Good day, everyone, and welcome to the Mercury Systems First Quarter Fiscal 2019 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, Mike Ruppert. Please go ahead, sir.

Good afternoon, and thank you for joining us. With me today is our President and Chief Executive Officer, Mark Aslett. If you have not received a copy of the earnings press release we issued earlier this afternoon, you can find it on our website at mrcy.com. The slide presentation that Mark and I will be referring to is posted on the Investor Relations section of the website under Events and Presentations. Please turn to Slide 2 in the presentation. Before we get started, I would like to remind you that today's presentation includes forward-looking statements, including information regarding Mercury's financial outlook, future plans, objectives, business prospects and anticipated financial performance. These forward-looking statements are subject to future risks and uncertainties that could cause our actual results or performance to differ materially. All forward-looking statements should be considered in conjunction with the cautionary statements on Slide 2 in the earnings press release and the risk factors included in Mercury's SEC filings. 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 also discuss several non-GAAP financial measures, specifically adjusted income, adjusted earnings per share, adjusted EBITDA and free cash flow, organic revenue and acquired revenue. A reconciliation of these non-GAAP metrics is included as an appendix to today's slide presentation and in the earnings press release. I'll now turn the call over to Mercury's President and CEO, Mark Aslett. Please turn to Slide 3.

Thanks, Mike. Good afternoon, everyone, and thanks for joining us. Like to start the call by thanking the entire Mercury team for their continued focus on execution and delivering great results. I'll begin by providing a business update. Mike will review the financials and guidance. And then, we'll open it up for your questions. Mercury delivered solid results for the first quarter of fiscal 2019. Extend the momentum from Q4, installing the new year strong. We came in at above the high-end of our Q1 guidance for revenue, adjusted EBITDA and adjust EPS, while making good progress operationally. Total bookings for Q1 were up 67% year-over-year, hitting an all time record and driving a strong 1.24 book-to-bill. We ended the quarter with a record backlog of more than a $0.5 billion up 41% year-over-year. Total revenue for the first quarter increased 36%, organic revenue was up 6%. We continue to expect an increase of 8% to 9% for this fiscal year. Our largest revenue programs in the quarter were at F-35, WIN-T [ph] Predator, CDS and Filthy Buzzard. On the bottom line adjusted EBITDA increased 25% from Q1 last year. Free cash flow was up 271% year-over-year and in line with our target yield at 50% of adjusted EBITDA. Turning to Slide 4, Mercury has executed well on its strategy to become a leading provider of secure and safety critical processing subsystems for aerospace and defense applications. We strongly believe that over time more and more of the technology that goes into U.S. military platforms will need to be designed and produced domestically. This represents an enormous opportunity for Mercury given our strategy, capabilities and the investments we have already made. At the same time I have no doubt that the U.S. defense industry will need to continue to leverage…

Thank you, Mark and good afternoon again everyone. Mercury's first quarter results were strong. Revenue adjusted EBITDA, adjusted EPS and free cash flow were up substantially from Q1 last year. We delivered record bookings and concluded the quarter with record backlog. We completed the acquisition of Germane Systems and increased the size of our revolving credit facility, providing us more flexibility going forward. Given the strength of our Q1 results, we're anticipating continued strong performance for the remainder of the year. As a result, we're increasing our full year fiscal 2019 guidance for revenue, adjusted EBITDA and adjusted EPS. I’ll walk through the updated guidance shortly. Turning now to the metrics on Slide 9. Mercury's revenue and bookings growth continued to translate into solid profitability in Q1. Total bookings increased 67% year-over-year, driving a 1.24 book-to-bill ratio. We ended the quarter with record backlog of $507.9 million, which is an increase of 41% compared to Q1 fiscal 2018. Backlog expected to ship within the next 12 months, increased 34% from Q1 last year to $377.8 million. Total revenue increased 36% from Q1 last year to $144.1 million, exceeding our guidance of $135 million to $141 million. Organic revenue was up 6% year-over-year, and as Mark mentioned, we continue to expect 8% to 9% organic growth for fiscal 2019. We also saw strong growth in our acquired businesses during the quarter, highlighting the continued success of our M&A strategy. Our strategy of identifying businesses with good growth profiles and integrating them into Mercury to inflect growth is clearly working. As we expected, gross margin for Q1 was down year-over-year, coming in at 42.8% versus 47.8% in Q1 of fiscal 2018. This decline reflected anticipated changes in program and product mix. The inclusion of Themis and Germane, which have lower gross margins…

