emerald - retirement.ladwp.com · 2/8/2017 · mr. besecker is founder, chairman, president and...

EmeraldAdvisers,Inc.SmallCapitalizationGrowth

Preparedfor:

DataasofDecember31,2016

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Information contained herein should be used for one‐on‐one presentations only and should be accompanied by this disclosure.

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Section A: Company Overview

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Joseph E. Besecker, Chairman, President and CEO, Emerald Asset Management, Inc.Mr. Besecker is Founder, Chairman, President and CEO of Emerald Asset Management, Inc., parent company to five subsidiary investment advisory firms. He has over 30 years of experience in the money management business. Mr. Besecker has led Emerald from a start‐up investment/research firm in 1991 to a diversified asset management firm with over $4.6 billion under management today, listed by Pensions & Investments as one of the largest money managers in the U.S. ranked by institutional tax‐exempt assets. From an initial three employees in 1991, Emerald and its subsidiaries have grown to more than 40 employees located in offices in Leola, King of Prussia and Pittsburgh, Pennsylvania, Cleveland, Ohio and Oceanside, California.

Mr. Besecker has been a key investor and provided expertise to a number of early‐stage venture capital projects and has been recognized for his achievements in the venture capital community with nominations as a finalist of both the Ernst & Young Entrepreneur of the Year Award and Enterprise Entrepreneur of the Year Award. Mr. Besecker has appeared frequently in the national financial media, including The Wall Street Journal, The New York Times and USA Today and has been a regular contributor to CNBC, Fox Business News and Bloomberg. He has received national recognition for his work as an investment analyst, including being named as a Home Run Hitter by Institutional Investor magazine and lecturing at Oxford University.

Mr. Besecker strongly believes in giving back to the community and created the Emerald Foundation in 2010 as a way to give back to the community. He has served as a National Trustee and Past President of the Leukemia & Lymphoma Society and as a board member of the Boys and Girls Club (Lancaster, PA). Under his leadership Emerald was named the Corporate Citizen of the Year in 2005 by the Central Pennsylvania Business Journal. Mr. Besecker and his wife Martha have four children: Jeb, John, Liam and Lily.

Joseph W. Garner, Director of Research, Emerald Advisers, Inc.Mr. Garner is Director of Research and a member of the Small Cap and Mid Cap Portfolio Management teams. He is also a Manager of the Emerald Growth Fund. Mr. Garner’s research efforts are focused on small and mid‐sized firms in the Business Services, Capital Goods, Consumer, Financial Services, and Technology sectors. In 1997, he was named as a “Home‐Run Hitter” by Institutional Investor magazine, and has appeared on Bloomberg Television and CNBC. He also has been quoted in Fortune, Bloomberg Business News, USA Today, Dow Jones News Service, Standard & Poor’s, MarketWatch, Investor’s Business Daily, Wall Street Journal, and other media. Mr. Garner served as President of the Millersville University Foundation and previously served as Chair of the Board’s Investment Committee. Prior to joining Emerald in 1994, Mr. Garner was the Program Manager of the PA Economic Development Financing Authority (PEDFA) and an Economic Development Analyst with the PA Department of Commerce’s Office of Technology Development. Mr. Garner received an MBA from the Katz Graduate School of Business, University of Pittsburgh, and graduated magna cum laude with a BA in Economics from Millersville University

Presenter Biographies

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Founded in 1991, Emerald is a diversified investment management firm that specializes in actively managed investment portfolios, withan emphasis on fundamental, hands‐on research analysis. Corporate offices are located in Leola, Pennsylvania with satellite offices at King of Prussia and West Conshohocken in suburban Philadelphia and Pittsburgh, Pennsylvania; and Cleveland, Ohio. Emerald’s west coast regional headquarters are located in Oceanside, California.

Emerald’s mission is to provide high quality professional management with a primary emphasis on risk control to public and non‐public institutional and retail clients by adhering to a strict culture of compliance and high ethical standards. We are dedicated to the achievement of consistent client investment success without engaging high risk.

We believe our equity and income‐producing products provide investors with a convenient way to benefit from the knowledge and insights of an experienced investment team. In addition, we believe clients are advantaged by our low turnover in investment staff which continues to enhance our collective experience and delivers consistent risk‐adjusted performance.

Corporate Background

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Mandate Small Capitalization Growth

Fund Structure Separate Account

Small Cap Growth Asset Base (SMA) $2,164 mm

Small Cap Growth Mandate (All Clients) $3,855 mm

Total Assets Under Management $4,570 mm

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Small Cap GrowthPortfolio Management Team

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Kenneth G. Mertz II, CFAChief Investment Officer/Portfolio Manager

Stacey L. SearsPortfolio Manager / Analyst

Joseph W. GarnerPortfolio Manager /Director of Research

Investment Experience

38 Yrs. 22 Yrs. 22 Yrs.

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Equity Portfolio Managers / AnalystsCoverage & Firm Tenure

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David Volpe, CFA, MADeputy CIO Port. Manager ‐ ACG & MCGCoverage: Energy17 Yrs. Tenure

Stephen AmsterdamAssociate Manager ‐MCGCoverage: Semiconductors / Technology / Gaming 15 Yrs. Tenure

Joseph HovorkaAssociate Manager ‐MCGCoverage: Consumer DiscretionarySince July 2016

Derek Fisher Analyst Coverage: Technology / Professional Services .19 Yrs. Tenure

Scott Blumenthal, MBAAnalystCoverage: Basic Materials / IndustrialsCapital Goods / Engineering / Defense / Aerospace / Construction 12 Yrs. Tenure

Nishit Trivedi, PhD, MBBS, MBAAnalystCoverage: Molecular Diagnostics/ Hospitals / Medical Devices 11 Yrs. Tenure

Terry M. Smith, PhD, MBAAnalystCoverage: Biotechnology /Drugs & Pharma. / Managed Care10 Yrs. Tenure

Joseph A. Besecker, MD, FAAPResearch AssociateCoverage: Biotechnology / Emerging Pharma / Medical Devices 15 Yrs. Tenure

Kenneth G. Mertz, CFAChief Investment OfficerPort. Manager ‐ SCG & BankingCoverage: Financial Services 24 Yrs. Tenure

Stacey L. Sears, MBAPortfolio Manager ‐ SCGCoverage: Consumer 24 Yrs. Tenure

Joseph W. Garner, MBADirector of ResearchPort. Manager ‐ SCG Coverage: Consumer Goods / Technology / Transportation22 Yrs. Tenure

Steven E. Russell, Esq., MBAPort. Manager ‐ SCV & BankingCoverage: Financial Services /Technology Communications 16 Yrs. Tenure

Andrew RohrerAnalystCoverage: Agriculture / Automotive Transportation 8 Yrs. Tenure

Nathan R. Jones, PhD, MBAAnalystCoverage: Technology 3 Yrs. Tenure

Anthony CarlucciResearch AssociateCoverage: Consumer Discretionary/Staples Since February 2016

Team Emerald15 Investment Professionals 13 Yrs. Avg. Tenure 20 Yrs. Avg. Industry Experience

Information contained herein should be used for one‐on‐one presentations only and should be accompanied by this disclosure.5

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Corporate Profile


Parent Company: Emerald Asset Management, Inc.

⦁ Incorporated November, 1991 ⦁ S‐Corporation / 100% ESOP‐Owned

⦁ $4.7 Billion Firm‐Wide Assets Under Management as of December 31, 2016

⦁ Driven by In‐depth Fundamental, Bottom‐up Research

Affiliated Advisers:EmStone Advisers LLC

Traditional and Enhanced Fixed‐Income Portfolios

Emerald Direct Lending Advisers LLC

Reg D Limited Partnership FundsEmerald Managed Yield Plus Collective Investment Fund

Partial Client List

PublicCommonwealth of Pa. Contra Costa County (CA)State of Illinois Teachers’18 Pennsylvania Counties

CorporateIndependence Blue CrossCarpenter TechnologyShands Healthcare

EndowmentsLower Susquehanna Synod of the ELCAShippensburg University Foundation

Taft‐HartleyUFCW Tri‐State Pension FundMARTA (Metropolitan Atlanta

Rapid Transit Authority)

Sub‐Advisory RelationshipsPrudential Investments

It is not known whether the clients approve or disapprove of Emerald services provided through its subsidiaries. Emerald did notuse performance‐based data to determine which clients are included on this list. Clients were selected based upon their generalname recognition and as a representative sampling of the types of accounts managed. Performance‐based data was not used todetermine which clients are included on this list. Clients were selected based on a sampling of the types of accounts managed.

Emerald Asset Management

Emerald Advisers

Small Cap ValueMid Cap GrowthAll Cap Growth Small Cap Growth1

PA Small Cap Core11Closed to new investments.

Emerald MutualFund Advisers Trust

Mutual Funds Emerald Growth Fund1

Emerald Small Cap Value FundEmerald Insights FundEmerald Banking & Finance Fund

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Contact Us

Contacting Us:

3175 Oregon Pike, Leola, PA 17540

Phone: 800.722.4123

Website: www.teamemerald.com

Your Team Emerald Contacts:

Sales / Client Relationship

John Thompson, Senior Vice President

[email protected]

Client Services / Operational Support

Serena Tenant, Asst. Vice President

[email protected]

Manager

Kenneth G. Mertz II, CFA, President & CIO

[email protected]

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7Information contained herein should be used for one‐on‐one presentations only and should be accompanied by this disclosure.

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Section B: Investment Process & Discipline

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Research‐Driven Active Portfolio Management

• Top line & bottom line growth drives stock values higher.

• Seek to maximize returns and minimize risks by capitalizing on the inefficiencies inherent insmall‐cap markets Over 1,000 Russell 2000 stocks have five or fewer sell‐side analysts, while over 350 stocks have

two or fewer. (Source: FactSet as of 1/12/17)

• Dedicated to intense fundamental, bottom‐up research designed to identify unrecognized,under‐researched companies.

• In‐house fundamental investment research is the key to outperforming benchmark marketindices.

• Industry & scientific expertise across all sectors.

