Good day everyone and welcome to the Mercury Systems Second Quarter Fiscal 2018 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 Executive Vice President and Chief Financial Officer, Gerry Haines. Please go ahead, sir.

Good afternoon, and thank you everyone for joining us. With me today is our President and Chief Executive Officer, Mark Aslett. If you have not received a copy of the earnings press release we issued earlier this afternoon, you can find it on our website at mrcy.com. 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 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, possible, potential, assumes, seek and other 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, the timing of such funding, general economic and business conditions, including unforeseen weakness in the company's markets, effects of any U.S. government shutdown or extended continuing resolution, effects of continuing 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 in technological advances and delivering technological innovations, changes in or in the U.S. governments' interpretation of federal procurement regulations and rules, market acceptance of the company's products, shortages in components, production delays or unanticipated expenses 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, changes in tax rate or tax…

Thanks, Gerry. Good afternoon everyone and thanks for joining us. I will begin today's call with a business update, Gerry will review the financials and guidance, and then we'll open it up for your questions. Mercury continued to deliver solid results in the second quarter fiscal 2018, organically and in our acquired businesses. We came in at/above the high end of our guidance in all of our metrics achieving record revenue, bookings and backlog. Design win activity was strong and our key programs are doing well, we're seeing more opportunities in the marketplace and we continue to execute successfully on our M&A, market penetration and market expansion strategies. We made solid progress from an operational perspective, thanks to another great effort by the Mercury team. We continue the consolidation of our RF manufacturing locations associated with the integration of Delta Microwave. We completed the Richland Technologies Systems integration. We also continued the insourcing activity of our world class trusted digital and microelectronics manufacturing facility in Phoenix. Finally, we announced the acquisition of Themis Computer which is expected to close in early February. Looking quickly at some of the numbers; total revenues for Q2 including the acquired businesses were up 20% year-over-year. Our largest revenue programs in the quarter were Aegis, SEWIP, F-35, E2D Hawkeye and Filthy Buzzard. Total bookings were up 24% from Q2 last year and our book-to-bill was a strong 1.14. Our largest bookings programs were F-35, JUS [ph], Aegis, Paveway and Patriot. Adjusted EBITDA for Q2 on a consolidated basis was up 17% year-over-year and a 23% revenue within our target model. With the business firing on all cylinders, the main uncertainty we face relates to the defense budget which was not approved at the end of calendar 2017 as we and others have anticipated. The government…

Thank you, Mark and good afternoon again everyone. Before we go through the company's financial results, I will note that unless otherwise stated, we will be discussing those results, comparisons to prior periods and guidance on a consolidated basis. These consolidated results include the CES and Delta Microwave businesses we acquired in the second and fourth quarters of fiscal 2017 respectively and Richland Technologies or RTL, which we acquired during the first quarter of fiscal 2018. Collectively, the contributions of these businesses comprise what we will prefer to as acquired revenue for purposes of this call. As a reminder, we are now reporting two categories of revenue breakdown, organic and acquired. Organic revenue is defined as revenue attributed to businesses that have been a part of Mercury for more than four full quarters. Acquired revenue is defined as revenue associated with acquired businesses that have been a part of Mercury for four full quarters or less. After the completion of four full quarters, acquired businesses will be treated as organic for current and comparable historical periods. I'll turn now to Mercury's second quarter results which were strong on both a consolidated basis and organically, highlighted by record revenue, bookings and backlog, as well as progress on yet another strategic acquisition. Total revenue increased 20% from Q2 last year to a record $117.9 million, exceeding our guidance range of $112.5 million to $116.5 million. Organic revenue for Q2 increased 12% year-over-year to $104.9 million, up substantially from the 7% organic growth rate recorded in first quarter of fiscal '18. Acquired revenue was $13 million, which is not comparable to Q2 of fiscal 2017 due to the inclusion this year of Delta Microwave and RTL which were not a part of Mercury in Q2 of last year. Our customers are seeking growth…

[Operator Instructions]. Our first question comes from the line of Jonathan Ho of William Blair. Your line is now open.

I just wanted to start out -- also maybe a few clarifications around your organic growth this quarter and were you guys satisfied with the organic growth and are you seeing sort of the translation from some of the acquisitions that you've made over the past couple of years; show up in terms of those numbers?

