Mercury Systems Inc (MRCY) 2002 Q3 法說會逐字稿

Good day and welcome everyone to the Mercury Computer Systems, Incorporated third quarter fiscal 2002 earnings results conference call. Today's call is being recorded. At this time I would like to turn the call over to the President and CEO, Mr. Jay Bertelli. Please go ahead, sir.

Thank you and welcome, ladies and gentlemen. Before we get into the meat of the call today, I'm sure that most of you also saw the press release announcing that Mr. G. Mead Wyman is retiring. It is with sadness that I see Mead move on but he has served the Company extremely well over the years and he is going to stay with us through this transition period, probably through the end of June sometime until he gets itchy to go fishing down in Martha's Vineyard.

But in any event, Mead has done a great job for us over the years. He was responsible for taking us public and I certainly am going to miss him, as well everybody here. But we have Jack Alexander coming on board. He was elected at the Board meeting on Monday as the CFO, effective May 1st, so this is Mead's last public appearance for Mercury. But Jack, you all saw his background. I'm not going to get into that but we're looking forward to Jack contributing significantly to the overall management of the Company as we continue to look forward to growing into a hundreds and hundreds of millions. So with that we'll get started with the earnings announcement. First, I'm going to ask Mead to cover the Safe Harbor.

OK thanks, Jay. Thanks also for those kind comments and let me add to your statement that I really think we're turning the Company's Chief Financial Officer role over to an outstanding individual who is going to be able to fill and overfill my shoes.

Let's go ahead with the forward-looking Safe Harbor statement. During this conference call, Jay and I may make several forward-looking statements, including those dealing with our future overall business and market segment performance. Accordingly the Company wishes to take advantage of the Safe Harbor Provisions. Forward-looking statements involve risks and uncertainty that could cause actual results to differ materially from those projected or anticipated. Factors that could cause or contribute to such risks and uncertainty include, but are not limited to, general, economic and business conditions, competition, changes in technology and methods of marketing, delays in completing various engineering and manufacturing programs, changes in customer order patterns, changes in product mix, continued success and technological advances and delivering technological innovations, shortages in components, production delays due to performance quality issues with outsourced components and various other factors beyond the Company's control. These risks and uncertainties include such additional factors as are described in the Company's recently filed reports with the Securities and Exchange Commission in the USA. The Company wishes to caution listeners of today's conference call not to place undue reliance upon any such forward-looking statements, which speak only as of the date made.

Thanks, Mead. Well, folks, this was our 45th successive profitable quarter. We pulled it out and we're quite proud of that. Let me talk a little bit about the defense business, since that is the area that seems to be getting the most attention these days. We continue to get comments from analysts and investors indicating that it is counter-intuitive that Mercury's defense business would be under-performing at a time when defense spending is seemingly increasing, particularly considering our involvement in the ISR or Intelligence, Surveillance and Reconnaissance area. It's a fact that with the signing of the defense budget in early January, government outlays are finally beginning to increase and prime contracts are beginning to be awarded, some for programs we are already a part of and others we have targeted for a new business development. However, it is also true that the budget process was significantly delayed and at the same time represented a considerable shift in funding priorities reflecting both the new administration's determination to transform the military and to address the need to counter the domestic and international threat of terrorism.

Each of these factors we believe has had an impact on our defense business over the past three quarters and will continue to impact us going forward. Over the past several months, our sales folks have had numerous meetings with customers and government program offices. At each meeting they ask whether there has been a business increase or decrease since 9/11 and why. Almost all have indicated that business has pulled back. This business retrenchment is attributed to either, one, a general budget re-planning effort to refocus resources for the war on terrorism, or two, to move short-term resources into immediate operational needs such as bombs and fuel.

I've got a collection of summary comments from several customers who are program managers that I'd like to share with you, without mentioning any names or program names. A lieutenant colonel, who is a program manager, indicated that all of his programs were being accelerated and he is experiencing major re-planning of his programs that focus sensor payloads on the war. But in the meantime, some temporary stalling of funding is anticipated until the re-planning is completed within the next three to six months. A technology director at one of our customer's research centers indicated that there has been a pull-back of funds for selected programs. They have won some number of R&D contracts but the funding has not yet materialized. And the manager at another research center indicated they had seen a general slowdown of R&D funding and were not making their revenue targets. A communications engineering manager indicated that there has been a general slowdown of funds for most programs he is involved with. However, some communications programs already in production have been accelerated to support immediate operational requirements. A business development manager at one customer location indicated they were experiencing a general slowdown of funding resulting in some temporary layoffs.