Investment Philosophy

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Information contained herein should be used for one‐on‐one presentations only and should be accompanied by this disclosure.10

Research‐Driven Active Portfolio Management

Our philosophy has been rooted in the belief that fundamental, bottom‐up research is the key in gaining exceptional understanding of the companies we choose to include in our investment portfolios. Since the beginning, we have persisted with our fundamental investment approach utilizing a 10‐step research process generating approximately 2,000 company meetings a year on‐site at the company, or off‐site at conferences, trade shows or other locations, targeting the best perceived early‐stage growth companies and quality value companies. On a stock by stock basis, we look where we believe earnings will be regardless of market cycles. This hands‐on approach provides us with unique insights into industry trends as well as company specific trends that we believe gives us an advantage over managers who rely solely on traditional, top‐down research techniques. As a result Emerald portfolios bear little resemblance to the broad market. Our research process, unique blend of independent thinking, strict adherence to style and process, seasoned expertise in selecting stocks, and exploitation of innovative trends, clearly differentiates us from our peers.

Investment Research ProcessDRIVEN BY RESEARCH

Emerald’s research team focuses on providing fundamental research and analysis of every investment opportunity, utilizing a proprietary process initiated in 1992.

10-Step Process

1. Review SEC Filings, Press Releases and News Stories The process includes monitoring relevant media sources such asindustry press, financial press and popular press.

2. Meet with Management Meet with management across the organization in areas such as executive management, marketing, product development, operations and finance. The Emerald Research Team conducts approximately 2,000 meetings per year on‐site at the company, or off‐site at conferences, trade shows or other locations.

3. Interview CustomersInterview customers to determine (1) the critical factors driving their buy decision, (2) what competitors or alternatives were considered, (3) level of satisfaction with the quality of the product or service, and (4) likelihood of generating repeat business.

4. Interview CompetitorsInterview competitors to determine their strengths and weaknesses, as well the competitors' perception of the strengths and weaknesses of the company.

5. Interview SuppliersInterview suppliers to determine their ability to supply the products/services required by the company. Also, assess the extent of potential supply chain bottlenecks.

6. Interview DistributorsInterview distributors to determine potential issues and opportunities in the company's distribution channel such as inventory levels, demand drivers and competitive pressures.

7. Develop Financial and Valuation ModelsDevelop a financial model to analyze financial performance and estimate future cash flows, earnings and financing needs. Use a valuation model to analyze relative and absolute valuation.

8. Review Third‐Party ResearchReview published research from sell‐side analysts and industry research firms to compare our data points and financial estimates. Also, use third party research to assess security‐specific and industry‐specific sentiment.

9. Publish an internal research reportPublish an internal research report summarizing the company's business, competitive advantages, management strengths/weaknesses, growth drivers and risks, as well as stating investment conclusions and recommendations.

10. Communicate, Communicate, CommunicateThe entire research team meets formally twice per week and informally on an ongoing basis with the portfolio management team to discuss the fundamentals of all current and potential holdings. Internal discussions are held throughout the process.

Investment Research Process

10-Step Process

Information contained herein should be used for one‐on‐one presentations only and should be accompanied by this disclosure. 11

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Trading & Monitoring Systems

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TradingEmerald Advisers employs a two‐person trading desk for all of its trade executions. The professional staff has extensive experience trading equities and working to achieve best execution. Emerald’s Head Trader brings 16 years’ experience to the team. The trading desk uses a 5‐level grading system which is employed for each and every trade executed by the desk. Each one of these grades are compiled and further reviewed by Emerald’s Best Execution Committee. Emerald believes this review process provided an in‐depth look to every trade and every executing broker utilized. This extensive grading process is used by Emerald to review trading effectiveness as well as broker approval and utilization.

Emerald utilizes the FIX order routing through the NYFIX FIX engine. The implementation of FIX has significantly increased Emerald’s ability to monitor its trading on a real time basis. The FIX engine provides real time execution and prices, each with electronic time stamps. The FIX connections provide instant data dissemination, which has added in streamlining Emerald’s trading practices and back office functions.

Analysis/MonitoringEmerald currently utilizes the INDATA iPM portfolio accounting system, along with the NYFix trading platform, which greatly reduces the potential for human error by automating trade‐related tasks.

The team utilizes the FactSet system in conjunction with the INDATA portfolio accounting system to assist in the monitoring/management of portfolio risk. The entire portfolio team is enabled to receive FactSet via desktop, laptop and e‐mail. This enables us to be real time 24/7. These tools help monitor active non‐systematic risk on the individual stock, industry and sector levels and is used in our weekly general, technology, healthcare/life sciences research meeting as well as at our daily portfolio manager meeting.

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Stock Selection is a Fundamentally Driven Process

IDEA GENERATIONSTOCK SELECTION PROCESS

Universe Universe is Russell 2000 Capitalization ≤ the largest

Russell 2000 company15‐Member Team

Assigned Sector/Industry Coverage

Expertise / Tenure10‐Step Process

Fundamentally driven Bottom‐up focus Meetings with management Written report generated for

every stock

Buy Criteria Competitive advantages Leadership position Strong management Growth rate exceeds peer group Differentiated growth drivers Under‐researched by the Street

Buy Decision Valuation deemed attractive

relative to defined growth prospects

Security fits within portfolio risk constraints

PORTFOLIO CONSTRUCTION

Diversified Portfolio 110 – 120 stocks Sector & industry diversification

Unequal Weighted At the stock level

‐ Position sizes range ½ ‐ 2%‐ Stock specific risk/cross‐risk/correlation

At the sector/industry level‐ Sector/industry weights are a fallout ofthe bottom‐up investment process

Ability to participate in a broader opportunity set than our peers

Risk Averse Sector: ≤ 3x R‐2000 Index (max. 45%) Industry: ≤ 15% Stock : ≤ 5% holding size

≤ 5% ownership in company

Investment Process

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Summary of Investment GuidelinesThe representative benchmark for this mandate is the Russell 2000 Growth and therefore all representative component characteristics are in line with client investment guidelines. In addition, Emerald is in agreement with performance objectives in that our process attempts to outperform the stated benchmark by 100 to 200 basis points of annualized excess return over a given market cycle.

Compliance with Investment GuidelinesEmerald Advisers, Inc. certifies that the Plan's assets have been managed in conformance with the objectives and guidelines delineated in the City of Los Angeles Water & Power Employees’ Retirement Plan Investment Policy dated 09‐14‐2016.

Investment Guidelines

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Section C: Market Overview

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Market OutlookDRIVEN BY RESEARCH4th Qtr. 2016

Performance Review

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The improbable victory of President‐elect Donald Trump and a Republican sweep of Congress propelled the market to new highs as the prospect of less regulation, tax reform, accelerating infrastructure and defense spending led to broad based optimism that economic growth and corporate profits are poised to reaccelerate in 2017 and beyond.

Small capitalization stocks were the largest beneficiary of this shift in sentiment, with the Russell 2000 surging 8.83% during the quarter, substantially outpacing the Russell 1000 which appreciated by 3.83%.

The gains in small capitalization stocks, however, were largely concentrated in the “Value” component of the Russell 2000 driven by outsized gains in the energy, financial services and materials sectors. These gains propelled the Russell 2000 Value to appreciate by 14.07% during the fourth quarter, outpacing the Russell 2000 Growth which gained 3.57%.

Index q4 2016 CY 2016Russell 2000 Growth 3.57% 11.32%Russell 2000 Value 14.07% 31.74%Russell 1000 Growth 1.01% 7.08%Russell 1000 Value 6.68% 17.34%Russell 3000 Growth 1.20% 7.39%Russell 3000 Value 7.24% 18.40%

Source: Russell Investments

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Performance Review

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At the sector level, within the Russell 2000 Growth, the utilities and financial services sectors led gaining10.49% and 10.42% respectively, whereas the health care and energy sectors lagged, declining by 6.66% and 1.21% respectively. (Source: Russell Investments)

Russell Sector R2000 Growth R2000 R2000 ValueTechnology 1.66% 5.60% 13.15%Healthcare ‐6.66% ‐5.74% ‐1.40%Consumer Discretionary 6.56% 7.06% 7.83%Consumer Staples 0.31% 5.62% 12.78%Energy ‐1.21% 16.42% 19.86%Materials & Processing 9.76% 11.78% 15.24%Producer Durables 9.94% 11.46% 13.12%Financial Services 10.42% 16.95% 18.79%Utilities 10.50% 6.57% 5.38%

Source: Russell Investments

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Performance Review

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Decomposing the performance of the Russell 2000 only serves to further highlight the significant divide between the Growth and Value components of the index, as those companies with the fastest revenue growth rates meaningfully underperformed their slower growing peers, gaining only 10.8% for the year and substantially trailing the gains posted by the broader index.

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Performance Review

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Within the Russell 2000 Growth Index, this same subset of the fastest revenue growth companies returned a negative 0.98% for the full year 2016.

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Market Outlook

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Portfolio positioning: Overweight positions: Technology, Consumer Discretionary, Utilities and Financial Services sectors Underweight positions: Producer Durables, Healthcare and Consumer Staples sectors

After a concerning start to 2016 with recession fears driving the direction of the market, the full year of2016 will end up marking the 7th consecutive year of domestic economic expansion.

Although domestic GDP growth started out with 2016 slowly gaining less than 1% in the first quarter,growth again reaccelerated with third quarter GDP expanding by 3.5% and fourth quarter GDP, aftersome intra‐quarter volatility, now tracking at 2.9% according to the Atlanta Fed GDPNOW Forecast.

Corporate earnings, as benchmarked by the S&P 500, are also on the upswing after returning to positivegrowth in the third quarter of 2016 following six quarters of negative sales and earnings comparisons.

The forthcoming changing of the guard with Donald Trump set to take his position as the 45th Presidentof the United States in January has also brought a renewed sense of hope and optimism that economicgrowth and corporate profits are poised to reaccelerate in 2017 and beyond.

Emerald similarly views President‐elect Trump’s pro‐growth agenda which is keyed on tax cuts,deregulation, infrastructure and defense spending as a further catalyst for economic improvement.

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Market Outlook

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Small capitalization stocks, with their domestic orientation, should be well positioned to benefit from any fiscal stimulus implemented by the next administration. With domestic economic growth further poised to reaccelerate, we expect earnings growth to similarly reaccelerate moving forward with small capitalization stocks again particularly well positioned.

While the market, up to this point, has viewed the new administration’s policies as the recipe for reflation, there remains a great divide between the hope that has been driving the market since the November U.S. Presidential Election and the realization of the benefits from the expectation of tax reform, deregulation and infrastructure spending.

As a result we would expect periods of heightened volatility in the market over the course of 2017 as domestic policy, trade policy, and foreign policy initiatives get outlined and implemented and the efficacy of those measures and their impact to domestic economic growth and the budget deficit are assessed.

