Mercury Systems Inc (MRCY) 2014 Q3 法說會逐字稿

Good day everyone, and welcome to the Mercury Systems Third Quarter Fiscal 2014 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 Company's Senior Vice President and Chief Financial Officer, Kevin Bisson. Please go ahead, sir.

Good afternoon everyone, 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 we issued earlier this afternoon, you can find it on our website at www.MRCY.com.

We'd like to remind you that remarks that we may make during this call about future expectations, trend, 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, could, should, would, planned, expects, anticipates, continue, estimate, project, intend, likely, forecast, probable, potential, and similar expressions.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties include but are not limited to, continued funding of defense programs as well as the timing and amounts of such funding, general economic and business conditions including unforeseen weakness in the Company's markets, effects of continued geopolitical unrest and regional conflicts, competition, changes in technology and methods of marketing, delays in completing engineering and manufacturing programs, changes in customer order patterns, changes in product mix, continued success in technological advances and delivering technological innovations, 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 restructurings, or delays in realizing such benefits, challenges in integrating acquired businesses and achieving anticipated synergies, changes to export regulations, increases in tax rates, changes to generally accepted accounting principles, difficulties in retaining key employees and customers, unanticipated costs under fixed price service and system integration engagements, and various other factors beyond our control.

These risks and uncertainties also include such additional risk factors as are discussed in the Company's filings with the US Securities and Exchange Commission, including its annual report on Form 10-K for the fiscal year ended June 30, 2013.

The Company cautions readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. The Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date of which such statement is made.

I'd also like to mention that, in addition to reporting financial results in accordance with generally-accepted accounting principles, or GAAP, during our call, we will discuss several non-GAAP financial measures, specifically adjusted EBITDA and free cash flow. Adjusted EBITDA excludes interest income and expense, income taxes, depreciation, amortization of acquired intangible assets, restructuring expense, impairment of long-lived assets, acquisition costs 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 and free cash flow to GAAP cash flow from operations are included in the press release we issued this afternoon.

With that, I'll turn the call over to Mercury's President and CEO, Mark Aslett. Mark?

Thanks Kevin, good afternoon everyone, and thank you for joining us. I will begin today's call with a business update. Kevin will review the financials and guidance, and then we'll open it up for your questions.

Mercury delivered results for Q3 at or above the high end of our guidance, plus record defense bookings. Total revenue was $55.5 million versus our guidance of $50 million to $56 million. Our GAAP loss from continuing operations was $0.02 per share. This was favorable to our guidance of a loss of $0.15 to $0.09, and much improved both sequentially and year-over-year excluding one-time items.

Adjusted EBITDA was 14% of revenue, up 52% sequentially and up 47% year-over-year, and well above the high end of our guidance. Cash flow from operations also exceeded our forecast for the quarter. Total revenues in our defense business were $51.1 million, essentially flat with Q2 and up $1.7 million or 3% from the third quarter last year.

International defense revenues for the third quarter including FMS were 18% of total defense revenue compared with 17% in Q2. From a program perspective, Aegis, Gorgon Stare and Predator/Reaper were major revenue contributors this quarter, as was a classified airborne radar program.

Radar revenue grew 28% from Q3 last year, and is up 45% year-to-date compared with the same period in Fiscal 2013. Radar is the largest source of revenue in our Mercury Commercial Electronics segment, so MCE is continuing to rebound strongly after a difficult Fiscal 2013.

Although industry conditions remain challenging, our major highlight this quarter was bookings, which totaled $76.1 million, up 51% sequentially and 57% year-over-year. Total defense bookings increased 56% sequentially to a company record $74.6 million. Our book-to-bill was 1.4 compared with 0.9 in Q3 last year. Our book-to-bill in defense improved to 1.5 from 0.9 in the sequential second quarter and 0.9 a year ago.

Defense backlog and total backlog exiting Q3 were up on a sequential basis 22% and 16% respectively. There were four large programs this quarter from a bookings perspective. We received the order for the first round of SEWIP Block 2 LRIP Phase 2 with Lockheed Martin. We received a large booking associated with certain technologies on JSF with Raytheon, and we continue to see strong bookings on Aegis with Lockheed Martin.

In addition, we received a follow-on production order for Gorgon Stare Increment 2 which is in in-theatre and working extremely well. International defense bookings including FMS were 11% of total defense bookings compared with 48% in the sequential second quarter.

We're pleased by the recent positive developments in Washington, most notably the Ryan Murray Budget Agreement, the FY Defense Appropriations Bill, and the Administration's FY 2015 budget. However, the overall environment remains challenging.

During the third quarter, we continued to make rapid progress on the second phase of our acquisition integration plan. As we reported when we announced our q2 financial results in January, we expect that Phase 2 will result in gross annualized expense reductions of $16 million when fully implemented.

