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Mercury Systems, Inc. (NASDAQ:MRCY)

F3Q13 Earnings Call

April 30, 2013 5:00 pm ET

Executives

Kevin M. Bisson – Senior Vice President, Chief Financial Officer and Treasurer

Mark Aslett – President and Chief Executive Officer

Analysts

Tyler Hojo – Sidoti & Company

Peter Arment – Sterne Agee

Michael F. Ciarmoli – Keybanc Capital Market

Brian Ruttenbur – CRT Capital Group LLC

Howard Alan Rubel – Jefferies & Co. Inc.

Operator

Good day everyone and welcome to the Mercury Systems Third Quarter Fiscal 2013 Earnings Conference Call. Today’s call is being recorded. At this time for opening remarks and introductions, I’d like to turn the call over to the company’s Senior Vice President and Chief Financial Officer, Kevin Bisson. Please go ahead, sir.

Kevin M. Bisson

Thanks Kate and good afternoon and thank you for joining all of us. With me today is our President and Chief Executive Officer, Mark Aslett. If you have not received a copy of the earnings press release, we issued earlier this afternoon, you can find it on our website at www.mrcy.com.

We’d like to remind you that remarks that we may make during this call about future expectations, trends and plans for the company and its business constitute forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. You can identify these statements by the use of the words may, will, could, should, would, plans, expects, anticipates, continue, estimate, project, intend, likely, forecast, probable, potential and similar expressions.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties include but are not limited to continued funding of defense programs, the timing of such funding, general economic and business conditions including unforeseen weakness in the company’s markets, effects of continued geopolitical unrest and regional conflicts, competition, changes in technology and methods of marketing, delays in completing engineering and manufacturing programs, changes in customer order patterns, changes in product mix, continued success in technological advances and delivering technological innovations, changes in the U.S. government’s interpretation of federal procurement rules and regulations, market acceptance of the company’s products, shortages in components, production delays due to performance quality issues with outsourced components, inability to fully realize the expected benefits from acquisitions and restructurings or delays in realizing such benefits, challenges in integrating acquired businesses and achieving anticipated synergies, changes to export regulations, increases in tax rates, changes to Generally Accepted Accounting Principles, difficulties in retaining key employees and customers, unanticipated costs under fixed price service and system integration engagements and various other factors beyond our control.

These risks and uncertainties also include such additional risk factors as are discussed in the Company’s filings with the U.S. Securities and Exchange Commission including its Annual Report on Form 10-K for the fiscal year ended June 30, 2012. The Company cautions readers not to place undue reliance upon any such forward-looking statements which speak only as of the date made. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances after the date on which such statement is made.

I’d also like to mention that in addition to reporting financial results in accordance with Generally Accepted Accounting Principles or GAAP, during our call, we will discuss several non-GAAP financial measures, specifically adjusted EBITDA and free cash flow.

Adjusted EBITDA excludes interest income and expense, income taxes, depreciation, amortization of acquired intangible assets, restructuring expense, impairment of long-lived assets, acquisition costs and other related expenses, fair-value adjustments from purchase accounting and stock-based compensation costs. Free cash flow excludes capital expenditures from cash flows from operating activities.

Reconciliation of adjusted EBITDA to GAAP net income and free cash flow to GAAP cash flows from operations are included in the press release we issued this afternoon. Finally a word about our segment reporting this quarter we begin reporting our results in two new segments Mercury Commercial Electronics or MCE, and Mercury Defense and Intelligence Systems or MDIS instead of the previous Advanced Computing Solutions or ACS and Mercury Federal Systems or MFS segments. The MCE segment primarily includes the former ACS business including Micronetics. MDIS includes the former MFS in core electronics.

With that, I will turn the call over to Mercury’s President and CEO, Mark Aslett. Mark?

Mark Aslett

Thanks Kevin. Good afternoon, everyone, and thank you for joining us. I’ll begin today’s call with a business update, Kevin will review the financials and guidance and then we’ll open it up for your questions.

We made very good progress this quarter and the team executed well. We recorded the first low rates initial production revenue for SEWIP Block 2 that we anticipated and we delivered results above the high end of our guidance across all our key metrics.

Total revenue for the quarter was up 9% sequentially to $54 million versus guidance of $44 million to $50 million. Our capital earnings from continuing operations improved to $800,000 from a $4.8 million loss in the second quarter.

Earnings were $0.03 per share versus our guidance or loss of $0.02 to $0.08 per share. Adjusted EBITDA was up five fold from Q2 to approximately 10% and significantly above the high end of our guidance. In addition, we continue to generate positive cash flow in the quarter. The only downsize were low bookings and few design wins and I will speak to those metrics in a moment.

Despite the macros there was most stability in the business in the third quarter, although conditions in the defense industry remain very challenging, the approval in March of the defense budget for the government’s fiscal 2013 was a step in the right direction.

Sequestration did ultimately take effect leading to ongoing uncertainties around budget shortfalls and the pending reprogramming of bonds as the government fiscal year progresses, but the part of our business hit hardest by the defense slowdown early in our FY13. The MCE core business performed well. This business delivered improved results on a sequential basis for the second consecutive quarter, excluding Micronetics, defense bookings were up 5% sequentially and defense revenues were up 12%. We also made substantial progress in our most important bookings in Q3, important programs in Q3.

