Mercury Systems Inc (MRCY) 2011 Q2 法說會逐字稿

Welcome to Mercury Computer Systems second quarter fiscal year 2011 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 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 at www.mc.com.

We would 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, 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, would, plans, expects, anticipates, continue, estimate, project, intend, likely, and similar expressions.

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

These risks include but are not limited to, general economic and business conditions including unforeseen weakness in the Company's markets, effects of 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 in 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 with outsourced components, inability to fully realize the expected benefits from acquisitions and divestitures, or delays in realizing such benefits.

Changes 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 on any forward-looking statements, which speak only as of the date of this call.

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

I would also like to mention that in addition to reporting financial results in accordance with Generally Accepted Accounting Principals, or GAAP, we will discuss several non-GAAP financial measures, specifically adjusted EBITDA and free cash flow during our call.

Adjusted EBITDA excludes interest income and expense, income taxes, depreciation, amortization of acquired intangible aspects, restructuring expense, impairment of long lived assets, acquisition and other related expenses, fair value adjustments from purchase accounting, and stock-based compensation costs.

Free cash flow excludes capital expenditures from cash flows from operating activities.

A reconciliation of adjusted EBITDA to GAAP net income from continuing operations and our free cash flow to GAAP cash flows from operating activities are 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.

Thank you Bob.

Good afternoon everyone, and thanks for joining us.

I will begin with the second quarter business update, following we will review the financials and discuss our guidance, and then we will open it up for your questions.

Mercury performed well in Q2.

We delivered another stellar quarter while also working to complete the acquisition of LNX Corporation that we announced on January 12th.

Revenue came in slightly above the high end of our guidance range.

GAAP EPS significantly exceeded our guidance, as did adjusted EBITDA which grew 94% year-over-year.

It was also a strong quarter in terms of operating cash flow.

Commercial revenue in our ACS business grew 11% year-over-year to $11.7 million.

This growth was driven by KLA-Tencor as well as increased revenues from ASLR.

Bookings in our commercial business were down 22% year-over-year in Q2 reflecting the fact that new orders from KLA-Tencor are coming to an end.

As we expected and as we have discussed previously, we have now received confirmation that Mercury is not a part of KLA-Tencor's next generation product offering.

As part of our long-term plan we will continue to engage with KLA for future platforms that may require a more performance-oriented solution.

However our backlog driven revenue from KLA will continue to diminish over the next few quarters.

We continue to expect roughly flat revenue in our commercial business in FY 2011 compared with FY 2010.

Turning to our defense business in Q2, total defense revenue including ACS and Mercury Federal was $43.9 million, up 27% from a year ago.

Defense bookings, however, were down 13% year-over-year.

Our book to bill in defense was 1.0, compared with 1.4 a year ago.

Total Q2 bookings and backlog were down 14% and 12% respectively year-over-year, and our total 12-month backlog was down 7%.

As you may recall in the second quarter of last year, we booked an unusually large $28 million order for the Aegis program which makes a tough year-over-year comparison.

The largest of our defense bookings this quarter was for NTR SIP which is the multi platform radar technology insertion program for the Global Hawk UAV.

We also booked orders for B-1B, SEWIP, the Surface Electronic Warfare Improvement Program, as well as the Patriot and Aegis Missile Defense programs.

These bookings demonstrate the success of our strategy, that focus Mercury on specific areas in the defense market place, namely ISR, electronic warfare, and missile defense, that we believe will see robust funding and growth going forward.

We are focused on transforming, growing and scaling the business by strengthening our relationships with the primes, and becoming a Best-of-Breed provider of open commercially-developed, application-ready and multi intelligent sub systems for the ISR market.

We believe that establishing ourselves as a trusted outsourcing partner to the primes, will enable Mercury to perform well in the environment of overall defense budget constraints and procurement reform that we expect for the years ahead.

The services and systems integration business we have developed within ACS positions us well.

The services led engagements we have and are winning through SSI, will generate long-term production-based revenue and annuity streams for Mercury through the sale of commercially developed application-ready sub systems to the primes.

Our Mercury Federal systems business will take us to the next level, providing the primes with affordable ISR sub systems that deliver even greater value.

The best forward-looking measure of success in these initiatives is design wins.

We won 11 new designs in the second quarter of 2011, all of them in defense, this compares with a total of eight wins, five in defense, and three in commercial in Q2 of last year.

The five year recordable value of our Q2 design wins grew to $318 million, an increase of $249 million, or 358% year-over-year.

The probable value of our design wins through the first half of FY 2011 is greater than all of FY 2010.

This does not include the recent acquisition of LNX Corporation, and I will talk more about this in a moment.

Our design wins continue to focus on radar, electronic warfare, and EO/IR.