The actions we took prior to our call last quarter are expected to achieve about $10 million of these projected savings. We expect the actions completed since then, that is through the end of Q3, will increase the cumulative annualized savings to nearly $12 million, or approximately 70% of the total.

According to our original plan, completing Phase 2 was expected to take about 18 months. However, as a result of careful planning and great execution by the team, we now expect it to take about 12 months, meaning by the end of this calendar year.

The first of our Phase 2 priorities is to take full advantage of the investments we've made, positioning Mercury as a world-class player in the RF and Microwave industry. These investments focus on creating our advanced microelectronics centers in New Jersey and New Hampshire, and consolidating several of our existing non-core facilities in the New Hampshire AMC.

The three months since our Q2 call have been extremely busy from an operations perspective, and the team has achieved a lot. We've moved the local Micronetics components and subsystems businesses to the New Hampshire AMC, as well as another small Micronetics operation that was previously based in Monroe, Connecticut. All this was accomplished seamlessly and with minimal disruption to our customers. By the end of the fourth quarter, we will have consolidated another small Micronetics facility in the Hudson AMC while also implementing the first phase of our headquarters facilities consolidation.

Upon completion of our facilities consolidation plan, which we anticipate happening in Fiscal 2015, we will have significantly reduced our manufacturing footprint. We expect this will not only further decrease our expense base, but also facilitate our efforts to drive advanced microelectronic solutions into the marketplace.

Since our Q2 call, we've also made substantial progress on the systems side of the integration, which is the second priority in our Phase 2 plan. Our goal is to create a common set of core business processes and IT systems following our three recent acquisitions. Over the past three months, we've successfully launched an integrated program monitoring system in our MC Service and Systems Integration business, which will also be implemented by our Mercury Defense Systems business unit. At the same time, we transitioned our RF subsystems operations at both AMCs to Mercury's existing ERP and a new MRP system, while also implementing a common payroll and banking platform company-wide.

Ultimately, our goal is to have common processes and systems that span the entire enterprise. These initiatives will enable us to realize time and resource savings that should improve gross margins, lower G&A expense, and drive greater efficiency across the organization. They should also make Mercury an easier company to do business with.

As we've stated before, our goal is to achieve our target business model for Fiscal 2015, assuming approximately 10% annual revenue growth next year, a normal program mix, and reduced operating expenses from our Phase 2 integration activities.

Our expected growth in FY 2015 will primarily be driven by existing SEWIP Block 2 business and associated content expansion opportunities, Patriot upgrades to both FMS and domestically, F-35 and Filthy Buzzard, as well as continued strength on Aegis.

Our strong bookings performance delivered in Q3 and another strong bookings performance expected in Q4 position us well as we head into next fiscal year. In terms of our forecasted results for FY 2014, revenue guidance is heightened to $215 to $219 million. On the bottom line we're substantially raising our EPS and adjusted EBITDA guidance with Fiscal 2014, based on the strong performance of the business in Fiscal Q3.

Looking farther ahead, we continue to believe that Mercury's strategy, technology, capabilities and ongoing programs and platforms align well with the DOD's new roles and missions. At an industry level, we have the benefit of four major underlying growth drivers. The first is the DOD strategic shift to the Asia/Pacific region, or the Pacific Pivot, as it's known. We believe this will drive opportunities for our MCE business in the areas of specialized server-class processing, packaging, digital, RF and Microwave, [for] ISR sensor upgrades.

The Pacific Pivot should also lead to growth opportunities related to EW and ECM subsystems, particularly in [NDS].

The second growth driver is platform modernization. Electronic upgrades for aging military platforms are the most cost-effective way of adding the new war fighting capabilities we need in this tight budget environment. This is at the heart of what we do. It creates the potential for us to expand beyond our traditional embedded processing products and become a provider of advanced RF and Microwave sensor-processing subsystems. This is a low-risk opportunity to sell more content to existing customers on new, as well as existing, programs and platforms.

Our third growth driver relates to exportability. All our customers are pursuing FMS and international sales opportunities. Selling internationally fuels their growth, improves margins, and opens the door to having foreign customers fund some of the NRE expense that the DOD is now less willing to pay for. Our opportunity here is to provide specialized processing subsystems as well as digital, RF and Microwave products and subsystems that can be exported.

And finally, outsourcing by the large primes remains alive and well, as they seek more affordable advanced sensor processing capabilities. We've clearly positioned Mercury as a trusted outsourcing partner to the primes.

On a more Company-specific level, these growth drivers translate into near-term priorities that will form the base of our plans for Fiscal 2015. One priority is to grow our integrated digital RF and Microwave subsystems sales to the primes. This leverages our recent acquisitions in AMC investments which have been very well-received by our customers.

We've invested a great deal in building a better alternative for the challenges the industry is facing. The design and manufacturing capabilities we've created in our AMCs are clearly resonating with our customers and showing great promise.