Certainly. [Operator Instructions] Our first question is from Jon Raviv with Citi. Your line is open.

Hey. Good evening everyone.

Hi, Jon.

Hey. Can you just talk a little about the organic growth trajectory this year, coming out of 2% to 6%, while talking about the 8% to 9% for the year? Just how should we expect things to roll out over the course of the year? And then I know you've talked about acceleration thereafter so you can also add a little perspective on how you see that ticking up after FY2019?

Sure. So we’re currently expecting organic growth to be approximately 9% in Q2. And I said, overall we're remaining at that 8% to 9% for the year. Not what we currently see right now. If you look at our LTM organic growth through the end of the first quarter, it's up 11%. So beyond fiscal 2019, I think we still feel extremely good about how we're positioned. Yes, I think we'll continue to be well aligned with the budget and the need for ongoing modernization in the two major markets segments in which we're participating, those being C2I and Sensor and Effector. And I think we've demonstrated our ability to continue to grow the business over a multi-year period at high single-digit, low double-digit rates and supplement on organic growth with acquisitions. And if you look at over the past five years, we've got a 20% compounded growth rate over that same period. So I think we continue to feel good, Jon, about the business how it's performing as well as our ability to grow organically and through M&A.

And on that organic growth, I mean, you've historically been able to kind of put some space in between you and what some of your major customers are doing in terms of organic growth. With those customers now pointing to in some cases up to 8% organic growth in 2019. How do you see that delta playing out over time? The delta again between the organic and inorganic? Sorry, go ahead, Mark.

Yeah, we'll see. I mean, if you look at the DoD outlays, right, they were up 10% year-over-year and up 10% year-to-date. RDT&E and O&M funding typically have got a shorter spending window compared with procurement dollars, which as you know kind of spun – or can’t spun multi-year period. We've clearly seen a pickup in RDT&E activity, which is driving the high of bookings in the short-term, as well as the increased levels of CRAD funding that Mike had mentioned. So bookings were up 67% year-over-year, we had a 1.24 book-to-bill, CRAD is I think as Mike mentioned is up 79% and up 34% LTM. So I think we're already beginning to see the impact of some of that budget, kind of increased budget spend kind of flow through. And we'll have to see how that plays out going forward. But we do feel that we're pretty well positioned overall. If you look at the 24% growth that we've delivered in the last 12 months and 11% organic growth over the last 12 months, we're quite pleased with our performance.

Thanks. I’ll hop back in the queue.

Thank you. Our next question is from Seth Seifman with J.P. Morgan. Your line is open.

Thanks very much and good afternoon.

Hi, Seth.

Hi, I wonder if you could talk a little bit more about mix and what's expected for the rest of the year in terms of the acceleration in organic growth that you're going to see. And if that comes more on the Sensor and Effector side or more on C4ISR. And then also in terms of the customer funded research that you've seen has that been more in one of those buckets or the other. And then in terms of where it's trending in both?