The major wins in Q2 included two new design wins in the Air Force EO/IR space, and we also won a new design that continues to expand our footprint on the SEWIP.

However, clearly our most significant design win this quarter was for JCREW 3.3, the next generation counter-ID program of record.

JCREW is a ground-based mobile software defined jammer, designed to defeat improvised explosive devices or roadside bombs.

Mercury has previously been down selected by two primes to work on JCREW.

As we announced at our Investor Day in November, the contract was awarded to ITT, the prime of which our content was significantly greater.

We believe JCREW 3.3 is a very important program opportunity, and I would like to give it a little more color.

First of all, we believe the program is healthy and continues to move along as planned.

Our internal planning assumption is the five-year probable value of the design win is approximately $250 million.

This number excludes the content provided by LNX Corporation.

Including the LNX content increases our potential value on the program by over 40% for a total of approximately $350 million.

Although our design win metric is a five-year probable value due to the nature in the history of this program, we believe the rollout could be over a four-year period not five.

These numbers assume a roll-out similar to JCREW 3.2, which is in the order of 5,000 systems for the Marine Corps.

As you are probably aware, JCREW 3.3 is a joint program.

If the Army decides to adopt it, the number of systems and hence our probable value could be much larger.

For example, the Army and the Marine Corps deployed JCREW 2.1 in approximately 25,000 systems.

If this were to occur, we would record another design win at that time.

We currently expect to begin seeing revenue from the low rate initial production as early as the government's 2012 fiscal year.

However, since there is a lead time associated with production, we could see our first booking for LRID as early as this summer.

If the program is fully funded and goes into full production as we expect it will, we could begin seeing production revenue as early as government fiscal year 2013.

In SSI, we still expect revenue to be down from Mercury's full 2011 fiscal year following a strong FY 2010.

SSI's Q2 performance was in line with these expectations.

Bookings more than doubled year-over-year while revenue declined 46%.

Although SSI's business is expected to remain lumpy at this early stage in its development, our pipeline of opportunity looks good, and the deals we have won are likely to continue to generate annuity revenues for ACS that extend well beyond the year in which the initial services were delivered.

For example, SSI opened the door for us on Patriot, providing us with services-based revenue initially followed by the sub system annuity revenues we have received since then.

We continue to expect additional Patriot bookings and revenue in fiscal 2011 in large part driven by Raytheon's announced goals for sales in Saudi Arabia.

In addition we expect our involvement on existing programs and platforms, largest among them our business with Lockheed Martin on the Navy's Aegis Ballistic Missile defense system to continue to provide a solid foundational revenue base for Mercury over the years ahead.

Mercury Federal Systems or MFS is also helping us to transition toward becoming an ISR sub systems company.

Adding the capabilities of MFS to our core ACS business enables us to work on classified projects and work directly with customers much earlier than we have in the past.

This will make it possible for our ACS business to achieve new ISR design wins that wouldn't have been possible otherwise.

For the moment, our results in MFS are primarily driven by a single large program, a next generation persistent ISR image processing sub system on a tactical UAV.

For Q2 FY 2011 MFS bookings rose by $1.8 million year-over-year to $2.2 million, and revenue was up slightly.

We have been participating in phase one of this persistent ISR program for some time, and it is going well.

We believe that the Pentagon and the Air Force are committed to the program and the war fighting capabilities it will provide.

We currently expect the funding for phase two to be resolved as part of the current DoD budget cycle.

If you look at what is happening in the IRS market at large, the number of sophistication sensors on and over the battlefield are increasing.

These next generation sensors are collecting an overwhelming amount of data.

One of the areas we are focused on in ACS and MFS is this explosion of information, and how to actually handle the processing, storage, exploitation and dissemination of the data on board the platform.

Our ability to drive innovation in this area reinforces our position as a leader in the high end embedded computing and electronic sub systems for the ISR market.

Recently I concluded my remarks with some comments on the potential to supplement our organic growth in ACS and MFS through tuck-in or bolt-on acquisitions.

I have described our structure as being focused on opportunities in three areas.

First, adding technologies or products that can help ACS expand its core business by competing more effectively in the ISR and EW markets.

Second, adding content and services to the defense and intelligence programs and platforms where Mercury currently participates or could participate in the future.

And third, adding an ISR platform company that we can build around in our Mercury Federal Systems business.

As we announced on January 12th, we believe that acquiring LNX Corporation supports all three of these objectives.

Adding LNX to our business significantly strengthens our product portfolio in RF and our capabilities and signals in intelligence and EW.

Combined with the Echotek digital receiver business we acquired in 2005, LNX paves the way for Mercury to design and develop a new generation of software defined sub systems for future capabilities in these markets.

In addition, we believe that LNX's technology and market presence could substantially strengthen our MFS business over time.

Near term and most importantly, LNX is currently providing the RF receiver for the JCREW 3.3 program, while Mercury was already providing the signal processing.