We've had more than 19 customer visits since we opened the new Hudson facility, and I couldn't be more pleased with the feedback. We are clearly being viewed as a better alternative than many of our customers' existing suppliers. Just last week I signed an MOU with one of our customers that could double our RF and Microwave business on an existing program.

We continue to believe that RF and Microwave as it relates to next-generation EW and radar subsystems will likely become the fastest-growing part of our business.

Another priority is to drive electronic warfare subsystems sales in our MDS business to a broader industry customer base.

Finally, our third near-term priority relates to the fact that we have invested significantly in refreshing our embedded sensor processing portfolio during the good times. Now, we're positioned to reap the benefits by capturing additional new opportunities in specialized server-class computing beyond defense [service]. These are computing applications that historically we haven't played in, but where we can now expand our presence on existing programs and platforms with unique and differentiated technology.

Our opportunity stems from the fact that the industry is moving away from commodity commercial computing as more and more of its design and production have moved offshore. This positions Mercury as the leading US-owned domestic designer, developer and producer of specialized embedded server-class processing for defense and intelligence applications.

This comes at a time when the prominence and the integrity of these technologies are increasing (technical difficulty).

Overall, we feel good about our prospects with bookings and revenue growth. In the near term, if we can continue to deliver this growth while completing the second and final phase of our integration plan, we should benefit from the substantial operating leverage that we're building in our business. This leverage should further strengthen Mercury's position to deliver significantly-improved profitability, cash flow generation, and shareholder value as we move forward.

With that, I'd like to turn the call over to Kevin. Kevin?

Thank you Mark, and good afternoon again, everyone. Turning to our financial results, revenue for the third quarter of Fiscal 2014 of $55.5 million was $1.4 million higher than revenue of $54.1 million the third quarter of last year, and was at the upper end of our stated guidance of $50 million to $56 million.

The Company generated a GAAP net loss of $0.02 per share in this year's third quarter compared to GAAP EPS of $0.03 per share in the third quarter of Fiscal 2013. This quarter's loss per share was significantly more favorable than the Company's financial guidance of a net loss of $0.09 to $0.15 per share for the quarter.

Fiscal 2014's third quarter financial results included restructuring charges related to the Company's acquisition integration plan announced in January, while last year's third quarter results benefited from the retroactive reinstatement of the Federal R&D Tax Credit.

Excluding the impact of both of these items, the Company generated EPS of $0.05 per share in this year's third quarter compared to a net loss of $0.02 per share in the third quarter of last year.

Adjusted EBITDA for the third quarter Fiscal 2014 of $7.7 million was $2.5 million, or 47%, higher than adjusted EBITDA of $5.2 million for the third quarter of last year and substantially exceeded our stated guidance of $1 million to $4.1 million.

The Company generated free cash flow of $1.1 million in this year's third quarter, and ended the third quarter with $45.7 million of cash and cash equivalents, and with no debt.

Reviewing third quarter financial performance in more detail, beginning with bookings: total bookings were $76.1 million which were $27.5 million or 57% higher than total bookings of $48.6 million for the third quarter of last year. Third quarter bookings performance was the second highest quarterly bookings total in the Company's history and the highest in more than ten years.

Defense bookings for the third quarter of $74.6 million were $30.8 million or 70% higher than defense bookings of $43.8 million for the third quarter of last year, and set an all-time record for the Company. The substantial increase in bookings in this year's third quarter compared to last year stems from higher SEWIP, F-35 and Gorgon Stare program bookings. Combined, these programs totaled more than $30 million in bookings for the quarter.

From a revenue standpoint, total revenue for our largest operating segment, Mercury Commercial Electronics or MCE, was $47.6 million which was $3.6 million or 8% higher than the $44 million of MCE revenue generated in the third quarter of last year. The increase in revenue between years came from higher UAV program revenue, and from a classified airborne program that were partially offset by lower SEWIP program revenue.

Revenue from the Company's Mercury Defense and Intelligence Systems, MDIS operating segment, was $11 million which was $2 million lower than the $13 million of MDIS revenue for the third quarter of last year.

The year-over-year decrease in MDIS revenue was attributed principally to lowered DRFM-related program revenue and lower MIS service revenue that were partially offset by higher Gorgon Stare program revenue.

It should be noted that operating segment revenue for the third quarter of Fiscal 2014 does not include adjustments to eliminate $3.1 million of inter-company revenue.

Total company defense revenue including MCE and MDIS for the third quarter of $51.1 million was $1.7 million higher than the $49.4 million of defense revenue in the third quarter of Fiscal 2013. As mentioned previously, the increase in defense revenue between years stems from higher UAV program revenue and revenue from a classified airborne program that were partially offset by lower MDIS revenue.

Defense revenue comprised 92% of total company revenue in the third quarter of Fiscal 2014, which was comparable to last year's third quarter. Of the total defense revenue in the third quarter of this year, $9.4 million or 18% came from international customers compared to $8.1 million, or 16% in the third quarter of last year. Revenue from international customers includes foreign military sales to our prime customers as well as direct sales to non-US-based customers.