Yes, we were very happy with it this quarter Jonathan. In Q2 the organic revenue grew 12% year-over-year versus 7% last quarter. I think as we've said in prior calls, we're actually being very successful taking the acquisitions that we've done previously and through the investments that we've made in the business and the channel that we have -- being able to inflect the growth rate of those business northwards versus what they would do on a standalone basis; so yes, we're pretty happy with the results.

And then just in terms of the Themis business; I think you said in the press release that this was growing pretty quickly but is there any sort of metric you can give us in terms of how quickly that business is growing?

So we actually haven't disclosed the growth rates and obviously we don't yet own the company, it is the deal having to close. We're estimating that they are doing roughly $57 million of revenue per calendar year '17 with an EBITDA that is roughly in line with ours at 23%. So we'll have more to say about it on the call next quarter and our recommendation will be to hold off, try to include any of the revenues from that acquisition, given that we'll have more to say about it on the Q3 call.

And then just one final one in terms of the impact from the government shutdown and lack of budget clarity; I mean you guys have executed through CRs in the past, is there anything different about this time or any sort of impact that you're seeing that maybe changed from last quarter?

I think, if you look at what I said in my prepared remarks I think last quarter we were anticipating that there would be a defense budget appropriation by the end of the calendar year, obviously that didn't happen, it's played over into the new calendar year, we were operating under another continuing resolution following a short shutdown of the government. So it's clearly more challenging than what we've seen, our expectation right now based upon the consensus view is that there will be an FY18, FY19 budget deal that removes the prior budget cuts associated with sequestration followed by an FY18 defense appropriations by mid-February. So that's what we based off our guidance on and we certainly hope that that happens.

Our next question comes from Seth Seifman of JP Morgan. Your line is open.

I guess in looking at the strong bookings and the backlog growth that you guys had during the quarter, if you could talk a little bit about how much of it came from sort of positions that you have on existing programs that are growing versus maybe how much of it came from share gain and you talked in the past a little bit about how you're gaining share and kind of whether you see that share gain accelerating from where it was three months ago or whether it's at the same pace or starting to level up?

I think overall we continue to perform extremely well. As we talked about on the call, if you look at our two major market segments in Q2, sensor in effect [ph] which is the more traditional part of our business was up 20%. If you kind of go down the level inside of that market segment, really what is driving the growth is a couple of different areas; the first is EW and the EW business increased 38% in Q2 fiscal year '18 versus the prior year. So clearly, that is well above the growth rates in the industry which suggest that we continue to do well, meaning taking share, as well we've obviously got some programs that are in production. The weapon systems arena is also an area that we continue to benefit from, that particular market segment was up nearly three-fold versus the prior period. And then as I said in my prepared remarks, we're also beginning to see some modernization activities in the EOIR [ph] space which for us is relatively small percentage of our revenue today, but we believe it's going to be larger going forward as some of the programs that we're winning and our customers are pursuing hopefully move into production. So we're very pleased with how the business is performing and Gerry, I don't know if you want to add anything?

Yes. So one other dimension that I mentioned on the prepared remarks section is this, transition that we're seeing to the integrated subsystems, so I noted the 7% year-over-year increase but the important factor is that that's on the back of a 26% increase year-over-year last year, so you can really see the way we're executing that strategy and that cuts across those dimensions that Mark was talking about and so it in effect protects both, the organic and the acquired businesses as we assemble those capabilities together. And we do think that we're unique in that regard, and so we're extremely happy to see that happening because those unique capabilities we think also leave us very well positioned with those customers as we look forward.

Thanks for that Gerry. If you kind of take it from more of a technology level, there is really two areas that we've talked about in the past that we're taking shifts. One is in the RF domain, and I think we've mentioned that there is a couple of different industry participants that are really struggling right now and we continue to take share from them, primarily in EW but also we're seeing some opportunities in the radar domain from an RF perspective. The other is in secured processing and as you know, this has been a theme for us for many years and in fact, we're now on our fourth generation of embedding critical security technology into the processing infrastructure at a time when our customers needed both domestically, as well as to enable foreign military sales, and we're clearly taking share in that domain as well. So we're extremely pleased with how we're positioned and the progressing side of the business.

