Good day and welcome, everyone, to the Mercury Computer Systems Incorporated First Quarter Fiscal Year 2013 Conference Call. Today's conference is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Senior Vice President and Chief Financial Officer, Mr. Kevin Bisson. Please go ahead, sir.

Good afternoon, and thank you for joining 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, you can find it on our website at www.mc.com. We would like to remind you that remarks that we may make during this call about future expectations, trends and plans for the company and its business constitute forward-looking statements 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 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, divestitures and restructuring 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…

Thanks, Kevin. Good afternoon, everyone, and thanks for joining us. I will begin today’s call with the first quarter update; Kevin will review the financials and guidance and then we will open it up to your questions. The results we announced this afternoon were in line with the revised guidance we announced on October 4. Total revenue for the quarter was flat year-over-year at $49 million, including a partial quarter of Micronetics which we acquired on August 8. Our GAAP net loss from continuing operations was $7.2 million or $0.24 per share compared with GAAP net income of $0.09 per share for Q1 of last year. The increased loss largely reflects SEWIP revenue delays and the fiscal first quarter restructuring action we previously announced. Adjusted EBITDA was down 81% year-over-year and below our current target business model. We've said for the past 9 months that government financial year ‘13 would likely be a year of transition leading to reduced visibility and heightened risk for the defense industry. Along with the approaching sequester, budgetary constraints on defense spending coupled with political gridlock in Washington have led the industry to operate in what currently appears to be a soft sequestration environment. This we believe has resulted in a slowdown in defense program funding and contracting and could continue to affect our financial results and visibility for the next 6 to 12 months. The funding and contracting environment had a more significant impact on our first quarter business than we initially anticipated. The main factor being delayed orders associated with SEWIP Block 2 which is beginning the transition from the engineering phase to low rate initial production. Total defense revenues were down 1% from Q1 of FY’12 and total defense bookings were down 41%. Our book-to-bill in defense for the first quarter was…

Thank you, Mark, and good afternoon again, everyone. Turning to our financial results, in the first quarter, revenue for the quarter of $49.4 million was largely flat with revenue of $49.1 million in the first quarter of last year, and was within our revised guidance of $48 million to $50 million as provided earlier this month. The company incurred a GAAP loss from continuing operations of $0.24 per share in this year’s first quarter, compared to GAAP earnings from continuing operations of $0.09 per share in the first quarter of fiscal 2012. This year’s first quarter of loss per share was on the favorable end of the company’s revised guidance of a net loss of $0.24 to $0.28 per share per quarter. Included in the company’s GAAP loss per share for the first quarter of fiscal 2013 was a significant restructuring charge that contributed approximately $0.11 per share to the reported $0.24 per share loss for the quarter. In addition, the delay in the receipt of the SEWIP program order that was cited in our early October announcement of revised financial guidance contributed an additional estimated $0.10 per share to the first quarter of loss. Finally, the inclusion of Micronetics’ financial results for the quarter, excluding restructuring cost added $0.03 per share to the first quarter’s loss, largely due to purchase accounting adjustments. Adjusted EBITDA for the first quarter of fiscal 2013 of $1.6 million was 7.1 million lower than the adjusted EBITDA of $8.7 million for the first quarter of last year, but was at the high end of our revised guidance of negative $1 million to a positive $2 million for the quarter. The company ended the first quarter with $30.6 million of cash and investments and with no debt, but incurred a free cash flow burn of…

[Operator Instructions] And we will take our first question from Peter Arment.

Yes, Sterne Agee. Mark, Kevin, a question regarding, could you go over just first more detailed question on the expenses for the operating expenses, you mentioned $24 million; what’s the breakup that you are looking at for those for the second quarter?

Basically from an operating expense standpoint, we’ve got 3 things going on here. Number one is -- I am just comparing between Q1 and Q2, on the increasing operating expenses, you have got a full quarter’s worth of Micronetics operating expenses in Q2 compared to Q1; so you’re going to have an increase relative to that. But more than offsetting that increase is 2 take downs. The number one is obviously, we had a big restructuring charge in the first quarter that we obviously are not going to have in the second quarter, but it’s going to be a significant reduction from that perspective. And then secondly, you are also seeing as we mentioned the savings in, I’ll call at the based business associated with the restructuring actions that we took in Q1 coming to bear in Q2. So the combination of lack of restructuring charge and base savings associated with that restructuring are the real causes for the reduction sequentially quarter-to-quarter.

