

Okay.

That's the only item of an acquisition nature that occurred during the December quarter.

Is that going to be reported in the, in that other category we had.

The emerging businesses I suppose.

Yes.

We refer to that as our biotech venture, if you will.

But it will be in that segment for Q&K reporting.

Super, thanks, guys, I look forward to seeing you on the 13th.

You can find out more about them by looking at solmap.com, that's their website.

Thank you.

Our next question will come from Jeff Rosenberg with William Blair.

Please go ahead.

Good Afternoon.

Hi, Jeff.

When we look at the expectation for the second half ramp, is that.

How much of that is tied to improvements with business with ages or any sort of color on the specific visibility you have on the improvement?

Well, there is some AEGIS business, I'm going to say single-digit millions that we have in the forecast for this year and I can't say it is coming in to Q2, but it is in the forecast for this fiscal year.

And obviously given the commercial part of the business was even a smaller part this quarter.

There is even a more substantial ramp there.

And can you talk a little.

More of that is coming from Visage.

And what is the on the non-defense side.

Visible drivers that you can talk about in the second half ramp.

Our view forward, where is that step upcoming from in Q2 and it is coming from, It's coming certainly from Visage Imaging and our ACS business.

That's where the bulk of the dollars coming from.

And I hesitate to parse for you but you will see dramatic step up in Visage Imaging.

So, it is not insignificant the growth there in terms of dollars even though what that group just reported here in this September quarter or what we reported on behalf of that group is about 4 million.

Okay.

Step up there and also a step up in the ACS side which we believe will be continued to be driven by the defense and the commercial opportunities.

Jeff, the commercial business that we are talking about here is some that we have had for quite awhile like with KLA Tank Corp, .

for example and it is business coming out of there, at Metric Graphics, is another one, we refer to it all as Metric GRaphics, but the business that comes about as a result of the sale or the licensing of their software to the manufacturers to, the chip manufacturers that are using their software in conjunction with our software on a cell

Did the mix this quarter surprise you in ACS or did you, I know the revenues came in pretty much with your expectations but more SKU toward defense than you thought coming in.

I think a little bit.

We had an end of quarter SKU too.

So, this is, it is not perfect science here.

We had moving parts in the third quarter and so I am not going to say we were surprised.

We knew what we were working with.

But you don't know where you are going to land it exactly.

We ended up with a little more defense than we thought or we would have done a better job with the guidance 90 days ago.

In terms of the long-term view, you talked about the potential to get back to 15% operating income.

Does that assume the ability to prove to yourselves if you will, that you can maintain the kind of gross margin that you had this quarter on a consistent basis or can you get there with gross margins that are closer to 60, how should we think about what type of gross margin you need to sustain to get to the 15% number.

60.

6-0.

Yes.

That's the operative assumption there and the other assumption is that we have head room in the operating expense infrastructure and that will not have to increase that much looking forward and not to say we won't be rearranging things and we will not have to increase net/net that much.

And we, our break even as a company right now, top line is for a full year is around 210, 215, revenue.

Annualized and as we approach 300 million on the top line, that's where we can see that timeless business model kicking in at the 15% or better that Jay was referring to.

But we are obviously not there right now, but that what conservative assumptions on the gross margin line, 60%..

6.0, not the 64 that we just saw here in Q1.

Jeff, just a little bit more color on it too, I know you are fairly new to the company there are several different gross margins within the company.

We have got the VSG software business, we got VI that's mostly the software business and the margins there are significantly different than the rest of our business.

And our commercial, the traditional commercial business that tend to be heavily hardware oriented and has a lower gross margin typically than the defense business.

The defense business has had a better gross margin and when the mix and the way the orders come in.

It is never as predictable as you like.

It makes it challenging to say the least, to predict the future if you will.

Except the fact that we can feel comfortable I believe that we are on the right track here forward.

Absolutely.

And just for what it's worth, my son is rooting for the Red SOX also.

All right.

Jeff.

Our next question -- .

How come you are not rooting for the Red SOX.

I will for this series.

We know who you root for.

Our next question comes from Paul (inaudible - background noise)

Actually my question has been answered.

Bob, maybe one thing you could do for us is contrast the model on the medical area relative to your other businesses.

Yes, what you are really saying is what does that model look like versus the big ACS business.

Is that, getting that right, Paul?

Yes, I think you are expected to be significantly different.

We don't really not in maturity and if you could help us.

All right.

I will give it a shot for you here.

It is a little extent radius.

And if we look at our call our core business.

Where the defense lies and the commercial business such as Jay mentioned what we have historically done with KLA 10 Corp.

and the new things we are doing in the communications phase.

That business will grow, our view is that it will grow albeit at a rate lower than what Visage Imaging has the potential to do and that ties directly to the, for instance, the Frost and Sullivan report that Jay was referencing.

The market opportunity for Visage Imaging, the market, for 3-D medical imaging specifically the visualization and the PAC space.

And it is fairly.

It is large.

So, one thing we have to put down here is high growth rate on Visage Imaging and respectable growth rate on the core business.

And gross margin for our core business, it has got defense, and we have always done well there and we deliver a very, I am just going to call it a very capable and powerful platform in some very specific defense applications we had a lot of value, you can expect the gross margin is very high.

On the commercial side of ACS, it is a little different.

We are always being challenged there.

