Mercury Systems Inc (MRCY) 2003 Q4 法說會逐字稿

Good day and welcome, everyone, to the Mercury Computer Systems 4th quarter and year-end fiscal 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. Jay Bertelli.

Please go ahead, sir.

Thank you.

Good morning, everyone, and thank you for joining Mercury's 4th quarter 2003 year-end earnings conference call today.

With me on the call is Joe Harnett, our Vice President and acting CFO.

Also joining the call today is it our newly appointed Vice President of Investor Relations Diane Basilli.

After four years of managing our Investor Relations program, Gary [Oland] who most of you are very accustomed to working with.

Gary had indicated that he would like a new challenge, so we are pleased that Gary has accepted a new creative role as Senior Business Analyst.

This allows us to leverage Gary's experience and knowledge of our business and focused industries as part of our team that is supporting our growth initiatives and will no longer be leading the I.R. function.

We took the opportunity to add to the strength of the management team by bringing in someone with extensive IR and corporate communications experience.

We are pleased to add Diane's experience and skills to the Mercury team.

Diane brings investor relations experience from technology and growth companies such as Digital Equipment, Compaq, Staples, and most recently [INAUDIBLE].

She has a very strong financial background with roles at both the corporate and division levels, including financial planning and analysis, controllership and business analysis.

We will be formally introducing her to our investors over the next few weeks.

I expect the press releases will go out tomorrow.

This morning, she will open our call with our safe harbor statement.

Diane.

Thank you, Jay.

I'm very pleased to be here at Mercury Computer.

Good morning and welcome to the 4th quarter 2003 year-end earnings conference call.

If you've not received a copy of the earnings release, can you find it on our website at www.MC.com.

We'd like to remind you that remarks we may make during this call about future expectations, trends and plans for the company and its business constitute forward-looking statements for purposes of the safe harbor provisions of the private securities and litigation reform act of 1995.

Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated.

For a discussion of these risks and uncertainties we refer you to the companies report filled with the Securities and Exchange Commission.

Including the companies quarterly report on form 10 Q for the quarter ended March 31, 2003.

Further information regarding forward-looking statements and risk factors is included in the press release we issued today reporting the company's year-end results.

We caution the listeners of today's conference call not to place undue reliance on the forward-looking statements which speak only as of the date of this call.

We undertake no obligation to update any forward-looking statements.

I'm now pleased to turn the call over to the Vice President and acting Chief Financial Officer, Joe Harnett.

Thank you, Diane.

This morning I'll be reviewing our revenue by business unit and I'll discuss the company's operating performance, review the balance sheet and cashflow results and discuss our outlook for 2004.

First, let me summarize the total company 4th quarter results as reported earlier this morning, 4th quarter 2003 revenues were $44.5 million.

Up about 4% over the prior year.

Operating income for the 4th quarter was $5.8 million.

Or 13.1% of revenues, included in operating income was a $1.4 million charge related to a workforce reduction.

Earnings per share for the 4th quarter were 20 cents, which was at the high end of our previous guidance.

For the year, revenues grew to $180.2 million.

An increase of 20.1% over prior year revenues of 150.1 million.

Earnings per share for the 2003 fiscal year grew to $1.03 from 69 cents fiscal 2002.

Turning to the 4th quarter specifics, I'll review revenue by business unit.

Please note that all comparisons are to the 4th quarter of fiscal 2002.

The defense electronics group reported revenue of $32.5 million or 73% of total revenues for the 4th quarter, down about 5% from the same period last year.

Within the three application areas, radar, signals intelligence and emerging markets, we saw good growth in both radar and signal intelligence during the quarter, offset by a decline in the emerging market's business.

This is due in large part to the redirecting of funding towards more tactical applications.

Our medical imaging revenues were $7.4 million representing approx. 17% of total revenues, up from 11% last year, even as the CT portion of this business continued to decline to $1.2 million.

Excluded in the CT portion of the business, revenue from digital x-ray and MRI modalities continue to demonstrate good growth in the quarter, expanding by 18% over the same quarter last year.

Our OEM solutions revenues were $4.6 million.

Or approximately 10% of total revenues, and doubled in size from last year.

Growth was primarily driven by applications in the semiconductor market.

Our total company book to bill was below 1 for the 4th quarter.

Our total backlog at the end of the 4th quarter was $57.3 million compared to $59.8 million at the end of our third quarter.

Of the ending backlog, about 88% or $50.2 million shipments expected to ship within the next 12 months.

2003 review in total.

For fiscal 2003, revenues were up 20% over fiscal 2002, including a $9 million increase contribution from the I.O. center of excellence which was acquired in April of last year.

DEG full year revenue was 69% of total revenue, and exceeded 25% growth including the acquisition of IOCE.