And then just as a follow-up, if you look at the National Defense strategy that the Pentagon released last week and what they say in the business section talks about looking to do faster development, more iterative development, more frequent upgrades; I would imagine that that's something that works to your benefit but at the same time it's probably something that's very easy to put in your strategy document and much more difficult to translate into the real world. And so I guess, whether you've picked up on any movement in this direction at the department already and how focused you see the customer being on this item and the degree to which you think your customers the defense primes see this as something that would drive further outsourcing.

It's a great point and obviously I think we believe that we're extremely well aligned with the national defense strategy is laid out by secretary modest. I mean the themes were asked when you kind of look at that is the fact that we're moving into a period where we're focusing on what he describes as the great part competition with really more strategic practice and specifically targeting China and Russia. As we know, both of those countries have got much more sophisticated technology and capabilities than some of the terrorist threats that we faced historically and a lot of that is leading to this wave of modernization that we see occurring in really the core of our business on the sensor side, as well as C4I modernization. From a business model perspective, I think you also hit the nail on the head and we've seen under Secretary [ph], a real focus on trying to not only improve -- continue to improve the affordability which is being an ongoing theme but also speed up the rate at which new technology is introduced down range largely because the threats are moving very rapidly, the military needs to be able to keep up with the pace at which these threats are occurring. And so the fact that we've got a business model that produces technology much more quickly, much more affordably at lower risk than the older way of doing it, we think bodes extremely well for Mercury in the longer term. So we were very pleased with what Secretary might have said and our positioning with respect to that.

Our next question comes from the line of John [ph] of Citi.

Just talking about some of the budget ups and downs right now; can you just describe almost the mechanism by which an extended CR and/or shutdown impacts your financials, I mean are you seeing your customers slow their spending in reaction to that?

Not that we can identify specifically but clearly, I'm sure that there is concern with the very short shutdown and the fact that we are in an extended CR compared to what we've had in the past. And the impact of any future shutdown or an extended CR, obviously will really depend upon the duration of any potential shutdown and how the DOD and our customers respond.

Can you just review some of the things that you've done now, sort of got the impression that between larger backlogs and market penetration strategy; no one is immune from these sorts of things but these things have to be purchased, the things have to be done especially in the context you guys are being a lot smaller than the total defense budget. I mean what have you done to almost derisk or minimize risk or mitigate risk around these sorts of things that weren't in…

It's a great point. So we've obviously worked extremely diligently since fiscal 2013 to reduce our dependency on what we would describe as book ship revenue and the way in which we've done that is by really building up our backlog and so we've ended Q2 with a record backlog and we've had multiple records in a row and it's totaling now $376 million and we've got a very strong 12 months forward revenue coverage. So in essence what we've been doing is we've been focusing on reducing the amount of book ship is really buying down the amount of risk in the business period to period. So to put this in perspective, and to put and find a point on it, if we went back to say fiscal Q2 of fiscal '13, the book ship in the core of the business which was MCE operating segment at that time, it was round about 45%. If you look on an LTM basis, the amount of book ship revenue that we have is round about 15% of total revenue. So there has been a dramatic reduction in terms of the risks that we've had as we focused on building the backlog.

Our next question comes from the line of Michael Ciarmoli of SunTrust. Your line is open.

Just to stay on that line of questioning with the continuing resolution, Mark, I mean the guidance for the remainder of the year, had we had a budget in place, would that have changed your outlook at all? I'm just trying to -- maybe if you can specifically quantify if there has been an impact at all? Did it prompt you guys to maybe introduce a little bit more conservatism in the forecast given the unknown and I'm sure we're going to have shutdown talks three weeks from now as well.

Well, I mean it's hard to say specifically Mike. I mean, what we try to do is take into account a multitude of practice when we guide and obviously if we look at where we're at with the budget, we do anticipate that there have been a budget deal, a multi-year budget deal with an appropriation. So we think that we've taken that in account into the guidance and that's the numbers that you already went through.

