Mercury Systems Inc (MRCY) 2008 Q2 法說會逐字稿

Good day, everyone, and welcome to the Mercury Computer Systems, Inc.

second quarter fiscal 2008 earnings 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 Manager of Financial Planning and Analysis, Ms.

Leslie Schaefer.

Please go ahead.

Good afternoon, and thank you for joining us.

With me today are our President and Chief Executive Officer, Mark Aslett, and our Senior Vice President and Chief Financial Officer, Bob Hult.

If you have not received a copy of the earnings release, you can find it on our Web site, www.mc.com or on the FirstCall Network.

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, which involve risks and uncertainties that could cause the actual results to differ materially from those projected or anticipated.

Additional information regarding forward-looking statements and risk factors is included in the press release we issued this afternoon, reporting the company's second 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 upon any forward-looking statements.

We 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.

Management believes these 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 marketplace and to establish operational goals.

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

Reconciliation of GAAP to non-GAAP financial results discussed in today's conference call is contained in the company's second quarter fiscal year 2008 earnings release.

I am now pleased to turn the call over to Mercury's CEO, Mark Aslett.

Thanks, Leslie.

And hello, everyone.

It's great to have you on the call.

I'm excited to be part of the Mercury team, and I'm looking forward to meeting as many of you as possible in the months ahead.

On a separate note, I'd also like to thank those of you who participated in the investor survey we recently commissioned as part of our strategic review.

The announcement of my employment was made in mid-November.

So before we get going, I'll tell you briefly about my background.

If you attended or listened to the Web cast of our presentation at the Needham Growth Conference earlier this month, this will be a repeat.

But for everyone else, it may be useful to hear about where I come from and the experience I bring to Mercury.

I'm actually an engineer by training.

I started out as an electronics engineer and then quickly moved into software engineering.

And obviously, as you can tell from my accent, I'm clearly not from Boston.

I'm actually from a town in Northern England.

Early in my career, I worked at British Telecom as an engineer and then moved into sales at a company called GEC Plessey Telecommunications or GPT, the largest telecom supplier in the UK.

While there, I sold capital infrastructure upgrade programs to European carriers, focused particularly on BT, which was then GPT's largest account.

After getting an MBA at Harvard Business School, I returned to GPT and managed the product portfolio for their largest division, a billion-dollar high technology business focused on telecommunications equipment.

That role was interesting because it involved mainly organic product development, figuring out which new products to develop and how to allocate our R&D dollars to maximize return on investment.

At that point, GPT merged with Marconi SpA of Italy, creating a multibillion-dollar company.

I worked on the integration and go-to-market strategy, and brought to market Marconi's new optical networking products.

I was then promoted and became President of Marconi North America.

At the time, Marconi did not have a strong presence in the North American marketplace.

As President, I developed a North American market entry strategy that culminated in the acquisition and integration of two major businesses, totaling about $6.5 billion.

At that point, I moved into another Marconi business, Marconi Systems and Capital.

That functioned essentially as a captive private equity arm for businesses they already owned.

I was responsible for the planning and development of businesses in the capital equipment, systems and services areas, totaling about $3.5 billion.

Like any private equity group, what we did was develop strategies for those businesses, how do we grow and maximize returns, especially from a cash flow perspective.

After 2000, I worked on the buyout of the two divisions that were left within Marconi.

Those divisions were ultimately sold to strategic buyers.

I then signed on as President and ultimately became CEO of a company called Enterasys Networks, that some of you may be familiar with.

Enterasys was a New York stock exchange company, and my role there was to turn around the operations as part of a new management team that was brought in following an SEC investigation.

Largely, what we did was reposition the business within the networking industry based on the strategy of differentiation around embedded security.

We substantially improved the financials of the business, reversing $120 million loss and returned the company back to profitable operations and positive cash flow.

We completely refreshed the entire product portfolio and created significant growth drivers in the business.

Ultimately, we sold Enterasys for a 74% premium to the enterprise value.

