Mercury Systems Inc (MRCY) 2003 Q2 法說會逐字稿

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Good day and welcome, everyone, to the Mercury Computer Systems, Incorporated 2003 earnings results conference call.

Today's call is being recorded.

At this time I'd like to turn the call over to the President and Chief Executive Officer, Mr. J. Bertelli (ph).

Please go ahead, sir.

Thank you, Jimmy.

And good morning, everyone.

Welcome to our second-quarter conference call, our first to be conducted midday.

Our intent for this schedule was perhaps to avoid some of the competition for your time during the early evening hours and to let us get home earlier.

So if you'd please let our team know what your reaction is and comments as to whether or not you think that this midday timing is appropriate, I would appreciate it so we can factor that into our future plans.

Before we go any further, I would like to remind you all that today's conference call is being recorded, and is the copyrighted and I'm also obligated to let you know the risks of forward-looking comments we might make during a call.

I'm going to ask Jack to read our Safe Harbor Statement.

Good morning.

Various remarks that we may make during this call about future expectations, trends, plans, prospects and performance for the company and its business constitute forward-looking statements for the purposes of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements may reflect our current beliefs, expectations, and estimates, and we cannot assure the future results or outcomes of matters described in any of these statements.

Actual results could differ materially from those projected or anticipated in the forward-looking statements.

As a result there's certain risks and uncertainties.

Such risks and urn certainties 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 mix, continued success in technological advances, and delivering technological innovations, shortages of components, production delays, 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 U.S. securities and exchange commission.

The company cautions listeners of today's conference call not it place undue reliance upon any such forward-looking statements, which speak only as of the date of this call.

And the company undertakes no obligation to update any of the forward-looking statements during made during the call to reflect events or circumstances that may change after the call.

Thank you, Jack.

I'm very pleased to report that we've completed another very strong quarter of over all performance.

Considering the continued more (inaudible) of the world economy and markets that are either in or near historic slumps, ours was a great quarter and one of which we're all very proud.

This was our 48th consecutive quarter of profitable performance.

That's 12 straight years.

Considering that this month marks our 20thanniversary of operations, that says something about the consistency of our performance and the strength of our business model.

This was also our third successive quarter of meeting or exceeding our business objectives reflecting our efforts towards growing the business while improving overall predictability and operating effectiveness of the company.

Second quarter revenues were at $47.7 million.

An increase of 27% over last year's second quarter.

Our operating income was $7.5 million representing a respectable 16% of revenues.

And net income was $6.5 million.

Diluted earnings per share for the quarter were 29 cents, compared to 16 cents for Q2 '02, an increase of 81%.

Both revenue and E.PS for the quarter were within the guidance we announced December 9, 2002.

The fact that we were able to assess the quarter's performance and provide the early indication of the improved quarter out is a result of the strength of the backlog and the improvements the team has been making in various business processes throughout the sales and operations areas.

We made significant progress during the quarter and the reorganization of our business units we began at the beginning of the fiscal year.

We (inaudible)electronics group.

For those of you that may not be familiar with Barry (ph), he was previously the vice president and general manager of our wireless communications group.

The resources associated with the wireless group haven and allocated between the defense electronics group and our (inaudible) solutions group reporting to mark (inaudible).

With these changes, the lawyers communication group no longer exists as a stand-alone business unit.

Commercial wireless infrastructure applications that we are pursuing will be only in businesses that Mark's group will continue to develop.

In addition, the three defense electronic group market teams we mentioned earlier in the year continue to take shape.

As a reminder, the three teams that we created include signals intelligence, radar, and emerging market teams.

With the emerging team, initially focused on applications such as smart weapons, data exploitation, and sonar.

The expectation is that as we segment the market, the defense market, we're able to bring more resources to bear at a final level of (inaudible) to understand the customer's requirements in order to continue to define and develop the products that are best suited for those individual application areas.

As Mercury grows and its markets change, it is becoming increasingly important for us to establish a consistent corporate brand image.