The defense budget approval let to strong Aegis booking for the second quarter in a row and the potential for further bookings growth in Q4. In addition, as I said, we recognized our first (inaudible) from SEWIP Block 2. That said, we remain cautious in our outlook and in the way in which we are managing the business. We are still taking it one quarter at a time, while continuing to drive improvements. Looking specifically at defense, total defense revenues grew 9% sequentially to $49.9 million, total defense bookings however were down 21% for an unusually strong Q2 to just under $44 million.

Our book-to-bill in defense was 0.9 in Q3, compared with 1.2 in Q2, our total book-to-bill was 0.9 compared with 1.3 in the immediately preceding quarter. Our defense backlog exiting in third quarter was down 5% sequentially. From a bookings perspective we received a largest Aegis order in more than a year during the second quarter, and we followed that up with strong Aegis bookings in Q3. We are anticipating Q4 to be a strong booking quarter driven largely buy a further increase in Aegis bookings. This is mainly as a result of having a defense budget in place and partly due to increased foreign government interest in Aegis, given the recent geopolitical instability. Our major bookings in the quarter defense business this quarter included credit repo, a classified radar program upgrade and Gorgon Stare. From a revenue perspective, Aegis and SEWIP were the two largest programs in Q3, largely as a result of the defense appropriation build in past. Aegis revenue was up nearly $7.5 million sequentially.

Our customers begin the transition to our SEWIP Block 2 that we expected during the quarter. As a result we recognized our first SEWIP LRIP revenue following the several quarters of delays.

Revenue from our smaller run rate deals relate to spares maintenance from repair was down on a sequential basis, the industry environment continuous to affect this part of our business. However we are signs of stabilization as we move into the fourth quarter. Our bookings with smaller run rate deals were up in Q3 for the second quarter in a row.

As I mentioned, this is a charging quarter from a design wins perspective and our slowest core at the design wins quite sometime, we received a total of two design wins both of them in defense. This compares with seven wins, six of them in defense in the immediately preceding quarter. Our design wins continues to focus on radar, electronic warfare, and electro optical infrared. The five-year probable value of our design wins this this quarter was approximately $33 million compared with approximately $43 million in Q2.

We continue to believe that two factor contributing to the slowdown design wins first the decline new program start standing from the recent considering resolution and secondly lower internal R&D spending by the clients and the signs of sequestration, operating under in a improve defense budget instead of the CR, does seem to have loosen things out somewhat. It’s evidenced by SEWIP, Aegis and some of our other large programs this quarter, we’re seeing increased activity in our customer base that we believe could lead to an improvement in design wins in Q4.

While we wait for the clarity around the macros, we continue to tightly manage the business from a revenue, expense and cash standpoint. Focusing on execution in the areas that within off control where we begun to see the impact of self sequestration back in the fourth quarter of FY‘12. We took the first and a series of decisive steps to reduce our overall expense levels and minimize working capital. These steps ultimately included two major restructurings. At the same time, we’ve ensured that we have sufficient liquidity and financial flexibility.

Not only to manage the ongoing needs of the business but also for future M&A proposes when visibility and conditions in our end markets are more favorable. We also use the opportunity to align the business around new operating units Mercury Commercial Electronics, Mercury Defense Systems and Mercury Intelligent Systems as discussed in the company’s Investor Day back in November. As Kevin mentioned earlier, we will report our results along two segments that logically group our expanded capabilities and reflects the way in which we manage the business.

As I indicated last quarter, we’ve taken a strategic force from an M&D perspective. The $200 million revolving credit facility we obtained in the second quarter is intended primarily for future M&A. However integrating Micronetics remains upturn focus and it continues to perform well. The Micronetics team, technology and future opportunities have all met or exceeded our initial expectations.

We’re maintaining a cautious approach to leverage in this environment with an eye toward not having undue financial risk to the currently high level of industry risk. Sequestration was triggered during our third quarter, resulting in a $40 billion plus impact on overall defense spending. This timing means that the DoD spend rate through the first half of government fiscal 2013 has been significantly greater than it should have been. The resulting budget shortfalls will largely be felt in the O&M account. This will likely lead to reprogramming of a portion of the remaining fiscal 2013 RDT&E and procurement funds next month. Accordingly, we are expecting reprogramming risks over the next couple of quarters.

In addition, we are hearing more and more about (inaudible) government fiscal 2014. This reflects continued differences in Washington regarding the debt ceiling and widely-spread budget proposal put forth by congress as well as the administration. All of this continues to guide our visibility and create the potential for delays and contracting activity, new program starts, programs transitioning between phases and foreign military sales. Coupled with the possibility of DoD investment account reprogramming, significant risk remains the overall timing and levels of program funding.

These risks could clearly impact our business and our financial performance through the current quarter and into FY14. As I said in the past, we nonetheless believe the companies on going programs and platforms aligned well with the DoDs new roles and missions and should survive these potential challenges. Our top strategic priority for the near-term is to leverage our relationship with the primes and drive bookings and revenue from these existing programs as well as new programs and platforms.

