Mercury Systems Inc (MRCY) 2011 Q3 法說會逐字稿

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

third quarter fiscal year 2011 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 Senior Vice President and Chief Financial Officer, Mr.

Bob Hult.

Please go ahead, sir.

Good afternoon.

Thank you for joining us.

With me today is 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 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, continues, estimate, project, intend, likely, " 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 are not limited to general economic and business conditions, including unforeseen weakness in the Company's market, affects 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 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 utilize the expected benefits from acquisitions and divestiture, or delays in realizing such benefits.

Challenges in integrating acquired businesses and achieving anticipated synergy's 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 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 assets, 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.

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

Thanks, Bob, good afternoon, everyone, and thanks for joining us.

I'll begin with the third quarter business update, following that, Bob will review the financial and guidance, and then we'll open it up for your questions.

Mercury continued to deliver very good financial results in Q3, while also closing the LNX acquisition, and completing a successful follow-on stock offering, this increased our liquidity by $94 million.

Revenue came in at the high end of our guidance range improved 37% year-over-year.

GAAP EPS significantly exceeded our guidance even after the effects of our stock secondary offering.

Adjusted EBITDA more than doubled year-over-year and slightly exceeded the high end of our target operating model.

Gross margin was in line with guidance, and operating cash flow increased 19% year-over-year.

Against the backdrop of solid financial results, there were a couple of disappointing items this quarter.

First total bookings in the quarter were low.

This was due primarily to lower semiconductor bookings in ACS commercial year-over-year.

In addition, although our defense bookings grew 9% this quarter, compared to a year ago, growth was affected by the Government's continuing budget resolution, the delay in the approval of the FY 2011 defense budget.

as well as slower foreign military service.

Secondly, also on the commercial side, ASML informed us late in Q3 that we have been designed out of their product line.

This is further evidence that the commercial world is focused on price and not the size, weight, and power optimization where we provide significant value.

We saw the medical imaging world shift to low cost technologies from years ago, and now we are seeing it again in the semiconductor space.

Without business with AFML to offset the decline in back log driven revenue from KLA-Tencor over the next few quarters, revenue in our ACS commercial business will fall off faster than we had planned.

The good news, however, is that the underlying growth rates in our defense business are healthy, and we are currently anticipating that they will accelerate next year.

Our services-lead strategy is working well, and our involvement on existing programs and platforms provides a solid foundational revenue base for Mercury over the years ahead.

Looking at Patriot as an example, the meets program, which was due to replace the Army's existing Patriot fleet has been canceled as part of the President's FY 2012.

As a result it now looks like the US Army which deploys the largest number of Patriot systems will likely upgrade to the next generation of Patriots.

The Patriot could be a bigger program for us going forward than we had previously anticipated.

In the short-term, however, we now believe that the Patriot bookings for Saudi Arabia and Turkey have likely moved to our next financial year.

The Navy Service Electronic War-fare Improvement Program SEWIP is another important program for us.

We expect to see the first Lrip bookings in FY 2012 earlier than we had anticipated the upgrade cycle in airborne radars has also kicked in to gear.

We anticipate strong growth in the classified airborne radar program, where our latest technology is enabling new capabilities that have been very well received by the war fighters.

We have also started booking new business to upgrade the capability of the air force's existing long-range bomber.

The Mercury program that has been dormant for sometime.

Both of these programs appear to be well funded as we head in to our next financial year.

In addition, the outlook for bookings and revenue associated with the joint strike fighter or JSF is looking stronger than we had initially planned, and we also expect continued strength in global force.

So while the loss of KLA-Tencor and ASML is expected to result in a major decline on commercial revenue for financial year 2012, we anticipate that our defense business has the potential to grow significantly compared with FY 2011.

Overall we expect this defense growth to translate in to roughly high single digits, low double-digit organic revenue growth at the Mercury level in FY 2012, versus FY 2011.

With that as background, let's take a closer look at our results for Q3.

Total defense revenue, including ACS and Mercury Federal was $44.1 million, up 29% from a year ago.

The major programs driving this program were Global Hawk, Patriot, an upgrade to the existing long range airborne bomber program that I mentioned earlier, as well as JSF.

Total bookings were down 20% year-over-year in Q3.

In the commercial business, booking for Q3 last year were $20.5 million, whereas this quarter, commercial bookings were $7.7 million, driven by lower semiconductor business.

Defense bookings as I mentioned were actually up 9% year-over-year in Q3, although lower than we had anticipated largely due to delays in Aegis and Patriot bookings.

Despite these delays for FY 2011 we currently expect that our defense bookings will increase more than 20% year-over-year.

Moving to backlog, total and 12-month backlog year-over-year were down 27%, and 26% respectively in Q3.

The majority of the decline is being driven by low Aegis bookings, as well as lower commercial semiconductor business.

Now that the defense budget is finally passed, we currently expect the strong bookings quarter in Q4.

We expect that our commercial backlog will continue to decline, but our defense ending backlog in Q4 will be higher than where it ended in Q4 of last year.

The largest of our defense bookings this quarter was for the Aegis Missile Defense Program.

Although again due to the CR bookings were not at the level that we had anticipated.

We also booked orders for the (inaudible) NPR tip, Global Hawk and a classified airborne radar program.

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

The services and systems integration business we have developed within ACS, positions us to capitalize on these market opportunities.

We select SSI revenue to be down year-over-year of FY 2011, following a strong FY 2010.

Q4 was consistent with these expectations.

As SSI bookings were up 123% year-over-year, while revenue was down 63%.

With SSI being a relatively knew and therefore lumpy business, we believe the best measure of SSI current contribution is the number and the volume of Mercury's design wins, where SSI's involvement is now a key driver.

