Good day and welcome, everyone, to the Mercury Computer Systems Incorporated third-quarter fiscal 2008 earnings results conference call. (Operator Instructions). At this time, for opening remarks and introductions, I would like to turn the call over to the Manager of Financial Planning and Analysis, Ms. Leslie Schaeffer. Please go ahead, Ms. Schaeffer.

Good afternoon. And thank you for joining us. With me today are our President and Chief Executive Officer, Mark Aslett, and our Senior Vice President and Chief Financial Officer, Bob Hult. If you have not received a copy of the earnings release, you can find it on our website, www.mc.com. We would like to remind you that remarks that we may make during this call about future expectations, trends and plans for the company and its business constitute forward-looking statements, which involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Additional information regarding forward-looking statements and risk factors is included in the press release we issued this afternoon reporting the Company's third-quarter fiscal year 2008 results and in the Company's periodic reports filed with the SEC. We caution listeners of today's conference call not to place undue reliance upon any forward-looking statements, which speak only as the date of this call. We undertake no obligation to update any forward-looking statements. In addition to reporting financial results in accordance with generally accepted accounting principles, or GAAP, we will also be discussing non-GAAP financial measures adjusted to exclude certain charges, which we will specifically identify. Management believes these non-GAAP financial measures assist in providing a more complete understanding of the Company's underlying operational results and trends, and management uses these measures, along with their corresponding GAAP financial measures, to manage the Company's business, to evaluate its performance compared to prior periods in the marketplace, and to establish operational goals. However, they are not meant to be considered in isolation or as a substitute for financial information provided in accordance with GAAP. A reconciliation of GAAP to non-GAAP financial results discussed in today's conference call is contained in the Company's third-quarter fiscal year 2008 earnings release. I am now pleased to turn the call over to Mercury's CEO, Mark Aslett.

Thanks, Leslie. Good afternoon, everyone. Thank you for joining us on today's call and for your continued interest in Mercury. I will begin with an update on the business, and then Bob will review the financials and our guidance for the fourth quarter. At that point, we will open it up for your questions. Q3 was a good quarter for Mercury. We executed on the strategic plan I outlined for you last quarter, improved our underlying operations and delivered financial results at or above the top end of our guidance range. These results, again, were largely driven by our Advanced Computing Solutions business, which, as we expected, continued to perform well. Total revenue increased by $3.9 million sequentially or 7% to $56.5 million. ACS revenue represented 89% of Mercury's total revenue in the quarter. Our book-to-bill improved to a positive 1.15 this quarter from 1.1 in Q2. Gross margins remained strong for the quarter at 59%, and operating expenses were close to forecast. As a result, non-GAAP EPS exceeded our guidance at $0.04 a share. Operating cash flow was a solid $9.6 million for the quarter, and free cash flow was also strong at $8.3 million, the highest since the first quarter of fiscal '06. On our conference call last quarter, I outlined a set of measurable strategic objectives for the short, medium and long term. We said we would take one step at a time, expecting challenges and not expecting quick fixes, and that's exactly how Q3 unfolded. In the short term, we laid the groundwork for taking costs out of the business, at the same time improving operations and enhancing cash flow, as demonstrated by our financial results. Executing against our medium-term objectives, we made progress in strengthening and growing the core defense business in ACS. Total revenues…

Thanks, Mark, and good afternoon, everyone. I will review revenue for the third quarter of fiscal 2008, including details by business unit, discuss Company operating performance, balance sheet and cash flow results; and then finish with a discussion regarding the outlook for the fourth quarter. I will discuss the numbers on both a GAAP and non-GAAP basis. Third-quarter revenues were $56.5 million, above our guidance of approximately $53 million to $55 million and up 7% from the second-quarter revenues. GAAP operating losses were $7 million. This includes stock-based compensation expense of $3.2 million, amortization of acquired intangibles of $1.8 million, a $0.8 million inventory write-down associated with the avionics and unmanned systems group, and $1.2 million in restructuring costs pertaining to the AUSG deal and the closure of our Fuerth, Germany, office. The GAAP net loss for the third quarter was $5.6 million, resulting in a loss per share of $0.26, which compares favorably to our previous guidance of a range of a loss of $0.28 to a loss of $0.22. On a non-GAAP basis for the third quarter, operating income was $49,000. Non-GAAP operating income excludes stock-based compensation expense, amortization of acquired intangible assets, the inventory write-down and restructuring charges. We use a non-GAAP tax rate of 30%. Non-GAAP net income was $951,000. The non-GAAP diluted earnings per share for the third quarter were $0.04, above our guidance range of a loss of $0.04 to breakeven, primarily due to higher revenues and gross margin improvements. The non-GAAP gross margin for the quarter was 59.3%, above our guidance of approximately 58%. Our non-GAAP operating expenses for the quarter were $33.5 million, slightly higher than our guidance of approximately $33 million. The book-to-bill ratio for the quarter was 1.15, driven primarily by our defense business. Backlog, including deferred revenue, was $98…

