Oct 23, 2012
Operator
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.
Kevin Bisson
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.
Kevin Bisson
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.
Kevin Bisson
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 beyond our control.
Kevin Bisson
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 10K for the fiscal year ended June 30, 2012.
Kevin Bisson
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 statement to reflect events or circumstances after the date on which such statement is made.
Kevin Bisson
I would 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 from continuing operations and free cash flow to GAAP cash flows from operating activities are included in the press release we issued this afternoon.
Kevin Bisson
I am now pleased to turn the call over to Mercury’s President and CEO, Mark Aslett. Mark?
Mark Aslett
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.
Mark Aslett
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.
Mark Aslett
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.
Mark Aslett
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.
Mark Aslett
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.
Mark Aslett
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.
Mark Aslett
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 0.81 and our total book-to-bill was 0.83.
Our defense backlog exiting Q1 benefited from the recent addition of Micronetics and was up 10% year-over-year.
Mark Aslett
We see delays and reductions across our defense business from ongoing programs to new programs transitioning between phases like SEWIP, to smaller run rate deals and new defense design wins. We are experiencing a broad slowdown across several of our large ongoing programs such as Aegis, Global Hawk, Patriot, ASIP, F-16 and Predator and Reaper.
Mark Aslett
These are not programs or platforms that we believe are at risk nor are they indicative of Mercury performance issues but they are currently producing at lower levels than they have in the past, largely we believe due to the slow funding and contracting environment.
Mark Aslett
The same is true for smaller run rate deals that we get each and every quarter. These deals are typically related to spare parts, maintenance and repair and are not necessarily associated with named programs.
Although, these run rate deals have been steady revenue drivers for us over the years, this is another area where we would be impacted.
Mark Aslett
We're also seeing a fall off in new services led design wins. This reflects the fewer dollars associated with new programs starts under the current continuing resolution.
It also reflects the price coming back on the internal research and development spending because of the potential for sequestration.
Mark Aslett
There is a total of 6 design wins for the first quarter, 5 of them in defense. This compares with 9 wins, 8 of them in defense in Q1 last year.
The 5 year probable value of our Q1 fiscal ‘13 design wins was approximately $143 million, compared with $39 million in the first quarter last year.
Mark Aslett
The increase in volume reflects 2 major design wins related to cause DRFM or Digital Radio Frequency Memory subsystems which are integral to modern electronic warfare applications.
Mark Aslett
Another important design win this quarter was associated with greater content on SEWIP Block 2. We feel very good about the relationships we built with Lockheed around SEWIP and continue to expect that SEWIP will be an important bookings and revenue driver for Mercury going forward.
Mark Aslett
So this is clearly a challenging environment for Mercury and the defense industry as a whole. Our plan for the near-term is to focus on controlling what we can’t control, taking it one quarter at a time and staying ahead of the curve by being as proactive as possible.
Mark Aslett
In the fourth quarter of FY ’12, we implemented a restructuring action that is expected to resolve an approximately $5 billion of recurring annualized savings. Looking further to the deterioration of the industry environment as the first quarter unfolded, we implemented a second round of cost reduction actions.
These actions reduced the size of our workforce by 142 positions and is expected to lower annualized expenses by an additional $20 million beginning in the second quarter of FY ’13.
Mark Aslett
At a total company level, 107 of the Q1 headcount reductions were centered in the ACS engineering and administrative functions in our headquarters. These actions were taken for 2 reasons, first, to deal with the bookings and revenue slowdown we’re experiencing in the KOR compute part of our ACS business.
Mark Aslett
Second, is that in the first fiscal quarter we successfully completed the new product introduction cycle we have embarked upon 5 years ago and we no longer need to invest at the same level.
Mark Aslett
When I joined Mercury, our products were behind the competition. Since then, we have invested approximately $225 million in R&D that has produced an industry leading and state of the art embedded processing portfolio.
Mark Aslett
We’ve pioneered new capabilities such as developing teraflop GPU based multi-computers for sensor and Big Data processing applications. We created an industry leading embedded Intel server class product line.
