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Mercury Systems, Inc. (NASDAQ:MRCY)

F3Q 2014 Earnings Conference Call

April 29, 2014 05:00 PM ET

Executives

Kevin Bisson - SVP and CFO

Mark Aslett - President and CEO

Analysts

Tyler Hojo - Sidoti & Company

Howard Rubel - Jefferies & Company

Peter Arment - Sterne, Agee

Jonathan Ho - William Blair

Mark Jordan - Noble Financial

Michael Ciarmoli - KeyBanc Capital Markets

Operator

Good day, everyone and welcome to the Mercury Systems’ Third Quarter Fiscal 2014 Earnings Conference Call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the company’s Senior Vice President and Chief Financial Officer, Kevin Bisson. Please go ahead, sir.

Kevin Bisson

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

We would like to remind you that remarks that we make during this call about future expectations, trends and plans for the company and its business constitute forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. You can identify these statements by the use of the words may, will, could, should, would, plans, expects, anticipates, continue, estimate, project, intend, likely, forecast, probable, potential and similar expressions.

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

These risks and uncertainties also include such additional risk factors as are discussed in the company’s filings with the U.S. Securities and Exchange Commission, including its Annual Report on Form 10-K for the fiscal year ended June 30, 2013. The company cautions readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. The company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made.

I would also like to mention that in addition to reporting financial results in accordance with generally accepted accounting principles, or GAAP, during our call, we will discuss several non-GAAP financial measures, specifically adjusted EBITDA and free cash flow. Adjusted EBITDA excludes interest income and expense, income taxes, depreciation, amortization of acquired intangible assets, restructuring expense, impairment of long-lived assets, acquisition costs and other related expenses, fair value adjustments from purchase accounting and stock-based compensation costs.

Free cash flow excludes capital expenditures from cash flows from operating activities. Reconciliation of adjusted EBITDA to GAAP net income and free cash flow to GAAP cash flows from operations are included in the press release we issued this afternoon.

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

Mark Aslett

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

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

Adjusted EBITDA was 14% of revenue up 52% sequentially and up 47% year-over-year and well above the high end of our guidance. Cash flow from operations also exceeded our forecast for the quarter. Total revenues in our defense business was $51.1 million essentially flat with Q2 and up 1.7 million or 3% from the third quarter last year. International defense revenues for the third quarter including FMS were 18% of total defense revenue, compared with 17% in Q2.

From a program perspective Aegis, Gorgon Stare and Predator/Reaper were major revenue contributors this quarter ours was a classified airborne radar program. Radar revenue grew 28% from Q3 last year and is up 45% year-to-date compared with the same period in fiscal ’13. Radar is the largest source of revenue in our Mercury Commercial Electronic segment so MCE is continuing to rebound strongly after a difficult fiscal ’13. Our low industry conditions remain challenging our major highlight this quarter was bookings which totaled $76.1 million up 51% sequentially and 57% year-over-year. Total defense bookings increased 56% sequentially to a company record $74.6 million. Our book-to-bill is 1.4 compared with an 0.9 in Q3 last year. Our book-to-bill in defense improved to 1.5 from 0.9 in the sequential second quarter and 0.9 a year ago. Defense backlog and total backlog exiting Q3 were up on a sequential basis 22% and 16% respectively. There were four large programs this quarter from a bookings perspective. We received the order for the first brand of Seaward block 2 over phase 2 with Lockheed Martin. We received the large booking associated with certain technologies on JSF with Raytheon and we continue to see strong bookings on Aegis with Lockheed Martin. In addition, we received a follow on production order for Gorgon Stare Increment 2, which is in theater and will be extremely well.

International defense bookings including FMS were 11% of total defense bookings compared with 48% in the sequential second quarter. We’re pleased by the recent positive developments in Washington. Most notably the Ryan-Murray budget agreement the FY Defense Appropriations Bill, and the Administrations FY15 Budget. However, the overall environment remains challenging. During the third quarter, we continue to make rapid progress on the second phase of our acquisition integration plan. As we reported, when we announced our Q2 financial results in January, we expect that phase 2 will result in gross annualized expense reductions of $16 million when fully implemented. The actions we took prior to our call last quarter we’re expected to achieve about $10 million of these projected savings. We expect the actions completed since then that is through the end of Q3 will increase the cumulative annualized savings to nearly 12 million or approximately 70% of the total.

