Mercury Systems' CEO Hosts FY14 Investor Conference (Transcript)

| About: Mercury Systems, (MRCY)

Mercury Systems, Inc. (NASDAQ:MRCY)

Fiscal 2014 Investor Day

November 12, 2013 09:00 a.m. ET


Mark Aslett – President & CEO

Kevin M. Bisson – CFO

Todd Harrison – Senior Fellow, Center for Strategic and Budgetary Assessments

Mark Aslett

So, I was little surprised when I looked outside and saw the snow this morning and I blame the people who are coming in from Chicago. So, welcome everyone, my name is Mark Aslett, the present CEO of Mercury Systems. I would like to welcome you to our Fiscal 2014 Investor Day presentation. The presentation does contain some forward-looking statements. And due to risks and uncertainties, the actual results may different materially from what you see or hear today. So, please take the opportunity of reading our Safe Harbor statement of additional disclosure on our risks. You could look at recently filed Form 10K.

So, we got a pretty busy agenda, we are very pleased to have Todd Harrison, who is the senior fellow from the Center for Strategic and Budgetary Assessments, joined us here today, as our keynote and guest speaker. I think Todd has got an excellent perspective in terms of just looking it as defense budget overtime historically and understanding. Yes, what that could mean going forward in terms of what the budget environment could look like. And we have invited Todd clearly, given everything that's going down in DC. Because I think it really set the context. So the company and its strategy in terms of what we are doing.

So following Todd, I will give a strategic and business update, following that we will take a twenty minute break. So an opportunity of grabbing a coffee. Then DDA will take over and give us some more detailed update on our major programs. Kevin, will follow with the brief financial update. We will then close down the formal part of the presentation including the webcast, and we will open it up for your questions.

So with that I would like to hand it over to Todd for his presentation.

Todd Harrison

Good morning everyone and the title of my briefing ‘Fiscal Uncertainty in the Defense Industry’ and we are in a period of -- rather large uncertainty, but this is not something that’s unexpected. And that's why I want to take a few minutes and go through and try to put this in some historical perspective, this type of uncertainty we are seeing in the defense budget and what we might expect to see in the coming years. And what the impact of this could be on the defense industry.

If you look back over time, this is the overall DOD budget adjusted for inflation, so it's in constant dollars, today's dollars, going back to the end of World War II. And you can see that we are now in the fourth budget cycle that we had since the end of World War II and the paraphrase Mark Twain, history doesn't often repeat itself, but it does rhyme. And so, I think that historical trends are not predictive of the future, they are instructive so what I might happen in the coming years.

Now the first cycle, you see that on the far left, the Korean War, you see a certain surge in defense spending. And when that happened, the ranks of our military swell got up to 3.6 million. You can see in the green line, there is active duty end strength. So as we ramped up and mobilized for the war in Korea, we increased the ranks and as a working to a close, we reduced the number of people in the military down to about 2.5 million and the defense budget fell 51% in real terms in the period of about three years, so it's a very quick drawdown. But that market change in U.S. military posture for the first time in American history, at the end of the Korean War, we maintained a sizable peace time military and a peace time defense industry.

And you can see the budget gradually increased over time, and then it started to despite for the Vietnam War, peak in disclosure 68 for Vietnam. And then started declining, decline by about 25% in real-time over the next seven years. And of course you will see with the Vietnam budget cycle and strength went up again to 3.5 million and at the end of the conflict, it came down significantly. The budget did not come down as significantly at the end of Vietnam though, even though end strength came down because that's when we transitioned to an all volunteer force, meaning we got rid of the draft and when you get rid of the draft, you accept to pay people a wage that would induce them to join the military. So our personnel cost went up significantly just to put it in perspective via pay for listed troops, E1's and E2's, literally doubled overnight, January 1, 1972 and that was actually before we ended the draft that we were trying to reduce our reliance on the conscripts.

So the drawdown was not quite as much at the end of the Vietnam War and then you see the 80's buildup by call – some people call it the Cold War build up, but of course all of this was the Cold War. But the Reagan 80's buildup sharp increase in defense spending that was different because we weren’t actually fighting a hot war somewhere, so that was not going to pay for operation somewhere around the world in Vietnam, Korea. It was primarily going into procurement. We were buying large quantities of equipment in the 80s and so we were able to recapitalize much of our force with very modern equipment, the size of the force went up slightly, we went from two million to 2.2 million in the act of duty but then we peaked in fiscal year 85, and what's interesting, a lot of people forget that the first sequester that we had was in FY 86, and that what's started. That's when they created the law that the current budget control act as amended, Graham Rudman Hollings, and the concern then was that the deficit, as it is today.

And they created this law and the mechanism of sequestration to help control the deficit and to enforce automatic spending reductions, if those deficit targets were exceeded. So, we had a sequester in FY 86, I looked it up the other day, it was a 5% cut across applicable defense account. But when they passed the law, they knew that it was going to immediately trigger that cut. So, that's a little different then what has happened recently. So they knew when they passed it, it will be a 5% cut and then what Congress did is they learned to fit within the cap in the future years and they are able to avoid sequesters in subsequent years until you get into the 90s and then they did have some small sequesters, one of them which was the technical glitch that they – you know, did not estimate properly and had the sequester like a million dollars across the DOD budget, not much.

But you can see, the 90s drawdown and again, this was all in the base budget. There was no war that was being drawn down. You see, it was a significant decline, 35% decline in real terms over a period of more than a decade, I think it was 13 years that the budget decline before it finally reached bottom, and end strengths declined again by about a third even though it did not increase significantly in the lead up to that buildup. So here we are today, the right-hand side, the solid blue part of it, is the base defense budget, the blue ash part above it, is the war related funding, of funding overseas contingency operations. So as best, as we been able to separate it out unlike previous conflicts, we’ve largely funded the war cost in separate appropriations bill, so we can estimate, what the increase was due to these wars.

You would expect as we are now out of Iraq and we are on our way out of Afghanistan, the war related funding should gradually disappear in the coming years. What I find striking though, is in this buildup you know, it's easy to assume that it was because of Iraq and Afghanistan. But about half of the increase in defense spending over the past decade was in the base budget and the other thing is surprising is the green line there, act of duty end strength was basically flat, we have covered right around 1.5 million in the active-duty military, even though the base budget has increased significantly. So that is something that is fundamentally different about the situation we are in now. This drawdown will be different because this buildup was fundamentally different.

Now looking forward, we actually have something written in the law. The budget control act, as it is now amended, puts in place spending caps that apply to DOD in future years all the way through FY 21 and so that is a useful scenario to look at. The green, the solid green part the graph you see here are the spending cap, the portion of the caps that apply to the DOD budget that's the base DOD budget now including war costs. The green hashed area on the top is the war related funding that's just my estimate, we don't know what that will be. War related funding is not subject to the budget cap, so it does create kind of a loophole, the DOD and Congress can use to get around them to a certain extent, if they are willing to. But just assuming a gradual continued drawdown in Afghanistan, what's interesting, I think a lot of people don't realize is the budget caps that are currently in place, the budget will drop again in 2014 to a level of 475 billion for DOD. But that is the low point, the drawdown will be over at that point in the base budget and the budget caps actually start increasing after that they actually increase slightly faster than inflation, as you can see here because this is adjusted for inflation.

Now that doesn't seem too bad, but the problem is that DOD has been planning even in the 2014 budget request. They were planning for a budget that is about 50 billion higher in each year. So over a decade that's half a trillion dollars more that they are planning to have that according to the budget caps, they will not have. So they still have not done the reprogramming, the reformulating their budget and their strategy to fit within these budget caps, and so that's what the pain will be, it's a difference between what DOD was planning to have and what the budget cap will allow them to have.

Now, they are currently preparing an alternate FY 15 budget two parallel budget, but the alternate at FY 15 budget and their slight up, it goes within the five-year defense plan, the alternate one would fit within these budget caps. So, they are painting a budget, they would actually fit within that. They have not decided and it will ultimately be up to the White House that will be, whether or not to release that budget. So come February, typically, when they should be releasing the budget, we could either get the higher-level budget that doesn't show us what the cuts would be or we could get the alternate FY 15 budget that actually shows us what those cuts will be, right now we just don't know but they are putting serious effort into that alternate FY 15 budget and I will say that being from DC, if the planning work that they have done, the fact that they put a lot of things on paper for this alternate FY 15 budget, even if they don't release it, it will probably leak out, at least parts of it will leak out. Once it's on paper, you can't stop it.

Now, I look at this and I say, the BCA is spending capital interest in because that's current law and so we certainly should take that into account. But I don't think that's necessarily the worst case scenario, it's certainly doesn't look that bad compared to previous drawdown. So, what I did as I went through the budget and I said, what if this drawdown follow the patterns of previous draw downs and not just at the top line level, but if you look within the budgets, it's a different account, what's going on in procurement, RDTNE, ONM, and Mil Pers.

