Leslie Schaeffer - Manager of Financial Planning and Analysis Mark Aslett - CEO Bob Hult - CFO

Steve Levenson - Stifel Nicolaus Jonathan Ho - William Blair Andrew Barrows Shao Wang - Lotus Investment Peter Trapp - Bifrost Capital Glenn Primack - Broadview Advisors

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 in ACS increased sequentially by $3.6 million or 8% to $50.3 million. This growth was entirely driven by defense, which was up approximately 14% sequentially, driven largely by signals intelligence business.

Overall, defense represented 70% of ACS's total revenue this quarter. Year-on-year, and year to date, ACS defense revenue has grown around 20%.

Along with SIGINT, our radar business also remained strong this quarter. As you know, for the past few years, the DoD has been focused on supporting our forces in Iraq and Afghanistan, which, amongst other things, has meant a greater emphasis on upgrading and extending existing platforms.

Both our radar and SIGINT businesses have benefited from that spending. We expect their continued growth to support the strategic heavy lifting ACS still needs to do in aligning its resources, accelerating new product development and improving its market penetration.

The need for improvement is particularly critical in the commercial business within ACS, where revenue declined slightly quarter-over-quarter and which is down more than 30% from Q3 of last year. This quarter, we continued to see declines in our legacy medical business and in semiconductor, where a slowdown in capital equipment spending has affected one of our key customers.

Overall, however, we continue to lay the groundwork for future growth and improved performance in ACS, particularly on the defense side. Q3 was another good quarter for design wins, five in defense and one in commercial, with three of the six awards involving new products designed within the past 18 months.

Last quarter, we said that improving shipment linearity in ACS would be a high priority. In Q3, we successfully improved linearity by approximately 9 percentage points in month three of the quarter, compared to Q2.

Concurrent with the better linearity, we also performed better in on-time customer delivery. Despite these improvements, however, inventory was up by $4.5 million versus Q2, largely due to the impact of customers requesting changes to the timing of their deliveries in the last two weeks of the quarter.

It's clear that we still have more work to do with respect to managing inventory, and we're making this a priority going forward. That said, ACS's operating income improved this quarter, both sequentially and year-on-year.

Sequentially, high revenues largely drove the increase. And year-over-year, an improved gross margin and lower operating expenses were the major drivers.

The improvement in book-to-bill in Q3 was largely related to a single large order in the last few days in the quarter, so the number for Q4 is likely to be slightly below 1. For all of fiscal '08, however, we expect our book-to-bill to improve from last year's 0.88 and be above 1.

Although ACS has now had three consecutive quarters of good performance, we need to see more progress in our product portfolio refresh in engineering and in product operations. During the quarter, Leon Woo and Steve Anderson joined ACS as Vice Presidents in Engineering and Product Operations, respectively.

And their mission is to drive improvement in these areas. I worked closely with both Leon and Steve, while all three of us were in Enterasys, my prior company, and it's exciting to see them getting their arms around our business and making real progress in accelerating our time-to-market.

Let's turn now to Visage Imaging, where it was another challenging quarter. Sales of our legacy products were below the forecast, and we were slow to coordinate our sales plans and joint selling efforts in our OEM relationships with Siemens and Agfa.

However, on a positive note, we did get the first direct sales of our new CS product, which we believe will likely be the driver for growth for VI going forward. If you recall, last quarter, in light of the projected revenue decline and increased operating loss, we asked the VI team to develop a reset plan for the business.

The team began executing on that plan immediately. Our goals were twofold.

First, to leverage VI's new direct sales force and drive direct sales of our new CS product line into large hospitals. And second, to take enough costs out of the business to significantly lower our breakeven for fiscal '09.

Looking first at the cost side, during the quarter we began closing VI's facility in Fuerth, Germany, and transferred select staff, work and intellectual property to our remaining German location in Berlin. We expect this to be complete in the September quarter.

In parallel, we finalized an asset sale of a low-margin professional services business with roughly 30 people on staff that we've determined is no longer core to the future of VI. That sale should be completed by the end of the fiscal year.

