Mercury Systems Inc (MRCY) 2010 Q4 法說會逐字稿

Good day, and welcome everyone to the Mercury Computer Systems Incorporated fourth quarter fiscal 2010 earnings results conference call.

Today's call is being recorded.

At this time for opening remarks and introductions, I would like to call the call over to the Company Senior Vice President and Chief Financial Officer, Mr.

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 press release, you can find it on our website at www.mc.com.

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

You can identify these statements by the use of the words may, will, should, plans, expects, anticipates, continue, estimate, project, intend, and similar expressions.

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

These risks include but not limited to, general economic and business conditions including unforeseen weaknesses in the Company's markets, effects of continued geopolitical unrest and regional conflicts, competition, changes in technology and methods of marketing, delays in completing engineering and manufacturing programs, changes in customer order patterns, changes in product mix, continued success in technological advances, and delivering technological innovations, continued funding of defense programs, the timing of such funding, changes in the US government's interpretation of Federal procurement rules and regulations, market acceptance of the Company's products, shortages in components, production delays due to performance, quality issues without outsourced components, inability to fully realize the expected benefits from acquisitions and divestitures, or delays in realizing such benefits, challenges in integrating acquired businesses and achieving anticipated synergies, and difficulties in retaining key customers.

Additional information regarding forward-looking statements and risk factors is included 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.

I would also like to mention that in addition to reporting financial results in accordance with General Accepted Accounting Principles, or GAAP, during our call we will discuss a non-GAAP financial measure, typically adjusted EBITDA.

Adjusted EBITDA excludes income and expense, income taxes, depreciation, amortization of acquired intangible assets, restructuring expense, impairment of long-lived assets, acquisition and other related expenses, and stock-based compensation costs.

A reconciliation of adjusted EBITDA to GAAP net income from continuing operations is included 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 will begin with an update on our business for the fourth quarter, Bob will review the financials and discuss our guidance, and then we will open it up for our questions.

Q4 was the strong finish to a year of solid progress for Mercury.

Onour call a year ago, we said the business was positioned to expand on both the top and bottom lines.

We produced consistent growth in revenues and adjusted EBITDA since then.

Total revenue for the fourth quarter of $63.6 million exceeded the high end of our guidance range by $3.6 million.

Total defense revenue including ACS and Mercury Federal increased 40% sequentially and by 20% year-over-year to $47.9 million.

This growth was mainly driven by the $19 million Aegis missile defense order we shipped as planned in the quarter.

This was also a strong quarter for commercial revenue which grew 87% year-over-year to $15.8 million.

The work we have done to restructure, refocus and strengthen our defense business over the past two years has significantly improved Mercury's operating leverage.

Our GAAP earnings from continuing operations in the fourth quarter of fiscal 2010 was $0.77 per diluted share, compared with guidance of $0.25 to $0.28 per share.

The major variances to guidance were approximately a $0.32 gain due to the partial release of a tax valuation allowance, as well as a $0.14 gain due to higher revenues and lower operating expenses.

Adjusted EBITDA for Q4 increased from $5.9 million a year ago, to $12.4 million compared with our guidance of $9.3 million to $9.9 million.

We ended fiscal 2010 with a positive book to bill of 1.03.

Total backlog including both defense and commercial is up 6% year-over-year, and our 12 month backlog is up 27% year-over-year.

We expect this backlog to translate into solid year-over-year revenue growth in fiscal 2011.

Last quarter I said we expected weaker defense bookings in the second half of FY 2010 which is the way in which things played out.

For the full fiscal year, defense bookings were down 18% year-over-year and our book to bill was 0.9.

Bookings in MFS came in lower due to shifts in the timing and funding of our largest single program in that business.

And as mentioned last quarter several deals were also delayed in ACS services and systems integration.

More about both of these businesses in a minute.

Finally a major driver was that we were expecting higher bookings from certain foreign military sales in ACS that did not occur during the year.

One such example was Patriot.

We now expect to realize strong Patriot bookings and revenues in fiscal 2011.

As Raytheon mentioned on their earnings call last week, International Patriot was the highlight of the recent Farnborough Air Show.

They believe that Saudi Arabia is likely next in line, then Turkey could be later in the year.

They also mentioned that UAE is going well, as you may recall that Congress has already approved the sale of Patriot systems to Taiwan.

Despite the delays that occurred in the fiscal year, one important take away on our defense business is that we believe nothing fundamentally has changed.

We still do expect to report solid year-over-year growth in bookings and revenue in our defense business in fiscal 2011.

At the same time, our commercial bookings for the fourth quarter were up more than 400% year-over-year in Q4, and up 82% for FY 2010 as a whole.

Our commercial backlog is up 500% entering fiscal 2011 compared to the year ago.