According to our original plan, completing phase 2 was expected to take about 18 months however as a result of careful planning and great execution by the team we now expect to take about 12 months meaning by the end of this calendar year. The first of our phase 2 priorities is to take full advantage of the investments we’ve made positioning Mercury as a world class player in the RF and microwave industry. These investments focus on creating our advanced microelectronic centers in New Jersey and New Hampshire and consolidating several of our existing non-core facilities in the New Hampshire AMC. The three months since our 2Q call are being extremely busy from an operations perspective and the team has achieved a lot. We moved the local Micronetics components and subsystems businesses to the New Hampshire AMC as well as Micronetics operation that was previously based in Monroe, Connecticut. All this was accomplished seamlessly and with minimal disruption to our customers. By the end of the fourth quarter we will have consolidated another small Micronetics facility in the Hudson AMC while also implementing the first phase of our headquarters facilities consolidation. Upon completion of our facilities’ consolidation plan which we anticipate happening in fiscal ’15 we will have significantly reduced our manufacturing footprint. We expect this will not only further decrease our expense base but also facilitate our efforts to drive advanced microelectronic solutions into the marketplace.

Since our Q2 call, we’ve also made substantial progress on the system side of the integration which is the second priority in our phase 2 plan. Our goal is to create a common set of core business processes and IT systems following our three recent acquisitions. Over the past three months, we successfully launched an integrated program management system in our MCE service and systems integration business which will also be implemented by our Mercury Defense Systems business unit. At the same time, we transitioned our RF subsystems operations at both AMCs to Mercury’s existing ERP and the new MRP system while also implementing a common payroll and banking platform companywide. Ultimately, our goal is to have common processes and systems that’s finally [Indiscernible]. These initiatives will enable us to realize time and resource savings which should improve gross margins, low G&A expense and drive greater efficiency across the organization. This should also make Mercury an easier company to do business with.

As we stated before our goal is to achieve our target business model for fiscal 2015 assuming approximately 10% annual revenue next year the normal program mix and reduced operating expenses from phase 2 integration activities. Our expected growth in FY15 will primarily be driven by existing SEWIP Block 2 business and associated content expansion opportunities, Patriot upgrades with both FMS and domestically, F-35 and Filthy Buzzard as well as continued strength on Aegis. Our strong bookings performance delivered in Q3 and another strong bookings performance expected in Q4 position us well as we head into next fiscal year.

In terms of our forecasted results for FY14, revenue guidance is $215 million to $219 million. On the bottom line we substantially raising our EPS and adjusted EBITDA guidance for fiscal 2014 based on strong performance in the business in fiscal Q3.

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

The Pacific pivot should also into growth opportunities relate to EW and ECM sub-systems particularly in NDS. The second growth drivers platform modernization. Electronic upgrades aging military platforms for the most cost effective way providing the new war fighting capabilities we need in this tight budget environment. This is the heart of what we do. It creates the potential for us to expand beyond our traditional embedded processing products and before provider of advanced RF and microwave sensor processing sub-systems.

This is a low risk opportunity to sell more content to existing customers on new as well as existing programs and platforms.

Our third growth driver relates to exportability; all customers are pursuing FMS as international sales opportunity. Selling international fuels the growth, improves margins and opens the door to having foreign customers. On some of the NRE expense, the DoD is now less willing to pay for. Our opportunity here provides specialized processing sub-systems as well as digital RF and microwave parts and sub-systems that can be exported.

And finally outsourcing by the large primes remains alive and well, as they seek more affordable, advance processing capabilities. We’ve clearly positioned Mercury as a trusted outsourcing partner to the primes. On a more company specific level these growth driver translate into near-term priorities that will form the basis of our plans for fiscal 2015. One priority is to grow our integrated digital RF and microwave substance and sales to the prime. This leverages our recent acquisitions and AMC investment which have been very well received by our customers.