We won 11 new designs in the third quarter of 2011, eight of them in defense, and three in commercial.

This compares with a total of 14 wins, ten in defense, and four in commercial in Q3 of last year.

The decline year-over-year reflects the fact that under the continuing budget resolution, no new program could be started.

The five year probably value of our Q3 design wins were $68 million, flat with Q3 of last year.

For the first nine months of fiscal 2011, the total five-year probably value of our design wins was $475 million, compared with $154 million for the same period in FY 2010.

This reflects in large part the JCREW win we reported in Q2 this year.

In defense specifically, fiscal year to date, the five-year probable value is $457 million, versus $128 million last year.

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

The most significant wins this quarter were for the Aegis Ashore ballistic missile defense system, a grand-based version of Aegis.

The next phase is the airborne ISR imaging processing subsystem in our Mercury Federal Systems business, a classified cyber program with the major defense pride, and next-generation RF tuner system, for a Homeland security system won by LNX.

And a high data rate airborne terminal for beyond line of sight of communications.

A couple of items to note at Mercury Federal Systems, we launched MFS three years ago as part of our transition towards refocusing Mercury as a commercial ISR subsystem 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.

It positions our ACS business to achieve new ISR design wins that wouldn't have been possible otherwise.

The first point I'll note is that MFS is executing successively on its objective as demonstrated by the design win I just mentioned.

The Q3 of FY 2011, MFS reported $4.3 million in bookings, compared with $2.7 million in Q3 last year, and revenue was up 49% to $3.5 million.

Looking forward, we currently expect to see funds begin to flow for the next phase of (inaudible) ISR program that we are heavily involved in, in early FY 2012.

The second point is that Dave Martinez has decided to leave his position as President of MFS and return to MIT Lincoln Labs.

Although Dave will be missed, I am pleased to announce that MFS will remain in very capable hands as Paul Monticello will assume interim leadership of the business.

Paul joined MFS about a year ago, having served as a group leader at the advance (inaudible) exploitation group at Lincoln labs.

He has been doing an outstanding job as the project lead on the ISR program since joining Mercury, so the transition should be fast and seamless.

I typically conclude my remarks by discussing our acquisition strategy.

LNX was the first product of that strategy, and it represents a good fit with are our strategic objectives which are threefold.

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

Second, having content and services to the defense and intelligence program 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.

Adding LNX to our business immediately strengthened our product portfolios in RS and our capabilities in (inaudible) intelligence and EW.

The process of integrating LNX with Mercury is going very smoothly and the technology synergy has opened up even more opportunities than we had anticipated.

Looking forward, we have a good working pipeline of deals for both ACS, and MFS, which is , as I have said previously, a focus on small companies that are performing well.

We're not going to comment on the timing of any possible future acquisitions other than to say that we are at various stages of discussion with a number of companies.

We are taking our time and being methodical of getting to know them and their capabilities just as we did with LNX.

Before moving on, I'll take this opportunity to announce that Bob Hult has informed the board that he plans to retire as CFO in financial year 2012.

And we have started a formal search of his replacement.

I was very pleased when Bob agreed to stay on as CFO at the time I joined the company.

Bob has been a great partner to me these past three-plus years, and a valuable resource to Mercury since long before that.

We'll continue to benefit from Bob's presence until his successor is on board.

As we have in prior years at this time, I'll conclude with some observations about where we see the business heading in our coming fiscal year.

The primes in making significant changes in response to both the ongoing challenge of procurement reform and the immediate impact of the CR and funding dynamics we have seen over the past six months.

We continue to believe the way we have positioned ourselves, as the commercial outsourcing partner to the primes, as they seek the rapid development of more open and affordable ISR subsystem solutions will benefit Mercury as these changes continue to unfold.

It's going to be increasingly challenging for our customers and we are ideally situated to help them navigate this period of change.

Like the primes we our selves have to deal with the push out in funding to some of our key programs due to the delay in the defense budget being approved, and from a timing perspective, the significant decline in commercial semiconductor business is unfortunate in the near term.

Nonetheless, we currently expect that the underlying strength in our defense business will fuel a good fourth quarter, wrapping up a solid financial year 2011 and positioning us for another good year in FY 2012.

We are participating on existing programs and platforms that are well funded and in some cases, entering favorable upgrade cycles.

Our business model aligns well with defense procurement reform, our new business pipeline looks very good, and we are winning some great new designs, and finally, we have strengthened our balance sheet as we search for complementary acquisitions in our commercial item defense business.

We plan to continue providing financial guidance on a quarterly basis and won't be providing specific guidance for the first fiscal quarter until our next conference call.

However, so you do have some color on our longer-term picture, I'll provide our current perspective on the upcoming financial year.

We're in the midst of our budgeting and planning process for FY 2012, and so although we have not yet completed that exercise, we currently expect a roughly high single-digit, low double-digit overall organic revenue growth rate year-over-year.

We currently expect our operating profit to be roughly in line with the low end of our current target business model, and our adjusted EBITDA becoming roughly in line with the model's high end.

Due to the impact of the newly issued shares we currently expect EPS to be approximately flat year-over-year.

Looking farther ahead, during Q3, the government's pre solicitation for JCREW 3.3 was very helpful in firming up the specifics of the low-rate initial production phase.

In particular, the size of the soul source Lrip award to ITT is up to 1,350 units.

The period of performance is scheduled for Q3 of government financial year 2012, through Q4 of government financial year 2014.

We are currently modeling Lrip bookings to start during our financial year 2012, with revenue beginning during the first quarter of our financial year 2013.

We believe that JCREW has the potential to have a major positive impact on Mercury's 2013 fiscal year and beyond.