This bookings and backlog growth was driven largely by a product transition with KLA-Tencor.

Given that we are reaching the end of this product transition, we are not currently expecting additional KLA books in FY 2011.

In addition our involvement in KLA's next generation system now seems doubtful.

Nonetheless the higher commercial backlog going into the new year has improved our visibility and our confidence in continuing to model roughly flat revenue in commercial for fiscal 2011 this compares with FY 2010.

We have also begun to see a ramp in production revenues related to the next generation product roll-out at ASML.

We expect that over time our business will ASML help compensate for the expected decline in revenue from KLA.

Let now turn to the defense business where we expect to continue seeing solid growth in both the near and longer term.

We have refocused this business in key markets, including ISR, ballistic missile defense and electronic warfare, where we believe DOD funding and foreign military sales will continue to grow over the next several years.

We have also aligned our business model with the comprehensive procurement reform to which the DoD is firmly committed.

We have positioned Mercury as an outsourcing partner, who can help the prime succeed in this new procurement environment.

I will speak to the five factors that we believe will drive our defense growth over the next several years.

The first of these growth drivers is design wins.

The most significant long term leading indicator in our business.

The dollar volumes for any given design win are usually small initially, but our future growth is all about getting on the right programs and platforms and then seeing these wins develop into significant revenue streams over time.

We have been successful in growing the number and the value of our design in defense, and the fourth quarter was no expectation.

Mercury won 11 new design wins in the fourth quarter of 2010, all of them in defense.

This compares with a total of 10 design wins all in defense in Q4 of last year.

For fiscal 2010 as a whole, the total five-year probable value of our design wins increased 3% from last year to $229 million.

In defense specifically, the five-year probably value was up 19% year-over-year to $203 million.

Our two most significant design wins this quarter were both in electronic warfare.

One was for our next generation airborne signals intelligence capability deployed on a number of manned and unmanned airborne assets.

The other key design win which is likely much larger was related to the surface electronic warfare improvement program.

Seawhip is the Navy's next generation electronic warfare suite, for which Lockheed Martin has been selected as the prime.

Together these wins represent significant opportunity for Mercury over the years ahead.

Our second growth driver is the government's increasing demand on the primes for more cost-effective, more open, more rapid capability upgrades utilizing more firm fixed price contract awards.

We created our service and systems integration business within ACS to capitalize on this emerging opportunity.

Driven by four large bookings in FY 2009, SSI ended fiscal 2010 with a $23 million backlog, that resulted in FY 2010 revenue growing 85% year-over-year, clearly a great performance.

SSI is still, however, a nascent and somewhat lumpy business and bookings in FY 2010 were down by $7 million year-over-year.

Due to lower books and a much lower backlog than we had going into FY 2010, we are anticipating lower overall SSI service revenues in fiscal 2011.

That being said, we will continue to see the benefits from SSI deals well beyond the time when the initial services were delivered.

Deals previously won in SSI are likely to generate production based annuity streams for ACS in fiscal 2011 and beyond.

It is clear to us that we have succeeded in aligning Mercury with the primes as a Best-of-Breed outsource provider of application-ready subsystem solutions for ISR.

This positions SSI to become an increasingly important part of our business model longer term.

Our third and most immediate source of growth is our involvement with programs that are ramping or that are already in production today, such as Aegis, JSF, Global Hawk, BAMS, Patriot, F-16, and the [Predator Repe] UAVs.

We expect these programs to continue providing a growing stream of foundational revenue for the Company over the next several years.

Revenues in our radar business for 2010 as a whole grew 31% year-over-year driven mainly by the Navy's Aegis missile defense capability, which was our largest single program in FY 2010.

In terms of fiscal 2011 and future years, we expect to see continued growth in Aegis shipments and revenues through Lockheed Martin, as well as stronger Patriot foreign military sales through Raytheon.

We believe we are also well-positioned for potential upgrades to the radar of the F-16, and in upgrades to the Naval Surface fleet EW capabilities as previously mentioned.

From an existing design win perspective, electronic warfare could be our most significant organic growth opportunity specifically within the counter ID space.

Developing technology that can effectively detect and counter roadside bombs has become one of the DoD's top priorities.

We have been down selected by two primes to work on the next generation counter ID program of record.

We expect the government to decide to move forward with one of these primes in the fall.

Then it comes down to the question of whether the program will be fully funded, and how quickly it will roll out.

Although we stand to benefit in either case, the decision by the government to award the program to a particular prime could ultimately be a game changer for Mercury, in terms of our total revenue from programs in production beginning as early as fiscal 2012.

Fourth in our list of growth drivers is Mercury Federal or MFS.

The hybrid business model that we have created with MFS enables us to provide services directly to the end customer at the front end of the design and development process.