We’ve introduced important security capabilities across our products. We lead in the packaging dimension with important new innovations such as airflow by [ph] our next generation of cooling technology, which is leading to a dramatic improvement in processing density.
Mark Aslett
And last but not least, our embedded software is second to none in the industry and is a key enabler to our customers being rapidly able to port their applications on a truly opened sensor processing subsystem. These are the products and solutions that have and will continue to lead to new design wins and future growth in our business.
Mark Aslett
Turning to Micronetics, 35 positions were eliminated during Q1 relating to the first phase of our integration activities. This phase focus reorganizing Micronetics from 5 independent businesses built through acquisitions over time into 2 business units focused on RF components and RF subsystems as well as streamlining some redundant corporate and overhead functions.
Mark Aslett
Reducing headcount is never easy and we have parted with many talented and hard working former colleagues. However, we have been careful during these reductions to focus on retaining key engineering talent and middle management to preserve both our unique capabilities and our ability to scale up once we get through this period of our industry uncertainty.
Mark Aslett
As a result, we believe we have preserved the intrinsic value of the business while significantly and quickly reducing our overall expense levels. From a strategic perspective, we are now forecasting and managing the business differently than in the past given the end market conditions.
Knowing that we can’t control the timing of order flows or revenues at this juncture, the team is working hard to maximize our results during these difficult times in the defense industry.
Mark Aslett
We are focused on managing all the things that are within our control, chief among them are operating expenses, working capital investments, CapEx and cash flow. Our management is the business for the next several quarters is now less about driving to deliver revenue upside and more around managing to more a conservative revenue plan built around shippable backlog and high probability book ship orders.
Mark Aslett
Wanting to stay away from making large future bets from an inventory perspective, this deal has continued to move to the right. We have also slowed down or in some cases ceased purchasing long lead time materials ahead of order receipt for programs where the order timing is questionable.
Mark Aslett
Avoiding the related working capital investment will help us to manage cash flow to the short-term and should help us rebuild backlog as the year progresses. Overall, we believe that we been very proactive under really tough circumstances.
We've accelerated the Micronetics integration and complete the first phase in less than 2 months.
Mark Aslett
We executed on an aggressive restructuring in the KOR business that aligned our cost structure with a lower revenue environment. With the product portfolio refresh and improved operating leverage in the business, we should be well positioned when the industry returns to more normal conditions.
Mark Aslett
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 where our end markets are more favorable. As we announced last week, we closed on $200 million unsecured revolving credit facility with very favorable terms.
Mark Aslett
This facility is available for general corporate purposes, but primarily future M&A. That said, right now we are focused on integrating Micronetics and don’t wish to lever up adding financial risk to the industry risk we are currently experiencing.
Mark Aslett
Over the longer term, we remain very positive in our prospects and the fact that we have and will continue to build intrinsic value in our business despite multiple previously hours in budget turbulence, we’ve delivered 15% compounded growth organically in our defense business since 2008, with improved profitability. We're confident that given our lower cost structure, Mercury will not only quickly recover when the industry returns to a more normal environment, but also be positioned for accelerated growth and improved profitability for the long-term.
Mark Aslett
With that, I would like to hand it over to Kevin.
Kevin Bisson
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.
Kevin Bisson
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.
Kevin Bisson
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.
Kevin Bisson
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.
Kevin Bisson
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 $10.9 million in this year’s first quarter. Reviewing first quarter performance in greater detail; total revenue for our largest segment, Advanced Computing Solutions or ACS was $42.7 million, which was $4.6 million lower than the $47.3 million of ACS revenue generated in last year’s first quarter.
Kevin Bisson
The year-over-year decrease was due to a $5.4 million decrease in ACS defense revenue that was partially offset by $800,000 increase in commercial revenue. The decline in ACS defense revenue stemmed largely from unusually high JSF related revenue in last year’s first quarter and lower year-over-year Global Hawk program revenue that were partially offset by revenue derived from the acquisitions of KOR Electronics and Micronetics.
