Mercury Systems Inc (MRCY) 2009 Q4 法說會逐字稿

Good day and welcome to the Mercury Computer Systems fourth quarter fiscal 2009 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 Company's Senior Vice President and Chief Financial Officer, Bob Hult.

Please go ahead, sir.

Good afternoon and thank you for joining us.

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

If you have not received a copy of the earnings release, you can find it on our website at www.mc.com.

We would like to remind you that remarks that we 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 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 fourth quarter and fiscal year 2009 results and in 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 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 principals 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 and 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.

A reconciliation of GAAP to non-GAAP financial results discussed in today's conference call is contained in the press release we issued this afternoon.

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

Thanks, Bob.

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

I'll begin with an update on the business.

Bob will then review the financials and discuss our guidance for the first quarter and then we'll open it up for your questions.

On our call 12 months ago we said fiscal 2009 would be a pivotal transition year for Mercury and it was.

We executed successfully on each of the three goals in our turnaround strategy.

We refocused the business and completed the divestiture of our non-core businesses in a very challenging M&A environment.

We improved the underlying operations of the business and returned the Company to profitability and we developed a strong and growing position for Mercury in the defense, intelligence, surveillance and reconnaissance or ISR space.

As a result, we exited fiscal 2009 a more focused and profitable enterprise.

From a financial reporting standpoint, we are finally unmasked the true profitability and potential in our core business.

Now it's all about growth.

The progress we made in fiscal 2009 positions us well to expand our business on both the top and bottom lines, as we begin the new fiscal year.

We are in a design win led business, so if you look at the factors that we believe will drive our growth going forward, the first is growth in the number and volume of our design wins.

Fiscal 2009 was a great year in this regard as the five year probable value of our defense design wins increased 51% from fiscal 2008.

The second growth driver will be growth in complementary ISR related services and systems integration business in ACS.

We also made excellent progress in expanding this part of our business in fiscal 2009, delivering year-over-year revenue growth of 157%.

Our third growth driver is Mercury Federal Systems.

The defense electronics market as a whole is 10 times larger than the commercial item defense electronics market that ACS has targeted in the past.

Fiscal 2009 proved the Mercury Federal model can work and work well.

Revenue in MercFed's first real operating year grew to $5.7 million from essentially zero in fiscal 2008 on $11.9 million in bookings.

Beyond defense, in our ACS commercial business the recession driven erosion continued in the fourth quarter.

Commercial revenue was down 34% year-over-year for the fourth quarter and down 24% for the full year.

Our return to growth in commercial will primarily depend upon the timing of any eventual rebound in the semiconductor space.

At this point, the signs of improvement in that industry are inconsistent, and as a result, we expect to see further declines in our commercial bookings and revenue in the first quarter of fiscal 2010.

Looking ahead, however, we have laid the groundwork for regrowth in this part of our business as well, with significant semiconductor design wins in FY 2009.

I'll touch more on the growth outlook in a few minutes, but first some comments on our fourth quarter results which clearly were better than we anticipated.

On a continuing operations basis, revenue and non-GAAP earnings both exceeded the high end of our guidance range, coming in at $48.4 million and $0.13 per share respectively.

Mercury continued to generate solid free cash flow in Q4 and we completed our divestiture efforts on schedule by successfully selling the VSG business.

As a result, we paid down the remaining $5 million of our $125 million convertible senior notes and we ended the quarter with a healthy cash balance.

Total defense revenue in the fourth quarter including ACS and Mercury Federal grew 7% sequentially and by $3.3 million or 9% year-over-year to $40 million.

For fiscal 2009 as a whole, total defense revenue increased by $14.5 million, or 11% from the prior fiscal year.

In terms of bookings, on our call last quarter we said that Q4 was off to a fast start.

Within the first three weeks of the quarter, we had already received two POs totaling $30 million.

One for a grand base radar program for theater missile defense with one of the major primes and the other for radar technology on the DOD's next generation fighter platform.

Including additional radar and electronic warfare bookings that came in later in the fourth quarter, bookings in ACS Defense increased 106% year on year to $58 million.

Including Mercury Federal, our defense bookings grew 108% year-over-year in Q4.

For fiscal 2009 as a whole, defense bookings grew 20% from fiscal 2008, representing the largest bookings year ever in Mercury's defense business.