This can open up design win opportunities for our ACS business in areas beyond the commercial item defense electronics market, that historically we wouldn't have been able to address.

MFS clearly differentiates Mercury from our competitors.

It places us in a stronger position to serve as subsystems architects for next generation ISR programs and platforms.

Bookings at MFS were down by $4.4 million for FY 2010 as a whole, while revenues nearly doubled to $11.1 million.

For Q4 specifically MFS bookings declined 45% sequentially and by 13% year-over-year to $1.5 million.

Our major program in this business is for next generation persistent ISR image processing soft system on a tactical UAV.

In the near term, MFS bookings and revenues are likely to remain highly concentrated, and will continue to be driven by the single large program.

Longer term, we expect MFS to become a more significant part of our overall revenues.

If phase two of this program is rewarded and development and funding moves ahead as we think it may, MFS bookings could begin ramping sooner than we had previously anticipated.

Our fifth growth driver is the potential for acquisitions.

We continue to look for opportunities in three areas, first strengthening our ISR domain expertise in MFS.

Second, gaining access to the most promising ISR platforms and programs, and third, adding technology and products that can expand our platform content footprint.

We begin fiscal 2011 well-prepared to pursue these opportunities.

We settled the auction rate securities issue with UBS, and ended fiscal 2010 with $74 million in cash as expected, as well as zero short term and long-term debt.

We also strengthened our monitoring team by recruiting a Vice President of Corporate Development, who brings experience with a major US bank in defense-related M&A.

In addition last month, we announced that Gerry Haines has joined Mercury as Senior Vice President of Corporate Development and Chief Legal Officer.

Gerry brings us in-depth knowledge and experience with M&A and corporate finance, as well as an extensive business and legal background.

We also added significant depth of experience to our Board last month with the arrival of George Muellner.

George brings to the Board a wealth of knowledge in defense contracting and aerospace technology, as well as government acquisition experience and is also a highly decorated US military veteran.

I will wrap up simply by saying that we are in a good place with the programs we are on and with our business model.

We have aligned Mercury with the fundamental shift that is taking place towards outsourcing by the primes and towards service based offerings, that can lead to production based annuity streams over time.

A couple of our current early phase programs have the potential to become strong revenue capitalists, if they are funded and go into production.

And as I just mentioned, we have laid the groundwork to drive incremental growth through acquisitions as well.

Looking ahead to fiscal 2011 specifically, we are expecting our defense business and Mercury overall to deliver another year of solid top line growth.

We demonstrated this year that we can translate higher revenues into higher GAAP operating income and adjusted EBITDA.

We believe more strongly than ever in our thesis that Mercury will grow into its longer term operating model as the business scales.

Bob will have more to say about our expectations for the business going forward.

So with that, Bob, I will turn it over to you.

Thank you Mark.

As a reminder, I will discuss our results on a GAAP basis.

Please note that commenting with FY 2010 our non-GAAP measure for reporting financial performance is adjusted EBITDA.

We believe that GAAP combined with adjusted EBITDA is consistent with practices in the defense industry.

In addition, since we divested all of our noncore businesses and have been treating them as discontinued operations since the end of FY 2009, the numbers I will be discussing relate only to continuing operations.

Mercury's total revenue for the fourth quarter of fiscal 2010 was $63.6 million, exceeding the top end of our guidance range of $58 million to $60 million.

This compares with $48.4 million in revenue for the fourth quarter of fiscal 2009.

For the full 2010 fiscal year total revenue increased nearly 6% to $199.8 million, from $188.9 million in fiscal 2009.

Please note that in Q1 of fiscal 2010 Mercury elected to adopt a new EITF-08-1 revenue arrangements with multiple deliverables.

Although Mercury was not required to adopt this guidance until Q1 of FY 2011 we elected to early adopt as the Company believes this guidance allows for the recognition of revenue for an arrangement with multiple deliverables to more closely mirror the economics of the arrangement.

As a result of this adoption in the first, second and third quarters of fiscal 2011 Mercury recognized a net $2 million, $2.3 million and $3.2 million respectively, that would have been deferred under the previous guidance EITF 00-21 for multiple element arrangements.

We recognized a net $17.6 million in Q4, the majority of which was from our large Aegis program shipment, resulting in incremental revenue of $25.1 million for full year FY 2010.

GAAP income from continuing operations for the fourth quarter of fiscal 2010 was $18.0 million, or $0.77 per diluted share, on approximately 23.3 million shares outstanding.

This was well above our Q4 guidance of $0.25 to $0.28 due to three factors.

First higher revenue and lower operating expenses accounted for a combined $0.14 of the difference.

Secondly, a partial release of the valuation allowance on our deferred tax assets accounted for approximately $0.32 of the difference.