Kevin Bisson
Revenue from the company’s Mercury Federal Systems or MFS operating segment for the first quarter was $9.9 million, which was $5.7 million higher than the $4.2 million of MFS revenue for the first quarter of fiscal 2012.
Kevin Bisson
Similar to the last 2 quarters, this significant increase in revenue between years was due primarily to higher revenue from the Gorgon Stare program as well as the inclusion of revenue from Paragon Dynamics or PDI, which was acquired as part of KOR Electronics. It should be noted that operating segment revenue for the first quarter of fiscal 2013 does not include adjustments to eliminate $3.2 million of intercompany revenue.
Kevin Bisson
Total defense revenue, including ACS and MFS, for the first quarter of $44.5 million was $500,000 lower than defense revenue of $45 million in the first quarter of last year. Excluding the addition of KOR, PDI and Micronetics first quarter defense revenue declined 13.5 million or approximately 30% year-over-year, reflecting the considerable slowdown in defense procurement in light of the threat of sequestration as Mark referenced in his remarks.
Kevin Bisson
Defense bookings for the first quarter of 36.1 million were 24.8 million or 41% lower than the $60.9 million in defense bookings in the first quarter of last year. Excluding an unusually large JSF related booking in last year’s first quarter, defense bookings declined by approximately 11% between years.
The company’s first quarter bookings performance is a direct result of a more pronounced slowdown in purchase order activity fundamentally affected by the lack of clarity regarding the defense budget for the current government fiscal year.
Kevin Bisson
Mercury’s total book-to-bill ratio for the first quarter of fiscal 2013 was 0.8, which was below the 1.3 book-to-bill ratio in the first quarter of last year. Defense book-to -bill of 0.8 for this year’s first quarter was similarly below the 1.3 ratio generated in the first quarter of last year.
Again, last year’s first quarter JSF booking had a significant impact on the high book-to-bill ratio in the first quarter of last year.
Kevin Bisson
The company ended the first quarter of fiscal 2013 with a $120.2 million of total backlog, which was 18.4 million or 18% higher than the $101.8 million of backlog at the end of last year’s first quarter. Of the total ending backlog in the first quarter, a 102.7 million or 85% is expected to be shipped within the next 12 months.
$107.9 million of the ending first quarter backlog relates to defense which is $10.1 million were 10% higher than last year’s defense backlog.
Kevin Bisson
From a bottom line perspective, the company incurred a GAAP loss from continuing operations of $7.2 million in this years’ first quarter compared to GAAP earnings of $2.7 million in last year’s first quarter. The difference in bottom line performance between years was primarily due to lower gross margin, resulting from an unfavorable product mix.
Kevin Bisson
As such, lower organic defense revenue which carry higher gross margin was largely offset by acquisition related RF and services related revenue that carry comparably lower gross margin. In addition year-over-year operating expense growth derived mainly from the $5 million of restructuring charges incurred in this year’s first quarter has $4.5 million of incremental KOR PDI and Micronetics operating expenses were essentially offset by lower based operating expenses.
Kevin Bisson
As we mentioned publicly earlier this month, the company completed a sizable headcount reduction at the end of the first quarter, resulting in a significant restructuring charge at quarter end. Of the 142 positions eliminated, approximately 75% involve engineering and administrative functions at the company’s headquarters facility to address the rapid slow down in bookings and revenue in our KOR compute business.
And as Mark noted earlier, the completion of our KOR compute product refresh that the company undertook 5 years ago.
Kevin Bisson
The remainder of the headcount reductions pertained to initial integration efforts related to the Micronetics acquisition. All told, we expect that this action and other cost reduction initiatives will yield approximately $20 million of annualized savings, beginning in the current fiscal quarter.
Consistent with our comments last quarter, the company has been aggressive in managing operating expenses in light of the difficult industry dynamics.
Kevin Bisson
Adjusted EBITDA of $1.6 million for the first quarter of fiscal 2013 was $7.1 million lower than the $8.7 million of adjusted EBITDA generated in the first quarter of last year. The reduction in adjusted EBITDA between years is mainly attributable to the pre-tax loss generated in this year’s first quarter.