A colonel at one major government research lab indicated they're experiencing minor changes in funding along with some refocusing of resources toward terrorism. A chief engineer for a major program in which Mercury is involved indicated the program is definitely being re-planned for an accelerated development schedule to support the war on terrorism. A contract director at one customer location indicated some of their programs in production with immediate operational impacts were being accelerated. Most other programs were being re-planned and re-budgeted for long-term focus on the war.

So these are just a few examples of the information that we've been gathering to help you have a level of confidence that the current issues in our defense business are transitory and that the future in this segment looks bright, certainly brighter than the past few quarters. But it is not possible for me to try and forecast when or to what extent Mercury's defense business could benefit from increased defense outlays.

In the medical business, while we had another good quarter of performance, fourth quarter performance is expected to be down sharply, bringing performance for the year in line with our previous guidance of roughly flat with last year. There is a general softness in the overall medical diagnostic imaging market that we saw developing in this past quarter and also some erosion in revenues from the CT modality as customers are expected to introduce new CT designs, which do not include Mercury's products.

As you see in our press release, we continue to be successful at gaining new design wins in the semiconductor imaging sector. As we begin to see signs that this industry could be in the early stage of recovery we are excited by the future revenue potential these design wins represent. And you can see that we are continuing our business development activity within the wireless sector. I want you to realize that we are rationalizing our investments in this area and working to leverage both the skills and technology resulting from this investment into those areas of the business where we may shorten the time to market.

Specifically, we're looking at taking some of the products and certainly some of the intellectual property that has been developed and moving it into the defense space where we think it's appropriate, especially in light of the need to increase our

capability as a country. So with that I'm going to turn it over for detailed analysis of the numbers to Mead.

OK, thanks again, Jay. Good afternoon again to all of you. As indicated in our pre-announcement on March 19th, our revenues and earnings for the quarter were below our previous guidance. However, we are pleased to report that the revenue and earnings came in at the high end of our expected range.

Before reviewing the details of the quarter let me summarize the key facts. Third quarter revenues were 34.9 million. Net income was 2.7 million, or 8 percent of revenues, allowing us to record our 45th consecutive quarter of profitability. Earnings per share for the quarter were 12 cents, at the high end of our guidance in the pre-announcement.

Now let's drill down a bit into the numbers. Defense electronics revenues were 17.6 million, or 51 percent of total revenues in the third quarter, compared to $31.4 million or 67 percent of total revenues during the third quarter of last year. We do continue to see positive signs that the defense business is improving, including the fact that our book-to-bill ratio for the defense this quarter exceeded 1.30. This is the second quarter in a row that our defense bookings have exceeded revenues.

Medical imaging revenues were $14.3 million or 41 percent of total revenues in the third quarter, compared with 10.3, or 22 percent of total revenues during the third quarter of last year. Although the medical business has exhibited very good growth this quarter, we do not anticipate this level of growth to continue into the next quarter, the quarter that we're in now, and into fiscal year 2003 as forecasts from our customers indicate lower volumes. Other commercial revenues were $2.9 million, or 8 percent of total revenues in the third quarter, compared to 5.3 or 11 percent of total revenues during the third quarter of last year.

Gross margin as a percent of total revenue was 61.4 percent for the quarter just ended, which is lower than the immediately preceding quarter where the gross margin percent was 66.3 percent. The primary reason for the decrease in margin was a shift in product mix from high margin defense business to lower margin medical and commercial business. A secondary, and much smaller, factor reducing gross margin percent was an increase in inventory reserves. Selling, general and administrative expenses decreased 8 percent to 11.7 million or 33 percent of revenues for the quarter from 12.6 million or 27 percent of revenues for the same period last year. This decline in expense is primarily due to the completion of the first and major phase of the implementation of our new ERP system during first quarter of this year, this fiscal year. Sorry, the first quarter of this calendar year. Further factors in the decline of SG&A expense were lower sales commission levels resulting from the lower sales volume and cost reduction activity in view of lower business levels.

Research and development expenses increased 9 percent to $8.8 million, or 25 percent of revenues for the quarter, from $8 million or 17 percent of revenues in the same period last year. The increase in R&D expenses as a percentage of revenue was primarily due to the lower sales volume this year coupled with higher R&D expenses. Engineering expenses for this quarter were higher than last year, primarily due to the addition of a new medical development program plus an increase in engineering head count.