Thirdly, the remaining difference of $0.04 resulted from other tax related items including in FY 2010 effective tax rate true-up, and certain discrete items.

For the fourth quarter last year Mercury reported GAAP income from continuing operations of $3.1 million, or $0.14 per diluted share.

For fiscal 2010 as a whole, GAAP income from continuing operations increased to $28.1 million.

Or $1.22 per diluted share, from $7.9 million, or $0.35 per diluted share, for fiscal 2009.

Again the year's results were positively influenced by the partial release of our valuation allowance and an FY 2010 effective tax rate benefit of approximately 5%.

Breaking it down by operating unit, revenue in ACS including both defense and commercial for the fourth quarter of fiscal 2010 was $62.6 million, compared with $47.2 million in Q4 last year.

For the full fiscal year ACS revenue increased to $193.7 million from $185.3 million in fiscal 2009.

Revenue in our services and systems integration business within ACS for the fourth quarter of 2010 was $4.7 million, compared with $7.0 million in Q4 last year.

For the full year fiscal 2010 revenue in SSI increased to $24.4 million, from $13.2 million in the prior fiscal year.

In our Mercury Federal systems business, Q4 fiscal 2010 revenue was flat sequentially and year-over-year at $2.3 million.

For the full fiscal year, revenue in MFS grew to $11.1 million from $5.8 million in fiscal 2009.

This was a strong quarter for Mercury's core defense business.

Total defense revenue for Q4 including ACS defense and MFS increased 20% to $47.9 million, from $40.0 million in Q4 of fiscal 2009.

Sequentially total defense revenue was up by 40% from Q3.

For the full 2010 fiscal year, total defense revenue was $157.5 million, up 9% from $144.9 million in fiscal 2009.

Commercial revenue for the fourth quarter of fiscal 2010 increased 87% to $15.8 million from $8.4 million in Q4 last year.

Sequentially commercial revenue was up 68% from the $9.4 million we reported for Q3.

For fiscal 2010 as a whole, commercial revenue totaled $42.3 million down from $44.1 million in the prior fiscal year.

Turning to bookings, total bookings for the fourth quarter of fiscal 2010 were $51.6 million, compared to $64.4 million in Q4 last year.

Sequentially total bookings were up 3% from $49.9 million in Q3.

Q4 is a difficult comparison year-over-over, because in the fourth quarter of 2009, our bookings included two orders in our services and systems integration business that totaled more than $30 million.

Mercury's total book to bill ratio for the fourth quarter including ACS and MFS was 0.81.

This compares with 1.14 in the sequential third quarter, and 1.33 in Q4 last year.

For the full 2010 fiscal year, book to bill was 1.03, compared with 1.11 in fiscal 2009.

Our Q4 total backlog including deferred revenue was $104.6 million.

This compares with backlog of $116.6 million for the sequential third quarter, and $98.2 million in Q4 of fiscal 2009.

Approximately 73% of our current backlog relates to defense.

Approximately 85%, or $88.4 million of our total Q4 backlog relates to shipment scheduled within the next 12 months, this is down by $6 million from Q3, but up by $18.7 million, or 27% from the fourth quarter of 2009.

Given the year-over-year growth in our backlog, we should see continued improvement in our near term revenue visibility, and in our ability to execute future quarters in a more linear shipment fashion.

In defense specifically, bookings for the fourth quarter of fiscal 2010 including ACS and MFS were $27.1 million.

This compares with total defense bookings of $29.4 million in the sequential third quarter, and $59.8 million in Q4 last year.

Again Q4 year-over-year defense bookings reflected the difficult comparison as previously mentioned.

Our defense book to bill for Q4 including ACS and MFS was 0.57, down from 0.86 in the sequential third quarter, and 1.49 in Q4 of fiscal 2009.

Our backlog in defense Q4 decreased to $76.8 million from $98.7 million in Q3, and $93.8 million in Q4 of FY 2009.

The sequential decline was primarily due to the large Aegis shipment this quarter.

Mercury's adjusted EBITDA for the fourth quarter of fiscal 2010 was $12.4 million.

This compares with $5.9 million for the fourth quarter of fiscal 2009.

Please be reminded that our Q4 results include a $7.4 million tax benefit derived from the partial valuation allowance reversal against our deferred tax assets.

Adjusted EBITDA for Q4 2010 excludes the impact of approximately $5.6 million in net benefits as follows, $0.1 million in interest income, $0.1 million in interest expense, an $8.4 million tax benefit, $1.4 million in depreciation, $0.4 million in amortization of acquired intangible assets, and $1.0 million in stock-based compensation charges.

We did not incur any restructuring, impairment, or acquisition and other related expenses during the quarter.

As Mark said, our results in Q4 reflected continuing improvement in our operating leverage.