Longer term, we believe LNX also has the potential to strengthen our position on SEWIP program, and create opportunities to participate in several classified Homeland Security and Intelligence missions.

In line with the deal grounders I have outlined previously in terms of the overall landscape, LNX is a smaller private company that is performing well.

It is closely adjacent to our existing business, and the size of the transaction was well within our means given Mercury's cash position.

We expect Mercury to continue performing well from a cash flow perspective in fiscal year 2011.

For the second quarter, operating cash flow increased 57% from Q2 of FY 2010 to $8.1 million.

This is important since we continue to evaluate additional opportunities to supplement our organic growth through acquisitions.

In conclusion, we feel good about the direction of the business as we begin the second half of our fiscal year.

Mercury's focus on specific areas in the defense market place, ISR, electronic warfare and missile defense, that we believe will see robust funding going forward.

With our ACS service and systems integration business and MFS, we have positioned ourselves as a trusted outsourcing partner to the primes.

And now we have begun our journey to supplement the Company's organic growth through acquisitions.

Along with all of our peers in the defense industry, we are looking forward to the earliest possible approval of the defense budget, to help alleviate current concerns surrounding the timing of and overall funding levels for DoD this year.

Our pipeline is strong and continues to grow.

We are doing a good job winning new designs and strengthening our presence on important well-funded programs.

Although we see some potential risk associated with the timing of orders and lumpiness in our defense business based on the budget.

Based on the momentum we have seen, we currently expect a strong second half.

Overall, we continue to believe that fiscal 2011 will be another year of solid growth on both the top and bottom lines, as we continue to make progress towards our long-term operating model.

With that I would like to hand it over to Bob.

Bob?

Thank you, Mark.

This was another quarter of solid results for Mercury, total revenue for the second quarter of fiscal 2011 increased 23% year-over-year to $55.5 million, exceeding the top end of our original guidance range of $54 million to $55 million.

This compares with $45.2 million in revenue for the second quarter of fiscal 2010.

GAAP income from continuing operations for the second quarter of fiscal 2011 was $5.2 million, or $0.22 per diluted share on approximately 24 million shares outstanding.

This was well above our original Q2 guidance of $0.10 to $0.12 per share.

For the second quarter last year, Mercury reported GAAP income from continuing operations of $1.9 million, or $0.08 per diluted share.

The upside from guidance was due to higher revenues, stronger gross margin, lower operating expenses and a revised effective tax rate for fiscal 2011 of 33% now that the federal R&D tax credit has been renewed.

In terms of our results for the first half of the fiscal year, we are off to a strong start.

Total company revenues for the first six months of FY 2011 grew 16% to $107.6 million.

Our defense revenues for the first six months of FY 2011 grew 8% year-over-year to $81.6 million, demonstrating the progress we have made in strengthening our core business.

GAAP income from continuing operations was up 40% year-over-year to $8.9 million, and adjusted EBITDA grew 47% to $19.5 million.

Breaking down our second quarter results by operating segment, revenue in ACS including both defense and commercial for the second quarter of fiscal 2011 was $53.2 million, up 22% from $43.8 million in Q2 last year.

Revenue in our services and systems integration business within ACS for the second quarter of 2011 was $3.8 million, compared with $7.1 million in Q2 last year.

As we have said, SSI is still an emerging business capability with some lumpiness in both bookings and revenue.

Looking at the full fiscal year, we entered FY 2011 with a lower backlog than we did in FY 2010, and we continue to expect SSI's FY 2011 revenues to be lower year-over-year.

In our Mercury Federal Systems business, Q2 fiscal 2011 revenue was $3.6 million, up from $3.3 million a year ago.

As Mark said, given that our bookings and revenue in MFS remain concentrated on a single large program, we continue to model flat revenue for full year FY 2011 compared to FY 2010.

Note that revenues by operating segment do not include adjustments to eliminate intracompany revenues of $1.3 million included in those operating segments.

Total defense revenue for Q2 including ACS defense and MFS was $43.9 million, up 27% from $34.7 million in Q2 of fiscal 2010.

This growth was primarily driven by radar sales from our Aegis and Patriot programs.

Mercury's commercial revenue was $11.7 million for the second quarter, up 11% from $10.5 million in Q2 last year.

For the full 2011 fiscal year we still expect commercial revenue to be flat with FY 2010.

Turning to bookings, total bookings for the second quarter fiscal 2011 is $48.2 million, a 14% decrease compared with $56.1 million in Q2 last year when we booked a large Aegis radar order.

Compared with the sequential first quarter, bookings were down 7%.

As Mark said we currently expect to see strong bookings in the second half of FY 2011 particularly in defense, so we are anticipating a good result for the full year.

