Mark Aslett - CEO Gerry Haines - CFO.

Sheila Kahyaoglu - Jefferies Jason Gursky - Citi Michael Ciarmoli - KeyBanc Capital.

Good day everyone, and welcome to the Mercury Systems Fourth Quarter Fiscal 2016 Conference Call. Today's call is being recorded. At this time for opening remarks and introductions, I'd like to turn the call over to the company's Executive Vice President and Chief Financial Officer, Gerry Haines. Please go ahead, sir..

Thank you, operator. Good afternoon, and thank you for joining us. With me today is our President and Chief Executive Officer, Mark Aslett. If you've not received a copy of the earnings press release we issued earlier this afternoon, you can find it on our website at mrcy.com.

We 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 use of the words may, will, could, should, would, plans, expects, anticipates, continue, estimate, project, intend, likely, forecast, probable, possible, potential, assumes and other 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, the timing 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 or in the U.S.

government's interpretation of federal procurement rules and regulations, market acceptance of the company's products, shortages in components, production delays or unanticipated expenses 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 product, service and systems 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 U.S. Securities and Exchange Commission, including in our Annual Report on Form 10-K for the fiscal year ended June 30, 2015, and in our prospective supplement on Form 424B5 filed April 4, 2016.

The company cautions readers not to place undue reliance on 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 arising after the date on 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, adjusted income from continuing operations, adjusted earnings per share or EPS, and free cash flow.

Adjusted income from continuing operations excludes several items from GAAP income from continuing operations.

The excluded items are amortization of intangible assets, restructuring and other charges, impairment of long-lived assets, acquisition and financing costs, fair value adjustments from purchase accounting, litigation and settlement income and expense, and stock-based compensation expense, as well as the tax impact of those items.

This yields adjusted income from continuing operations, which is expressed on a per share basis as adjusted EPS calculated using weighted average diluted shares outstanding. Adjusted EBITDA excludes depreciation, interest income, as well as income taxes in addition to the exclusions for adjusted income from continuing operations.

Free cash flow excludes capital expenditures from cash flows from operating activities. A reconciliation of these non-GAAP metrics is included in the earnings press release we issued this afternoon. Finally, we'll be discussing the Company's financial results comparisons to prior periods and guidance on both a consolidation and organic basis.

The organic results we're reporting today are non-GAAP and include the LIT business we acquired in Q2 of fiscal 2016 but exclude the Microsemi cargo business we acquired in Q4. With that, I'll turn the call over to Mercury's President and CEO, Mark Aslett..

RF and microwave and secure processing while working to assemble critical and differentiated solutions to sensor and emission processing. We'll also remain focused on smaller capability, led tucking acquisitions similar to LIT while building our pipeline of larger opportunities with the recent carbout being a good example.

During fiscal '16, we demonstrated our ability to complete a large acquisition and a complex set of financing transactions quickly and with great results. We have built strong internal corporate development and integration teams that are skilled in executing complex business combinations.

Finally, as a buyer, we are diligent and offer sellers swift and discreet execution. The Microsemi transaction demonstrates all of these capabilities. It has been less than 90 days since the closing and everything is going extremely well. We feel good about the diligence that we did in our assessment of the business. We'll really like the new team.

The team is thrilled to be part of Mercury, working in a mainstream of a business that shares their mission. We're making good progress on integrating the acquired business and we're looking forward to harvesting the synergies that we've previously discussed. Our planning to the manufacturing efficiencies is under way and on track.

We've already begun shifting the business from a distribution model to direct sales from Mercury and we're beginning to see the cost synergies we expected. Our plans from realizing purchasing efficiencies are also on track. Also well under way are the migrations to Mercury's business system infrastructure and security platforms.

We are on track to have 100% of the infrastructure and security migrated in four to six months from the close and 100% for Legacy ERP applications within six to nine months. The feedback received from customers has been exceptionally positive.

The primes are looking for a fewer number of more capable suppliers that can invest in new technology and capabilities while bringing greater scale.

Our customers can see that the acquired businesses are [ph] to what we currently have, that we scale the business particularly in the art of microwave domain and that we combine two supplies that independently were viewed as very strong, but together are even stronger. In summary, fiscal 2016 was a great year for Mercury.

The strategy we're pursuing is resonating with our customers, it's also consistent with the government's defense priorities and goals for procurement reform.