We continue to feel very good about the relationships we built with Lockheed around Aegis, SEWIP and several other major program pursuits. Consequently, we continue to expect that both Aegis and SEWIP will be important bookings on revenue drivers for Mercury going forward. Extending the timeframe out beyond the near-term into fiscal 2014, we have the opportunity for a number of major new design wins should our customers be selected. These programs will be important to growing Mercury’s Enterprise volume for our shareholders going forward. They include AMDR, the next generation AESA radar replacement, SEWIP Block 3, S16 radar upgrades, E2D Hawkeye and Patriot U.S. Army on top of our existing programs such as Aegis and SEWIP Block 2. This potential is testament to the product portfolio refresh and the acquisition strategy that we’ve implemented over the past five years.

In also demonstrates our success and positioning Mercury as the premier commercial ISR and EW subsystem outsourcing partner to the defense primes. We believe these strategies have created significant intrinsic value in our business, despite unprecedented volatility in the defense budgeting and contracting environment. We continue to expect surprised to face greater pressure to outsource to companies like ours and believe that Mercury is well positioned to capture a significant share of this potential opportunity. Recall firms that given our focus on cash management and recent expense reductions, the ultimate recover it will generate substantial operating leverage. We believe this will lead to a significant improvement in Mercury’s profitability, cash flow generation and enterprise volume.

With that, I would like to turn it over to Kevin. Kevin?

Kevin M. Bisson

Thank you, Mark and good afternoon again everyone. Now turning to our financial results, revenue for the third quarter of fiscal 2013 of $54.1 million was 9% higher sequentially and revenue of $49.8 million for the second quarter this year and exceeded our stated guidance of $44 million to $50 million. The company generated GAAP EPS of $0.03 per diluted share in this year’s third quarter compared to a GAAP loss of $0.16 per share in this year’s second quarter. This quarter’s GAAP EPS exceeded the company’s guidance of a net loss of $0.02 to $0.08 per share for the quarter.

Third quarter EPS benefited from the retroactive reinstatement of the Federal R&D tax credit, which was included in our third quarter guidance. This benefit contributed approximately $0.05 per share in earnings for the quarter. Adjusted EBITDA for the third quarter of fiscal 2013 of $5.2 million or 10% revenue was higher than the $1 million of adjusted EBITDA for the second quarter this year and exceeded our stated guidance of negative $2.5 million to positive $1 million. The company generated free cash flow of $1.2 million in this year’s third quarter and ended the third quarter with $35.1 million of cash and cash equivalents and with no debt.

Before going into greater debt on our third quarter financial results, I wanted to reiterate both Mark’s and our earnings release that beginning this quarter the company will be reporting its segment results under two new reporting segments; Mercury Commercial Electronics or MCE and Mercury Defense and Intelligence Systems or MDIS. These new segments replace the company’s previous segments, Advanced Computing Solutions or ACS and Mercury Federal Systems or MFS. Select historical financial information presented in the new segment format can be found in our earnings press release issued earlier today.

With that in mind and taking a look at the third quarter in greater detail, total revenue for our largest segment, MCE, was $43.9 million, which was $3.5 million or 9% higher than MCE revenue of $40.5 million generated in the second quarter of this year, but $10 million lower than the third quarter of fiscal 2012. The sequential increase in revenue was driven by increased Aegis and SEWIP program revenue. The year-over-year decrease in revenue was due primarily to lower Patriot and UAV related program revenue that was partially offset by the impact of acquired Micronetics revenue.

Revenue from the Company’s MDIS segment for the third quarter was $13 million, which was $1.1 million lower than the $14.1 million of MDIS revenue in this second quarter and $2.3 million lower than the third quarter of last year. The sequential and year-over-year decrease in MDIS revenue is attributed mainly to lower engineering development revenue. It should be noted that operating segment revenue for the third quarter of fiscal 2013 does not include adjustments to eliminate $2.8 million of intercompany revenue.

Total defense revenue, which includes MCE and MDIS, for the third quarter of $49.4 million was $3.9 million or 9% higher than this year second quarter, but $14.7 million lower than the third quarter of fiscal 2012. As mentioned earlier the sequential increase in revenue was filled by higher revenue related to the Aegis and SEWIP programs. The declined in year-over-year defense revenue in this years third quarter as mentioned previously stems from lower Patriot in UAV related program revenue and lower MDIS revenue that were partially offset by the inclusion of Micronetics revenue.

Defense revenue comprised 91% of total company revenue in the third quarter of fiscal 2013 which was comparable this year second quarter but was five percentage points lower than last years third quarter. The year-over-year decline in the percentage of defense revenue was primarily due to lower overall defense revenue and the addition of acquired Micronectics commercial revenue.

The commercial revenue for this year’s third quarter of $4.7 million were slightly higher than $4.3 million generated in the second quarter and significantly higher than the $2.9 million in last year’s third quarter. The year-over-year increase in commercial revenue was principally due to inclusion of Micronetics commercial revenue in this year’s third quarter.