Looking at the top line, although VI's Q3 revenue was slightly down, compared to the sequential second quarter, we do remain excited about the long-term opportunity for VI. However, it may take several quarters to begin demonstrating solid revenue momentum.

Our new CS line of 2D/3D integrated packs and 3D/4D client/server architecture is a peer software offering that delivers a powerful value proposition. CS is particularly compelling for large hospitals where implementing our technology onto an existing PACS solution can dramatically improve efficiency and patient care.

From a go-to-market perspective, we now have a direct and indirect channel mix that has the potential to work well in the large hospital space, especially in partnership with Siemens. Our CS direct sales function is still new, and so we haven't yet seen the desired level of productivity.

But it was exciting to see the team begin converting our direct CS pipeline into sales in the quarter, adding Dartmouth-Hitchcock Medical Center in Hanover, New Hampshire; Tufts Medical Center in Boston; and three hospitals in Europe as new customers. In addition, we closed Q3 with a solid pipeline of new CS direct sales opportunities.

As the team continues to gain traction, our path from here will depend largely on the length of the sale cycle, healthcare funding in general, as well as the overall competitive environment. Moving on, at a total company level, the long-term part of our strategy centers on three initiatives.

One, improving our position through greater exposure to software and services; two, exploring adjacent growth opportunities around the core defense business, through initiatives like Mercury Federal; and three, optimizing the return from our portfolio of businesses. Our roadmap in ACS Defense and the vision that we're developing for that business represent initial steps on the first of these objectives.

But clearly, we have more work to do. Mercury Federal with ACS won the $2.5 million contract this quarter to help develop a platform for counteracting improvised explosive devices.

But Merc Fed overall is still very much a nascent business and will not be material in the near term. Objective number three, rationalizing the portfolio, is where we have made real progress.

In addition to selling VI's services business and the facilities consolidation in Germany in the third quarter, we shut down our AUSG operation and licensed the intellectual property. AUSG is an avionics and unmanned systems group that provides portable navigation systems with 3D synthetic vision for the general aviation community.

It's not connected to our core ACS defense business, but instead was set up as one of our emerging growth businesses and has not been profitable. This week, we signed an agreement with Honeywell to exclusively license AUSG's intellectual property for approximately $3.2 million in cash, which we expect to receive in Q4.

In summary, I believe the strategic course we've set will make Mercury a stronger company and a more formidable competitor in markets that offer real potential. We have a great reputation in the marketplace because we solve problems that others can't, because we make our customers' products work better, and because we do it faster and at a lower cost.

It is a testament to the quality of our people and our technology and the longstanding nature of our customer relationships. Our strategy is intended to leverage these competitive advantages going forward.

Near term, we expect to continue to improve the underlying operations of the business and generate cash from operations. Phase II is developing and launching the new products we need as the foundation for future growth.

At the same time, we will continue to be aggressive in capitalizing on opportunities to unwind and rationalize our business portfolio, generating cash and improving our operating results along the way. This is a longer-term effort, where the gains will be made incrementally quarter-over-quarter by consistently improving execution.

We look forward to reporting more milestones in the quarters ahead, leading to profitable growth and greater value for our shareholders. With that, I will turn it over to Bob for the financial review.

Bob?

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 million, an $8.4 million sequential increase from the second quarter of this year.

Of the ending backlog, $90.7 million or approximately 93% relates to shipments expected within the next 12 months. Now, I will discuss our business by segment for the third quarter.

Advanced Computing Solutions, or ACS, which consists primarily of our defense, semiconductor, communications and legacy medical businesses, reported revenues of $50.3 million or 89% of total corporate revenues for the quarter, down approximately 3% from the year-ago period. The decline is the result of a year-over-year drop in ACS's commercial revenues from approximately $23.1 million to approximately $14.9 million.

This drop reflects a decline in sales of commercial communications applications, semiconductor solutions and legacy medical systems. The drop was mostly offset by an increase in year-over-year defense revenues from approximately $20.9 million to $35.4 million.

Sequentially, ACS revenue increased $3.6 million or 8% from the second quarter. ACS book-to-bill for the quarter was 1.12.