With that, I would like to turn it over to Bob.

Thank you, Mark.

This was another quarter of solid results for Mercury.

Total revenue for the third quarter of fiscal 2011, increased 37% year-over-year, to $59.9 million, which is the top end of our guidance range of $58 million to $60 million.

This compares with $43.6 million in revenue for the third quarter of fiscal 2010.

GAAP income from continuing operations for the third quarter of fiscal 2011, was $5.4 million, or $0.20 per diluted share on approximately 27.3 million shares outstanding.

Actual EPS results include the increased share count impact of our February 2011, secondary offering, whereas our guidance did not.

Put another way, EPS actual pre stock offering were $0.22.

This was well above our original Q3 guidance of $0.16 to $0.18 per share.

For the third quarter last year, Mercury reported GAAP income from continuing operations of $3.7 million or $0.16 per diluted share.

The upside from guidance was primarily due to lower operating expenses.

On a year-to-date basis, FY 2011 continues to be a year of top line growth and profit improvement.

Total Company revenues for the first nine months of FY 2011 grew 23% to $167.5 million.

Our defense revenues for the first nine months of FY 2011, grew 15% year-over-year to $125.6 million.

Again, demonstrating the progress we have made in strengthening our core business.

Year to date, GAAP income from continuing operations was up 42% year-over-year to $14.2 million and adjusted EBITDA grew 77% to $30.8 million.

Breaking down our third quarter results by operating segment, revenue in ACS, including both defense and commercial for the third quarter of fiscal 2011, was $58.1 million, up 38%, from $42.2 million in Q3 last year.

Revenue is our services and systems integration business within ACS for the third quarter of 2011, was $2.8 million, compared with $7.5 million in Q3 last year.

As we have said, FSI is still an I merging business capability with lumpiness in both bookings and revenue.

We continue to expect SSI's FY 2011 revenues to be lower year-over-year.

In our Mercury Federal Systems business, Q3 fiscal 2011 revenue was $3.5 million, up from $2.3 million a year ago.

As we said, entering FY 2011, 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.

Please note that revenues by operating in segments do not include adjustments to eliminate inter Company revenues of $1.7 million included in those operating segments.

Total defense revenue for Q3, including ACS defense in MFS was $44.1 million, up 29% from $34.2 million in Q3 of fiscal 2010.

Mercury's commercial revenue was $15.8 million for the third quarter, up 68% from $9.4 million in Q3 last year, driven by KLA-Tencor (inaudible), and ASML.

For the full 2011 fiscal year, we now expect commercial revenue to increase approximately 15% to 20%, compared with FY 2010.

Turning to bookings, total bookings for the third quarter of fiscal 2011 were $39.8 million, a 20% decrease compared with $49.9 million in Q3 last year.

Compared with the sequential second quarter, bookings were down 17%.

The decrease sequentially and year-over-year reflected lower commercial bookings from KLA-Tencor, and defense program delays associated with the late approval of the Federal budget, and the interim continuing resolution.

With the budget now approved, we currently expect to see a rebound in defense bookings during Q4 of FY 2011, though anticipating a good result for the full year.

Mercury's total book-to-bill ratio for the third quarter, including ACS and MFS was 0.67, this compared with 0.87 in the sequential second quarter of fiscal 2011, and 1.03 for full year FY 2010.

Our Q3 total backlog, including deferred revenue was $85.5 million, this compares with backlog of $96.8 million at the end of Q2, 2011, and $116.6 million for Q3 last year.

Approximately 84% of our current backlog relates to defense.

In addition, 82% was $70.3 million of our total Q3 back log, relates to shipments scheduled within the next 12 months.

Total defense bookings for the third quarter of fiscal 2011, including ACS, and MFS were $32.1 million.

This is down 23% compared where defense bookings of $41.8 million in the sequential second quarter of fiscal 2011, and up 9% compared with $29.9 million Q3 last year.

Our defense book-to-bill for Q3, including ACS, and MFS was 0.73, down from 0.95 in the sequential second quarter of fiscal 2011, and 0.86 in Q3 last year.

A backlog and defense for Q3 decreased to $71.9 million from $78.9 million in Q2 of fiscal 2011.

Defense backlog in Q3 last year was $98.7 million, this included approximately $28 million of Aegis orders, $19-plus million of which shipped in the very next quarter, namely Q4 FY 2010.

Mercury's adjusted EBITDA for the third quarter fiscal 2011 was $11.3 million, this compared to $4.2 million for the third quarter of fiscal 2010.

For the first nine months of FY 2011, adjusted EBITDA was $30.8 million, compared to $17.4 million for the first nine months of FY 2010.

Adjusted EBITDA, excludes the impact of approximately $5.9 million in net benefits as follows, $0 interest income and expense, a $2.0 million tax expense, $1.7 million in depreciation, $0.7 million in amortization of acquired intangible assets, $0.1 million in acquisition costs, $0.1 million in fair-value adjustments for purchase accounting, and $1.3 million in stock-based compensation charges.

In terms of adjusted EBITDA margin, we are now performing in the range of our long-term pro form target of 17% to 18%.

And in fact, our adjusted EBITDA margin for the last two quarters, Q2 and Q3 has been 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.

Turning to our tax rate, for Q3 FY 2011 we used an effective tax rate of approximately 33% before discreet items, and we continue to expect 33% to be our effective rate for the full fiscal year 2011.

Our gross margin for the third quarter of fiscal 2011 was 55%, consistent with our guidance of 55%, and 100 basis points above our target model.

Operating expenses for the third quarter of fiscal 2011 were $25.9 million, compared with $23.7 million in Q3 last year, and only slightly up sequentially from $25.1 million in Q2.