Well, procurement spending in previous budget cycles has declined to a level of -- its remarkably similar, $62 billion in today's dollars. At the end of the Cold War, it came down to $62 billion in today's dollars at the end of Vietnam, it came down to $62 billion, at the end of the Korea procurement actually came a little lower than that. So what if procurement spending sell to $62 billion in this drawdown that would be a reduction of about a third from where we are today. Right now we are about $99 billion in procurement dollars. RDTNE accounts, if you look at them over time, in previous draw downs RDTNE accounts do not decline as much as they grow during the buildup phase, it looks more like a step function, it just keeps going up over time. So RDTNE spending already in the three years of this downturn has declined 25%. That is as much or more as our RDTNE accounts have declined in any previous drawdown. So I would assume by historical standards the decline in R&D funding may already be over. So assume that we stay at the current level of about $65 billion in RDTNE funding.

Military personnel and operation and maintenance account, when you look at them on a per person basis because those costs should naturally scale with the number of people in the service. They actually grow even during downturns. Military personnel costs actually accelerate during downturns that's what we have seen in the past. I don't think that can happen again because military personnel cost grew so dramatically over the past decade. I don't want to tempt Congress to do this but I don't think they could make them increase any faster than they have already increased. You know, once you give people free healthcare for lives and things like that I just don't know how you could make it any more expensive but I don't want to tempt them to do it. But I think it's fair to assume that these costs will continue to grow on a per person basis. Mil Pers will probably grow somewhere around 2% per year above inflation on a per person basis. ONM has pretty steady historical growth of about 2.8 % a year on a per person basis.

So assume that those cost continue to grow but the total number of people in the military, if you follow the historical trends will come down and an historical drawdown scenarios, we have reduced our end strength by a third or more in each previous downturns. So assume that we reduce our end strength by a third in this downturn so we would go down to about a million people in the active-duty military that would by the way be the smallest active-duty military we had since 1940. But you multiply that I will do all the math with the procurement at $62 billion, RDTNE at $65 billion, reduce your end strength by a third, but let your cost of compensation and ONM grow and drove in another $10 billion for military construction and family housing, you will end up with a total defense budget in today's dollars of $415 billion by the end of this drawdown, and I just assume that the drawdown happened over the rest of the decade through FY 21, the end of the budget cap for convenience here.

But this actually to me is more of a worst-case scenario and I say worst case, because I don't think it will actually happen but it is possible because all the things that went into that, all the assumptions I used to built to that case, all things that have happened in the past. So it's reasonable to think that these things could happen again. But I say it's a worst case scenario because I think we will actually end up doing better than that because for several reasons. You know, as I said earlier this buildup was different and so I think that will make this drawdown different. So the size of the military as I said before is fluctuated around 1.5 million. We are already planning to go down to 1.4 million in the active-duty military and I should backup there probably many of you have heard that the Army and Marine Corps increase their size over the past decade, that's true, they increased by about a 100,000 total but the Air Force and the Navy were cutting end strength over their entire last decade. So that actually balanced it out.

The Army and Marine Corps are already planning to take that hundred thousand out of their report so that's going to take us down to 1.4 million. So, we have already be smaller than we were when we started the buildup. If you look at the equipment inventory, we did not do a lot over the past decade to recapitalize and modernize much of our inventory equipment, you know, I will give you one example. If you look at major acquisition programs, over the 2000s in that decade, I counted a dozen major programs that were canceled while still in development, meaning, we didn't field a single item at a cost of $50 billion on those program. I am talking things like future combat systems, transformational satcom, satellite. The future inventory architecture, major programs, we spent billions of dollars. They were canceled for a variety of factors, many of them needed to be canceled. Quite frankly, but the result is we spent a lot of money and we don't have anything to show for it. Many other programs went far over their cost expectations, and we are ultimately cut short, like the F-22 program, we did not end up buying as many as we plan, we plan to buy over 700, they stopped at 187.

So we ended up not recapitalizing much of the inventory. So now if you look at the Air Force, the number of aircraft in Air Force inventory has declined from 6,228 aircraft to today we have 5,244. So we are thousand fewer aircrafts today after a decade of increasing budget. The average age of the aircraft in the Air Force inventory went from 19.6 years to 24.4 years. So the aircrafts are older now, than they were at the beginning of this build up.

The Navy, if you look at total ship count of the Navy. We started this build up with 344 ships in the Navy. We now have 288 ships in the Navy. So the Navy has gotten smaller as well and much of the new equipment that was bought for the Army and the Marine Corps was specific to the conflict in Iraq and Afghanistan, for example the MRFs that we bought in Iraq when we started transitioning forces for surge in Afghanistan, we realized those MRFs weren’t actually that useful in Afghanistan we need a different vehicle, so we bought different MRFs through Afghanistan that we did in Iraq. And now they were drawing out of the Afghanistan we are actually not bringing back much of the equipment that we brought down in the first place. We are shredding and filling up for scrap.

So what we did by new thing those were point solutions if you will and they are not -- they don't translate back into the base force going forward. So big thing that I think has changed is military compensation costs. If you look at from 2001 to 2012, the annual compensation costs pay and benefits per active-duty service member group 57% in real terms. So people are costing us almost 60% more now per person then they did at the beginning of this build up and now suggesting for inflation. And that does not include war related cost to the extra pay tax benefits you get for being Iraq and Afghanistan not including that and not including the additional cost of veterans benefits and veterans health coverage because that’s not part of the DOD budget. I have included all those additional cost it’s enormous and how much of it is growing. So I fail about say to that this build up was different, so I don’t think this is drawdown will necessarily follow the pattern of previous drawdown.

In previous buildups, we produced a military that was larger in size, had newer equipment and therefore was more expensive. So in the drawdown we could get smaller, we could stop buying new equipments because we already had a good inventory new equipment and reduced our expenses. But this buildup produced a military that is smaller, older and more expensive how do you drawdown from that, that is the challenge now facing DOD.

So in these DOD, this combination of internal cost growth within the defense budget the changing security environment abroad as we wind down from two major counter insurgency, counter terrorism operations and its activities into pacific and the fiscal uncertainty all of those factors together present a difficult set of strategic choices for the Pentagon.

Now over the summer the Pentagon conducted the strategic choices and management reviews the scammer as some of us call it, I think they call it the skimmer. And this, if you look at the out brief of the secretary Hagel gave. They framed the strategic choices as basically a choice between future capabilities in near term capacity and I'll say upfront that it's not actually at the academy like this so it is plenty of gray area in between, but I think it’s actually framework for looking forward what this might mean for the future.

Your future capabilities are things like investing in new technologies, modernizing your inventory of equipment, rebalancing the capabilities in your reports so they are more relevant for future threat environment. Particularly how do we operate in less permissive environment in the future. Where people are actually trying to shoot down our aircraft and keep us out, keep our ships at bay, what kind of systems, what kind of capabilities do we need to operate in that environment in the future. But if you do that if you focus on those future capabilities, well in a budget constrained environment they have to be offset. So the offsets would be greater reductions in your force structure taking down the size of the overall force and excepting a near-term risk and readiness and that’s politically a difficult thing to talk about in DC, but it is a real decision, a real strategic choice you could make as they look.

In the next five years or so I think that it’s better to accept some risk and not be able to or not be fully prepared for a major conflict, so that I can better prepared 10 years from now that is a choice you can make. And if you’re someone who believe that the threat environment is getting worse overtime that’s a smart decision to make, it’s better to take risk now when the risk are not at great then take risk in the future when you think the threats will be even worse.

But, as much as DOD strategy is leaning towards these future capabilities and you look at the skimmer and the way they frame it they do seem to be favoring the future capabilities argument here. I think the experiences of the past decade are really pulling the DOD back towards near-term capacity as being the focus. If your focus is on near-term capacity that means you will do things like limit reductions and force structure as much as possible trying to keep a larger force and prioritizing near-term readiness, so pouring money into training and maintenance to keep your force ready to fight on the moments noted.

But if you doing that in the budget constrained environment that again have to be off that, so that would come at the expense of your modernization programs, you would have to delay programs reduce quantities or even terminate some program.

And if you’re not buying new stuff’s that means you have to maintain or upgrade existing equipment. And so I think there are -- this is obviously a difficult choice but to put it in perspective that is not one decision that you could make in DOD, you would not make a single decision to focus one or the other. In reality there are thousands of decisions that you would make as part of your defense plan and your defense strategy and at sometimes these decisions would be going at opposite directions with one another and it would not be made by one person it would be made by literally scores of senior leaders across the military, across the civilian leadership and in the Congress.

But ultimately I think all of these thousands of decisions made by all of these different people. They call that something at least in hindsight will look like a defense strategy, and so the question is all those decisions which way do they end up leaning in total, do they lean more towards future capabilities or more towards near-term capacity that’s a big question right now which will this strategy lean and quite frankly it’s too sensitive.

I’m hopeful that it would lean towards future capabilities but I’m not certain. What I find interesting is the decisions you would make and the trends that you see going on in the militarily that are independent of this decision. The things that you would see that what happen regardless of what strategy you choose and I want to talk about a couple of those trends I see going on that I think particularly relevant for the defense industry.

So one trade-off I see or trend that I see is migrating from program centric weapon sys -- platform centric weapon system to censor centric weapon system. So platform centric weapon system are basically the way the military is traditionally operated for a decade is new military capabilities are built around new platforms so if you want to do some new things, you build a whole new platform whether it’s a fighter jet or bomber or ship or a tanker whatever and that new platform is for that new capability.