Mercury's total book to bill ratio for the second quarter including ACS and MFS was 0.87.

This compares with 0.99 in the sequential first quarter of fiscal 2011 and 1.03 for the full year FY 2010.

We continue to expect a book to bill greater than 1 for the full fiscal year 2011.

Our Q2 total backlog including deferred revenue was $96.8 million.

This compares with a backlog of $104.1 million at the end of Q1 2011, and $110.4 million for Q2 last year.

Approximately 82% of our current backlog relates to defense.

In addition, 85%, or $82.2 million of our total Q2 backlog relates to shipments scheduled within the next 12 months.

Total defense bookings for the second quarter of fiscal 2011 including ACS and MFS were $41.8 million.

This is up 1% compared with defense bookings of $41.3 million in the sequential first quarter fiscal 2011, and down 13% compared with $37.8 million in Q2 last year.

Our defense book to bill for Q2 including the ACS and MFS was 0.95, down from 1.09 in the sequential first quarter of fiscal 2011, and 1.38 in Q2 last year.

Our backlog in defense for Q2 decreased to $78.9 million from $81.1 million in Q1 of fiscal 2011.

Defense backlog in Q2 last year was $103.3 million.

Mercury's adjusted EBITDA for the second quarter of fiscal 2011 was $10.7 million.

This compares with $5.5 million for the second quarter of fiscal 2010.

For the first six months of FY 2011 adjusted EBITDA was $19.5 million compared with $13.3 million for the first half of FY 2010.

Adjusted EBITDA for Q2 fiscal 2011 excludes the impact of approximately $5.5 million in net benefits as follows, zero interest income and expense, a $1.7 tax expense.

$1.6 million in depreciations, $0.3 million in amortization of acquired intangible assets, 0.3 million in acquisition costs, and $1.6 million in stock-based compensation charges.

In terms of adjusted EBITDA margin, we continue to close in on our long-term pro forma target of 17% to 18%, and in fact our adjusted EBITDA margin for Q2 was slightly above the model at 19%.

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

The federal R&D tax credit was recently renewed, and as a result for Q2 FY 2011 we used an effective tax rate of approximately 33%.

We also expect 33% to be our effective tax rate for the full fiscal year.

Our gross margin for the second quarter of fiscal 2011 was 57% above our guidance of 55%, due to favorable product mix, continued material cost improvements, and lower other cost of goods sold.

Operating expenses for the second quarter of fiscal 2011 were $25.1 million, compared with $24 million in Q2 last year, and slightly down sequentially from Q1 fiscal 2011.

As we have stated in the past, we believe there is operating leverage available as the business scales.

In line with our guidance at the beginning of the year, we expect that operating expenses for FY 2011 will grow at approximately 50% of the rate at which our revenue will grow.

We are on a multi-year journey to improve the underlying operations of the business.

By enhancing our engineering methodology and supply chain processes, we continue to introduce new products at a faster pace, improve product quality and deliver cost effective time to market benefits for our customers.

Inventory for Q2 was up sequentially to $20.6 million from $18.9 million at the end of Q1 FY 2011.

Inventory turns for the second quarter improved to 4.6 turns from 4.5 turns in the first quarter of fiscal 2011.

DSOs in the second quarter of fiscal 2011 were 53 days, down from 68 days in the sequential first quarter, and a decrease from 62 in Q2 last year.

We continue to improve Mercury's ability to generate cash from operations.

Operating cash flow for the second quarter of FY 2011 increased 57% year-over-year to $8.1 million from $5.2 million in Q2 last year.

For the first half of FY 2011 cash from operations was up 125% from the same period last year.

Free cash flow was $6.1 million in Q2, an increase of 92% from $3.2 million in Q2 last year.

We closed the second quarter of 2011 with a total of $88.4 million in cash and cash equivalents, an increase of $6.2 million from the first quarter of fiscal 2011.

At the end of the second quarter our total employee head count excluding contractors was 549, compared with 531 at the end of Q1 FY 2011.

I would like to quickly recap Mercury's acquisition of LNX Corporation before we move on to guidance.

As a reminder, the purchase accounting for the transaction will be completed coincident with our March quarter closing.

Mercury acquired LNX on January 12th, 2011 for $31 million in up-front cash, plus a cash earn out of up to $5 million.

We expect the transaction to be neutral and modestly accretive to earnings in the first year, with significant upside potential driven by LNX's presence on the JCREW 3.3 program.

We are very pleased with the acquisition costs relative to the future earnings potential of the business.

In terms of size and overall characteristics, the deal falls within the parameters we have discussed previously and aligns well with Mercury's cash position.

The transaction concluded on January 12th, subtracting $31 million from the $88.4 million in cash we had on hand at the end of Q2.

Looking further down the balance sheet we view zero short and long-term debt.