We have invested a great deal in building a better alternative for the challenges the industry is facing. The design and manufacturing capabilities we have created in our AMCs are clearly resonating with our customers and showing great promise. We had more than 19 customer visits since we opened the new Hudson facility, and I couldn’t be more pleased with the feedback. We’re clearly being viewed as a better alternative than many of our customer’s existing suppliers.

Just last week I signed an MOU with one of our customer that could double and RF and microwave business on an existing program. We continue to believe that RF and microwaves as it relates to next generation and EW and radar sub-systems will likely become the fastest growing part of our business.

Another priority is to drive electronic warfare sub-systems sales in our NDS business to a broader industry customer base.

Finally our priority relates to the fact that we have invested significantly in refreshing our embedded sensor processing portfolio during the good times. Now we’re positioned reap the benefits by capturing additional new opportunities in specialized server class computing beyond the sensor.

These are computing applications that historically we haven’t played in, we can now expand our presence on existing programs and platforms with unique and differentiated technology. Our opportunity stands with the fact that the industry is moving away from commodity commercial computing as more and more of its design and production have moved offshore. This positions Mercury as the leading U.S. owned domestic designer, developer and producer a specialize embedded server class processing to defend intelligent applications.

This comes at a time when the prominence and integrity of these technologies are increasing. Overall we feel good about our prospects with bookings and revenue growth. In the near-term if we can continue to deliver this growth while completing the second and final phase of our integration plan. We should benefit from the substantial operating leverage that we’re building in our business. This leverage should further strengthen Mercury’s position to deliver significantly improved profitability, cash flow generation and shareholder values going forward.

With I would like to turn the call over to Kevin. Kevin.

Kevin Bisson

Thank you Mark and good afternoon again everyone. Turning to our financial results, revenue for the third quarter of fiscal 2014 of $55.5 million was $1.4 million higher than revenue of $54.1 million in the third quarter last year and was at the upper end of our stated guidance of $50 million to $56 million. The company generated a GAAP net loss of $0.02 per share in this year’s third quarter compared to GAAP EPS of $0.03 per share in the third quarter of fiscal 2013. This quarter’s loss per share was significantly more favorable than the company’s financial guidance of a net loss of $0.09 to $0.15 per share a quarter. Fiscal 2014’s third quarter financial results included restructuring charges related to the company’s acquisition integration plan announced in January while last year’s third quarter was also benefited from the retroactive reinstatement of the federal R&D tax credit. Excluding the impact of both of these items the company generated EPS of $0.05 per share in this year’s third quarter compared to a net loss of $0.02 per share in the third quarter of last year.

Adjusted EBITDA for the third quarter of fiscal 2014 of $7.7 million was $2.5 million or 47% higher than adjusted EBITDA of $5.2 million for the third quarter of last year and substantially exceeded our stated guidance of $1 million to $4.1 million. The company generated free cash flow of $1.1 million in this year’s third quarter and ended the third quarter with $45.7 million of cash and cash equivalents and with no debt. Reviewing third quarter financial performance in more detail beginning with bookings; total bookings were $76.1 million which were $27.5 million or 57% higher than total bookings of $48.6 million for the third quarter of last year. Third quarter bookings performance was the second highest quarterly bookings total in the company’s history and the highest in more than 10 years.

Defense bookings for the third quarter of $74.6 million were $30.8 million or 70% higher than defense bookings of $42.8 million for the third quarter of last year and setting all time record for the company. The substantial increase in bookings in this year’s third quarter compared to last year stemmed from higher Seaward F-35 and Gorgon Stare program bookings. Combined these programs totaled more than $30 million in bookings for the quarter. From a revenue standpoint, total revenue for our largest operating segment Mercury Commercial Electronics or MCE was $47.6 million which was $3.6 million or 8% higher than the $44 million of MCE revenue generated in the third quarter of last year. The increasing revenue between years came from higher UAV program revenue and from a classified airborne program that were partially offset by lower Seaward program revenue.

