Mercury Systems Inc (MRCY) 2004 Q1 法說會逐字稿

Good day everyone, and welcome to this Mercury Computer Systems Incorporated first quarter fiscal 2004 earnings results conference call.

Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Ms. Diane Basile.

Thank you.

Good morning everyone, and welcome to the Mercury Computer Systems first quarter 2004 earnings conference call.

If you have not received a copy of the earnings release, you can find it on our website, www.MC.com, or on the First Call network.

We would like to remind you that remarks we make during this call about future expectations, trends and plans for the Company (indiscernible) forward-looking statements for the purpose of the safe harbor provisions of the Private Securities 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 those risks and uncertainties, we refer you to the Company's reports filed with the Securities and Exchange Commission, including the Company's quarterly report filed on Form 10-K for the year ended June 30, 2003.

Further information regarding forward-looking statements and risk factors is included in the press release we issued today, reporting the Company's first quarter results.

We caution listeners of today's conference call not to place undue reliance on any forward-looking statement, 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 back over to Mercury's President and Chief Executive Officer, Jay Bertelli.

Thank you, Diane.

Good morning, and thank you all for joining Mercury's first quarter 2004 earnings conference call today.

The real exciting news out of Boston is the Red Sox.

How about those Red Sox?

They trounced the Yankees and they are going to do it again; the dream team is back.

This is fantastic.

Everybody is all fired up back here, I can tell you that.

All you New Yorkers, eat your heart out.

With me on the call today is Joe Hartnett, in addition to Diane.

Joe is the Vice President, Controller and the interim Chief Financial officer.

At this point, I would like to briefly review the first quarter results and then turn the call over to Joe to provide the additional financial details for the quarter.

I will then provide some context for trends that we see in the industries that we participate in, and I'll also have final comments before we open the call to your questions.

As you know, those of you who have seen the press release, we delivered a solid first quarter.

For the quarter, revenues grew three percent and our operating income expanded 12 percent over the same quarter last year.

First quarter earnings per share were 15 cents.

That marked our 51st consecutive profitable quarter.

Earnings came in at the midpoint of previous guidance.

Cash flow from operations was 9.2 million, and we ended the first quarter with a balance of cash and marketable securities at 122 million.

Backlog increased by $6 million to 63 million, and the book to bill for the quarter was greater than one.

During the quarter, we demonstrated continued progress against our three strategic objectives -- one, organizational development; two, operational effectiveness; and 3, continuing to be a leading innovator.

With regards to the organizational development, I'll give you an update on the CFO search.

The search for the permanent CFO remains ongoing.

Joe has exemplified Mercury's talent (indiscernible) strength.

We can confidently evaluate the strong pool of candidates knowing that Joe and the team that he has built are keeping our financial processes on track.

Joe will start his team through the fourth quarter year-end closing, 10-K filing and now the first quarter earnings.

With regards to the operational effectiveness initiative, the strong first quarter results demonstrated our continued preparation (indiscernible) effectiveness when measured against our value creation metrics.

Our ongoing focus on drivers of value creation such as process efficiency and supply chain management helped us to reduce our operating expenses to $21.5 million, from 23.7 million in the previous quarter, enabling good operating profit expansion.

Additionally, successful implementation of our working capital initiatives drove Days Sales Outstanding down to 43 and inventory turns up to 6.8.

Joe will talk a little bit about this later.

In the innovation category, we are committed to investing in our future by being the most innovative company in the specialized computing business.

Strong investment in research and development to maintain and improve core technologies and to develop new products are central to strengthening our position with existing customers and expanding our reach into new markets.

As one example, this week at the (indiscernible) conference in Boston, we demonstrated a software defined radio -- or SDR -- application, using Xilinx FPGA's and Mercury's heterogeneous multiprocessing environment.

The Xilinx components provided easy reconfigurability for switching waveforms, and even deploying new waveforms to radios in the field.

And Mercury's multicomputer system provided the reconfigurable multiprocessing and switch fabric necessary to (indiscernible) supported multiple complex waveforms in a single radio unit.

This demonstration clearly showed the value of Mercury's agriculture in the SDR space, and opens the door to new market opportunities made possible buy our continuing R&D investments.