These factors are likely to be further complicated by the direction of the dollar, the trajectory of the Federal Reserve’s path to normalization, the structure of the yield curve, the impact to housing and consumption, and a lack of recovery in productivity growth.

Offsetting these risks, Emerald’s research team continues to find innovators, consolidators and market share gainers in our domestic universe.

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Section D: Performance Review

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WPERP Performanceas of December 31, 2016

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0.00

2.00

4.00

6.00

8.00

10.00

12.00

QTD 1 Year Since Inception

LA Water Health (Gross)

LA Water Health (Net)

LA Water Retirement (Gross)

LA Water Retirement (Net)

Russell 2000 Growth

QTD 1 Year Since Inception LA Water Health (Gross) 4.00 9.97 3.88 LA Water Health (Net) 3.85 9.33 3.28 LA Water Retirement (Gross) 3.88 9.85 3.78 LA Water Retirement (Net) 3.73 9.21 3.18 Russell 2000 Growth 3.57 11.32 5.53

LA Water Health ‐ Excess Return 0.28 ‐1.99 ‐2.25LA Water Retirement ‐ Excess Return 0.16 ‐2.11 ‐2.35

Performance Disclaimer ‐ The performance information reflected is approved for “One‐on‐One” client presentations only. The gross performance figures do not reflect the deduction of investmentfees; the investment advisory fees are described in Part II of Emerald Advisers’ Form ADV. For example, if a client placed $100,000 under management and a hypothetical gross return of 10% wereachieved, the investment assets before fees would have grown to $259,374 in ten years. However, if an advisory fee of 1% of average net assets were charged, investment assets would have grown to$234,573, or an annual compounded rate of 8.9%. This includes all reinvestment of dividends. The fee used when computing net returns is the highest fee stated in our Form ADV at 1%.

Information contained herein should be used for one‐on‐one presentations only and should be accompanied by this disclosure. Information contained in this presentation is for the use of the intended recipient only and cannot be reproduced or reused without prior written consent.

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Div. SCG Composite/WPERP Univ. Comparisonas of December 31, 2016

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Source: PSN, Universe: Small Cap Growth, Diversified SCG Since Inception: 10/1/92

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Performance Disclaimer ‐ The performance information reflected is approved for “One‐on‐One” client presentations only. The gross performance figures do not reflect the deduction ofinvestment fees; the investment advisory fees are described in Part II of Emerald Advisers’ Form ADV. For example, if a client placed $100,000 under management and a hypothetical grossreturn of 10% were achieved, the investment assets before fees would have grown to $259,374 in ten years. However, if an advisory fee of 1% of average net assets were charged,investment assets would have grown to $234,573, or an annual compounded rate of 8.9%. This includes all reinvestment of dividends. The fee used when computing net returns is thehighest fee stated in our Form ADV at 1%.


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PSN universe calculations are on a gross of fee basis.

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5

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15

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25

30

RAT

E O

F R

ETU

RN

Latest Quarter 1 Year 3 Years 5 Years 10 Years Since Inception HIGH (0.05) 8.65 22.31 10.49 17.99 11.22 13.78 FIRST QUARTILE 5.25 15.65 7.14 15.98 9.35 12.85 MEDIAN 3.19 10.99 4.79 13.90 8.49 11.70 THIRD QUARTILE 1.23 7.32 2.73 12.79 7.41 10.02 LOW (0.95) -2.39 0.78 -0.74 10.07 4.95 8.52 MEAN 3.26 11.37 4.97 14.18 8.34 11.34 VALID COUNT 147 147 143 134 109 26

Div SCG SMA Gross CompositeLA Water Health GrossLA Water Health NetLA Water Retirement GrossLA Water Retirement NetRussell 2000 Growth

Latest Quarter 1 Year 3 Years 5 Years 10 Years Since InceptionVALUE RANK VALUE RANK VALUE RANK VALUE RANK VALUE RANK VALUE RANK

4.38 31 10.39 53 7.48 21 17.26 7 9.68 20 11.68 503.99 34 9.96 56 N/A N/A N/A N/A N/A N/A N/A N/A3.84 35 9.32 63 N/A N/A N/A N/A N/A N/A N/A N/A3.87 34 9.85 58 N/A N/A N/A N/A N/A N/A N/A N/A3.73 38 9.22 64 N/A N/A N/A N/A N/A N/A N/A N/A3.57 40 11.32 48 5.05 46 13.74 54 7.76 65 7.96 99

Year

201620152014201320122011201020092008200720062005 2004

Emerald

10.40%4.43%7.73%50.5%18.6%‐0.8%30.0%34.8%‐36.4%2.8%13.6%9.3%4.5%

Russell 2000 Growth11.32%‐1.38%5.60%43.3%14.6%‐2.9%29.1%34.5%‐38.5%7.1%13.4%4.2%14.3%

Year

200320022001200019991998199719961995199419931992 (3 mos.)

Emerald

52.1%‐28.3%‐5.3%‐24.6%102.0%‐9.7%27.4%22.3%48.0%3.2%21.2%8.9%

Russell 2000 Growth48.5%‐30.3%‐9.2%‐22.4%43.1%1.2%13.0%11.3%31.0%‐2.4%13.4%17.0%

Performance Disclaimer ‐ The preceding performance information is approved for use in “One‐on‐One” client presentations only. The above performance results for the Emerald Advisers, Inc.,Diversified Composite do not reflect the deduction of advisory fees or other expenses normally incurred in the management of an advisory account. The Adviser’s fees are fully described in Part II ofits Form ADV. If a client placed $100,000 under management and a hypothetical gross return of 10% were achieved, the investment assets before fees would have grown to $259,374 in ten years.However, if an advisory fee of 1% of average net assets were charged, investment assets would have grown to $234,573, or an annual compounded rate of 8.9%. The results reflect the reinvestmentof all dividends. Past performance is no guarantee of future results. Results vary so that a client may show a profit or loss in their account depending upon the market conditions and specific portfolioperformance. As shown above, the Diversified Composite tracks the performance of all accounts managed in this style that have been with Emerald for at least one month where the Advisermaintains full discretionary authority and for those which are not classified as broker‐dealer directed “wrap” accounts. As of December 31, 2016, the Diversified Composite represented 47% ofEmerald Advisers’ total assets under management.


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RATE OF RETURN REPORTED GROSS

Emerald Div. SCG Composite Cal. Yr. Perf.as of December 31, 2016DRIVEN BY RESEARCH

WPERP Retirement4th Qtr. 2016 Performance Attribution

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Performance AttributionLA WATER RETIREMENT vs. Russell 2000 Growth9/30/2016 to 12/30/2016U.S. Dollar

LA WATER RETIREMENT Russell 2000 Growth Variation Attribution Analysis

Port. Port. Port. Bench. Bench. Bench. Average Total Contrib.Average Total Contrib. Average Total Contrib. Weight Return To Return Allocation Selection Interaction Total

New Russell Sectors2 Weight Return To Return Weight Return To Return Difference Difference Difference Effect Effect Effect Effect

Total 100.00 3.88 3.88 100.00 3.59 3.59 -- 0.29 0.29 -0.22 1.74 -1.23 0.29

Consumer Discretionary 19.61 6.82 1.26 16.52 6.55 1.10 3.09 0.27 0.17 0.08 0.06 -0.00 0.13Energy 1.92 -9.13 -0.21 1.02 -1.21 -0.02 0.90 -7.92 -0.19 -0.04 -0.10 -0.10 -0.23Financial Services 13.37 12.36 1.23 11.87 10.42 1.19 1.50 1.93 0.04 0.11 0.18 -0.14 0.15Health Care 17.72 -9.17 -1.78 21.94 -6.61 -1.60 -4.22 -2.56 -0.18 0.38 -0.44 0.06 -0.01Materials & Processing 8.22 18.32 1.39 9.51 9.76 0.95 -1.29 8.55 0.44 -0.12 0.76 -0.13 0.51Producer Durables 7.39 19.66 1.46 14.58 9.96 1.51 -7.19 9.70 -0.05 -0.47 1.35 -0.71 0.17Technology 24.18 1.81 0.47 19.31 1.66 0.27 4.87 0.14 0.20 -0.12 0.14 -0.00 0.02Utilities 4.53 0.81 0.05 2.27 10.49 0.23 2.26 -9.68 -0.18 0.14 -0.21 -0.22 -0.29[Cash] 3.06 0.10 0.00 -- -- -- 3.06 0.10 0.00 -0.28 -- -- -0.28


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WPERP RetirementCY 2016 Performance Attribution

Performance AttributionLA WATER RETIREMENT vs. Russell 2000 Growth12/31/2015 to 12/30/2016U.S. Dollar

LA WATER RETIREMENT Russell 2000 Growth Variation Attribution Analysis

Port. Port. Port. Bench. Bench. Bench. Average Total Contrib.Average Total Contrib. Average Total Contrib. Weight Return To Return Allocation Selection Interaction Total

New Russell Sectors2 Weight Return To Return Weight Return To Return Difference Difference Difference Effect Effect Effect Effect

Total 100.00 10.01 10.01 100.00 11.35 11.35 -- -1.35 -1.35 0.30 0.62 -2.27 -1.35

Consumer Discretionary 18.56 17.88 3.41 17.87 13.37 2.76 0.68 4.51 0.65 -0.18 0.60 0.17 0.59Energy 1.35 10.75 0.14 0.94 -0.33 -0.08 0.40 11.08 0.22 0.11 0.18 -0.20 0.09Financial Services 17.29 6.35 -0.14 11.03 18.38 2.17 6.26 -12.03 -2.31 0.35 -1.29 -1.53 -2.47Health Care 18.21 -5.56 -2.17 23.47 -9.06 -3.95 -5.26 3.50 1.78 1.10 1.39 -0.47 2.03Materials & Processing 7.54 35.34 2.76 8.53 34.15 3.01 -0.99 1.19 -0.25 -0.26 0.27 -0.14 -0.14Producer Durables 6.55 23.09 1.73 13.45 25.71 3.72 -6.91 -2.62 -1.99 -0.81 -0.12 0.06 -0.87Technology 24.09 13.98 3.43 19.42 18.08 3.26 4.66 -4.10 0.16 0.20 -0.60 -0.23 -0.63Utilities 3.81 21.71 0.83 1.93 12.65 0.30 1.88 9.07 0.53 0.14 0.20 0.07 0.41[Cash] 2.61 0.31 0.01 -- -- -- 2.61 0.31 0.01 -0.57 -- -- -0.57

DRIVEN BY RESEARCH


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On a relative basis, Emerald’s performance outpaced that of the benchmark for the quarter driven largely by stock selection. At the sector level, the most notable positive contributors to return included performance within the materials, technology and consumer discretionary sectors. Although performance within the producer durables and financial services sectors were only neutral to relative performance, each of these sectors demonstrated positive factors that contributed to performance. Collectively, these factors offset relative underperformance within the utilities and energy sectors.