Our adjusted EBITDA margin for Q4 increased to 20%, from 10% in the sequential third quarter, and 12% in Q4 of 2009.

Closing in on our longer term pro forma target of 17% to 18% for the full 2010 fiscal year, our adjusted EBITDAR margin increased to $29.9 million, or 15% from $22.9 million, or 12% in fiscal 2009.

A reconciliation of adjusted EBITDA to GAAP net income from continuing operations is included in the earnings press release we issued this afternoon.

On the tax front Mercury's FY 2010 effective tax rate which excludes the impact of the valuation allowance release and other discrete items was approximately a 5% benefit, this was primarily driven by the Company's decision to adopt EITF-08-01 revenue arrangements with multiple deliverables for book purposes at the beginning of FY 2010.

We are currently working to request IRS approval to adopt 08-1 for tax purposes effective in FY 2011.

In addition based on information that became available to us at the end of FY 2010, we determined we can release approximately $7.4 million of our valuation allowance relative to our deferred tax assets.

Accordingly we reversed $7.4 million into our Q4 FY 2010 tax provision as a benefit.

An additional $7.5 million of deferred tax assets, with a full valuation allowance remains on our books.

These DTAs are Massachusetts state R&D tax credits which we do not believe we will be able to utilize in future periods.

For FY 2011 we expect to evidence a more normalized effective tax rate of approximately 37%.

Our gross margin for the fourth quarter of fiscal 2010 was 54.3%, slightly below our guidance of 55%.

For FY 2010 as a whole, gross margin was 56.3%, up from 55.8% from fiscal 2009.

Our FY 2010 gross margin was more than 200 basis points higher than our target business model gross margin of 54-plus%.

Our strong gross margin performance continued to be driven by three factors, first, higher revenue, second, a favorable product and business mix, and third, lower fixed manufacturing costs and other costs of goods sold.

As I have mentioned in prior calls, our investments and engineering methodologies and supply chain capabilities continue to drive product quality and time to market benefits.

As a result we are continuing to see declines in warranty costs, inventory provisions, and scrap.

Operating expenses for the fourth quarter of fiscal 2010 were $25.4 million, compared with $23.4 million in Q4 last year, and $23.7 million in the sequential third quarter.

And below our Q4 guidance of approximately $26 million.

Operating expenses for the full 2010 fiscal year declined modestly to $95.2 million from $97.7 million in fiscal 2009.

Moving on to guidance, for the first quarter of fiscal 2011, I am sorry I skipped a page.

I am going to back up.

Before we go to guidance let me continue to wrap up on the year end performance.

We continued to make good progress improving the underlying operations of the business in terms of our supply chain infrastructure and working capital and our ability to generate cash from operations.

Inventory for Q4 was down sequentially to $17.6 million, from $20.1 million in Q3.

When we preposition material to support the large Aegis radar shipments that were delivered in Q4.

Inventory turns for the fourth quarter were 6.6.

For fiscal 2010 as a whole, inventory turns improved to 5.0, from 4.3 in fiscal 2009.

DSOs in the fourth quarter of fiscal 2010 were 62 days, down from 63 in the sequential third quarter.

Mercury generated $1.0 million in positive free cash flow in Q4.

For fiscal 2010 as a whole, free cash flow totaled $8.4 million, compared with $7.1 million for fiscal 2009.

Turning to the balance sheet, we have repaid our zero cost loan with UBS leaving us debt free.

In regard to our auction rate securities we exercised our rights to sell our remaining securities back to UBS at par on June 30.

The transition settled on July 1, and therefore the Company had a receivable from UBS at 6/30, which is included on our year end balance sheet in markable securities and related receivables.

I am pleased to report that we received the cash on July 1.

Mercury closed fiscal 2010 with a total of $74.3 million in cash, cash equivalents and marketable securities including related receivables.

We have zero short and long-term debt.

At the end of the fourth quarter, our total employee head count excluding contractors was 523 compared with 540 at the end of Q3.

Now finally, moving on to guidance for the first quarter of 2011 we currently expect a revenue range of $48 million to $50 million.

Please be reminded that Q1 tends to be our seasonally slow revenue quarter, followed by stronger quarters as the year progresses.

We anticipate reporting Q1 gross margin in the range of 56% to 57%.

First quarter operating expenses are currently expected to be approximately $26 million.

CapEx for Q1 of fiscal 2011 is projected to be approximately $2 million.

We expect to report first quarter GAAP income from continuing operations in the range of $0.03 to $0.06 per diluted share, on approximately 23.7 million shares outstanding.

Turning to Mercury's adjusted EBITDA guidance for the first quarter of fiscal 2011, our estimate excludes the following approximate amounts, zero interest income and expense, depreciation of $1.5 million, $0.3 million in amortization of acquired intangible assets, $1.7 million in stock-based compensation costs, and as I said, an estimated FY 2011 tax rate of approximately 37%.