Now for details about the quarter, I will turn the call over to Joe.

Thank you Jay, and good morning.

This morning I will be reviewing our first quarter performance and our business outlook for the second quarter of 2004.

I will first discuss revenues by business unit, then talk about total company operating performance.

I will then review the balance sheet and cash flow results for the quarter.

First, let me summarize our first quarter results as reported earlier this morning.

First quarter 2004 revenues were 40.5 million, up about three percent over the prior year.

Operating income for the first quarter was 4.5 million, or 11 percent of revenue.

This represents an increase of approximately $500,000, or 12 percent, over the same quarter last year.

Earnings per share for the first quarter were 15 cents compared with 19 cents in the same quarter last year.

First quarter 2003 earnings per share of 19 cents included $1.6 million of non-operating income related to the prior sale of the shared storage business unit, or the SSBU.

Turning to the first quarter specifics, I will now review revenue by business unit.

Please note that all comparisons are to the first quarter of fiscal 2003.

Our defense electronics group reported revenues of 28.8 million, or 71 percent of total revenues for the first quarter.

This represented an increase of about 13 percent from the same period last year.

Within the three application areas -- radar, signal intelligence, and emergent applications -- we saw strong growth in both radar and signal intelligence during the quarter, slightly offset by a decline in our emergent applications business.

Our medical imaging revenues were 7.2 million, representing 18 percent of the total revenues for the quarter.

In total, the medical imaging revenues were in line with our expectations for this quarter.

The first quarter decline of 27 percent over last year was driven substantially by the difficult comparison resulting from the absence of CT revenues.

While the first quarter of 2003 represented a strong quarter for the CT modality at $1.8 million, this quarter, as projected, CT revenue was essentially zero.

If you exclude the CT portion of the business, revenues declined 13 percent over the same quarter last year, reflecting the cyclical impact of our other modalities in the medical imaging.

Turning to our OEM solutions group.

OEM solutions group reported revenues of 4.6 million, or 11 percent of total revenues, up 13 percent over the first quarter last year.

Growth was primarily driven by applications serving the semiconductor market.

During the quarter, we recorded orders from (indiscernible) production systems, and we also saw an increase in orders related to wafer inspection applications.

Backlog in book to bill.

The total book to bill ratio was greater than 1 for the first quarter.

Our total backlog at the end of the first quarter was 63.4 million, up 6.1 million from the 57.3 million at the end of last quarter, and more significantly, the first increase in backlog recorded in five quarters.

Of the ending backlog, about 91 percent, or 57.8 million, relates to shipments expected within the next 12 months.

Gross margin.

Gross margin was 64.1 percent for the quarter, down from 65.1 percent for the same quarter last year due to a higher content of long-term revenue contracts in the quarter, which carry a lower margin, and to lesser extents, increased inventory provisions.

Operating expenses.

Operating expenses were 21.5 million for the quarter, a decrease of 2.2 million from the fourth quarter of FY '03, largely reflecting operational effectiveness initiatives, including a reduction in force during the fourth quarter.

As we indicated on the fourth quarter conference call, we continue to monitor key metrics in order to maintain an appropriate operating expense cost structure relative to revenue growth expectations.

During the quarter, these expenses are comprised of selling, general and administrative expenses of 12.8 million and R&D expenses of 8.7 million.

Headcount.

Our associate population at the end of the first quarter was 577, which is essentially unchanged from the beginning of the year.

Operating income.

Operating income of 4.5 million represented 11 percent of revenue for the quarter, and as I mentioned at the beginning of the call, we achieved a 12 percent expansion in operating income from last year on revenue growth of about 3 percent.

Net income of 3.3 million was 8.1 percent of revenue, down from 4.1 million in the first quarter of last year.

Please note that last year's first quarter net income included 1.6 million of non-operating income related to the sale of the SSBU.

Turning to the balance sheet.

Now turning to the operational cash flow and balance sheet performance, the first quarter of 2004 was another demonstration of the success of our working capital initiatives.

Mercury again drove solid cash flow results during the first quarter, ending the quarter with approximately 122 million in cash and investments.

Cash flow from operating activities was 9.2 million in the quarter.