As a result, we believe that we're well-positioned to continue delivering important new program wins, robust bookings and above-industry average growth and revenue, GAAP operating income and adjusted EBITDA. We look forward to another strong performance in fiscal 2017. Gerry will take you through our guidance with Q1 in the four fiscal year.

So with that, I'd like to turn the call over to Gerry.

Gerry?.

Thank you, Mark and good afternoon again, everyone. Before we go through the financial results, I like to remind you that unless otherwise noted, I'll be discussing the company's financial results, comparisons to prior periods and guidance on a continuing operations basis.

In addition, based on the way we now operate the combined business, we are reporting Mercury's financial results as a single segment. This eliminates the historical distinction between Mercury Commercial Electronics and Mercury Defense Systems.

Our business has become more highly-integrated around the technologies we have developed internally and acquired in recent years, as well through our centralized and integrated go-to market strategy and corporate support functions. This process was solidified by our Q4 acquisition. Reporting as a single segment reflects this integration.

As Mark discussed, Q4 was a period of extraordinary activity for Mercury. We completed the largest acquisition in the company's history, in conjunction with completing two significant financing transactions. In the process, we maintained a strong balance sheet and flexible capital structure to support future growth.

Along with all of this, we also put together a very solid fourth quarter, delivering a strong finish to a successful fiscal 2016. On a consolidated basis including the recently acquired Microsemi businesses, fiscal 2016 marked another year of double digit growth in both revenue and backlog.

Our book to-go ratios were positive, coming in at 1.22 for Q4 and 1.11 for 2016 as a whole. Our record backlog of $287.7 million on a consolidated basis was up $79.7 million or 38% from $208 million a year ago. Of this total backlog, approximately $224.9 million relates to the organic business, which is also a record.

Approximately $239.2 million of the backlog or 83% of the total is expected to be shipped within the next 12 months. Our fiscal '16 bookings and backlog growth positioned us very well as we enter fiscal '17.

Turning to our financial results for the fourth quarter, on a consolidated basis, total revenue increased $21.3 million, worth 33% from Q4 last year, to $85.4 million. This includes organic revenue of $68.8 million, ahead of our guidance of $65.5 to $68.5 million for the organic business.

On a consolidated basis, international revenue including four military sales was 17.6% of total revenue, up from 16.1% in Q4 last year. Revenue from radar and electronic warfare accounted for 67% of consolidated total revenue, compared with 85% a year ago.

The lower proportion reflects the larger and more diverse revenue mix for the quarter as a result of the acquisition. Radar revenue was down 14% year-over-year while electronic warfare revenue was up 75%. We continue to translate our revenue growth into solid profitability in Q4. For Q4 of fiscal '16, Mercury's total gross margin was approximately 45%.

On an organic basis, Q4 gross margin was in-line with our organic guidance of 46%. This compares with gross margin of nearly 49% in Q4 of the prior year.

Fiscal '15's fourth quarter have strong gross margin due to product sales mix, while in Q4 of fiscal '16, total gross margin was negatively affected by an inventory evaluation step up driven by purchased accounting for the Microsemi transaction.

This purchase accounting impact will also affect Q1 of fiscal '17, but will start to diminish in Q2 and should be largely immaterial in Q3 of '17. Q4 consolidated operating expenses were $30.5 million, compared with $23.3 million for the same period of last year.

This includes organic operating expenses of $24.6 million, which is roughly in-line with our organic Q4 guidance and includes $0.5 million of acquisition-related expenses. Consolidated GAAP income from continuing operations for the fourth quarter of fiscal 2016 was $8.5 million or $0.22 a share.

This consolidated figure compares with the $6.1 million or $0.18 per share in Q4 last year.

Consolidated GAAP income from continuing operations for Q4 of fiscal '16 includes approximately $3.7 million or $0.6 a share in amortization of intangible assets; $2.3 million or $0.4 a share of stock-based compensation expense; $0.7 million or $0.1 per share of acquisition in financing cost; $0.3 million or less than $0.1 per share of restructuring expenses; and $1.4 million or $0.2 a share of fair value adjustments from purchased accounting.

In Q4 of this year, we also received a benefit of $1.9 million or $0.5 a share, related to a favorable settlement of a claim related to the core electronics acquisition in 2012. We also received a $1.1 million or $0.3 per share benefit resulting from adoption of the new accounting standard for the treatment of share-based compensation.

While these litigation and tax items positively impacted our GAAP results, they're excluded from adjusted EBITDA and adjusted EPS.