The problem though is that overtime new platforms are taking longer and longer to build. The unit costs are growing exponentially from one generation to the next and as a result of the long development time and their high cost, high unit cost we have to keep these platforms in service for decades. We have plenty of aircraft in the inventory right now that are 40, 50, even 60 years old simply because we can’t afford to replace them yet or it’s going to take too long before the replacement comes online.

Now a censor centric model for building new military capabilities means that it is not about the platform, but rather what capabilities you can hang on that platform. So the advantage here is you can have incremental improvement overtime in a factor cycle time, you can make improvements more quickly as technology improves and you can make better use of these large fixed capital investments in platforms that have been made in previous generations.

Now the development effort here sensors centric world would focus on building sensors payload and other components and capabilities growing platform. And the platform essentially becomes truck to carry these sensors and other payloads for them. Now the other trends I see going on here I think is interesting is the transition from man system to autonomous system and when I say autonomous I do not mean unmanned, I mean autonomous not having a man in the loop.

Now we are not there yet, but we are somewhere in the middle here, I think a lot of the unmanned systems we have today they are actually remotely piloted, remotely controlled they fall somewhere in the middle they are part of this trends. And this is due to several factors that are making man system less and less attractive to the militarily as I said before growing personal related costs are making man systems less attractive, growing peace time training costs because man systems you have to actually train them doing real world exercises to practice the people who are using them and risk aversion quite frankly. We have become much more risk averse to society to putting our service members live at risk for smaller scale type complexes. As you could see near the way that we carried our operations in Libya and the fact that we did not carry out our operations and in Syria demonstrate the risk of aversion that we have developed overtime.

Now autonomous the systems offer several key advantages of course you got lower peace time training and personnel related cost. And it’s not just because you don’t have a person actually in the platform or a person in the loop controlling it. It’s because machines don’t need practice. Once you program the machine and it can do the function you do not have to practice that machine as regularly as you do a person, people need practice, machines don’t. And so, your peace time operating costs are substantially lower and that actually in our base defense budget that’s a lot of routine for about third of our based defense budget goes to just peacetime training we just have to keep practicing people over and over so that they will be ready to do their job.

So autonomous systems can reduce those expenses greatly and they’re not to mention if you’re not operating the systems as much during peacetime then you don’t have to have all of the people to go along with that to support the maintenance of the system’s during peacetime, so you can significantly reduce the number of people that you have and by the way if you’re not having to conduct all these peacetime training exercises you don’t have to buy as many systems overall.

If you look at our inventories of F-16 fighters at any given time almost half of the inventories of F-16s are dedicated to training they are coded for training. Now they can be used for combat of course, but we have to keep half of them set-aside for training just to keep new pilots coming in and keep them fresh and keep the pipeline of pilots moving, so you could buy many of your system if you go to the more autonomous systems.

Of course autonomous systems offer several operational advantages as well they are not limited by human endurance or human data-processing capabilities which our minds or specially for pilots after about eight hours of pilot basic return to the Jell-O. And so, the systems keep going from much longer and that actually opens up new missionary of that previously not possible and of course no risk to human life that’s true for remotely auto piloted vehicle as well as autonomous systems.

Now I know that there is some reluctant figure to more autonomous systems because you can imagine not in the near future but 20, 30 years now perhaps. That you could have systems that go out the identify target on their own without being human in the loop they prosecute that target they actually make the decision to fire or not to fire and return to base they could do all of this basically based on programming and the sensors that they have on board. And people are reluctant and to go quite that far but I like to point out the people that the most destructive weapons we have in our inventory are autonomous systems, nuclear weapons on ICBMs they are autonomous. They fly on their own without a man in the loop to preprogrammed set of target and destroy them. And we have been living with those autonomous systems for decades since 1950s and so I think people need to put in perspective that autonomous system are nothing new and in fact we were just be bringing some of that technology down to a lower scale of disruptive.

Now the bottom line here is these trends that we’re seeing the trends from platform centric to censor centric weapon systems, the trend from man system to autonomous system these changes could be very disruptive in the defense industry. I think there is a lot of possibilities that it brings along but it could be disruptive as well. And the bottom line is with any disruptive change they are going to be winners and the losers in the defense industry and despite from of what you may hear from many of the big primes and I know that they are telling this in a lot of their conference calls with investors they can all be winners. Not all programs can be protected, not all programs will be protected depending on the depth of the budget cuts, DODs gone to have to make some hard choices. I mean, the example I like to give people as you hear the air force repeatedly say their top three acquisition priorities are the F-35, the KC 46 tanker and the next generation bomber, long-range strike bomber. Those three programs are major acquisition programs planned in the Air Force budget over the next decade.

The fact is that under the BCA level budget cap, they can't afford all three of those. They just can't. So, something will have to give, they will have to reduce, delay, do something to at least one of those three top priorities, and in the deeper cut, that I showed you under my historical trends scenario, they may not even be able to afford protecting two of those top priorities. So, the question now is what are the real priorities? Of those top three for the Air Force, rank them, one, two and three, that's what we need to hear from the Air Force. Now, I am hopeful than in the alternate FY 15 budget request that they are working on now, if they actually release that or if it leaks out, we will be able to some of those priorities, at least how they would prioritize at the level of the BCA spending caps. But the bottom line is, we should expect, fewer new program starts, we should expect reduced quantities and we should expect some shift and what DOD is buying and the types of systems they are buying. I think the companies that are going to do better, are those that foresee the trends and position themselves accordingly.

Now, unlike the 1990s drawdown, I do not expect to see massive consolidation in the defense industry. We are already especially at the prime level, already significantly consolidated from the last drawdown. What I think is, more likely to happen is we will see businesses starting to focus more on their core strength. And perhaps get a thing, something that aren't core to their business. Now, for the prime, their core business really is platform integration. That's what they do. And that's what you need a large company, to do. To do that large-scale systems integration and bring large systems together. Now the various components in sub systems that go into this platform are not really a core business for many of the primes. That's where the primes are going to rely more and more on the second and third tier of the defense industry. Where these firms can provide a specialized design and engineering skill, that the prime is quite frankly, can't afford to keep in help. Because as we are looking at our future where there are few and fewer new program starts. And it's not as centered around the platform, is really more about the systems that and the censors that go on the platforms. The primes simply aren't going to have enough work, they are not going to have enough new programs, going on in at any given time to keep all of this specialty skills fully employed.

So, it makes sense for them to outsource it, to the second and third tier and quite frankly, the smaller second, third tier companies that have these specialized skills. They can then leverage their capabilities across multiple primes. And this actually worked out, I think it's actually a more economically efficient arrangement for everyone. For the primes, for the second and third tier companies and for DOD's because you know, you can keep people more fully utilized and so you can lower your overhead rates by not having people unutilized for as much of the period of time. And an interesting thing about this, is you could actually, people worry about ending up with monopolies at the prime level, you can actually end up with some outcome invisible monopolies at the second and third tier. The DOD may not even be aware of where there's only one or perhaps two companies that have a certain specialty skills that applies across multiple program and multiple primes are using DOD, may not even have the visibility and know if that exist.

I think you know, to wrap things up here. The key questions for defense companies right now, are what core to the business, how they are going to weather this downturn, but most importantly, how are they positioning themselves for the upturn. Because I will end on a happy note here, that even though, the budget is coming down and this drawdown you know, it may last another year, it may last another ten years, we don't know yet. But at some point, we do know the budget will turn around. We know the budget will start to come back up and the question is who going to be the best position to take advantage of the upswing and the budget when it does inevitably happen. I think the companies that focus on the core business, that focus on positioning themselves for the capabilities, DOD is most likely need in the future, they are the one, who are going to come out of this on top.

And so with that, I will turn back over to Mark.

Mark Aslett

So, I hope we found that, you know, pretty interesting you know, perspective in terms what's happening in the industry. I just made a couple of notes in terms of some of the things that said, the two that struck me in particular. Yes, the first is, yes, really looking at companies that can foresee the trends and position themselves accordingly. And in essence, that's what my presentation is all about. We are going to talk to you about, many of the same things that Todd has discussed but putting in context, of our customers what we actually see occurring and how it is that we position the company to success in that environment.

The second thing that just, I think Todd said, in his closing remarks was in relation to what could happen in the industry going forward. In particular, the primes over time, in essence, and I am paraphrasing here. I think we could see the potential of an unwinding a decade worth of vertical integration. So, it becomes much more platform integrated then nature and we see that the defense industry changes over time. Where there is a reemergence of a strong, tier two and tier three base. But specialist companies for their particular area of capabilities much like what's occurred in the aero space industry. So, I think that's the potential for what could happen going forward. And in essence that's what we have done. You know, we have created a very specialized company around building very sophisticated sense of processing sub systems.