Revenue from the company’s Mercury Defense and Intelligence Systems or MDIS operating segment was $11 million which was $2 million lower than the $13 million of MDIS revenue for the third quarter of last year, the year-over-year decrease in MDIS revenue was attributed principally to lower [indiscernible] related program revenue and lower MIF services revenue that were partially offset by higher Gorgon Stare program revenue. It should be noted that operating segment revenue for the third quarter of fiscal 2014 does not include adjustments to eliminate $3.1 million of intercompany revenue. Total company defense revenue including MCE and MDIS for the third quarter $51.1 million was $1.7 million higher than the $49.4 million of defense revenue in the third quarter of fiscal 2013. As mentioned previously the increase in defense revenue between years stemmed from higher UAV program revenue and revenue from a classified airborne program that were partially offset by lower MDIS revenue.

Defense revenue comprise 92% of total company revenue in the third quarter of fiscal 2014 which was comparable to last year’s third quarter. Of the total defense revenue in the third quarter of this year $9.4 million or 18% came from international customers compared to $8.1 million or 16% in the third quarter of last year. Revenue from international customers includes foreign military sales to our prime customers as well as direct sales to non-U.S. base customers. The key programs driving international revenue in this year’s third quarter were the Aegis and F-15 Electronic Warfare programs as well as direct sales to a customer in the Asia Pacific region. Commercial revenue for this year’s third quarter of $4.4 million was slightly lower than the $4.7 million generated in last year’s third quarter. The year-over-year decrease in commercial revenue resulted from lower RF component related revenue.

Mercury’s total book-to-bill ratio for the third quarter of fiscal 2014 was 1.4, which was substantially higher than the 0.9 book-to-bill ratio in the third quarter of fiscal 2013. Defense book-to-bill of 1.5 for this year’s third quarter was similarly well ahead of the 0.9 book-to-bill ratio recorded in the third quarter of last year. It should be noted that for the first nine months of fiscal 2014 both total company and defense related book-to-bill ratios were at 1.1. The company ended the third quarter of fiscal 2014 with a record backlog of $151.1 million which was 23.4 million or 18% higher than the $127.7 million total backlog at the end of the third quarter of last year. Of the total ending backlog for the third quarter 116 million or 77% is anticipated to be shipped within the next 12 months, $137.2 million of the ending third quarter total backlog related to defense which was 28.5 million or 26% higher than defense backlog at the end of the third quarter of fiscal 2013.

From a bottom line perspective the company incurred a GAAP net loss of $600,000 or $0.02 per share in this year’s third quarter compared to GAAP earnings of $800,000 or $0.03 per share in last year’s third quarter. As noted earlier financial results for the third quarter of last year benefited by approximately 1.4 million or $0.05 per share from the reinstatement of the federal research and development tax credit that was retroactive to January 2012. In addition this year’s third quarter included restructuring charges that when tax effected contributed $2.2 million or $0.07 per share to this year’s third quarter reported loss. Excluding the impact of these items the company generated earnings of $1.6 million or $0.05 per share in the third quarter of fiscal 2014 compared to a loss of 600,000 or $0.02 per share in last year’s third quarter.

The sizable improvement in operating performance for the company in the third quarter of this year compared to last year was due to a 3 point improvement in gross margin. This continues to trend from the sequential second quarter of a recovery in the company’s higher margin digital signal processing business in fiscal 2014 compared to fiscal 2013. In addition, favorable operating performance for the third quarter compared to the prior year was attributable to operating expense savings excluding restructuring charges from the company’s acquisition integration plan announced in January.

Adjusted EBITDA of $7.7 million or 14% of revenue for the third quarter of fiscal 2014 was $2.5 million or 47% higher than the $5.2 million of adjusted EBITDA for the third quarter of last year due primarily to the improved operating performance of the business between years. Relative to our stated financial guidance for the third quarter we are pleased to report that the company was at or above the high end of its guidance in fall key financial measures. Third quarter revenue of $55.5 million was at the end of our guidance of revenue between $50 million and $56 million. Gross margin of 45% in the third quarter was 5 point to 7 point higher than our stated guidance as previously unforecasted and higher margin digital signal processing program revenue replaced comparably lower margin RF and microwave program revenue that moved to the fourth quarter. Reported GAAP loss per share of $0.02 for the third quarter was significantly favorable to our guidance of a net loss between $0.09 and $0.15 per share. And finally adjusted EBITDA of $7.7 million for the third quarter was well above the company’s guidance of 1 million to 4.1 million for the quarter.