The key programs driving international revenue in this year's third quarter were the Aegis and F-15 electronic warfare, or EW programs, as well as direct sales to a customer in the Asia-Pacific region.

Commercial revenue for this year's third quarter of $4.4 million was slightly lower than the $4.7 million generated in last year's third quarter. The year-over-year decrease in commercial revenue resulted from lower RF component-related revenue.

Mercury's total book-to-bill ratio for the third quarter of Fiscal 2014 was 1.4, which was substantially higher than the 0.9 book-to-bill ratio in the third quarter of Fiscal 2013. Defense book-to-bill of 1.5 for this year's third quarter was similarly well ahead of the 0.9 book-to-bill ratio recorded in the third quarter of last year. It should be noted that for the first nine months of Fiscal 2014, both total company and defense-related book-to-bill ratios were at 1.1.

The Company entered the third quarter of Fiscal 2014 with a record backlog of $151.1 million, which was $23.4 million or 18% higher than the $127.7 million total backlog at the end of the third quarter of last year.

Of the total ending backlog for the third quarter, $116 million or 77% is anticipated to be shipped within the next 12 months. $137.2 million of the ending third quarter total backlog related to defense, which was $28.5 million or 26% higher than defense backlog at the end of the third quarter of Fiscal 2013.

From a bottom line perspective, the Company incurred a GAAP net loss of $600,000 or $0.02 per share in this year's third quarter compared to GAAP earnings of $800,000 or $0.03 per share in last year's third quarter. As noted earlier, financial results for the third quarter of last year benefited by approximately $1.4 million, or $0.05 per share, from the reinstatement of the Federal Research and Development Tax Credit that was retroactive to January of 2012. In addition, this year's third quarter included restructuring charges that when tax-affected contributed $2.2 million or $0.07 per share to this year's third quarter reported loss.

Excluding the impact of these items, the Company generated earnings of $1.6 million or $0.05 per share in the third quarter of Fiscal 2014, compared to a loss of $600,000 or $0.02 per share in last year's third quarter.

The sizeable improvement in operating performance for the Company in the third quarter of this year compared to last year was due to a 3 point improvement in gross margin. This continues the trend from the sequential second quarter of a recovery in the company's higher-margin digital signal processing business in Fiscal 2014 compared to Fiscal 2013.

In addition, favorable operating performance for the third quarter compared to the prior year was attributable to operating expense savings excluding restructuring charges from the Company's acquisition integration plan announced in January.

Adjusted EBITDA of $7.7 million or 14% of revenue for the third quarter of Fiscal 2014 was $2.5 million or 47% higher than the $5.2 million of adjusted EBITDA for the third quarter of last year, due primarily to the improved operating performance of the business between years.

Relative to our stated financial guidance for the third quarter, we are pleased to report that the Company was at or above the high end of its guidance in all key financial measures. Third quarter revenue of $55.5 million was at the high end of our guidance of revenue between $50 million and $56 million. Gross margin of 45% in the third quarter was 5 to 7 points higher than our stated guidance as previously unforecasted in higher-margin digital signal processing program revenue replaced comparably lower margin RF and Microwave program revenue that moved to the fourth quarter.

Reported GAAP loss per share of $0.02 for the third quarter was significantly favorable to our guidance of a net loss between $0.09 and $0.15 per share.

And finally, adjusted EBIDA of $7.7 million for the third quarter was well above the Company's guidance of $1 million to $4.1 million for the quarter.

Turning now to the balance sheet, the Company ended the third quarter of Fiscal 2014 with cash and cash equivalents of $45.7 million, and no debt, which was $1.2 million higher than the $44.5 million of cash and cash equivalents at the end of the sequential second quarter. The Company generated $1.1 million of free cash flow for the third quarter, as $2.2 million of operating cash flow driven by the quarter's cash earnings was partially offset by $1.1 million of capital expenditures.

I want to spend the next few minutes updating you on the financial progress of our acquisition integration plan that the Company announced as part of its second quarter earnings release approximately 90 days ago. As Mark noted earlier, based on the rapid progress of the integration plan to date and the Company's ability to accelerate Fiscal 2015's planned actions to earlier in the fiscal year, we now expect the integration plan to be completed by January of 2015, a full six months sooner than anticipated.

As noted in January, the Company continues to estimate gross annualized expense savings of $16 million upon the completion of the integration plan. During the third quarter, the Company completed actions that generated nearly $10 million of the planned $16 million of gross annualized savings, indicating the front-end-loaded nature of this plan.