The reason I share all this with you is to let you know that my experience runs the gamut from engineering to sales and marketing, to portfolio management, product development, M&A and general management experience, both working for and managing public companies.

With that, a quick word about our agenda for this afternoon.

By now, you've probably seen our press release.

In short, I believe we executed well in Q2 and delivered respectable financial results, largely driven by continued momentum in our advanced computing solutions, or ACS business.

Revenue totaled $52.6 million, a 7% increase sequentially.

Our book-to-bill for the quarter was a positive 1.1.

Gross margins remained strong, expenses were slightly below plan, and we exceeded our guidance for both revenue and non-GAAP EPS.

This performance is all the more remarkable, given a very weak quarter for our Visage Imaging business, and I'll have more to say about that in a moment.

What I would like to do first is to discuss some initial observations about the business, touch on our guidance for the fiscal year, and then share some early strategic themes that I can see developing.

At that point, Bob will cover the financials and then we'll open it up for your questions.

Turning now to our business in the quarter, ACS revenue increased by $4.5 million, or nearly 11% sequentially, which more than offset the shortfall in VI.

ACS defense continues to perform well, driving the overall growth of the company.

Similar to Q1, ACS delivered a good quarter for design wins.

Six of our Q2 wins were in defense and two were commercial, and all but one involved new products designed within the past 18 months.

This suggests that we're continuing to make progress in leveraging our R&D investments and acquisitions.

We're also starting to make progress in penetrating new accounts, although clearly we can improve in this regard.

An example is the signals intelligence system we're developing with Lockheed Martin using our microwave tuner and IF acquisition technology.

We had a very successful demonstration of this system in the quarter, which we believe could lead to important business for us going forward.

Unfortunately, the shipment linearity in Q2 left a lot to be desired.

This obviously presents risks to achieving our quarterly objectives, and we've made it the priority to improve in this area on a go-forward basis.

Although ACS has now had two consecutive quarters of good performance, a gain largely driven by defense, those two quarters should not be considered convincing evidence if the turnaround is complete.

We feel good about our reputation, our technology expertise, our customer relationships, and the outstanding capabilities we have in engineering.

We have room for improvement in terms of our overall direction, our products and road maps.

We also have work to do in program pursuit and capture, and in expanding our customer base.

Turning now to Visage Imaging, clearly we were all disappointed with our Q2 performance, as revenues declined from $3.9 million to $3 million sequentially.

The first questions to ask are what happened, why did it happen, and what steps are we taking to improve VI's future results.

Starting with the outer layers of the onion, if you will, I believe we could have done a much better job with our sales forecasting going into the quarter.

We didn't see the kind of bookings we anticipated for some of our legacy products, and some of our smaller deals and distributors did not perform as well as expected.

Sales in VI also reflected the fact that the signing of Siemens and actual OEM deals was delayed.

However, if you peel deeper into the onion, I believe these issues are symptomatic of something larger, this being the fact that VI's products and sales channels are actually at a fairly early stage of development.

In fact, it wasn't until the RS&A show in November that we truly launched our new CS product line and our direct sales force was not fully operational until December.

On that basis, I think it's fair to ask whether our original expectations for the VI business in fiscal '08 were realistic and achievable.

As of today, and with the benefit of 20/20 hindsight, I think the answer to that question is no, that we're not.

Clearly, we were overly optimistic about our ability to convert our sales pipeline and it will take more time before CS revenues begin offsetting the decline in sales of our legacy products.

We thought that VI would grow to become a $30 million business this fiscal year, and we now expect it to be roughly half that size.

Looking ahead to the long-term, however, I believe that VI represents Mercury with excellent potential.

We have brought to market some innovative next generation 2-D/3-D integrated packs and 3-D/4-D client server capabilities that bring tremendous value to large hospitals.

Many of our competitors who are talking about having a client server architecture really have what we consider to be an antiquated hardware base model that doesn't scale.

We have built a pure software offering that we think is a much better value proposition for hospitals in the long term.