The effective tax rate for Q3 fiscal 2002 was 21.4 percent as compared to 32 percent in the previous year. This reduction in quarterly tax rate brings our annual tax rate down to 28 percent as compared with the 32 percent last year. The reduction in annual tax rate was due to the lowering of the Company's income forecast coupled with an expected increase in tax preference items such as research as the research and experimentation credit and tax-exempt interest income. We anticipate the 28 percent is the appropriate tax rate for the remainder of fiscal 2002. Again, net income as 2.7 million or 8 percent of revenues for the third quarter compared with 7.9 million or 17 percent of revenues for the same period last year.

Cash and investments increased slightly to 96.2 million as of March 31st from 95.6 million as of June 30th, 2001. A decrease in cash occurred from a buyback program of 519,000 shares of Company stock- or approximately $17.5 million. This cash outflow was more than totally offset by the cash inflows from operations. Day sales outstanding improved to 52 days as of March 31st, 2002, as compared with 64 days at June 30th, 2001. Normally we expect DSOs to average approximately 60 days.

Inventory increased to 15 million as of March 31st, 2002, from 12.8 million as of June 30th, 2001. Our inventory turns of 3.6 times in this quarter was in line with the turns recorded during the first and second quarters of this fiscal year but were down from last year's fourth quarter number of 5.4, which was the highest we've seen in recent history.

I'd just like to remind you of a few pieces of information with regard to our outlook now as described in the earnings release. The Company continues to expect fourth quarter fiscal 2002 revenues to be in the range of 40 to $43 million excluding the contribution expected from our Myriad Logic acquisition. Including the contribution from Myriad Logic, we would anticipate total revenues in the $42 million to $45 million range. At these levels of revenue, we would expect earnings per share to be in the range of 18 to 26 cents. Fiscal 2002 total revenues then are expected to be in the range of $149 million to $152 million including the contribution of Myriad Logic. At these levels of revenues we expect EPS to be in the range of 63 to 71 cents.

With that, we'll take questions.

A question and answer session will be conducted electronically. To ask a question simply press the star key followed by the digit one. We'll take as many questions as time permits and we'll proceed in the order that you've signaled. Again it's star one to ask the question and our first question will come from

,

.

Thank you. A few questions. Just jumping back to the cash quickly, the cash balance as of the March quarter did not include any of the effects of the payment for Myriad, correct?

That's correct. The transaction is considered to have taken place on April 1st.

OK so then you've touched on the March cash balance relative to the June quarter. Can you touch on it relative to December? It seems to have ticked down about 8 or 9 million.

Relative to which date, Brad?

December.

Yes, it will take me a minute to look that up but I'll give you the answer shortly. Can we go on to--

Absolutely. I just want to touch on your expectations for next quarter. You mentioned medical down pretty significantly to get to that flat year-over-year number. It implies a pretty sizable number out of defense in Q4. What do you see outside of the 3.6 that gets pushed from the March quarter into June? Do you see a tick up outside of that as well?

A tick up from what, Brad?

OK you're going to see a pretty sizable sequential increase in defense revenues in the fourth quarter to hit your target.

Yes.

Part of that is going to come from the 3.6 million that pushed from the March quarter into the June quarter.

Yes.

And then there is another increment that will come from issues outside of that 3.6 million.

Yes.

Can you describe in a little more clarity what you're seeing outside of that 3.6 million that will tick up the revenue sequentially.

By program name? I guess--

Some direction as to where that's coming from.

Well, most of it is coming from business that we've been pursuing for some period of time. There is very little in the way of what I'll call new business development activities generating that revenue. These are programs we're primarily designed into and again orders that have been anticipated, were forecast for the most part at the beginning of the fiscal year and they're starting to come true.

OK. OK. And your expectations for Myriad going forward. We're looking at about 2 million in revenues next quarter. How will that be combined into your results? Where will we see that? Will we see that in one of the specific segments?

It will be-- obviously it will be consolidated in. We haven't finalized our decisions on how it will be treated from a segmentation standpoint but clearly virtually all of that business is associated with the defense sector and so the likely outcome is that it will be included in that segment. Also, Brad, I can give you the answer on the cash. The cash investment was 106 at December 31st and essentially the main factors in the quarter itself bringing the amount down to the $96 million figure was the bulk of the buyback. In fact, really virtually all of the buyback program took place in the March quarter and the offset to that was cash from operations. There weren't any other major transactions.

OK. All right. That answers it. Can you just touch on your head count including your engineering?

Yeah.