And then Mark, just I think we have a pretty good understanding on your details you had given us on SEWIP and some of the other programs, but Patriot was one that I thought that we would see the potential for; we would begin to see some movement here with the U.S. army. What is going on there? Maybe you could just give us an update there?

Okay, sure. So obviously there is a lot of opportunity particularly in the Middle East according to Raytheon's public statements with countries such as Kuwait, Turkey which has been delayed a couple of times now. The decision on that is expected in the latter part of calendar Q4 or early calendar Q1 of 2013. Over and above that, Raytheon is pursuing Oman, Qatar and Kuwait. So there is a fair amount of opportunity. As it relates to the U.S. Army, we did book that design win in the fourth quarter of financial year ‘12, but there is really no news on that at this point in time. So our bookings this quarter were down pretty substantially versus the first quarter of last year. That’s largely due to the fact that in the first quarter of ‘12, we booked the over $9 million deal for Saudi Arabia. So net-net, we think that Patriot is a pretty important program. It is a growth oriented program. The challenge is ever on the program itself is predicting the timing of the order flow given that most of the sales are largely FMS related, which are both lumpy and basically notoriously difficult to predict. So we think it's solid, it's a growth oriented program. But FMS sales are slow.

Right, okay, and then I guess high level, also just regarding your interactions with the Primes, I mean, you talked about the Primes cutting back on their internal R&D budgets. But it doesn’t sound like you are getting the flow through either regarding any outsourcing opportunities right now. When do you think or how do you think, what’s going on there?

So I think as I said in my prepared remarks that we’ve basically seen slowdowns, in really 4 major areas. One of them is to do with services led design wins. So on a dollar basis, we actually had a great quarter design wins with the 5 year probable value being $143 million which is substantially up year-over-year. Two of those design wins were to do with KOR where we’ve got basically 2 design wins, one with their existing DRFM system and one for their next generation. And on top we had a large design win for SEWIP Block 2. But in essence, I think what’s happening is that under a continuing resolution there are no new program starts. So we kind of saw a slowdown associated with that. And then, I think right now our customers are just very reticent to spend money in light of the potential for sequestration. So we don’t think it’s anything to do with our competitiveness or our products. We think that we’re very well position there, it’s just a general, what’s going on in the environment.

And we’ll take our next question from Tyler Hojo with Sidoti & Company.

Just wanted to ask you about, just kind of acquisitions, some of the acquisitions that you’ve made. It sounds like your outlook for Micronetics hasn’t really changed since you’ve made the acquisition, is that a fair statement?

So I think that’s fair, we think that the Micronetics is going to be a good acquisition; it’s got some great customers, great management team, great technology, good programs that they are involved with. So yes, we feel good about Micronetics.

Okay. So if the outlook for Micronetics hasn’t changed. I am just trying to understand a little bit better why your kind of the legacy Mercury business would be much more impacted than Micronetics, is it possible that there is some concern that, that may be we will see some of this impact in the business that you just acquired?

So we think basically what we are seeing in the KOR of the ACS compute business right now, we are really, we are seeing 4 different phenomena. The first is that we are seeing a broad slowdown in programs that have generally produced at a higher level in prior periods. We think that again is basically due to what’s going on in the environment given the potential for sequestration. That’s also being manifested in kind of those run rate deals, these are maintenance spares and repairs that aren't necessarily associated with main programs, but we saw a pretty substantial slowdown there. That we believe is due to the fact that under the current continuing resolution I guess they omitted to actually include the OCO funding. So they currently actually using O&M funds to actually fund some of the war efforts since obviously having an impact on that part of our business. The third area is in relation to design win activity that I mentioned, so that we basically just went through. So in essence I mean we are literally seeing an impact across the board and with the fourth one being programs transitioning between phases such as SEWIP. We do think there is a difference between the compute part of the business and RF. As we look at the RF business, typically what we are seeing there is that RF in the microwave part of the business has got much longer lead times than what we typically see or in the compute part of our business. So I think that's part of what we are seeing also. Finally, as it relates to Micronetics, they come into Mercury with a very, very strong backlog and outlook. And so, it’s a bit of an apple and a pear from a comparison perspective.