So, with that, I would like to get in talking a little bit about Mercury and the strategy. So, many of the company, we are actually founded some 30 years ago. And we actually in public that's 1998. Today, we are positioning ourselves as a commercial outsourcing partner to large defense prime contractors to sophisticated sense of processing sub systems. We operate under what's known as commercial item business model. And what that basically means is that, we are investing significantly in terms of our own research and development. And we are selling own commercial terms to our large prime customers. In essence that goes down to, we got a higher margin potential going forward because we are generating a return, it will generate return, that's commence with both the investment that we are making, as well as our risks. We focused to business on part of the market, where we believe we will continue to see robust funding and growth, particularly as we look towards the new rules and missions. Specifically ISR, our Intelligence Surveillance Reconnaissance, EW, our Electronic Warfare as well as Missile Defense.

We are also involved I think and accosted with a great set of programs in those key areas and you know, we will dealt into that a little more detail, more in DDA part of the presentation. For the financial perspective, rejuvenating company and Fiscal 13 was actually a tough year for us. You know, we were probably a leading indicator, and certainly one of the first to see the advance on sets of our customers preparing for the potential sequestration that would occurred towards the backend of calendar 2013. So, we did see a substantial reduction in terms of our revenues and our profits. However, we are pretty aggressively, you know, I think address that with some significant restructuring. And we focused on basically monitoring the business differently. Focusing on continue to generate positive cash flow, as well as actually looking to build our backlog, which I think we did pretty successful, our backlog is 34%, to get ending Fiscal 13, compared with the prior year.

In more normal times, I think we demonstrated, however the potential of the business. We have effectively doubled defense revenue since Fiscal Year 07 or grew – have grown our defense revenues compounded 15% of that same period. All we can improve profitability. So, we feel that we can get back to our target business model in this environment and we feel that we can do it in a reasonable period of time.

So, for investors highlight perspective. We feel that we got a leading market position, is a pure play defense electronics company. And we feel that in this environment, of you know, consolidation in the industry a pure play is probably the best place for the company. We got very unique and differentiated capabilities to build this very sophisticated sense of processing subsystems that we feel are relying with the three major industry growth drivers going forward. Those being the shift towards the specific the modernization of aging military platforms, as well as the dry to be able to export more law on a defense technology overseas, foreign military as well as international military sales. I think our business model positioned the company extremely well. Not only do we stand to benefit from increased outsourcing from the prime. But with the technology capabilities that we have and the money that we are spending on R&D, we feel our strategically positioned towards over take share. So, I think we got a management team finally that not only knows how to turnaround the business but also to grow a business organically as well as to grow the business to acquisition and to position it well in the industry given its conditions.

So, shifting to what we see is being as the challenges and opportunities within the industry. I think the challenges in the short, were all around political dysfunction in Washington. Longer-term, I think this is the potential for craving over defense spending, I think Todd talked about it that a little bit and in defense procurement form is also well underway and is changing the dynamics within the industry. Despite that we feel that there were myriad of opportunities, the first three or more industry related in terms of the challenges that we see within the military and hence the investments that they need to make which provide opportunity for us around this specific towards aging platform as well as foreign sales. And then this one that we feel it is very specific to Mercury, given our business model and our position within the industry itself, which is the outsourcing trend.

So delving into a little bit more detail, looking at the challenges, in the short term, it's really bad that dysfunction that we see down in Washington. And we go the automatic budget cuts that related to the sequester will beginning an government fiscal 2014 under another defense continuing revolution and both of these items, they are having the impact that basically disrupting the overall DOD budget process as well as the spend level. But I think beyond, it's really the uncertainty around what's likely going to happen in the future. This causing many of the issues that we face in the industry level.

Moving to the long term, I think the challenge that we see in the, for the defense budget, unless we deal with some of the structural inefficiencies in terms of our economy and some of the spending increases, it's the potential for long-term craving out of defense spending. And we see this potential happening at two levels. At a national level what we see happening is our economy is actually recovering at a lower rate than many of the politicians would have hoped. But at the same time, we are spending more money on both healthcare and social spending and at some point, it's likely there are interest rates are going to grow n the national debt. Basically leaving less money available for the disruption we are spending, including defense.

We also see a very similar phenomenal actually occurring inside of the defense budget. I think Todd talked about it. That we have seen a pretty substantial growth terms the cost associated with military personnel, both in terms of the compensation as well as try care or health care expenses. And we coupled out with the fact that really the last time that we recapitalized on military platforms, within the mid 80's under President Reagan. We have seen more of the budget being consumed associated with ONM or operational and Maintenance cost. Basically cost that are keeping the platforms flying or the ship sailing and its leaving less money available for modernization. So, we got some structural issues that we need to deal with as a country both at a national level and inside the DOD budget in terms of the defense.

Finally procure reform, defense procure formal, procurement reform 2.0 or better by in part 2.0. I think this is no, no. It's also well underway and you know, I think at the heart that it's having a structural change or causing structural change within the industry and it certainly change in the compactive dynamics. We see two major things happening, the first is the shift towards more firm big price contracted towards, which in essence it's causing our customers to outsource more work to commercial companies like Mercury, who can do things more quickly as well as more cost effectively. The other in this environment is that the government is willing to fund less of the nonrecurring engineering of the R&D expense itself and at times when the industry needs more capabilities to modernize. So, despite these challenges, we still feel that the defense industry is provides significant opportunity and we will remain a 500 billion dollars plus industry going forward:

Shifting towards the opportunities that we see. The specific pivot is really top-of-the-list and I think the, that's part of the new roles and missions. What this basically means is that the platforms in the sense of themselves are going to be operating differently. If you look at the wars that we been fighting for the past decade, many of the sense is basically stead down it's because we are fighting to ground based wars. The platforms as we shift towards the specific, is going to operating as much higher altitudes at much greatest stand of distances. So the platforms are going to need better and more sophisticated sense as then we have available today. As Todd mentioned, we are seeing a shift from mount to un-mount and then autonomous platforms that basically going to require more computer and more intelligence on both the platforms to operate more autonomously. Because many of our adversaries are actually investing in anti access or area denial capabilities, we are going to need more sophisticated electronic warfare and electronic countermeasures on both the platforms themselves. It's not all about kinetic weapons anymore, it's going to about who dominates the electromagnetic spectrum and that's where electronic warfare comes into play and we feel that we are very well positioned there.

Finally like we seen over the past decade, on board exploitation or the transformation of vast qualities of big data into actionable intelligence in real-time. We remade a trend that we feel we will continue and enjoy going forward. From an aging platform perspective, I think Todd mentioned just the age of the some of the systems that we got, I mean, to put in perspective, the U2 is being flying for 58 years. It's pretty old. And so, and I think what we see from a budget perspective in this more or steer environment, this going to be a less money available for major new weapon platform development and more of a focus on how do you actually modernize the existing platforms that you have. The most cost-effective and quickest way of doing that is actually by upgrading the senses on the platform and that in essence where we play and so I think the chance going forward is at an industry level is how do we actually accelerate the adoption of the delivery of those new senses to provide more capability that will help in terms of bringing down the support cost and ONM budget overtime.

Finally, pretty much all of our customers as speaking growth overseas in terms of foreign military as well as international sale, not only to actually open often and expand the addressable market and also to explore growth opportunities overtime but also because of what we have seen occurring over the past couple of years, where international customers are willing on fund some of the R&D cost to basically upgrade the platforms themselves. So, it's basically a double benefit.

So as Todd talked about in terms of just some of the trends that we see are happening. These are some of the quotes that we are hearing from our customers. So, this kind of taking it down, moving from you know, what's happening at a macro level within the industry, to what's happening with Mercury and its customers. And so what we see is that they are all dealing with growth issues, margin issues and rising costs. So, they are all telling us, they need to keep their existing program sold and whilst they are all dealing with obsolescence issues on platforms, the competition actually view those obsolescence issues as a way is actually and seeding the incumbent, so the degree of competition ongoing is rising for the existing programs. As to seeking growth overseas, you can’t simply export the technologies and capabilities that you have today. You got to upgrade those capabilities to allow the systems to be exported to open up that growth overseas.

As we shift towards the Pacific the threat to the missions and the concept to operations are technically much more challenging and hence more costly. We need more technology and more capabilities to deliver the sensors that are going to resolve the -- or to play in with the shift towards the Pacific going forward. From an industry perspective, the defense Primes’ business model of [gross under cost-plus] for the past decade. So they now are trying to figure out how to actually deal with the fixed price contract awards. They are all trying to shift away from a very high fixed cost business model to a more variable cost model in nature.

They are all trying to figure out ways in which they can consolidate their supply base, and deliver new technology with less monies available. So when Todd talked today, foreseeing the trends and the companies basically positioning themselves appropriately for this environment, we feel that we have done that. We feel that we identified I think in pretty good clarity the major issues that our customers would face over time, and the way in which we have actually addressed them is by providing more innovative solutions, enhanced capabilities for the sort of subsystems that we provide. We have addressed many of the supply chain issues that our customers face from a scalability perspective.

And then probably the big one in this environment is we have addressed affordability because we positioned ourselves as being the outsourcing partner to the clients, more sophisticated yet more affordable subsystems solutions. So what I would like to do is basically walk through each one of these in turns, and to let you know what it is that we have done to position the company well for growth and improve returns.

Starting with the computer part of our business, we think that we have innovated substantially to deliver enhanced new processing capabilities, but also we have invested in technologies and capabilities that we feel will allow the company to basically take share going forward. Today we feel that we have got the industry’s most up-to-date and differentiated embedded processing product portfolio that is available.