Thank you Mr. Hult. (Operator Instructions). And we will go first with Steve Levenson with Stifel Nicolaus.

Thank you. Good afternoon.

Hi, Steve.

Nice to see the progress that you're making. Aside from the licensing agreement funding that you talked about, are there any other payments that will come down the road, or is this it, one shot?

In relation to AUSG, it's a onetime payment for the intellectual property. However, on the sale of the ES/PS business, we do expect to receive approximately slightly less than $1 million, but spread out over a two-year period.

Okay. And that's going to help you avoid -- have you determined how much expense or loss that might help you avoid going forward?

Exactly. Steve, on the AUSG license to Honeywell, that business was almost burning $1 million a quarter. So the loss avoidance there looking forward approaches $4 million, in addition to the $3 million, $3.2 million of cash, which we will see here in the June quarter.

Great, thanks. Did you have any 10% customers during the quarter?

We had one, a defense customer, one of our usuals.

And is that on signal intelligence platforms?

That's correct.

Lastly, last night, Northrop announced that they had won or the government announced they had awarded Broad Area Marine Surveillance program to Northrop, which uses the Global Hawk. With the SIGINT packages and whatever else is on there, have you got an idea of what your content is or what sort of participation you might have on BAMS?

We believe that we're going to be a part of the BAMS program going forward.

Nothing beyond that, though, right now?

It is definitely a program that we will be a part of. I don't think we've given specific guidance in terms of dollar values associated with programs, Steve, historically.

That's okay. Thank you very much.

And we will go next to Jonathan Ho with William Blair.

Good afternoon, guys.

Hi, Jonathan.

Hi, how are you doing. Just a couple of questions. First of all, on the auction rate securities, can you give us a little bit more color on what's happening on that side, especially relative to the put, and sort of your expectations on what's going to happen in the next couple of quarters on that side?

Sure. They are two distinct matters, the convertible debenture and the auction rate securities. So let me first talk about the convertible debenture. As you know, we issued that in April of 2004. It's a $125 million instrument, 20-year instrument. It does have a put and call feature at the 5, 10, 15 year marks. So the first time that option presents itself is May of 2009. And I think we've been very consistent from the get-go that we would have the cash available to meet the put, should the need arise. And of course, the challenge was always on the company to be in the opposite position of doing so well that we could perhaps call it. And we still do have the funds available to meet that put. If you work through the cash balances we have, the expected cash we will generate from operations in the near term, and even just taking some of the proceeds from these smaller divestitures that we noted here in today's call, that alone is more than sufficient to meet the put, assuming that the auction rate securities are still tied up in an illiquid market. So that has been the key to everything. And then the whole notion here of establishing a margin loan facility with UBS, which is at no cost to us unless we actually borrow those monies, if you will, and they would come at a rate of LIBOR plus 125 basis points, so not a bad rate. But we haven't borrowed those funds. It's just extra facility to get our hands on more cash should the need arise. But frankly, we do not see that that's even going to be remotely required.

Okay. And with regard to Visage Imaging, can you give us a little bit more color on maybe the level of visibility that you have going forward? I know you guys had talked about sort of putting together this plan, but how do you feel about your confidence level in VI right now?