It is critical for us to position ourselves correctly in the eyes of existing customers as well as in the minds of new perspective customers.

Vince Mancusso (ph) been appointed Vice president of a newly created corporate marketing department contributing to the our act to capture the complete value of our solutions.

Vince's role for the past six years is head of the defense's electronics group giving an excellent perspective of what we must do to best position ourselves within our chosen markets.

We believe that this new organizational structure will both support our strategic objectives for growing our business by providing increased customer and applications focus and also support our objectives for growing the skills and management depth of the company by providing increased opportunities for developing the leadership and management talent required for our future success.

Now, let me return it back over to Jack who will give you the financial details for the quarter, summarizing the first half and give you the update of our outlook for the rest of the year.

Jack?

Thank you, J. We increased revenues by 27% and EPS by 81% year over year.

Before discussing the outlook for next quarter and the remainder of the year, I want to highlight a few specifics in the second quarter.

I'll summarize revenue by business unit, discuss the operating performance, review balance sheet and cash flow highlights, and then discuss our performance in the context of the value driver spring work that we're using.

All comparisons that I'm going to make are to the comparable period last year, unless we indicate otherwise.

Defense electronics revenues increased 27% to$31.7 million representing 66% of our total revenues during the quarter.

The increase year over year is the result of several orders being accelerated into the quarter to meet specific customer requirements as well as a strong backlog position entering the year and to the inclusion of the IO center of excellence which was acquired late in FY '02.

To give you a feel for the contribution of IOCE, the company did $2.6 million in revenue in the comparable period last year as a stand-alone enterprise.

For the quarter, medical imaging revenues decreased slightly to 10 -- slightly to$10.4 million which represents 22% of our total revenues during the quarter.

This reflects the continued trend of lower sales into computer tomography systems offset by increased sales for use in magnetic resonance imaging systems and digital X-ray systems.

In OEM systems revenues increased 188% from small base last year to$5.6 million, which represents 12% of our total revenues in the quarter.

The increase in revenues was due primarily to increased sales of airport baggage scanning systems as well as increased shipments of development systems to semiconductor customers.

The segment continues to be negatively impacted by the continuing depressed state of the semiconductor market.

Our total backlog decreased to $70.8 million at December 31st from $78.4 million at the beginning of the year.

But this compares very favorably to $46 million in the comparable period last year.

Of this total backlog at 12.31, 63.2relates to the next 12 months.

Our book to bill ratio was slightly less -- and this was affected by the higher shipments to meet customer requirements during the quarter.

Gross margin % was 65.2 for the quarter consistent with recent experience in our expectations.

Compared to Q2 of last year, margins are down just over 1%, primarily do due to the inclusion of the IOEC.

Selling general and administrative expenses increased to$13.9 million for the quarter, which compares to$12.4 million last year.

The increase in expenses was due to a couple of factors, including the settlement of a former employee's claim against the company, which approximates $800,000.

Additional sales and marketing costs to support the higher revenues as well as the acquisition of IOCE including amortization of intangibles of 200,000.

SG&A increased 1.3 million from the preceding quarter.

Research and development expenses increased 15%from a year ago to $9.7 million or 20% of revenues for the quarter.

The increase from Q2 of last year resulted from the additional spending and development programs which ramped throughout 2002 into a lesser extent, the inclusion of IOCE.

R&D expenses increased 600,000 from the previous quarter.

Our operating income of $7.5 million was 15.7% of revenue for the quarter.

Non-operating income for the quarter increased by $600,000 from last year and this increase primarily reflects the elimination of losses from our investment and agile vision which was sold in the third quarter of last year.

Non-operating income includes $1.6 million of deferred gain in the sale of the SSBU, again we want to emphasize these payments will conclude in the third quarter of this fiscal year.

The effective task rate for the quarter was 31%, which compares to 28% in the second quarter of last year.

Our net income increased to $6.5 million or 14% of revenues for the quarter.