I attended the RS&A show prior to joining Mercury just to check out the technology firsthand.

Listening to some of the customers and potential customers talking about what VI has done from a technology perspective, I think we are in a good position to increase our market share and grow the top line.

I've asked the V I team to develop a reset plan for the second half of the year.

This plan will build on the platform we've created and more realistically evaluate where we are today.

I truly believe the market fundamentals are strong and our market strategy is correct, as evidenced by the recent Frost & Sullivan award.

We had a great launch at RS&A and now have a direct and indirect sales channel that makes sense, especially working with Siemens.

[Acto] on the other hand is going to take more time to produce.

So clearly, VI needs to keep building the pipeline and show some top line momentum, and that's our highest priority in this particular business.

At this point, the timing is still a question in my mind.

As I said earlier, we thought that VI would grow to become a $30 million business this fiscal year, and now we expect revenues to be roughly half that.

If it takes several quarters to begin demonstrating positive top line momentum, which would not be unrealistic, our expectations for VI go from essentially break even in our previous guidance to a projected loss of $9 million for the full 2008 fiscal year.

If you also factor in the lack of shipment linearity and operational issues around ACS that I described, the prudent thing is to reset our annual guidance for the remainder of this fiscal year, which I will do in a moment.

The visibility in our business is about one quarter right now, and we don't expect to see much improvement in the near term.

Consequently, looking beyond Q3 of '08, at least through fiscal '09, our plan is to continue providing quarterly guidance while moving away from annual guidance until we have regained the necessary level of visibility.

While we walk you through the revised guidance in detail, but looking just at the headlines for full year fiscal '08, we now expect revenues to range from approximately $209 to $214 million, and we expect to report non-GAAP earnings in a range of $0.08 to $0.17 per share.

Without this background, I promised you some early observations about where the business has been and where we see it going in the future.

If I step back and ask what was it that interested me in joining Mercury, it's a company with a great reputation in the marketplace.

When you speak to the defense and commercial customers about Mercury, they talk about our ability to solve problems that others can't, and they are actually comparing us with some very large companies with much bigger R&D budgets.

Mercury is a company that works closely with customers to understand how we can accelerate the real-time applications they are looking to bring to market.

We make our customers' products work better.

They operate faster and more efficiently than if Mercury hadn't been involved.

That's because our solutions solve problems our customer can't using their existing or standard computing platforms, and we can do it faster and at lower costs because we're able to leverage our technology across multiple markets, as opposed to our customers developing their own platforms for their specific applications.

Our strong brand reputation is also a testament to the quality of Mercury's people and the customer relationships we've built up over a long period of time.

Combined with what we've done over the years from a technology perspective, we are positioned to do well in the long term.

Mercury went through a significant restructuring in the quarter ended June of '07, where we tried to recreate the leverage that had been lost when the company was organized around specific vertical markets.

Our goal was not only to lower our cost structure, but also to recreate our technology leverage across multiple verticals and reduce our time to market.

So moving on, at this stage, I'm still learning the business, going through all the functions and plans to get a better sense of where things stand.

The objective is to make the changes we need to improve our performance.

And the truth is, some of those changes will take some time.

We are seeing some positive impacts from the restructuring, the stronger book-to-bill in ACS, chief among those.

In the short term, my sense is that the opportunity is around improving the underlying performance of the business.

As a business, we seem to be doing a lot of things with varying levels of efficiency and effectiveness.

We need to narrow our focus, looking at how we prioritize our investments in R&D, and the markets we're targeting, and making sure that we have the right products in offer with the right resources aligned to accelerate our penetration of those markets.

We've gone from the middle of calendar year '07 when we had five business units to the three we have today, where we have more work to do.

The structure and alignment is still less than optimal and we need to recruit the leaders we're missing in key areas.

We're approaching the required improvements on three levels -- short, medium and long term.

In the short term, from an operations perspective, I think we have real potential to improve the cash flow in our business.

I believe in improving our supply chain and underlying manufacturing operations, achieving better shipment linearity and increasing turns should enable us to generate more cash on a near-term basis.