Okay, very helpful. And just lastly for me, Mark. We have gone through the entire call to this point without discussing JCREW. I guess it wouldn’t seem, right if I didn’t ask you a question on that one. Any changes in regards to kind of how are you viewing the program, obviously it slipped a bit here, but just your comments there would be helpful?

Yes, sure. So it is basically still official new news on the status or the fate of the program. As you know, all program funding has been exhausted at this point and our customers basically stopped work. As you know also we actually removed all JCREW I1, B1 bookings and revenue from our FY ‘13 plan due to the delays that we are currently experiencing. So we still believe that the program itself is the program of record or remains the program of record and that the Marine Corp has absolutely got an ongoing and urgent need as evidence by that funding request in the recent GFY’ 13 budget submission -- where there is basically no new news at this time.

And we will take a question from Michael Ciarmoli with KeyBanc Capital Markets.

Just maybe to stay on Tyler asset thinking, Mark can we assume the KOR is still tracking as well according to plan?

Yes.

Okay. I know you guys probably don’t want to disclose it, but it would seem like your organic business is probably down 30% or so, give or take. Is that a fair assumption?

Yes, that’s correct.

We’ve state that in the remarks.

Do you guys think -- obviously the sequestration -- and maybe I know the answer to this. The wars winding down, how much of the funding pressure might just be primes finally realizing how much of the funds they’ve been realizing over the past couple of years coming from supplementals and they are now starting to just -- maybe it's paralysis or maybe they are just sifting through available funding. But do you think there is been more of an off-tempo slowdown risk that’s hitting the business. I mean, certainly it could be applicable to JCREW not having troops deploy. Has that factored into the analysis at all?

I don't think so. I don't think it's related to that Mike. It's related to the fear of sequestration. Basically, they don’t want to spend money that they’re not sure that it's going to be available under that scenario. So we know the depots are basically hoarding money. That's impacted those small run rate deals. We know that under the sequestration scenario, there is concern about programs transitioning between phases and see weapon [ph]. You know, the anti-deficiency legislation that we’ve talked about in the past is also coming in to play. So from our perspective, from what we can see and what we are hearing from our customer, it’s very much due to the macroeconomic environment and not due to the off-tempo.

What are you guys getting, what’s the latest you’re getting from the Hill on sequestration? I guess, Obama threw everybody a curve ball last night saying it will not happen. But what sort of your internal planning, do you think it’s actually going to happen or do you think we’ll get some sort of deal or what are your kind of contacts or experts saying?

Well, I thought it was interesting that President Obama said, it will not happen last night. I think his advisors after the fact in the spin room were saying that it should not happen. So I don’t know whether there was a proverbial slip there or not. I think there is a range of different scenarios that may or may not occur with respect to sequestration. I think the view right now is that there is a form of sequestration that the budgeting is up in the round about $500 billion level. How we get to that point in terms of the process, it’s still unclear, because there is a lot of work to be done to get to that piece of legislation being approved by Congress and also approved by the President. So we feel that we’re already seeing the effects of sequestration, maybe because we’re smaller defense company. This business model is different, than done at the large primes. They’ve got multi-billion dollar, multi-year backlogs. They recognize a lot of that revenue under a percent of completion type of contracting, whereas we’ve got a 6-month backlog on average and our order flows are somewhat lumpy due to the fact that we’re shipping systems for revenue. So it’s hard to tell, Mike, exactly what’s going to happen because there is not a lot of guidance, but we already feel we are seeing the impacts.

Got you, fair enough. Last one, what are you thinking about in terms of the portfolio and in terms of any additional kind of need here or desires to sort of round out the center of chain as you guys kind of elaborate on.