Okay. So if I kind of look at the – it is really I would say four drivers overall growth that we see in the business. We're expecting a strong performance in our radar processing. We'll continue to expect a strong performance in EW. We’re clearly seeing fund flows into that specific area. If you look at the weapon systems arena. Yes, we've seen a very substantial uptick. LTM weapon systems revenues are actually up over 100% through the end of Q1. And if you look at our weapon systems bookings in Q1, it was up tenfold versus the prior period. So we're clearly seeing some moneys flow there. I think beyond that, we obviously have targeted the C2I space, C4I space. And we are benefiting from the acquired revenues from Themis and Germane. But we've also seen a very substantial increase in the previously acquired CES business that is based over in Geneva. That is targeting comms processing as well as mission computing. And we're winning some very nice design wins there. If you – so that’s kind of generally what we see, I mean, we're seeing growth really across the business. With respect to CRAD, yes, I think it's similar where we won two pretty significant awards this quarter. In the classified missiles domain for RAD tolerant storage and RAD tolerant processing that we're pretty excited about. We saw two quite significant mission computing design wins over in our business in Geneva as well. So yes, which is supplementing obviously the significant IRAD investments that we're making as well. So hopefully that provides some color, Seth.

Yes, yes, definitely…

And Seth, I would just add, just from a guidance perspective. As Mark said, we're in a period of significant design wins and new program starts. When you think about guidance for the rest of year, we do have CRAD normalizing in terms of the level of that so more design wins come in. That's a good thing for us, but right now in our forecast we haven't normalize it.

Right, okay. And then just as a clarification, Mike, did you say at the end of the prepared remarks CapEx of 5% or so of sales this year?

Yes. So we talked before about maintenance CapEx being about 3% to 4% of revenue. This year and it was a little below that in Q1. For this year, we're expecting about 5% and the two real drivers are associated with the build out of our Huntsville facility, as well as the integration of two of our facilities in California. One in Camarillo and in Oxnard, California associated with the delta microwave acquisition. So that's what's driving it up a little higher this year.

Yes. Most of the – we're not really a capital intensive business. I think as Mike said, most of the capital increases are largely associated with our integration programs. And as you know, full integration of the businesses that we're acquiring is a critically important part of our strategy going forward. It has been since the outset.

Thank you very much.

Okay.

Thank you. And our next question is from Sheila Kahyaoglu with Jefferies. Your line is open.

Good evening. Maybe can you provide some color on how Germane and Themis are tracking versus your expectations? You said in your prepared remarks that they're doing quite well. And just broadly speaking if you could maybe elaborate on your comments with regards to Supermicro both risks and as an opportunity for Mercury?

Yes. So both of the businesses are performing extremely well. They are growing strongly. We are in the early stages of combining the two businesses together but we've already completed very substantial integration efforts of Themis as part of Mercury. And as I mentioned on the call, in my prepared remarks this quarter we actually transition Themis on to Mercury’s ERP platform. So we couldn't be happier with kind of how the integration is going and how the business themselves are performing. I think with respect to Supermicro, I kind of hit it on the call. There's been no impact to the business financially. As a result of the alleged hack, we haven't seen any change in customer behaviors or change in the outlook to the business as a result. Stepping back however, I think if you think about the need, we do expect that over time more and more of the technology that goes into U.S. military platforms will need to be designed, developed and produced here domestically. And that has been a core tenet of our strategy for many years. And when we acquired Themis and Germane, one of the synergies that we saw as a result of the deal was being able to actually transition our own internally developed and manufactured products into their rack server solutions over time and as customers needs dictate. So we think that we're probably one of the best companies in the industry from a positioning perspective to help the industry and the DoD transition to these types of capabilities here domestically.

Thanks Mark. And then just one on free cash flow is particularly good in the quarter. How do we expect that to move forward for the rest of the year? Some of it is CapEx moving up from 3% to 5% of sales, any moving pieces you could provide with regards to working capital?

Yes, Sheila. So first of all, as you know we're not specifically guiding free cash flow numbers but we are continuing to target the 50% number that we put out there. If you look at the rest of the year in terms of a couple of things that you've mentioned from a CapEx perspective we do expect is to pick up probably in the latter half. From a working capital perspective, we think there's probably some opportunities at the end of the year – by the end of the year in terms of DSOs and inventories. But overall we're happy with where we are from a cash flow perspective. What we've done with the business and the outlook going forward around our cash flow.

Great, thank you.

Thank you. Our next question is from Ken Herbert with Canaacord. Your line is open.