Defense bookings for the third quarter of $43.8 million were a $11.9 million lower than the defense bookings of $55.7 million for this year’s second quarter and $2.4 million lower than the $46.2 million of defense bookings in the third quarter of last year. The sequential decline in defense bookings was due mainly to the absence of the large B-1 Bomber, and SEWIP bookings that occurred in the second quarter that were partially offset by higher UAV-related bookings in third quarter.

The year-over-year decline in bookings was largely the result of the SEWIP bookings that were partially offset by the addition of bookings from Micronetics. Mercury’s total book-to-bill ratio for the third quarter of fiscal 2013 was 0.9, which was lower than the 1.3 book-to-bill ratio in the second quarter, but higher than the 0.7 book-to-bill ratio in the third quarter of fiscal 2012. Defense book-to-bill of 0.9 for this year’s third quarter was similarly below the 1.2 book-to-bill ratio generated in the second quarter and above the 0.7 book-to-bill recorded in the third quarter of last year.

It should be noted that for the first nine months of fiscal 2013, both total Company and defense-related book-to-bill ratios were at 1.0 compared to 0.9 for both measures for the first nine months of last year.

The company entered the third quarter of fiscal 2013 with a $127.7 million of total backlog which was $5.5 million lower than the second quarter, but $22.5 million or 21% higher than the backlog at the end of the third quarter of last year. Of the total lending backlog in the third quarter of $101.1 million or 79% is expected to be shipped within the next 12 months. $108.7 million of the ending third quarter total backlog related to defense, which was $5.6 million lower than the second quarter’s defense backlog, but $9.2 million or nearly 9% higher than defense backlog at the end of the third quarter of fiscal 2012.

From a bottom line perspective, the company generated GAAP earnings of $800,000 in this year’s third quarter compared to a GAAP net loss of $4.8 million in this year’s second quarter. The sequential improvement in bottom line performance was due primarily to higher sales volume and product mix related gross margin. Gross margin percentage increased sequentially from 35% in the second quarter to 42% in the third quarter based on the impact of higher margin revenue from the Aegis and SEWIP programs.

In addition, the company’s third quarter financial results benefitted from the reinstatement of the Federal R&D tax credit during the quarter that was retroactive to January of 2012. The R&D tax credit reinstatement contributed approximately $1.4 million or $0.05 per share in earnings for the quarter.

On a year-over-year basis, the third quarter earnings of $800,000 were lower than the $5.2 million of earnings in last year’s third quarter. The lower earnings were principally due to lower sales and product mix related gross margin that was partially offset by $4 million of lower operating expenses resulting from the benefits of the restructuring action initiated earlier this fiscal.

It should also be noted that the reduced operating expenses year-over-year were inclusive of $2.5 million of additional expenses associated with the acquisition of Micronetics. Adjusted EBITDA of $5.2 million or 10% of revenue for the third quarter of fiscal 2013 was $4.2 million higher than the $1 million of adjusted EBITDA for the second quarter of this year. Higher sequential earnings were the primary driver of improved adjusted EBITDA results. This year’s third quarter adjusted EBITDA was lower than adjusted EBITDA in last year’s third quarter as lower earnings were partially offset by higher amortization expense resulting from the Micronetics acquisition.

Relative to our stated financial guidance for the third quarter, we are pleased to report that the company exceeded its guidance in the all key financial metrics. Third quarter revenue of $54.1 million, exceeded our guidance of revenue between $44 million and $50 million.

Earnings per share of $0.03 for the third quarter exceeded our guidance of a loss of between $0.02 and $0.08 per share. Finally adjusted EBITDA of $5.2 million for the third quarter comfortably exceeded guidance of negative $2.5 million to positive $1 million.

Turning now to the balance sheet. The company ended the third quarter of fiscal 2013 with cash and cash equivalents of $35.1 million and no debt. This was $1.2 million higher than the $33.9 million of cash and cash equivalents at the end of the second quarter of fiscal 2013.

The company generated $1.2 million of free cash flow for the third quarter as $1.7 million of operating cash flow due to higher cash earnings was partially offset by $0.5 million of capital expenditures. While the company was pleased with its financial performance in the third quarter, which saw significant sequential revenue margin and bottom line improvement, we believe as Mark pointed out in his comments, that there continues to be meaningful industry uncertainty that could continue to adversely impact our future financial performance.

With the DoD still developing plans to implement sequestration cut for fiscal 2013, and its fiscal 2014 budget not factoring in additional mandated sequestration cuts. The company believes the prudent course of action is to continue the operating model it has undertaken over the last several quarters, that is to forecast revenue conservatively in order to build a backlog, minimize forecasted revenue that needs to be both booked and shipped in a given quarter, minimize the build-up of working capital, and ultimately preserve liquidity. As such and given the continued lack of visibility in the sector, we are continuing to practice over the last several quarters providing only quarterly financial guidance.

With that in mind, we are forecasting fourth quarter total revenue to be in the range of $48 million to $54 million consistent with prior quarters we expect the slip in fourth quarter revenue to be approximately 90% defense and 10% commercial. The company’s fourth quarter revenue forecast also reflects defense revenue that is largely in line with third quarter defense revenue. Within our stated revenue guidance, we are projecting gross margin to approximate 40% for the fourth quarter, which is slightly below the third quarter gross margin.