28


WPERP Retirement 4th Qtr. 2016 Performance Review

‐2.00

‐1.50

‐1.00

‐0.50

‐‐

0.50

1.00

1.50

2.00

ConsumerDiscretionary

Energy FinancialServices

Health Care Mat. &Processing

ProducerDurables

Technology Utilities

WPERP Retirement

Russell 2000 Growth

DRIVEN BY RESEARCH

Portfolio Performance Summary

Top 10 Contributors to Return

Bank of the Ozarks, Inc.

Microsemi Corporation

Spirit Airlines, Inc.

BofI Holding, Inc.

Tutor Perini Corporation

Headwaters Incorporated

Apogee Enterprises, Inc.

GTT Communications, Inc.

MicroStrategy Incorporated

Matthews International Corporation

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Contributors

The materials sector was the source of the portfolio’s greatest relative outperformance this quarter. Specifically, the portfolio benefitted as a result of relative outperformance within the building materials and glass industries.

Relative outperformance within the consumer discretionary and technology sectors also contributed positively to return, driven largely by relative outperformance within the funeral parlor, leisure time, communications technology, semiconductor andelectronic entertainment industries.

Performance within the producer durables sector, although neutral to overall relative performance due to the portfolio’s underweight position, experienced a strong contribution to performance from stock selection during the quarter. Within the sector, the portfolio achieved a solidly positive contribution to return from holdings within the air transport, aerospace and office supplies industries.

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DRIVEN BY RESEARCH WPERP Retirement 4th Qtr. 2016 Performance Review

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Top 10 Detractors to Return

Sarepta Therapeutics, Inc.

Opus Bank

Cornerstone Ondemand, Inc.

Sequential Brands Group, Inc.

Alder Biopharmaceuticals, Inc.

bluebird bio, Inc.

Intercept Pharmaceuticals, Inc.

Ophthotech Corp.

Imperva, Inc.

MacroGenics, Inc.

Detractors

The portfolio experienced modest relative underperformance within the energy and utilities sectors. Although there were no fundamental issues with the holdings in each of these sectors, stock selection proved to be a headwind to performance in each of the aforementioned, as the portfolio holdings within the oil: crude producers and tele‐communications industries underperformed the benchmark.

Portfolio Performance Summary

30


DRIVEN BY RESEARCH WPERP Retirement 4th Qtr. 2016 Performance Review

Market OutlookDRIVEN BY RESEARCH

For the trailing twelve month period, the portfolio trailed the benchmark as a result of challenging relative performance within the financial services, producer durables, and technology sectors. Interaction effect was the largest headwind to performance as stock selection for the year was a positive to contributor to return.

Performance within the financial services and producer durables sectors were the largest detractors to return. Relative performance was challenged as a result of the portfolio’s relative underweight to producer durables and disappointing stock selection within the financial services and technology sectors.

Partially offsetting the aforementioned was stock selection driven relative outperformance within the healthcare, consumer discretionary and utilities sectors.

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DRIVEN BY RESEARCH

31

Calendar Year 2016Performance Review


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32


DRIVEN BY RESEARCH WPERP RetirementCY 2016 Performance Attribution

‐5.00

‐4.00

‐3.00

‐2.00

‐1.00

‐‐

1.00

2.00

3.00

4.00

5.00

ConsumerDiscretionary

Energy FinancialServices

Health Care Materials &Processing

ProducerDurables

Technology Utilities

WPERP Retirement

Russell 2000 Growth

Market OutlookDRIVEN BY RESEARCH

At the stock level, top contributors included:

Burlington Stores, Inc.

Trex Company, Inc.

Microsemi Corporation

Veeva Systems, Inc.

WellCare Health Plans, Inc.

Installed Building Products, Inc.

GTT Communications, Inc.

Gigamon, Inc.

Tutor Perini Corporation

Spirit Airlines, Inc.

Conversely, top detractors to performance included:

Imperva, Inc.

Adamas Pharmaceuticals, Inc.

First NBC Bank Holding Co.

Acadia Healthcare Company, Inc.

Kforce Inc.

Korn/Ferry International

Impax Laboratories, Inc.

EPAM Systems, Inc.

MacroGenics, Inc.

Opus Bank

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WPERP Retirement CY 2016 Performance ReviewDRIVEN BY RESEARCH


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Section E: Portfolio Review & Characteristics

34

DRIVEN BY RESEARCH

Top Ten Holdings

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35


Company Ticker Sector % Held1. Veeva Systems, Inc. 2. Bank of the Ozarks, Inc.3. Microsemi Corp.4. Vonage Holdings Corp.5. Apogee Enterprises, Inc.6. GTT Communications, Inc. 7. BofI Holding, Inc.8. LendingTree, Inc. 9. 8x8, Inc.10. MicroStrategy, Inc.

VEEVOZRKMSCCVGAPOGGTTBOFITREEEGHTMSTR

HealthcareFinancial ServicesTechnologyUtilitiesMaterials & ProcessingTechnologyFinancial ServicesFinancial ServicesUtilitiesTechnology

2.462.202.141.991.881.761.731.691.681.66

WPERP Retirement Top Holdingsas of December 31, 2016DRIVEN BY RESEARCH

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36

WPERP Retirement Holdingsas of December 31, 2016DRIVEN BY RESEARCH


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38



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WPERP Ret. & Health Performance Detailas of December 31, 2016

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DRIVEN BY RESEARCH


WPERP Retirement Portfolio Sectorsas of December 31, 2016

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Portfolio Sector Allocation vs. Benchmark

Indicates weighting changed 0.5% or greater from previous quarter.

Sector Emerald Russell 2000 Growth* Russell 2000*

Consumer Discretionary 19.7% 16.7% 13.3%

Consumer Staples 0.0% 3.0% 2.6%

Energy 1.2% 1.0% 3.5%

Financial Services 14.1% 12.4% 28.4%

Health Care 15.4% 20.9% 12.1%

Materials & Processing 8.8% 9.9% 7.5%

Producer Durables 9.1% 15.0% 13.8%

Technology 23.7% 18.9% 14.2%

Utilities 4.6% 2.3% 4.6%

Cash 3.2% 0.0% 0.0%

42

* Source: Frank Russell Company – see full disclosure


DRIVEN BY RESEARCH

* Source: Frank Russell Company – see full disclosure, ** Database estimate, Emerald’s internal estimates are higher.

*** In order to better reflect Emerald’s characteristics relative to the Russell Indices, Emerald is now calculating its P/E, Price/Book, Price/Sales and Price/Cash Flow ratios based on a weighted harmonic average in line with Russell’s calculation methodology.

**** Representative account.

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43

Characteristic WPERP Russell 2000 Growth*

Projected Growth Rate (3‐5 Year)** 16.4% 15.0%

P/E Ratio (Trailing 1 Year) *** 25.7x 24.0x

P/E Ratio (Forward 1 Year) *** 22.4x 21.0x

ROE (Avg.) 14.7 16.5

R2 vs. Russell 2000 Growth**** 0.97 1.00

Yield (%) 0.71 0.82

Price / Book Value*** 3.2x 3.7x

Price / Sales*** 2.0x 1.5x

Price / Cash Flow*** 14.9x 12.1x

Median Market Cap (By No. of Stocks) $1,491 mm $872 mm

Wgt. Average Market Cap $2,236 mm $2,167 mm

Turnover (Trailing 12 mos.) 56% ‐‐‐

WPERP Retirement Portfolio Characteristicsas of December 31, 2016DRIVEN BY RESEARCH


Notice:“Frank Russell Company is the source and owner of the Russell Index data contained or reflected in this material and all trademarks and copyrights related thereto. This is a presentation of USER. The presentation may contain confidential information and unauthorized use, disclosure, copying, dissemination or redistribution is strictly prohibited. Frank Russell Company is not responsible for the formatting or configuration of this material or for any inaccuracy in USER’s presentation thereof.”

Russell Disclosure

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44Information contained herein should be used for one‐on‐one presentations only and should be accompanied by this disclosure.

DRIVEN BY RESEARCH

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3 Year Portfolio Risk Measures (Repr. Account)as of December 31, 2016

45

Performance Disclaimer ‐ The performance information reflected is approved for “One‐on‐One” client presentations only. The performance figures do not reflect the deduction ofinvestment fees; the investment advisory fees are described in Part II of Emerald Advisers’ Form ADV. For example, if a client placed $100,000 under management and a hypothetical grossreturn of 10% were achieved, the investment assets before fees would have grown to $259,374 in ten years. However, if an advisory fee of 1% of average net assets were charged,investment assets would have grown to $234,573, or an annual compounded rate of 8.9%. This includes all reinvestment of dividends.

Source: PSN, Universe: Small Cap Growth, Inception: 10/1/92, Period Type: Quarterly, Risk Index: Russell 2000 Growth, Riskless Index: 90 Day T‐Bill

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

-10

-5

0

5

10

15 8

9

10

11

12

13

14

15

16

17

-2

-1

0

1

2

3

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10 -0.2

-0.1

0.0

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0.8

0.9 0.5

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1.3 -0.2

-0.1

0.0

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20

HIGH (0.95)FIRST QUARTMEDIANTHIRD QUARTLOW (0.05)MEANVALID COUNT

R-Squared0.960.900.860.800.590.84128

Alpha6.122.530.04-1.93-4.860.36128

Std Dev Pop9.43

11.0212.1213.3315.5812.19128

Tracking Error Pop2.754.275.156.248.535.24128

Batting Avg0.750.580.500.420.250.49128

Beta0.610.790.880.961.150.88128

Sharpe Ratio Pop0.860.590.360.18-0.070.39128

Info Ratio Pop1.120.40-0.13-0.50-1.11-0.05128

Treynor Ratio13.408.514.932.59-0.995.50128

Emerald Advisers Emerald DiRussell 2000 Growth

VALUE RANK0.80 741.00 1

VALUE RANK2.68 230.00 50

VALUE RANK13.53 8112.70 64

VALUE RANK6.04 700.00 1

VALUE RANK0.67 50.00 99

VALUE RANK0.95 701.00 83

VALUE RANK0.54 320.39 46

VALUE RANK0.40 250.00 43

VALUE RANK7.69 304.91 50

DRIVEN BY RESEARCH

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Section F: Fee Schedule

46

DRIVEN BY RESEARCH

47

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Los Angeles Water & Power Employees’ Retirement Plan & Retiree Health Benefit Fee Schedule:

59.5 basis points on all assets

WPERP Fee ScheduleDRIVEN BY RESEARCH


1 | NTRI

INTERNAL REPORT Nutrisystem, Inc.