Hi, good afternoon, Mark and Mike.

Hi, Ken. How are you doing?

Very good, thank you. I appreciate the color on the facility consolidations in California, Themis and Germane. But can you provide an update on the ramp in Arizona on that facility and I know it was bit of a working capital headwind not too long ago. How is that facility ramping and can you just remind us of when you expect it to be a tailwind in some of the milestones or contributions into the back half of this year?

Sure. So the build outs, the SMT facility in Phoenix I think is progressing well. We've completed a fair amount of the transition from our previously outsourced partner. It will continue to a lesser extent for the remainder of the year. And as we've said in the past, we're continuing to seek to make that as well as our other manufacturing locations in RF, as well as the custom microelectronics packaging, operationally more efficient over time and that's an ongoing program. We were very pleased this quarter. As I mentioned in my prepared remarks to be to hire Amir Allahverdi, who ran manufacturing – the whole of the manufacturing operations of Meggitt. And so we're going to be on a similar journey there. It's an important part of our model and we see continued opportunity.

Okay. That’s great. Thank you. And then if I could, there's certainly been discussion lately about maybe different levels as part of the fiscal 2020 defense budget request. And I'm not going ask your opinion about where that exactly comes in but under a scenario theoretically where maybe it comes in closer to the $700 billion. I'm just curious in your business model when you look at the outsourcing trends and flight-to-quality in supply chain delevering. How do you view if we are under maybe more top line pressure into fiscal 2020, the pros or cons relative to your business model?

Yes, it's a great question. I think if you look at we really just begun to see the increases in outlays, FY2018 it was up 10%. I think the year prior to that it was up 3%. It was up very low single-digits. I think in 2016 and prior to that, it was roughly flat. Mercury through really throughout a period of very low single-digit growth or even kind of declines has been able to grow the business in high single-digit, low double-digit rates. And it's exactly because of the trends that you mentioned. We are seeing our customers actually outsource more of the work that they previously did in-house and the outsourcing is occurring at a subsystem level. And then we I think have done a pretty good job at taking share in really two different areas. The first is in RF where there truly is a flight-to-quality where Mercury is invested significantly in its RF development and manufacturing capability where other companies hardened. And as a result of that we are displacing them in certain areas. The second area is around secure processing and we're now in our fourth generation of truly embedded secure processing capabilities that we're now manufacturing in our own facility domestically. And we've got capabilities that are far in advance of what the competition has. And so we're taking share in that domain as well. The final thing that I would kind of point out is that I think as a company we've done a pretty good job. It really targeting what we believe to be the faster growth streams in the budget overall. And you can clearly see that with the growth that we've experienced in areas like EW or also in the weapon systems arena that is growing very, very rapidly and continues to do so. So I think our business model is working well. It's driven by the investments that we're making and some of the industry trends that I've just mentioned, Ken.

Well, thanks for all the detail and really nice quarter.

Thank you.

Thank you. Our next question is from Ronald Epstein with Bank of America Merrill Lynch. Your line is open.

Good afternoon guys. This is Kristine Liwag calling in for Ron. Mark, Mike what's driving the $9 million cash inflow from deferred revenues and customer advances. And if book-to-bill continues to exceed one should we expect this to be continue tail into working capital.

Yes, so let me touch on the deferred revenue question. So, one of the things that we've been working to do as we've done more subsystems is get advance payments and milestone payments from our customers. What happened this quarter is we had a very, very big design win in booking. As part of that we’ve received $13 million advance payment that increased accounts receivables. It also increased deferred revenue. So that's what you're seeing around that.

I see and generally speaking what are the key milestones for cash collection. So, when you get an order how much cash do you get up front versus when you receive it are there milestones or at delivery.

So, it varies dramatically from program to program. So, I wouldn't say there's necessarily a rule of thumb Kristine.

Great. Thanks.

Thank you. Our next question is from Peter Arment with Baird. Your line is open.