We closed the fourth quarter with a book-to-bill in defense of 1.49, up from 1.25 in the sequential third quarter and 0.78 in Q4 of last year.

In summary, we worked hard in fiscal 2009 to strengthen our core defense business and focus on high growth areas in the defense electronics market.

Our bookings in the fourth quarter reflect the progress we have made to date.

Let's come back now to the growth drivers in our business, starting with design wins.

Winning new designs requires new products.

In both our single processing and multi-computer product lines we're in the midst of the most comprehensive technology refresh cycle in Mercury's history.

As a result we positioned ourselves within the defense prime contractor community as the leader in high end digital signal processing.

The new products coming out of our pipeline enable the primes to deliver new capabilities to their customers and ultimately to the war fighter.

In this environment, the key is product velocity.

The faster we can bring new products to market, the faster we can increase the volume and the value of our design wins.

We've been focused for more than a year now on creating significant hardware design reuse and leverage in the business as the way to enhance our velocity and product development.

As a result, we are better positioned to respond to the government's increasing focus on QRC or quick reaction capabilities.

Design requirements are evolving rapidly and we are positioning Mercury as a Company that can rapidly react and bring new technologies to market to meet the new requirements.

Looking ahead we'll be focused on reinforcing this position by improving the software design reuse and leverage in our model.

Defense electronics is a high mix, low volume business, where the key is not only product velocity, but also product customization.

Enhancing our software design reuse and leverage will allow to us be faster and more efficient in the ways which we deliver this customization.

Defense Secretary Gates has been quoted as saying that he would rather have a 75% solution in months than a 100% solution in years.

Through improved hardware and software design leverage and reuse, we're playing directly into this new philosophy.

As we begin fiscal 2010, we believe that Mercury is well positioned in each of the three key areas within the overall ISR market, radar, electronic warfare and electro-optical infrared or EOIR.

We had only one 10% program in ISR in fiscal 2009 and we have established a broadly diversified presence on the right programs and platforms.

In terms of the numbers, we received a total of 27 design wins in the first three quarters of fiscal 2009 and added another 10 wins in Q4.

In all of the Q4 wins were in defense.

The five year probable value for the 10 wins is approximately $53 million.

On a fiscal year basis, the five year probable value of our design wins total $211 million, an increase of $38 million, or 22% compared with design wins in fiscal 2008.

Looking specifically at defense, the probable value of our design wins increased 51% from $106 million in fiscal 2008 to $160 million this year.

Turning now to the second growth driver, a larger role for our services and systems integration business in ACS.

Our goal is to capture the two-thirds of the commercial item defense electronics market that in the past our focus on hardware has left untouched.

Transitioning from a hardware-centric focus to a complementary service and systems integration model aligns Mercury with the biggest challenges faced by the large primes today, the government's demands on them to get more war fighting capability into theater more rapidly and at a lower cost.

The government is clearly frustrated with proprietary closed systems, significant schedule slippages and huge cost overruns.

A new best of breed model is emerging which embraces open systems architectures and that include greater use of commercial items.

We play directly into this trend in both Mercury Federal and in the ACS services and systems integration business.

Mercury's in the best position to integrate the single processing subsystem, because this is our specialty.

It's what we do.

Expanding our role as an ISR subsystems integrator for the primes has the potential to help scale our business faster than the hardware-based business alone.

Mercury's recognized as the best of breed in high end digital signal processing, and the leader in commercial item technologies for the defense market.

In fiscal 2009 we took this leadership a step further and led the development of the next generation embedded systems standard, VPX, with what we called OpenVPX.

This standard is now in the process of being adopted by the industry standards body that supports the defense electronics industry.

OpenVPX positions Mercury as the key architecture partner to the primes in their performance migration to open systems.

Historically, they couldn't have both high performance and open standards.

Today, they can, using Mercury's new approach.

Our plan for 2010 is to do the same thing from a software perspective.

In terms of both hardware and software, our objective is to use OpenVPX systems as the path to design reuse and standardization and faster to deliver a more complete solution in a more cost effective and timely manner.

The Q4 bookings for the theater missile defense ground based radar program is a good example of how the services and systems integration model is enhancing and growing our business.

Our role in this program started out as a traditional $6 million booking to provide hardware for the radar.