EPS of 29 cents is up from 16% -- 16cents in the second quarter of '02.

And I'd like to summarize a few key points in the balance sheet and cashflow highlights.

We made significant progress in managing working capital during the quarter.

Our day sales outstanding decreased to 31 days at the quarter end from54 in Q1.

And substantially better than our targeted range.

The improvement is due to continued progress in revenue process improvements as well as significant improvement in linearity and in addition we benefited by a number of customers accelerating shipment requests and payments due to the calendar year end.

Accounts receivable balance at the end of the quarter was $16.4 million, and that's significantly lower than our September 30 balance of 23.5.

This decrease, of course, resulted in a significant contribution of free cash flow in the quarter.

Going forward we expect our DSO to range in the mid 40's based upon the improvements we posted to date and continued focus on revenue linearity.

Made progress on inventory as well.

Our inventory decreased to12.8 million at quarter end.

That compares to 14.8 at the end of September.

And is down from 13.4 million a year ago.

Inventory terms improved to 5.2 from 3.8 turns reported a year ago.

And 3.7 reported in the September quarter.

A number of factors have contributed to the improvements in inventory including higher than originally forecasted shipments within the quarter and linearity again helped in this area as well as initial progress on our initiative to reduce inventories.

We're pleased with our initial progress in this area, but still see an opportunity for improving many aspects of our supply chain and inventory management.

Our intermediate target for inventory turns is six times per year.

Cash and investments increased by $21.5 million during the quarter to 107.7 million at the end of the quarter.

And that's up from 86 million as of September 30th.

Am quick(inaudible) from the second quarter follows.

Net income was 6.5 million, depreciation and amortization of 2.1 million, 1.4 million of capital expenditures, and then the decrease in operating capital of 14.4 million,7.1 million coming from receivables and 2 million coming from the inventory reduction.

This resulted in free cashflow of 21.6 million for the quarter, a very strong performance.

In addition, we repurchased 50,000 shares for a total cost of 1.5 million during the quarter, and we do expect to make additional purchases under the program through the balance of calendar year 2003, unless extended or curtailed by the board of directors.

Our headcount increased to 607 associates at the end of Q2, up from 540 a year ago and 6 from the preceding quarter.

The increase over last year includes 30 associates resulting from the acquisition of IOCE and the balance of the increase is due to head count additions in R&D and selling.

Like to (ph) highlight our performance in the framework of the value drivers framework at the investor meeting in September, we presented the initiative to drive (ph) the monitor of our power or performance based on share hold value creation.

The framework focuses our tension attention on key drivers of share value including revenue growth, operating effectiveness, capital management, as well as the predictability and consistency of operating performance.

The framework allows us to monitor, communicate, present our performance with a focus on the drivers of shareholder value.

Various programs have been established to improve our performance in each of these areas and we have established the systems of dashboards to monitor our performance on both leading and lagging indicators of performance in each of these areas.

I'm very pleased to report significant progress in each of these major drivers in the second quarter in the first half of the year.

Sales growth, as we indicated, we recorded a significant gain of 27% compared to last year.

The organic growth rate was about 20% with the balance contributed by the acquisition of IOCE.

In terms of operating effectiveness, we made substantial progress in a number of key initiatives.

Of significant note is the linearity of revenue within a quarter.

The company, like most companies, has historically operated with a large percentage of revenue recorded late in the quarter.

This has a number of unfavorable consequences including performance risk, high costs due to overtime and expediting, as well as high receivables and inventory levels.

We assembled a team of sales operating in finance associates early last summer to attack the hockey stick with a goal of leveling revenue and I'm pleased to let you know that we achieved this goal in the second quarter.

In terms of capital management, we summarized that we posted significant progress in both receivable and inventory management.

One of our new metrics in this area looking at the operating cash cycle, the sum of DSO, we reduced the measure from our historical range of 150 to 160 days down to 105 at the end of Q2.

In addition to the benefit of improved benefit linearity, the additional improvements resulted from our efforts to work on the management of receivables and inventory and related processes.