As a result adjusted EBITDA for Q1 FY 2011 is currently expected to be in the range of $4.5 million to $5.8 million.

In closing, Mercury turned in a strong FY 2010 driven by 56-plus% gross margin, and a successful effort to hold down operating expenses.

Looking ahead we believe that our target model for gross margin in the 54-plus % range remains valid over the planning period.

We expect that operating expenses for FY 2011 will grow at a slower rate approximately 50% of the rate at which our revenue will grow.

Upward pressure on OpEx for FY 2011 is mainly related to cost of living and merit pay increases, and selective hiring and engineering and new product development.

The restructuring and refocusing of our business over the past two years, is strengthening our operating leverage, and we expect to make continued progress towards achieving our target business model.

Again we estimate that our effective tax rate for FY 2011 will be approximately 37%, making for difficult year-over-year comparisons to FY 2010, where evidenced by 5% effective tax rate benefit.

With that, we will be happy to take your questions.

Operator?

You can proceed with the Q&A session now..

Thank you.

(Operator Instructions).

And we will go to Joe McIlree with Merriman.

Thank you and good evening.

Hi, Jim.

I apologize if you went over this at the beginning of the call.

Did you talk about design wins during the quarter, in terms of the numbers and the dollar amounts?

So we actually did mention some of that in my script.

The total design wins for the quarter were 11.

We had 11 in defense which was one more than what we had in the same period last year.

And then typically you give a five-year probable value attached that.

Did you do that as well?

Yes The five-year probable value of our defense design wins on a year-over-year basis in Q4 was up 17%.

For the year as a whole, our defense design, the five-year probable value of our defense design wins was actually up 19% on a year-over-year basis.

Okay.

Great.

Bob, does your tax rate assumption assume the R&D tax credit is reenacted or not?

The 37% rate for 2011?

Correct.

No, it does not.

Should it be and it probably will, we will get another one or two points out of that.

So we could move down modestly by one or two points from 37, but we did not plug it into that rate.

We will wait until it is actually done.

Right.

Okay.

And why is gross margin up substantially quarter-to-quarter on a sequentially lower revenue anticipation?

What is always the case with us is the product mix within a given quarter.

It varies according to the program and the business mix, Jim.

Okay.

I was hoping you wouldn't say that, but I thought you would.

Well product and business.

Business being the mix between defense and commercial.

It could also be influenced by the SSI business, how large is that in the given quarter.

There are a number of variables there.

I think big picture if you look back on it this past year, we kind of modulated around a very narrow range, and I would expect that for FY 2011 we will see the same thing.

Again mix can change it one quarter to the next.

Okay.

Great.

I will get back in line.

Thanks a lot.

Thanks, Jim.

We will go left to Tyler Hojo Sidoti & Company.

Good evening, guys.

Hey Tyler.

How are you?

Good, thanks.

So I guess through your script there, Mark, you kind of mentioned solid growth in fiscal 2011 several times.

So my question is, what is that in context to?

In context to what you have historically done, or the ISR space as a whole?

Can you kind of walk us through that a little bit?

Yes.

My comments were really in relation to what we delivered in financial year 2010.

So it is kind of a year-over-year comparison.

Okay.

I see.

Maybe you could talk about a little bit Mercury's growth prospects relative to the market as a whole.

Some of the larger players that play in the same space that you guys do, have indicated somewhere in the high-single digit kind of C4 ISR growth rates on a go forward basis.

I mean is it too aggressive to assume that perhaps you could outpace that growth, just given your size and the platform opportunities you have?

Is it unreasonable?

Maybe, maybe not.

We are kind of looking at the high-single digits to low-double digits, depending on what happens with our major program drivers.

We feel that we are well-positioned within certain areas of the defense budget.

We have talked a fair bit about those being ISR, missile and defense, and EW, and potentially longer term counter ID.

So we think when we have got the right mix of programs, that programs that we are on are performing well, we think our business model is in line with the acquisition reform that we are seeing out of the administration.

I think we are in a good position to grow, but it all depends on the timing and the funding of certain programs.

Okay.

Thanks for that color.

And then just on Merc Fed was that profitable in the quarter?

Mercury Fed.

Almost.

We are hovering around breakeven, Tyler.

Okay.

And maybe you could just comment on how the transition in leadership is going there?

You touched on near term expectations, but maybe if you could just touch on that?

Yes, so I think Dave and the team is doing a great job.

We did recruit another individual into the Merc Fed leadership team this quarter, to lead the systems and technology push.

As we have talked about our business is highly concentrated around a large single program where we are providing a next generation persistent IRS image processing subsystem.

We believe that we are well-aligned for phase 2.