We then generated another $6 million in bookings for custom engineering and prototype delivery, representing the services element.

Finally, by bringing together the complete radar processing subsystem which is the systems integration piece, we've raised our total bookings to approximately $18 million.

In terms of our fourth quarter results, ACS services and systems integration bookings were $4.9 million, and revenue increased 112% sequentially to $7 million.

For fiscal 2009, ACS services and systems integration bookings were $13.6 million, and revenues of $13.2 million, both significant increases over fiscal 2008 levels.

We feel good about the performance and trajectory of this part of our business as we begin fiscal 2010.

Let's go now to the third driver, Mercury Federal.

Mercury Federal's hybrid business model positions us well to be selected as a best of breed QRC subcontractor to develop and coordinate the entire ISR signal processing and computing architecture for upgraded or new ISR programs and platforms.

Clearly, we demonstrated the value of this model in fiscal 2009, as bookings increased to $11.9 million from $400,000 in the prior fiscal year.

Sticking with Mercury Federal and touching on the defense budget for a second, we believe that looking forward, the DOD and intelligence community budgets will demonstrate very modest topline growth.

However, we foresee continued robust support for increasing investments in commodity control and intelligence surveillance and reconnaissance assets, Mercury's sweet spot.

We are seeing additional monies being applied to procure more airborne ISR systems that offer significant improvement in finding, tracking and engaging multiple individual high value targets over hundreds of miles in various urban and mountainous environments.

In the FY 2009 and FY 2010 budgets the DOD allocated $2.4 billion in procurement funding for an additional 137 medium altitude ISR unmanned systems such as the Reaper and Predator and $2.8 billion for an additional 12 Global Hawk high altitude platforms.

Today, Mercury's providing the processing hardware and software for these platforms radar sensors.

In FY 2009 Mercury Federal was awarded an important contract by a rapidly growing prime as the best of breed subcontractor to pull together a new processing system for the Reaper aircraft that supports multiple sensors configured in a single pod.

This new ISR processing system that we're developing for the [gorgonstair] Reaper unmanned aerial system includes the hardware and software capabilities of our converged sensor network architecture.

For the first time, this system will allow multiple operational assets to receive timely, relevant information over larger areas of interest.

Indeed, Mercury's new advanced processing solutions addressed the DOD's principle airborne ISR challenge, of quickly processing large data sets and getting meaningful information to many tactical users in a timely manner.

Perhaps Lieutenant General Deptula of the Air Force summed up this challenge best by stating last week that we are going to be swimming in a sea of sensors and drowning in data.

Today, we are also aggressively working with our prime partners on options to upgrade existing manned ISR platforms with our converged sensor network architecture capabilities in order to improve the operational utility of these deployed assets.

Based on our experience this past year, we feel really good about Mercury Federal's growth prospects going forward and its ability to significantly enhance our competitive position within the ISR space.

As we mentioned last quarter, in conjunction with our shelf registration, we are also at an early stage in beginning to explore acquisition opportunities.

We have a single goal in mind for any potential acquisition.

That goal is to strengthen our ISR domain expertise and grow the core by increasing our access to and content on the most promising ISR platforms and programs.

Wrapping up, the fourth quarter was a solid conclusion to a successful turnaround year for Mercury.

Although we currently expect that our commercial markets could remain challenged for some time to come, the progress we have made in strengthening and expanding our defense business positions us well to deliver renewed growth in fiscal 2010 and beyond.

Bob, over to you.

Thank you, Mark.

As a reminder, I'll be discussing our fourth quarter and fiscal year 2009 results and first quarter guidance on both a GAAP and non-GAAP basis.

In addition, now that we've divested all of our non-core businesses and treated them as discontinued operations, the numbers I will be discussing relate only to continuing operations.

I'll also note that we have replaced non-GAAP earnings with adjusted EBITDA as one of our guidance measures.

Starting on the top line, total revenue for the fourth quarter of fiscal 2009 was $48.4 million, slightly above the top end of our guidance range of $46 million to $48 million.

This compares with revenues of $50.6 million for the sequential third quarter, and $49.6 million for the fourth quarter of fiscal 2008.

For fiscal year 2009 as a whole, Mercury's total revenues were $188.9 million, down 1% from the prior fiscal year.