And by Moore's law and if you will, and if we stay ahead of it, we win the business but Characteristically there is some margin pressure there.

And even ACS is a blended margin.

And that margin is tending to look like the corporate average right now.

Back to Visage Imaging, the emerging 3-D medical imaging business.

That business over time will be more, much more software than hardware and that's our belief any ways.

Where someone wants an accelerated platform, we will provide it and the accelerated platform that we are offering right now is GPU based in the primary as an example.

And not going to call it a commodity but you know what that does for the gross margins on the hardware side.

So, that's got pushes and pulls also and long-term, and will it look like a software business total software business, 80 to 90%.

We don't think so.

But we think it will be in excess of 70% on a long-term timeless business model.

Bottom line, operating profit, serious high teens for both businesses are quite possible.

We might even be able to do better on the medical imaging business and again, that is very perspective looking down the road a few years and frankly, we don't, we don't know on that one, but that's our view.

Thank you, there's helpful.

Okay.

We will take our next question, gentlemen, from Bob White with Jeffries.

Can you give us a feel for the cell processor related revenue in fiscal '08?

What are we looking at in the cell processor?

We have somewhere in the order of between 40 to 50 systems out there.

Different locations between defense and commercial customers that have it in their labs under evaluation testing and et cetera.

And it is premature for us to give any forecast with regards to how many of those are going to end up going into production because there is always a number of customers out there that will latch on to something new and play around with it for awhile.

And so, we are not ready to declare that this is going to and $100 million product for us.

On the other hand, we certainly do expect revenues out of the cell product or let me call it, single-digit millions.

High single-digit millions in the fiscal year.

Okay.

And Jay, where are you saying the most success.

I think at one point, you spoke about the EDA companies.

Any more successful than others.

I believe we announced that there was a design win at KLA10-cor and obviously the one at Metric Graphics.

Those are the two big ones's that we can talk about and there is a number of them in defense.

And we just got an award out of SeaCom which is the Army Communications command for a multi million dollar system.

Cell based system to do some special things with.

And others, there are good activity within the defense space too.

Okay.

And Bob, looking at the restructuring are redone with the structuring?

You hope so.

Yes, that was Jay.

Yes, we are.

And in fact, some good news to report there.

And if you look careful at the reporting operating expenses for the September quarter, we got a full yield from the restructuring activities which occurred in the fourth quarter of last year, June to be specific by month.

So, we came out of the gate strong with a much reduced operating and expense structure and we do expect that to continue throughout the year.

So, you are saying we have seen the full benefit.

In Q1, yes, we did.

Thank you.

We will take our next question from Gerry Heffernan with Lord Abbett & Company.

Please go ahead.

It is Gerry Heffernan and my question was what the previous person asked there.

And I was trying to compare the quarter-over-quarter expenses and wanted to, if our intended benefit of the restructuring was a $15 million annualized expense reduction.

Don't know any reason why they wouldn't be coming through on a rather even basis quarter-to-quarter.

I was seeing the operating SGA expenses only down 2.2.

What am I missing here?

2.2, sequentially?

Actually I was going year-over-year?

Yes, that's what you are missing.

The quarters two, three, and four last year, our operating expenses were pretty much 35 million in each quarter.

And we just reported a number just above 30.

So, your actually saw a 5 million decrease sequentially in the average of the previous three quarters.

So, we are not saying that is going to continue.

There was some other moving parts in there, program related expenses and what not, we think it is going to be more like 32, 33, each of the next three quarters.

So, if you work that through, you are easily going to see the 15 million expense savings on the OpEx line.

Okay.

So, you were not including amortization of acquired intangibles.

No.

No.

Even so, I see 19-1 and 13-8.

I mean this is a non-GAAP view.

So I am not sure what you are looking at.

Well, I am looking at the numbers as presented in the press release here.

If I can request just, I don't want to take up too much time on this.

Just so you don't confuse all the rest of us.

What we are saying, for the full year, non-GAAP operating expenses which excludes stock based compensation and amortization of intangibles is 128 million.

And what we reported last year on that same non-GAAP basis was 139 million.

Though, there is 11 million right there.

And there is modest hiring as we step through this year.

Nothing too measurable and then you have normal reasons why operating expenses go up like an annual salary increase for the employees and just other general inflationary items.

So 13 million is definitely there.

What you see is, what you calculate the non-GAAP expenses to be for the current quarter just reported?

30.3.

Okay.

I will work from there.

Sure.

And then work some numbers that give yourself 128 for the full year and you will, you will be able to prove that the expenses are there plus some.

Expense reductions are there plus some.

One final question, if I could.

Sure.

The discussion early on about the AEGIS program, one, what was the periodical that you referred to where the AEGIS program was discussed.

Defense news.

October 15th.

Okay.

And I believe you said something about, delivery of as far as what they are looking to do, the AEGIS system, delivery of units in the second half of '08.

Were you referring to fiscal year '08.

Calendar year '08.

I am sorry, I didn't hear the answer.

Calendar year '08.

Thank you, for the clarification.

You're welcome.

At this time, gentlemen, we have no other questions standing by.

I would like to turn the program back to you for any additional closing comments.

Thank you all for attending.

We switched the call to Wednesday with the expectation that we would remove some of the conflicts that you all have with other companies reporting out and appreciate your attending the call and we will see you in three months and go Red SOX.

Thank you everyone for your participation and you may disconnect at this time.