However, we have considerable heavy lifting to do, because of the complexity and the large number of moving parts.

We have in effect a high-mix, low-volume business model.

So to do this right, our product operations will need to be simplified and we will need a much higher level of cross-functional coordination and better systems than exist today.

These are the kind of things I've been involved with before and I'm excited about the potential.

The team has made decent progress on every one of these fronts already, and now we need to take it to the next level.

In the medium-term, I think it's about how we strengthen and grow the core.

If you look at the ACS business, which is clearly the core, I believe that in retrospect, we may have underfunded parts of that business in order to support some other areas that are either start-ups or businesses that are not performing as we would like.

I've been hearing from some investors that the company's diversification efforts have stretched too thin at times and the underfunding of ACS is likely an offshoot of that.

As we strengthen the core ACS defense business going forward, we'll be looking at how to focus our market pursuits and reduce our time to market, how do we finish existing engineering commitments and fund new product developments to accelerate growth and market penetration in the most promising parts of the business.

I think we have a great sales force and great relationships with our customers.

We're right alongside them, helping solve these significant challenges.

Right now, if you look at the prime defense contractors, we're in specific divisions within those primes.

I think we have room to expand our opportunities there and generate stronger revenues from our existing customer base.

However, to do this, we're going to need new product, and that could be an issue in the short-term.

In the long-term, it's about how do we position the business in more attractive markets.

If you look at ACS today, we're focused on embedded multicore, multicomputing, which is largely VME.

We're very strong in defense, but we're still very much a hardware-based business.

Our challenge is to grow the software and services business to exploit adjacencies around the core, a great example of which is Mercury Federal.

In summary then, our plan is to take one step at a time, expecting lots of hard work and not expecting quick fixes.

This is a multiyear effort.

Our reorganization last year created improved efficiencies, and we have taken significant costs out of the model, and this should definitely help us going forward.

At the same time, we'll continue to seek opportunities to maximize the return to shareholders from Mercury's portfolio of businesses.

Our objective is to use the next couple of quarters to develop a realistic plan, and at the same time make an incremental progress each quarter, improving the bottom line and generating cash.

With that, I'll turn it over to Bob for the financial review.

Thanks, Mark.

Good afternoon, everyone.

I will review revenue for the second quarter of fiscal 2008, including details by business unit, discuss company operating performance, balance sheet, 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 on both a GAAP and non-GAAP basis.

Second quarter revenues were $52.6 million, above our guidance of approximately $51 million, up 7% from first quarter revenues.

Gross margin was 59.9% versus 56.4% in the second quarter of last year.

The increase is primarily due to operational and quality improvement.

Gross margin was higher than our guidance of approximately 58% for the quarter due to a favorable product mix.

Operating expenses for the second quarter increased slightly from the first quarter.

GAAP operating losses were $5.8 million.

This includes stock-based compensation expense of $3.6 million, amortization of acquired intangibles of $1.8 million, and a small restructuring charge of $192,000.

The GAAP net loss for the second quarter was $6.1 million, resulting in a loss per share of $0.28 above our previous guidance of a loss of approximately $0.37.

On a non-GAAP basis for the second quarter, operating losses were $230,000.

Non-GAAP operating losses include stock-based compensation -- excuse me, exclude stock-based compensation expense, amortization of acquired intangible assets and restructuring charges.

We use a non-GAAP tax rate of 30%.

Non-GAAP net income was approximately $800,000.

The non-GAAP diluted earnings per share for the second quarter were $0.04.

Second quarter non-GAAP EPS was above our guidance of a loss of $0.05, primarily due to the better than expected revenues and gross margin improvements.

Our book-to-bill ratio for the quarter was 1.1, driven primarily by our defense business.

Backlog, including deferred revenue, was $89.6 million, a $5.4 million sequential increase from the first quarter of this year.

Of the ending backlog, $75.4 million or approximately 84%, relates to shipments expected within the next 12 months.