Non-GAAP earnings from continuing operations for the fourth quarter of fiscal 2009 were $0.13 per diluted share, also above the high end of our guidance range which was $0.05 to $0.08 per share.

For the full year, non-GAAP earnings from continuing operations were $0.49 per diluted share, compared with $0.51 for fiscal 2008.

Looking at our revenues by operating unit, revenue in ACS including both defense and commercial, were $47.2 million, down 4.5% from the sequential third quarter and down 4.3% from Q4 of fiscal 2008.

For the full year fiscal 2009, ACS revenue was down by 1.7% to $185.3 million, from $188.5 million in fiscal 2008.

Our Mercury Federal Systems segment had an outstanding year.

Revenue increased from $200,000 in FY 2008 to $5.7 million in FY 2009.

Mercury's total book-to-bill ratio including ACS and Mercury Federal, for the fourth quarter was 1.33, and for the full year, 1.11.

Our fourth quarter total backlog including deferred revenue was $98.2 million, an increase of $15.9 million from the sequential third quarter, and up by $20.6 million from the fourth quarter last year.

Of the current total backlog, $69.7 million or approximately 71% relates to shipments scheduled within the next 12 months.

In addition, $93.8 million or approximately 96% of our total backlog relates to defense.

Note that backlog has also been adjusted for discontinued operations.

Moving down the income statement, fourth quarter GAAP income from continuing operations was $3.1 million, or $0.14 per diluted share.

This compares with a GAAP loss from continuing operations of $900,000 or $0.04 per share in the same period last year.

For the full year, GAAP income from continuing operations increased to $7.9 million in fiscal 2009, from a loss of $4.4 million in fiscal 2008.

Mercury's fourth quarter GAAP results include approximately $1.4 million in charges as follows.

$1million in restructuring expenses, $0.5 million in amortization of acquired intangible assets, and a negative $0.1 million in stock-based compensation charges.

On a non-GAAP basis, excluding the impact of these charges, and the difference between GAAP and non-GAAP tax rates, fourth quarter non-GAAP income from continuing operations was $2.9 million or $0.13 per diluted share.

This compares with $2.4 million in Q4 last year.

We used a non-GAAP tax rate of 34% in FY 2009 and 30% in FY 2008.

Depreciation was $1.3 million in the fourth quarter of 2009.

For full year fiscal 2009, non-GAAP income from continuing operations was $11 million or $0.49 per diluted share, compared with $11.1 million or $0.51 purchase diluted share last year.

Adjusted EBITDA which excludes FAS 123R charges was $4.9 million for the fourth quarter.

For full year fiscal 2009, adjusted EBITDA was $21.1 million.

Reflecting the steady progress that we have made in enhancing the leverage in our business model, gross margin for the fourth quarter of 2009 was in line with our forecast, while operating expenses were slightly lower.

Our non-GAAP gross margin for Q4 was 53.4%, slightly above the high end of our guidance range of 52% to 53%.

For full year fiscal 2009, non-GAAP gross margin was 55.9%.

This compares with a non-GAAP gross margin of 58.4% in fiscal 2008.

Gross margin has declined from previous levels due to a change in business mix.

Gross margin was also adversely impacted this past year by abnormally high inventory reserves associated with the slowdown in our commercial business.

At the same time, the actions we've taken to lower our costs over the past year are clearly evident in our results.

Non-GAAP operating expenses for the fourth quarter of fiscal 2009 were $22.0 million, this compares with $22.5 million in the sequential third quarter, and $23.9 million in Q4 last year.

Discontinued operations have been excluded for all periods.

For the fiscal year as a whole, non-GAAP operating expenses declined to $89.2 million, from $99.9 million in fiscal 2008.

Turning to the balance sheet and cash flow statement, cash, cash equivalents and marketable securities at the end of the fourth quarter of fiscal 2009 totaled $91.9 million, compared to $85.6 million at the end of the sequential third quarter.

As previously mentioned, during the fourth quarter we redeemed the remaining $5.3 million balance on our convertible senior notes.

In addition, we received net proceeds of $9.1 million from the sale of VSG.

Mercury generated $2.4 million in free cash flow in Q4.

This compares with $1.5 million in the sequential third quarter.

For fiscal 2009 as a whole, free cash flow was $7.1 million.