Turning now to the balance sheet, company ended the third quarter of fiscal 2014 with cash and cash equivalents of $45.7 million and no debt which was $1.2 million higher than the $44.5 million of cash and cash equivalents at the end of the sequential second quarter. The company generated $1.1 million of free cash flow for the third quarter as $2.2 million of operating cash flow driven by the quarter’s cash earnings was partially offset by $1.1 million of capital expenditures. I want to spend the next few minutes updating you on the financial progress of our acquisition integration plan that the company announced as part of its second quarter earnings release approximately 90 days ago. As Mark noted earlier based on the rapid progress of the integration plan to-date and the company’s ability to accelerate fiscal 2015’s planned actions to earlier in the fiscal year we now expect the integration plan to be complete by January of 2015 of full six months sooner than anticipated.

As noted in January the company continues to estimate gross annualized expense savings of $16 million upon the completion of the integration plan. During the third quarter, the company completed actions that generated nearly 10 million of the plan to 16 million of gross annualized savings indicating the front end loaded nature of this plan. Third quarter actions included the elimination of 61 positions primarily in SG&A and manufacturing as well as the closure of our Monroe, Connecticut facility. With the planned fourth quarter actions outlined earlier by Mark the company estimates achieving nearly $12 million or 70% of the planned $16 million of annualized savings by the end of fiscal 2014 with the bulk of these savings coming from SG&A and manufacturing functions. Total restructuring charges for the fourth quarter of fiscal 2014 are expected to be $2 million.

For fiscal 2015 the additional planned integration actions are forecasted to achieve the remaining $4 million of annualized savings by January 2015. Again a full six month earlier than expected, the earlier completion date tends from the company’s overall acceleration of its planned facility consolidation as compared to the original integration plan.

As a result the company anticipates incurring $3.3 million of restructuring charges in fiscal 2015, which is $900,000 lower than the $4.2 million estimate provided at the last quarter’s earnings call.

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

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

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

Based on the financial guidance provided for all of fiscal 2014 we are forecasting fourth quarter total revenue to be in a range of $52 million to $56 million. The estimated revenue range for the quarter assumes strength from the Aegis Gorgon Stare and several airborne EW programs. Consistent with prior quarters we expect the split in fourth quarter revenue to be approximately 90% defense and 10% commercial.

Within our stated revenue guidance we are forecasting gross margin of between 41% and 43% for the fourth quarter which is below the 45% gross margin generated in this year’s third quarter. As described earlier lower gross margin is primarily due to product mix as the third quarter included greater proportion of higher margin digital signal processing revenue that have not been expected.

The fourth quarter is currently anticipated to include a greater proportion of RF and microwave revenue that carry comparably lower gross margins. Operating expenses inclusive of $2 million of estimated restructuring charges are forecasted to be $27 million for the fourth quarter which is in line with the third quarter expense levels. From a bottom line standpoint we anticipate a recorded GAAP loss per share in the range of $0.04 to $0.10 per share for the fourth quarter. Based on an estimated weighted average share count of 31 million shares.

Excluding restructuring charges the range is estimated to be between breakeven and loss of $0.06 per share. The loss per share forecast assumes an income tax benefit of approximately 38%, consistent with the third quarter loss per share range forecasted for the fourth quarter also includes an approximate $0.04 per share impact from the amortization of intangible assets. Adjusted EBITDA for the fourth quarter is estimated to be between $2.4 million and $5.4 million. We anticipated fiscal 2014 with cash and cash equivalent between $47 million and $48 million.

Operating cash flow from cash earnings and lower receivables related working capital are expected to be partially offset by capital expenditures. Fourth quarter capital expenditures are likely to be slightly higher than third quarter tie principally for the company’s acquisition integration efforts.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Tyler Hojo of Sidoti & Company. Your line is open.