One of the major trends that we see occurring within the industry from a processing perspective is the significant shift under way. When you look at much of the processing that has occurred onboard military platforms over the past decade, much of that was actually with freescale [Indiscernible]. The change that we see occurring is that pretty much all of the new design wins that we are seeing going onboard these military platforms are more around Intel FPGA and GPUs.

Whereas many of our competitors have actually focused on taking Intel mobile devices, and to put them into the embedded systems world because they are much easier to package and [Indiscernible], we actually went the complete opposite direction. As a company, we are the only ones in the industry that have got truly Intel server class devices that is going to allow the amount of compute power onboard these systems going forward the next generation sensors. To put in perspective for those of you that actually follow Intel, our latest generation processing element has got dual Haswell processors. These are 5 core devices. So we basically got a 10-core Intel server class device on something that is literally the size of an iPod, but just a little bit thicker.

That is a really hard thing to do. It requires a tremendous amount of innovation and capability to be able to pack that amount of compute density into that sized footprint. We pioneered the use of GPUs or graphical processing units that basically have powered the gaming revolution, and we have applied that to onboard sensor processing, particularly as it relates to big data and video applications.

As we shift towards the Pacific, I mentioned earlier that the platforms themselves are going to be operated differently than in the two ground wars that we have been fighting. The platforms themselves are going to be operating at much higher alternatives at much greater distances, and so well, what is the big deal. The big deal is that the higher the altitude that you go, it becomes much more difficult as to how to cool those devices. So we have innovated in key technologies, both thorough Air Flow-By and on latest generation Liquid Flow-By that is going to enable the sensors on these next generation type platforms.

This next one is probably the one that I feel has got the greatest growth potential, an ability for us to basically displace the competition going forward. So as we have been actually reengineering and delivering a lot more capability in the Intel server class processing domain, we have actually embedded key exportable capabilities into the product portfolio. And we have been told that we are years ahead of the competition.

So think about it, is if you want to actually go and develop a next-generation architecture, would you develop one that isn’t exportable today, and the answer is absolutely not. So we have got a great position in the industry as these products or sensors come up for a refresh that we have got the technologies and the capabilities available today to basically do that, which combined with the software capability or our advanced middleware, it is basically going to allow us to rapidly port our customers’ applications, algorithms and techniques and capability onto an open systems architecture more quickly and more cost effectively.

So as we shift forward and as we look at, you know, basically completing the product portfolio refresh and finishing up some work around some specific programs or products related to some specific programs we feel that we can use more of our R&D dollars to actually accelerate the adoption of these new technologies and capabilities that are available today, and in essence taking share.

Shifting to what we have done to basically expand our capability set, we have done a number of acquisitions in the RF and microwave domain that have not only substantially increased the size of our addressable market, and will allow us to competitively take share, but we have also got the capabilities that are available to actually build these next-generation sophisticated AESA radar, electronic warfare, electronic countermeasures and intelligence gathering subsystem solutions.

What makes this unique today and this is a really important point is that we are the only commercial item company that we know of within the defense electronics industry that has got all of the capabilities end-to-end in-house to build sophisticated radar or sophisticated sensor processing subsystems. Why that is important is that we actually have acquired and we’re preintegrating the technology. This becomes critically important as our customers are actually outsourcing more work to companies such as us, because if we are doing the preintegration the subsystem solutions that we provide will be more affordable over time compared to doing it in-house. So we have got unique and differentiated capabilities in RF, conditioning, distribution and switching, you know, very advanced wideband tuners, receivers, exciters. We have got the capability of being able to do FPGA near-sensor based processing that is critically important to low latency applications such as electronic countermeasures or electronic warfare.

In our Mercury Defense Systems business we have got advanced commercial DRFMs, or digital radio frequency memory subsystems, which are a critical component of modern electronic warfare, as well as advanced software-defined transceiver subsystems that can be used for dissemination. So we feel that we have got the capabilities end-to-end along the sensor processing chain.

However, it is not all about the capabilities, what is important is basically growth. So you see on the right-hand side of the slide is a typical radar processing or electronic warfare subsystem. There is actually not too much difference between the two, other than say maybe some of the processing capability. But what you see on the right-hand side of the slide is basically two slots in the middle of that chassis processing that is traditional Mercury’s market. However, what we have done as we have moved into the RF and microwave is substantially increase the size of our addressable market.

In these types of subsystems, there is 3x to 5x the content in RF and microwave than what there is in traditional Mercury processing. And as we complete the product portfolio, we can not only provide new capabilities, but we can use more of our R&D funds to basically outsource more work that our customers, that we are currently doing in-house or to competitively take share. And we are doing that today and we’re actually seeing that it is a faster time to money, and I think the best example of that is SEWIP, which you will see as the presentation progresses.

So what has been key to enable this potential growth in the size of our market and open up the avenue from a growth perspective is the acquisitions that we have done, but also the investment in our new advanced microelectronic sensor, which is both timely as well as really important, particularly as we see programs transitioning from the low rate initial production into full rate production, and again SEWIP is a great example of that.

So we feel that RF and microwave is actually going to likely be the fastest growing part of our business over time. And what we’ve done through the acquisitions which has provide us the technology capability combined with the AMC which has given us the scalability is we create meaning that looking forward if we continue to acquisitions in this space we can rapidly assembly those companies and capability into the existing platform meaning any potential future deals in this space should be highly accretive.

Looking at the same growth opportunity but this time through the eyes of our customers, what you see in the bottom part of the slide is two significant relationships that – through the Micronetics those being with BAE as well as Excel. And you see the amount of revenue that we’ve got that’s coming from RF and microwave with those particular pans. We see in the middle and the top part of the slide is basically more traditional customer relationships and if you go back what I just said that in resources substance where we provide capability there should be 3x to 5x the amount of RF and microwave there isn’t traditional mercury processing. This gives us a substantial opportunity not only to actually increase the size of our pie but also to grow business.

What’s really nice about this growth strategy however is we’re actually selling into the same customers, the same executive relationships, the same engineering organizations, the same procurement organizations onto the same platform into the same program and into the same as they were currently selling our processing capabilities. So it’s a very, very low risk way of basically growing inside of the instilled base and the fact that we’ve actually acquired the technology and were pre-integrated provides more affordable solutions and a better alternative.

So, we didn’t move into this market place likely, we know it’s a change in strategy for us and we know it’s a different type of technology and we spent a tremendous amount of time looking at the industry structure. And what we saw was really an industry structure that looks like in our glass and that’s my kind of poor equivalent of – its suppose to be our glass in the right hand side of the side. What you see is that the top industry you got some companies that are potentially larger than Mercury in terms of size, however many of them are part of a much more widely diversified business and those parent companies were actually deemphasizing the defense electronics part of that business and more reemphasizing either aerospace industrial or scientific and our customers are seeing and we view that as an opportunity.

What we also see is a least one player in the space that’s a significant player in both EW and radar subsystem solutions that are actually forward integrated and they’re now competing with our customers and many of our customers the large primes are looking to move away from them.

Towards the bottom part of the market, we see an industry that’s pretty fragmented, you got a lot of small private companies that have got interesting technologies and capabilities that the prime have introduced into that program in the cost plus environment given what’s happening in an industry level around defense spending and the turbulence that we’re seeing down in Washington around the budgeting process many of those companies are actually struggling today and has a created a huge amount of risk in terms of the primes portfolios programs. So many of them have the technology capability but they basically lack both the scope as well as the scale to transition this programs move into full rate product. So, we see the opportunity both at the top of the market as well as the bottom of the market to basically take share.

And in essence what we said about to do is to create a better alternative, we’ve acquired the technology capabilities that we need to build these sophisticated EW and radar processing subsystems outside of the antenna and we did that through the acquisitions LNX as well as Micronetics and core. However, given that the industry structure is such that there really are no contract money factors in RF and microwave production like they’re also in the ability to be able to do the production of digital processing. You need a capability that’s more vertically integrated. So we were extremely fortunate to basically pick up a facility in Hudson Newhampshire the AMC, the Advanced Microelectronic Center that were beginning to move into this week. Where the former owner had invested our developer is estimating nearly $20 million in terms of infrastructure.

So, we’re into that facility basically for pennies on the dollar. What it gives us a tremendous amount of capability and capacity as the program such as [Seaward] transitioning from low rate initial production into full production. What it also gives us is actually built in plant redundancy from a single supplier and we’ve seen opportunities literally within the last couple of quarters where our customers are willing to outsource more work to a single supply because we got that redundancy build in house.

It’s not just about the design and the development capability however, we’ve also invest money – engineering capabilities that are co-located inside of the facility and that’s critical not only to optimize new designs but to basically help outsource or to onboard more outsourced work. The facilities themselves were also very modern, we’ve invested in key automation, manufacturing and automated test which is important from a margin perspective going forward again as some of these programs that involves with transition into production. So, we feel with the capabilities that we have with the scalability that we have addressing many of the risks that our customers have identified from supply chain perspective, we’re the better alternative in RF and microwave going forward.