In terms of predictability and consistency of operating performance, our efforts to improve our forecasting process and the visibility into our progress towards achieving those targets has resulted in our third consecutive quarter of meeting or exceeding our guidance.

We continue to work in this area principally to extend our improved visibility into the mid term performance.

Just briefly summarizing the first half results, I want to highlight a few key points as compared to the same period last year.

First half revenues were $87.1 million, a 20% increase from last year.

Our book to bill for the first half was slightly under one, resulting in a decrease of our total backlog from 78.4 to 70.8 million at 12/31/02.

Operating income for the first half of FY '03 was 11.4 million or 13% of revenues and that represents a 41% increase from last year.

EPS for the first half was 48 cents compared to 33cents, an increase of 45% from last year.

And again, we had very good working capital performance in the first half and strong cash flow generating 36 million in free cash flow in the first half.

Turning to our business outlook, for the third quarter of 2003, we expect revenues in the range of 48 to 51 million.

The mid Pont point of this range would represent you 42% growth over the third quarter of last year.

Operating income will proximate 16%and we estimate EPS28 to 32% per share.

The mid-point of this range would represent 150% growth over a relatively easy comparison from the third quarter of last year.

In terms of total performance for FY '03, we're updating our outlook for revenues to be in the range of 180 to185 million.

This compares to 170 to 175 in our previous guidance.

The mid-point in range would represent 22%growth over FY '02.

At these revenue levels, operating comes at approximate 14% and we estimate EPS in the range of $1 to $1.10 per share.

The mid-point of this range would represent 52% growth over last year.

Some specifics by business, in the Defense Electronics Group, consistent with our first-half performance we expect DEG to grow 30%to 35% including the contribution of IOCE.

We expect the defense business to grow 20 to 25% excluding the acquisition.

In the medical group we expect medical revenue to decline 10% to15% in FY '03 due to the continued falloff in revenues and the CT modality and due to the lower revenue persist (inaudible) another modality.

This anticipates a falloff in the second half versus year-to-date performance.

This is primarily due to the reduction in revenues in the CT systems.

In our early M group we expect significant growth here between 50% to 70% in 2002 levels based on the new semiconductors currently in development and higher shipments for use in -- this guidance anticipates a fall off in the second half as we have completed the delivery of the development systems in the first half but are not anticipating a recovery in the semiconductor market in the short time.

Our gross margin is a percentage of revenue will proximate 30% of sales.

In R&D, we expect to be in the low 20's as a percentage of sales.

Operating margins would be approximately 14 to 15% for the full year, non-operating income will decrease in the second half of FY '03 and this reflects a number of factors.

First the elimination of the losses on our Agilevision (ph) joint venture which was sold in Q302.

Second lower net interest income due to reduction in interest rates and finally the deferred gain on the sale of SSBU which has been 1.6 million per quarter will conclude in the third quarter of this year.

We do expect to collect the$1 million under the escrow agreement early in Q4, and it is possible that this could be collected in Q3.

Our tax rate for the rest of the year is expected to remain at31%.

It and we expect earnings per share in the range of$1 to $1.10 per share.

The mid-point of this range would represent a 52% growth over last year.

In summary, Q2 was a very strong quarter.

Revenues, margins, and expense levels all approximated a revised expectation.

We grew revenues, made substantial progress in managing working capital and had very strong cash flow for the quarter.

We'll continue to closely monitor the bookings trends, given the broad economic and geopolitical uncertainty.

J.?

Thanks, Jack.

Considering the continued difficult economic environment we're absolutely delighted with our first-half business performance and the prospects for a strong second half.

Our highly skilled and motivated associates have worked very hard to make progress in growing the business and improving the consistency and predictability of the business.

This in turn has led to significant improvements in our overall operational effectiveness.

Company's well positioned to capitalize on any improvements in market conditions within the markets and application areas that we target.

Our enthusiasm is dampened only by the continued difficult economic environment and unpredictability geopolitical situation facing the world.

