Mercury Systems Inc (MRCY) 2013 Q3 法說會逐字稿

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.

Thanks, Kate. 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 US 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 systems 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 US 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 new segment reporting. This quarter, we began 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 and core electronics. With that, I'll turn the call over to Mercury's President and CEO, Mark Aslett. Mark?

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've made very good progress this quarter and the team executed well. We recorded the first low rate 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 to $50 million. Our GAAP earnings from continuing operations improved to $800,000 for a $4.8 million loss in the second quarter. Earnings were $0.03 per share versus our guidance of a 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 downsides were lower bookings and fewer design wins and I'll speak to those metrics in a moment. Despite the macros, there were was more stability in the business in the third quarter. Although conditions in the defense industry remained 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 FY '13, 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 on our most important bookings in Q3 -- important programs in Q3. The defense budget approval led to strong Aegis bookings 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 LRIP revenue from SEWIP Block 2. That said, we remain cautious in our outlook and in the way in which we are managing the business.

We still taking it one quarter at a time while continuing to drive improvements. Looking specifically at defense, total defense revenues grew 9% sequentially to $49.4 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 the third quarter was down 5% sequentially.

From a bookings perspective, we received the largest Aegis order in more than a year during the second quarter and we followed that up with strong Aegis bookings in Q3. We're anticipating Q4 to be a strong bookings quarter driven largely by 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. Other major bookings in the core defense business this quarter included Predator/Reaper, a classified [radar program] upgrade and Gorgon Stare, a classified radar program upgrade and Gorgon Stare. From a revenue perspective, Aegis and SEWIP were our two largest programs in Q3 largely as a result of the defense appropriations building costs. Aegis revenue was up nearly $7.5 million sequentially. Our customer, Lockheed Martin did begin the transition to LRIP on SEWIP Block 2 that we expected during the quarter. As a result, we recognized our first SEWIP LRIP revenue following several quarters of delays. Revenue from our smaller run rate deals relate to spares, maintenance and repair was down on a sequential basis. The industry environment continues to affect this part of our business.

However, we are seeing signs of stabilization as we move into the fourth quarter. Our bookings of smaller run rate deals were up in Q3 for the second quarter in a row. As I mentioned, this was a challenging quarter from a design win perspective. (inaudible) for design wins for quite some time, 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 quarter was approximately $33 million compared with approximately $43 million in Q2. We continue to believe that two factors are contributing to the slowdown in design wins. First, the decline in new programs starts stemming from the recent continuing resolution and secondly lower internal R&D spending by the clients in advanced sequestration.

Operating under an approved defense budget instead of a [CR] does seem to have loosen things up somewhat. As evidenced by SEWIP, Aegis and some of 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 await further clarity around the macros, we continue to tightly manage the business from revenue, expense and cash standpoint, focusing on execution in the areas that are within our control.

When we began to see the impact of self-sequestration back in the fourth quarter of FY '12, we took the first in 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 purposes 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 Intelligence Systems as discussed at 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 reflect the way in which we manage the business.

As I indicated last quarter, we've taken a strategic course from an M&A perspective. The $200 million revolving credit facility we obtained in the second quarter is intended primarily for future M&A. However, integrating Micronetics remains our current focus and it continues to perform well. The Micronetics team, technology and future opportunities have all matched 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 in part from overall defense spending. This timing means that the DoD spend rate through the first half of government fiscal '13 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're expecting reprogramming risks over the next couple of quarters. In addition, we're hearing more and more about (inaudible) for government's fiscal 14. This reflects continued differences in Washington regarding the debt ceiling and the widely desperate budget proposal put forth by Congress as well as the administration. All of this continues to cloud our visibility and create a potential for delays in 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 FY '14.

As I said in the past, we nonetheless believe that Company's ongoing programs and platforms align well with the DoDs 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 and 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 value for our shareholders going forward. They include AMDR, the next-generation Aegis radar replacement, SEWIP Block 3, F-16 radar upgrades, E-2D Hawkeye, and Patriot US 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. It also demonstrates our success in 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 the primes 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. We're confident that given our focus on cash management and recent expense reductions, the ultimate recovery will generate substantial operating leverage. We believe this will lead to a significant improvement in Mercury's profitability, cash flow generation and enterprise value.

With that, I'd like to turn it over to Kevin.