This comprised of 3.3 million in net income, 1.9 million of depreciation and amortization, with the balance of 4.0 million resulting from working capital initiatives.

First quarter capital expenditures were approximately $1 million.

I'd like to provide you an update to Mercury's stock repurchase program.

The current program was recently extended through December 2004, where the total of 25 million authorized and just under 15 million remains available for future purchases, with the primary intention of providing an offset to dilution from our stock plans.

Cash and investments were 121.7 million at the end of the quarter, an increase of 8.4 million from the fourth quarter of 2003, and up 35.5 million from the same quarter last year.

First quarter days outstanding, or DSO, were 43 days.

This again represents a very strong 11 day reduction from the same period last year.

This is at the low-end of our target range and reflects strong collection efforts within the quarter.

We continue to demonstrate progress in inventory and other supply chain management initiatives, as turns grew from 3.7 in the first quarter of last year to 6.8 for the first quarter of this year.

This significant progress against our value creation initiatives have us on track to achieve our goal of approximately six turns for fiscal 2004.

As we discussed last quarter, we'll continue to monitor key metrics and business drivers with the objective of maintaining an appropriate cost structure.

In summary, we delivered a solid first quarter.

We were able to leverage our operating expense controls, expand operating margins and demonstrate a continued success in our working capital initiatives.

Now I'll turn to our business outlook.

For the second quarter of fiscal 2004, revenues are expected to be in the range of 39 to 42 million.

At these revenue levels, we would expect earnings to range from 13 to 17 cents.

We remain within the range of our guidance for annual revenue and earnings per share set on our July 31 conference call.

I would now like to turn the call back over to Jay for his additional remarks.

Thank you, Joe.

A few comments about the business in general.

We see a continuing and growing need for solutions that solve complex computing problems across each of our primary application markets.

We believe that Mercury is uniquely positioned to leverage the industry trends.

I would like to look more closely at each of our three major business areas and describe how Mercury provides these solutions for our customers.

Starting with defense.

Mercury continues to see revenue for products used in deployment platforms.

This area of the business reflects sales to programs that we reported as design wins in earlier quarters, as well as spares and replacement parts for programs where we have been installed for a longer time.

As you know, new design wins are a more reveling indicator of Mercury's future business.

When we announce a sale for a program's early stages, it is a step along the path to (indiscernible) sales from that program (technical difficulty).

The sale of RACE++ computers to General Dynamics for their ship monitoring program, which we announced during the quarter, is one such win.

Another from the last quarter of FY '03 is the sale of systems to General Atomics for the LINKS (ph) unmanned aerial vehicle synthetic aperture radar processor.

While each of these result in small revenues today, they improve our competitive position to participate in the more lucrative run rate business a few years out.

We also continue to invest in research and development intended to generate future program wins, and to strengthen our position in reaching deployment on currently won designs.

For example, the XR series multicomputer is based on the Intel architecture, representing a strong initiative aimed at some of the applications that can be supported today with a few Pentium (indiscernible) processors, which previously required much larger RACE multicomputers based on (indiscernible) PCs and DSPs.

While our mainstream technology has accelerated to a level where consumer grade processes employ a viable platform for a few applications, Mercury still possesses unique intellectual capital required to make the applications perform to their greatest potential, and we believe that this expertise will continue to drive sales of all of our solutions.

At the other extreme of the performance curve are systems such as the ImpactRT 3100, which we announced in March and are delivering to the semiconductor industry.

Along with other rapid I/O based systems that Mercury is developing, these systems address the high-end space, where applications are frequently pent up waiting for deployable platforms that can run them.

While the ImpactRT 3100 system initially shipped to a customer in the semiconductor space, it is a (indiscernible) product with applicability in the high-end of defense electronics in applications such as signals intelligence and sensor fusion.

Just as our 972 processor first generation multiport system enabled a prototype space-time adapter processing system to be field tested in 1977, we are building our new family of high compute density processes for deployed versions of these advanced radar systems that could never be achieved previously because of power, weight, performance and cost constraints.

We at Mercury are very proud to be playing a major role in the defense of our country by providing powerful computing solutions for ISR platforms.

Turning to medical.