May 6, 2016 (NTRI - NASDAQ) Joseph W. Garner Update Report

Current Price $25.52 Rating Buy FY16 EPS $1.23 Book Value/Share $2.28 52-week High $30.92 Shares Out 29.4M EPS Growth Rate 15% Cash/Share $0.76 52-week Low $17.44 Market Cap 750.5M FY16 PE 20.7 Insider Ownership 2.9% Price Target $32.00 Avg. Daily Vol 448.1K FY16 PEG 0.7 Institution Ownership 98.3%

Business Description Nutrisystem, based in Fort Washington (PA), is a leading commercial weight loss company whose products

and services include a nutritionally balanced weight loss program, multi-day weight loss kits available at select retail locations, and digital tools to support weight loss. The company’s primary offering is a four-week food package direct shipped to the consumer that consists of breakfasts, lunches, dinners, snacks, and flex meal plan recipes that are supplemented with fresh fruits, vegetables, and dairy products. The meal plans feature more than 150 portion-controlled menu options at different price points including frozen and ready-to-go entrees, snacks, and shakes that serve as the foundation of a low Glycemic Index diet. Nutrisystem also offers comprehensive individualized counseling options from trained weight loss counselors, registered dietitians, and certified diabetes educators that are supplemented by the company’s digital weight loss tools. Nutrisystem generated over $460 million in revenues in 2015.

Competitive Advantages

Strong and Well-Established Consumer Brand – Nutrisystem is one of the most widely recognized brands in the commercial weight loss industry, as it has helped consumers with their weight loss goals for over 40 years. In the last eight year alone, the company has invested over $1.0 billion in marketing the Nutrisystem brand. According to ConsumerAffairs.com, Nutrisystem ranked as the #1 weight loss program brand for 2016. (https://www.consumeraffairs.com/nutrition/nutrition.htm#) The strength of the brand has enabled the company to successfully differentiate itself from a plethora of small, and often fad-oriented, competitors.

Time Tested Product Efficacy – Nutrisystem has a long term track record of demonstrated success in enabling consumers to meet their weight loss goals. The company’s proprietary consumer research found that its customers lost an average of one to two pounds per week and tended to stay on the program for eleven to twelve weeks. The company has also sponsored clinical research trials at leading academic centers in patients with Type 2 diabetes that demonstrated statistically significant and clinically meaningful weight loss and improvements in HbA1c, as well as improvements in secondary endpoints, such as waist circumference, total plasma cholesterol, and blood pressure.

Compelling Consumer Value Proposition – Nutrisystem offers consumers a convenient, private, and cost effective alternative to traditional weight loss programs. The company’s weight loss program is ordered via the Internet or telephone and is shipped directly to the consumer, providing the convenience and anonymity that weight loss programs delivered via weight loss centers cannot offer. In addition, the meals are clearly labeled and easy to prepare and eliminates the confusion of reading nutrition labels, measuring portions, or counting calories/points/carbohydrates. The Nutrisystem program is also priced at as little as $9.82 per day, positioning it as one of the most economical commercial weight loss programs.

Highly Efficient, Low Cost, and Scalable Business Model – Nutrisystem primarily operates via a direct-to-consumer distribution channel where it interacts with its customers via telephone and the Internet. As such, the company has avoided the fixed cost laden and capital intensive bricks-and-mortar weight loss center model employed by several of its competitors. The company has also streamlined its back-of-the-house operations by outsourcing the production of its food products and fulfillment operations to third party providers. As a result, the company has a largely variable cost-based operating structure that enables it to flex with demand in a relatively rapid manner. Also, capital requirements are relatively low, ranging from $7.6 million to $13.0 million, or less than 3% of total revenues, over the past three years. This has resulted in a highly profitable business model that generated a Return on Invested Capital of over 65% and Free Cash Flow of over $40 million in 2015. Nutrisystem’s flexible and highly profitable business model enables the company to respond to the market in a relatively time efficient manner and provides the company with the cash flow

2 | NTRI

necessary to aggressively pursue growth investments such as product innovation, program marketing, and acquisitions, while paying an attractive dividend and funding share repurchases.

Assessment of Management Nutrisystem is led by its President and CEO Dawn M. Zier. Ms. Zier joined the company in November 2012,

after having served in several executive capacities at RDA Holding Co., the parent of The Reader’s Digest Association, including President of International, President of Europe, and President of Global Consumer Marketing. She is an accomplished Direct Marketing executive, having received the 2014 Direct Marketer of the Year award from Target Marketing and the 2014 Silver Apple Award from Direct Marketing New York. Since arriving at Nutrisystem, Ms. Zier has implemented a strategy that has successfully turned around the company’s financial performance and returned the company to a growth path by refocusing on product innovation, weaning the business from persistent discounting, offering customizable programs featuring premium food offerings, implementing a more disciplined data-intensive approach to marketing, and streamlining the cost structure. She has also rebuilt the company’s senior management team, most notably through the additions of Chief Marketing Officer Kiera Krausz (previously served in senior marketing and business development roles with Animated Storyboards, Time, Inc.’s QSP subsidiary, and Reader’s Digest Association) and Chief Financial Officer Michael P. Monahan (previously served in senior finance related positions with PetroChoice Holdings, Exelon, and Accenture, as well as Nutrisystem’s VP of Finance). The financial results produced by Ms. Zier’s team have been impressive. After six consecutive years of declining revenues, Nutrisystem returned to a double-digit revenue growth rates in 2014 and 2015. In addition, over the period of 2012 to 2015 the company realized a more than four-fold improvement in both EPS and Return on Invested Capital to $0.96 per share and 65.6%, respectively.

Nutrisystem’s corporate governance standards are relatively strong. The company has a non-classified Board of Directors that consists of several accomplished consumer products and media executives and includes only one insider (Ms. Zier). The company also operates under a “pay-for-performance” model where over 70% of executive compensation is driven by performance based incentives, including the achievement of revenue, adjusted EBITDA, and EPS targets. While management equity holdings are meaningful at 2.9% of the total shares outstanding, we would prefer to see a higher level of equity ownership by officers and directors further aligning the interests of management with shareholders.

Growth Drivers

Nutrisystem is Addressing a Large and Growing Market – According to the National Institutes of Health (NIH), 35.7% of the U.S. adult population is considered to be obese with over 6% of the adult population considered to be extremely obese. The prevalence of obesity is similar for both men and women, however 74% of the adult male population is considered to be either overweight or obese. In addition, nearly one-third of children and adolescents are considered to be overweight or obese. This is leading to several health concerns, including a rising rate of individuals with diabetes, which topped 29 million individuals in 2014, according to the Center for Disease Control and Prevention. As a result, the U.S. weight loss market grew to a sizable $64 billion in 2014, according to Marketdata Enterprises. Nutrisystem represents less than 1% of the overall domestic weight loss market, despite being a leading commercial weight loss program, offering considerable opportunity for further market penetration.

Attracting New Customers and Re-Activating Prior Customers – Under the direction of the company’s new senior management team, Nutrisystem has emphasized product innovation and customizable programs featuring premium food offerings backed by a highly effective data-intensive approach to marketing. This has resulted in a refreshed and revitalized brand that has proven effective in attracting new customers and re-activating prior customers. In 2015, new customer revenues grew 15% y/y driven by increased customer starts, improved pricing, and a longer length of stay. At the same time, reactivation revenues grew 7% y/y and represented a meaningful 25% of total revenues. The trends remained strong in Q1-16 as new customer revenues grew 15% y/y and reactivation revenues accelerated to also grow 15% y/y. We believe that the company is well positioned to continue to generate double-digit revenue growth for the foreseeable future.

South Beach Diet Represents a Compelling Second Brand Offering – In December 2015, Nutrisystem acquired The South Beach Diet brand from SBD Holdings Group for $15 million, including the addition of South Beach Diet founder Dr. Arthur Agaston to Nutrisystem’s Science Advisory Board. Nutrisystem is gearing up for the launch of a South Beach Diet weight loss program into the direct-to-consumer channel in January 2017. During 2016, the company plans to invest $3 million ($0.09 per share) in product marketing, website development, product development, clinical trials, and back-office infrastructure. The South Beach Diet

3 | NTRI

represents a meaningful second brand under the Nutrisystem umbrella and an intriguing growth opportunity for the company. Given the relatively modest acquisition price and launch costs, we estimate The South Beach Diet program has the potential to become a highly accretive offering for the company. Assuming an incremental profit margin of 15%, we estimate Nutrisystem will generate a positive payback when it exceeds $120 million in revenues, which will likely be achieved by 2018. We estimate that The South Beach Diet program has the potential to add over $0.10 per share in incremental EPS in 2017 and over $0.25 per share in incremental EPS in 2018.

A Menu of Additional Growth Opportunities – Nutrisystem is also pursuing a number of additional growth opportunities in the areas of innovative product offerings and new distribution channels. For example, in Q1-16 the company entered the Health & Wellness category with the introduction of Shake360, a shake-based meal supplement that offers three servings of vegetables and 16 grams of plant protein, along with probiotics and antioxidants in each shake. Nutrisystem has also been expanding its presence in the retail distribution channel with Wal Mart and several leading grocers through the offering of five-day meal packages and individually packaged snacks and Nutrisystem-branded products. Nutrisystem’s retail revenues grew 28% in 2015 to $35 million. After a slow start to 2016, retail revenues are expected to be relatively flat on a y/y basis in 2016 before resuming growth in 2017. In aggregate, we believe new product categories and new distribution channels have the potential to represent meaningful incremental growth opportunities for the company.