We also have a $15 million operating line of credit, a $20 million acquisition line of credit, and a $100 million universal shelf registration that remains effective.

In short, Mercury is well prepared to continue to supplement its organic growth for future acquisitions.

Now moving to guidance which includes anticipated results from LNX.

For the third quarter of fiscal 2011 we currently expect a revenue range of $58 million to $60 million.

We anticipate our Q3 gross margin to be approximately 55%.

Our third quarter operating expenses are currently anticipated to be about $27 million.

CapEx for Q3 of fiscal 2011 is projected to be approximately $4 million.

We expect to record third quarter GAAP income from continuing operations in the range of $0.16 to $0.18 per diluted share, on approximately 24.1 million shares outstanding.

Turning to Mercury's adjusted EBITDA guidance for the third quarter of fiscal 2011, our estimate excludes the following approximate amounts, zero interest income and expense, depreciation of $1.9 million, $0.8 million in amortization of acquired intangible assets, $0.1 million in costs related to the LNX acquisition, a gain of $0.1 million related to fair value adjustments from purchase accounting, $1.3 million in stock-based compensation costs, and as I said, an estimated FY 2011 effective tax rate of approximately 33%.

As a result, adjusted EBITDA for Q3 FY 2011 is currently expected to be in the range of $9.5 million to $10.4 million.

Summing it up, this was a quarter of continued growth and progress toward achieving our target business model, and we are looking forward to a strong second half.

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

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

Very good.

(Operator Instructions).

Our first question will come from Mark Jordan of Noble Financial.

Good afternoon gentlemen.

First I would like to talk a little about the JCREW 3.3.

When you are talking about a production cycle of typically of four years that could get compressed to three.

Will that be starting in essence at the end of the current fiscal year where you would start your LRID is that where you start your four-year cycle?

And secondly, through that four-year period, do you see it being relatively level loaded, or would it peak in year two and taper?

So we basically think it will be a four-year rollout period that included the LRID.

So LRID ancillary production.

It is our current expectation the LRID would start in government financial year 2012 for Mercury from a revenue perspective.

But given the lead times associated with production, we currently expect or anticipate a booking some time in the summer.

From a loading perspective, we don't really know exactly what the production would look like, Mark.

We will have to wait on that.

I am looking at just your LNX, obviously with the 3.3 opportunity you implied $100 million for the 5,000 units, or for a company of that size, it is a huge incremental contract.

Why were they interested in selling themselves just at the front side of this program?

We have been talking to them for a while.

And I think the timing associated with the funding, or the actual program roll-out itself is not wholly certain.

It comes down to what do you believe is the right thing for you as the owner of the business.

And I think Lamberto felt that it was the right thing for him to do to sell at that time, which we are very pleased about.

Final question, if I may, relative to the tax rate.

Bob, you said you now see the normalized tax rate of 33% in your guidance for the third quarter it looks like implied as a 31.8% effective tax rate.

Is that delta just the normal R&D tax credits?

No, I think your best approach here is to take the 33% as the effective tax rate recognizing that in any given quarter there is the possibility for a few discreet items of almost a de minimis amount.

Thank you.

Our next question comes from Brian Ruttenbur of Morgan Keegan.

Yes, thank you very much.

The third quarter, maybe we can talk a little about it.

Because your revenues are going to be up.

Yet your earnings guidance is down from second quarter.

Is that all because of tax?

What else is going on?

Are gross margins going to be weaker in the third quarter?

Can you help walk me through it?

Sure, the simplest answer to that from a math perspective is, it is the gross margin guidance that we are providing there.

We have been running a couple hundred basis points above our model for a while now.

It does vary quarter to quarter mostly because of business and product mix.

I think if you run the traps on the math, Brian, it is mostly gross margin.

There is more revenue there and a lower gross margin, and OpEx before the LNX acquisition is in line with where it has been the last couple of quarters, and then of course you have to add in the LNX OpEx also.

When we finish our purchase accounting, there are some charges in there.

So if you carefully look at the breakout of the amortization of the acquired intangibles for Q3, you will find that they are 400,000 or 500,000 above what they were in Q2, and that is a direct result of the LNX acquisition.

On the tax rate front, same effective tax rate 33%.

There were some discreets in Q2 that actually lowered that rate a bit by a couple hundred thousand dollars.

They were discreet so they would not repeat in the third quarter.

So the actual tax rate that you report in the third quarter will be, I heard someone say 31.5%?

I think Mark used a very finely pointed pencil on that one.

Our guidance is built around a 33% ETR for the third quarter.

Okay.

Stick with 33.

I am sure the difference is going to be lost in the rounding anyway, but 33% is the right view for our ETR for quarters three and four.

Very good.

And the other question I have, and this was asked, but I will ask it from a different angle, of course we have to deal with JCREW 3.3, and you said revenue is going to start in 2013.