That was partially offset by higher year-over-year add back of purchase accounting adjustments due to the recent acquisitions and this year’s restructuring charge add back.
Kevin Bisson
Turning to the balance sheet, the company ended the first quarter of fiscal 2013 with cash and investments of $30.6 million and no debt, which was $85.4 million lower than the $116 million of cash and investments at the end of fourth quarter of fiscal 2012.
Kevin Bisson
The decrease in cash and investments for the first quarter was driven by $74.3 million of cash used to acquire Micronetics during the quarter, combined with the $10.9 million free cash flow burn for the quarter. This free cash flow burn was driven by $9.9 million of operating cash flow burn, largely the result of a loss incurred in the first quarter, combined with higher organic inventory related to the SEWIP order delay and lower accruals.
Capital expenditures were $1 million in this year’s first quarter.
Kevin Bisson
With regards to forward-looking guidance, the company will be providing only quarterly financial guidance due to the lack of clarity within current defense contracting and funding. With that as a backdrop, we are targeting second quarter total revenue to be in the range of $43 million to $49 million.
This range assumes procurement challenges persisting within the defense sector.
Kevin Bisson
In addition, as Mark referred to in his comments, this forecasted revenue range also reflects a much higher reliance on revenue derived from orders in backlog and less on orders to be booked and shipped in the second quarter. We believe that in these unprecedented times, when defense procurement has slowed to historically low levels, it is prudent to prepare operational plans forecasted revenue, where customer commitments are more readily identifiable and reliable.
While perhaps, sacrificing some revenue upside potential, it minimizes the buildup of working capital and hence preserves our available cash on hand.
Kevin Bisson
Consistent with prior quarters, we expect to split in second quarter revenue to be approximately 90% defense and 10% commercial. At the midpoint of our guided revenue range, we expect second quarter defense revenue to approximate this year’s first quarter defense revenue as increased revenue from a full quarter’s impact from Micronetics is forecasted to be largely offset by lower organic defense program revenue.
Kevin Bisson
We want to emphasize that our revenue guidance does not include any revenue associated with the current SEWIP program due to the unplanned delays the company has experienced relative to this program over the last 2 quarters.
Kevin Bisson
Within our stated revenue guidance, we are projecting gross margins to approximate 35% for the second quarter, which reflects a higher proportion of revenue deriving from Micronetics’ whose gross margin is lower than the company’s organic defense business.
Kevin Bisson
Operating expenses are forecasted to be $26 million for the second quarter, which is nearly $6 million lower than the first quarter operating expenses. The sequentially lower operating expenses expected for the second quarter reflects savings associated with the cost reduction actions completed in the first quarter and lower restructuring charges that are partially offset by a full quarter’s affect of Micronetics’ operating expenses including increased amortization expense related to that acquisition.
Kevin Bisson
From a bottom line perspective, we are targeting a GAAP loss per share in the range of $0.17 to $0.24 per share for the second quarter based on an estimated weighted average share count of 30.1 million shares. Within this loss per share range, we project a $0.06 per share impact from the combination of intangibles amortization and trailing restructuring costs.
Adjusted EBITDA for the second quarter is estimated to be between negative $2.1 million and positive $700,000.
Kevin Bisson
With regards to liquidity, we anticipate ending the second quarter with approximately $30 million of cash investments and no debt which is essentially flat with our cash position at the end of the first quarter. We expect to generate a small amount of operating cash flow during the second quarter that will be largely offset by forecasted capital expenditures.
Kevin Bisson
As a final note on liquidity, you may have noticed that the company announced a week and a half ago that it had replaced its existing $35 million secured revolving credit facility with a $200 million unsecured revolving credit facility. As we mentioned at last quarter’s earnings call, we entered into this larger facility to provide financing capabilities that would allow the company to continue with M&A strategy in light of its current cash on hand following the closing of the Micronetics acquisition in the first quarter.