Well let's go onto the next question, Brad, and we'll get some data here. Let's make sure we've got the right data.

And our next question will come from

with SG Cowan.

Good afternoon, guys.

Hi, Rob.

I wonder if you could touch a little bit more on the business model impact of Myriad? Are the margins relatively similar and you mentioned it adds a couple of million to revenue. Will it add to earnings per share immediately or if not when would you expect it to contribute?

We're expecting a couple million dollars, $2 million to $3 million this coming quarter. Q4 probably contributes nothing to the EPS number business model itself primarily into the defense community. We would expect that the margins would be comparable to what we are used to seeing on our products.

So we should expect a commensurate addition to R&D expense essentially offsetting the margins because you're mainly adding engineering capability?

Well, there's about 27 people I think it is in the group and while there are some engineers there are also people associated with the sales and marketing and the manufacturing of it. We're going to leave it function as a separate entity if you will down in Maryland, IO center of excellence.

so to put it another way essentially operating income roughly breakeven initially and split across the various categories.

Split across--

In other words it adds engineering as well as SG&A expense?

Yes, yes.

You mentioned a change in your thinking for the tax rate for this fiscal year. Mead, I know you have not finished your planning process or made any guidance for the next fiscal year but do you have any thoughts on what the tax rate ought to be for next year?

Well, it's very preliminary, Rob, but we think that it will move back up to the 30 percent range right around there. It will not be as low as it is this year.

I noticed in the text of the press release although you didn't mention it, Jay, in the highlights at the beginning of the call, the new single board, low cost product aimed at the medical business. Given the fact that there's also some new CT products into which Mercury content is not designed, if you could give a little more color on what you think the sales cycle might be if you are successful to get designed into the more cost sensitive segment of medical that you're targeting with this new product?

Well, in fact, we already have a couple of design wins for the product but it won't have any significant impact on revenue for the next several months. It's not clear right now how much revenue we'll see in next fiscal year from it just because of the design cycle. Outside of that in terms of the CT business itself, part of the planning process right now is considering what it is that we need to do to go back after that modality since the products, some of the products we were selling into that were shark based products and the current product was not suitable. The

based product was unsuitable for that application and so we're back looking at how much we want to invest to go after that market again.

And what about the new software based visualization system? Where is that relative to design wins or being product-ized?

Well it has been under development with one prospect or customer specifically but there's no commitments as of this time to including it in their product. It's something that we're working towards and would hope that within the next few months we would have something to say about that.

Great. Turning to the semiconductor equipment market for a minute, the last few days there has been some positive news coming out from various players in that segment, you know trying to call the beginning of an upturn I guess. Do you have any input from your customers across these eleven design wins, when they expect to begin production on some of these projects?

Most of the activity that we're involved with is the next generation systems that will go into the new fabs. We've recently seen some potential activity to retrofit all the systems in existing fabs and that looks quite encouraging. However, I think it's premature for me to put any kind of numbers out there. Let me just say that the folks in the semiconductor industry are starting to feel very bullish, at least for this quarter. We'll see what happens next quarter. But it bodes well for us. However, there's still a level of uncertainty that causes me to want to stay away from giving you any forecasts right now.

And just a reminder to our audience, star one to ask the question. We'll go next to

with Fidelity and Company.

Good afternoon, guys.

Hi, Steve.

Just a quick one on D and A and cap ex for the quarter?

The cap ex I basically can give you on a year-to-date basis.

That's fine.

I should be able to give it to you otherwise but if that's satisfactory.

That's fine.

Our cap ex is roughly in the-- I'm having a problem pulling this sheet out. It's roughly 3 million through the three quarters and what was the other parameter?

D and A.

OK unfortunately we don't-- we have our balance sheet and P&L but we don't have the cash flow statement available.

OK that's not a big deal at all.

So I'm sorry. I can-- let me give you the year-to-date number for the cap ex. It's 2.9 million year-to-date and depreciation, we'll try and get an answer to you in the next few minutes. I can get that perhaps before the end of the call. But while I'm at it let me go back and pick up the earlier question about head count. Our head count at March 31st of full time and part-time employees was 590 and of those 210 were engineers working in the engineering departments of the Company. That would not include engineers working as application engineers in the field or in other non-engineering parts of the Company.

I guess just moving over to the semiconductor business for a little bit, I notice I guess back in the peak years and F O1 you did about 16.6 at the commercial segment so I'm assuming probably 13 or 14 of that was semiconductor related. If we take the design wins that you've received since that cycle and assumed let's say a rosy scenario where you get similar production levels on the semiconductor side from those years, what do you think your annual revenue contribution could be?