Our GAAP income from continuing operations for Q4 last year included approximately $1.7 million or $0.3 per share per amortization of intangible assets; $0.7 million or $0.1 per share of restructuring in other charges; $0.3 million or less than $0.1 per share of acquisition in financing cost; and $2 million or $0.4 a share of stock-based compensation expense.

Mercury's Q4 adjusted EBITDA increased 29% to $18.3 million on a consolidated basis from $14.2 million in Q4 of last year.

This includes $13.6 million of adjusted EBITDA from organic operations, above the high-end of our organic guidance range of $12 million to $13.5 million and at approximately 20% of organic revenue near the midpoint of our existing target business model.

Consolidated adjusted EPS for the fourth quarter increased to $0.29 a share up 11.5% from $0.26 per share in Q4 fiscal 2015. Of this amount $0.25 per share was attributable to the organic business exceeding the high end of our guidance range of $0.20 to $0.22 per share for the organic business.

Turning to the balance sheet Mercury added -- ended sorry fiscal 2016 with cash and cash equivalents of $81.7 million up 5% from $77.6 million a year earlier.

Operating cash flow of $16.1 million driven by cash earnings was partially offset by approximately $3 million of capital expenditures this yielded approximately $12.2 million of free cash flow during the fourth quarter compared with $10.2 million keep 4 of last year.

In addition we added $92.3 million of net proceeds from a follow on equity offering completed in April and $192 million of net proceeds from the term long-aid financing. Even after more than fully offset by the $300 million purchase price and expenses associated with the acquisition completed on May 2, 2016.

For fiscal 2016 of the whole our consolidated operating cash flow was $36.9 million while free cash flow was $29.1 million. Compared with $32.2 million and $26.2 million in fiscal 2015 respectively. I’ll turn now for financial guidance for the first quarter and full fiscal year 2017. This guidance reflects the positive outlook that mark discussed.

We believe that mercury's market opportunities and backlog position is to continue delivering solid revenue growth in Q.1 and fiscal 2017 on both a consolidated and organic basis. We expect to translate this growth into even stronger operating and earnings performance.

We're also lifting our target business model by 400 cases points of the adjusted EBITDA level to a new range of 22% to 26% of revenue from the prior 18% to 22%. Even with this significant step up we once again expect to achieve performance within our new target business model for the full fiscal year 2017.

For purposes of modeling and guidance we have assumed no restructuring acquisition or financing related expenses in the period discussed.

With that as a background, for the first quarter of fiscal 2017 on a consolidated basis we're forecasting revenue in the range of $82 million to $87 million of which roughly 70% is expected to come from the organic business.

We expect consolidated gross margin for Q1 to be in the range of approximately 44% to 45% this includes a $2.1 million negative impact of inventory fair value adjustments. Resulting from purchase accounting. And anticipated mix of program activities and product sales for the quarter.

Consolidated Q1 operating expenses are expected to be approximately $33 million to $34 million, and Q1 expenses include $0.3 million of non-cash expense attributable to the least of our new headquarters location as work commences on the build out of that facility. This non-cash charge is driven by lease accounting under GAAP.

This duplicative expense will end in May, 2017 when actual cast rent payments commands for the new site, and the lease for the current site has expired. Q1 GAAP income from continuing operations on a consolidated basis is expected to be $1 million to $2.3 million or $0.02 to $0.06 per share.

Adjusted EPS for Q1 on a consolidated basis is expected to be in the range of $0.19 to $0.23 per share these estimates assume approximately $4.5 million amortization of intangible assets $2.1 million a fair value adjustments from purchase accounting, $3.8 million of stock based compensation expense and an effective tax rate of approximately 35% for the quarter.

Adjusted EBITDA for the first quarter is expected to be in the range of $17 million to $19 million representing approximately 20% to 22% of revenue at the forecast that revenue range.

Improved year over year consolidated profitability that we're forecasting for Q1 reflects the impact of sales growth and continued gains in operating leverage in the organic business, as well as margin accretion associated with Microsemi cabouts businesses.

Against that backdrop the anticipated growth and profitability in the organic and acquired business consistent with our original expectations. The integration efforts are progressing on schedule and as anticipated. For the full fiscal year. We currently expect consolidated revenue to be in the range of $368 million to $376 million for fiscal 2017.

Again with roughly 70% of that attributable to the organic business. We currently expect fiscal 2017 GAAP consolidated income from continuing operations to be in the range of $15.5 million to $18.1 million.

