Good day, everyone, and welcome to the Mercury Systems Third 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'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. 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, 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. I'll begin by providing a business update, Mike will review the financials and guidance, and then, we'll open it up to your questions. Mercury delivered strong results in the third quarter of fiscal 2019, including record booking, backlog, revenue, adjusted EBITDA, and adjusted EPS. We continue to execute strategically by building new capabilities, growing organically, and supplementing organic growth with strategic M&A. We closed on the acquisition of GECO Avionics early in Q3. And on April the 18, we completed the acquisitions of Syntonic Microwave and The Athena Group which expand our capabilities in electronic warfare as well as embedded security. Mercury has been successful delivering high-single-digit to low-double-digit organic revenue growth which we've supplemented with M&A. Over the past 3.5 years alone, we've completed 10 acquisitions deploying nearly $700 million of capital. As a result, over the last four fiscal years we've grown total company revenue and adjusted EBITDA at compound annual growth rates of 24% and 51% respectively. This model of strong margins and high organic revenue growth supplement with disciplined M&A and full integration is the embodiment of our strategy. We believe this strategy will continue to generate significant value for shareholders over the longer-term. Looking at fiscal 2019, we're raising our full-year revenue and adjusted EBITDA guidance and now expect 10% to 11% organic growth for the year, 3 to 4 percentage points higher than fiscal 2018. Turning to our Q3 results on Slide 4. We produced record revenue which increased 50% in total and 31% organically year-over-year. Our largest revenue programs in the quarter were from next-generation missile system, WIN-T, SEWIP, F-35 and Filthy Buzzard. Our bookings momentum remained strong. Total bookings for Q3 increased 26% year-over-year leading to a record backlog which was up…

Thank you, Mark, and good afternoon again everyone. Q3 was a record quarter for Mercury in terms of bookings, revenue, adjusted EBITDA, and adjusted EPS. Operating cash flow and free cash flow were strong. We concluded the quarter with a book-to-bill of 1.09 and record backlog. Organic revenue for Q3 was up 31% year-over-year. We now expect organic revenue growth for fiscal 2019 of 10% to 11% up from our previous guidance of 9% to 10%. We're anticipating strong financial performance in the fourth quarter and increase in our fiscal 2019 guidance for revenue, adjusted EBITDA, and adjusted EPS. In addition to organic growth, our focus on acquiring businesses that fit with our strategy and integrating them into Mercury is delivering results as planned. As Mark said, Germane and Themis are performing well on the top and bottom-lines as we continue to integrate both acquisitions. The GECO Avionics integration is also on track. The acquisitions we announced on April 18th Athena and Syntonic are further examples of our ability to identify strategic companies that differentiate Mercury and to work efficiently with owners to complete transactions. We believe this capability has created and will continue to create significant value. The pipeline of new opportunities that fit with our strategy is robust and we anticipate continued M&A activity going forward. Turning now to Slide 9 and our Q3 results. Mercury's total bookings increased 26% year-over-year to a record $189.7 million driving a 1.09 book-to-bill ratio. Year-to-date, our book-to-bill is 1.13. We ended the quarter with record backlog of $558.2 million, up 30% from Q3 fiscal 2018. Backlog expected to ship within the next 12 months increased to $367.3 million. Q3 was another strong quarter for revenue growth. Total revenue increased 50% year-over-year to a record $174.6 million exceeding the top end of…

[Operator Instructions]. And our first question is from Pete Skibitski from Alembic Global. Your line is now open.

Hi guys, nice quarter.

Thank you.

On the West Coast consolidation you mentioned it will end soon. That -- can you re-emphasize as far as your margin expansion play and that when it is done should we expect CapEx to decelerate pretty meaningfully next year?

So the consolidation that we're doing is really part of our full integration strategy. We did something very similar on the East Coast when we completed a number of acquisitions there also. And so what we seek to do is to try and consolidate our footprint and then invest in the facilities to create more scalable automated manufacturing capabilities. So that's the plan. We're seeking to actually complete the consolidation or the build out and then the consolidation of the facilities early in the new fiscal year and after which CapEx for that specific acquisition integration should go down. However we've got other acquisition integration activities underway as well.

Yes, and Pete I would just add to that, we've said historically that our maintenance CapEx is about 3% to 4% of revenues. We've talked about 5% for this year. And as Mark said, what really drives the expansion CapEx is the integration of our acquisitions.

Got it, understood. Okay, and then last question. You're approaching your fiscal 2020 and I'm just wondering how much you guys are concerned if we get a CR for DoD into maybe calendar 2020, should we think about that having any impact here fiscal 2020 or is the backlog so good and the trends so good that that maybe would be more of a fiscal 2021 impact for you guys?

So hard to tell exactly what might happen. I think our operating assumption right now is that it's likely going to be a three-month CR. We've heard that it may go longer than that so a little too early to dwell. We are obviously very pleased with the bookings performance. We've got another record backlog that was up 30% this quarter. So we are in a good position but we're not really going to talk about fiscal 2020 from a guidance perspective. We're going to wait until our Q4 call to do that.