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

We're continuing with our long-term effort to improve the underlying operations of the business.

Thanks for the work that has been done to strengthen our engineering and supply chain methodology and processes.

Our new products are being launched at a faster pace with delivered enhanced quality and faster time to market benefits to our customers.

Inventory, including LNX for Q3 was down sequentially to $19.3 million from $20.6 million in Q2 of FY 2011.

Inventory turns for the third quarter improved to 5.6 turns from 4.6 in the second quarter of fiscal 2011.

DSOs in the third quarter of fiscal 2011 was 67 days, up from 53 in the sequential second quarter and an increase from 63 in Q3 last year.

This was a function of the non-linear shipment pattern we experienced during the quarter.

Mercury's ability to generate cash from operations continues to improve.

Operating cash flow for the third quarter of FY 2011 increased 19% year-over-year, to $5.4 million, from $4.5 million in Q3 last year.

For the first nine months of FY 2011, cash from operations was up 86% from the same period last year.

Free cash flow increased 54% to $3.7 million in Q3 from $2.4 million in the same period last year.

We closed the third quarter of 2011 with a total of $156.4 million in cash and cash equivalents.

We entered Q3 with $88 million of cash, disbursed $31 million to the LNX acquisition, netted $94 million in proceeds from the secondary offering, and generated $4 million free cash flow within the quarter.

At the end of the third quarter, a total employee headcount, excluding contractors, were 612, compared with 549 at the end of Q2 FY 2011.

Most of this increase is due to the addition of 63 employees associated with the LNX acquisition.

Mark discussed our strategy relative to future acquisitions, and Mercury continues to be well prepared to execute on that strategy from a balance sheet and liquidity perspective.

We have zero short and long-term debt.

We also have a $35 million operating line of credit with Silicon Valley Bank.

Now moving on to guidance.

For the fourth quarter of fiscal 2011, we currently expect a revenue range of $57 million to $59 million.

We anticipate Q4 gross margin to be approximately 56%.

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

We expect to report third quarter GAAP income from continuing operations in the range of $0.11 to $0.13 per diluted share on approximately 30 million shares outstanding.

CapEX for Q4 of fiscal 2011 is projected to be approximately $3 million.

Year to date, CapEx is $5.3 million.

Turning to Mercury's adjusted EBITDA guidance for the fourth quarter of fiscal 2011, our estimate excludes the following approximate amounts.

Zero interest income and expense, depreciation of $1.8 million, $0.7 million in amortization of acquired intangible assets, a gain of $0.1 million related to fair-value adjustments from purchase accounting, $1.4 million in stock-based compensation cost, and as I said, an estimated FY 2011 effective tax rate of approximately 33% before discreet items.

As a result, adjusted EBITDA for FY 2011 is currently expected to be in the range of $9 million to $10 million.

Looking farther ahead, as Mark said the underlying growth rates in our defense business are strong, positioning Mercury for another good year in FY 2012.

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

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

(Operator Instructions).

And we'll first go to Tyler Hojo with Sidoti & Company.

Hey, good evening, guys.

Hey.

First question I guess in terms of your commentary on the fiscal out year, what are you baking in to your assumptions in terms of CREW deliveries?

And also just kind of wondering, you said commercial was going to be done with the loss of ASML.

What is the expectation for commercial ACS as well?

Okay.

As I said in the prepared remarks, Tyler, what we expect right now for CREW, is that the revenue won't begin until our first quarter of financial year 2013.

So we expect to see bookings during financial year 2012 but no revenue until the first quarter of 2013.

As it relates to the ASML and commercial business in general, I'm not going to get too specific in terms of what we see during financial year 2012, but what we expect to occur at the Mercury level is that we expect or anticipate high single-digit, low double-digit revenue growth on the top line, and that kind of takes in to account, CREW, as well ASML.

Okay.

But the expectation is that commercial ACS will be down quite a bit year-end-year?

Yes, that is correct.

We are expecting that the commercial business will decline, and that we are seeing a significant up tick in our defense business as we look at FY 2012.

Okay.

So if CREW -- if the assumption is that CREW doesn't ramp until fiscal year 2013, that is a pretty big growth rate in defense ex-CREW.

Could you maybe talk a little bit about that?

Yeah, we feel pretty good right now, and as I said in the prepared remarks we are seeing an upgrade cycle in airborne radar.

There was a couple that I mentioned on the call that we expect to be pretty significant programs for us starting next financial year.

One is an upgrade to the Air Force's existing long-range bomber, and another one is a fighter radar program that is also going through an upgrade cycle.

So there are two big programs -- relatively large programs that we think is going to cause growth.

We are also expecting a strong year in Patriot.

There is a number of different things, programs that are basically moving the numbers.

Okay.

All right.

That sounds good.

And then I just want to also talk about backlog for a second.

Sure.

I get why, kind of the book-to-bill was light this quarter -- or weak this quarter --

Yes.

-- but what is it -- is it something program specific that is giving you so much confidence in terms of seeing the backlog jump year on year by the end of the next quarter?

Yeah, we -- I'm not going to get specific in terms of which of the programs that we expect to increase, but we are expecting a strong rebound in our defense bookings in the fourth quarter, and at this point we anticipate that our fourth quarter ending backlog and defense will be higher than it was in Q4 of last year, so I think Bob kind of articulated in his script what we see, what has really occurred in the backlog this past quarter, and a big piece of it was just due to lower -- the fact that last year we had much higher Aegis bookings in the second quarter that we shipped towards the end of the year.

So we expect to rebound in the fourth quarter in defense bookings

All right.

Great.

I'll let somebody else ask.