Tyler Hojo - Sidoti & Company

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

Mark Aslett

Sure, basically one thing Tyler is although we actually received the bookings for the first increment of Block 2 LRIP phase 2 the actual revenue associated with that is now in the first half of our fiscal ’15. So it’s basically one moving part.

Tyler Hojo - Sidoti & Company

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

Mark Aslett

Sure. Yes, we do kind of expect another strong bookings quarter as I say it’s in my prepared remarks. The major drive of bookings that we anticipate right now is in relation to Patriot. So, I don’t know where you have the opportunity of listening to Raytheon’s call but there is certainly a lot more activity going on in Patriot both FMS and as we’ve talked about in the past probably the largest opportunity that we see is with the U.S. Army and we’re expecting some of that in the fourth quarter. So Patriot by far is the largest in bookings that we’re pursuing in Q4.

Tyler Hojo - Sidoti & Company

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

Mark Aslett

Sure. I think from an M&A perspective I think the strategy is somewhat set I think played out cost and services are becoming end to end provider of advanced and processing subsystems and most of our position is as you know been in the RF and microwave domain and our strategy is playing it very well. There are certainly some technologies that we could add to that although I think we’ve got a great breakfast capability not just from a technology perspective but also from a manufacturing perspective which is absolutely critical because it’s really the ability to be able to manufacturing volume that is probably one of our customers’ biggest concerns and I think we’ve addressed that and we’ve certainly I think becoming a better alternative for our customers versus their alternative suppliers.

The other way of viewing I think the opportunity from an M&A perspective is really one of scaling the platform that we’ve created. So the reason that we’re very focused on basically the integration plans that I think we’re executing against extremely well is to integrate the office that we have but from an IT and from a process perspective but also to consolidate the facilities into the two AMCs that we’ve created. So what that affords us from an opportunity perspective is that we could potentially go and acquire additional RF and microwave companies and integration those into the platform that we’ve created meaning that those any potential future acquisition not domain should be highly accretive from an EBITDA perspective. So that’s kind of the way which we’re thinking about it.

Operator

Thank you. Our next question comes from the line of Howard Rubel of Jefferies. Your line is open.

Howard Rubel - Jefferies & Company

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

Mark Aslett

No, I don’t think we’ve changed our focus Howard I think the opportunity is both of the things that you mentioned the outsourcing is alive and well that MOU that I mentioned that we signed last week I think is a good example of work that is previously being done in house been outsourced to a company like Mercury this invested significantly in terms of its RF and microwave development but probably more importantly the production capability. Seaward is a great example of us been able to take share again in the RF and microwave industry both from the high end of the industry where our customers are viewing existing supply as maybe being less flexible than a kind of a mid tier player like Mercury or on the lower end where you’ve got companies that can really develop the technology but they represent a huge risk this programs transitioning to production. So I think we’ve got opportunities in both outsourcing as well as taking share and that’s what we’re focused on Howard.

Howard Rubel - Jefferies & Company

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

Mark Aslett

Yes. So I think if you look at as we described in our Investor Day there were three opportunities major opportunities for us to expand our content on the Seaward program and basically we just delivered the first engineering prototypes to our customer Lockheed associated with the first one and so we should start to see some opportunities from a revenue perspective in Seaward block 2 as we move into fiscal ’15. The second opportunity is again we’ll deliver the engineering prototypes of that product probably this quarter both of those were actually taking business away from a position of a pretty large company that was really failing to deliver and I think we’ve done that both from a technology as well as from a economic perspective. And then the third one we basically graph share from a small company who although they were great at developing the prototype just hadn’t really got the way with all to basically scale into production is Seaward block 2 moves into that full rate production phase next year. So there is couple of great examples I think the three examples that I stated are well over 150 million in terms of potential so we feel pretty good about our ability to take share in RF and microwave.

Howard Rubel - Jefferies & Company

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

Mark Aslett

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

Howard Rubel - Jefferies & Company

No I think your answer to the first one is very well I appreciate them. Thank you.