As a reminder, our auction rate securities settlement agreement with UBS entitles us to full repayment of our ARS portfolio at par on June 30, 2010.

In the interim, we have a $33 million zero cost loan from UBS.

As Mark discussed, we've been focused on improving the underlying operations of the business.

Our goal is to make our business model more efficient, so we can generate the cash necessary to scale a business profitably.

Working capital is key to this effort and we have executed on initiatives to strengthen our overall supply chain capabilities, manage down inventory, and improve our performance in cash collections.

Inventory decreased by $2.1 million sequentially in the fourth quarter of fiscal 2009.

For FY 2009 as a whole, inventory was down by $7.4 million from fiscal 2008.

Fourth quarter DSOs were 53 days, compared to 60 in the sequential third quarter.

Accounts receivable were down to $29 million from $34 million in Q3.

The constant challenge we face is the lack of shipment linearity within a given quarter in our business.

We've been addressing this in conjunction with our customers, but we still have work to do.

Nonetheless, we feel good about the progress we've made on working capital overall and the Company's ability to generate cash from operations.

At the end of the fourth quarter, our total employee headcount excluding contractors was 517, compared with 522 at the end of Q3, and 530 at the end of fiscal 2008.

All of these figures exclude employees associated with discontinued operations.

Before we move on to guidance, I would like to note that our $100 million universal shelf registration went effective May 20th.

As stated in our form S-3, any proceeds raised through the sale of securities under the shelf are intended for general corporate purposes including funding potential acquisitions.

In addition, I would like to extend our appreciate to Mercury's shareholders for voting in favor of our stock option exchange program for employees.

Option holders exchanged 431,000 under water stock options for 154,000 non-vested shares.

The exchange program was largely cost neutral and reduced our overhang by 1.1%.

Let's move on to our guidance for the first quarter of fiscal 2010 which incorporates a new non-GAAP measure of financial performance, adjusted EBITDA.

We'll be using adjusted EBITDA going forward because we believe that it is more in keeping with practices in the defense industry than our previous non-GAAP earnings measure.

Our guidance for Q1 reflects the operational and market momentum driving our defense business as we begin the new fiscal year.

Although we expect commercial revenues to continue declining, we expect to report strong growth in defense revenues and as a result, another quarter of solid profitability for Mercury.

For the first quarter of fiscal 2010, we currently expect a revenue range of between $43 million and $45 million.

We anticipate reporting a Q1 GAAP gross margin of approximately 56% to 57%.

GAAP operating expenses are currently anticipated to be approximately flat, both sequentially and year-over-year.

CapEx for the first quarter of fiscal 2010 is projected to be approximately $2.5 million and depreciation, approximately $1.3 million.

On this basis, GAAP earnings from continuing operations for Q1 are currently expected to be between $0.03 and $0.08 per diluted share, on approximately 22.6 million shares outstanding.

As I mentioned, commencing with Q1 of fiscal 2010, our non-GAAP measure of financial performance will change to adjusted EBITDA.

Our estimate for the first quarter of FY 2010 excludes the following approximate amounts.

$1million in stock-based compensation costs.

Net interest income of $100,000.

$400,000 in you amortization of acquired intangible assets and depreciation of $1.3 million.

Our GAAP tax rate for FY 2010 is expected to be approximately 27%.

As a result, adjusted EBITDA for the first quarter of fiscal 2010 is expected to range from $3.5 million to $5 million.

I'd like to conclude by announcing that coincident with preparing our FY 2010 strategic operating plan, we have updated our pro forma target business model to better align with our current operations.

The model consists of two segment.

The first is our advanced computing solutions or ACS business.

ACS includes our core defense business, including services and systems integration and our commercial business.

The second segment consists of Mercury Federal Systems.

Now that we've divested our non-core businesses, refocused ACS on high growth defense markets and developed Mercury Federal Systems, looking at Mercury in terms of these two segment provides more insight into the underlying performance of our business.

Prior to our portfolio rationalization, Mercury's consolidated target model reflected a blend of businesses including the high gross margin, software-driven VSG and VI units, which have since been divested.

The historical model targeted a 58% plus gross margin and a 15% non-GAAP operating margin.

We're resetting the target model to continue to reflect a 14% to 15% operating margin on a non-GAAP basis, but at an expected lower gross margin of 54% plus.