So the year the defense electronics group segment reported double-digit growth in each application area radar signal intelligence and emergent applications.

While the medical segment represented 20% of total revenue, it reported a year-over-year decline of 14%.

This was primarily delivered by a 51% decline in CT applications.

On CT applications and digital x-ray MRI expanded by 7% over last year.

OEM solutions revenue grew to 11% of the total company revenue from 7% last year.

Primarily driven by increased shipments to semiconductor capital equipment, OEM for development and testing new semiconductor inspection in mass generation systems.

We are pleased with our revenue growth in virtually all of our business segments.

Gross margin was 66.4% for the quarter and 65.5% for the full year.

Driven primarily by productivity improvements, coupled with a favorable mix of defense programs that reached the production stage.

Operating expenses were $23.7 million for the quarter and $92.4 million for the full year.

These expenses prized of selling general and administrative expenses of $14.1 million for the quarter and $54 million for the year.

R&D expenses were $9.6 million for the quarter and $38.4 million for the year.

R&D approximated 21% of revenues for the year.

Although operating expenses grew over 2002 in absolute dollars as a percent of total revenues, operating expenses declined from 55.5% to 51.2%. 4th quarter operating expenses included approximately 1 million in charges related to a workforce reduction, which coupled with our continued focus on operational effectiveness, was expected to generate annualized operating savings of approximately $3.3 million in FY 'O4.

Operating income of 5.8 million represented 13.1% of revenue for the quarter, and was $25.8 million or 14.3% of the fiscal year, up from 9.7% in 2002.

Net income of $22.7 million was 12.6% of revenue, up from $15.8 million and 10.5% in fiscal 2002.

Included in 2003, net income was approximately $5.8 million of nonoperating income, related to the sale of the shared storage business unit or the SSBU.

Now, turning to the balance sheet and cashflow, turning to the operational cashflow and balance sheet performance, strong working capital management again drove solid cashflow results.

Cashflow from operating activities was $7.6 million per quarter.

This comprised of $4.3 million in net income. 2.3 million in depreciation and amortization.

For the full year cash provided for operating activities was $50.5 million.

Up from $15.9 million in 2002, primarily on the strength of working capital initiatives instituted during the year.

Excluded from this calculation were capital expenditures of $1.7 million for the quarter and $6.2 million for the year.

Also during the quarter the company purchased approximately 200,000 shares for $4 million as part of the share repurchase program which was expanded in may of 2003.

For the full year, the company purchased approximately 387,000 shares for $10.1 million.

With a total of $25 million authorized $14.9 million remains available for future purchases, with the stated intention of providing offsets to our stock plans.

Cash investments were $113.3 million at the end of the quarter.

Up $2.1 million from the 3rd quarter and up $41.9 million from fiscal 2002. 4th quarter day sales outstanding the DSO were 47, representing a very strong 21-day reduction from the same period last year, and toward the higher end of our Targeted mid-40s range.

Inventory turns of 5.6 for the quarter were up from 4.2 turns last year, and for the full year were able to improve our inventory turns by one full turn to 4.9 for fiscal 2003.

And our working capital and supply chain initiatives are not done yet.

We continue to make progress in inventory and other supply chain initiatives as we drive toward our goal of 6 inventory turns per year.

Our total employee population was 576, down 40 from last quarter.

This net decline is driven by a reduction in workforce as described earlier, offset by key hires.

Our 2004 outlook, going-forward, I would remind the audience that our 2004 income estimates will not include any contribution related to the sale of the SSBU.

For the full year 2003, this contribution was $5.8 million of nonoperating income.

Our outlook for the 2004 fiscal year is based on trends we've experienced over the past six months, particularly in worldwide defense.

We have built our plans on conservative growth assumptions, expenses to achieve solid financial performance while continuing to invest in critical programs, I will provide ranges for our top line expectations for each business unit.

Then I will discuss total operating expenses and a range of expected income.

As the year progresses, we'll continue to monitor business conditions to ensure that our expense structure investment targets are consistent with the market conditions.

On the top line, we built our plan under the assumption of flat to moderate growth relative to 2003.

Or a range of $180 to $190 million in revenue.

On a quarterly basis, we would expect revenues for the first three quarters to be relatively flat year over year with growth curbing towards the end of the year.

The electronics group.

In total we have modeled the defense electronics group to grow flat to 5% on the top lines next year.

However, within this segment, there are certain program tradeoff that is we anticipate.

While certain programs are expected to grow significantly, others will likely offset.

We will continue to monitor ordering patents.

Medical imaging.

Due to the decline in our CT business, we project a total revenue for this business could be a 5 to 8% decline relative to 2003.

Total 2003 medical imaging revenues included $7.2 million related to CT applications.

This one, even with a 5% decline in the segment that would represent 17 growth in non-CT applications.

OEM solutions.