Now, I would discuss our business by segment for the second quarter.

Advanced computing solutions or ACS, which consists primarily of our defense, semiconductor, communications and legacy medical businesses reported revenues of $46.7 million, or 89% of the total corporate revenues for the quarter, down 8.5% from the year-ago period.

The decline is the result of a year-over-year drop in ACS commercial revenues, from approximately $24.5 million to approximately $17.1 million.

This drop reflects a decline in sales of commercial communications applications, semiconductor solutions and legacy medical systems.

The drop was partially offset by an increase in our year-over-year defense revenues from approximately $26.5 million to $29.6 million.

Sequentially, ACS's revenue increased $4.5 million, or 11% from the first quarter of this year.

ACS's book-to-bill for the quarter was 1.13.

For the second quarter, Visage Imaging, which is our wholly-owned subsidiary that focuses on the 3-D medical imaging market, reported revenues of $3.0 million, or 6% of total corporate revenues, down 39% from the year-ago period.

Sequentially, VI revenues declined $900,000 from the first quarter.

As Mark discussed, VI is at an earlier stage of development than anticipated, both from a product and sales channel readiness perspective.

VI's book-to-bill for the quarter was 0.9.

The combined revenues for Mercury's other business segments totaled $2.9 million.

Our visualization sciences group, or VSG, which sells development tool kits and visualization applications to geo sciences, engineering and manufacturing and other markets, reported $2.4 million in revenues for the second quarter of fiscal 2008, versus $1.8 million for the same period of fiscal 2007, up approximately 35%.

VSG's book-to-bill for the quarter was approximately 1.

The combined revenues for our other emerging businesses approximated $500,000.

Turning to the balance sheet and cash flow statement, cash, cash equivalents and marketable securities at the end of the second quarter total $156.4 million, representing a $2.2 million decrease from the end of the first quarter.

This decrease includes a net operating cash outflow of $2.1 million, and $1 million for capital expenditures in the period.

As you may have noted, our accounts receivable balance increased $9 million from the first quarter due to an end of quarter shipment SKU.

As we focus on improving our supply chain execution, accounts receivable and inventories represent an opportunity to generate cash from operations.

Second quarter day sales outstanding were 74 days.

Inventory returns were 3.5.

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

I would now like to move to guidance.

For full year fiscal 2008, we are lowering our revenue outlook from $225 million to a range of approximately $209 million to $214 million.

We project a full year total corporate revenue mix of approximately 58% defense and 42% commercial.

Despite the reduced revenue estimates, the company continues to expect significant improvement in the bottom line as compared to fiscal year 2007 as a result of the restructuring actions taken in the fourth quarter of 2007.

In addition, our gross margin is expected to be stronger on a year-over-year basis due to positive product mix and continued operational and product quality improvements.

For the full year fiscal 2008, we now expect gross margin to approximate 60%.

For the fiscal year, operating expenses continue to approximate $128 million on a non-GAAP basis.

Due to the lower revenues, we are lowering our GAAP EPS guidance for the full year fiscal 2008 from the previously guided loss of $0.54 per share to a loss per share ranging from $0.96 to $0.83.

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

The diluted shares for the full year are projected to be approximately $21.6 million.

The impact of stock-based compensation costs for the full year will be approximately $12.3 million.

The amortization of acquired intangibles will be approximately $7.2 million and restructuring costs for the year are approximately $200,000.

The non-GAAP effective tax rate will be 30%, and the non-GAAP shares are projected to be approximately $22 million.

After these adjustments, we expect fiscal year 2008 non-GAAP earnings per share to be in the range of $0.08 to $0.17, a reduction from the previously guided $0.33.

CapEx for 2008 is projected to be approximately $6 million.

Depreciation will be approximately $8 million.

For the third quarter, we currently expect revenues to be in the range of approximately $53 to $55 million.

We anticipate the gross margin to be approximately 58%.

Operating expenses are currently anticipated to be approximately $33 million on a non-GAAP basis.