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 than revenue of $49.8 million for the second quarter of 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% of revenue was higher than the $1 million of adjusted EBITDA for the second quarter of 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 depth on our third-quarter financial results, I wanted to reiterate both Mark's comments 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 year's 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 inter-company 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's second quarter, but $14.7 million lower than the third quarter of fiscal 2012. As mentioned earlier, the sequential increase in revenue was fueled by higher revenue related to the Aegis and SEWIP programs. The decline in year-over-year defense revenue in this year's third quarter, as mentioned previously, stems from lower Patriot and 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's second quarter, but 5 percentage points lower than last year's 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 Micronetics commercial revenue.

Commercial revenue for this year's third quarter of $4.7 million was slightly higher than the $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 the inclusion of Micronetics commercial revenue in this year's third quarter.

Defense bookings for the third quarter of $43.8 million were $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 the third quarter. The year-over-year decline in bookings was largely the result of lower 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 was 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 ended the third quarter of fiscal 2013 with $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 ending backlog in the third quarter, a $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 Aegis and SEWIP programs. In addition, the Company's third quarter financial results benefited 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 actions initiated earlier this fiscal year. 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 all key financial measures. 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 cuts 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 this sector, we are continuing to practice for 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 split 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 expenses are forecasted to be $25 million for the fourth quarter, which is slightly higher than the third quarter mainly due to lower customer-funded 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 count of 30.3 million shares. This loss per share forecast assumes an income tax benefit of approximately 30% for the fourth quarter. The loss per share range forecasted for the fourth quarter also includes an approximate $0.05 per share impact from the amortization 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.

(Operator Instructions) Tyler Hojo, Sidoti & Company.

Yeah, hi, good evening, guys.

Hi.

Hi, Tyler.

I was hoping we could dig in a little bit more on Micronetics. I think you said in the prepared remarks that it was tracking according to plan. What I'm a 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 something going on with booking trends within that acquisition?

No. If you look at the first two quarters since we acquired in 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, here it's a lumpy business, there is nothing going on. We think the business is performing at or above our initial expectations.

Okay. So, would you expect to see a kind of a snap back in their bookings in Q4?

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

Okay, that's great. And maybe just moving to something else. When we look at the guidance for Q4, I was hoping that maybe you could talk a little bit about expectations on a program level. It looks like you're 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 need to me booked and the shipped? Thanks a lot, Mark.

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 revenue that we need to deliver from book ship in a specific quarter. The major program that I think we're anticipating good, strong revenues in the fourth quarter. Aegis is certainly one and SEWIP is another, pretty much repeating what we did in Q3.

Well, we would expect Gorgon Stare also to be a sizable contributor in the quarter as well, Tyler.

Okay. And what about Patriot?

Patriot, I don't think we're 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 is 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 recognized zero Patriot revenues through the first three quarters of fiscal 2013.

Just to kind of reiterate I think some of the things that Bill said on the call, I think the Raytheon do expect to receive a decision on [Q8] in that Q1, but that didn't happen and they now are expecting that in the latter half of that Q2 or early Q3 that they may actually get the paperwork that supposedly is being signed by Q8 resulting in an order from them. So, that will be positive. I think beyond Q8, Qatar is probably the next one that is up that could be late call to 2013. And then, I think as Bill said again I think they are expecting news on Turkey, which is being delayed for several quarters, largely due to the fact that they borrowed systems for NATO.

Getting close to the home, I think we were pretty encouraged to see that the Patriot Missile Defense system really took center stage in the Army's fiscal year in 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 '14.

Okay, that's great color. And I guess, maybe I can just squeak one more in there. It looks like that 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?

Yeah, I mean, it's a little unclear, Tyler, to be honest. I mean I think we saw the award late this evening. It basically said that Northrop had been granted or awarded $14 million to complete the developments of the JCREW I1B program. In essence, the award was from [NOC] and its funding them to get through the final phase of development and demonstration in preparation for milestones C.

If you kind of then shift over to the budget, in the FY '14 budget request, JCREW I1B1 funding was actually reduced and on top of that and as you probably aware [NOC] on behalf of the Marine Corps issued an RFI late last year that's really known JCREW bridge in the industry, it's actually seeking non-developmental crude systems that can be fielded quickly to address still urgent and compelling operational requirements that the Marine Corp has.

And if that initiative proceeds, it could lead to a contract for a thousand production units both the Navy and the Marine Corp. So yeah, we're a little confused. I think today, our existing efforts with I1B1 with Exelis effectively on hold and we've been pursuing this bridge opportunity with another of our existing customers in line with the requirements outlined in that RFI.