Transitioning now to what we see happening more in terms of the outsourcing trends. So, what you see here is basically a selection of that come from many of the large players within the defense industry over the past three or four quarters. And so, what we see in a very high level a record earnings increased yields, momentum drive, large buybacks, but under the covers the substantial changes that are occurring and we see that each and every day given the level of rapid within the industry and I think that boils down to a few key things, the first is that the headcount reductions are well underway and they’re happening week in, week out, month in, month out. Now, we haven’t seen I think any one particular headcount action that rises to a level of materiality for many of our customers, but if you look at the cumulative change overtime it’s substantial there are lot of heads coming out of these businesses. We also trying to figure out how to actually move from a very high fixed cost business model into one way they are creating more of the variable cost structure. So substantially reducing that facility footprint as well as the management layers as well as just the overall headcount.

Firstly, on the supply base they trying to buy down risk move away from supplier to introduce risk and can't meet these some of the affordability target to companies that they can know that will deliver all the time.

And this last one is an interesting one so they’ve got a capital allocation strategy where that increase in the yield and increase in the buybacks and in some instance this is the expensive retail R&D. So they still could get access to more technology and more capability, so under all these circumstances how they are going to do it and what we see happening is that the way which they are going to do is by outsourcing more and more work to specialized commercial companies or specialized players in the second and third tier of the industry. Who can do things more quickly and more cost effectively. So in essence that’s the way which you set up the company, we set ourselves up to be a specialist provider that outsourced to do the outsource design development production for very specialized central processing subsystems. We have acquired the capabilities along the sense of change that allows us to basically provide that end to end capability which is critical when you look at the factor with pre-integrating of the technology and the pre-integration improves the overall affordability. We have invested in supply chain particularly in RF and Microwave that actually helps by down risk and create the better alternative broad customers going forward given the industry structure. Our engineering organization can either do complete outsource design development production of a central processing subsystem or in some instances can simply be an extension of our customer engineering organization. So, net, net I think we created not only the technology capabilities and address the affordability to our outsourced business model to have all of the capabilities that our customers need at a time when they needed the most, which is why we believe that outsourcing is probably the largest secular growth opportunities that we see. If our customers just simply outsource an additional 10% of the work that they do in-house, it would more than double the size of our addressable market so we feel this as an enormous opportunity for the company over time particularly given what Todd descried in terms of the change of you know what we think could happen within industry, the price will become more platform integrated and outsourced more of the specialist work to other company.

Transitioning out some of our programs this is a slide that we introduced into our investor day presentation last year and I think the feedback overall was very positive so we put we've updated it for this year. I’m not going to go into this in detail because TDA is part of the part of the presentation as largely focusing on a review of the major programs, which suffice to say that we fail what we got a great set of portfolio program that are very much aligned with what we see to be the major growth drivers within the industry such as the ship towards the specific modernization of the platform as well as foreign military and international sales. So it’s our current assumptions based upon the phase, the timing, and the possible volume which could change overtime with our best estimate at this particular, this particular snapshot.

So if I should summarize the program I would say that RF and microwave is expected to be the fastest-growing part of our business as we transition towards the growth opportunities going forward. Existing SIWAP Block II and future content expansion as well as navy maybe it’s looking at creating a derivative opportunity for use in other ways or in other areas provide a larger short-term growth potential. Particularly is the program itself is moving from low rate initial production into full production next year. We see upside potential on SIWAP Block III which is you know still be uncompleted. But it is a testament I think to the both of the acquisition strategy that we pursued as well as our investment in the AMC.

Since we were here a year ago we’ve seen $165 million to $385 million growth in possible values and loan as a result of the acquisition in the AMC. So, that’s an enormous amount of growth potential that we've added, we feel because we creating a better alternative in the industry.

So [Seaward] driven growth for long sides of other key programs along with the continued integration of the businesses that we have acquired and other savings that we are working on. We feel likely accelerate the top to both achieving profitability as well as our target business model in a reasonable period of time.

So for to summarize I would say that we feel that our strategy, acquisitions, business model, and investments have positioned up extremely well to drive continued growth in improved returns. We got key innovations that not only provide the technologies and capabilities that allow --that required the next generation sensor processing upgrades. But we also invested in our key technology which is capabilities that we believe will allow us to take share over time. In the RF and microwave domain we substantially increased size of our addressable market. But we also believe that we facilitated the very low risk content expansion driven growth strategy. We have invested not only in terms of the capabilities that we need through the acquisitions, but also in terms of the key supply chain issues and constraints that our customers see particularly in the RF and Microwave domain and so we feel and ask and enable your greater outsourcing in RF and Microwave as well as our ability to take shift.

Finally we will feel it the fact that we’ve acquired the technologies and capabilities and we’re doing the pre-integration of that technology and how the engineering organizations that in essence can do the outsource design and development. Is the key to improving the affordability of the subsystem solutions over the time.

So with that I would like to handed over to oh no -- we are going to do a brief 20 minute Bob. 15 minute coffee break so. Probably now we’ll have DDA pick the presentation. Thanks.

Unidentified Participant

Well assume the presentation I believe I have been asked to bring everybody. I think we are a little bit beyond now, but I think we will recover the time. We are good, okay.

Good morning everybody. Thank you, Mark. I think the room needs to wake up a little bit. There is more coffee if you want. Okay. Good. I think Mark and Todd did a good job. I am DDA CO present of metric commercial electronics called MCE. MCE is a commercial item business that are just business units for metrics. Today I will walk you through the market overview and then I will focus on providing an update on key programs which you should fuel our goal. We are focused on Information Surveillance Reconnaissance, ISR, radar and electronic market. As you will see I believe full aligned to what we will talk about sensor centric strategy, leveraging product and technology across program and plan.

As we talk about key trends which are changing the landscape in our two main markets radar and electronic warfare which should add positive effect to it. So electronic warfare and radar market are being shaped by the pacific pivot, electronic warfare threat sorry, electronic warfare threat range from regular warfare improvised explosive devices based on the Iraq, Afghanistan war to complex integrated defensive system with peer to peer country conflict and that’s less case anti access, area Denial drives complex stemming solution.

The goal is the control of electromagnetic spectrum degradation, disruption, or attack of the enemy senses which require platform upgrade with new electronic warfare capabilities. It's why you see flurries of new programs like [indiscernible] and it’s derivates affecting a electronic warfare upgrade. Similarly, the new threat is driving radar upgrades replacing mechanical antennas is complex active electronic scan array, AESA which provide beta capacities for A2/AD. AESA radar drives complex mode requiring processor and RF upgrades. In addition, the sophistication of AESA antenna makes it production more complex requiring needs for new environment radar simulator to import production efficiency and cost.

As you can see low strengths of our investment strategy and are providing new opportunities for Mercury. First let me talk about our market segmentation. Radar has been a esoteric and home market. Radar is still very strong presenting 39% of revenue in fiscal year 13. We have been enrolled now on the processing side but with a recent acquisition in NF and microwave we are opening new opportunities based on the session of that market and establish relationships with our customers.

Is the player of the synergies of the [indiscernible] we vote key customers. In addition, as Mark mentioned previously the ARS content is 3s to 5x higher than the processing one. We have a composition in airborne radar with F-16 and S-25 and S-22 program but we are also very firm in ballistic missile defense program with Patriot and AEGIS radar.

Our electronic warfare market share is going nicely based on the acquisition and our market focus. These markets represents 33% of Mercury revenue. It's our number one gross market for the future. We have been driving our strategy to align with you these priorities towards the pacific pivot as well as [Indiscernible].

we believe with our investment in RF and microwave through acquisition and with advanced micro sensors offering state of the art full-year automatic micro electronics manufacturing we are taking market share. The good example of that expansion is the CV program. We are also increasing opportunities with BAE our AMC being strategically positioned next to them. Our customers facing reduction are focusing on FMS and international sale. The DOD is doing the same, leveraging R&D funding from international sets as well.

Good example of Patriot for new radar digital processing, F-16 with the ASAR radar or F-15 with electronic warfare upgrade. We have been investing in extra enabled product to take advantage of that trend and open new opportunities for us. FMS and international sales now represent 22% of our revenue and growing.

As a result of our capabilities, and our market focus aligning to the market trends discussed earlier, we have been selected by major primes on the franchise format. Some example, looking AEGIS, return Patriot, [Indiscernible] F-16.

We have a long story of success on those key programs. We have been involved on more than 300 programs with most major times in decent. We’re cover radar at electronic warfare on UAR [Indiscernible]. We have a confident session based on processing capabilities making us the trusted advisor of strategic supply with major primes. This is opening now opportunities in the microwave market based on our new acquired capabilities.

I will begin to some of the programs in more details. Starting with the navy program, the well known AEGIS, the navy ballistic missile defense program. As you know AEGIS is a cornerstone of the overseas ballistic missile defense strategy with the focus on the Pacific. The AEGIS is critical for countering new ballistic missile threat on peer countries and FB countries. We provide a [Indiscernible] radar processing system to lock in. It's a franchise program from Mercury and AEGIS collided a highest bookings in FY13 with $30 million and more than $100 for the plant today.

Based on the missile defense [Indiscernible] and FMS opportunities we will extend to 20 ship still expected to be awarded in the following five to six years for total potential greater than $85 million to us.