Continuing the trend that we experienced in 2003, we've modeled double-digit growth for this business segment between 15 and 30%.

Driven by a design wins within the semiconductor business.

We anticipate a benefit from the semiconductor cycle upturn.

We expect gross margins for approximately 65%, which is consistent with the levels that we experienced throughout most of 2003.

One significant change to composition of our P&L relative to 2003 will be operating expenses.

Results from our cost efficiency programs, coupled with the recent reduction in force are expected to drive operating expenses down by about $3 million in comparable 2003 run rates.

We expect operating expenses to approximate 50% of revenues or about $90 million.

We will continue to monitor leading indicators as the year progresses.

And if revenue trends strengthen towards the top end of our expectations, we will increase investments as appropriate.

We remain committed to investing research and development, expect that R&D investments will remain within historical levels at about 20 to 21% of sales.

At these levels, we would expect operating margins would approximate 15% for 2004.

With a 31% expected tax rate.

We expect earnings per share to be in the range of 85 to 95 cents.

In terms of working capital improvements, we expect our DSO to be within the mid-40s range and inventory turns to approximate six times.

Capital expenditures should be consistent with the prior two years that we've experienced and should approximate 5 to $6 million.

Depreciation and amortization is expected to be consistent to what we experienced in 2003, or about $8 million.

Our balance sheet is strong.

We have the cash reserves to support our strategic growth initiatives and to finance organic growth in our target application areas.

Our business model allows us to grow cash despite this environment driving flat to moderate revenue growth.

At this point I'd like to turn the call back over to Jay for industry comments and additional context regarding our business outlook.

Thank you, Joe.

Joe discussed the financial results for 2003.

At this point, I'd like to provide some context surrounding our markets and industry trends before we open up the call for your questions.

As you've seen, 2003 was a very strong year for Mercury.

To summarize, we achieved our 50th consecutive profitable quarter, 4th quarter earnings were 20 cents a share, which is at the high end of the previous guidance.

And for the year, revenues grew 20% over 2002 to $180 million.

Earnings per share were $1.03.

During 2003 we made significant progress against our strategic objectives.

We were focusing on operational effectiveness initiatives, such as reducing our overall operating expense run rate which we achieved and Joe has addressed the numbers there.

And we focused on creating strong cashflow and again, I think the numbers that Joe gave you is evidence of that, or with the results of our working capital management initiatives.

Our commitment to investing in the future is demonstrated by the announcement that was made today, which was included the Diamond Series scalable open system multi-computers, based upon the Intel processors and Lenox operating environment.

These include our deep knowledge and industry leadership and signal imaging processing systems and customized subsystems, integrating the latest Intel Zeon processors.

We also made significant investments in FPGA based products and introduced a product called Advantage-RT.

These products are expected to have a widespread use in defense and commercial markets.

We also introduced impact RT, which was a major investment initiative to produce a compact PCI based system which utilizes the first industry rapid I/O system.

Those systems started shipping in April of this year.

We also have been investing heavily in the development of a new high-end system for airborne applications.

This has already been accepted by one of our major customers but we will not be making any formal announcement until the end of the year.

Impact RT which I mentioned previously, is initially aimed at the semiconductor market.

That's the market where we've delivered the first system.

We've also made significant investments in the defense organization, which will allow us to continue to keep focused on new opportunities and to grow that business.

I believe that Mercury is uniquely positioned to leverage the industry trends that we see.

There's a continuing and growing need for computer intensive solutions in all of our markets, which solve complex computing problems.

Let me review each of our application markets.

I'll start with medical.

The business performed as expected in '03 and will perform at approximately the same level in '04.

During '03, we began the development of the products necessary to enable us to regain our CT business, and also, to position us for the future 3-D realtime reconstruction computing requirements which will apply to a number of the modalities.

The innovative systems we had developed such as our FPG-based product, Advantage-RT,and our newly announced Diamond Series of Intel-based multi-computers should lead to design wins which will put medical on a strong growth path in '05 and beyond.

The business we don't have is satisfied by the inhouse engineering teams.

Market competition drives our customers to lower costs, which results in pricing pressure on us.

This actually is a good thing, it drives us to be more efficient so as to maintain our margins in our position as a responsive long-term supplier.

We are aggressively competing against the inhouse design teams as we have stated before.

The OEM solutions group.

The business doubled in '03 to approximately $20 million.

Our semiconductor business grew as a result of development systems for the many design wins and early stage production systems.

We are expecting continued growth business in the 15-30% range based on the modest up-trend in the semiconductor business.

If the industry rebounds strongly, well do significantly better.

This business unit continues to pursue market development activities in the Telecom space.

Our leadership and rapid I/O interconnect technology is evidenced by our impact RT system delivered in April, is generating interest in those companies interested in adapting rapid I/O.