Third quarter actions included the elimination of 61 positions, primarily in SG&A and manufacturing, as well as the closure of our Monroe, Connecticut facility. With the planned fourth quarter actions outlined earlier by Mark, the Company estimates achieving nearly $12 million or 70% of the planned $16 million of annualized savings by the end of Fiscal 2014, with the bulk of these savings coming from SG&A and manufacturing functions.

Total restructuring charges for the fourth quarter of Fiscal 2014 are expected to be $2 million. For Fiscal 2015, the additional planned integration actions are forecasted to achieve the remaining $4 million of annualized savings by January 2015, again, a full six months earlier than expected.

The earlier completion date stems from the Company's overall acceleration of its planned facility consolidations as compared to the original integration plan. As a result, the Company anticipates incurring $3.3 million of restructuring charges in Fiscal 2015, which is $900,000 lower than the $4.2 million estimate provided at the last quarter's earnings call.

Now turning to financial guidance, with three quarters of Fiscal 2014 complete, the Company is forecasting full-year revenue of $215 million to $219 million, a tightening of its previous range of $215 to $225 million dollars of revenue. On the bottom line, the Company is raising its full-year guidance with the forecasted loss per share for Fiscal 2014 now in the range of $0.17 to $0.23 per share, compared to prior guidance of a loss of between $0.20 and $0.34 per share. Excluding restructuring charges, the loss per share for the year is anticipated to be between $0.06 and $0.11 per share, which is well ahead of prior guidance of a loss of $0.10 to $0.24 per share.

Driving the improved bottom line guidance for Fiscal 2014 is a more favorable gross margin performance for the second half of this year. Full-year gross margin is now projected to be 44% compared to previous guidance of 42% to 43%. The improved margin performance is expected to be the result of a more favorable product mix driven by the continued recovery in the Company's higher margin core processing business.

We are also raising our guidance for Fiscal 2014 adjusted EBITDA. For all of Fiscal 2014, the Company is forecasting adjusted EBITDA in the range of $18 million to $22 million as compared to the previous range of $14 million to $20 million. At the upper end of this range, the Company would generate adjusted EBITDA of 10% of revenue for Fiscal 2014, and would nearly double adjusted EBIDA compared to Fiscal 2013.

Based on the financial guidance provided for all of Fiscal 2014, we are forecasting fourth quarter total revenue to be in the range of $52 million to $56 million. The estimated revenue range for the quarter assumes strength from the Aegis, Gorgon Stare, and several airborne EW programs. Consistent with prior quarters, we expect the split in fourth quarter revenue to be approximately 90% defense and 10% commercial. Within our stated revenue guidance, we are forecasting gross margin of between 41% and 43% for the fourth quarter, which is below the 45% gross margin generated in this year's third quarter.

As described earlier, the lower gross margin is primarily due to product mix as the third quarter included a greater proportion of higher-margin digital signal processing revenue that had not been expected. The fourth quarter is currently anticipated to include a greater proportion of RF and Microwave revenue that carry comparably lower gross margin.

Operating expenses inclusive of $2 million of estimated restructuring charges are forecasted to be $27 million for the fourth quarter, which is in line with the third quarter expense levels. From a bottom line standpoint we anticipate a reported GAAP loss per share in the range of $0.04 to $0.10 per share for the fourth quarter, based on an estimated weighted average share count of 31 million shares.

Excluding restructuring charges, the range is estimated to be between break-even and a loss of $0.06 per share. The loss per share forecast assumes an income tax benefit of approximately 38%. Consistent with the third quarter, the loss per share range forecasted for the fourth quarter also includes an approximate $0.04 per share impact from the amortization of intangible assets.

Adjusted EBITDA for the fourth quarter is estimated to be between $2.4 million and $5.4 million. We anticipate ending Fiscal 2014 with cash and cash equivalents between $47 million and $48 million. Operating cash flow from cash earnings and lower receivables-related working capital are expected to be partially offset by capital expenditures.

Fourth quarter capital expenditures are likely to be slightly higher than third quarter, tied principally to the Company's acquisition integration efforts.

With that, we'll be happy to take your questions. Destiny, you can proceed with the Q&A now.

(Operator instructions) Our first question comes from Tyler Hojo, Sidoti & Company, your line is open.

Yes, hi guys. I guess just the first thing I'm trying to understand is, when we look at kind of the reduction in the high end of the full-year revenue guidance range, just trying to get my mind around that in context with the fact that you came in towards the higher end or at the high end of your third quarter guidance, you had the strongest bookings period in both defense and overall in the third quarter than we've seen in a couple of years, and you're expecting Q4 bookings to be strong. Can you help me with that?

Sure. It basically boils down to one thing, Tyler, is that although we actually received the booking for the first increment of SEWIP Block 2 LRIP Phase 2, the actual revenue associated with that is now in the first half of our Fiscal 2015. So, it's basically one moving part.

I see, okay. All right, well, that makes it easy, and then just in regards to bookings for 4Q, I think you kind of couched that as being another strong quarter. What's your definition of that? Is that book-to-bill north of 1, and if so, kind of what from a program level drives that?