Operating Margin Expansion – Over the past three years, Nutrisystem has realized a dramatic improvement in its operating profit margin from 2.59% in 2012 to 9.27% in 2015. However, the company remains well below the peak profit margins in the 20%-25% range realized in 2006 and 2007. While we do not expect Nutrisystem to approach its prior peak margins in the foreseeable future as the company continues to invest in the development of new product offerings (South Beach Diet and Shake360) and new distribution channels (retail expansion), we do believe the company has a meaningful opportunity to expand its operating profit margin to a mid-teens percent of revenues by better leveraging marketing and general and administrative expenses. We estimate that each 100 basis point improvement in the operating profit margin will boost EPS by over $0.11 per share, based on the company’s current revenue run-rate.

Issues / Risks The most notable risks associated with Nutrisystem shares include the following:

The highly fragmented and competitive nature of the weight loss industry. Nutrisystem must remain competitive in the areas of program efficacy, price, taste, customer service, and brand recognition. Competition ranges from commercial weight loss programs, pharmaceutical providers, packaged diet food companies, nutritional supplement providers, and self-dieting.

The fad oriented nature of consumers with regard to dieting, which can result in dramatic shifts in market share from one year to the next.

Nutrisystem’s reliance on third party food manufacturers. The company could be challenged if it is unable to obtain sufficient quantity, quality, and variety of food offerings from its vendors. While the company’s supplier base is relatively diversified, its two largest vendors represented 19% of inventory purchases in 2015.

The ability of Nutrisystem’s management team to successfully establish The South Beach Diet as a commercial weight loss program, which is a change from the brand’s primary prior positioning as a self-directed diet program.

The company’s reliance on developing and efficiently deploying highly effective advertising and marketing programs.

Summary and Recommendation Nutrisystem has been revitalized under the leadership of its new senior management team, firmly positioning

the company as a sales leader and innovation leader in the commercial weight loss industry. The company has realized a recovery in new customer volumes and is re-activating prior customers at a much higher rate, leading to a dramatic improvement in the company’s revenue growth rate. In addition, the company continues to innovate in the areas of developing premium product offerings (Uniquely Yours), new weight loss programs (The South Beach Diet), and more engaging marketing programs. This has led to a dramatic recovery in both revenue and EPS growth with revenue growth of 15% and EPS growth of 28% estimated for 2016. We believe the company’s growth

4 | NTRI

prospects are not fully reflected in the share price with the stock trading at 21x estimated 2016 EPS and only 17x estimated 2017 EPS, which is well below the company’s estimated earnings growth rate of over 25% for the next two to three years. The valuation appears even more compelling on an EV/EBITDA basis where Nutrisystem is trading at 11.0x estimated 2016 EBITDA and 8.8x estimated 2017 EBITDA, as the stock is actually trading at a discount to its financially and strategically challenged commercial weight loss industry peers on 2017 estimates. Our 12-month price target is $36 per share, or 22.5x our 2016 EPS estimate, representing upside potential of over 40%. We rate Nutrisystem shares as a BUY.

Financial Summary

NTRI Annual Results

FY15 FY16 FY17 FY15 3-15 6-15 9-15 12-15

Revenue 462.6M 531.6M 664.8M Revenue 137.2M 130.3M 104.9M 90.2M EPS 0.89 1.23 1.57 EPS 0.10 0.42 0.25 0.19 Y-Y Rev Growth 14.8% 14.9% 25.0% Y-Y EPS

Growth 34.8% 28.2% 28.1% FY16E 3-16 6-16 9-16 12-16

Comments Revenue 162.1M 149.0M 119.0 101.6 Estimates reflect Emerald estiamtes EPS 0.13 0.51 0.35 0.24 Y-Y Rev

Growth 18.1% 14.4% 13.5% 12.5%

Y-Y EPS Growth

29.1% 23.5% 38.8% 23.7%

Additional Data

Current Price 25.52 12-month High 30.92 12-month Low 17.44 FY End 12/2015 Dividend 0.7 Shares Outstanding 29.4M

Shares Short 2.1M Avg Daily Vol 448.1K Cash and ST Invest 15.5M ST & LT Debt 0.0M

Updated: 5/6/16

FY Share 52-wk 52-wk Market EV FY2016 FY2017LT

Growth FY2016 FY2017 FY2016 FY2017 FY2016 FY2017 FY2016 FY2017End Price High Low Cap. ($M) ($M) EPS EPS Rate (%) P/E P/E Rev ($M) Rev ($M) EBITDA EBITDA EV/EBITDA EV/EBITDA

Weight Watchers International, Inc. WTW Dec $13.36 $26.61 $3.78 $852.8 $2,791.3 $0.94 $1.19 -4.20 14.2x 11.2x $1,208.8 $1,270.1 $272.38 $290.71 10.2x 9.6xNutrisystem, Inc. NTRI Dec $25.99 $30.92 $17.44 $763.6 $737.5 $1.23 $1.57 17.50 21.2x 16.6x $531.6 $664.8 $67.34 $83.80 11.0x 8.8xMedifast, Inc. MED Dec $34.42 $34.95 $26.67 $407.7 $336.2 $1.82 $2.02 #N/A 18.9x 17.0x $281.9 $298.7 $37.70 $39.20 8.9x 8.6x

$674.7 $1,288.3 #N/A 18.1x 14.9x 10.04x 8.99x

Commercial Weight Loss

1 | KTOS

INTERNAL REPORT Kratos Defense & Security Solutions, Inc.

December 13, 2016 (KTOS - NASDAQ) Andrew D. Rohrer Initial Report

Current Price $7.84 Rating Buy FY16 EPS -$1.00 Book Value/Share $3.37 52-week High $7.94 Shares Out 72.2M EPS Growth Rate 10% Cash/Share -$0.39 52-week Low $2.99 Market Cap 566.0M FY16 PE #N/A Insider Ownership 21% Price Target $9.00 Avg. Daily Vol 905.9K FY16 PEG #N/A Institution Ownership 41.7%

Business Description Kratos is a provider of a high technology military products. The company separates its offerings into three

reporting segments. Kratos Government Solutions (“KGS”) includes the company’s microwave electronic products, satellite communications, modular systems and defense and rocket support operating segments. The Unmanned Systems (“US”) reporting segment includes unmanned aerial, ground, seaborne, and command, control and communications system businesses, and the Public Safety & Security (“PSS”) segment designs maintains and operates security and surveillance solutions, which include cameras and related software.

The company has a $900m backlog, $580m of it funded. Management has line of sight to a $6B pipeline of potential work and ~$1B of that pipeline will be submitted for bid in the next several months. Kratos employs 2,800 people is headquartered in San Diego, California.

Competitive Advantages

Ownership of intellectual property– Kratos owns its intellectual property, so on project wins the company is sole sourced. They own the data package.

Unmanned Aerial Vehicle expertise– Kratos has unique expertise in unmanned aerial vehicles (UAV’s). The units that compose the vast majority of the United States UAV fleet are propeller-driven and are designed to compete in uncontested environments (where the United States “owns” the skies). Future conflicts, particularly with Russia or China would require a much more capable unmanned aircraft. That is the solution that Kratos provides. The company has taken rocket-propelled unmanned target drones and converted them to fully functioning tactical combat aircraft – capable of flying alone, or with manned flight and directed as swarms. Over the past 1.5 years there have been a number of government procurements for high-performance, jet-powered, unmanned aerial drone aircraft. Kratos has won every one of those.

Wolf pack expertise– Being able to manage a swarm is a force-multiplier. Working with a “wolf pack” swarm where a minimum of 20 drones can be controlled by single operator (wing-man) would make an individual manned aircraft far more effective. Kratos has deep expertise in this technology.

Scarcity Factor– The defense industry base has declined significantly. There are less than five stand-alone products companies. Most have been acquired or operate as a duopoly. There are high-barriers to entry in the industry and management expects further consolidation. This potentially positions Kratos as a take-out candidate. (Harris Corp. bought Kratos peer Exelis for $4.56B in February, 2015).

Assessment of Management Eric DeMarco has been Chief Executive Officer of Kratos since April, 2004. Prior to joining the company Mr.

DeMarco served as Chief Operating Officer of The Titan Corporation, a publically traded company that specialized in providing communications solutions to intelligence agencies and the Department of Homeland Security. Prior to his tenure at The Titan Corporation Mr. Demarco held public accounting positions within multi-national and publically traded companies. Mr. DeMarco holds a Bachelor’s degree in Business Administration and Finance from the University of New Hampshire.

Deanna Lund has been Chief Financial Officer of Kratos since 2004. Prior to working at Kratos, Deanna also worked at The Titan Corporation from 1998-2004 in senior roles of Operations Analysis. Ms. Lund is a Certified Public Accountant and previously worked at Arthur Anderson. She holds a Bachelor of Science degree in Accounting from San Diego State University.

2 | KTOS

We believe this management team is very capable of growing top and bottom line results. Since 2004 sales have grown from $397m to an expected $665m in 2016, while EBITDA has grown from $28m to full year 2016 expectations of $43m. The company’s Board of Directors includes entrepreneurs and Silicon Valley based Venture Capitalists which also brings a wide array of technical and government experience to the company.

We believe Kratos has adequate corporate governance practices. There are eight board members and, other than Mr. DeMarco, all are defined as independent by NASDAQ Stock Market listing standards.

Growth Drivers

Unmanned Systems Growth – Kratos is targeting growth within its Unmanned Systems segment which currently accounts for ~10% of total company revenue. This includes a focus on the United States future Unmanned Combat Aerial System (UCAS). Key goals of the UCAS system include aircraft that are remotely piloted in contested environments, autonomous support of fourth and fifth generation fighter aircraft and force multiplication via swarming technologies. In order to address these needs, Kratos has developed products and won two notable programs, with a third hopeful win in early 2017:

Gremlins: Kratos was the prime awardee on the DARPA Gremlins program. Under Gremlins a C-130 aircraft releases a swarm of high-performance drones which perform their mission and are then recovered in-flight by the C-130. Kratos makes the drones. Each sells for ~$700,000 and the total addressable market is “several hundreds of millions of dollars, up to billions.”

Low Cost Attributable Strike Unmanned Aerial System Demonstration (LCASD): The main goal of the LCASD program is to provide a high-performance UAV that can be configured for multiple mission scenarios. The aircraft is a retrofitted target drone that could be launched from small bases without runways and could be recovered or sent on one-way missions. In winning this program Kratos beat seven other competitors in July of 2016. The initial contract terms includes $7.3m in government funding, while Kratos will invest ~$33.5m over the 30 month period of performance. Potential spirals associated with this contract are valued at $100m. The aircraft sell for $3m or less for the first 99 units, $2m for or less for greater than 100 units. The aircraft must have a 3,000 mile mission radius and carry a 500lb. flexible payload and be capable of traveling Mach 0.9.