This is based on Mercury's targeted profitability within the next two to three years, excluding acquisitions.

And the expected mix in that time frame between our ACS and MFS businesses, where MFS contributes between 10% to 15% of overall corporate revenues.

The ACS unit continues to drive high margins and we are targeting 55% plus gross margin and 15% operating profit in this larger part of our Company.

This gross margin target is slightly down from currently reported gross margin levels due to the faster growth in services and systems integration offerings that we expect over the next two to three years.

Mercury Federal Systems, being a value added service provider for the primes and federal government agencies, is targeting a more typical 20% gross margin and a 10% to 12% operating profit.

In addition, our new target business model will deliver an adjusted EBITDA margin in the 17% to 18% of revenue range.

Mercury concluded fiscal year 2009 as a more focused and profitable enterprise and we believe this new target model aligns well with our new and stronger positioning.

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

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

Thank you, Mr.

Holt.

(Operator Instructions) We'll go first to Tyler Hojo with Sidoti & Company.

Hey, good evening, guys.

Hi, Tyler.

I was hoping maybe you could talk a little bit more about the systems integration and services business in ACS.

Last quarter I think you gave us a number, just in terms of what that contributed in revenue in the quarter.

And I'm hoping that you can start maybe the dialogue by giving that again.

Okay.

So the revenue in services and systems integration this quarter was $7 million.

Okay.

I mean, that's more than double what it was in the third quarter.

Can you maybe talk about what drove that and what your expectations are for that little niche in the segment as we move into fiscal 2010 and beyond?

Yes.

So if you look at what we're trying to do at a corporate level, we're really positioning the Company as an ISR subsystems integrator, so kind of building upon our expertise in high performance single processing and adding complementary services and systems integration to increase the size of the deals that we're going after.

So what we're starting to see is more and more opportunities for deals that are within our existing pipeline to provide more of those types of services to our existing prime defense contractor customers.

So that's kind of the what we're trying to do and I think we expect good growth out of that business going forward.

Okay.

Great.

And maybe you could just comment on -- I'm not sure if you're familiar with -- I imagine you are familiar with the OCI clause in the new defense procurement legislation.

And I'm just wondering if you think this impacts basically the business model going forward and if it potentially puts some risk to some of the things you're trying to accomplish here.

Okay.

Let me start out by talking about the rules as they stand today.

We've done a pretty thorough OCI review and through that review, we determined two things, that currently we have no work or planned projects that trigger the current OCI rules.

And secondly, the way in which Mercury and MercFed work together doesn't trigger the existing OCI rules.

So I think we believe that we're fine today.

Looking at the new pieces of legislation, of which there's two, the National Defense Authorization Act, as well as the Weapons Systems Acquisition Reform Act.

Over the next 12 months, that could result in the definition of new best practices or changes to the [DFAS].

Our best view of it is that the primary focus area of the government is likely to be the large primes, under the definition and potential conflicts associated with being classified as a lead systems integrator, neither Mercury or MercFed is a lead systems integrator.

So while -- so basically we don't believe we've got a problem.

What we're going to continue to do is basically monitor any potential changes and make sure that we're in compliance with it going forward, Tyler.

Okay.

That sounds good.

And just lastly from me, on the R&D side I think you were down somewhere in the mid-teens sequentially.

Obviously you're up sequentially in design wins.

I mean, just on the R&D front, obviously part of the story has been trying to leverage those R&D dollars but I mean, is this downward trend something to expect going forward or have you kind of bottomed out here?

So, if you look at the R&D, it can be lumpy quarter-to-quarter, depending upon things like the timing of prototype deliveries, etc.

Our expectation is that R&D will remain relatively flat overall for FY 2010.

And so that's our expectation.

It may be up a little, may be down a little on a quarterly basis.

All right.

Great.

Thanks for all that color.

Okay.

Thanks, Tyler.

We'll go next to Mark Jordan with Nobel Financial.

Good afternoon, gentlemen.

Just following up a little more explicitly on the R&D.

If it's flat year-over-year, you did say you saw op expenses being flat sequentially so that would imply a little bit higher R&D in the outquarters of fiscal 2010?

Mark, it's Bob.

We're really trying to stand firm on not getting into the business of forward guidance beyond the next immediate quarter.