And the risks they bring to any attempts to project future business performance with any level of confidence.

Therefore, we believe it is prudent to maintain a cautiously OPT mystic outlook for the remainder of the year at this point.

That will wrap up the formal part of the presentation.

And now we'll be happy to take your questions.

Thank you, gentlemen.

If you do have a question for Mr. Bertelli or Mr. Alexander, you may signal us by pressing the star key followed by the digit one on your touch-tone phone.

We'll take your questions in the order you signal us.

In addition, if you are on a speakerphone and have your mute function utilized, you will want to release this before you press star one, it will block the signal from reaching our system.

We'll take our first question from Lee Advil (ph) with Elmridge Capital Management (ph).

Great quarter there, guys.

I have a question about the nature of the pull in the defense business and if you can sort of quantify on the magnitude if that's possible, does that sort of continue for another quarter or so, or are we done?

There were a number of orders that came in with what's referred to as DX ratings, and that requires that they be given priority.

And so because of these DX ratings, we were obligated to prioritize them and ship them ahead of other orders, if you will.

In terms of the magnitude of them -

About $5 million.

J. Bertelli -- about $5 million in total.

: And this is related to what sort of area?

Is this something that is for research and development?

What is the nature of the products here?

Why was -- why was there a rush?

The defense department provides a system of priorities in order to assure that they get the products before they go out to commercial customers.

They sort of preempt the (inaudible)here from the standpoint of making sure that they -- if there's any shortage in components that they're at the top of the list.

That's what's referred to as this DX rating.

So a number of orders came in which we're not at liberty to discuss, as to why they have a DX rating, but all I can tell you is that that's what caused us to have a ship more business than we maybe would have shipped in Q2.

: And qualitatively, if you had to -- I'm sure you know, but if you had to guess, what is the end use here?

Is this for lab, research department or is this something that goes out in the field?

All of the above.

And will this continue, or is this basically order you expected in the next quarter, the following quarter and just shipped all this -- in the previous quarter?

Will we continue to see D X-rated orders?

Certainly.

Again just to make sure I understand, these are orders you expected and just the spreading out over the quarters was just -- sorry -- was more focused on the previous quarter.

Yeah.

It was a matter of booking and shipping in the same quarter.

Right.

Right.

I guess on the last question relates to the IBM payments.

How do you expect them to play out -- I think you previously mentioned in one of your Q's that you expect to get more next quarter or you expected to continue -- well, what is the amount left and how do you expect it to play ought over the next two quarters?

As we said, we get the normal quarter payment within the third quarter.

There is a $1 million escrow that is due us under the contract, and timing of that is due early in the fourth quarter.

So it is possible that we'd come in at the end of Q3.

Right.

Okay.

And then that would be the total of $2.6 million, around 8 cents?

Yes.

Okay.

Total remaining payments are $2.6 million.

Right.

Okay.

Thanks a lot for your time.

Jack Alexander Thank you.

Next we'll hear from Don Young (ph) with U.B.S. Warburg.

Yes.

Thank you and good morning.

First, Jack, congratulations on the asset management.

It's just remarkable improvement and very rapidly achieved.

My hat's off to you.

The question I would like to go into in a little more detail is the medical imagining.

That business came in well above what we were expecting and even your guidance for a 10% to 15% decline in the second half is less than we were an anticipating or let me put it this way, it's less of a decline or better business.

I wonder if you take apart the pieces, is the CT erosion less than 82 expected?

Did you win one of those back?

Or is the MRI and some of the other businesses coming in stronger?

What's the dynamic that's leading to the upside in medical?

It's both those factors, actually.

The CT eroded slower than what we had expected.

We continue to see that eroding in the second half, which is the reason for the more conservative outlook in the second half.

And we did have strong demand in the other modalities in the first half, which we do not expect to see at those same high levels in the second half, Don.

Okay.

Are you winning back one of these accounts that you thought you were losing?

