White Paper

w w w. m r c y. c o m WHITE PAPER 4 age in the low single digits of revenue. Just like the global technology organizations noted earlier, we have to innovate early and often. At our core, we are a technology company. Our end customers are for the most part defense industry participants, so our own investment in R&D is specifically designed to complement that of our customers. But the key is that we follow, and fund, a layered, commercial, technology development model. Our thesis revolves around the fact that we believe the defense industrial base can and in fact does work, even if not perfectly. There is cutting edge work being done across the DoD, the primes, within the specific armed services and within both government and non-profit labs. However, tapping more efficiently into the vast potential invest- ment of commercially based organizations like Mercury, the innovation and investment needed to fuel the exponential growth in much needed applied technology development could be significantly bigger. Mercury Systems is just a small part of the puzzle. Imagine though, if there were a thriving ecosystem of companies investing 12%-15% of their revenue in a sustained effort to address defense technology needs. The innovation being asked for by the Pentagon could happen faster, more affordably, and on a vastly greater scale than it happens today. In addition, this could free up current government funding for supple- mental work, helping to address other, or additional, defense priorities, or could be used for just plain savings. We believe Mercury Systems has, driven by customer needs, evolved a business model that works. It could also serve as a test bed for demonstrating how the commercial industrial base can be leveraged to support defense, and add momen- tum to the innovation engine. All of this would help ensure that we and our allies can meet the challenging times we face. Mercury Systems' Next Generation Business Model Thesis: Our Next Generation Business Model is gaining traction. We are just one Tier 2 supplier in a huge industry. However, we believe the defense industrial base can build a nimble, innovative, sustainable business model structure driving rapid, cost-effective applied technology innovation. Our Next Generation Business Model speaks to a continuing chal- lenge within the DoD and the overall defense industrial base. Very few companies, from large primes, to Tier 2 and Tier 3 providers of technologies, have found a way to invest significantly in internal R&D, while also profitably running their business. Why? The reasons are many but part of the answer lies in what was uncovered in the 2016 DoD Procurement Annual Report. While there is some evidence, although not conclusive, that the BBP initiatives have helped with cost containment, there is no evidence, conclusive or otherwise, that recent defense acquisition initiatives have fostered innovation, created a more competitive commercial environment, or helped make the US and our allies better prepared for the challenges that lie ahead. The reason, we believe, lies in the fact that DoD directives like BBP speak to driving innovation. However, the conversation around innovation, the drive for Yet, given the increased global threats and relentless geopoliti- cal uncertainty, this level of investment isn't sufficient to match the continuous need for more and better technologies at an ever-increasing pace. However, there is a missing component in support of the funding and development of technology capabilities and solutions supporting our nation's and our allies' defense. That missing link is the failure to fully leverage the enormous technology investment of commercially- oriented organizations that can be applied in support of the DoD. There are many commercial businesses that already support the defense industry, many of them primarily technology firms, and they as well as others, could become a much bigger part of the picture helping to fund and drive innovation moving forward. A Layered Approach to Technology Investment For perspective, think of how commercial tech- nology companies approach technology devel- opment. In the commercial technology world organizations invest a substantial percentage of their annual sales into self-funded R&D. The data varies by year and even by quarter but here are a few examples: Microsoft 13%, Cisco 14%, Google 18%, Applied Materials 15%, Facebook 30%. Regardless of their age or technology focus, the internal investment in R&D is substantial. An even more relevant example of a large technology participant is Intel, investing around 20% of its revenue in R&D - a high percentage. Mercury, in turn, often incorporates com- mercially available third-party technologies into its solutions, benefiting from on-going investment by those third parties. As we use others' microprocessing technologies, we then apply our own technologies and other innovations, supported by our own self-funded R&D investments. As a result, there is an enormous compounding effect as multiple enterprises are advancing multiple technologies into highly integrated solutions. All of this happens at little or no cost (or risk) to the government, yet provides significant support to our defense customers and end users. We ultimately build technolo- gies that are designed specifically to meet the needs of the DoD, but we do so by leveraging commercially developed technologies, integrating these innovations directly into what we are doing for our customers. Much like the companies noted above, Mercury currently invests between 12%-15% of its revenue annually into internal, self-funded R&D. Why? Stated simply, we do this for much the same reason as the global commercial technology companies mentioned above. It's the only way to succeed. We invest, or co-invest with our customers, in key technologies anticipating the evolving needs of the key defense programs and missions. As a commercial company, we have learned that we cannot survive let alone thrive with an R&D budget percent-

• Cover