So as we said with the recent acquisition of Micronetics, we really did complete the first phase as a result of that acquisition. We think that we have got a strong RF and microwave portfolio, and as we alluded to on the call, we just recently refreshed at the end of Q1 our embedded processing portfolio. So we have got a lot of capabilities, and right now we are very much focused on integrating Micronetics. We completed the first phase of that integration within a 2 month, which is very, very rapid. And the next phase will be complete by the end of the year. So we are pretty happy with what we have got and we are pursuing opportunities in the customer base, and we will continue to look for opportunities going forward, but right now we are focused on the integration.

And we will take a question from Jonathan Ho with William Blair & Associates.

Just wanted to understand a little bit better some of the commentary that you gave about looking at the business differently and now having may be more reliance on backlog driven business versus book-to-ship. I just want to understand how much more conservative you are being here, and if you can give us any color around sort of how you are changing FP&A or how you are changing about how you look at the business from that perspective?

Sure, I think as Kevin said in his prepared remarks, we are taking a more conservative stance in terms of our forecast. And as largely around deals that are shippable from our backlog is well high probability booked ship orders where the deals are likely in purchasing and we know what year the funding money are coming from. We are doing that we are just obviously if you look at what happened with SEWIP we forecast that for the last 2 quarters in Q4 from a bookings perspective. And in Q1 from both the bookings and revenue perspective, and it didn't happen 2 quarters in a row. So we took that deal out of our guidance this quarter. It's still outside, but we didn't guide as part of our guidance just given the environment that we are currently operating it.

Got it. If we can just talk a little bit about the SEWIP program in particular; do you still anticipate that it comes in at some point in the future, is there a cascade effect maybe in terms of, if it gets delayed that quarter and future shipments also get delayed. I just want to understand is there kind of a catch-up effect where once the money starts flowing then everything within the fiscal year still takes place, but maybe in a more concentrated manner?

Sure, we are going to tell you one quarter at time, again SEWIP is outside of our guidance at this point given the delays that we have experience in last 2 quarters. Well, timing of the program generally is that Lockheed is currently integrating and testing to SEWIP block 2 solution. We do believe at this point the name is actually signed up on milestone C which is a very, very positive step forward, given that the sign off on milestone C is what allows the program to transition into that LRIP phase. On the contractual side, our customers are meeting with the Navy again in early November to try and resolve the open tease and seize related to LRIP production contract. But again, just given the delays that we’ve experienced in the last 2 quarters, we haven’t included that in our revenue guidance.

And we’ll take our next question from Michael Lewis with Lazard Capital Markets.

So I just want to look at ACS a little deeper. Is there a way for you to tell us the proportion of the shorter cycle versus longer cycle revenue within that business?

Not really, Mike, no.

So would we assume that’s longer cycle, Mark?

No, it's a mix of both. So I think we’ve really got one issue in the business right now, which is being the delays that we're seeing across the patch in the ACS KOR compute part of our business. We [indiscernible] that size the company’s expense structure in line with the current run rate or the run rate that we see in the business today. So we think that we've been taking appropriate action now.

And then just after you closed up Q1 and you are continuing to see progression in the bookings, as we look into where we are in Q2 right now, are they on plan, below, above plan, could you give us some idea how that’s coming in right now?

So we feel that we’re going to have a positive book-to-bill in Q2. So hopefully, we’ll deliver that, but that’s what we’re currently forecasting.

Okay. And then, just one more and I’ll go out of way here; Kevin, I was wondering for your new facility, could you give us what your unused facility fee is and then also the rate for the funds once you would actually do an acquisition and use these funds?

Yes. Basically, in terms of the borrowing rates it’s essentially either based off of a base rate that’s can do a primary or it’s a LIBOR rate that’s essentially a spread based on the leverage ratio that we have at the time that we take out the debt. So it can range anywhere from, I don’t know, anywhere from 50 basis points up to higher amounts upon the leverage. A lot of this Mike is filed with our, as an exhibit, we filed our 8K, I think it was about a week and a half ago. Certainly, the commitment fees I think, I’ll just say all-in the fees were well less than $1 million.

And we’ll take a question from James McAree from Neuberger Berman.

I just had a couple of quick things kind of following-up on some of the previous questions. But -- and you might have talked about this, I may have missed it, but the gross margin in the quarter on the $49.5 million of revenue, it looks like eyeballing about 41%; was there something in the mix that caused such a big margin change?