The fourth quarter revenue forecast is expected to have a slightly higher mix of RF and microwave product revenue as compared to the third quarter resulting in the lower forecasted sequential gross margins. Operating expense is forecasted to be $25 million for the fourth quarter, which is slightly higher than the third quarter, mainly due to lower customer fund in R&D. Forecasted operating expenses for the fourth quarter fully reflects the benefits of the company’s recent restructuring initiatives and the inclusion of incremental year-over-year operating expenses related to Micronetics.

From a bottom line perspective, we anticipate a GAAP loss per share in the range of $0.07 to $0.13 per share for the fourth quarter based on an estimated weighted average share accounts of 30.3 million shares. This loss per share forecasts assumes an income tax benefit of approximately 30% from the fourth quarter. The loss per share range forecasted for the forth quarter also includes an approximate $0.05 per share impact from the amortizations of intangible assets. Adjusted EBITDA for the fourth quarter is estimated to be between $100,000 and $3 million. Relative to liquidity we anticipate ending the fourth quarter with cash and investments between $37 million and $40 million as improving operating cash flow is forecasted to be partially offset by capital expenditures.

With that we’ll be happy to take your questions. Kate, you can proceed with the Q&A now.

Question-and-Answer Session

Operator

(Operator Instructions) I’m showing our first question comes from the line of Tyler Hojo with Sidoti & Company. Your line is open.

Tyler Hojo – Sidoti & Company

Yeah, hi good evening guys.

Unidentified Company Representative

Hi Tyler

Unidentified Company Representative

Hi

Tyler Hojo – Sidoti & Company

I was hoping we could dig in a little bit more on Micronetics, I think you said in the prepared remarks that I was tracking or quoting the plan, what I’m little bit uncertain about is the commentary regards to bookings I think you said if you excluded Micronetics bookings would have been up, is there is something going on with booking trends within that acquisitions?

Unidentified Company Representative

No, if you look at the first two quarters since we acquired them Tyler, we had very, very significant book-to-bill I think it was 1.2 in the first quarter and was over 1.3 in the second quarter. So it’s a lumpy business there is nothing going on we think the business is performing at or above our initial expectations.

Tyler Hojo – Sidoti & Company

So would you expect to see kind of snapback in their bookings and in Q4?

Unidentified Company Representative

We’re not going to forecast specifically in an operating unit level, but we are anticipating stronger bookings in the fourth quarter overall.

Tyler Hojo – Sidoti & Company

Okay, that’s great and maybe just moving something else, when we look at the guidance for Q4, I was hoping that maybe you could talk a bit about expectations on a program level, looks like your expecting patriot to kind of kick in a little bit in that quarter. Are there any other programs and I’m also curious about what sort of expectations you have in there for orders that both need to be booked and shipped? Thanks a lot Mark.

Mark Aslett

Yeah. So from a book ship perspective I think as we said in prior quarters we are taking a much more conservative approach in terms of the amount of revenues that we need to deliver from book ship in a specific quarter. The major program that I think we are anticipating good strong revenues for in the fourth quarter. Aegis is certainly one and SEWIP is another one, pretty much recreating what we did in Q3.

Unidentified Company Representative

We would expect Gorgon Stare also to be a sizeable contributor in the quarter as well Tyler.

Tyler Hojo – Sidoti & Company

Okay, what about patriot.

Unidentified Company Representative

Patriot, I don’t think we are actually anticipating really any bookings or revenue at this point in time, but clearly I think based upon what Bill said on the Raytheon earnings call, there’s still a lot of opportunity in the Middle East and beyond. I think the challenge that Raytheon has had is that foreign military sales are notoriously difficult to predict and as you know as we said on the last call we’ve essentially booked zero, both zero dollars and recognize zero patriot revenue through the first three course of fiscal 2013, just to kind of reiterate, I think some of the things that Bill said on the call, I think right down did expect to receive a decision on QA in that Q1, but that didn’t happen and they are now expecting that in the later half of that Q2 or early Q3. This may actually get the paperwork that supposedly has been signed by Q8 resulting in an order for that, that will be positive.

I think beyond Q8 Qatar is probably the next one that is up and that could be late called a 2013, and then I think as Bill said again I think they are expecting news on Turkey, which has been delayed for several quarters largely due to the fact that they borrowed systems from NATO.

Getting close to the home yeah, I think we were pretty encouraged to see that is the Patriot missile defense system really took center stage in the Army’s fiscal year 2014 missile defense budget request. It’s clearly selected Patriot as its primary surface-to-air missile program, particularly given the recent constellation of (Inaudible), so I think overall we are really not expecting much from Patriot this fiscal year, but we believe that we should start to see a pick up in Patriot as we are heading into our FY 2014.

Tyler Hojo – Sidoti & Company

Okay, that’s great color and I guess maybe I can just squeak one more in there, it looks like there was some press out on the JCREW program earlier today, Northrop was awarded another $14 million in development funding. I mean what is the expectation on that now is that pretty much dead in the water for you all how should we think about that?