If the program is awarded and the development and the funding moves ahead this year, as we think it may, then we could start and see a more rapid ramp in bookings in MFS than maybe even what we anticipated last quarter when we spoke.

We will see.

Very good.

And just lastly for me, if you can perhaps comment on the EMARS program.

You highlighted it last quarter I think when I asked you the question.

It seems like some of the primes are really starting to talk about that one?

We believe that we could be well-positioned for EMARS in the SIGINT side of things, via one prime in particular.

We will have to wait and see how the program progresses.

But we are part of several EMARS bids.

Okay.

Several meaning more than two?

Not necessarily.

Thanks a lot..

We will go next to Mark Jordan with Noble Financial.

Good afternoon gentlemen.

A question relative to Aegis program.

Obviously a significant surge in revenues Q4.

Could you give us a sense as to the order of magnitude of the Aegis potential for 2011, and how with would that program be spread out over the year?

So Aegis as we talked about is we expect it to be a roughly 10% program going forward.

We still believe that is very much the case.

That 10% is based around kind of the existing program and the way in which we expect that to play out.

As we talked about, however, we do see additional upside opportunities around Aegis longer term, associated with taking our capability and maybe putting it on different platforms, additional ships that may be funded in the budget, and then maybe taking the Aegis capability and putting it ashore.

I think if you stick with the goal of having it as approximately a 10% program, you are not going to be far wrong from a planning perspective.

This year total bookings in Aegis actually totaled over $35 million.

We actually did, we got more business this year than what the 10% that we have been planning against.

As it relates to the timing as we found out during this year, it could be somewhat lumpy.

We are not I think going to forecast how that may play out on a quarter-by-quarter basis.

Okay.

Looking at Aegis is in the early phase of a fourth generation roll-out.

Are you shipping and in fiscal 2011 third generation product, and how does that shift to fourth generation impact your revenue streams?

So the products we are shipping now are part of the 4.01 system.

It is our latest generation of product that will be going into production.

Okay.

And could you give a little color as to when the timing or what are the gating issues relative to military sales on Patriot?

Yes.

Today we received a PO for a single country, which was UAE, and received that booking in the fourth quarter of FY 2009.

As Raytheon mentioned on their earnings call last week, they are obviously pursuing a number of different countries.

What they are highlighting is that they believe that Saudi Arabia is likely next in line, and that they could see Turkey later this year.

In addition I think as we have spoken about in the past, Congress has already approved the sale of Patriot systems to Taiwan.

Out of all of the ones that they are pursuing, they are the three that we see in the near term.

And if you were to look at, say, a value of X award for a military sale, a Patriot sale announcement from Raytheon, is your content in the order of magnitude of 10%?

Can you give us a sense of size on what that might represent?

No, not really.

We expect that it is going to be pretty significant for us, as we are going forward.

I am not prepared at this point to kind of put a number on it.

Okay.

Thank you very much.

We will go next to Kevin Chiabotonni with Boenning & Scattergood.

Good afternoon guys.

First looking at Boeing's acquisition of Argon ST, can you provide us can with some color regarding what you see there in terms of opportunities or challenges for Mercury?

Argon is clearly an important customer.

We think that we have been doing a pretty good job for them on some of their most important programs.

I think as we are looking at the acquisition, we believe that the sale to Boeing is something that will benefit us in the longer term.

Argon has been particularly strong in the Navy around their C Increment E and C Increment F programs, which were a part.

And if you look at Boeing's strength, clearly they are very strong in the airborne domain.

One of our beliefs is that Boeing will help transition some of Argon's SIGINT capabilities more quickly into airborne production platforms, and we could benefit as a result of that.

Okay.

That is helpful.

And then L3 recently received a pretty sizable order for airport scanners.

Is that something that you guys were involved in?

Not to my knowledge, no.

Okay.

Thanks that is all I had.

Next to Jonathan Ho with William Blair.

Good afternoon.

Can you just give us your thoughts now in terms of the timing for ASML's ramp-up, relative to the KLA I guess wind down, and maybe your thoughts in terms of how that is going to impact the commercial side of ACS throughout the year?

Sure.

We are definitely starting to see the ramp.

We saw a 50%, over 50% increase in terms of bookings with ASML in the fourth quarter, as compared with the third.

We do believe that we will continue to see that growth as we are looking forward into financial year 2011.

Basically I think as we have said in the past, we are part of their next generation, both of their next generation systems, and on the call last quarter, we mentioned that we thought that most of their growth to date was coming from their lower end platform of which we are not a part.

It looks as if things are shifting more in line with their next generation systems of which we are a part.

So I think what we are expecting is that the ramp will continue.

They had a great quarter in terms of bookings, backlog, and had record growth.

We believe that we will be a part of that.