Is that going to be the first half of 2013, the end of 2013?

And what do you anticipate in that?

So again, the timing specifically is not nailed down.

Understanding at this point in time is that the revenues will start in government financial year 2012, which means that we are likely to get a booking some time over the summer.

And the revenues are largely for the LRIP.

The production revenues are what will likely start in government year financial 2013.

Okay, so that would be, your revenues would not be beyond LRIP it wouldn't really be kicking in until your fiscal 2014?

Fiscal 2013.

Okay, so you will be getting LRIP money in 2012 a little bit, and then fiscal 2013 you should be getting regular production dollars?

Yes.

There is a one quarter difference between our quarter and the government's financial quarter.

Right.

Very good.

And how big is the LRIP that you would be recognizing?

We don't know at this point.

We expect it to get a better visibility over the coming quarters.

At this point we are anticipating a booking sometime probably in the summer.

We will keep you apprised as things progress.

Okay, and one final question on that.

The $350 million over the five years, using that math, it is not going to be a simple divide that by five, is it?

And make it easy for us?

Instead it will be weighted to the back end, the front end?

Can you give us some kind of color there on that?

We don't really know, Brian.

We expect that the roll-out is probably going to be a four-year period and not a five-year period.

But the actual timing and the timing and the lumpiness as it were of the actual revenues for the program, we just haven't got that visibility right now.

If that becomes apparent to us, then we will certainly let you know.

Thank you very much.

Our next question comes from Tyler Hojo of Sidoti & Company.

Good evening.

The first question for you, Mark.

In your prepared comments you said you expect the second half of this fiscal year to be strong.

What do you mean by that?

Relative to what?

Relative to the first half?

Relative to the back half of last year?

Relative to the first half.

Okay, all right, that sounds good.

So that would obviously presume that you would expect the fourth quarter to be up sequentially from the third?

Well we will have to wait and see.

We are giving guidance one quarter at a time.

Yes, yes.

I know.

That was a nice try though.

You nearly got me on that one.

Yes, I tried.

In terms of the SSI sales in the quarter, you said they were down something like 40%.

Do you have an actual dollar number?

I think we gave it out.

It is revenue for Q2 was $3.8 million.

Okay, 3.8.

And understood that you expect that to be down off of kind of a tough comp for last fiscal year.

What is your expectation for defense sales in aggregate?

I think before you indicated high single-digit/low double-digit growth this fiscal year.

Has that changed?

No, it hasn't changed.

I think we remain with that expectation.

Okay, good.

And quick question on the program that you don't like to talk about that is big for Merc Fed.

There was press out recently that they failed some sort of test.

I am just trying to kind of couch what that means.

If that program goes away, I mean, how meaningful is it to Mercury's kind of long-term growth outlook?

Let me address it.

There has obviously been a lot of speculation and kind of articles in the press recently about that particular program.

We believe the information in the articles is basically dated.

We also believe the Pentagon and the Air Force are committed to the program and the war fighting capabilities it is going to provide.

We also expect that the funding for phase two will be resolved as part of the current DoD budget cycle.

And I think if you look at some commentary recently that came from Captain John Kirby, who is the spokesperson for Admiral Mullen, who is the US Joint Chief of Staff, he is basically in favor of fielding this capability as soon as practical, with the expectation that any of the technical issues would and could be addressed once it is fielded.

I think there is a lot of swirl right now.

We still feel really good about the program and our position on that program, and the capabilities that it is going to provide.

So it is still an important program for MFS, and we expect it is likely going to be a growth driver for us going forward.

Okay.

That is quite helpful, thank you.

And one last question/clarification, if I may.

In terms of JCREW 3.3, so the five-year probable value you guys provided in the prepared remarks, that assumes 5,000 systems, is that right?

That is correct.

That is based on our internal planning assumptions based upon the projected roll-out of a similar system which is JCREW 3.2.

Yes, 5,000 systems.

Okay.

And when you talk to your customer, what kind of probability do they assign that the volumes could be in fact greater than the 5,000 systems that you kind of threw out there?

At this point we don't really know.

I think what I said in the prepared remarks is if you look at JCREW 3.3, it is the program of record for counter-ID going forward.

CREW 3.3 is also a joint program, meaning that it will potentially provide capabilities to other services.

Go back to the roll-out of what happened with JCREW 2.1,the Army did pick up the capabilities of that system, and as we said in the past, clearly if the Army pick up JCREW 3.3, the volumes could go northward substantially larger than what we are currently predicting.

Right now we believe that we are taking more of a conservative approach, and we are kind of on the lower end of the range based upon a roll-out, or a potential roll-out to the Marine Corps.

Understood, and actually one quick one for you guys as well.

In terms of the sales guidance that you have out there for next quarter, what are you expecting in terms of sales contribution from LNX?