For the third quarter, Visage Imaging, which is our wholly owned subsidiary that focuses on the 3D medical imaging market, reported revenues of $2.9 million or 5% of total corporate revenues, down approximately 4% from the year-ago period. Sequentially, VI revenues declined $100,000 from the second quarter.

VI's book-to-bill for the quarter was 0.99. As Mark discussed, VI remains at an early stage of development and it will take time to build momentum.

The combined revenues for Mercury's other business segments totaled $3.3 million. Our Visualization Sciences Group, or VSG, which sells development toolkits and visualization applications to geosciences, engineering and manufacturing and other markets, reported $2.9 million in revenues for the third quarter of fiscal 2008, up approximately 44% from the year-ago period.

VSG's book-to-bill for the quarter was approximately 1.6. The combined revenues for our other emerging businesses totaled $361,000.

Turning to the balance sheet and cash flow statement, cash, cash equivalents and marketable securities at the end of the third quarter totaled $162.1 million, representing a $5.7 million increase from the end of the second quarter. This increase includes a net operating cash inflow of $9.6 million, $1.3 million for capital expenditures in the period, and a $2.2 million unfavorable mark-to-market adjustment of our auction rate securities.

Included in the company's $162.1 million cash, cash equivalents and marketable securities balance is $48 million of student loan auction rate securities, $50.25 million at par. These debt securities are all highly rated investments, with AAA ratings.

Since mid-February 2008, auctions for all the company's auction rate securities have failed. We believe that the current illiquidity of these investments is temporary in nature.

It is our expectation that our ARS investments will eventually be liquidated through successful future auctions for called redemptions at par, plus accrued interest. We assert that we have the financial ability and intent to hold these investments until successful liquidation as described.

The combination of our cash reserves, future cash flows from operations and proceeds from portfolio divestitures will be more than adequate to fund the Corporation's cash needs over the next few years and to meet the potential put to the company for the repayment of the outstanding $125 million Mercury convertible debentures in May 2009. To further bolster our cash reserves, we have finalized an additional $15 million margin loan facility with UBS, who manages our cash investments, extra insurance.

Third-quarter day sales outstanding were 60 days. Accounts receivable declined from $43.3 million to $38 million, driven by improved shipment linearity within the quarter.

Inventory turns were 3.3. As Mark highlighted, inventory increased $4.5 million during the quarter, from $24.3 million to $28.8 million.

At the end of the quarter, the total employee population, excluding contractors, was 745 employees. Now, I would like to move to guidance.

For the fourth quarter of fiscal 2008, we currently expect a revenue range of between $53 million and $56 million, translating to a full-year revenue estimate of approximately $211 million to $214 million. The bottom end of the range represents an increase from the previously guided range of $209 million to $214 million.

We project a full-year total corporate revenue mix of approximately 62% defense and 38% commercial. We anticipate the Q4 gross margin to be approximately 58% to 59%.

Operating expenses are currently anticipated to be approximately $33 million on a non-GAAP basis. The GAAP losses per share are currently expected to range from a loss of $0.30 to a loss of $0.22 for the fourth quarter of fiscal 2008.

The GAAP tax benefit is estimated at $1 million for the fourth quarter. And shares are projected to be approximately 22 million.

The impact of the stock-based compensation cost for the fourth quarter will be approximately $2.8 million. The amortization of acquired intangibles will be approximately $1.8 million.

And restructuring and impairment charges are estimated to be approximately $1.3 million. The restructuring and impairment charges include remaining AUSG and Fuerth closure adjustments.

The non-GAAP tax rate is 30% and the non-GAAP diluted shares are projected to be approximately 22 million. As a result, fourth-quarter fiscal 2008 non-GAAP per-share estimates are currently expected to be in the range of a loss of $0.05 per share to earnings of $0.01 per share.

CapEx for 2008 is projected to be approximately $5 million. Depreciation will be approximately $8.5 million.

With that, we will be happy to take your questions. Operator, you can proceed with the Q&A session now.

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.

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.

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

Hello, anyway Andrew.

Hello, to you.

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.

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.

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

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.

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.