Operator

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

Peter Arment - Sterne, Agee

Good afternoon. Mark question on when do you expect Seaward block 3 how that competition to move forward and how are you viewing that?

Mark Aslett

So Seaward block 3 we believe that the ward is likely going to be made late summer early fall it does look like it’s moved out probably three months. Beyond Seward block 3 we think probably the award for the derivative at Seaward block 2 which is to the smaller platforms could also be made over the summer months. And then I think finally as we talked about before Seaward block 2 itself and it does move into full rate production next year and then beyond the opportunity that we have providing our existing content we’ve also got the opportunity to the content expansion that I just described and is a part of Howard’s question. So Seaward next year becomes a really important program for us.

Peter Arment - Sterne, Agee

So Mark when you look at that program and how your bookings are trending particularly I guess I see now the strong bookings quarter this quarter and the fourth quarter it seems to imply may be I am still in for clarifications your comments are that fiscal ’15 looks like 10% revenue growth looks pretty achievable, are we interpreting that correct?

Mark Aslett

Yes, certainly our goal for next fiscal year and I think if you look at we had a record bookings performance in Q3 driven by Gorgon Stares, Seaward, F-15 and Aegis and we also got some Patriot bookings also which as you know is being relatively lied over the five-12 months but that’s clearly is trying to pickup we do anticipate another strong bookings quarter in Q4 which in essence positions us extremely well as we head into next year and we really got three major program that I think are going to be important for us in fiscal ’15. Clearly Seaward is one, Aegis is another, and Patriot is really the third, and we’ve got a list of about 10 but those are three big movers.

Peter Arment - Sterne, Agee

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

Mark Aslett

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

Operator

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

Jonathan Ho - William Blair

Can you talk a little bit about some of the challenges that you’re seeing out in the defense environment I think you’ve sided that a couple of times but just wanted to hear from you what maybe is a little bit more difficult out there?

Mark Aslett

Sure. I think overall I mean we’re certainly pleased with some of the recent developments in particular we’ve got a FY Defense Appropriations Bill I think the Ryan Murray by far budget add basically traded sequester of budget cuts that at least took the sequester off the table for ’14 and ’15. And finally the president submitted his budget request. So I think they’re all positive the charges I think still relate to just the timing that’s in order and funding flows and it’s still moving pretty slowly and I think the recent SEWIP Block 2 LRIP Phase 2 was a good example of that, although we got the booking the revenues -- certain revenue associated with that program basically move that to fiscal ’14 into the first half of our fiscal ’15.

We’re very pleased with the bookings performance, but it’s still challenging Jonathon.

Jonathan Ho - William Blair

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

Mark Aslett

So as we said before we basically laid out a plan that was 18 months is now 12 months. A lot of the activities relate around facilities consolidation plan that will again relate to the new AMC that we have in Hudson and New Hampshire. So to date we basically moved in the former Micronetics components business and the subsystems business that will local in the New Hampshire region. We also closed one of the smaller Micronetics facilities that was based in Monroe, Connecticut. And we got a number of other facilities consolidation activities that’s going to take place. So it basically boils down to how quickly can we move those facilities into the New Hampshire AMC and get the systems and the businesses back up and running and not consolidate facility.

So I think the reason that we were able to pull things in, is that we’re actually executing extremely well. And we feel pretty confident as a result of the activities to date that we can basically bring forward the last remaining facility into the Hudson AMC kind of in the late calendar year building next calendar year.

Operator

Thank you. Our next question comes from line of Mark Jordan from Noble Financial. Your line is open.

Mark Jordan - Noble Financial

Question relative the pricing environment that you see moving forward. Obviously you have been able to document the 16 million of cost reductions. Do you believe that you’ll be able to regain all of those benefits all of that 16 million will drop to the bottom line or do you think as you move to say gain share and grow the business that you will have to be more aggressive on pricing and net-net in fact some percentage of those cost efficiencies.