The GAAP losses per share are currently expected to range from $0.28 to $0.22 for the third quarter of fiscal 2008.

The impact of stock-based compensation for the third quarter will be approximately $3.1 million, and the amortization of acquired intangibles will be approximately $1.8 million.

GAAP tax rate is 30%, and the non-GAAP diluted shares are projected to be $21.6 million.

As a result, third quarter fiscal 2008 non-GAAP EPS is currently expected to be in the range of a loss of $0.04 per share to break even.

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

Operator, you can proceed to the Q&A session now.

Thank you, sir.

(OPERATOR INSTRUCTIONS) We'll go first to Jonathan Ho with William Blair.

Hi, everybody.

Hi, Jonathan.

There's an implied ramp for Q4 if we use the midpoint of Q3 revenue guidance.

Can you give us some color on maybe your visibility into Q4 right now and maybe what's the source of, I guess, that expected acceleration?

Jonathan, it's Bob.

Let me start you off with the implied ramp on the -- I don't think it's much of a ramp on the low end of the guidance at 209 if 214 is a bit of a ramp.

Okay, and then...

That's not much.

I hope you're using the new range of 209 to 214.

We've really taken the ramp out of H2 compared to H1.

And is that going to be mostly because of the Visage expectations?

Exclusively because of Visage.

As Mark noted, we were expecting approximately 30 million of revenue from Visage Imaging this year.

We're now looking at about half of that.

Okay.

But that's really the adjustment in the full year guidance.

Taking a look at the 12-month backlog number, that appears to have increased pretty significantly between last quarter and this one.

Can you talk a little bit about what's happening there and maybe update the pipeline of opportunities number that was given at the analyst day, and just come up with some color on how that's looking right now?

Yes, I'll hit the numbers and Mark will jump in with some color.

Two quarters now in a row of book-to-bill at approximately 1.1, in a nutshell, that's the story.

And if you look slightly down at the next level, the ACS book-to-bill is slightly stronger than that, 1.13, and that is where our backlog business lives.

Visage Imaging is not a backlog business as you know.

It's a software-oriented business.

But you're probably looking for a little color in addition to the numbers?

Yes.

Yes, I think we're seeing some good momentum in the defense business.

I think, overall, your defense is clearly driving the upward momentum of ACS, so I think it's largely driven by some of the new products and some of the new design wins that I think has been mentioned previously on earlier calls.

Great.

I'll hop back in the queue.

Thanks.

(OPERATOR INSTRUCTIONS) We'll go next to Steve Levenson of Stifel Nicolaus.

Thank you.

Good afternoon, Mark and Bob.

Hi, Steve.

Hi.

And good luck, Mark.

You know, I'm sure this isn't going to be easy, but hopefully it will work out as things have done for you in the past.

Thank you.

I have a question about head count.

Where does the head count stand right now?

Okay.

I thought I noted that.

737, Steve.

Okay.

Sorry, I must have missed that.

That sounds like it's pretty much the same as it was last quarter.

It's exactly flat.

And in fact, it is only up eight from where we ended last fiscal year.

So net eight higher in H 1.

Okay.

And are you finding you're able to retain engineers?

Was there some churn in there so -- I don't know if you lost some people and you're hiring new people, but do you feel like you've got the appropriate experience level?

Yes, I think-

On your R&D staff?

Yes, I think the guys in engineering are very, very experienced.

I think like any organization, you always have turnover, but it's nothing that's out of the ordinary at this point, and if we are losing people, replacing them with very qualified people.

So, we feel pretty good about where we're at.

And any plans on what you're going to do with the cash and the outstanding converts?

Are you going to keep it status quo?

No real change there, Steve.

We have the cash to pay the note back in May of '09, should it be put to us.

You know, there is a put right that the holders have and I think we've tried to be very clear that we have the cash and we intend to have the cash should it come to that.

And then, I have to say, with a little bit of a smile on my face, but our goal will be to be performing at a level where that won't happen.

But the cash will be there should we need it.

Great.

Thanks very much.

Yes.