Thanks a lot.

Okay.

We'll go next to Michael Lewis with Lazard Capital.

Thank you.

Hey, Mark, will the low rate production on JCREW be even-based through that time period, or would you expect to see some type of accelerated production on that Lrip?

Yeah, right now, Mike, the period of performance is what I described on the call.

However, I think that, you know, we believe that the Lrip phase itself is probably going to be more front-end loaded.

We don't expect it to reach too far in to FY 2014.

Okay.

And if I could just shift gears and follow-on the following speaker, have you been able to quantify how much did not hit in Q3 as a result of HCR?

Not specifically?

I mean, I think we got impacted in a number of different areas.

Probably the one that we had the largest delay in was actually around Aegis, where the Aegis bookings do appear to have been delayed out of the quarter, and we expected the bookings for Aegis will actually be down as a whole.

However, given the importance of the program and the fact that Aegis actually saw increased funding in FY 2012, we still expect that Aegis will remain one of Mercury's largest programs, and this quarter we actually booked the design win for Aegis Ashore.

So the program is on track, but we definitely saw a delay in that program this quarter.

The other one that is not necessarily related to this CR per se, but we also saw delays around was actually Patriot, and Patriot is slightly different.

The delays there were largely due to foreign military sales, which as you know are notoriously difficult to predict.

At this point we believe the Patriot bookings for Saudi and Turkey have moved out of this year and in to our next financial year, but even that program we also had some good news, which is that during the President's budget near the meets program was canceled, and it is looking like the US Army will now upgrade their existing Patriot fleet with the new Patriot system of which we are a part.

So we had a couple of delays in the quarter, but there was some upsides as well.

I agree there.

Just one more question, and I'll get out of the way here.

I noticed some comments coming out of Air Force that they intend to invest more in automated Intel systems.

Yeah.

I think this was an important comment because it was the first time I heard them publicly speak about this.

Yeah.

Have you seen any of this interest start to equate to order flow from this customer?

Or do you expect to see a ramp in orders, as we progress through next year?

Well, I think we -- if you take the example of the (inaudible) program that we have in Mercury Federal Systems, the systems are actually performing well, and we just completed the PDR for the second phase of that.

We also believe with the defense budget being approved that the funding for that next phase will actually start to flow, and, we are expecting a good year on that program next year.

Outside of that, we are also seeing through other primes more interest in the capabilities that we have to push more of the exploitation on board the platform to shorten the time to information, which as we know is a major trend and as a Companying that is an area that we have invested in significantly, and we believe that we are ahead of the pack.

So although we haven't seen it directly from the government, because in large part our customers are primes, we are seeing more interest from the primes themselves.

Okay.

Great.

And, Bob, congrats on the news of your retirement.

Thanks, Mike.

All right.

I won't be for awhile.

We have to get my replacement on board and up to speed first.

We'll go next to Brian Ruttenbur with Morgan Keegan.

Great.

Thank you very much.

It's hard to follow up on Mike's congratulations, but congratulations on the retirement.

Lots of cosmopolitans there.

The Patriot delay can you give us a dollar amount related to that?

No, not specifically.

We don't typically break out the amounts either on bookings to revenues certainly on a prospective basis of the programs, but the two countries that we were -- that Raytheon is pursuing, Saudi Arabia and Turkey, are two of the larger ones, based on the bookings that we have previously received.

So they are both relatively sizable they are below $10million each but they are still sizable.

Okay.

At the end -- as you look forward to 2012 -- because this is very much a 2013 story in JCREW 3.3, you anticipate by the end if your backlog is going to be up year-over-year, at the end of 2011, then at the end of 2012, do you an anticipate it would be up 30% or 10%?

Where do you see backlogs being at the end of 2012.

We are not going to get out and forecast that that far, Brian.

I think -- we said that the backlog in defense is we expect to be up on a year-over-year basis at the ending of Q4, but we also said that we expect our commercial backlog to continue to decline.

I think right now, I think what we are comfortable saying is that from a total Company perspective, we expect our revenues to be high single-digit, low double-digit, and that's on an organic basis only.

Clearly with the offering we are expecting to be able to put some of the money to work to acquire complementary companies, but I'm not going to talk about where we expect the backlog to be ending at the end of FY 2012.

It's just a little too far out.

I agree.

I got to ask, though.

Thanks a lot.

Yes.

We'll go next to Peter Arment with Gleacher & Company.

Yeah, good afternoon, Mark and Bob.

Hey, Peter.

Hey, Peter.

Mark, I guess following up on those fiscal 2012 kind of comments, now you have looked in detail at the fiscal 2012 budget, what is your assessment of how, I guess, some of your key programs, the funding there, how that looks for you guys going forward on a organic basis?

Yeah, we are actually felt that we did well.

I think we are continuing to see the themes play out in terms of the areas that we have chosen, which are ISR, EW, as well as missile defense.

So I think net-net when you look at it, we felt pretty good about the way in which the budget is shaking out.

Now, we'll see whether or not it holds during the cycle of the FY 2012 approval process, but as it is laid out today, we believe that we did good.

Okay.

And regarding your operating expenses I guess you kind of gave a road map there a little bit, but do you still feel confident you'll be able to hold those at kind of the levels they are at, given with your increasing sales that you are projecting?

I think we are very confident with regards to the guidance that we gave for Q4.

What I perhaps didn't call out clearly enough in my remarks is they do include obviously the operating expenses associated with the LNX operation that we acquired on the 12th of January.

We also think we still possess operating leverage with regards to the business looking forward.