Industry literature anticipates that hundreds, if not thousands, of these two program aircraft will be built.

UTAP-22: is an unmanned “wing-man” aircraft that is 20 feet long with a wingspan of 10 feet. Kratos received an initial contract of $12.6m, one of the largest contracts given to date, to integrate sensor payloads for large, complex military exercises. This aircraft will fly in the first half of 2017 which management hopes will lead to production. The goal of the UTAP-22 program is to have support aircraft serve either fully autonomous or semi-autonomous roles. Each aircraft sells for $1m-$3m per aircraft and the total addressable market is “hundreds of millions of dollars”.

Satellite, Technology & Training – While the most notable near term drivers of revenue and earnings growth are likely to be in Unmanned Systems, we believe the company’s Satellite communications offerings will also benefit results. Kratos is the industry leader in radio frequency interference, monitoring and geolocation. The company maintains and protects a majority of U.S. satellite systems today and offers command and control systems, satellite monitoring systems and signal intelligence systems.

Satellite Command & Control is a ~$200m-$210m annual run rate business growing at mid-single digits. Kratos provides software and hardware that allows for secure network access for Department of Defense systems and commercial systems that the DoD leases. Kratos has 85% market share in the Satellite Command & Control area. This work is typically done at large stations where Kratos provides the systems (not out in the field).

The company also offers technical training and has recently booked some notable wins:

August, 2016: The KC-46 Pegasus tanker High Fidelity Maintenance Training System has an initial contract value of $20m. The KC-46 is the Air Force’s newest air refueling tanker aircraft and Kratos will deliver to Boeing full-scale simulators for realistic training.

September, 2016: The Marine Common Aircrew Trainers (MCAT) has an initial contract value of $54m. Kratos will provide a common training device for the Marine Corps to train crews on the USMC CH-53E Super Stallion (helicopter), MV-22B (Osprey), UH-1Y Venom (helicopter).

3 | KTOS

October, 2016: The JFCC/USS Stratcom Global Satellite has a contract value of $6.2m and expands radio frequency monitoring, interference detection and geolocation services. The contract will add seven new worldwide monitoring sites, host 60 antennas and provide visibility to over 50 satellites.

Increased Federal Defense Spending – Kratos business is 62% exposed to the Federal government. Department of Defense budgets for each fiscal year extend from October 1 through September 30. The Budget Control Act of 2011 resulted in a 7.8% reduction in the Department of Defense budget. Spending levels remained at a base of ~$496B in FY 2014 and FY 2015. In FY 2016 the discretionary defense budget was raised ~$50B to $548B and that number is expected to be $30B higher than the base in 2017, according to the Bipartisan Budget Act of 2015. We believe the Department of Defense environment has improved and its spending is focused on perceived threats that directly intersect with the system areas that Kratos supports. Over the last five years $500B was cut from the U.S. defense budget, an environment that now appears to be changing. Management feels confident that Republicans in the House, Senate and Presidency will offer a catalyst for defense-related spending.

Drone Target System Growth – Within the Unmanned Systems business Kratos also provides jet powered unmanned aerial drone target systems. On November 30, 2016 the company announced a contract award for multiple systems with production expectation expected to begin in 2016. While the exact terms and size of this agreement cannot be released (the unmanned target drone system is expected to be produced at a secure facility), this announcement does move the company towards its goal of doubling the Unmanned Systems business within 24 months.

Issues / Risks Kratos is heavily exposed to U.S. government spending. In 2013, 2014 and 2015 U.S. government contracts

accounted for 62%, 57% and 61% respectively, of total revenue. If U.S. government spending priorities were to shift away from defense-related expenditures Kratos could be negatively impacted.

If the key markets targeted by Kratos continue to grow the competitive landscape may grow intense. Many of the company’s competitors are larger companies with greater resources and economies of scale. This could force Kratos to lower price to remain competitive and therefore negatively pressure margins.

We believe that by maintaining strong government relationships, keeping tight control of the company’s intellectual property and focusing on high-growth areas of development, Kratos is well positioned to benefit from its technological advantages.

Summary and Recommendation We believe Kratos offers a unique opportunity to invest in a growing defense-related name with clear barriers to

entry and identifiable growth drivers. Management has guided investors to a multi-year target of $800m in revenue and $80m in EBITDA, up from 2016’s estimated $664m in revenue and $43m in EBITDA. From a previously operated commercial wireless business the company has $300m in net operating losses that can be utilized up to $11.6m annually. Cash taxes over the last two years have been $2-$2.5m. The company’s diverse contract base means that as of September 25, 2016 no contract represented more than 5% of revenues.

We believe the high scarcity value of such a stand-alone company that owns its intellectual property and is sole-source for its products also makes this investment attractive. After three years of declining revenue the company appears to be at an inflection point as growth from new contract wins in the Gremlin, LCASD programs and UTAP-22 offer significant upside to both top and bottom lines. Management expects the UAV business to double through the next 24 months due additional contributions from aerial target drone wins as well as production of the U.S. Navy’s BQM-177A sub-sonic aerial target drone, which is expected to begin production in 2017. Unmanned Systems has a high fixed cost model and with a large portion of the up-front investment already in place, we believe Kratos will have a high degree of operating leverage moving forward.

We believe the company can generate $720m in revenue in 2017 and EBITDA of over $54m. If, as expected, the UAV business does double, then the company’s stated goal of $800m in revenue and $80m in EBITDA appears achievable. We are therefore initiating coverage of Kratos with a BUY rating and a $9 price target, equivalent to ~13x EV/EBITDA. This valuation incorporates this aggressive growth in the UAV business beginning in 2017.

4 | KTOS

Financial Summary

KTOS Annual Results

FY15 FY16 FY17 FY15 3-15 6-15 9-15 12-15

Revenue 657.1M 664.2M 705.7M Revenue 182.5M 160.5M 161.7M 177.5M EPS -1.04 -1.00 -0.19 EPS -0.28 -0.26 0.92 -0.08 Y-Y Rev Growth -24.3% 1.1% 6.2% Y-Y EPS

Growth -23.0% -3.6% -80.6% FY16E 3-16 6-16 9-16 6-17

Comments Revenue 153.0M 168.2M 165.4M 175.5M Estimates reflect sell-side consensus EPS -0.37 -0.17 -0.39 -0.06 Y-Y Rev

Growth -16.2% 4.8% 2.3% -1.1%

Y-Y EPS Growth

#N/A #N/A -142.4% #N/A

Additional Data

Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan2

3

4

5

6

7

8

9

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

Source: FactSet Prices

Kratos Defense & Security Solutions, Inc. (KTOS-US)Volume (Thousands) Price (USD)

Volume Kratos Defense & Security Solutions, Inc.

Current Price 7.84 12-month High 7.94 12-month Low 2.99 FY End 12/2015 Dividend 0 Shares Outstanding 72.2M


Updated: 12-July-2016

FY Share 52-wk 52-wk Market EV FY2016 FY2017 LT Growth FY2016 FY2017 FY2016 FY2017 FY2016 FY2017 FY2016 FY2017 FY2016 FY2017End Price High Low Cap. ($M) ($M) EPS EPS Rate (%) P/E P/E Rev ($M) Rev ($M) P/S P/S EBITDA EBITDA EV/EBITDA EV/EBITDA

Kratos Defense & Security Soluti KTOS Dec $7.17 $7.94 $2.99 $517.6 $954.0 ($1.01) ($0.19) #N/A -7.1x -38.4x $664.7 $720.0 1.44x 1.33x $43.03 $54.00 22.2x 17.7x

Northrop Grumman Corporation NOC Dec $233.54 $251.80 $178.19 $41,164.2 $46,448.2 $11.72 $12.11 8.29 19.9x 19.3x $24,027.1 $24,027.1 1.93x 1.93x $3,554.07 $3,737.29 13.1x 12.4x

Raytheon Company RTN Dec $142.98 $150.54 $117.62 $41,985.6 $44,881.7 $7.46 $7.41 8.60 19.2x 19.3x $24,428.3 $24,428.3 1.84x 1.84x $3,753.28 $3,718.04 12.0x 12.1x

L‐3 Communications Holdings, InLLL Dec $155.25 $161.56 $108.05 $12,002.2 $15,005.2 $7.96 $8.38 23.92 19.5x 18.5x $10,309.7 $10,309.7 1.46x 1.46x $1,202.32 $1,284.77 12.5x 11.7x

Lockheed Martin Corporation LMT Dec $252.18 $267.62 $206.08 $73,882.9 $85,398.9 $12.22 $12.70 8.60 20.6x 19.9x $46,517.9 $46,517.9 1.84x 1.84x $6,797.39 $6,969.30 12.6x 12.3x

General Dynamics Corporation GD Dec $174.63 $178.67 $124.18 $53,178.3 $54,761.3 $9.79 $10.06 7.31 17.8x 17.4x $31,416.8 $31,416.8 1.74x 1.74x $4,794.36 $4,832.36 11.4x 11.3x

Orbital ATK, Inc. OA Dec $87.33 $94.55 $70.79 $5,113.8 $6,642.6 $5.51 $6.00 9.66 15.9x 14.5x $4,452.5 $4,452.5 1.49x 1.49x $672.95 $697.99 9.9x 9.5x

OSI Systems, Inc. OSIS Jun $75.50 $92.09 $49.16 $1,439.3 $1,663.7 $2.11 $2.87 18.00 35.8x 26.3x $829.7 $829.7 2.01x 2.01x $136.80 $165.78 12.2x 10.0x

$28,660.5 $31,969.4 #N/A 17.7x 12.1x 1.72x 1.70x 13.21x 12.12x

Defense Contractors

1 | MRCY

INTERNAL REPORT Mercury Systems

27th February 2016 (MRCY – NASDAQ) Nathan Jones, Ph.D., MBA Initial Report

Current Price $19.43 Rating Buy FY16 EPS $0.71 Book Value/Share $10.87 52-week High $20.96 Shares Out 34.8M EPS Growth Rate 22% Cash/Share $0.95 52-week Low $13.49 Market Cap 676.7M FY16 PE 27.7 Insider Ownership 5.0% Price Target $27.00 Avg. Daily Vol 188.2K FY16 PEG 2.8 Institution Ownership 91%

Business Description

MRCY sells supercomputing subsystems into embedded platforms for the DoD, making them similar to an embedded Cray-like computing solution with very little to no competition for new program bids and an extremely high win rate.