One particularly exciting example is 3-D interventional imaging, which will benefit from Mercury's investments in FPGA technologies to allow near real-time diagnostic image generation, using smaller, more affordable multicomputers.

Once again, Mercury is applying its expertise to these markets, packaged into the hardware that customers buy.

As affordability increases, these applications become accessible to a larger consumer base, driving up demand for medical imaging systems.

Ultimately, Moore's (ph) Law and technology improvements drive smaller consumer grade processes into these solutions as well?

They almost certainly will, but this is also certain;

Mercury is already working on (technical difficulty) applications that will require our expertise in a broad range of image acquisition (indiscernible).

Finally, our OEM solutions group.

All indicators point to expanding activity in the semiconductor markets, beginning in the coming quarters.

We expect to see this growth reflected in sales to programs already in production, as well as moving the programs that have designed Mercury in, but have been waiting for an economic upturn or other milestone before starting (indiscernible) production.

The OEM group represents an excellent example of design wins resulting in run rate business within a shorter development cycle than is frequently seen in major defense projects.

And work continues in both the OEM and defense groups on telecommunications and signals intelligence opportunities that will benefit from Mercury's unique expertise and applying multicomputer solutions to computer (indiscernible) applications.

Looking ahead, while all indications of an improving economy are encouraging for our civilian sector businesses, questions remain in the defense space due to political uncertainties and the escalating cost of the United States activities in Iraq.

Costs of day-to-day operations and reconstruction are driving deficits, and political leaders may decide to address them with delays or reductions in new systems.

However, while budget cutters might conceivably target high-profile program such as the (indiscernible), the Iraqi operations have also validated the use of (indiscernible) surveillance platforms such as Global Hawk and Joint Stars systems, both of which incorporates Mercury's processors.

Likewise, the continuing need for intelligence both on the battlefield and in the shadows, point to an expanded funding for signals and communications intelligence, and imaging solutions to support the campaign against terrorism.

Mercury is well positioned to continue (indiscernible).

Our investment in R&D continues to yield systems and make us an attractive long-term supplier with defense contractors.

We continue to build the intellectual capital that makes us a valuable partner.

Ultimately, it's that knowledge, that expertise, that assurance of long-term stability that drives Mercury's competitive advantage in all of our markets, and which is the core of our sustainable value proposition.

This investment is paying off today with continued profitability, even in this challenging climate, and it seeds the growth that we expect to see in the quarters ahead.

Before we open the call up to take your questions, I wanted to take a minute to summarize what we have talked about today.

Mercury posted excellent first quarter results.

We've demonstrated continued progress against our strategic objectives -- our continued focus on value creation drivers such as process efficiencies, supply chain management and predictability in delivering results.

Revenue and earnings were consistent with guidance.

Operational effectiveness initiatives translated into operating profit expansion and excellent cash flow from operations.

As we go forward, we will continue to monitor industry trends and topline indicators, as revenue from defense applications is historically vulnerable to funding timelines.

To continue to broaden our market opportunities, we are investing in new products, and at the same time seeking complementary acquisitions, strategic alliances and partnerships.

We have a strong balance sheet and financials to support these endeavors.

I continue to have confidence in the growth potential of the markets we serve and the strong team of dedicated associates we have assembled.

As Joe stated previously, we are reiterating our guidance for the year.

The long-term outlook remains bullish, quarterly (indiscernible) aside.

With that, I will open the call up for questions.

(OPERATOR INSTRUCTIONS).

Bill Benton, William Blair.

Jay, I was going to say how about those Cubs, coming here from Chicago.

But I guess I can't really do that.

I was rooting for the Cubs.

How about those Cub fans?

At any rate, I had a few questions but I'll limit myself to one and go back into queue here.

You talked about your guidance and I know you reiterate the kind of full year number.

I'm just trying to get a feel, with the backlog -- kind of your confidence level in the guidance.

I know you talked about defense spending and the backlog was up.

And so I am just seeing if you could talk specifically about on the defense aside, on the zero to five percent that you talked about previously, do you feel like it's more toward the zero or the five?

Or is it still a little too fuzzy there?

And then on the OSG side, you had given outlet of 15 to 30 percent.

And you had talked about it maybe starting to ramp here.