We have translated that in to the past in a manner where we feel we can curtail the growth in operating expenses bringing them in at a lower rate than what the top line will grow, and I don't know if you had a chance to push the numbers around a little bit that we did share with regards to FY 2012, but when you do, I think you'll, once again, see operating leverage being evident in the -- what guidance we did share here with regards to FY 2012, so, yes.

No, did, and you can see as you mentioned at the high end.

And just one more regarding -- on the JCREW more, just a housekeeping, Mark.

You mentioned the Lrip unit numbers.

It is up to 1,350 units.

The way in which it was described in the Navy's pre solicitation, yeah.

The actual numbers we wont know until our customer at ITT has received their RFP and negotiated with the government.

Hence the slow down to us.

But the in which it is described is up to 1,350 units.

And how does that offhand, if you know, compare with -- I guess you compared it to previous versions where they procured roughly 5000 systems, and certainly higher on some of the earlier versions.

How does that compare in terms of an Lrip pace.

It is hard for me to go back and compare with JCREW 2.1.

Although the information is available it is very hard to kind of parse out.

I can tell you compared to our expectations from an Lrip perspective, I think the numbers were very, very solid.

Okay.

Great.

Nice quarter, guys.

Yeah, thank you.

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

Good afternoon, gentlemen.

A question relative to the cellular marketplace.

You had two interesting announcements in the -- recently, one with the Korean ETRI.

And also with com agility.

Could you just say what your strategy is, and how -- can you quantify the opportunity you have as you move to higher capacity 4G installations around the world?

Yeah, I think it's a little too early to actually try to quantify that market.

The Korean opportunity in particular is kind of interesting, because they are fully leading the way in terms of true 4G rollouts, and this technology, which is really for a technology demonstration phase could be a part of that.

So it is going to be hard to quantify exactly what that means longer term, but it does demonstrate that we have capabilities maybe in the RF, and the wireless domain that we are going to be looking to apply in to other commercial opportunities.

Okay.

So if we are looking at it in terms of gauging this as sort of beyond the fiscal 2013 window for meaningful revenue?

Yeah, I don't think it's -- we certainly don't think it is going to be meaningful next year, but from a capabilities perspective and from this particular customer's perspective we think it's a nice design win.

Okay.

Could you chat a little bit about SEWIP in terms of what you have learned incrementally from your last call --

Yeah.

-- as to when you think that that is going to start generating revenue, and how it might be deployed to the fleet?

Sure.

We haven't got a tremendous amount of new information other than we now expect to see the first Lrip bookings for that program, during our financial year 2012, whereas historically we had presumed that it may have been more like FY 2013, so it looks like it is going to be favorable to us.

How that translates in to revenue next year, we haven't really quite got that visibility yet, and we are really not at a point where we would like to disclose that, but incrementally more positive for us.

Okay.

And could you -- when you are look at the -- or modeling the commercial declines relative to the semiconductor industry, is there a -- is it relatively flat, and then is there a quarter like the second quarter where it really drops down and that business kind of winds down, or is it a very slow taper through the year?

Again, I think we're still in the midst of our planning, so we are really not at point where we can get more granular with respect to the quarterly fazing of the decline in semiconductor revenue, but we do expect it to be down significantly next year, but we also expect our defense revenues to be up substantially leading to that high single-digit, low double-digit revenue growth at the Mercury level on an organic basis only.

I think Mark, the best you can do there with regards to the semiconductor revenues going forward is to assume that each one would have some activity and H2 would have much less activity with regards to the semiconductor piece, and then, of course, there are the other pieces of our commercial business, so I don't know if we can put it in a quarter for you, but H1 versus H2 might be the way to handle it.

Okay.

Final question to clarify your comments on next year from a revenue upper single digits to lower double digits, could -- did I get you direct, given the margin guidance that you were looking for, relatively flat year-over-year EPS?

Yes, so basically what we said was we expected that the profit operating profit will be roughly in line with our existing model, the lower end of that model.

The adjusted EBITDA will be roughly at the high end of our guidance -- of our existing target model, but due to the increased share count we do expect that on an organic basis, EPS will be roughly flat year-over-year.

Thank you very much.

Okay.

We'll go next to Jonathan Ho with William Blair.

Hey, guys.

Hey, Jonathan.

Just a couple of house-keeping questions.

The first one is when you guys are talking about organic growth, are you excluding LNX in that revenue guidance?

No, LNX is included.

Yeah, we the second year of ownership, even if the first year is a partial, we consider that to be organic going in to the second year.

Got it.

Got it.

And as we look at sort of the discussion around the semiconductor business, what are your thoughts in terms of it potentially coming back at some point.

Is this something that we shouldn't look for, or is there still potential for KLA or ASML to come back to your platforms?

There may be.

But I think as it said in the script I think we have seen this movie before, particularly given what happened in the semiconductor in the medical imaging space.

Whereas our systems are characterized by opportunities that are sized, weighed, part constrained, and I think medical imaging and now semiconductor are really focused on the lowest-cost solution, and that's not really the sort of work that we do, so not to say that it won't come back, but my sense is it's not something that we think is going to occur.

Fair enough.

Fair enough.

And just in terms of your commentary on some of the shifts in behaviors with regards to some of your larger partners now looking at US the preferred commercial partner.

Howis that been playing out?

Are you guys seeing larger portions of deals being pushed your way, or just increasing numbers of opportunities?

How should we think about that?

Yeah, I think we are seeing it that way.

Basically what we are looking to do is capture more of the subsystem content, but to do those developments on commercial terms, which means that for the prime to get things more affordable and rapidly than they can do it with their in-house groups.

So we are absolutely seeing that play out, and part of our M&A strategy, particularly in the ACS, is looking at filling out that capability to be able to provide more of a complete subsystems solution, and I think you can start to see that, actually in our design-win numbers that I rattled off on the call those numbers are up pretty substantially on a year-over-year basis through the third quarter.