J. Bertelli We don't have anything to report as of today.

So none of the business can be attributed to new business activity, if you will.

Okay.

Yeah, the CT product shipments are still the old systems.

Thank you.

And Rob Stone (ph) with S.G.

Cowen Securities has our next question.

Congratulations, guys, and let me add my kudos to Jack as well.

Seems like your pencil's pretty sharp.

Thanks, Rob.

I wonder if you could comment a little bit, J., on the new market areas that you're trying to develop in defense.

Any more color commentary there?

Well, what we're doing really is focusing in on opportunities within this emerging market SPAT, what we're -- space, emerging markets.

We've been developing over the last few years smart weapons data exploitation are two different examples of it.

It's premature to talk about what we expect to see for business.

We're not going to identify it specifically at this point in time.

But suffice to say that we see some -- what we think is going to be some significant opportunities for us in those areas.

And the reason for setting up the organization, as we did, is because sometimes the product requirements are different than we need to keep the focus in on what customers need and to bring in the voice of the customer in helping us define the products for each of these particular spaces as they -- as the requirements start to differentiate themselves.

Could you give us some sense of the time horizon for programs in these areas?

These are things in R&D now, you know, would visibility on contracts be, you know, six months to a year or 12 months to 18?

Could you give us a sense of the timeline?

I know you're not ready to announce any specifics yet.

Rob we'd just lurch them all into the total projections for the defense business.

I'm not going to start breaking it out specifically at this point.

Okay.

But the -- but the programs generally are -- you say they are emerging markets so they're in areas where the work is at more R&D and design and development stage?

Yes.

Great.

Thank you.

And we'll take our next question from Don Moriarti (ph) with Twin Oaks Partners.

: J., when do you think you'll get -- in the medical arena, when do you think you'll get back to your normal share of that market?

And I know you've missed a cycle here, and when does that end, and do you think you'll get your full share back again after that?

Well, I certainly think we'll get our full share back.

The question is, when?

Each of the companies have different product cycles and so we have to work with each individual company.

They're in different phases of design and selection for that next generation machines, and we're in the process of trying to develop the appropriate solution for it.

So I expect that we -- next fiscal year, not this fiscal year, but next fiscal year we'll be in a better position to know when we can look forward to seeing the CT business come back in.

Okay.

Thanks.

And next we'll hear from Scott Robertson (ph) with Investec.

Great quarter, J.

Thanks, Scott.

Could you talk a little bit about where you see R&D going in the back half of fiscal '03?

Are we kind of going to be stable at this, you know, 9 1/2 level, million per quarter or do you see that ticking up slightly over the next -- over the next four quarters, as a matter of fact?

Slightly in the second half and consistent with the guidance we gave for the year it would be in the low 20's.

Okay.

As a percentage of revenue.

Okay.

Great.

Thank you.

And we'll take our next question from Alan Fornieh (ph) with Pennant Capital Management.

Good morning, guys.

Great quarter.

I had a question, I think you touch on some of this during the presentation.

I apologize if I missed it.

But can you run through the backlog again now versus the previous quarter and last year, and also break the backlog out acquisition versus organic?

Yeah.

Let me -- I think I'll be able to respond to all of that except acquisition versus organic.

I don't think that's a big contributor anyway.

Our total backlog at December 31st was 70.8 million.

That compares with 78.4 million at the beginning of the year.

And the September quarter would have been ended at 74.8 million.

And again, that compares with 46 million in the comparable period last year in.

Great.

Thank you.

And I would like to remind our audience it is star one if you do have a question or comment.

And we'll pause for just one moment.

One final reminder with that is star one if you have a question to our comment.

And Mr. Bertelli, it looks as though there are no further questions.

I'll turn the conference back to you for any closing remarks

Thank you, all for participating in this conference call.

And we'll look forward to joining you three months from now.

Thereabouts, mid April.

Thank and you have a good day.

Good-bye now.

And that does conclude today's conference.

We thank everybody for your participation.

And have great day.