We currently expect adjusted EBITDA for all of fiscal 2017 to be approximately $82 million to $86 million and increase of 43% and 50% from fiscal 2016 on a consolidated basis.

Finally we expect to continue generating strong, positive operating cash flow in fiscal 2017 driven primarily by cash earnings, an outstanding point by an increase in capital expenditures compared to last year.

The increase in fiscal 2017 CapEx will be driven by an investments in equipment and infrastructure improvements supporting the achievement of anticipated acquisition related synergies, the tenant a portion of the filled out of our headquarters location, and to support continued organic growth in a consolidated business.

In summary our continued success in growing up top and bottom line in today's defense environment demonstrates that our strategy is working well. We believe that Mercury's fiscal 2017 will be another year solid revenue growth, higher operating income and stronger profitability. With that we'll be happy to take your questions.

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

[Operator instruction] Our first question comes from Sheila Kahyaoglu from Jefferies. Your line is now open. .

Revenue outlook and how we should think about the core business performing and maybe decelerating growth rate in that business little bit and maybe you could give a different color with that the top best programs in the direction of those. .

So we missed the first part of your question, Sheila I think you might have been on mute when you it, could you just repeat it please..

Sure in terms of the fiscal 2017 by the new outlook the implied guidance with the Microsemi assets implies the organic businesses is about -- the core business is about flat organically. Can you just give us an idea why that's decelerating from a robust fiscal 2016 and also if you could give us some color in terms of the top five programs. .

Sure, so I think overall we typically tend to start the year at somewhat conservatively I think it’s probably likely in the case of fiscal 2017 particularly given here what we expect to occur which is another budget continuing resolution.

You know the uptakes we do expect --- I think it's because the prepared remarks growth in both the organic as well as the recently acquired business. And the overture in the pipeline really looks pretty good for next year.

We're expecting growth to be driven by -- as well as electronic warfare as well as growth piece is larger tight to the activities that – the opportunities we see occurring in the Intel service products that we can bringing to market. We also expect growth across pretty much all of our major product lines in which I think is doing quite well.

Overall next year from revenue prospective we anticipate that our top revenue programs will be SEWIP, Aegis [ph]..

And just to slow down I guess in the patriot is the only one that goes up verses 16..

Yes, so part of it was actually third largest revenue program in fiscal 2016 clearly a really important program for the company.

We don't expect that the revenues in fiscal 2017 will be as high as what they were this year, that being said we do expect very strong growth in bookings year-over-year based upon various foreign military national sales that including likely Japan upgrade as well as potentially Poland. .

Thank you very much for the color. .

Thank you. Our next question comes from Jason Gursky from Citi. Your line is now open. .

Hi, good afternoon guys. You touched on part of my question in response to Sheila there but I was wondering if you could address what you used to the opportunity and risks to the guidance that you just issued, I think you suggested that there might be some conservatism.

At this point in the year on the organic side of the business partner there might be some opportunities. Can you help perform this initial credit cards but if you could talk a little bit about what you think what gets in there and then what are the risks to the guidance, what's going to happen guidance this year..

I think the guidance that we gave is kind of balance given you know where we are in the year and what we see right now, we do anticipate as I just mentioned another course roughly in election Cycle.

I think the risks that we see are actually due to the timing as specific programs, here are example during fiscal 2016 we did experience some order delays on the Aegis program that we expect to week hoop in fiscal 2017 and Aegis is likely going to be a significant revenue contributor as well as bookings contributor this fiscal year.

Well with respect to you know what is kind of going up and down, I kind of went through you know what we see happening from market segment perspective, we see strong growth opportunities and – and EW modernization is wildly strong opportunity pipeline with respect to program protection that in the advanced embedded security capabilities that we have.

The top revenue growth programs in fiscal 2017, are likely going to be LRDR [Ph] F-35 and Aegis and probably -- and we do expect in taking to account in our guidance some decline in revenues year-over-year Patriot being one of them.

So we think in summary the guidance that is appropriate in based on where we are in the year and face in terms of what we see happening in the environment. .

Have one follow up if I might. I just want to talk a little bit about the cash cycle, and whether you see there any risks opportunities both on the payables and receivables side -- Some of the OEMs of your referred Customers suggesting that they are getting some slow payments out of DOD.

Trying to get a sense of whether this is becoming a widespread industry phenomena and whether it is also attracting suppliers like yourself, thanks. .

Sure. So we haven't really seen what we would call any direct impact from some of I think what you're talking about that's happened across, which isn't to say that we never would.