So we believe that the strategy is working well.

Great.

Thank you.

We'll go next to Steve Levenson with Stifel Nicolaus.

Thanks, good evening, everybody.

Hey, Steve.

Hey, Steve.

Just a question related to operating expenses.

You have got LNX in there, does that mean R&D expenses are staying about the same?

Going up a little bit?

Going down a little bit?

LNX is certainly in there, and they did show up with R&D expense.

So dollar terms it has been going up a little bit, as a percentage of revenue, it has been coming down substantially as the business has been growing.

Got it.

Thank you.

Now in the last few weeks, there's been some news out of the Army that they are going to recapitalizes their Humvee fleet, which I imagine includes changing out a lot of the electronics.

Do you think that is going to excelerate demand for counter IED systems or anything else your products go into?

It could, Steve, we don't have the visibility that say, ITT has in their discussions with the Army.

So it's hard for me to comment on this point, but the recapitalization of ground systems would -- I think would bode well.

Okay.

Thanks.

And lastly, there is current system out there, I guess, called the CREW Duke V3.

Yeah.

Are there any Mercury products on that one?

No, we're not on Duke.

Okay.

Thanks very much.

Okay.

Thanks, Steve.

We'll go next to Howard Rubble with Jefferies.

Thank you very much.

Couple of things, Mark, first to go back to AMSL, what sort of precipitated this kind of fairly dramatic change?

I think it -- well, first of all we were surprised that it occurred late in Q3, so it came out of the blue for us.

We were in the midst of the negotiations for the long-term supply agreement, as well as talking about new potential design wins.

My guess is that per what I just said is that the semiconductor in particular are extremely cost conscious and it turns out that the new supplier to ASML's price is the same as our cost to put it in perspective.

Yeah, I get that.

You don't make a lot of money swapping dollars.

No.

So how do you think about restructuring the business?

And making it -- I heard a couple of comments that earlier questions about keeping track of SG&A, but how do we make sure we don't see an inventory hit or that you can wind the business down in an effective manner?

Yeah, we haven't got any concerns there, Howard.

As we have been saying, really, over the last couple of years, our commercial business is highly, highly leverages from an expense perspective, and so it's not like we have a separate team of people that are only working on commercial, and then from an inventory perspective, we continue to have a very, very tight reign on our inventory as you have seen over the past few years, so we don't expect at this point any issues there.

Yeah, one of the first things we looked at, Howard, when we got the news, but fortunately it is pretty much a bill-to-order business with a forecast in the background for winding up components, so there's nothing there, so we are fortunate on that front.

I mean, it's kind of $20 million a year that sort of goes away.

Is that a good sort of sense of it?

It probably did not quite hit those levels.

We thought we were building towards those levels.

Yeah, and I think the what we were anticipating per what we said in the past is that ASML would be ramping while KLA would be coming down, so in effect we have both of those that are declining next financial year, but despite that we still feel that our defense business is actually going to accelerate next year, and hence the guidance that we have given.

The good news is we already had figures the defense would ramp, the bad news is we also figured it would ramp, I guess, Mark, would be a -- (laughter).

Yeah.

Last thing.

Could you give us a sense of the design wins you are chasing, or give us some -- you did a nice job of continuing to provide us with the five-year value, but is there any way to sort of the about the aperture you are look at for opportunities?

Aperture in what dimension, Howard?

What are you thinking there?

Can you help me out a little?

Oh, sure just in terms of some of these additional defense opportunities.

Obviously you talked about something with a radar --

Yeah.

Okay.

I get it.

So I think we -- first of all we believe that services and systems business is absolutely playing out in way in which we don't anticipate.

they are involved in the majority of our design wins.

And what we have found out is that when they do get involved, the deal sizes typically go up, so this quarter we had he Aegis, Ashore, which was a good one, we have been working with it, but we have our own kind of procedures and documentation that we need before we can actually record a design win.

So we got Aegis this quarter.

One of the interesting ones that we also won this quarter was a classified cyber program with one of the major primes, and this again was the service and systems integration-lead opportunity.

It's -- early technology demonstration phase, but they see a tremendous amount of power in the sort of computing capabilities that we can provide as it relates to certain cyber analysis that they are looking to do, so we actually feel pretty excited about that one longer term now, because it's really a new area for us, we're very heavily DoD centric, and this is more IC related, so that one could be a pretty interesting one.

One of the other design wins this quarter was actually in Homeland security, driven out of LNX, that was, again, a Homeland security, slash IC opportunity based upon some of their very sophisticated, very low par, very brood tuning range RF subsystems capability.

So we feel pretty good about what they are doing.

And then I think more generally, as we look at that airborne upgrade cycle that we mentioned earlier, we have seen two that have popped relatively quickly, and then the one that could be large for us in the longer term is the upgrade to the F-16 (inaudible) radars, which obviously we are working with one of the primes, and we believe that could be a -- an opportunity that could afford itself probably in financial year 2013, but we'll see how that one develops, but that's an important one as well.

Thank you, Mark.

Will go next to Jim McIlree with Merriman.

Yeah, thank you.

Good evening.

Can you give some indication of how much LNX contributed in the quarter, and any expectations for Q3 -- or excuse me, Q4 as well?

You know, Jim, we kind of set the ground rules on the date of the acquisition, and said that we were fully integrating them, and we were not going to break them out given that they are not a segment, but rather embedded inside our VCS business unit.

They did in calendar 2010 run with approximately $14 million of revenue in a pretty decent bottom-line performance that lined up with Mercury's business model.