Mercury has been public since 1998. They are a very selective, program-based defense subcontractor that

is ultimately reliant on budgetary funding, but resides in the areas of the budget that see rising tide regardless of budget cuts (exception was the sequestration that hurt 2013 in a big way, company stock just recovering now). The defense budget is currently in a stovepipe situation, not a rising/lowering tide situation, i.e. areas that are more important get the funding now while less important areas get cut completely. Mercury’s largest customers are Raytheon, Lockheed, and Boeing with Mercury selling embedded subsystems that go into their products. Competitive Advantages

Highest-end INTC server-class processing subsystems and incredible security are difficult to replicate leading to fewer competitors in a time when more primes are outsourcing – Mercury builds the latest INTC server-class processing subsystems. They outsource board-level manufacturing (buy chips, RF, microwave, and memory elements) and then adapt them with very advanced modular designs. They are specifically adapted for nanosecond response time in any environmental conditions as RADAR and EW systems need to know what’s following you at all times and can never fail.

Defense industry has cut its ability to innovate b/c of sequestration – Technology-dev cycles are much quicker today such that a decade makes things obsolete as soon as they come to market. Primes no longer want to spend money on basic integration, because they can no longer spend money now for something that doesn’t differentiate, making Mercury much more essential.

Bow wave of retirement age engineers in workforce – CEO of Lockheed said 50% of workforce in engineering will be eligible for retirement in 5 years. This is making them willing and ready to ‘dis-integrate’ and partner and be more oriented towards outsourcing.

Unique business model that allows Mercury to operate as a high-tech commercial company – Internal R&D funds the development of modular, reusable, open innovation. Pre-integration improves affordability and time to market with ability to rapidly customize and adapt to new platforms. The traditional COTS board model has been broken because of defense procurement reform. Less cost-plus, government-funded integration means that under firm fixed pricing, the prime contractors bear significant risk and expense, driving more and more willingness to outsource pre-integrated subsystems. Mercury’s approach results in more affordable, lower risk, simplified supply chain. Their open architectures and middleware speed adoption. Mercury is pioneering a truly next-gen defense electronics business model with unique technology and capabilities on key production programs. This is driving well above average growth and

2 | MRCY

dramatic improvement in profitability. The business platform is built to grow further through both organic and acquisitive means.

Figure 1. Mercury is in the ‘sweet spot’ of a new and evolving DoD landscape that involves significant outsourcing of R&D by prime contractors.

Assessment of Management Mark Aslett, CEO – He has re-centered the company around core defense processing, very high-end computing embedded data-intensive applications. Mark has been with company for 7-8 years, and he stepped into a bit of a turnaround in 2008-2009 timeframe. Gerald Haines, CFO – Previously, he had a 10-year working history with Mercury’s CEO through his position at a prior company (Gerry has been with MRCY 5 years)..

Growth Drivers

Prime outsourcing is set to continue to occur at an increasing rate going forward – Defense electronics is currently a $35B market, but the captive market is 19X the COTS merchant supply. Outsourcing growth is not tied to increased defense spending and is expected to occur at an accelerated rate going forward (see grey inset bars in graph below, 8% CAGR vs. total market 1% CAGR). Primes are more willing than ever to outsource to more capable suppliers that are willing to invest and share risk.

3 | MRCY

Figure 2. Expectations for continued prime outsourcing as the fastest growth segment within the broader framework of DoD budget.

Figure 3. Amidst this backdrop of prime outsourcing, defense budgetary environment is improving significantly, with 2016 representing the first step-function change upwards since 2012, and the growth projected to remain healthy through 2020.

Key program values and pipeline opportunities are accelerating – Mercury has a low-risk content expansion growth strategy driven by key production programs. In their investor presentation, management highlights growth in total potential value 2.5X to $4B during the past three years. At the same time, they converted 1.4X of possible to probable value in RADAR (65%) and electronic warfare (35%).

4 | MRCY

Figure 4. Key programs by segment and value.

Figure 5. Current and future key programs delineated by size and duration. A large number of awards are set to be awarded during the next 12-18 months, including the >$1B F-35 award set for later this year. This sets the stage for very strong multi-year growth curve that coupled with accelerating backlog and strong defense spend should lead to acceleration in top-line growth and earnings power.

5 | MRCY

Issues / Risks

Competition from larger, well-capitalized competition – While no true analog to Mercury exists outside ofthe primes themselves, GE and Curtis Wright are strong in processing whereas Teladyne is strong in RF subsystems. Given that Mercury pre-integrates across these capabilities, we believe these competitors pose little risk to Mercury’s more affordable, simplified supply chain where the prime deals with only one vendor instead of 10.

Defense budget – While the defense budget is the best it has been in years for Mercury, this will be a constant need for monitoring as even the perception of negative defense budget could knock the stock down and compress the multiple, even if Mercury’s programs and growth rate don’t actually get cut.

6 | MRCY

Summary and Recommendation Mercury’s business currently resides in the sweet spot of the improving DoD budgetary landscape. The

company is growing effectively through a combination of organic (~10-12% CAGR) and acquisitive means. The recent acquisition of Microsemi’s RF/MW business puts Mercury on an entirely new growth trajectory and affords the company with myriad bottom- and top-line synergies going forward. To highlight a few of the key advantages of this acquisition: 1.) de novo market opportunities in munitions and seeker technologies, 2.) shifting MSCC’s distribution model to a direct relationship with the prime contractors, 3.) obtaining a secure, trusted DoD mftg facility, and 4.) critical embedded security features of MSCC’s products that fit in perfectly with MRCY’s ‘made in the USA’ mantra. On balance, Mercury continues to pioneer a very attractive next-gen defense business model in which defense primes are outsourcing more and more R&D to subsystem vendors such as Mercury. There is limited/decreasing competition as the barriers to entry are high and continue to mount; we believe this positions Mercury quite well for many years into the future.

After the acquisition closes, we see potential for FY17 and FY18 revs/EPS of $376M/$1.20 and $412M/$1.49. This will drive EBITDA to the $112M by FY18. Given the durable, long-lived growth rate, we value at 11X FY18 EBITDA and 18X FY18 P/E, which leads us to a 1-yr PT of $27. If organic revenue growth accelerates beyond 11% as we have modeled, we see potential for further upside due to an expanding multiples. Our 18-24 month price target is $35. At an expected deal price ~$19, we see 42% upside to current share price.

MRCY stock should move into the high-20s over the next year, as we believe that management has left ample room for upside as well as potential for significant new program catalysts. Management has continued to guide to a modest 7% top-line and 11% bottom-line growth. Then organic trailing 3-yr revenue CAGR is 11% in a poor defense budgetary environment. Given the improvements in defense budgets echoed across the board from companies we’ve spoken to recently, we believe that Mercury’s top-line can accelerate beyond 10% to the 12-14% range going forward. Supporting this thesis is the 24% bookings CAGR over the past three years while revenues have only increased at a 10% CAGR and book-to-bill exceeding 1.2 in recent quarters. We expect that as top-line growth accelerates, bottom line growth will approach high-teens to low-twenties going forward. In contrast to past years, Mercury now enters their fiscal year with >70% revenue coverage as opposed to 35% in previous years, derisking the need for new wins as the year progresses; most programs are 20 years or more in length, including 300 total defense programs with 25 primes.

7 | MRCY

Financial Summary

MRCY Annual Results

FY15 FY16 FY17 FY11 3-14 6-14 9-14 9-14

Revenue 234.8M 252.4M 303.8M Revenue 55.5M 53.7M 54.1M 54.1M EPS 0.31 0.71 0.79 EPS -0.02 -0.24 0.02 0.02 Y-Y Rev Growth 12.5% 7.5% 20.4% Y-Y EPS

Growth -183.8% 129.0% 11.8% FY12E 12-14 6-15 9-15 12-12

Comments Revenue 59.6M 64.1M 58.4M 58.4M Estimates reflect sell-side consensus EPS 0.11 0.18 0.06 0.14 Y-Y Rev

Growth 7.5% 19.5% 8.0% 8.0%

Y-Y EPS Growth

-650.0% -175.0% 200.0% 1300.0%

Additional Data

Current Price 19.43 12-month High 20.96 12-month Low 13.49 FY End 06/2015 Dividend 0 Shares Outstanding 34.8M


Updated: 30-Oct-2012

FY Share 52-wk 52-wk Market EV FY2017 FY2018 LT Growth FY2017 FY2018 FY2017 FY2018 FY2017 FY2018 FY2017 FY2018 FY2017 FY2018

End Price High Low Cap. ($M) ($M) EPS EPS Rate (%) P/E P/E Rev ($M) Rev ($M) P/S P/S EBITDA EBITDA EV/EBITDA EV/EBITDA

Mercury Systems, Inc. MRCY Jun $19.43 $20.96 $13.49 $794.0 $936.0 $1.20 $1.46 22.00 16.2x 13.3x $375.0 $412.0 2.12x 1.93x $94.00 $112.00 10.0x 8.4x

Curtiss‐Wright Corporation CW Dec $74.65 $77.08 $61.97 $3,330.7 $3,996.3 $4.55 $5.12 11.23 16.4x 14.6x $2,258.6 $2,391.0 1.47x 1.39x $440.86 $483.00 9.1x 8.3x

FLIR Systems, Inc. FLIR Dec $32.40 $33.78 $26.01 $4,456.9 $4,342.6 $1.86 $2.21 15.00 17.4x 14.7x $1,712.6 $1,808.3 2.60x 2.46x $401.49 $443.95 10.8x 9.8x

Harris Corporation HRS Jun $75.06 $89.48 $70.28 $9,356.5 $13,872.5 $6.12 $6.75 #N/A 12.3x 11.1x $7,701.3 $7,880.0 1.21x 1.19x $1,676.70 $1,772.40 8.3x 7.8x

Northrop Grumman Corporation NOC Dec $202.27 $202.27 $153.28 $36,645.7 $40,742.7 $11.96 $13.83 12.00 16.9x 14.6x $24,781.3 $26,620.6 1.48x 1.38x $3,719.64 $60.00 11.0x 679.0x

$10,916.8 $12,778.0 #N/A 15.8x 13.7x 1.78x 1.67x 9.81x 8.56x

Defense contractors

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