The design to cost initiatives are being driven, they drive improvement in our product development process, which makes us more efficient and competitive in all of our markets.

I want to talk about defense.

For the last week a large number of primes have reported strong numbers and growing backlog.

This supports our confidence in longer term growth for our defense business.

Our long-term defense market growth is built on a very strong position on domestic and international airborne surveillance platforms such as Joint Stars, Astor, Global Hawk, Predator and Witch Tail.

Also fighter aircraft such as the F-16, the F-22, the joint strike fighter and the F-18.

In addition, significant future growth is expected based on current activities in the comment markets.

Future combat systems which is a major Rumsfeld initiative, joint tactical radio systems, or JTRS network center walker initiatives and smart weapons.

The defense business will focus on bringing our computing system's expertise to where the D.O.D. budget is going.

Much of this growth is incremental to what we do today and is very significant.

Therefore we expect that our defense business will grow significantly faster than the growth in the top line defense budget would imply..

Let's look at the DOD budget forecast.

Though shallower than the Regan build-up, The Bush plan would sustain real increases over a much longer period.

The GYO request is for $370 billion, versus $364 billion in '03.

The sections of the budget we are affected by are the RDT & E projected to grow from $57 billion in '03, to approximately $61 billion in '04.

And procurement, projected to grow from $70 billion in '03 to $73 billion in '04.

The RDT & E budget is expected to grow to $67 billion in '05.

And procurement to $77 billion.

Two key transformation initiatives from Secretary of Defense Rumsfeld are worth mentioning.

Transform the U.S. defense establishment giving it the capability to swiftly develop new weapon systems through an alteration of current acquisition processes.

This leads to something called spiral development which supports technology upgrades during multiple stages of program development.

This should result in more business for Mercury during the development stages and since one goal would be to preserve the prime software investment, we should have a distinct competitive advantage.

Another initiative is to modernize command control, communications and intelligence systems.

This is seen as the key to transformation.

Mercury's strategic goals and investments are in line to support the transformation vision.

We are investing in intelligence, surveillance and reconnaissance applications or ISR.

And [CONMENT] These investments are already productive as our [CONMENT] business increased significantly last year.

Another initiative is battlefield communications.

A key area for growth.

The push for giant interoperability provided by software radios is the focus is our efforts on the JTRS -- or joint tactical radio systems and WIN-T programs supported by contracts with the D.O.D..

And we are actively pursuing contracts with two primes.

UAV's and other unmaned vehicles are strongly supported by the budget.

We are the computer of choice for a number of these platforms.

The joint strike fighter is an OSD priority.

Office of the secretary of defense priority, we are providing development systems for the radar on the joint strike [INAUDIBLE].

The E2 organization is a Navy priority.

As is it is the multi-mission aircraft.

Both of which produce the type of computers produced by Mercury.

These indicators all lend support to Mercury's long term growth outlook.

In the near term, forecasting the timing of defense funding is the critical variable.

The nature and complexity of the product development cycle requires that we invest that we develop product that is support programs which will go into production over the next seven years.

The increased budgets protected over the next seven years, specifically in areas requiring high performance processing computers, coupled with the investments we have already made and continue to make in developing the best computing solutions and investments in market support to assure customer success.

Leads me to believe that we will continue to have a very profitable growth business and defense.

We will continue to stress investments in innovative technologies by our technology office and our central engineering group.

Our customers expect us to continue to innovate with the latest technologies.

They inturn have made significant long-term commitments to Mercury by designing their applications to run on Mercury's systems.

By supporting our commitments to our customers, we will continue to achieve profitable growth and increase shareholder value.

Before we open the call to take your questions, I wanted to take just a minute to summarize our objectives for next year.

Clearly, we intend to maintain our strong financial position.

We'll monitor the industry trends and the top line indicators so as to make whatever adjustments are necessary in the course of the year.

We will continue to stress operational effectiveness initiatives which began some time ago, and that includes working capital improvements.

We will continue to invest in people and products to support our customers.

We're actively evaluating strategic acquisitions based upon intellectual property content as opposed to a bulking up strategy.

And also, acquisitions similar to what we did with [MERRIAL] logic over a year ago where there is adjacent expertise that will enable to us to provide more of a complete solution to our customers.We continue to maintain a strong balance sheet in the financials to support any acquisition initiatives.

I have great confidence in our business model.

Very strong management team.

With that, I'd like to open it up for questions.

Thank you.

Our question-and-answer session will be conducted electronically today.

If you would like to ask a question, please indicate by pressing the star key followed by one.

We'll take our first question from William Bentant from William Blair.

Good morning.

Just a couple questions, Jay you alluded to the strong results that have been reported by the primes and the backlog on the defense side.

And the RDT & E budget and precurements seem to be going up on the order of 6% plus next year.