Unidentified Company Representative

Yeah, it’s a little unclear Tyler to be honest I mean I think here we saw the award late this evening that basically said that in north of between granted or awarded $14 million to complete the development of the JCREW A1/B program, in that sense the award for now see, and it’s funding them to get through the final phase of development in demonstration in preparation for milestone C. If we kind of then shift over to the budget in the FY14 budget request in JCREW A1/B1 funding was actually reduced.

And on top of that and as you probably aware, you will not see on behalf of the [Rainco] an RFI later last year that’s really known JCREW bridge in the industry. That’s actually seeking non-developmental crew systems that can be failed it quickly to address sale urgent and compelling operational requirements that the marine co has, and in some initiatives proceed that could lead to a contract for a 1,000 production units both in Navy and in the marine core.

So we’re a little confused I thinking of today in our existing efforts with A1/B1 with XL as effectively on hold and we have been pursuing this bridge over (inaudible) with another of our existing customers in line with requirements outlined in that RFI so its unclear as to the official linkage if any between today’s JCREW A1/B1 announcement and the JCREW bridge RFI that I mentioned earlier so give in the uncertainty and as we’ve mentioned previously we face it removed all the JCREW A1/B1 bookings in revenue form our plant largely as a result of the repeated program and funding delays.

Tyler Hojo – Sidoti & Company

Okay great. I’ll let somebody els ask the question thanks a lot Mark.

Operator

Our next question comes from the line of Peter Arment with Sterne Agee. Your line is open.

Peter Arment – Sterne Agee

Yeah good afternoon, Mark and Kevin.

Mark Aslett

Hi Peter.

Kevin M. Bisson

Hi Peter.

Peter Arment – Sterne Agee

Mark you mentioned a couple of times about the kind of the reprogramming risks and certainly we get that, have you been able to kind of just flush-out or identify, quantify, what is that risk when you look at some of the program basically that you will have, is there any kind of color you could give us on that?

Mark Aslett

No I think there is really no detail at this point in time, because I think (inaudible) is completing its strategic review. And I think it’s our understanding that it’s not strategic review that will define which programs are ultimately going to be the winners or the losers.

If you look at the budget itself, I think we were – we were overall, I think we were pleased with the funding requests in both the FY13 defense appropriations bill, as well as the FY14 budget submissions for the programs that we’re involved with.

And if you like, I could kind of give you a perspective on some of those because we think that there was some pretty good news in that.

Peter Arment – Sterne Agee

Okay that will be helpful. Thank you.

Mark Aslett

Okay. So I think for the major program perspective Peter, features Ballistic Missile Defense, SEWIP Block 2 – all appear to be well supported. And I think importantly, when you look at what’s really going to drive the intrinsic volume or the enterprise volume in the business going forward, its many of the programs that we discussed in our Investor Day back in November.

And so from a naval perspective AMDR was fully funded as with SEWIP Block 3, E2D Hawkeye received full rate production approval and the Navy requested significant funds for additional sensor upgrades that were part of the P8 and the lower rate initial production of the Navy effectively received the full appropriation taking into account recent program delays. I mentioned Patriot, clearly that’s taking center stage in the Army’s missile defense budget submission and they clearly have selected Patriot as the program that they are banking on going forward. And there was significant funds requested and we believe it’s going to be important just the U.S. Army looks to actually upgrade their existing systems potentially next year.

Turning to the Air Force, I think the Air Force requested funding to begin upgrades of the F16 fleet to unease the radar that’s an program to us as we’ve discussed historically as well funding is requested to purchased the final two global hawk RQ-4 Block 40 and to complete the development of the radar technology insertion that were actually involved with. I think finally, I think from an Air Force perspective, they also requested pretty significant funding for both radar as well as signal intelligent systems upgrades with the MQ-9 Reaper.

So I think overall when we kind of step back and we look at the FY’13 appropriation as well as the FY’14 funding request, we were pretty pleased with how our major programs and pursuits faired. Clearly is the way in which you kind of sort it out of the question, however, there is definitely still uncertainty surrounding not only how it is that the budget will end up given the disparities of various budget scenarios, but also due to the lack of specificity at this time regarding (inaudible) review and the potential for reprogramming of funds.

Peter Arment – Sterne Agee

Yeah, okay, that’s very color. I guess part of the question I guess is, you know you said the company up to be preferred outsourcing partner, and lot of this what you picked off there is either new programs or upgrades or evolving programs and it’s seems like you would benefit from the demand there from that standpoint, what are you seeing regarding kind of movement among your prime customers.

Unidentified Company Representative

So, I think you know overall the outsourcing trend in my opinion is live and doing very, very well. We had a significant win this quarter where one of our existing customers for the first time outsourced at the subsystem level and this is customer that literally when I joined all they wanted to do is buy ports from Mercury. So I think up to a testament to the investments that we’ve made from technology as well as kind of moving up the hierarchy as we’ve acquired companies along the sensor processing chain. So I think it’s happening I mean if you look at these new design wins and pursuits that we’re involved with many of those are also great examples of the outsourcing activity occurring data. So it’s a alive and well

Peter Arment – Sterne Agee

Okay, thank you.