Thank you. Our next question is from Greg Konrad from Jefferies. Your line is now open.

I was just hoping seeing if you could maybe quantify the contribution from Athena and Syntonic or at least from a run rate perspective and how that kind of equates to the expected Q4 organic growth rate?

Yes. So in terms of Athena and Syntonic, we did not announce the amount of the revenue or contribution for the fiscal year for Q4. What we did say when we announced the transactions is that we don't expect them to be material to either Q4 or fiscal 2019. We've only owned them for about two months and they are smaller acquisitions. We think they fit incredibly well. And as Mark went through in his prepared remarks, we think there's a large opportunity to create value. But from a financial perspective this year it's minimal.

And then just from the financing, I mean, I think you said in the release that it would be paid for with the existing credit facility. And I think you ended the quarter with maybe $112 million in cash. I mean how should we think about debt at the end of the year versus kind of that cash build up at least from the beginning of the year?

Yes. So right now following the acquisitions of Syntonic and Athena, we have $324.5 million of debt on our balance sheet up from where we were at the end of the quarter. And you're right; we have $112.5 million of cash. One of the things we talked about on the -- in our prepared remarks was the pipeline we have around M&A. And we see a lot of opportunities in front of us. So we'll evaluate our capital structure, what we do with our cash as we as we go-forward. So we're always trying to keep an eye on the flexibility to take advantage of the M&A pipeline that we see.

Thanks. I'm just going to sneak one more in there. In terms of CRAD, you mentioned growth year-over-year maybe can you talk about where you're seeing the larger customer investments and when we think about the development timeline on the CRAD maybe how quickly that kind of materializes into maybe more sustainable programs? Thank you.

Yes. So CRAD was actually up 46% in the third quarter. So we continue to see some pretty substantial growth there. And as we talked about that is supplementing the significant investments that we're making. In terms of the market segments where we're seeing opportunities to work with our customers, it's really related to I would say three major areas. The first is in EW modernization, the second is in radar modernization, and the third is in the weapons systems arena.

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

Thanks very much. Good quarter and good afternoon.

Hi, good afternoon, Seth. How are you doing?

Good, good, thanks. Just wanted to ask I think maybe two kind of quick questions. First certainly you appreciate the growth in CRAD and kind of how it sees the future. The gross margin guide for the fourth quarter is for a tick up. Is that due to some of that CRAD work starting to move toward production or would you say that there is a reasonable opportunity that you continue to see maybe more of that come than expected and what's kind of the timeframe over which that moves toward production?

Yes. So my take just based upon the environment is that we're going to continue to see increased CRAD from the customers. The RDT&E line in the budget was up quite substantially that clearly trying to focus on next-generation technology investments and we're seeing the same thing for the customers. So I think that trend towards new capabilities will continue. It's hard to predict exactly what that will be kind of as we look forward to next fiscal year, but I do think the trend is towards more activity rather than less. From a timing perspective, with respect to some of these programs they roll at very different stages with respect to, as they transition from the prototype or EMD phase into IRAD. But we do think that when those programs do transition that the margin profile of those annuities will be higher than the margin associated with the engineering efforts today.

Yes. And Seth I would just add, we have program mix every quarter that causes up to up and downs. And you're right; our Q4 guidance is an uptick from where we were this quarter. But if you look back at the last couple of quarters, you see our gross margins fluctuate a bit. They were 44.6% in Q2. So it's really just program mix that you're seeing whereas over time, our gross margins have been relatively consistent.

Great. Thanks. And then I don't know if there's any additional color that you guys can give about the M&A pipeline in terms of where you're seeing the most opportunities and whether there are some larger opportunities as well as kind of smaller ones?

Yes. So I would say it's extremely active right now, it's probably the busiest that we've seen it for quite some time. I think the opportunities that we're looking at play very much into the themes that we've discussed in the past. We've got a number of those kind of going on in parallel. The first is in the C4I domain where we continue to see opportunities around rugged service. We've got an active theme around avionics processing and capabilities and mission computing where we see some opportunities and then we're also continuing to see opportunities in the security in the RF domain. So those are the areas that we're continuing to look at. And there's obviously a lot of other things that we get to see just given how acquisitive we are. We pretty much get to see most of the opportunities that are out there today. So we're quite pleased with how we're positioned and our ability to execute that.

Thank you. Our next question is from Michael Ciarmoli from SunTrust. Your line is now open.

Hey good evening guys. Real nice quarter. Thanks for taking the question. Just to pick on the gross margins a little bit. I mean the level they were at a multi-year low, I mean you've got the target model out there 45 to 50 and I get investing in the annuity programs but clearly as you alluded to, Mark, the DoD is investing, your R&D budget was up significantly. The big primes are kind of feeling the pressure of new versus legacy mix. Is there any danger that on top of taking more CRAD for a maybe longer sustained environment, does the pricing environment getting more challenging for you, I mean do your customers try to sliding that downhill as they look to shore up their margins or how should we be thinking about that?