But to go back to Mark Aslett's point on R&D, there is leverage, operating leverage in our model, so we're not looking at much growth here across OpEx.

As we grow into our model with top line growth over the next couple of years.

So that's kind of consistent with what we said in terms of our pro forma model structure.

Relative to the -- I want to make sure that I heard things properly on your revised model.

You said on a blended basis you're looking for 14% to 15% operating margins on a non-GAAP basis?

Is that correct?

That's correct, on a non-GAAP basis.

And then we believe we can deliver --

Would a GAAP adjustment be crudely 150 to 200 basis points if you were to look at that on a GAAP basis?

It's in that range.

But the big adjustment there -- the big adjustment is really depreciation, to get from an EBITDA -- I'd rather go towards EBITDA, Mark, if you know what I'm saying.

Yes, yes.

I think was what we're trying to do is to provide guidance on a GAAP basis going forward and an EBITDA basis.

I reset the model on a non-GAAP basis so that you could compare yesterday's Mercury model to tomorrow's, and I think our big message is yesterday's model had a non-GAAP operating percentage of 15% and we're ranging that 14% to 15% now.

Just because of the success you see in MercFed?

It's really coming down to mix with MercFed over the planning horizon, next two or three years, becoming 10% to 15% of our total revenues, and that will run with 10 to 12 points on the bottom line.

Okay.

Again, non-GAAP.

So if you want to adjust our non-GAAP down to a GAAP, you're probably going to have to take some of your historical charges that you've got in your model and attempt to model those going forward.

I'm going to try to stay away from that.

Okay.

Two more questions, if I may.

One, your restructuring charge was up to almost $1 million.

Yes.

Was that kind of a clean-up case and what should we look for sort of moving forward?

Yes, sure.

And then secondly, just with -- when do you -- will you be reporting a tax rate in the upcoming year?

You did say that you had an adjusted -- let's see.

You did have a tax rate of 27% assumed in some of your calculations.

When will your results reflect a reported tax?

Let me just quickly hit the tax rate.

Our best estimate right now is that we will evidence a 27% rate for 2010.

On to restructuring, we did incur about $1 million restructuring expense in the fourth quarter.

It was a little bit more than clean-you up, frankly.

We sold our final non-core asset in the June quarter, which gave us the opportunity to reorganize our corporate functions and that's primarily what that charge is all about, is a more focused Mercury going forward, ACS and MercFed having sold five businesses in the last 18 months.

So we took advantage of that opportunity in the fourth quarter and restructured.

We do not expect much in the way of restructuring charges going forward.

Thank you very much.

We'll take our next question from Steve Levenson with Stifel Nicolaus.

Thanks.

Good afternoon, Mark and Bob.

Hi, Steve, how are you?

Good, thank you.

Nice results.

On your ISR subsystems integration efforts, who do you think you're going to run into and how do you think you're going to beat them?

So I think if you look at our traditional competitors, given what we're doing, right, we're not looking to branch out into other areas of technical capabilities.

We're still focusing very much on the digitalization, single processing, compute capability for the platforms that we are selling into.

So I think our competitor set remains relatively stable.

What we're starting to see really is the primes looking to outsource more of the stuff that may have -- that they themselves may have done historically in this grand based radar program for theater missile defense is a great example.

The last time around, in terms of this particular program, the primes themselves did much of the work.

This time around, they've outsourced it to Mercury.

Okay.

Thank you.

Second, on the sales mix, I don't know if this is something you have, but it would be helpful.

Can you break it out between the upgrade and reset work that you're doing and what you're doing on new platforms?

No, we haven't got that information, Steve.

If you wanted to take a guess, do you believe it's skewed heavily one way or the other?

I would say the majority of the work today is on upgrades to existing platforms, specifically in ACS.

If you look at MercFed, they're more focused on new starts in the ISR space and the [gorgonstair] program that I mentioned is a very good example of a next generation ISR platform and system that's starting to incorporate our converged sensor network architecture capability.

Okay.

If you can say, is the customer there General Atomics is the maker of aircraft or Sierra Nevada as the maker of the sensor package?

We're not at liberty to say which one it is.

Okay.

And last is do you think the mix is going to stay this way, at least through fiscal 2010?

In terms of upgrades versus new?

Right.