[Indiscernible] base, which is also colliding potentially technology refresh opportunities as well for us. Magician looking market celebrated the official light of AEGIS system for last month. This system will be deployed in 2015. We also expect AEGIS show to come in the following year.

In summary AEGIS is a very strong revenue generator for Mercury and we have momentum for several years based on FMS.

The next program in production I like to talk about is the next generation radar processing system for the well know Patriot missile defense system an army program. The combat prevent patriot is the world's most advanced missile defense system, is the corner stone of air and missile defense architecture for 12 nations on the globe.

Right now, out of 80% of this upgrade instead of 20% in the [Indiscernible] this is a perfect example of the trend software we see more and more with all parts. $45 million booking to date, many from FMS, UAE, Taiwan and Saudi Arabia, many additional opportunities in the middle east according to rating. The short term opportunities from country Kuwait and Qatar and we expect [Indiscernible] career. We have got our first production order from the U.S. of this fiscal year as well. This order made Patriot our largest revenue in the fiscal year 2013.

Now the challenge with Patriot is the timing of order because most of the said item is based which are lengthy and notoriously difficult to predict. Last fiscal year for example we have got minimum booking but we expect a rebound this fiscal year based on the U.S. army next production order which is in the 2014 budget.

We believe a word to us will happen in [Indiscernible] of this career. After talking about navy program and an army major upon let’s talk about FS-1. We had a longstanding relationship with government in providing processing solutions for fighter radar F-16, F-22 and F-35 as well as the B1BF aircraft. The recently announced wing by Northrop Grumman for the F-16 radar upgrade of Taiwan and the USFO favor enable agile being radar is giving to Mercury a new franchise program.

The market size has been estimated by Northrop Grumman between 1000 to 2000 units we should drive between 50 million or 100 million opportunities to Mercury. Women adopted our new VPX project line. Our open VPX processing solution providing them a cost effective open architecture. The protective, long and major investment in software by providing them an easy path to prove their modern competitive participating solution. We expect to receive our first order this fiscal year from this program.

The next program is a very advanced UIR system. As you may be aware Mercury played an important part in the global program are all on the promise to provide the most image processing system carried by M29 paper. We just finished development and sale off the [Indiscernible] system to our customers. This work with [Indiscernible] under our quick section capabilities program and is a perfect example of Mercury's commercially developed technology can be implemented into the solution. The government program went from home test to flight test in 18 months and deliveries in 24 months.

So our deployable system of that complexity this is really, really fast and ahead of. This program generates in an excess of $28 million so far is revenue for Mercury. We expect additional unit to be awarded in fiscal year 2014. In addition to this unit, we are looking at additional development efforts and spare parts.

State of the art of an architecture allowing favorable upgrades to implement new capabilities whilst maintaining the primary mission, should these increments materialize we would then look into a total program value of another of 40 million to 50 million alongside this we are confident that this upgrade pass and the ability to leverage this processing capabilities to other program we provide an ongoing revenue stream for many years to come.

The next program called [Indiscernible] who selected those names, our former military defense system business unit with what about training of this. The Buzzer unit represents more of the older one on one safe protection system why the Buzzer jammer is designed to operate against more modern complex integrated defense.

This program was temporarily delayed last year due to the sequestration C, since then we are back on track and moving ahead. The navy just increase our existing IDIQ by $12 million. In addition, we got our first production order $4 million for Buzzer which is in final stage of development. We expect more orders to follow. For that program Mercury advanced design provided MDS defense system and state of the art capabilities to meet navy extreme requirements. A good example of synergy types at work. The acquisition of [Indiscernible] providing Mercury access to BA system, a major electronic warfare system. It also gives Mercury access to the assistant electronic warfare upgrade for FMS and the U.S. air force.

These electronic warfare solutions greatly improve the F-15 eco situation awareness, self protection, and electronic countermeasure capabilities. Boeing has awarded several FMS _ contracts by the U.S. air force for Saudi Arabia. This contract calls for production of 84 new F-15 aircraft and the modification of 70 existing ones. Last year, at the beginning of the fiscal year 2013, we got $11.7 contract which we are delivering as we speak. And we expect the new one in our second half of this fiscal year.

The new advanced microelectronic center AMC is extremely positively by BAE. They can even work through the plan they want if they want. There have been impressed by the capacity and the level of equipment in this AMC based on the previous joint investment. Other customers gave us similar feedback. These investments should clearly open addition of BA [Indiscernible].

Now let’s talk about SEWIP, the safest electronic warfare improvement program. A very exciting column as Mark pointed out which also demonstrate the success of our gross strategy by extending in the RF and microwave market aligning with the market trend driven by the increased needs of electronic warfare. SEWIP is an evolutionary development of block upgrade to the electronic warfare installed on the old U.S. F carriers, [Indiscernible].

The upgrades will improve , counter targeting and counter activities and is critical with new threat environment and the move to the Pacific pivot. We have been working with [Indiscernible] since the beginning of SEWIP We have helped them to win by our innovation in RF and microwave products.

We are in line in investment to the needs and [Indiscernible] success. Our success now is opening new opportunities to us. We expect to expand our content with the addition of the new capabilities in RF and microwave coming from micronetics we could roughly get 50% to 100% additional content by success. This program has been now moving to LA phase in spring 2013. We received a $30 million [Indiscernible] last year. We expect an additional structure for phase during this fiscal year and then the plan is moving to full production next fiscal year in 2015. We are in this home position to get additional content during phase II. We have already got some engineering services order to develop new micro module and there are more to come.

In addition, the need for new electronic warfare capabilities is a focus on the Pacific pivot is opening new to use derivatives on [Indiscernible] on the platform. This should drive new business for us as well.

SEWIP which is focusing [Indiscernible] together to win that contract. The competitive downfall is expected in spring 2014. Now we believe that [Indiscernible] very strong contender. If they win, Mercury is well positioned to price substantial content because of the addition of Micronetics capabilities.

Let me summarize the overall program of opportunities to us. In one year through acquisition of Micronetics and our investment in manufacturing capacity we increased of total potential value by up to $385 million. And the time to money is 12 to 24 months. We see we blocked to moving into production during our next fiscal year. In addition, some programs use derivatives of this technology that can move fast and what production level by fiscal year 2016.

Block 3 is expecting during our fiscal year 2014 this year with production in 2018 assuming the [Indiscernible] block three. The total potential opportunities for Mercury is between $590 million to $816 million with a very fast time to money. Fully funded program being aligned with the new threat on the pacific pivot.

In summary, despite the environment challenges in defense industry Mercury is well positioned driving toward in the coming year. Our focus on electronic warfare and radar is well aligned with DOD to Pacific pivots driving platform upgrade.

Sensor centric, AEGIS and Patriot are co-franchised and in production. SEWIP is in add way on same production in fiscal year 2015 next fiscal year we have expansion and derivative opportunities. This program should become our largest contract program with a short term to money. Our capabilities in RF and microwave with our new advance micronetics are driving new opportunities in CW and radar. We acquisition at those outsourcing partners of choice the bit of alternative. At the same time, Mercury is the only company that can provide capabilities covering the full sensor processing change. As you can see we are well positioned for both.

I would like to thank you for your time and let me produce now our Chief Financial Officer, Kevin Bisson.

Kevin M. Bisson

Thanks DDA and good morning everyone. I just want to remind you that we are coming down the home stretch of this agenda as after my remarks Mark will have a couple of closing comments and we will move to the Q&A. So turning to the financials.

I think it's very clear that back in Fiscal 2008 was beyond side of this new management team. That American team has shows the ability not only to turn the company around the world but also to grow the top line, well above industry averages. And more important bottom line is even more dramatic rate. So, let's look at the revenue in instance here. Now, over the five-year timeframe of fiscal 2008 and fiscal 2012, the company's overall revenue was 7% but with a focus on the defense side of the business by rearranging the business more to be coming up, the pure play defense electronics company, you can see that our defense revenues over that timeframe have run by a hundred million dollars or fifteen percent and a cap on annual growth rate basis that growth rate roughly six to seven times in the industry average over that timeframe and if you look at our bottom-line performance over that same timeframe, the improvements even more dramatic.

Now we use adjusted EBITDA as the profitability measured internally to evaluate not only our business units but the company in total.

Now whether you look at our adjusted EBITDA an absolute basis, on a relative basis, the performance is very impressive. At an actual basis are adjusted EBITDA, more than double from $23 million in fiscal 2008 to $49 million in fiscal 2012. And again over that same timeframe and under the relative basis are adjusted EBITDA as a percentage of revenue increase from 12% fiscal 2008 to 20% in fiscal 2012.

Now that 20% number fiscal 2012 is an important milestone because again back in fiscal 2008, with the new management team of Mercury, the team set an objective of achieving adjusted EBITDA of between seventeen and eighteen percent as noted on the far right-hand side of this chart. As you can see in fiscal 2011 and that's objective was adjusted EBITDA of 18% and in fiscal 2012 as I mentioned earlier, we exceeded that objective by achieving 20% adjusted EBITDA.