Sure, yes, we do currently expect another strong bookings quarter, as I said in my prepared remarks. The major driver of bookings that we anticipate right now is in relation to Patriot, so I don't know whether you had the opportunity of listening to Raytheon's call but there's certainly a lot more activity going on in Patriot, both FMS and as we've talked about in the past, probably the largest opportunity that we see is with the US Army, and we're expecting some of that in the fourth quarter. So, Patriot is by far the largest bookings that we're pursuing in Q4.

Okay, got it, and I guess just a little maybe a point of clarification. In the press release, you talked about kind of looking at I think bolt-on acquisitions as kind of the growth strategy, and certainly that's consistent with what you all have kind of indicated before, but I'm just curious if when you look at the portfolio today, do you see holes? You know, when these customers kind of come through your facility, are there capabilities that they kind of view as lacking? Just curious on how you view it just from a strategic standpoint.

Sure. I think from an M&A perspective, I think the strategy is somewhat set. I think we played our cards in terms of becoming an end-to-end provider of advanced sensor processing subsystems, and most of the [positions] as you know have been in the RF and Microwave domain, and that strategy is playing out very well.

There are certainly some technologies that we could add to that. Although I think we've got a great breadth of capability, not just from a technology perspective, but also from a manufacturing perspective which is absolutely critical, because it's really -- the ability to be able to manufacture in volume, that is probably one of our customers' biggest concerns and I think we've addressed that. And we're certainly, I think, becoming a better alternative for our customers versus their alternate suppliers.

The other way of viewing, I think, the opportunity from an M&A perspective, is really one of scaling the platform that we've created. So, the reason that we're very focused on basically the integration plan that I think we're executing [against] extremely well, is to integrate the assets that we have both from an IT and from a process perspective, but also to consolidate the facilities into the two AMCs that we've created.

So, what that affords us from an opportunity perspective is that we could potentially go and acquire additional RF and Microwave companies and integrate those into the platform that we've created, meaning that those -- any potential future acquisitions in that domain should be highly accretive from an EBITDA perspective. So, that's kind of the way in which we're thinking about it, Tyler.

Okay great, I'll hop back in the queue. I appreciate it.

Thank you, our next question comes from the line of Howard Rubel of Jefferies, your line is open.

Thank you very much. Mark, it sounds like what you've done is changed the focus a bit from trying to take outsourcing to instead take share from your competitors. Is that a fair way to think about some of the focus change?

No, I don't think we've changed our focus, Howard. I think the opportunity is both of the things that you mentioned. You know, the outsourcing is alive and well. That MOU that I mentioned that we signed last week, I think is a good example of work that is previously being done in-house being outsourced to a company like Mercury that's invested significantly in terms of its RF and Microwave development, but probably more importantly the production capability.

SEWIP is a great example of us being able to take share, gain in the RF and Microwave industry, both from the high end of the industry where our customers are viewing existing supplies as maybe being less flexible than a kind of a mid-tier player like Mercury, or on the lower end where you've got companies that can really develop the technology, but they represent a huge risk as programs transition into production.

So, I think we've got opportunities in both outsourcing as well as taking share, and that's what we're focused on, Howard.

Yes, but could you help me a little bit? I mean, if you talk about some specifics in terms of share takeaways, is there anything that you could quantify it, Mark?

Yeah, so, I think if you look at as we described at our investor day, there are three major opportunities for us to expand our content on the SEWIP program. Basically, we've just delivered it, the first engineering prototypes, to our customer Lockheed, associated with the first one and so we should start to see some opportunities from a revenue perspective and see what Block 2 as we move into Fiscal 2015.

The second opportunity is again, we'll deliver the engineering prototypes of that product probably this quarter. Both of those are actually taking business away from a division of a pretty large company that was really failing to deliver, and I think we've done that both from a technology as well as from an economic perspective.

Then the third one, we basically grabbed share from a small company who although they were great at developing the prototype, just haven't really got the wherewithal to basically scale into production, as SEWIP Block 2 moves into that full rate production phase next year.

So, a couple of great examples, I think the three examples that I stated are well over $150 million in terms of potential. So, we feel pretty good about our ability to take share in RF and Microwave.

And then last you know, there's the elephant in the room question. I mean, and I know there's lots of ways that you can answer this. So, giving you a moment to think about it. I mean, the press reports indicate that the company's been actively trying to sell itself. How do you react to that?

So, pretty much like every other publicly-traded company. You know, it's our policy not to comment on the industry rumors, but if you've got another question about the business or our results I'd be happy to take it, Howard.

No, I think you answered the first ones very well, I appreciate them. Thank you.

Okay, thank you.

Thank you, our next question comes from the line of Peter Arment of Sterne, Agee. Your line is open.