So it's unclear as to the official linkage if any between today's JCREW I1B1 announcement and the JCREW bridge RFI that I mentioned earlier. So, given the uncertainty and as we've mentioned previously, we basically removed all the JCREW I1B1 bookings in revenue from our plan largely as a result of the repeated program and funding delays.

Okay, great. I'll let somebody else ask a question. Thanks a lot, Mark.

Peter Arment, Sterne Agee.

Yeah, good afternoon, Mark and Kevin.

Hi, Peter.

Hi, Peter.

Mark, you mentioned a couple 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 or quantify what is at risk when you look at some of the program base that you have. Is there any kind of color you could give us on that?

No, I think there is really no detail at this point in time, because I think Secretary Hagel is completing his strategic review and I think it's our understanding that it's not strategic review that will define which programs 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 FY '13 Defense Appropriations bill as well as the FY '14 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.

Yeah, that'd be helpful.

Okay. So I think from a major program perspective Peter, AEGIS Ballistic Missile Defense, SEWIP Block 2 and Gorgon Stare all appear to be well supported. And I think importantly when you look at what's really going to drive the intrinsic value or the enterprise value in the business going forward, it's many of the programs that we discussed at our Investor Day back in November. And so from a Naval perspective, AMDR was fully funded as was SEWIP Block 3, E-2D Hawkeye received full-rate production approval and the Navy requested significant funds for additional sensor upgrades that were part of. The P8 entered low rate initial production of the Navy effectively received the full appropriations take 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 US Army looks to actually upgrade their existing systems potentially next year.

Turning to the Air Force, I think Air Force requested funding to begin upgrades of the F-16 fleet to an AESA radar. That's an important program to us as we've discussed historically as well funding was requested to purchase the final two Global Hawk RQ4 Block 40s and to complete the development of the radar technology insertion that were actually involved. Finally, I think from an Air Force perspective, they also requested pretty significant funding for both radar as well as signals intelligence systems upgrades to the MQ-9 Reaper.

So I think overall, when we kind of step back and we looked at the FY '13 appropriation as well as the FY '14 funding requests we were pretty pleased with how our major programs and pursuits faired. Clearly it's the way in which you kind of started out the question, however there is definitely still uncertainty surrounding not only it is that the FY '14 budget will end up given that disparity of the various budgets scenarios, but also due to the lack of specificity at this time regarding Secretary Hagel's strategic review and the potential for reprogramming of funds.

So, yeah. Okay, that's very good color. I guess part of the question, I guess is, you said is the company up to be that you preferred outsourcing partner. You know, in a lot of this, of what you ticked off is either new programs or upgrades are evolving programs and it seems like you would benefit from the demand there from that standpoint. What are you seeing regarding kind of movement among your prime customers?

So I think, overall, the outsourcing trend in my opinion is alive and doing 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 was a customer that literally when I joined, all they wanted to do was buy boards from Mercury. So I think that's a testament to the investments that we've made from a technology as well as kind of moving up the hierarchy as we've acquired companies along the sense of 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, Peter. So it's alive and well.

Okay, thank you.

Michael Ciarmoli, KeyBanc Capital Markets.

Hey. Good evening, guys, thanks for taking my questions.

Hi, Mike.

Hi, how are you guys? Just I guess, this one might be a tough one to answer, but a lot of the key programs, especially the ones you've outlined like you just said in Investor Day, well supported. You've kind of weathered the first nine months here with obviously zero Patriot participation and SEWIP and Aegis appear now to be taking online. Do you guys feel 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 tailwinds, just not really looking for guidance, but I mean, internally how are you guys feeling about the quarter-to-quarter pace of business?

Well, we certainly feel better in the second half of FY '13 than what we did in the first half and you can kind of see that in our numbers when you just do the H2 over H1 comparison. You're right when you kind of look at some of the programs that you described. When I went through the Patriot example, we basically had zero bookings in revenue, but it does seem like there's more activity just listening to Raytheon 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 bill and I think some of that uncertainty has gone away, we think that there's actually an opportunity to substantially increase bookings in the fourth quarter. That's probably is 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 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 probably the last four quarters. We've seen significant delays. But during Q3, Lockheed received the first long lead-time material contract, which allowed us to ship certain revenues during this quarter, but they also receive their 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 clouds 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 fold. So overall, we clearly feel better than what we have in prior quarters.

Okay, perfect. That's helpful and you just mentioned the gross margins. I think you mentioned roughly $101 million shippable from your current backlog over the next 12 months. I mean, you guys have pretty good visibility, I would assume so if it's 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 streams?