So it’s largely what we said earlier, which is basically the slowdown in the KOR compute part of our business, which typically carries a much higher gross margin than some of the acquired businesses in the RF and the services domain. So when that part of our business gets impacted, then you see basically flow through the gross margin line.

Yes, okay I thought that’s what you said, just want to make sure. And then in terms of having the business the restructuring that you have undertaken, the idea there is to say run at current revenues at cash flow breakeven, is that the idea of the restructuring at this point?

Exactly.

And we have a question from Howard Rubel with Jefferies.

I have a couple. First to follow on with the last question. At what level do you think you will be able to become profitable again, Mark?

So we are not going to predict that Howard, I mean it’s basically we are taking one quarter at a time from a guidance perspective and a lot depends on the top line and the mix of revenues. So we have given our guidance for Q2.

No, I understand that so, but you have sized the business not to make money at current levels is that correct?

Actually breakeven at the current revenue run rate yes.

Just you had a very nice order for KOR for $58 million -- the basic ordering agreement from the navy. How much of that was funded in the current quarter or will be funded or when you sign the agreement there is typically a certain amount?

No, so basically it’s a bow which is form of agreement that really covers the Ts and Cs of a potential future orders, so the agreement itself is valid for 5 years and can be it up to 58 million of orders. Each order however will come out really as an RFP will be subject to specific negotiations around the amounts that they want to order. So it’s not a funded contract to say, but it’s the ability of the government to be able to order from it over time.

Do you include that in the 5 year potential dollars?

From a design win perspective, yes, yes.

And then what was the backlog that you acquired with Micronetics?

Roughly about $24 million.

It was actually $30 million.

That’s at the end of the quarter when we acquired it.

I am sorry.

When we acquired the business Howard, shall we say?

Yes, at the time of the acquisition or?

The acquisition, yes. At the time of the acquisition we have about $24 million of backlog from Micronetics.

And so you said it grew during the quarter. So you are now at 30 from what happened?

Yes.

That’s correct. So they have a 2.38 book-to-bill for the quarter, Micronetics.

And what were the top 2 or 3 programs there?

So the major program was related to an EW finder upgrade with BAE, and unfortunately at this point we are not at liberty to kind of disclose the platform. They also experienced bookings for another EW program and more on the rotary side of the house with Xilinx. So there were 2 major ones in the defense domain. In the commercial domain, the largest booking that they had was for a commercial aerospace satellite communications communication arbitration.

So that was the major commercial business in the quarter as well?

Yes.

Our next question is from Brian Ruttenbur with CRT Capital.

The question has been asked, but I am not sure if I understand the answer. If sequestration hits, can you remain cash flow positive?

We believe that we're going to remain cash flow positive. We size the business based on what we think is going to happen from a revenue perspective. However, we're going to end up taking one quarter at a time as we said earlier.

Okay, and then the second question is a harder question, and you may not have any answer at this point. What about selling the company? What does the board think about that? Is there any kind of thoughts in your mind from a macro standpoint? When is the right time to exit if it is in fact the right time in the near-term or not?

So obviously that’s not something that we would comment on externally. Clearly the board on the stance what's going on in the industry as well as that fiduciary responsibility, and that is always an option to turn to the company, but it's not an option that we're pursuing about at this time.

We have a question from Mark Jordan with Noble Financial.

This is Eric [indiscernible], in for Mark Jordan. Just a quick question relative to gross margins. Now that Micronetics in integrated, is it reasonable for the Q2 gross margin guidance to reflect a normalized run rate for the balance of the year?

We’re basically providing one quarter at a time guidance, so clearly, Micronetics is integrated into our current Q2 guidance, but we’ll be updating Q3 guidance and when we report Q2. Got it?

Mark pointed out as well. We’ve only completed Phase I of the integration, so we do have additional integration activities going on. But, to his earlier point, we’re going one quarter at a time at this point.

And there are no further questions at this time. I’d like to turn the call back over to Mark Aslett.

All right. Well, thank you all so very much for listening. We look forward to speaking to you all again next quarter. Thanks a lot.

And this does conclude today’s conference. Thank you for your participation.