(OPERATOR INSTRUCTIONS) We'll take a follow-up from Jonathan Ho of William Blair.

Hi, guys.

I do have a follow-up question on what's happening in, I guess, the commercial businesses and why we're seeing this kind of continued decline.

Is that a pattern that we should continue to expect, kind of being offset by defense in looking forward?

I think if you look at it, Jonathan, beneath the covers, there's certainly a level of volatility in the business.

You know pretty well that I think over the last year or so or a couple of years, we saw a pretty significant decline in the legacy medical business.

I think overall we feel good about where our commercial is.

We've certainly got some good customer relationships, but I think the strength in the business today from a growth perspective is really being driven by what's going on within defense.

Okay.

And another question, just with regard to where you see kind of the opportunity to lever going forward.

I mean, you talked about kind of the R&D efforts and kind of the investment being spread too thin.

I mean what are kind of the target areas that you see as being the ripe opportunities for Mercury to really target?

Yes, I think it depends over what period of time you're looking.

I mean, clearly when you're in the short-term, you look at what's driving the defense, some of the new defense wins.

A lot of it is being driven by the new technology that we've got, that we've either developed ourselves or that came through the acquisitions.

So that's taking us deeper into the [second] area.

I think some of the work that we've done in ATCA in the commercial space, we're starting to see some early signs that that might be applicable into defense.

So those two are just as an example.

Okay, thank you.

Thanks, Jonathan.

And we'll go next to [Xiao Wang] of Lotus.

Good afternoon.

A couple of questions.

First, Mark, you mentioned at the beginning that second straight quarter of book-to-bill does not suggest a turn-around.

I infer that to be certainly a conservative kind of approach.

Is there something else that leads to you make that kind of a comment?

No, just basically what I said on the call.

You know, I think the opportunity in the short term is looking at the underlying operations of the business and seeing what we can do to generate more cash.

It's largely around supply chain and getting closer cross functional coordination.

To get the top line growing, I think in the midterm we've really got to focus on additional product development, as well as actually expanding our penetration into our existing customers so that no -- other than what I said, I don't think there's any major concerns there.

It's just we've got a lot of work to do to get this thing heading in the right direction.

Totally separate, I think I asked you this a couple weeks ago, so I'm not sure if you are willing to give an answer now.

Any targets for cash generation, say, for the calendar '08 year or fiscal '08 or -- where do you think, if not quantitatively, qualitatively you can go on a cash conversion cycle basis or something like that?

Yes.

I mean, if you look at, say, DSOs, our DSOs is a very high point.

I mean we're at 74.

Our returns are around 3.5.

So if you kind of look at those two things coupled with the SKU that we have in our revenue linearity or the shipment linearity towards the back end of the quarter, we can go attack those things.

We can generate, I think, additional single million dollars of cash on a quarterly basis.

You know, it's a lot of heavy lifting.

As I've said, there's no quick fixes.

We've really got to get the parts of the organization working better together.

Okay.

And then last, is it too soon to think about where you would surmise a head count number might be, say, at the end of calendar '08?

I think, at this point, the company has taken a tremendous amount of cost out of the business.

Clearly as we go forward, there may be a possibility there of additional reductions.

But we don't really focus on that.

I think what we're focused on is how do we make the business model more effective, certainly looking at the cash flow side of things.

In the midterm, as I said earlier, it does really come back to how do we get more products out of engineering and how do we grow the business by expanding our penetration into existing customers.

So, cost is not the major area of focus at this point.

It's really cash and how do we get more product and growth.

Got it.

Thank you.

And gentlemen, we have no further questions at this time.

I'll turn the call back over to you for any additional or closing remarks.

Okay.

Thank you, and thanks to everyone for listening.

In closing, we're very pleased with our results for the quarter.

We know we have a lot of work to do, but we're certainly optimistic in the long term.

We look forward to speaking with you again next quarter and this concludes our call.

Thanks very much.

And that does conclude today's conference.

Thank you for your participation.

You may disconnect at this time.