Operator

Our next question comes from the line of Michael Ciarmoli with Keybanc Capital Markets. Your line is open

Michael F. Ciarmoli – Keybanc Capital Market.

Hey, good evening guys thanks for taking my questions.

Unidentified Company Representative

Hey Mike it’s Palm.

Michael F. Ciarmoli – Keybanc Capital Market.

Hey how are you guys. Just I guess this might be the toughest one to answer but you know a lot of these key programs, especially the ones you’ve outlined, but you just said in the investor day, well supported, these kind of weathered the first nine months here with obviously zero patriot participation and key just a peer note kicking online. Did you guys still like the business is kind of hit bottom at this run rate. I mean obviously there is still lot of uncertainty and reprogramming risk, but it seems that some of these bigger programs coming back online you should get some tailwind, just not really looking for guidance, but I mean, internally, how are you guys feeling about the quarter-to-quarter pace of business?

Unidentified Company Representative

We certainly feel better in the second half of FY13 than what we did in the first half and you can kind of see that numbers when you just do the H2 over H1 comparison. You are right when you kind of look at some of programs that you described when I went through the patriot example, we basically had zero bookings in revenue, but it does seem like there is more activity just listening to Radeon and obviously in discussions with our customers around Kuwait, around Qatar, around potentially Turkey, and obviously with the funding request for the U.S. army.

If you look at Aegis, we had in Q2, we reported the bookings were up 3.5 times or $5 million sequentially and up 2.5 million year-over-year. In Q3, we actually had an even stronger quarter and bookings were up 11% sequentially to $7.8 million that was actually up 11 times year-over-year and when we look forward to Q4, now that we’ve actually got a defense appropriations bills and I think some of that uncertainty has gone away, we think that there is actually an opportunity to substantially increase bookings in the fourth quarter. That’s probably as a result of the budget itself, but also as a result of the recent geopolitical instability and the fact that this increased foreign military interest in the Aegis ballistic missile defense system by some of our foreign allies.

SEWIP, I think is also a program that has just started to produce for us, as you know and as we discussed in probably the last four quarters. We’ve seen significant delays. But during Q3, Lockheed received the first long lead-time material contracts, which allowed us to ship certain revenues during this quarter, but we also received our low rate initial production award as well for the first LRIP revenues, which we believe is going to lead to additional SEWIP revenues for us in Q4. So I would say that right now it certainly seems like there is a break in the cloud. And we were pretty pleased with the way in which the business performed on a top line and we saw great gross margin improvement and clearly we increased our EBITDA by 5 folds. So overall, we clearly feel better than what we have in prior quarters.

Michael F. Ciarmoli – Keybanc Capital Market.

Okay, perfect. That’s helpful. And just you just mentioned the gross margins. I think you’ve mentioned roughly a $101 million shippable from you current your backlog over the next 12-months. I mean you guys have pretty good visibility, I would assume so but shippable into the margin profile of that business. I mean are you expecting mix headwinds or tailwinds over the next 12-months just what kind of those visible revenue…

Unidentified Company Representative

So we’re not going to get kind of beyond the one quarter to time guidance. I think the approach that we’ve been taken in managing the business, seeking to fill backlog not take undue risk in terms of the amount of book shipped in the quarter has actually helped in terms of the visibility that we’ve got certainly in the next quarter or to. And we absolutely believe that in [time] site the decisions that we made to ship to that mode of operation substantially reduced our operating expenses and to kind of focus on building backlog was the right thing to do Mike.

Michael F. Ciarmoli – Keybanc Capital Market.

Okay. And then last one for me and I’ll jump off here.

Unidentified Company Representative

Sure.

Michael F. Ciarmoli – Keybanc Capital Market

Any major program losses that you guys are seeing, or you’ve got fewer design wins? Any you likely would have seen increased competition on some these programs that are out there?

Unidentified Company Representative

Yeah, maybe I got to say that, competition is really not top of list in terms of things that keep me up at night. I mean, it’s largely still the macros. If you look at, although we got a defense appropriations bill, we’re very thankful for that. You still got this reprogramming bill that’s going to get out of the congress, probably sometime in May due to [Eagle] strategic review. And then, although we’ve got three budget submissions on the table, there’s still big gaps between them and I think, we’ll see whether or not be are able to come to a conclusion as they start to discuss the debt ceiling increase in May through July, if not we’re probably going to end up with another continuing resolution for FY2014.

So, for me the competition is less of an issue then really just continue to deal with the macros. We don’t feel like we’re losing programs with anything. I think certain of the programs that we have been focused on, such as the AMDR, which could be awarded during Q2 according Lockheed CEO. We think that there is going to be downslope on the F-16 upgrades in August. We think that the Patriot U.S. Army is probably going to have it in FY14.

So lot of things that we’ve been talking about and focused on are actually coming into view in the not too distant future. We feel better about that.

Michael F. Ciarmoli – Keybanc Capital Market

Okay, perfect, that’s helpful. Thanks a lot, guys.