What we expect to have happen is that over time our business with ASML will compensate for the expected decline in revenue from KLA-Tencor beyond financial year 2011.

So that is kind of where we stand at this point, Jonathan.

On the SSI business, can you guys talk about maybe the sentiment that is out there?

I know some of the other larger defense contractors have pointed to an anti-contractor sentiment, and some slowing on the services side.

Are you guys seeing that or potential pushouts that are related to some of the ways and the supplemental out there?

Just want to get a sense for what is driving the impacts of that business?

Yes, not sure I would tie it to our SSI business per se, but I think we did experience some timing issues that relate to some bookings in the second half of the year, and in the fourth quarter in particular.

Nothing that we would be pursuing was lost per se.

It just kind of moved across quarterly boundaries.

At this point we believe that we are in a good position to basically grow our defense bookings and revenues on a year-over-year basis as well as grow Mercury as a whole.

Okay.

And last question for me is on the Gorgon Stare program, you had talked about this as sort of being the poster child for some of the defense procurement out there, defense procurement reforms.

Can you maybe give us a sense of whether this is I guess being more broadly implemented by the government, or whether you are seeing some changes in the attitude towards contracting?

Yes.

The major program that we are pursuing in Merc Fed is a persistent ISR program that we have talked about in the past.

We think that it is still a very important program.

It is a QRC program today.

We believe it is likely to transition into a phase 2.

And if that happens, and the program is funded, and the development works out, then we are expecting to see a pick-up in MFS bookings.

The way in which the government has approached the development of that program, I think it portends to the way in which we see acquisition reform taking place going forward.

We have talked about a shift toward more Best-of-Breed.

We have talked about spiral upgrade capabilities.

And that is exactly what we are doing on this program is a Best-of-Breed subcontractor for the signal processing.

We think it is an important program, we are expecting additional business from it, and we are hoping that it ultimately becomes the program of record in the budget.

There is more to go on that and things will unfold over the next year or so.

Great.

Thank you.

And we will take a follow-up with Jim McIlree with Merriman.

Great.

Thanks again, Mark.

Relative to that persistent ISR program in Merc Fed, you said that it might ramp up in fiscal 2011.

Is that part of the fiscal 2011 budget, or is that part of fiscal 2010 supplemental that just passed?

It is likely to be part of the fiscal 2011 budget.

Okay.

But there are also monies coming from elsewhere, and I can't really go too much into detail.

That is fine.

And again, I apologize if you went over this earlier.

Aegis revenue contribution in fiscal 2010, have you disclosed what that was?

No, we did not.

Would you like to?

Bookings were approximately $35 million and revenue was approximately 15%.

Okay.

Great.

Are any other programs over 10% for the year?

No.

That was the only 10% program that we had.

Okay.

Great.

And finally, it sounds like commercial you are expecting to be up fiscal 2011 versus fiscal 2010?

Is that a reasonable expectation?

No, as I said on the call, we are expecting the commercial revenues in financial year 2011 to be basically rough to flat on a year-over-year basis.

Okay.

I misunderstood.

ASML is compensating for the KLA decline, and that is how you get to flat?

Yes.

KLA we had huge bookings in the fourth quarter but it is really in relation to the product transition.

So in effect we were getting earlier bookings than what we were previously anticipating, so the revenue is going to kind of play out throughout the year, and when you net everything out, it hasn't really changed the picture, and we are expecting roughly flat revenues on a year-over-year basis.

Is that roughly equally divided between the four quarters, or is it going to be skewed in any particular quarter or half of the year?

No, I don't see it as a particular skew.

It will play out the way in which the business typically plays out, which is smaller getting larger as the year progresses.

Okay.

Awesome.

My last one, I think Bob, you said you were looking for OpEx to be $26 million?

Correct.

In the first fiscal quarter?

Right.

Trying to understand what you are spending it on.

It is a pretty significant increase over the prior, Q1 of fiscal 10 and I wouldn't call it a significant increase over the June quarter, but it is an increase.

Is it SG&A, R&D, or a little of both, or what?

It is a little bit in the R&D space with regards to our product development.

But I think the best comparison is to look at it sequentially.

I would not go year-over-year.

We did have some delays, spending delays in the first quarter of this past year, particularly with regard to some of our outside spend also associated with product development.

I would just go sequentially and when you do that, the increase is only a few hundred K, and it is clearly driven by cost of living, merit increases, which we are actually doing this quarter, effective the beginning of the quarter.

Not much in the way of hiring, very selective on that front.

Okay.

That is great.

Thank you.

That concludes the question and answer session.

I would like to turn the call back over to Mr.

Aslett for any additional or closing remarks.

Okay.

Thank you Celia.

Thank you for listening and look forward to speaking with you again next quarter.

That concludes our call.

That concludes today's conference, we thank you for your participation.