Well, the first assumption is not correct. Our semiconductor business is essentially building up from a very low level. The design wins that we've received and from which we anticipate a large increase in revenues really weren't on the radar screen in this year or in prior years. We did have business from two accounts but again that revenue was fairly small. It was--

Several million.

Yeah, several million. That was coming from

, the mass generation company and a small amount of business from Schlumberger.

That's been bought by Applied Materials.

That's now owned by Applied Material.

But, Steve, to address your question a little more generally, we look at this as a $50 million to $80 million available market to us and we think we can capture a greater than 50 percent to market share.

And just go on the defense side for a second, on these sonar-related platforms which seem to be where a lot of delays are, what are your customers saying just in terms of timing? I mean is this going to be a situation where these programs are going to be shut down for a year or two? Do they have any clarity at all? I mean are we talking 6 months? From some of these sonar platforms like DARCI they just seem to have gone dead.

Well if you apply a little logic to what you see in the paper and then read the press I think you realize that there is not much of a submarine threat so while I don't have any data that I can point to or any pronouncements from Rumsfeld. It just seems to sort of be logical that the monies are going to be redirected to areas where there is more of a threat today than there is from submarines, deep-water subs.

I mean you're basically seeing the increase in signal intelligence being offset by weakness in sonar essentially going forward maybe for the long term trend?

Well, we see opportunities to increase the radar business, both ground based and ship based radar, and also the sig. in space. There were a number of design wins in the last quarter that were in the sig. in space that could be attributable to 9/11. It's not clear to us. Some of them are classified.

All right and I guess the last question going over to medical for a second you're pretty much implying a pretty big sequential drop in 4Q so really preliminary for next year in your plan is you're assuming I would have guessed a year-over-year decline at medical given the steep downturn in the fourth quarter?

Well we're not ready to talk about the FY O3 numbers in general. That's a safe assumption to make.

OK. Thanks, guys.

And again it's star one to ask a question. And at this time we'll go to Bob Stafford with Stafford Capital Management.

Hi. I wanted to ask about the intermediate to longer term outlook for the medical area?

We believe that longer term, being looking out over the next three to five years, that the medical opportunity for us, the available market if you will, is somewhere in excess of $100 million and so we think there's a lot of potential growth in that space. It's a matter of having the right product. We missed the product cycle here a while back and it just caught up to us, but we understand the group is focused on the companies, the three or four major companies and the various modalities. And they are bringing in the information that we need to develop an array of products so that we can get that medical business back up and get a significant share of that $100 million.

OK. Thanks.

And we have a follow-up from Rob Stone with SG Cowan.

Hi, Jay. Coming back to the question about the semiconductor equipment design wins I wasn't really expecting you to put a dollar figure on that but to get some sense of when the new products might be expected to launch, is that in the next three months, six months, twelve months? You know some general sense of visibility if you have any?

This calendar year, towards the latter part of the calendar year.

OK. That's very helpful. Thanks. And, Mead, are you able to comment? You mentioned the defense book-to-bill was 1.3. Are you able to comment on the book to bill or backlog trend in the aggregate?

For the Company?

Yes.

Yes, I'll have to actually calculate that but let me go back to an earlier question about the depreciation and amortization. On a year-to-date basis it's approximately 5 million. For the quarter it's 1.6 million so let's dispense with that one and I'll get to the book-to-bill for the whole company momentarily.

Any more questions?

And at this time we have no further questions in the queue. I'll turn the conference back over to Mr. Bertelli for any additional or closing remarks.

Rob, if he's not able to come up with that number now we'll get it back to you later but if there's no other questions we appreciate your attendance and look forward to-- you got something?

Yeah, yeah, I can--

Hold on. Late breaking news.

The book-to-bill was greater than one. It was slightly greater than one. It was very close to one for the Company as a whole. Again I would caution Rob and the listeners not to attach too much significance to backlog numbers. Book-to-bill is important and we had a much stronger book-to-bill in defense this time than we had in the other parts of the Company so you can use the number 1.0 or slightly above that for book-to-bill in this quarter.

OK with that I call this a wrap for this quarter and look forward to our next call, which will be in early August I believe. Thank you ladies and gentlemen. Good night.

That does conclude today's Mercury Computer Systems Incorporated third quarter fiscal 2002 earnings conference call. You may disconnect at this time. We do appreciate your participation.