I think if you look at what we said, we wanted to get the team focused on the reset plan. I think they've actually done a pretty good job. We worked, as we say, to consolidate the facilities over in Germany, which really kind of cleans up the business. The sale of the ES/PS business was really, again, part of that cleanup. It's a legacy service business that we don't see really being tied to the future of where VI is going. If you look at the future, the future is very much around the growth in our new client/server architecture. And we believe that it's the direct sales efforts that are going to drive the growth in that business going forward. So the work that the team did this quarter was to really focus the business to allow us to actually focus on that CS part of the business that we believe to be the growth engine going forward. If you look at it, we did receive our first client/server sales this quarter. We feel really excited about that, Dartmouth-Hitchcock, Tufts Medical Center, as well as three sales over in Europe. And that's sort of a big proof point for us, that the technology that the team has created is fit for purpose, it's ready for prime time from a sales perspective. And the team feels pretty good about the pipeline that they've been building as well. So, at this point, we've got to get through and finish up the work on the sale, as well as the consolidation, and then focus on the topline growth and converting the pipeline that we've created.

Okay. Great. A final question is on the inventories. You guys had a write-down there. Can you just talk a little bit about what's happening on that side? Is this part of sort of the restructuring effort?

Yes. In other terms, consider it a restructuring charge. Tthe inventory associated with the shutdown of the AUSG business. That's all it is.

Okay. Fantastic. Thank you, guys.

(Operator Instructions). We will take our next question from Andrew Barrows, who is a private investor.

I didn't have a question. That must have been a mistake.

Hello, anyway Andrew.

Hello, to you.

And we will go with Shao Wang with Lotus Investments.

Just a quick question. I think, Mark, you had mentioned there is an increase in the inventory due to some customers delaying deliveries at the end of the quarter. I am wondering if you have any color on that?

Yes. It's the timing of deals towards the end of the quarter. Some of the customers basically decided to push the deals that we're working on over the other side of the quarter boundary. So we were left with the inventory. From our perspective, it's nothing to be concerned about. We believe that we're going to make progress on the inventory this quarter.

You mentioned that you thought book-to-bill would be less than 1 because of the large deal that came in at the end of the quarter. Can you give any sense as to where you think inventories might be?

I'm not sure that we've actually forecasted the inventory. I think overall, we're going to try and get the inventories down over time. That's the goal. I think if you look at what we said in terms of our short-term objective, it's to try and generate more cash out of the business. And we certainly did that this quarter with the improvement in the operating cash flow and the free cash flow. So working capital efficiencies is absolutely high on our agenda, and clearly inventory is a part of that.

Lastly, just assuming you were starting to enter the budgeting period for fiscal '09 maybe a little bit early, but if you look into fiscal '09, if you think about the cash generation issue, do you have a sense or a target that you might be shooting for, and also where headcount, you think, might be at the end of June '09?

Yes. We're early in the cycle here. And I think if you kind of go back to what we said on the last call, our intent is not to give annual guidance, but to kind of make progress quarter over quarter. So it's still a little bit early to tell at this point for '09. Bob, I don't know if you would like to add anything there.

Not on '09. You handled it nicely. Helping out a little bit here Shao, the June quarter, Q4 right in front of us here, we expect to generate cash from operations in the mid-single digits. And then of course we will receive the cash from the sale of AUSG also. So, sticking with this format of forecasting the quarter the next quarter, we're going to have a good cash experience in the June quarter here.

I thought you had mentioned in the outlook comments that cash generation would be something greater than that which we saw in the March quarter, if you add the two numbers together. Is that right?

Well, you've got to be careful there. Cash from operations, we certainly didn't say that, but I think it should line up with the experience.

Oh, okay, I got it.

So, a piece of that assumption there is, as Mark said, we've got to get that inventory going in the other direction to be able to deliver that. And then I just kind of view the cash that comes from divestitures as in a different bucket.

You made some nice progress on the DSO side. I'm assuming that's partly due to the linearity that you were able to successfully get in the March quarter.

The linearity experience this past quarter.

We've been driving it week to week.

Yes, and that's very encouraging, because we did have those signal changes that we alluded to that was a little problematic for us on the inventory side. So we're pleased with our cash collection efforts, but it's really linearity under the covers that drives that.

Low 60 is a reasonable level for DSOs going forward, then?

Oh, yes. So it should be. As long as we have a good execution in the operations dimension, that's fine, because our basic terms are 30 days.

I think the challenge that we have from the operations perspective is that we absolutely have a high-mix, low-volume business. So it's forecasting accurately, and as Bob said, improving the linearity. But we've got the guys focused on it. We did bring in, as you saw, a new head of operations, along with a new head of engineering. Both of those guys worked for me in my last company. So they kind of get the drill. We're attacking it.