Now, let's turn to the balance sheet. In this slide, you look to the far right-hand side. We currently have $40 million in cash on the balance sheet and no debt. Clearly ample liquidity for the company. Now we supplement that liquidity with $200 million on capital and credit facility, as well as a $500 million universal shelf registration. Now if you look at the slide from left to right, essentially, what it is showing you is a sources and uses of cash for the company over the last two plus years and on the surface what it shows you is that our cash balances have come down for about $150 million to above $40 million but if you look under the coverage, effectively what we have done is, we have taken that available cash back in Fiscal 2011 and provided back in the business with two significant acquisition for core electronics acquisition in fiscal 2012 and Micronetics acquisition in fiscal 2013. If you take those two acquisitions out, the company has generated $20 million of cash flow from operations over the timeframe indicates the ability to generate lots of cash in the business.

Now talk about the financial performance of the company from fiscal 08 to fiscal 2012, which I think is undeniably very, very impressive. When we entered fiscal 2013, we experienced some significant industry headwind with the onset of sequestration and what we saw from a financial standpoint is that impacted our bookings and our revenues very, very significantly, relative to prior period. Now we met those industry headwinds quite size ably by reducing our cost structure by roughly $25 million on an annualized basis from two very, very significant structure.

In addition what we do is we decided to run the business differently than what we had done in the previous five year period. We focused more on forecasting the business more conservatively, focusing on building backlog and preserving and enhancing on liquidity at the expense of top line sales growth. Now what this did was, it allowed us to generate a significant amount of operating leverage in the business, once we were able to raise our revenue above the lows in the first half of the fiscal 13. And the second part really manifest that operating leverage really coming to fruition. The comparison of our second half of 2013 key financial measures versus the first half of the fiscal 13.

Now you can see that from bookings in a revenue perspective. Our bookings in the second half of fiscal 13, increased 12% versus the first half and our revenue increased 10%. Now recognize again, these numbers from a percentage increase are lower than the averages that we have had over previous five year period. But even with those increases in the top line basis, look at the impact from the bottom-line perspective. Our bottom line gap results improved by 90% on the second half versus the first half. Our adjusted EBITDA more than triple in second half of fiscal 13 versus the first half. And from the cash flow perspective, we went from consuming cash in the first half in fiscal 13, to generating a significant amount of cash in the second half.

Now our focus on building backlog, pay dividends as well. You can see in the far right hand side, we ended fiscal 2013 with record backlog of a $140 million that was up 34% from ending backlog of fiscal 2012. And the important point here is the, besides the record backlog it allowed us to enter fiscal 2014, in much stronger shape than we did entering fiscal 2013. And the industry environment in fiscal 14 isn't much different than what we thought in fiscal 13, so obviously with a much, much better position as we entered fiscal 14.

Now couple weeks ago, I am sure most of you know, we released our earnings for the first quarter, financial results for the first quarter fiscal 2014 and just to reiterate, we noted that our revenue of $54 million for the first quarter was at the top end of our guidance that we have provided earlier and our bottom line results from a GAAP perspective as well as from adjusted EBITDA perspective exceeded our guidance for the quarter. We also mentioned at the earnings call for on October 29, it gave guidance for our current quarter and second quarter of fiscal 2014. And that guidance calls the revenue between $48 million and $54 million and that's roughly in line with the revenue guidance that we have given over the last couple quarters. From a GAAP loss per share basis, we are looking at GAAP loss for share between $0.06 and $0.12 per share, that's slightly better than the guidance were given in prior quarter. Next mainly due to the fact that we are expecting gross margins to come in a little higher that we have seen in the last several quarters due to more favorable product mix. In addition our adjusted EBITDA, between $400,000 to $3.4 million of guidance for the quarter is a little higher than we've had in the prior quarters again, the better performance that we are expecting on gross margin.

Now this slide, it has a lot of numbers but really one main point. And that is over the last five years, we met or exceeded our top and bottom line guidance to investors for all the two quarters. We clearly take seriously the guidance we provide to investors and I think we have shown a strong track record of achieving that.

Now, it's just about a year ago, actually at this event, that we establish a new target business model company that's far right-hand side in this chart and calls were adjusted EBITDA between 18% and 22%, it was higher than our historic target that I mentioned earlier, 17% to 18%. So, why did we change our target business model, is really for two reasons. One, I mean the obvious one is the fact that, our historic target business model we met in fiscal 2011, and exceeded it in fiscal 2012 as this chart knows with the 20% adjustment EBITDA. I think the other reason why we updated our established to new target business models because when we originally established the historic target business model in fiscal 08, we have undertaken three acquisitions since then. And those are acquisitions in RF microwave and services base that have financial profile, that are different than our core business and I want to speak to that for a few seconds.

In terms of this chart, you can see that on the right side is the current target business model. On the left hand side is our fiscal 2012 numbers. Think of that as a proxy for our historic target business model. And you can see that the income statement profile, it's somewhat different. I think the major differences are from an operator expense standpoint, you can see that our current target business model has operating expenses of the percent revenue lower. Then our fiscal 12 numbers. And that's really for two reasons. Number one, it came with the acquisitions, that we undertaken over the last couple of years. The development efforts in our RF and microwave businesses are essentially funded by our customers. So, in essence you get the benefit of lower R&D in those businesses, but effectively it's moving those cost up into the gross margin line. And that's why we are also seeing our gross margin in the current target business model, I mean, lower than fiscal 2012 numbers.

The other main reason why our operative expenses are lower from the percentage of revenue basis versus fiscal 2012 is because with the acquisition, we are anticipating, leveraging our SG&A expenses over higher revenue base, as a result of those acquisition and again, generating deficiencies associated with that.

Now, I want to spend a few moments on this slide, I think it's very important as we conclude the financial remark. Now, as the title of this slide indicates, we are not only committed as a management team to achieving our target business model but also achieving it on a timely basis. And now we recognize that at our current financial run rate. We are not going to hit our target business model anytime soon. But we also recognize that while there are long-term top line growth prospects for this company are very bright when you look at the program, that was being discussed by the DDA and Mark in their presentation. We also recognize and understanding, the current DOD budgeting environment is very difficult.

Now we have been able to navigate in this environment quite well over the last four to five quarters, again the focus being on building backlog, managing liquidity and generating cash. But in order for us to accelerate our ability to achieve the target business model, we need to look at multiple drivers of and multiple levels to achieve in that profitability on the timely basis. And really what this means is that, we got to look at the couple things. Number one is, we got to assess realistic industry condition, as we look at forecast in the business going forward. And we have to combine that and supplement that, with a focus on cost optimization. And the focus on cost is important because the end of the day is really the only driver that we can control, in order for us to achieve our objective.

Now, the good news is, we have shown ability in the past to manage our cost production quite well. Go back to my earlier comment, a little over year ago, with the onset of sequestration we took out $25 million of cost. So we have shown that ability to manage that the cost structure quite well but really, our objective going forward is that we need to balance, the benefits of future cost production with preserving and enhancing intrinsic value of the company. And the focus of our cost production is going forward it's not going to change dramatically from what we have done in the past. We are going to continue to focus on integrating the acquisition that we have undertaken over the last three years looking for more and more ways to integrate those businesses within our core. In addition we are going to look at our SG&A expense and looked to leverage of that SG&A expenses over our business units. And what I mean by that is, really focusing on ways to centralize as much possible both selling and general administrative services that we are providing to our businesses. And then finally, we are going to target R&D investments in the areas where they return those investments that we are going to look real quick.

Now obviously this isn't going to be easy. It's going to require a lot of work but I think at the end of the day, we can say one thing and that is, again, this management team is focused on achieving this target business model. And I learn by, alluding to remark that I said early when I opened up my presentation.

Back in fiscal 2008, this management team established the target business model of 17% to 18% adjusted EBITDA. Now that objective in fiscal 2011 and to achieve that objective in fiscal 2012, we established a new target business model a year ago, 18 to 22% higher in the historic model. I can tell you today, this management team is committed to achieving that target. We are committed to achieving in on a timely basis and utilizing whatever means possible to that.

I will turn over to Mark for closing comments.

Mark Aslett

So, thanks. Thanks for also joining to those of you that are online. Probably we got a much better this, understanding is how it is that Mercury's positioned in a pretty challenging environment. You know, we fail that, we made the investment, both organically as well as from acquisition perspective. And today, we got state-of-the-art, differentiated product portfolio, is not only is going to allow new capabilities to our customers and hence the DOD, is we are moving towards the specific, as we are looking to modernize the existing platform as we as explore growth overseas. But we are also made key target investments, in ways, in which we feel will help us actually accelerate the return on some of the investments themselves by taking share as well as enabling more outsourcing on behalf of from our customers.

We also feel RF and microwave should be the fastest growing part of our business. I think it's a validation of the investments and the acquisition that we made in both M&A, as well as the AMC. And you can see that in particular given the growth we have seen in see with program literally since invest a day, just one year ago. So, we feel pretty good about our position in the industry, our opportunities for growth, given some of the programs and the fact these programs moving into production. As Kevin said, we are actually committed to achieving you know, the target business model we have laid out in the reasonable period of time, looking all obvious opportunity to do that. So, with that, we would like to close down the formal part of the presentation and then you know, we will open it up for your questions. So, thank you very much for listening.

Question-and-Answer Session

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