I think the best way to reflect on that is, when we ran the acquisition call on the 13th, we clearly noted that in calendar 2010 LNX did $14 million in revenues.

I understand that.

Going forward we are not going to break it out as a segment.

It is fully integrated inside of our ACS business unit.

We did indicate that in its own right it will grow, so I think I would just kind of hold the line right there, and say, you won't see us talking about their revenues broken out, or their expenses, margins, whatever.

It lined up very well with our business.

The other piece of information we shared on the last call was when we viewed their business from an adjusted EBITDA standpoint, they have been delivering certainly in the range of our target business model.

So they showed up in very healthy financial shape.

Okay, so on a go forward basis, are you going to provide us with the new sub segment within ACS?No, that is what I am saying.

We are not going to break them out as their own segment.

Okay.

So we get nothing, great.

No, I really appreciate it.

Thanks a lot.

Our next question comes from Jim Mcllree of Merriman.

Hi, Jim.

Good evening, hi, guys.

Mark, you reiterated a commentary that the defense business would be up to single digits, low double digits for the year.

That is before LNX, correct?

Or does that include LNX?

That is before LNX.

Okay.

And I think you made a comment early in your prepared remarks saying that if that incremental CREW 3.3, the big volumes came along, that would be another design win.

Does that mean that you have to compete for another design win, or you would just--?

No, we don't believe so.

It is just us keeping score of our own internal metrics.

Okay.

So when you assume the best, when you report it you would have one design win with potentially a gargantuan number attached to it?

Hopefully.

Right.

Are Aegis and Patriot both expected to be up year-over-year fiscal 2011 versus fiscal 2010?

I don't think we have talked about it specifically on that basis, breaking it out at a program level Jim.

We are, Aegis will continue to provide foundational revenue capability.

We do expect growth of Patriot longer term, and the one that we are expecting from a Patriot perspective next is a sale to Saudi Arabia, which we know that Raytheon is pursuing.

Okay, and you said that --

They would meaningful contributors for --

They will be in our top five programs for the conceivable future as measured by revenues.

That is helpful.

Mark I think you said the second half you expect will be strong in terms of bookings.

Is there going, do those bookings have a short fuse to them?

Is it going to be book and ship kind of business, or is it a lot of bookings with projected fiscal 2012 deliveries?

It is a mixture of both.

And would you characterize that mixture as similar to prior quarters, or more geared towards book and ship, or more geared toward book and ship mixture?

I don't think there is a fundamental change, it is similar to what we have been doing.

Okay, great.

And then, Bob, I think you said $27 million in OpEx for fiscal Q3?

And that includes LNX.

Right, and that includes about $100k of acquisition costs?

That is an implied interesting question.

Our acquisition costs for LNX were relatively low.

We did incur most of them in the December quarter, so they were booked to the income statement in the December quarter, and if you go and look at that, I think you will find a number around 300,000, and there is another 100,000 which kind of completes the acquisition costs.

It throws them in a range of $400,000 or so for the deal.

I think we also outlined, or what Bob outlined is the incremental amortization of the costs associated with the amortization of the intangible assets.

There is the whole purchase accounting side, which we will finish that off here coincident with the March closing.

Okay.

So I understand those two deltas, the incremental 400,000 or 500,000 on the amortization.

That is probably a pretty good number though.

We are way down the track as you could imagine with regards to purchase accounting.

But it is not completed until it is completed.

But go with that number.

That is fine.

So LNX is for the most part fully loaded into Q3?

All else being equal, the $27 million will be kind of --?

Well, if you look at top line/bottom line, yes, it is pretty much a full load for Q3.

Just going back to those acquisition costs, they were I think fairly low.

But we did that work ourselves.

Okay.

Is the CapEx number, does LNX need anything extra?

No, nothing substantial.

No, on the acquisition call for LNX on the 13th, we noted that there were a few monies that we wanted to spend in the first couple of quarters with regard to integration and bringing them into a public company environment.

We were literally talking about $100,000 to $200,000 per quarter.

The CapEx you are referring to, we have been running $2 million a quarter, and I am guiding $4 million for the March quarter, we have got some significant initiatives on the way in the investment in the IT infrastructure space.

Very focused on improving our electronic data warehouse, and some other infrastructure investments that we are going after, but not directly related to LNX so core infrastructure at the parent company.

Okay, great.

And my final one, Mark there was a, you had a release this morning about your participation on SEWIP.

Can you just talk about potentially anything else you might get from that with LNX, or any other, is there any other opportunity with SEWIP that you have underway?

We actually announced, well we actually had another design win for SEWIP this quarter, so it will continue to expand out our footprint on that program given the very good work that we are doing with Lockheed Martin.

Longer term we do expect that there is definite applicability with the LNX technology on the SEWIP program.