I'm trying to square that with the guidance of kind of flat to 5% growth in the DEG business.

And then I had some follow-ups.

Okay.

The -- I believe the answer to that, is we typically lag the budget allocations, if you will.

It takes time from when the funds are budgeted until it flows through to the prime, and they get their programs in place.

And then go and select the vendors that they're going to use.

So it's not uncommon for us to see a lag between when the funds are appropriated and when they see it.

Is that your sense with regard to backlog?

Would you guys expect that to start to improve now that -- I guess some of the backlogs and the primes have improved nicely.

Some of your customers, and are you expecting that to show kind of gradual improvement throughout the balance of the year as we progress?

I would expect it to, yes.

Okay.

And then if you could maybe touch on progress that you're having on the CT side in terms of obviously you've got -- you said you've been developing a product, do you have a sense for when something may be decided there for the big 3?

Well, as I tried to say in my notes during the call, the investments have been made and will continue to be made in the product development part of it, and also, the development of the business with some specific customers.

But it's premature for me to say when we would expect to see a design.

What I can say is that we would not expect to see any significant revenue in '04 because all we would expect to be providing is some small number of development systems during '04.

Okay.

That's fair enough.

If you could just maybe update from the status of the CFO search.

And if you could talk about the employees cut, where was that -- to give you some sort of idea in terms of modeling that?

I'll let Joe give you the details on the reductions in force.

With regards to the CFO search, we've been actively and aggressively pursuing.

We have a search firm that's working with us, we've looked at well over 30 resumes, conducted 5 interviews with several more scheduled over the next 30 days.

There's a lot of great talent out there, and it's just a matter of time for us to get through the interviewing process.

So again, we're progressively pursuing it.

I hesitate at this point to give you a date as to when we would expect to close on anything, though.

Fair enough.

Joe, do you want to talk about the reduction of force numbers?

Yeah, the reduction in force was approximately 40 people.

Part of it was directly a factor in the customer support.

Approximately 10, the remainder was split evenly between R&D and SG&A.

Okay.

Relative to that, we expect to have a $3 million operating expense income reduction going-forward.

Great, guys.

Thanks.

Moving on, we'll hear from Jeffrey Tone with M. Krause & Company.

Good morning.

Jay, I'd like to get a better view of what the spending on R&D has really brought about for shareholders here, because I'm looking at earnings per share that have been reported to shareholders that with 90 cents for '04, we're actually in a downward spiral since year 2000.

How do we get a return on the dollars you're spending on R&D, and perhaps you can give us some sense of what percentage of the expected spending is defense oriented versus other things.

Thank you.

I think the -- you have to take into account what we contributed to EPS as a result of the sale of the shared storage unit, which was $5.8 million in 2003.

And you've had -- even if you put it back in, it's not going to be -- we're not showing a company that's got earning's growth.

Let's not talk about shared storage.

Let's talk about the effect that these investments of shareholder money that you're making compared to the return that the shareholders are seeing in earnings.

Well, we have targets of 10 to 12% of our revenue that we drop to the bottom line.

That's a model that we've been working with for a number of years, and some years we've been able to exceed it some years.

I believe we did this year.

So I believe we are returning to the shareholders for the amount of money we're investing in R&D.

But it's not resulting in earnings growth?

It's not resulting in revenue growth?

It's dropping from the bottom line.

Revenues are up, but so are other expenses, so the shareholder in effect was not seeing a return on a per share basis.

I'm not sure that I without having the numbers to see what you're talking about, Jeff, that we can talk about this --

well, I got your 10K open here, and I'm sure your acting CFO has one too.

I'm just looking at diluted earnings per share, which is the earnings per share after the options which are very generous on.

Basically, in a down trend.

We've been with your stock for a long time, you know that.

Yes.

And we've been very patient with you.

Well, if we didn't make the investments in R&D that we have been making, then we wouldn't have any preference.

The business can be characterized as I've said many times as requiring a significant level of investment in order to get the returns that we do.

It seems like you're spinning the R&D pedals faster and faster to come out with the same results.

So I don't know what you need to do.

Can you just give us some idea what percentage of the R&D is non-military?

The R&D budget has historically been somewhere between 18 and 20%.

That hasn't changed --

and that's the ballpark of revenues?

The R&D percentage of revenue, yes.

But what percentage of the R&D is devoted to military versus non-military.

It seems like the non-military has been where the shortfalls have occurred.

First it was the big investments you were making in the wireless communications.

And then it was the loss of the CT business, which you're now trying to recapture.

So I'm just trying to get a sense of what is military, which seems to be pretty reliable and going pretty well.

And what is the other stuff?

A large part of the R&D budget is invested in technology which is applicable across all the markets, so the investments that we make in the software, for example, which constitutes two thirds of the engineering staff, software engineers, the investments we make in the software is applicable across all of our markets.