How do you feel about that now, in terms of directionally at the lower higher end of that?

Well, I'm going to stay within the range, Bill, on both of them.

The issue is very simply that the defense business, as you know, tends to be lumpy.

There are a number of orders out there that we are looking at that are in the several million dollar range, and if one of them fails to come in it could be at the lower end.

If they all come in, it could be over the higher end.

So that's what causes us not to want to give any finer granularity at this point in time.

And with regards to OSG, we certainly expect to see good growth this year.

We've already started to see some of it.

It's still within the range that we talked about, and we're not ready to say that we're going to go above that range until we have the orders in hand.

And the number of design wins there are still -- you are at two in production right now?

Yes.

Rob Stone, SG Cowen.

Jay, following up on that same thread with the backlog up sequentially, but the guidance for the December quarter relatively flat and down quite a bit year on year -- do you see within the existing backlog a trend towards shipments that are more in the back half of the fiscal year?

Yes.

As a matter of fact, I can't tell you how it fell by quarter, but a large part of that is scheduled to ship within this fiscal year; it's just that it didn't come in for shipment in Q2.

We certainly are expecting to see some amount of book and ship within the quarter.

But as you know, we are attempting to be very conservative, if you will, and make sure that we feel confident that we'll be able to make the numbers that we give you the guidance on at the beginning of the quarter.

That's certainly fair.

One quick follow-up if I may, to Joe.

I missed what you said the CAPEX was for the quarter?

CAPEX was approximately $1 million.

Dave Heger, Kennedy Capital (ph).

You all had talked about the OEM business, and it sounds like it's ramping up on a year over year basis.

Do you have any sense from talking with your customers in that area, what type of impact could be anticipated if you start to see things pick up in semi equipment?

I believe we've factored the best year that we have into it when we gave the guidance for the year back in July.

And while things continue to look positive, we haven't -- I can't say at this point that we've seen the positive results translate into orders anymore than had already been projected.

So we're staying within the guidance that we gave previously for our semiconductor business.

In other words, if the semi industry started picking up more, then you would probably be up towards the higher end of that guidance?

If it's a more slower ramp, then down towards the low end?

That's your assessment of it.

Paul Spetz (ph), Capital Flows (ph).

Jay, I'll get back in queue as well, but the first question is the CT business.

Have you had some design wins there, and if so, what would be your target for which quarter you would begin to see shipments in that business?

The answer, Paul, is that we don't have any design wins that haven't been announced in that space.

I think we had talked previously that we expected to get some indication before the end of this calendar year as to whether or not our latest offering was going to be successful in that space, at least with one of the customers.

That is still in process, and no decisions have been made.

So as soon as we are able to announce something, we will.

(OPERATOR INSTRUCTIONS).

Glenn Primack, BroadView Advisors.

A couple of quick questions.

Is all the OEM business semiconductor?

And then, if you can talk a little bit more about design wins, defense and medical, that aren't in production?

Just how could we kind of quantify the size of that or what could that be?

The design wins in medical are in production.

There are many design wins in the defense business that -- it goes through phases.

You go through a phase where you get an order (indiscernible) -- you're selected for a prototype; it then can move to the next phase of engineering development, where there is some additional orders.

And then it may or may not go into production.

That cycle typically takes several years, literally.

So we've historically been generating somewhere between 5 and 10 design wins a quarter, I believe it is.

But they don't all turn into revenue for some period of time.

What I quoted here or talked about in the release here was 2 design wins that obviously resulted in some business last quarter and this quarter -- I should say our Q4 FY '03 and Q1 FY '04 -- that we would expect, when they move into production, to have some substantial revenue associated with.

But it's been very difficult for us to predict whether or not these programs will in fact get funded, and so we hesitate to try and give you a projection of revenue over several years, based upon design wins that we get in any one quarter.

All I can tell you is that over the years, the number of design wins have been increasing.

So there is a ramp up in the number of design wins.

You asked me another question, and I forgot (inaudible) --

OEM -- is that all semiconductor related?

Probably 90-plus percent of it is semiconductor related.

Joe, do you have a better number on that?

That's not a number that we publicly disclose.