Got it. What about on the -- I think in the prepared remarks you guys mentioned the electro-optic infra-red saying you plan to grow it and it will be bigger, can you walk us through that? I mean, if I envision your kind of investor day slides, you've shown all the mission kind of silos there and you didn't really have a major presence in EOIR, so what's the strategy there to grow that business; is it organic growth or you're going to target more specific M&A in that capability to drive growth? Do you have enough internally with design wins to drive a meaningful amount of growth there, maybe just elaborate a little bit?

Sure. So the chart that you're talking about is the market segmentation chart and that chart specifically is really more focused on demonstrating how it is that we're executing from an M&A. Mercury is already participating in EOIR and if you go back, we're on a program called [indiscernible] which is the preeminent wide area motion inventory platform. We're seeing a different type of requirement in EOIR and I'm not going to go specifically into detail because I think it's a relatively sensitive area but we do think that we've got the processing capability to go after that market opportunity that's going to require a tremendous amount of compute horsepower. So although it's a small percentage of the business today, it's roughly 3% of total revenue; we are seeing double-digit growth rates and these are in early stage, call it tech demonstrated programs but if any of these programs kind of go into production over the longer term we think it could be another important driver of growth combined with the other sensor upgrades that we're involved with.

And then last one, maybe Gerry, just housekeeping. Funding Themis on the revolver, what should we expect while interest expense probably not so much in the third quarter, fourth quarter, will that have a meaningful impact on financials that we should be thinking about at all in fiscal '18?

So you should start thinking about as soon as we do issue some guidance and we actually have taken out the debt as we said we expect or fund through the revolver, so assuming that all goes to plan we would see some interest expense in Q3 and then we'd see a full quarters load in Q4. It's going to still be a pretty modest debt level at about 1.5 turns, little under that net of our cash; so -- and it's a very good rate in terms of the revolver. So it is what it is but we haven't updated any of the numbers yet to reflect that.

Our next question comes from the line of Greg Konrad of ‎Jefferies. Your line is open.

I just wanted to go back to CR for a minute, you talked about how you've kind of derisked your own business but I think some of the businesses that you target on the M&A front are -- maybe a little bit more susceptible to the issues of having these extended budget negotiations; can you maybe talk about how that's impacted the M&A market and then on top of that with tax reform have you seen any change in sellers expectations?

Certainly for the business that we've recently acquired as well as the one that is pending, we don't think that there are any significant impacts that we can identify this time that is different than what I previously described. With respect to tax reform, and the change in rates, I think it probably does have a longer term impact in terms of sellers expectations with the high potential cash flow associated with the lower tax rate.

And then you talked about revenue synergies a couple of times in the prepared remarks, is there any way to kind of quantify what you look for when looking at targets in terms of upside from generating those revenue synergies?

Yes. So a big part of what we focused on is that content expansion strategy that we talked about previously. Mercury has built out a very strong strategic account sales model where we're dealing with the highest level of our customers on down and that's important because when our customers are actually outsourcing they are entrusting us with very important part, a critical technology element of their overall system. So when we're looking to acquire a business, we're looking for ways in which we can insert that technology to create a better solution for the customer in the short and longer term and I think we've been doing that very, very successfully given the growth rates that we've been experiencing.

The other thing is, we clearly look as we're evaluating what we can do with an acquisition and how might it change as a business once it's a part of Mercury. The technology point that Mark made is very important and is one of our key considerations. But we also look at our ability to leverage a channel which is very strong, so we're looking at the overlap from a customer standpoint, from a program standpoint, as well as the technologies that are either something that we're very familiar or is very closely adjacent to what we're already doing which is what gives us the ability to introduce those capabilities to the customer and also integrate those capabilities with the more highly integrated offerings that we set out to our customers.

And Themis is a great example of that; so if you think about it's really very complementary from a position perspective with respect to both companies, customers as well as the programs, and we do think that there is a strong ability for them to leverage the channel that we've created. Now they've already got a strong position in the rugged server markets and I think one of the potential synergy is that -- is the fact that Mercury has got an industry leading security IP portfolio that many of Themis's customers and programs we believe will benefit from. So it's really a highly complementary -- in the case of Themis, highly complementary acquisition. We also view it as a platform, right, so we're in the early stages of penetrating the C4I space, that's already over 10% of the total company revenue, the fastest growing market segment in which we're participating and we think that we're at the early stages of the growth in this particular sector.