So there's a commonality there.

Not only with the software, but also in the core technology that goes into the Asics that we have that go on all the products that we ship.

So the business has been built upon being able to leverage the core R&D investments across multiple markets.

okay.

So really no way to allocate between the two?

There are market specific development expenses that occur.

The development, for example, of what I alluded to as the high-end radar system that we've been investing in for some time.

We have an internal code name for it which won't make, I'm not going to give it to you, because it doesn't make any sense to you.

But that investment is specific to the defense industry.

Because a lot of that is the packaging, that's where we're investing the money and making the packaging work for the particular aircraft.

So that's a significant investment in the several millions of dollars that we're making in order to secure the long-term radar business that is on a number of these airborne surveillance platforms.

Is there any nondefense specific spending going on in R&D?

Yes, there is.

Could you give us some idea of what that might be?

Well, I can tell you that there was again, a variation --

what I mean is not the stuff that could be used either for defense or nondefense, but something that could be specific to the medical imaging or something that might be specific to the semiconductor analysis, that sort of thing?

We made a significant investment, without giving you the details of it, but we made a significant investment in developing this rapid I/O base product for the semiconductor industry..

That product or variations of it could be used in other businesses, but the initial impetus was to bring it to market in order to address the needs of the semiconductor industry.

That was several millions of dollars.

That was an '03 event.

We invested heavily in '03 and '02.

Are there similar things going on in '04?

Yes, there are.

Can you give us an idea what percent of your R&D will be specific to non-military areas?

Not today.

Okay.

When can we talk about that?

We are having an investor conference -- analyst conference in October.

It might be appropriate at that point to get into more of the details.

Will you be prepared to talk about it then?

We will be able to address some of the specifics as much as we're willing to divulge.

Which right now you're not willing to divulge any.

Thank you very much.

We'll now hear from Rob Stone with SG Cowen Securities.

Jay I wonder if you could comment on the medical business XCT which was up about 7% on the year, but significantly more on a year-over-year basis for the 4th quarter.

Giving us a sense of sort of linearity of that.

Was that an acceleration throughout the year or is that year I've on-year figure perhaps anomolies to the levels of shipments in the 4th quarter of last year.

I think to answer that question, we've seen continued growth throughout the year of the nonCT business, and it was not an anomaly, but we've seen consistent growth.

Although the 4th quarter was at the high end but we have experienced that trend through most of fiscal 2003.

Well, certainly it wouldn't have been -- if it was up 18% in Q4, it couldn't have been that same level in each quarter and only be up 7% for the year.

Or did I misunderstand your prepared remarks?

I think when we take a look at it, we provide the quarterly numbers as part of the 10K, but if we look at the 4th quarter year-over-year is essentially flat.

If we look at the CT business it's declined steadily over the quarter of '02 and '03.

I'm more interested in the non -- the rests -- the nonCT portion which I think you said grew 7% for the full year but 18% in the 4th quarter.

I'm trying to get a sense of, was that a big acceleration?

Or was there some down quarter in there?

How do I square those two percentage changes?

Well, I'm not sure where you're going with it, but let me suggest that what we expect from medical for '04 is relatively flat to '03.

So the growth that we saw in '03 in the business, which was primarily coming out of both MRI and the digital x-ray business, you can assume is flattening out, and again as I said, '04 should be close to '03.

Okay, so the growth rate for the nonCT portion in '04 is assumed to be what percentage for the year.

I think we're talking about the total medical business being flat '04 to '03.

Okay.

On the new Diamond Product, Jay, can you comment on the kinds of applications that you're targeting with that as opposed to the other products.

Are the differences driven by performance or by the software part of it, or can you help us get a little better understanding of those differences, and does that also enable you to target some new market areas that you, perhaps, would not have in the past.

I'll take the last part of the question first.

The answer is, yes, we expect to target new markets with this product.

We have obviously, as part of the development of the product and the business opportunity looked at markets beyond our traditional markets, and we certainly believe there will be opportunities there.

With regards to the initial thrust, it is being focused in the existing markets.

Medical specifically for applications and more customer specific, where customers have decided that they are going to go with an Intel based product line.

And then they start to look around for the solutions that incorporate Intel's processors, and so we recognize that if we're going to be able to get any of that business, we can't be trying to sell a PC-based system in there.

So those systems, you could consider them to be some traditional Mercury business in the commercial space.

Are systems that don't require any unique packaging solutions, if you will.

On the defense side, there are some applications which, again, don't require any packaging solutions which is not typical.

We expect to address with this.

So there are sonar opportunities, low-end, low frequency that doesn't require packages, that we think this product can be useful for in the data exploitation area.

We also are looking at the opportunities within the semiconductor space where this product could be more -- could fit in better based upon the price points than our existing products.