I would say a majority of the semiconductor business -- a majority of the OEM solutions group business is semiconductor.

It does fluctuate from quarter to quarter, as Jay said, as the design wins come through.

However, I don't believe it's as high as 90 percent, definitely not within the first quarter.

Bill Benton, William Blair.

First on the gross margin, if you could just help quantify the inventory provision impact on that number?

And you had given kind of 65 percent as a target for the year.

I just wanted to check your pulse on that, if that still feels good?

This is Joe.

I think we gave 65 percent guidance for the year.

The main driver was the long-term revenue contracts that we previously announced -- ANS (ph) long range radar;

Northrup Grumann;

Mesa, who carry a slightly lower margin due to the NRE of a customized solution; and to a lesser extent, inventory provisions, which was primarily the result of taking the IOCE business and putting them up on the Mercury methodology on a full basis.

The inventory provisions was not a material driver but a piece of the gross margin, and I feel that we're still on track to hit a 65 percent margin for the full year.

And then just on the operating expenses.

Your run rate now is below -- I think you're targeting 90 million; obviously, there's (indiscernible) with the sales level throughout the year.

But was there anything unusual in the quarter that may have kept that number lower than it would normally be on a run rate basis?

I don't think I would characterize it as anything unusual.

I think that we monitor operating expenses from a headcount perspective, and also discretionary spending, and monitor that with the revenue growth that we expect.

But nothing unusual on either one of those fronts.

Brad Evans, High Rock Capital.

Just a follow-up to that question, actually.

The R&D line came down quite nicely sequentially or from the fourth quarter; is that an appropriate run rate for the year at this point?

I think similar to the guidance that we gave, we expect R&D to approximate 20 to 21 percent.

So I'm not sure that that's an appropriate run rate.

As we look at the revenue being predominantly in the second half of the year, R&D expense should track to that.

On a full year basis -- you made some nice improvement here on the first quarter as well on the working capital front.

What are your expectations for working capital source or use for the full year at this point?

I believe working capital, we should remain positive for the whole year.

I think we made a significant working capital initiative within the first quarter.

I'm not sure I'd characterize that as run rate for the full year.

With the DSO being slightly below our target of the mid-40s, and the inventory turns up to 6.8 (indiscernible) tied in 6, I would expect to continue working capital initiatives, but not as dramatic as the first quarter.

Understood.

And just let me sneak one more in here.

In terms of -- can you just talk about, generically speaking, the pipeline from an M&A perspective in terms of acquisitions, what you're seeing out there?

Deal flow quality -- have you seen any improvement in terms of pricing?

There's a number of opportunities that we've looked at, and we're not at a point where we're ready to announce anything certainly.

So in terms of pricing, we haven't found anything that falls within what we think is a reasonable price or we would have executed on it.

(OPERATOR INSTRUCTIONS).

Paul Spetz.

Thank you.

My question was answered.

Bob Easthill (ph), Value Carbitt (ph).

I'm a new trader in the stock market, and it was brought to my attention, your company, about six months ago.

And I saw that the CFO resigned and there was some big news.

And I saw a big I saw a big stock drop, and I know you guys aren't allowed to talk about the stock price too much.

But what I wonder is are you guys internally doing better now than you were before April?

Internally?

What do you mean internally?

As far as how much revenue you guys made, because I haven't seen your quarterlies on what you did back when the CFO quit.

And I was wondering if the reason why the stock took a hit was because everyone was nervous that, with all the uncertainty in the environment, if a CFO quits maybe there's something ugly that did not rear its head.

So I'm an investor that's trying to do some homework, and the homework is maybe your company is undervalued because you are actually exceeding what you (indiscernible) left.

And my analogy is common sense -- if your revenues are higher than April and your profits are higher and you are guiding higher, maybe the stock is undervalued and should be back up to where it was in April?

And maybe it's going to get that way someday, so I am trying to use that as a guide.

If you could tell me yourself if you feel or know for a fact that your numbers are better now than in April?

And that would indicatively move your stock price back to where it was?

The financials are all on file.

You have access to all the data.

I suggest that you take a look at it.

I appreciate that.

That concludes our question-and-answer session, as well as today's call.

We thank everyone for your participation, and you may now disconnect.