So, we're not going to get kind of beyond the one quarter at a time guidance. I think the approach that we've been taking -- managing the business, seeking to build backlog, not take undue risk in terms of the amount of book shipped in a quarter has actually helped in terms of the visibility that we've got certainly in the next quarter or two. And we absolutely believe that in hindsight the decisions that we made to shift to that mode of operation substantially reduced our operating expenses and to kind of focus on building backlog was the right things to do, Mike.

Okay. And then last one from me and I'll jump off here. Any major program losses that you guys are seeing or you've got fewer design wins, any likelihood of seeing increased competition on some of these programs that are out there?

Maybe, I got to say that if competition is really not top of my list in terms of things that keep me up at night, I mean it's largely still the macros. If you look at the -- you know although we've got a Defense Appropriations bill, we're very thankful for that. You still got this re-programming build that's going to go to Congress probably sometime in May due to Hagel strategic review. And then, although we've got free budget you know submissions on the table, there is still big gaps between them and I think we'll see whether or not they 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 FY '14.

So, for me, the compensation is less of an issue than really just continue to deal with the macros. We don't feel like we're losing programs. If anything I think certain of the programs that we have been focused on such as the AMDR, which could be awarded during Q2 according to Lockheed CEO, we think that's going to be down slightly on the F-16 upgrades in August. We think that the Patriot U.S. Army is probably going to happen in FY '14. So, a lot of the 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.

Okay, perfect. But that's helpful, thanks a lot guys.

Brian Ruttenbur, CRT Capital.

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

No, we believe that we're through with the cost reduction activities based up on kind of what we see going forward, Brian.

Okay, and what would cause you to change that view? Would it be a 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 change, it would be the ramping up expenses or ramping down expenses.

Yes, I think right now, we believe there's more upside opportunity 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 '13 Defense Appropriations bill as well as the way in which the programs that we're involved with as well as some of the new design wins pursuits as well as programs potentially funded in the FY '14 budget. And I went through a number of those such as Aegis, SEWIP Block 2, Block 3, AMDR F-16 Patriot potentially. So, I don't think at this point we feel that we need to take additional costs out of the business. I think we did that pretty aggressively and decisively in Q4 and 1Q.

Great. Thank you very much.

(Operator Instructions) Howard Rubel, Jefferies.

Good afternoon, thank you.

Hey, Howard.

Couple things. Mark, you talked about AMDR, are you on all of the platforms?

No, we're not. we're actually working with Lockheed, who as you know is the actual, the incumbent on the existing Aegis system. So, that's where we're teamed with.

And on F-16, you're with Raytheon -- excuse me, with Northrop on SABR.

That's correct. Yes, with Northrop on the SABR platform. Yes.

And if we look at Aegis for a moment, there is not an infinite number of platforms. So, as you look at the awards that you've had to date, how does that sort of stack up with the kind of work orders and requirements to fit ships or refit ships in some cases?

So, if you look at last year, Howard, we had a pretty low bookings year of Aegis. I think, if my memory serves me correctly, it was actually less than $10 million. We're actually anticipating that we end up this year with two or three times that level. So I think we're heading into next fiscal year in a pretty good position on that specific program. Some of it has to do with the fact that the Defense Appropriations bill was improved and as you probably know, there was a potential for a multi-year procurement for DDG-51s as well as Aegis systems. And, we believe that could come to pass in the fourth quarter. Beyond that I think, as I mentioned in my prepared remarks, there's also increased interest from some of our foreign allies and I think it's in the public domain that Japan, who owns an older Aegis system, is looking for some upgrade. So, we still think there's plenty of opportunity to continue to improve the performance as well as for the sale of Aegis overseas.

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, it's not --?

Yes, we believe so for Aegis on average over time. Yes, yes

With respect to the headcount, did that stabilize in the quarter and could you give that to us please?

It did, yes. So headcount in Q3 --

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

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

Yes.

There were two design wins. How many did you compete for?

It's actually not a metric that we've disclosed, but I don't believe that we're actually losing any specific opportunities. I think it was pretty quiet overall in the third quarter, largely as a result of the [CRM], here the primes 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 rebound in design win activity in the fourth quarter, Howard.

Finally, for the $50 million odd or so that you're looking for in the fourth quarter, how much of it do you think you got in the bag or done or spoken for schedule?

So I would say that we're not going to give you the specific number, but we do think there's probably less book ship that we need in the fourth quarter than even what 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.

Thank you both very much.

Okay.

Thanks.

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.

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

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.