Yes, look I mean we always work with our customers to try and be as competitive as we can and to help them as they're trying to win more business. One of the big things that we're doing, as you know, is really leaning in on the IRAD side and we're kind of partnering with our customers on these next-generation programs. And they're in effect supplementing our R&D or high-levels of R&D with monies of their own to try and position themselves well to win new programs. So I think it's a very positive environment right now. I mean, you can kind of see that in the level of growth that we're delivering organically as well as a total company. And as I said in the prior answer, I don't really see that slowing down in the short, so. Mike, I don't know if you want to add anything there?

Yes. I mean, Mike, I would just add that as I look at the business, I start by looking at the EBITDA margins because the CRAD increases that we're seeing are shifts between COGS and IRAD that impacted gross margin and we've discussed that but they're offset at the EBITDA line. And so at the EBITDA level, we've been relatively consistent over the last couple of years. We were 23% in 2017, 23% in order of magnitude in 2018. This year the mid-point of our guidance is a little over 22% and the primary driver of that reduction is our acquisitions of Germane and GECO. That's about 1%. So if you exclude those, our acquisitions we would be about 23% EBITDA margins so in line with fiscal 2017 and fiscal 2018. And as Mark said in his prepared remarks, as we look at EBITDA, we see the opportunity over time to achieve the high-end of our target business model for all the reasons that that he mentioned. And so specifically on gross margins, we are seeing because you see that offset at the EBITDA level. It really is the acquisitions Germane and GECO are about 1.5% impact on gross margins. But then the rest of it is CRAD and because of the offset to R&D, we're still in our target range on the EBITDA margin volumes.

Got it. That's -- that's helpful. And then maybe just on the program side maybe one -- one on a big one for you guys, just how do you think about the F35 seems clearly the DoD doesn't want to procure as many I know that's been a big program for you. And then on the flip side maybe new pursuits, sensor is a -- what could be a very big radar program with SPADOC and Hypersonics and perhaps a new kill chain. Are some of these booking awards or design wins that you're seeing related to some of those new opportunities?

So the answer is, yes. So I think our position on the F35 is pretty strong. We continue to win more content on the program overall particularly in the RF domain where we want additional content for radar as well as this quarter, we actually took additional share for RF, EW applications. As I step back, and kind of look at the marketplace, I do think there is significant opportunities associated with radar upgrades in really two different areas. The first is associated with missile defense and there I think there is some significant opportunities for either new ground-based radars or upgrades to existing ground-based radars that we are participating in. The other is obviously the shift towards more Acer radars for both airborne ground and naval applications. And there's at least four, five maybe six opportunities that we see right now that are well underway. And so that is definitely a driver of some of the CRAD activity and we do think it bodes well just given our capability set. The other areas that I would say are important in terms of modernization activity is around EW. We're kind of seeing -- beginning to see that shift towards more cognitive and adaptive capabilities. In EYR, we're seeing new advanced processing architectures starting to come online to build to add more machine learning capability. In C2I, we're participating in processing architectures associated with adding AI capabilities. So we really like the positioning that we have as this modernization activity continues in across multiple different sensor domains.

Got it. And then on -- are you guys on or working with Lockheed and breaking on sensor, the Spectrum Efficient National Surveillance Radar program which could be the largest radar program ever. I mean are you guys working on that one?

So I'm not going to speak specifically to that, Mike. It's in early stage and it's obviously still competitive. But we do think that our technology suite particularly given the very high performance server class products that we've brought out and now with the rackmount rugged service that we have with Themis and Germane, we're very well-positioned for future upgrades.

Thank you. [Operator Instructions]. And our next question is from Jonathan Ho from William Blair and Company. Your line is now open.

Thank you. Hey this is John Weidemoyer for Jonathan. Thanks for taking our call. I'm just wondering to the extent you are at liberty to discuss when you mentioned in your presentation the new growth opportunities with GECO Avionics that you identified, could you speak to any of that?

Yes. I won't mention the specific platform but I think we were -- we've had multiple conversations with customers that are interested in their capability set technologies that combined with Mercury and it's largely targeted at Airborne upgrades, John.

Okay, great. Thanks. And I'm wondering the -- you mentioned that you have a robust pipeline for acquisition activity. And you mentioned it looks like multiple percentage points of growth augmentation in your outlook going forward to achieve like 20% total growth including acquisitions. I'm wondering how -- what kind of a runway do you kind of view that as like for the next year or two could it be even longer than that. Just trying to get a sense as you guys grow from your prior activity and you've done quite well this morning if it's robust enough to go even out into three to five years that kind of thing.

Yes. We believe so. I think if you look at over the last four fiscal years, we've grown total company revenue at a compound annual growth rate of 24%. And that includes high-single-digit, low-double-digit organic growth. As you mentioned we've supplemented with M&A. The M&A pipeline is pretty robust. I think the market size, our addressable market is large enough for us to continue what we've been doing for the last four or five years where we've created tremendous amount of volume. So that's really the strategy that that we have laid out and that we're executing against and that we're going to seek to continue to do.

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

Okay. Well, thanks very much everyone for listening. We look forward to speaking to you again next quarter. Take care.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.