Yeah thanks. Good evening Mark, Mike. Just the way – to just understand the CRADs increase obviously long-term it's very favorable. What is the best way to think about how this transition. Was this eventually we're going to start to see this move into LRIPs and other forms as we get out into fiscal 2020 or is this for efforts that go way beyond that.

So it could be both is the answer. Yes, we've got some that are relatively short period of performance. So the large plus site development work that we are doing for a missile system is a two year period of performance. It's a program that is still competitive in nature. So, we'll have to see how that potentially transitions over time. Other programs can follow the traditional EMD LRIP production cycle but I think as Mike said in his prepared remarks, we truly do view the incremental CRAD funding that is on top of the investments, the significant investments in IRAD that we're making is being the forerunner of future organic growth tied to those hardware annuities, which typically drive higher margins. So, yeah we've always got a mix of different programs at different stages Peter but yeah, we clearly are in a period of significant new design win activity.

You know that's helpful. And just also just regarding your program mix because you do have so many programs and you've won a lot. Do you have any headwinds though when we suggest thinking about the organic growth I mean 8% to 9% is very good but do we have any programs that are rolling off when we think about 2019 or going into 2020.

So we've, we've always got programs that are kind of moving as an example. If you look at your Patriot this year is probably not going to be a 10% revenue program for us. Yet we're expecting pretty strong bookings just given what Raytheon is seeing with orders or potential orders from Romania, Poland and Sweden as well as other companies. Aegis, I think is going to be a little lower in our existing business than what we've seen previously. Some of that back fit activity kind of slows down that being said, we’ve added some pretty significant content on the Aegis platform in the form of the KEDS and KEPS program which came to us through the acquisition of Themis. So, we've always got things kind of moving around in the portfolio. But, yeah if we kind of step back and you look at the guidance that portfolio mix change is anticipated in the guidance that we gave Peter.

That's great. And just lastly for me just on the – hey Mike on the increased credit facility obviously you take advantage of some very favorable terms and creating quite a bit of capacity but you already had a lot of flexibility already. So, is there opportunities in the pipeline are increasing or are you just want to have the capacity available to move.

Peter we didn't do it with a specific transaction in mind or anything like that but we do have a robust pipeline as we talked about opportunities that fit with us strategically. We're looking at acquisitions that are for small, medium and large. So we've been very active and we have the opportunity to upsize it and reduce the rate. And we thought it was a good opportunity to get the capacity when we could.

Appreciate the color. Nice result guys.

Thank you Peter.

Thank you. Out next question is from Michael Ciarmoli with SunTrust. Your line is open.

Hey good evening guys. Thanks for taking the questions. Maybe a Mark or Mike just on the gross margin. Would you be able to parse out, I know you've talked a lot about CRAD. But it seems like Germane and Themis each had lower gross margin profiles. Can you give us a sense of how much of the gross margin pressure was from just from the acquired revenues alone and does that – you've got a sort of a ramp in gross margin throughout the year, is that a function of just better performance and integration of those companies, or do we see mix or the level of CRAD kind of taper-off, just how do we think about the margin trajectory there.

Yeah so Mike let me start with the first one. And we obviously don't break out gross margins by acquired and organic but last quarter, we did because it was the first quarter right after we had acquired Germane. So we’ve provided our fiscal 2019 guidance consolidated and then broke out Germane. We could see is the impact of Germane on our gross margins was about 1.6%. And I think that’s relatively consistent. As we go through the year in terms of the increase in gross margin, it is not necessarily related to increased margins associated with the acquired businesses. It really is program and product mix. So, we've got CRAD being relatively stable over the course of the year and then we've got other programs moving in which is causing the increase. We had some accounting stuff we had about 600 K and in Q1 associated with inventory step-up related to the Germane acquisition. But really what's driving it up is program and product mix.