But it is at an earlier stage.

We are pretty excited about the capability these bring to the Company, Jim.

So that SEWIP announcement this morning was an additional design win?

No, the SEWIP announcement that we made was really the press release catching up with what we have been talking about historically, which is that we are a part of SEWIP block two, and as we described, we think that the SEWIP program is pretty important going forward.

Largely because if you step back, the investments that we have been making as a nation over the last 10 years or so have been very much focused on the asymmetrics.

Looking forward into some very, there is some grave concern surrounding some of the near, as well as the peer threats that we see coming out of in particular China.

And so we believe that there is going to be increased investments in the electronic warfare space, and this is one of the most important, if not the eminent EW upgrade program, particularly for the Navy.

We are thrilled to be a part of it, and we have delivered some tremendous innovations from a technology perspective, that allowed Lockheed Martin to basically beat out the incumbent.

We are thrilled to be a part of it.

Okay, great.

Thank you very much.

Our next question comes from Steve Levenson of Stifel Nicolaus.

Thanks.

Good evening Mark and Bob.

Hi, Steve.

Most of the good questions have been asked, but I will try to ask Tyler's question a different way.

Can you quantify the revenue targets for the LNX people to earn the full contingent payment?

No.

Basically we have got a $5 million earn-out target related to the sales associated with the JCREW 3.3 program.

And at this point we are not ready to break that out in terms of more specifics.

Thanks.

And on JCREW far and SEWIP, do you actually have any orders in-house other than for sample quantities for R&D?

No, both programs are still in the development phase.

As we mentioned we expect that the JCREW low rate initial production will begin from a revenue perspective as early as government financial year 2012, and we do anticipate a booking sometime before that.

We are in the early stages from a SEWIP perspective, but we are continuing to win more business on that program.

We are generating bookings and revenues, but as you say, they are more associated with the development phase.

Last one is does the pending acquisition of Applied Signal by Raytheon open up any opportunities, because of your good relationship already established with Raytheon?

We know the Applied guys and we have been talking to them.

Given in particular the acquisition of LNX which we think significantly strengthens our capabilities in the signal intelligence, communications intelligence, as well as the EW space, they are obviously areas that are of great interest to not only Raytheon, but also Applied.

We will see.

We will see over time.

but we definitely think that there are opportunities.

Just going back to your earlier question with regards to the earn-out, Mark noted it is tied very closely to the CREW program.

Our current expectation is very much that the earn-out will be achieved, and you will see that reflected in near certainty in our purchase accounting at the end of the quarter.

Okay.

Great.

Thank you very much.

We have one question remaining at this time, and that comes from Jonathan Ho of William Blair.

Hi, guys.

Hi, Jonathan.

Just a couple of quick questions on JCREW.

First, can you talk about whether there are any additional options associated with JCREW 3.3 and maintenance/spare parts that could add to the potential value?

We believe that it is baked into the numbers that we laid out on the call earlier.

And are there any other plans to cross-sell the JCREW technology maybe to other militaries, or other branches of the military at this point?

Not certain, but given the improvised explosive devices are the target, are the weapon of choice right now for insurgents, I would imagine that there are other militaries around the world that are looking for similar capabilities.

Whether or not we would export that technology, I don't know at this point, Jonathan.

Okay.

And then just taking a look at maybe the fact that JCREW looks like it will be the largest volume program in the Company's history, how do we think about investments that maybe you have to make to support that type of program, and how do we broadly think about the margins for the JCREW program at this point?

One of the good things I think about the program and about Mercury's business model is that we believe that we have a lot of operating leverage.

And so the engineering work is largely behind us on CREW.

We are an outsourced manufacturing model, and so there is really not a lot of investment for us as this program ramps into what is in effect much higher volumes than any other program we have seen to date.

We think that it could have a good, positive impact potential on our business model longer term.

Right now we are heading into our planning process, our strategic and budgeting process for financial year 2012.

It is our expectation that as we enter fiscal year 2012, we will be updating our pro forma model.

Great, and just a final question on sort of the overall activity levels, just given where the continuing resolution is, and maybe your expectations once the budget is signed, do you think things will just sort of bump back up at that point?

Right now clearly we are operating under a continuing resolution.

We will see what happens in March.

The budget could be approved, or we could end up with the CRA continuing.

We believe that our pipeline is strong.

It is definitely continuing to grow, and we are winning some great new design wins, as well as expanding and strengthening our presence on some very important programs.

Right now we feel pretty good in terms of the second half of the year.

There are potential risks, but we feel good.

Great, thank you.

There are no further questions at this time.

Okay, well thanks very much for listening.

We look forward to speaking to you again next quarter.

Operator, that concludes our remarks.

And that does conclude today's conference call.

We thank you for your participation, have a wonderful day.