Kevin Bisson
Furthermore, this new facility affords the company additional financing flexibility in view of the challenging industry dynamics, while taking advantage of an attractive borrowing environment. It should be noted that the facility is currently undrawn with no plans to currently utilize it.
Kevin Bisson
With that, we’ll happy to take your questions. Operator you can proceed with the Q&A.
Operator
[Operator Instructions] And we will take our first question from Peter Arment.
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?
Kevin Bisson
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.
Peter Arment
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?
Mark Aslett
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.
Peter Arment
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?
Mark Aslett
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.
Operator
And we’ll take our next question from Tyler Hojo with Sidoti & Company.
Tyler Hojo
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?
Mark Aslett
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.
Tyler Hojo
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?
Mark Aslett
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.
Tyler Hojo
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?
Mark Aslett
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.
Operator
And we will take a question from Michael Ciarmoli with KeyBanc Capital Markets.
Michael Ciarmoli
Just maybe to stay on Tyler asset thinking, Mark can we assume the KOR is still tracking as well according to plan?
Mark Aslett
Yes.
Michael Ciarmoli
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?
Mark Aslett
Yes, that’s correct.
Kevin Bisson
We’ve state that in the remarks.
Michael Ciarmoli
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?
Mark Aslett
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.
Michael Ciarmoli
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?
Mark Aslett
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.
Michael Ciarmoli
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.
Mark Aslett
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.
Operator
And we will take a question from Jonathan Ho with William Blair & Associates.
Jonathan Ho
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?
Mark Aslett
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.
Jonathan Ho
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?
Mark Aslett
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.
Operator
And we’ll take our next question from Michael Lewis with Lazard Capital Markets.
Michael Lewis
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?
Mark Aslett
Not really, Mike, no.
Michael Lewis
So would we assume that’s longer cycle, Mark?
Mark Aslett
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.
Michael Lewis
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?
Mark Aslett
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.
Michael Lewis
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?
Kevin Bisson
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.
Operator
And we’ll take a question from James McAree from Neuberger Berman.
James McAree
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?
Mark Aslett
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.
James McAree
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?
Kevin Bisson
Exactly.
Operator
And we have a question from Howard Rubel with Jefferies.
Howard Rubel
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?
Mark Aslett
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.
Howard Rubel
No, I understand that so, but you have sized the business not to make money at current levels is that correct?
Mark Aslett
Actually breakeven at the current revenue run rate yes.
Howard Rubel
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?
Mark Aslett
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.
Howard Rubel
Do you include that in the 5 year potential dollars?
Mark Aslett
From a design win perspective, yes, yes.
Howard Rubel
And then what was the backlog that you acquired with Micronetics?
Kevin Bisson
Roughly about $24 million.
Mark Aslett
It was actually $30 million.
Kevin Bisson
That’s at the end of the quarter when we acquired it.
Howard Rubel
I am sorry.
Kevin Bisson
When we acquired the business Howard, shall we say?
Howard Rubel
Yes, at the time of the acquisition or?
Kevin Bisson
The acquisition, yes. At the time of the acquisition we have about $24 million of backlog from Micronetics.
Howard Rubel
And so you said it grew during the quarter. So you are now at 30 from what happened?
Kevin Bisson
Yes.
Mark Aslett
That’s correct. So they have a 2.38 book-to-bill for the quarter, Micronetics.
Howard Rubel
And what were the top 2 or 3 programs there?
Mark Aslett
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.
Howard Rubel
So that was the major commercial business in the quarter as well?
Mark Aslett
Yes.
Operator
Our next question is from Brian Ruttenbur with CRT Capital.
Brian Ruttenbur
The question has been asked, but I am not sure if I understand the answer. If sequestration hits, can you remain cash flow positive?
Mark Aslett
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.
Brian Ruttenbur
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?
Mark Aslett
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.
Operator
We have a question from Mark Jordan with Noble Financial.
Unknown Analyst
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?
Mark Aslett
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?
Kevin Bisson
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.
Operator
And there are no further questions at this time. I’d like to turn the call back over to Mark Aslett.
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.
Operator
And this does conclude today’s conference. Thank you for your participation.