We will go to Peter Trapp with Bifrost Capital.

Yes, hi. During your presentation of the numbers and the outlook going forward, I thought you had said that the 2009 numbers were going to be something in the range of $209 million to $214 million. Did I misunderstand that as that was what the original 2008 number was?

Yes, we were not talking about 2009 there.

All right, that makes sense. So it was $209 million to $214 million was the original range.

And we tightened it up.

And you changed the range to $211 million to $214 million?

That's correct.

Okay. Then let me ask this, then. As far as your two business sectors are concerned, defense and commercial, could you give, as you look forward a couple of years here, some kind of target growth rate or some kind of general conceptual growth rate of those two businesses from the sense of revenue growth, just so we have a sense as to whether we're looking at a 10% grower here, or a 15%, or a 6%?

Yes. As you said before, I think we're not in the business today of kind of giving long-term growth rates. We're taking things quarter-over-quarter. We've got a lot of moving parts. We do feel pretty good about the defense business, which we think is the economic core. If you look at the progress in the defense business, on a year-on-year basis it's up over 20%. And it's more profitable than the commercial business. That's certainly where we're going to focus our attentions in terms of the growth perspective.

Well, so, when you look at your competition and you look at other people in the general defense area, I think of it as kind of like a 15% grower. So you think there's a chance to outgrow the general growth rate in the defense arena?

I think those numbers that I talked about were the growth looking backwards. We have had some pretty good growth rates, and our expectation is that through new product introductions and through market penetration, we can continue to grow that defense business. But at this point in time, I'm not sure it's prudent to sort of throw out some growth numbers there.

Okay. Let me just ask you, when you talk about your gross margins as 58% to 59% for the fourth quarter?-

Yes, for the June quarter, right.

Yes, well, it's a fourth fiscal quarter, correct?

Yes, we're June ending. I'm sure you know that.

That's what I meant. And so, can you give us a general sense as to what the difference in gross margins are between the defense and the commercial?

We've been somewhat nonspecific on that, but other than to say that they are higher in defense than they are in commercial, measurably so. And if you work with these splits, the revenue splits, you are going to see the range that I am referring to there.

Okay. All right. Well, I will work with that. Thank you.

Sure.

(Operator Instructions). We will take out next question from Glenn Primack with Broadview.

I was wondering what you think your incremental margin should be within that ACS business?

Not sure what you mean by that.

Well, assuming let's say at a $50 million type quarterly run rate, that the non-GAAP operating income should be breakeven, for every extra dollar in revenue, how much you think should drop to operating income?

I think if you look at the ACS business today, on a non-GAAP basis, it is profitable, kind of double digit. So that is where we are at. I think we feel pretty good about that going forward.

Okay. Oh, you know what, I must have been looking at the overall combined and not breaking out APS. All right. And then one last question, regarding how the FPGA vendors are moving down from 90 nanometer to 65 to 45, 40, how does that affect your business? Does it open up more opportunities for you, or?

We've got a strong capability in FPGA. FPGA compute nodes are pretty important in the business, especially the closer you get to the sensor. So obviously, as they are moving down in terms of nanometers, the more logic that you can create on the device, that increases the processing capability. So it's a trend that clearly we're going to take advantage of and we see that it's a positive thing.

Okay. Thanks

Again we will take a follow-up from Peter Trapp with Bifrost Capital.

When you were asked about 2009, I think somebody had asked you about your employee headcount. Is there any kind of indication as to where employee headcount is going in the next year or so?

Well, I think if you're trying to get out from an expense perspective, what are we doing there. Clearly we've already made some moves here in the quarter with the reductions in AUSG that had roundabout 15 people. The sale of the ES/PS business is another call it 30 people, as well as some reductions in relation to the consolidation in Fuerth. So clearly, we are going to see some heads leaving the business as it relates to the things that we've already or we've executed on this quarter. We'll continue to look for opportunities where appropriate, but at this point we have no other plans.

Okay. Thank you.

And it appears there are no further questions at this time, Mr. Aslett. I would like to turn the conference back over to you for any additional or closing remarks.

Okay. Thanks very much, Jennifer, and thanks to everyone for listening. We look forward to speaking with you again next quarter. This concludes our call.

That does conclude today's presentation. We thank you for your participation. You may now disconnect.