Yes, good afternoon. Hey Mark, question on when do you expect to see with Block 3, that competition and move forward and how are you viewing that?

Yes. So, SEWIP Block 3 we believe that the award is likely going to be made late summer, early fall. It does look like it's moved out probably three months. Beyond SEWIP Block 3 we think that probably the award for the derivative of SEWIP Block 2 which is for the smaller platforms could also be made over the summer months. And then, I think finally as we've talked about before, SEWIP Block 2 itself does move into full-rate production next year, and beyond the opportunity that we have providing our existing content, we've also got the opportunity for the content expansion that I just described as a part of Howard's questions.

So, SEWIP next year becomes a really important program for us.

Yes, so Mark, when you look at that program and how your bookings are trending, particularly I guess how you're going to see another strong bookings quarter this quarter and the fourth quarter, it seems to imply or maybe I'm just looking for a clarification. Your comments are that Fiscal 2015 looks like 10% revenue growth looks pretty achievable. Are we interpreting that correctly?

Yes, it's certainly our goal for next fiscal year, and I think if you look at -- we had a record bookings performance in Q3 driven by Gorgon Stare, SEWIP, F-35 and Aegis. And we also got some Patriot bookings as well, which as you know has been relatively light over the prior 12 months. But that's clearly starting to pick up.

We do anticipate another strong bookings quarter in Q4 which in essence positions us extremely well as we head into next year, and we really got three major programs that I think are going to be important for us in Fiscal 2015. Clearly, SEWIP is one, Aegis is another, and Patriot is really the third, and we've got a list of about 10, but those are the three big movers.

Okay, and that you would -- and just to follow up, just on the adjusted EBITDA target margin, I believe you know, long-range has been 18% to 22%. We won't get the full benefit of that just because the savings don't really fully on a run rate basis don't officially get completed until January, correct?

Yes, so that is true that the integration plan we're targeting, finalize or finishing that in the January time frame, but the actions that we've taken to date basically afford us 70% of the savings. So, we designed the plan to be very front-end loaded, and I think we're executing extremely well against that, hence our ability to basically pull in the plan itself by six months.

Okay, thank you.

Thank you. Our next question comes from the line of Jonathan Ho from William Blair, your line is open.

Hey, guys. Can you talk a little bit about some of the challenges that you're seeing out in the defense environment? I think you cited that a couple of times, but I just wanted to hear from you on what maybe is a little bit more difficult out there?

Sure. I think overall, I mean, we're certainly pleased with some of the recent developments, in particular we've got a FY defense appropriations bill. I think the Ryan Murray bipartisan budget act basically traded sequester for budget cuts. It at least took the sequester off the table for 2014 and 2015. And finally, the President submitted his budget request.

So, I think they're all positives. You know, the challenges I think still relate to just the timing that certain orders and funding flows [power] and it's still moving pretty slowly. And I think the recent SEWIP Block 2 LRIP Phase 2 is a good example of that. Although we got the booking, the revenue associated with that program basically moved out of our Fiscal 2014 into the first half of our Fiscal 2015.

So, we're very pleased with the bookings performance, but it's still challenging, Jonathan.

Got it, and just in terms of specific detail -- I mean, I know you guys referenced the fact that you are able to complete the cost savings six months ahead of time, but can you maybe just give us a bit more specifics as to what got done earlier and why sort of the tail end of the cost savings will still sort of take until the end of 2015?

Sure. So, as we said before, we basically laid out a plan that was 18 months, it's now 12 months. A lot of the activities relate around the facilities consolidation plan, that will again relate to the new AMC that we have in Hudson, New Hampshire.

So, to date, we basically moved in the form of Micronetics components business, and the subsystems business, that were local in the New Hampshire region. We also closed one of the smaller Micronetics facilities that was based in Monroe, Connecticut, and we've got a number of other facilities consolidation activities that's going to take place.

So, it basically boils down to how quickly can we move those facilities into the New Hampshire AMC, and get the systems and the businesses back up and running and not consolidate the facility.

So, I think the reason that we were able to pull things in is that we're actually executing extremely well, and yes, we feel pretty confident as a result of the activities to date that we can basically bring forwards the last remaining facility into the Hudson AMC kind of in the late part of the year, early next part of the year.

Great, thank you.

Thank you, our next question comes from the line of Mark Jordan from Noble Financial, your line is open.

Thank you, good afternoon. Question relative to the pricing environment that you see moving forward. Obviously, you've been able to document the $16 million of cost reductions. Do you believe that you'll be able to retain all of those benefits, all of that $16 million will drop to the bottom line? Or, do you think as you move to say gain share and grow the business, that you will have to be more aggressive on pricing and net-net give back some percentage of those cost efficiencies?