Yes, because I think if you look at the focus on much of the defense budget today is providing upgrades and new -- upgraded capabilities onto existing platforms, so yes, my belief is that that mix would remain relatively stable.

Great.

Thank you very much.

Thank you.

We'll go next to Phil Fredmond with PW Partners.

Hi, guys, how you doing?

Two questions, do you know about what percent of last year's continuing ops backlog was shippable?

Was it comparable to the 71% going into this year?

Phil, all the backlog numbers we've given have discontinued operations taken out of them.

Right.

Okay.

So the question, maybe I missed it, maybe you reported it.

So therefore, this year's number you said I think was around 71% is shippable the next 12 months so going into next year that helps us.

I'm trying to figure out what the percent shippable was last year, the next 12 months.

I can do a quick calculation.

It was much higher, Phil, 90% plus.

Okay.

Now, quick reminder there.

Total backlog is up over $20 million year on year.

Right.

And I think, what I want to make sure you're understanding here is, good example is the program that Mark was just talking about, where we're doing engineering services and systems integration work.

And the program that he broke down there, it's an $18 million program with a hard purchase order.

Three chunks.

$6 million products, $6 million service -- engineering services and another $6 million systems integration.

That plays out over a greater than 12 month period.

Okay.

I get it.

Makes sense.

So I think its goodness is what you're observing in the numbers.

Okay.

And second --

There's one other point that if you look at -- with the commercial business being down there's a much greater percentage of the backlog associated with the defense business this year than last.

Okay.

And just the second and last question is a follow-up to the margin question on the 14% to 15%.

Just to help frame it, the Q1 guidance you gave, the amortization I think of $400,000, the depreciation of $1.3 million, and the stock-based comp of $1.0 million, those are really the three -- those are really the three items, right, that would be excluded from a reported GAAP EBIT margin; right?

That's correct.

If I take that $2.7 million very simplistically, multiplied it by four and get $10.8 million, I'm not sure that's even close to reasonable.

You guys typically have done at the high end or better of your revenue numbers, so 45 times four is 180, simplistically let's so it's 200.

My number, not yours.

So that would say the numbers closer to 550 basis points off not the 150 to 200 of the prior questioner.

So is my math wrong or --

Well, you've put yourself in the annual guidance business here for 2010 and we're trying to stay out of that.

I know that.

But is my logic off in terms of -- is my logic of annualizing those items wrong?

No, you're taking the right -- you're dealing with the correct items, but you need to find obviously an algorithm to annualize them.

I'll go back to Mark Jordan's question.

He took a non-GAAP target bottom line of 14% to 15% and he was trying to get it down to GAAP.

And without parsing all the individual pieces, but you've itemized them for us or enumerating them, it's two to three points --

Then --

-- variability.

-- am I off in the stock-based compensation?

That is more first quarter loaded?

No, stock-based compensation this past year, total year ran about $5 million and it will run somewhere in a similar range this year.

But then same thing though with the amortization and depreciation should be fairly linear, I would think.

Depreciation won't move around too much.

And a note on the amortization of intangibles, you set these up when you acquire companies and the intangibles that we've been amortizing relate to acquisitions that Mercury made back in the 2004, 2005 time frame.

Not the ones we sold, the ones we still have, like our [Echotech] business in Huntsville.

These tend to run out variably depending what the asset is in the three, four, five year time frame.

So they burn off over time.

So you do have some moving parts there.

I think you should stick with two or three points with some variability, adjust non-GAAP down to GAAP in terms of a target business model.

Okay.

That's great.

I would also encourage you to stay on point and we're pretty comfortable looking at an adjusted EBITDA, which is going the other way, of 17% to 18% as a target business model, and I think you'll find that easier to work with as a comparable to other companies.

Okay.

Great.

Thank you.

Sure.

(Operator Instructions) And it appears there are -- we'll take a follow-up question from Tyler Hojo with Sidoti & Company.

I was just wondering if you had the operating margins for the segment, or do I have to wait for the 10Q -- or the 10K?

I think we should wait for the K to get filed.

Thanks a lot.

And it appears there are no further questions at this time.

I'd like to turn the conference back over to our speakers for any closing remarks.

Okay.

Thanks, Ryan, and thanks to everyone for listening.

We look forward to speaking with you again next quarter.

This concludes our call.

That does conclude today's conference.

We thank you for your participation.