Mark Aslett

I mean we don’t see the pricing pressure to say, I mean I think we said though, I think we do offer our customers a better alternative particularly in the RF and the microwave domain. One as we talked about the third leg of our acquisition integration plan is to actually invest more of our own internal research and development funding, as oppose to basically asking for funding for our customers. That’s certainly helping proving the affordability and it’s one of the reasons that why we’re actually beginning to pick up more work and displace the competition. So I think that’s kind of what we see right now Mark.

Mark Jordan - Noble Financial

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

Kevin Bisson

Mark this is Kevin. I think we’ve said publically that a target business model was to achieve gross margins between 45% and 50% for the company in total. They’ll get pretty close to that this year, I think in my prepared remarks I indicated that fiscal ’14 we expect total gross margins to be about 44% for the year. So we’re getting close to well under that range. And I think what the cost reduction actions that Mark talked about earlier in combination with the fact that our digital signal processing business core business of the company continues to recover.

I think we feel pretty confident; we’re going to get there fairly quickly in the near-term in terms of the 45% to 50% target.

Mark Aslett

If you look at through the first three quarters of fiscal ’14 Mark and our gross margin is 49% versus 43.4% last year. So I think it kind of comes back to that recovery in the core part of the business that continues.

Operator

(Operator Instructions). Our next question comes from the line of Michael Ciarmoli from KeyBanc Capital Markets. Your line is open.

Michael Ciarmoli - KeyBanc Capital Markets

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

Mark Aslett

So that seems to have stabilized Mike I think if you look through the year we expect that other business to basically be up year-over-year.

Michael Ciarmoli - KeyBanc Capital Markets

That’s helpful. And then maybe can you talk about the question you talked a little bit around digital signal processing recovering. What is specifically driving that and how are you guys looking at that product category on a longer term view?

Mark Aslett

Sure, so I think in the short term it’s basically specific programs that are now producing that we didn’t produce during our fiscal ’13. So we’re clearly seeing from UAV related programs kick in, that’s driving higher processing. We mentioned F-35 that’s a pretty significant bump during fiscal ’14 compared with fiscal ’13. I think longer term and if you look at the opportunities on Mercury and tried to describe it in my prepared remarks. Is that we see substantial change occurring in the marketplace.

And is basically around the needs to provide not only higher performance but also specialist capabilities within the processing domain that other companies don’t necessarily have. We see the opportunity basically taking up processing and actually to complete upgrade associated with the sensor itself. But what we also see is now the potential of taking up capability and absolutely moving to other parts of the platform architect from the processing perspective where we haven’t played historically.

The good example of which would be mission computing, also combat systems and we’ve got a number of different activities underway right now, this basically would allow us to expand all existing programs the existing platforms. And these could be quite meaningful in terms of the size the potential deals. So it’s really leveraging the investments that we’ve made in terms of our processing product portfolio but expanding into new market areas.

Michael Ciarmoli - KeyBanc Capital Markets

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

Mark Aslett

I think missile defense is clearly an area where there is going to be significant investment around the world, I think Raytheon talked about it a lot, there is 12 countries but they are currently using the Patriot system, and as a result of the new technology that was introduced as a result of the UAE upgrade which we’re a big part, it’s basically providing significant opportunities for upgrade to existing customers. As well as the potential for expansion beyond those 12. And so we know that the two that Raytheon are focused on both Qatar (ph) as well as Poland and I think we also mentioned Korea.

There is definitely some short term opportunities related to foreign military sales with Patriot. Probably the largest opportunity that we see is the U.S army upgrade which could begin in earnest in Q4. Beyond that I think there is also opportunities for the Aegis system. We’re clearly involved in the domestic reduction and the upgrade of the domestic fleet and so that’s already in production for us. But we’ll also see that some of our foreign eyes are looking to gain access to the Aegis system as well.

And we’re already doing both engineering work and expect production associated with some foreign countries as well.

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

Michael Ciarmoli - KeyBanc Capital Markets

Perfect, sounds good, thanks for taking the question.

Operator

It appears there are no further questions. Therefore I’d like to turn the call back over to you for closing remarks.

Mark Aslett

Well thank you all very much for listening. We look forward to seeing to you again next quarter. Take care.

Operator

Ladies and gentleman thank you for participating on today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.

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