Got it. And then just maybe one bigger picture Mark on this whole super micro and maybe the need to really shore up and secure this kind of supply chain for the DoD. I'm definitely in agreement it creates a lot of opportunities, but as you guys look at this, does it potentially layer on cost. I mean if more work needs to shift internally, does that change – potentially change working capital profiles and intensity or even profitability if you guys are now being asked to make commoditized parts and components something like a printed circuit board. Just any view there on how – obviously longer term, not going to impact anything soon, but how you guys might be thinking about that.

Yeah I don't believe so Mike. I think the DoD recognizes that the prices domestically developed and produce products are going to be different than the stuff is benefiting from huge volumes in offshore manufacturing locations. We have already invested in significant technologies associated with our embedded secure processing products. And we're going to continue to invest and we may invest slightly more to where appropriate or replace some of the Super Micro motherboards. But we think that the cost differential or they will be a cost differential or a price differential. So, we don't really see right now any kind of margin implications nor would I expect to see any significant changes to working capital either Mike.

Okay. Perfect that's helpful. Thanks.

Thank you.

Thank you. Our next question is from Jonathan Ho with William Blair. Your line is open.

Hi. Congratulations on the strong quarter. I just wanted to build on that last question and when we think about the potential for higher secure content and manufacturing requirements and future opportunities, how does that maybe influence or impact time willingness to outsource and potentially maybe even win rates. And so we have to look at whether that starts to happen or not.

Yes. So I think, I don't think it affects the outsourcing trend per se. I think we are in a very strong position to help the customers in the industry as a whole, transition to this domestically developed and produced supply chain. And we've been doing this as you know for many years. It's been a core tenet of this strategy. Mercury is on our fourth generation of embedded security products and we probably got the most contemporary embedded secure processing product portfolios in the industry. So if anything, I think it represents a significant opportunity for us to do what we've been doing which is taking share from other folks along the way. And as I said in my prepared remarks on the call one of the major synergies that we saw when we acquired Themis and Germane was to actually insert our capabilities into their products over time for certain applications and that’s something that we've begun to execute on.

Got it. And then just with the recent acquisition that was made by L-3, I just want to understand, does this create any opportunities or risks for you. Is there any potential for more competition in the M&A space, just want to get a sense of whether industry landscape changes are having any impact.

Are you talking about the merger Jonathan.

Yes.

So look, I think from my perspective it seems like a pretty good combination. Two strong companies getting together that create an even stronger business. As they merge and in essence kind of move up a level to become that sixth prime. Yeah, we actually believe that that could be even more opportunities for us to work together. Especially given the increased rate of outsourcing that we see occurring elsewhere in the industry. And it may even lead to some portfolio shaping because I think some of those companies have got assets at he Tier 3 and Tier 2 levels that may not fit with that strategy going forward but that’s purely hypothetical on my part. So, we’ll see, I think it's an interesting combination and yeah we think that we could potentially benefit from it longer term.

Thank you, thank you.

Thank you. [Operator Instructions] Our next question is from Jon Raviv with Citi. Your line is open.

Hey thanks for the follow-up. Just a question on the M&A pipeline. What are you seeing more of right now, kind of adding new platforms, or adding capabilities to existing platforms or [indiscernible]?

So it's a mixture Jon. We’ve really got kind of three themes going on in parallel, right now and the way in which we think about M&A it is very dramatic in nature. So, we obviously have built a rugged secure server or rugged server business targeting the C2I space that we think that we can continue to grow. Yeah, we've got a theme that is going on in kind of mission computing and avionics that I would say is pretty early stages but we see some opportunities there. On the sensor processing side we build a pretty substantial business in the RF domain. I think we continue to see large medium and small opportunities in that space. We've dipped our toe in the water internationally with the acquisition of CES that we did some time ago. So, then we see other opportunities to create potentially new themes but still sticking with that aerospace and defense electronics focus not straying away from kind of the core. And I think we've demonstrated our ability to kind of enter into close adjacencies and create significant businesses and extract value. And we're going to keep doing that.

Great thank you very much thank you.

Thank you. Mr. Aslett it appears there are no further questions, therefore I'd like to turn the call back over to you for any closing remarks.

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