Yes, I mean, we don't see the pricing pressure per se. I mean, I think we -- that said however, I think we do offer our customers a better alternative, particularly in the RF and Microwave domain. One, because as we talked about the third leg of our acquisition integration plan is to actually invest more of our own internal research and development funding as opposed to basically asking for funding for our customers. Then, that's certainly helping proving the affordability and it's one of the reasons that -- why we're actually beginning to pick up more work and displace the competition.

So, I think you know, that's kind of what we see right now, Mark.

Okay. Related question, in terms of longer-term gross margins, I mean if we look at the third quarter you had a very favorable mix. You were at 45.3% gross margin, Q4 less favorable mix, 41% to 43%. Call it average of 42%. If you were to go out 18 months, what would be that sort of very favorable gross margin range potential you would have, versus the less favorable one given the implementation of the cost reductions?

Yes Mark, this is Kevin. I think we've said publicly that our target business model is to achieve gross margins of between 45% and 50% for the Company in total. They'll get pretty close to that this year. I think in my prepared remarks I indicated that we'll, Fiscal 2014 we expect total gross margin to be about 44% for the year. So, we're getting close to the low end of that range. And I think with the cost reduction actions that Mark talked about earlier, in combination with the fact that our digital signal processing business, the core business of the Company, continues to recover, I think we feel pretty confident we're going to get there fairly quickly, in the near term, in terms of the 45% to 50% target.

If you look at it through the first three quarters of Fiscal 2014, Mark, our gross margin is 49% versus 43.4% last year. So, I think again it comes back to that recovery in the core part of the business that continues to --

Okay, thank you very much.

(Operator instructions) Our next question comes from the line of Michael Ciarmoli from KeyBanc Capital Markets, your line is open.

Hey, thanks guys, good evening and thanks for taking the questions here.

Hi, Mike.

Maybe Mark, could you just comment on kind of the shorter cycle aspects of your business, and maybe the bookings and revenues of those spares and repairs? I know you guys have talked about those obviously being under pressure, they were kind of removed from the forecast when you guys were really running this on a base case. Can you just give us kind of some color on what's happening with those pieces of revenue streams?

Sure. That seems to have stabilized, Mike. I think if you look for the year, we expect that that other business to basically be up year-over-year.

Okay, okay, that's helpful. You know, and then maybe can you talk about the question, you talked a little bit about it on digital signal processing recovering. What is specifically driving that, and how are you guys looking at that product category on a longer-term view?

Sure. So, I think in the short term it's basically specific programs that are now producing, that literally didn't produce during our Fiscal 2013. So, we're clearly seeing some UAV-related programs kick in, that's driving higher processing. We mentioned the F-35, that's had a pretty significant bump during Fiscal 2014 compared with Fiscal 2013.

But I think longer-term, if you look at the opportunity for Mercury, and I tried to describe it in my prepared remarks, is that we see a substantial change occurring in the marketplace, and it's basically around the need to provide not only higher performance, but also specialist capabilities within the processing domain that other companies don't necessarily have. We see the opportunity of basically taking that processing and actually to complete upgrades associated with the sensor itself, but what we also see is now the potential of taking that same capability and actually moving to other parts of the platform architecture from a processing perspective where we haven't played historically -- a good example of which could be mission computing, or for combat systems. And we've got a number of different activities under way right now that basically would allow us to expand on existing programs, existing platforms, and these could be quite meaningful in terms of the size of the potential deal.

So, it's really leveraging the investments that we've made in terms of our processing product portfolio, but expanding into new market areas.

Got it, and then just the last one, I mean it might be early for this but this whole Russia/Ukraine issue. Are you seeing any signs that that's going to translate into additional foreign military missile defense sales? As you guys kind of talk with customers, and work with your larger partners there?

Sure, I think missile defense is clearly an area where there's going to be significant investment around the world. I think Raytheon talked about it a lot, right, there's 12 countries that are currently using the existing Patriot system, and as a result of the new technology that was introduced as a result of the UAE upgrade, which we're a big part, it's basically providing significant opportunities for upgrade to existing customers as well as the potential for expansion beyond those 12.

And so, we know that the two that Raytheon are focused on, both Qatar as well as Poland, and I think they also mentioned Korea. So, there's definitely some short-term opportunities related to foreign military sales for Patriot, but probably the largest opportunity that we see is the US Army upgrades which could begin in earnest in Q4.

Beyond that, I think there's also opportunities for the Aegis system. You know, we're clearly involved in the domestic production or the upgrade of the domestic fleets, and so that's already in production for us, but we also see that some of our foreign eyes are looking to gain access to the Aegis system as well, and we're already doing both engineering work and expect production associated with some foreign countries, as well.

So, I think we're very well-positioned as it relates to missile defense, and I think it's going to be a long-term opportunity for us.

Perfect, sounds good. Thanks for taking the question, guys.

Mr. Aslett, it appears there are no further questions. Therefore, I would like to turn the call back over to you for closing remarks.

Okay, well thank you all very much for listening. We look forward to speaking to you again next quarter, take care.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.