Okay.

And then for the fiscal 2012 -- I'm not going to call it guidance -- let's just call it the fiscal 2012, kind of outlook.

Yeah.

Do you have a significant amount of the persistent -- the wide area, persistent ISR program in that fiscal 2012 kind of thoughts so far?

We have got -- we believe that MFS driven by this program is going to be up year-over-year.

It's not up dramatically, but it is going to be up, we believe, based upon the funding profile that we see occurring in our program.

Okay.

So the big drivers of the growth that you are seeing in the defense are the things you are articulated a couple of times during this call, the airborne programs, Patriot, et cetera?

Right.

Okay.

And finally, Mark, can you comment a little bit on your exposure to both Global Hawk and JSF?

I think both of those programs have had some fairly negative news recently, and I'm just trying to understand, how much you exposed if those things get reinstructured even further?

Yeah, so Global Hawk, we saw some net reductions for the block 40.

I think there were 11 aircraft that was removed.

However I think what is happening under the covers is the moneys are actually flowing in to other blocks, particularly the block 30, and so we still believe that Global Hawk is going to be strong for us, because we are actually start of both of those, and well as even prior generations.

JSF, we believe that actually JSF could be a -- next year could be actually a strong year for us, just based on some of the things that we are working on right now, so I can't go in to too much detail, but even despite all of the restructuring and the budget outlook, we still believe that it could be a strong program for us.

Okay.

And I'm sorry, just one more.

Sure.

Generally speaking, margins on the defense side compared to margins on the commercial or margins on the semiconductor piece of commercial, how do they compare?

You know in the past we have spoken about them as defense margins are higher than commercial on average.

Having said that, I think we are going as though commercial being lower.

Interestingly enough, our margins on ASML were quite high certainly higher than KLA, and they probably lined up better with our defense business.

So once again, a lot of moving parts here Second of all looking forward to FY 2012, Mark noted it, we are expecting growth in Mercury Federal, a more engineering services business model, which has a different margin profile, much lower than our ACS business, and of course, I don't think we said it, but SSI is building a pretty good head of steam here too, with a look forward to FY 2012, and that is an engineering-services oriented systems integration business, so I think you put all of those parts together, I would not expect much change in the overall gross margin performance of Mercury in 2012, compared to say this year or last year.

That's very helpful.

Thank you -- thanks a lot.

We'll go next to Michael Lewis with Lazard Capital.

Thanks, just a quick follow up on -- Bob, did you give the SSI revenue in the quarter?

I missed that?

I did.

I'll look it up for you, but I think it was $2.5 million.

$2.8 million.

I'm sorry, say that again?

$2.8 million.

Okay.

Thank you so much.

Right on.

We will go next to Tyler Hojo with Sidoti & Company

Hi, just want to go back to JCREW expectations in your kind of fiscal 2012 outlook or whatever you want to call it.

Yeah.

If you look at the Lrip the period of performance through the government's third quarter of fiscal 2012, through the end of fiscal year 2014, and I believe Mark, you said that your expectation was that the shipments would be towards the beginning -- or towards the earlier part of that period of performance.

So just kind of wondering why wouldn't you perhaps ship any CREW in your fiscal 2012?

So if you look at Q3 of government financial year 2012 equates to our Q4 -- sorry our Q4 of financial year 2012.

Yeah, right.

And we expect that the program could be delayed a couple of months, which basically pushes the revenue into our financial year 2013, during the first quarter of our financial year 2013.

So it is based on what we see occurring, and it's the best information that we have at this point in time.

Okay.

Tyler, better to park it at the beginning of our FY 2013 than the tail end of FY 2012.

It's just as Mark said -- we'll know more as we step through the year, but we have got it out for now.

Okay.

So are you hearing from ITT that potentially the contract could get pushed a little bit or --

No, I think, you know, it's just general conservativeness on our end.

It I think it's towards the back end of the fourth quarter based on what we see, and we think it just makes more sense to park it as Bob said in the first quarter, then having to struggle with any movement that may occur during financial year 2012.

Yeah, and of course once we get going, there will be a cadence to it right through 2013, and arguably in to 2014.

Right.

Okay.

It's all about which quarter does it start and we are plus or minus one.

Yeah, if you step back from it though, I mean, basically what the pre solicitation did, I mean at a very high level, it suggests very healthy volumes for the Lrip phase, and suggests that the program timing is roughly on track, so I think that's a good thing.

Okay.

Not to beat a dead horse but just one more follow onto that.

No problem.

What do you think your lead times are in terms of the products that you are shipping to CREW?

Well, we know what our lead times are, but I'm not going to disclose them on the call.

What we expect is we'll probably see a booking, based upon our current information somewhere around the mid-point of FY 2012.

Okay.

All right.

Great.

Thanks for the follow-ups.

Okay.

We'll go next to Peter Arment with Gleacher & Company.

Just a quick follow-up, regarding your M&A in particular in MFS with David Martinez leaving, is that going to have any impact?

I know he was helping you with a lot of it in terms of the relationships you were looking to build there.

No, I actually think to be honest think it may help us.

And here is the reason why a little bit.

I think it's easy to go to a company that has a very strong management team in this space and welcome them in to Mercury without having kind of another layer, so we wish Dave well, he has done some great work at Mercury, we feel very good about the interim leadership that we have, but I think it actually makes sense in light of Dave leaving.

Okay.

Thank you.

That's all the questions we have at this time.

I would like to turn the call back over to the executives of Mercury Computer Systems for any additional or closing remarks.

Okay.

Thanks to you all for listening today.

We look forward to speaking to you again next quarter.

Thank you.

That does conclude today's conference.

Thank you for your participation.