Next question comes from the line of Peter Arment of Baird. Your line is open.

Mark, I guess thinking about your discussion around Tier-3 to Tier-2 kind of moving into that integrated subsystems; I think you mentioned roughly 32% or 33% of your revenue mix -- as you continue to grow the capabilities, how quickly does that continue to increase? I mean, will this eventually be 50% of the mix? How should we think about that.

So the way I would think about it Peter is, it's a little hard to prognosticate what portion of the mix but what we want to see is what we have seen and I think I mentioned it in earlier response which is that we're selling more of those subsystems. Now if we go out and do another acquisition similar to those that we've done in the past what it does is dilute that percentage because we're acquiring entities that are down at the lower level and then what we're trying to do is again incorporate their capabilities into the portfolio of offerings but also into the specific solutions that we're offering so that we begin to leg up through to higher levels of integration in terms of what we're offering the customer. That does a couple of nice things for us; one is, obviously it gives us the optimal ability to leverage our channel, it also protects our positioning in those programs because we're more and more comprehensively and therefore tightly anchored into those as we capture content and that's what's helping to drive program values up and order values which is a trend that we've seen pretty persistently in the business in recent years. So again, our goal is to keep building that up and then diluting it by acquiring more capabilities of other companies and building them up as we go in creating kind of virtuous cycle to it. I can certainly feel that by far the majority of all of the new design win activity is actually at the subsystem level; so it's consistent with the theme of our customers actually outsourcing at a higher level, seeking the deal with company such as Mercury that are able to provide more affordable solutions more quickly with lower risk but not only the companies that are able to lean in from an R&D but also the companies that can actually manufacture and the capabilities that we built in the trusted manufacturing, domestic manufacturing is turning out to be a very significant competitive advantage for us.

That's one of the reason we've meet our transition so carefully is that it's a really important element of what we do and what we do for the customers and we do not want to disrupt that at all.

No, I was thinking indirectionally that it would have a high correlation if we continue to build record backlogs, so that's what it sounds like certainly. And then just regarding kind of the pipeline, Themis closing here early February; what's your comfort level around historically leverage, just -- whether there is opportunities that are still out there to do larger deals or you still think that there is plenty of kind of tuck-in deals?

I think as I said [indiscernible], we're focused on the smaller capability like tuck-ins, as well as the larger opportunities as and when they present themselves. You know, that we've got an in-house M&A team that has build very strong relationships, both on the larger side as well as on the smaller side and we're pretty much getting a look at everything that is out there. We are pretty disciplined in our approach, we're not just looking to gain scale for the sake of it, we're seeking to deals that are very strategically aligned with the strategy that we laid out in investor day and we're going to continue to do that. I would say right now that there is a fair number -- the market is quite active, let's put it that way.

Next question comes from the line of Brian Ruttenbur of Drexel Hamilton. Your line is open.

Just one quick question on tax; you're given guidance for 30% and fiscal '19, do you anticipate that that tax rate could go down into the 20s, the high 20s at least in 2020 or 2021 and what can you do to adjust that and is there anything that you can do to get your overall tax rate down into those ranges?

We aren't looking at something that would cause us to change our view as yet. There are probably a handful of nuances around things like the compensation deductions and as the company grows in size, that becomes probably a smaller overall percentage and therefore has less of an adverse impact in terms of the now lost portion of deductibility and so on. So it's more of a proportionality issue than anything else. And then the other thing is that our guidance does not include any discrete items, so that's the major element that we will see from time to time but as we've said in the past because that will vary and can vary pretty considerably from period to period, we don't build that into the general rate forecast.

And then are any of your acquisitions that you're looking at or that you're currently in the process of doing, will that NOLs or something like that help you in the future to lower that tax rate?

No. We don't really see any continuing benefit from an NOL standpoint, love it if we had it, sometimes we have an opportunity to pickup some of that through an acquisition which has happened in the past, so it's certainly something that we consider at the time as we're evaluating the acquisitions. The other thing and I don't think I called this out specifically but we don't see on the tax front any adverse consequence associated with team repatriation from overseas earnings and so on; so anything that we do because of course we now do own some overseas operations, we'll certainly take the new tax regime into effect which is overall favorable.

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

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