Then once we establish a foothold in the existing markets, we will start to take it out to other markets.

To your comments on the price point, is that also an element in the medical and defense areas, where there's sort of cross-over points on cost as well as packaging?

Or is cost not a factor there?

Cost is a factor in the commercial markets more than it is in the defense markets.

And what we've seen in some of these markets, it's again senior management decisions to go with what they consider to be a commodity based product in order to most closely follow the price curves from an Intel.

Would you expect the margin profile of that new product to be similar to the others who have within those commercial segments?

Or is it a different margin profile also?

Well, the bottom line net margins we expect to be roughly equivalent to what we see today.

Gross margins will be less -- maybe significantly less in some cases, but this product line does not require the R&D investments that we've made in the other products.

And so we expect to be able to support it with less R&D investment.

Therefore the net margins should be comparable.

Great.

Thanks very much.

Paul Meekz with Meekz & Kessler has our next question.

A couple questions for you, first of all, have you done your good will impairment test?

And do you expect that those figures will remain the same?

Yes, we've done that test.

And there was no impairment as a result of the audit that was completed for fiscal 2003.

So the next time you'll do the test will be a year from now?

Yes.

Okay.

Although if something were to change on a quarterly basis, we'd have to consider that.

Sure.

What do you believe is the secular top line growth rate once we get into a normalized environment?

The overall growth rate for the company?

Yes.

Looking out over the next couple years, I certainly believe from the planning we've been doing 15% plus percent is reasonable.

Can you repeat the stock repurchase detail?

I was on the call from the start but I had some problems hearing it.

Yes.

For the year we've purchased $10 million which was approximately 387,000 shares for the quarter we purchased $4 million, which was approximately 200,000 shares.

And what's your basic and diluted shares as of the end of the quarter, not the weighted average, but the actual figure?

Basic shares are expected to be --

give us a second to find it here.

It's an unusual question.

But basic shares for the quarter were 20.030m out and diluted were 21.656m.

And those are the figures at the end of the quarter not just what appears on the income statement?

Those were the shares on the income statement, which is the weighted average shares.

Do you know what the shares are at the -- you know, the end of the quarter?

Not the weighted average.

At the end of the quarter, it's approximately about $22 million shares outstanding.

22.

Yes.

On a diluted basis?

No.

I think we're confusing context here.

What I gave you was the basic and diluted shares you would use for the EPS calculation?

Yes.

And so it's 22 as of the end of the quarter?

Yes.

And the last, just so I don't cut you off.

What was the -- how much share repurchase is left.

It's approximately $14.9 million to repurchase under the current board approved plan.

Okay.

Thank you, gentlemen.

If you would like to ask a question, please press star one.

We'll now take a question from William Benton from William Blair.

A couple follow-ups, could you give us a -- I think, Jay, you may have discussed a little bit that the semiconductor area and OEM has been picking up.

Anything historically, you said there were two of the 13 design wins in production.

Can you give us an update there, and also maybe update us on the status of your thoughts and Envision?

Envision?

Yeah, the CTX 9,000?

Yeah.

We are not projecting a lot of business from Envision in this year's budget for obvious reasons, if you follow that industry.

Okay.

So again I think that we've been very conservative with our expectations there.

Yeah.

There are activities going on with regards to potential new designs for the next generation product.

It's premature for us to say much about that at this point in time.

With regards to the -- what was the first part of the question, the semiconductor business?

You historically talked about 13 design wins and two in limited production.

I didn't know if you could update us on how many of the design wins are currently in some sort of production phase.

And are there still 13 design wins or has that number changed as well.

That number has not changed and I don't believe that any of the other design wins have moved into limited production yet.

Okay.

So we're pretty much at the same stage, but it's just improve something.

Yes.

improve something.

Yes.

And then if you could just give us some kind of a general question, but kind of a progress report?

I know you've been talking a lot about expanding your target markets in terms of defense is there something you can say there?

Well, the emphasis has been in the [SIGMENT]/comment area.

As I tried to say in the call here, that that is certainly one of the areas where the DOD is putting a lot of emphasis --

right.

So we see that since we believe that the budgets are going to grow there in the [INAUDIBLE] and space, both for the classified part of the budget and the nonclassified.

And we are making investments on the marketing side in addition to the technology side, the product side, in order to be able to take advantage of opportunities there that we frankly did not address in the past?

You would expect revenue contribution to be a little further off.

We saw a reasonably good increase in the revenue last year in the SIG and space and are expecting that market segment to grow this year also.

Okay.

How about a smart tactical weapons.

There are some opportunities there that are being pursued, decisions had been postponed for sometime.

Some number of months before we can talk about whether or not we were selected -- we have been selected to work, it's whether or not they inturn are selected.

We'll now take a question from Peter Lou with Lou Capital Management.