Operator

Our next question comes from the line of Brian Ruttenbur with CRT Capital. Your line is open.

Brian Ruttenbur – CRT Capital Group LLC

Thank you very much, Mark and Kevin for taking my questions. Just talking about the potential forecasts within your own firm, is there a plan for further SG&A and R&D cuts in the near-term as you are sitting here waiting with uncertain times?

Mark Aslett

We believe that with further – with the cost reduction activities based upon kind of what we see going forward Brian.

Brian Ruttenbur – CRT Capital Group LLC

Okay. And what would cause you to change that view, would it be the CR for 14, could you change your mind within the next 90 days, can you give us some kind of perspective on what is the catalyst that would make your mind changes either ramping up expenses or ramping down expenses.

Mark Aslett

Yeah, I think right now we believe that more upside opportunities than we do downside risk in the business based upon the actions that we’ve previously taken and the way in which we’re currently managing the business. As I said I think we feel pretty good about the FY 2013 Defense Appropriations Bill, as well as the way in which the programs that were involved with as well as some of the new design wins pursued, as well as programs potentially found in the FY 2014 budget and I went through a number of those such as Aegis, SEWIP Block 2, Block 3, AMDR X16 patriot potentially. So, I don’t think at this point we feel that we need to take additional cost out of the business, so I think we did that pretty aggressively and decisively in Q4 and Q1.

Brian Ruttenbur – CRT Capital Group LLC

Great. Thank you very much.

Operator

(Operator Instructions) Our next question comes from the line of Howard Rubel with Jefferies. Your line is open.

Howard Alan Rubel – Jefferies & Co. Inc.

Good afternoon, thank you.

Unidentified Company Representative

Hey, Howard.

Howard Alan Rubel – Jefferies & Co. Inc.

Couple of things, Mark can you talk about AMDR are you on all of the platforms?

Unidentified Company Representative

No, we’re not, we are actually working with Lockheed who as you know is the actual, the incumbent on the existing Aegis system so that’s where came to it

Howard Rubel – Jefferies

And on that 16 year with Northrop Grumman saver?

Unidentified Company Representative

That’s correct, yeah with the Northrop Grumman saver platform yeah

Howard Alan Rubel – Jefferies & Co. Inc.

And if we look at the you just for a momentum, there’s not an infinite number of platforms, so as you look at the awards that you had to-day, how does that sort of stock with the kind of work orders and requirements to fit chips or refit chips in some case?

Unidentified Company Representative

So if you look at last year Howard, we had pretty low bookings year of Aegis, I think if my memory says me correct it was actually less than 10 million, we are actually anticipating that we end up this year with two or three times of that level, so I think we’re heading into next fiscal year, we’re in a pretty good position on that specific program, some of it is do with the fact that defensive procreations built with improved and as you probably know there was a potential for a multi-year procurement the DDG-51 as well as Aegis system and we believe that will come to pass in the fourth quarter, beyond that I think as I mentioned in my prepared remarks there is also a increased interest with some of our foreign NOIs and I think it’s a – it’s in the public domain that Japan who owns the older Aegis system is looking for someone upgrades. So we still think there’s plenty of opportunity to continue to improve the performance, as well as for the sale of the Aegis overseas.

Howard Alan Rubel – Jefferies & Co. Inc.

But if we look at sort of the business rather than the bookings, you’re sort of still in this $25 million to $30 million range?

Mark Aslett

Yeah we believe so, for Aegis on average over time, yeah, yeah.

Howard Alan Rubel – Jefferies & Co. Inc.

And with respect to the head count, did that stabilize in the quarter and could you give that to us please?

Mark Aslett

It did, yeah. So head count in Q3…

Kevin M. Bisson

About 770 employees, which was flat from Q2 to Q3 Howard.

Howard Alan Rubel – Jefferies & Co. Inc.

That’s sort of, kind of points to the revenue number and the ability to sort of stabilize the business.

Mark Aslett

Yeah.

Howard Alan Rubel – Jefferies & Co. Inc.

There were two design wins, how many did you compete for?

Mark Aslett

It’s actually not a metric that, we’ve disclosed, but I don’t believe that we are actually losing any specific opportunities. I think it was pretty quiet overall in the third quarter. Largely as a result of the CR and the prime is really ratcheting down their eye rod. During Q3, I think we did start to see things pick up and I think, we are anticipating currently a rebounding design win activity in the fourth quarter, Howard.

Howard Alan Rubel – Jefferies & Co. Inc.

And finally, for this $50 odd million or so that you are looking for in the fourth quarter, how much of it do you think you’ve got in the bag, or done or spoken for or scheduled?

Mark Aslett

So I would say that, we are not going to give you the specific number. But we do think there’s probably a less book shift that we need in the fourth quarter than even more we had in the third quarter. And that’s being continually coming down. So backlog looks in pretty good shape. The visibility for the fourth quarter currently looks like it’s in pretty good shape as well.

Howard Alan Rubel – Jefferies & Co. Inc.

Thank you both very much.

Mark Aslett

Okay.

Kevin M. Bisson

Thanks.

Operator

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

Mark Aslett

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

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.

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