But I think more of what we're seeing in our cash flow cycle is simply a little bit of transition to more services leading engagements which are bringing more services work through the front end on some of the newer program opportunities, that will tend to cycle through with some build-up of receivables some which will be until this we reach milestones and so on, and on those convert overtime on the we've seen what we consider to be appropriate levels and timing to those conversions as we go forward.

And it's something that we you know continue to watch and look for opportunities to manage as effectively as they can be.

And as we pointed out before we actually are pretty fond of the service and when engagement because it is exactly that element that leads to the longer term product sales cycle on the back end of those programs, which is where we tend to make better money and where you see some of those filled up and receivables tend to convert down to more you know desirable levels I guess I would call it.

And in overall we have seen anything related to collections that we thought was alarming. .

Sure, thank you..

[Operator instruction] Our next question comes from Michael Ciarmoli from KeyBanc Capital. Your line is now open. .

Good afternoon guys, thanks for taking my question.

maybe just elaborate or dig deeper on the regular deceleration so you've got the top profile growth program you just mention I mean are you saying some of these grow at a slower rate as they just mature and flatten out, and now and then maybe you know who could you also talk a bit about what probably your big program pipeline looks like you know what big programs that are out there that we should be monitoring that that could potentially help reaccelerate that pipeline.

.

Yes so I wouldn't get too hung up in terms the and the top line, again the guidance that we give is kind of in line with what we see in this phase of the year, and just what's happening in the environment.

our programs overall I think of performing pretty well, I went through it Patriot we do expect strong growth in bookings in next fiscal year there will be some revenue reduction, but again it's more just based upon just that the timing is the FMS programs.

Aegis is going to be another strong contributor we seeing more opportunities there, largely driven by the continued modernization of the domestic lease. The other additional opportunities associated with FMS development production. We are seeing additional opportunities associate with huge attacking sessions.

We’re expanding out beyond the center of all that part of the computer architectures onboard, as well is give potential opportunities in the IR and Microwave to main, you know Aegis we feel really good about. SEWIP continues to grow.

We won on a another design win on the SEWIP walk to program, this past quarter with Lockheed, our largest booking in Q4 was actually – with SEWIP walk 3, so that program continues to do well and also. Yet 35 in terms of our existing business again I think its doing well we expect to see growth in that business next fiscal year.

[indiscernible] which is the major program that we hide in our former MPS rating segment is being good growth as well, a lot because the program is moving into production.

You know we feel really good about the position that we are in, the business that we just acquired, I think they're going over it now with pretty excited about that is the opportunity in the guided missile and decision ammunition demand here there appears to be an uptake in spending in that particular area.

And we've consolidate together between both businesses a set of capabilities that we think will allow it to continue to grow our business longer term. So we feel pretty good about the position that we're in like overall. .

Got it, that makes sense.

And then just one more for me, the growth sort of implies that I don't know if we have the exact traveling but if its $115 million so there are looking to be growing maybe a 12% growth rate, is that rate being accelerated to some extent by synergy, you think that you know just trying to get a sense of how Microsemi is trending from you know from a programmatic and top line standpoint.

.

Yes, so overall, I think the business has been growing kind of low single digit we have said that every time we believe that we can reflect that growth rate north wards.

Largely as a result of or channel, here in terms of the early integration efforts we basically trained both sales forces and we’ve been dying joint poles together and there has been a fair amount of activity, in terms the combined businesses together you know we've pursued a very large RS sub-system for the next generation radar, on a standalone basis I think neither company would being able to deliver and it’s a combined RS capabilities, mechanical packaging expertise, as well as get manufactured these capabilities in the new Phoenix facility, that will allow us to go after what is other than from an opportunity perspective.

So we think that we will be able to reflect the growth rates over time, and we have seen some of that occurring fiscal 2017..

Great, thanks. And Gerry I may have missed it, did you give a growth margin for 2017..

Yes, we said -- we didn’t give it for the full year for Q1 we expected it to be 44-esh and again that’s the negative impact of the first accounting adjustment in that quarter..

So you are not going to give us a full year once?.

No..

Okay fair enough, thanks guys..

Thank you. Mr. Aslett, it appears there are further questions; therefor I would like to turn the call over to you for any closing remarks..

Okay. Well, thank you all very much for listening in the call. We look forward to speaking to you again next quarter, thank you..

Ladies and gentlemen, thank you for participating in today's conference. You may all disconnect. Everyone, have a great day..