I looked at the yearly cashflow numbers.

Since next year is top line, we'll be flat, and you continue to make progress in inventory in terms of what you're projecting to improve to six.

And I think your receivables collection is okay.

And you have cost reduction.

Can you give us a -- cashflow appraisal for next year which I would think would be up significantly from the 50 million you did this year, given the slowdown in revenue.

No, we're forecasting cashflow of approximately mid teens for FY '04 for a lot of the working capital initiatives that we made throughout the year, unfortunately can't be repeated at that dramatic stage.

Mid teens from down from 50 million?

This is -- I want to make sure we're talking about the same thing.

Cash flow from operations is only 15 next year?

Yes.

That's a huge decline in cashflow in a year that you're not growing.

I mean, you normally expect that with a flat year you can squeeze more cash out.

But most of the capital improvements throughout FY '03 are working capital initiatives where we made dramatic improvement.

Okay.

So that's not there next year.

Okay, thank you.

Now have a question from Richard with R.T.

Asset Management.

Good morning, gentlemen.

May question has to really do with the situation with the CFO and the board.

What is mercury going to do to improve corporate governance or take any kind of stance to make sure that situation doesn't happen again.

And secondly, do you plan on making any significant changes in capital corporate governance going-forward, and perhaps contemplate a dividend going-forward?

I know there is certain covenance in your bond agreement, but have you guys thought about that at all?

What bond are agreement are you referring to?

You have a debt covenant on your financing that prevents from my reading of it, prevents you from paying a dividend?

Yes, that is correct.

I think the dividends have been discussed an we thought that a stock repurchase program would more effectively have a return back to shareholders.

Right.

Going forward.

There are no current plans for dividends.

and what about -- is Mercury computing going to take any action to bolster the their corporate governance -- especially in a down year, companies in down years or flat years, things sometimes, you know, can change.

Not to the advantage of shareholders, I was wondering if you guys are going to address the situation during this time to make it a better company.

I think, if I'm to understand your corporate governance question, we've been under Sarbanes Oxly rules for well over a year and have complied with everything up to date and look forward to the section 404 internal control reviews that are going to be required as of 6/30 audit.

So at this point we're in compliance and have also bolstered our boards by adding lease deals to our audit committee.

Okay.

Well, thank you.

We'll now take a question from Paul Smitts.

I'd like to ask a couple questions.

One is the -- the first one, the new product that was just introduced.

I assume because the Intel processor and the Lenox operating system, you were unable to lever your back plane technology, but I'm wondering, and you can confirm or maybe explain that, but the second thing I'm wondering about, were you able to get some differential advantage there by utilizing your new I/O technology?

The first year integration of the product, Paul, is basically -- let me call it off the shelf as far as the hardware is concerned.

With the exception of some of the packaging capabilities that we've developed.

And the software where we have significantly improved the performance of some of the I/O subsystems in order to facilitate I/O transfers at a much higher rate.

We have made improvements in the overall performance of the system again in this first generation, but we have plans to continue to develop other areas which will give us performance improvements which then -- as Mercury is really noted for, being able to squeeze all the cycles out of the existing processors, so --

That's how you differentiate yourself in the commercial marketplace and give value to the customer?

That's certainly one of the ways.

The other way is to work with the customers to provide more custom solutions, and be able to charge for the value add that is provided there.

Because unlike our other businesses, we haven't built that cost into the margins.

Thank you.

The second question is, on the CAT scan business, perhaps you could give us an idea what we're looking forward to with your new products, being able to capture some of that business next year, and maybe you can tell us about the progress you've made along those lines.

Well, as I stated previously, the '03 was an investment year in the product development that is necessary for us to get back into that business.

And so we're at the point now where we're, in fact, able to demonstrate it and benchmark it, and we will be doing that over the next several months as we attempt to get into the next design cycles from the major CT manufacturers.

And how long are those cycles traditionally?

Well, the design cycles can be anywhere from 18 to 24 months before something will go into production.

And my last question, Jay, is, we've heard from a couple of firms that there's been some delay in what they expected it to be release dates for production stage products on the D.O.D..

Have you experienced any of that?

Let's set -- that's such a broad question, Paul, I don't know how to answer it?

Have you had some products or some programs that you've already been included in that are scheduled to go to production and has been delayed?

Not that I am aware of at this point.

Thank you.

We have no further questions at this time.

I'll turn the call back over to our speakers for any closing or additional remarks.

Thank you all for participating in this, and we look forward to talking to you again in October.

Don't forget the analysts conference in October.

Information will be coming out shortly, so that you can put it on your schedule.

And we'll look forward to seeing a number of you there, so we can get into some of this in more detail.

Thank you again.

Good-bye.

That concludes today's conference call.

I'd like to thank everyone for their participation.