Mercury Systems Inc (MRCY) 2005 Q1 法說會逐字稿

Good day everyone and welcome to today's Mercury Computer Systems Incorporated First Quarter Fiscal 2005 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.

Please go ahead ma'am.

Good morning everyone, and welcome to the Mercury Computer Systems first quarter 2005 earnings conference call.

If you've not received a copy of the earnings release, you can find it on our web site www.mc.com or on the First Call Network.

We'd like to remind you that remarks that we may make during this call about future expectations, trends, and plans for the Company and its business constitute forward-looking statements for purposes of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

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

For discussion of these risks and uncertainties, we refer you to the Company's report filed with the Securities and Exchange Commission, including the Company's annual report on Form 10-K for the year ended June 30, 2004.

Further information regarding forward-looking statements and risk factors is included in the press release we issued this morning reporting the Company's first quarter 2005 results.

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

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

With us on the call this morning are Bob Hult, Chief Financial Officer;

Joe Hartnett, Corporate Controller; and Jay Bertelli, Mercury's President and Chief Executive Officer.

I am now pleased to turn the call over to Jay Bertelli.

Good morning everyone.

As you probably read in our earnings announcement Mercury is pleased to announce its 55th consecutive quarter of profitability and the strongest ever first quarter in revenues.

This quarter was also the second highest reported quarterly revenue in our history.

We experienced solid growth in each of our business areas which are defense like tracks, imaging, and visualization solutions and our OEM solutions group.

Operating income of $8 million was 14.5% of revenue, earnings per share of 23 cents exceeded the top end of our guidance by a penny and cash flow from operating activities were strong at $11.2 million for the first quarter.

Cash and cash equivalents were $240.5 million at the end of the quarter up $2.2 million from the fourth quarter.

In addition to these strong financial results during the first quarter of FY '05 Mercury continued its investments in new products and technologies that will help sustain our growth.

They also proceeded with our strategy in open innovation which enables us to deliver products and services that provide our customers with the best solutions for their applications.

I will discuss these activities in more detail later in the call.

At this time I would like to turn the call over to our CFO, Bob Hult to provide details of the quarter’s results.

Thank you, Jay.

Good morning, everyone.

As you heard from Jay, the first quarter results were very strong.

We continue to have top line growth reporting our strongest ever first quarter revenue results and the second largest revenue quarter in our Company’s history.

I will review revenue including BPOs like business unit and I will then discuss company operating performance, balance sheet, and cash flow results.

I will close out with the discussion regarding the outlook of the second fiscal quarter and the fiscal year ahead.

Our objective is to provide the business contacts and to review the assumptions behind our guidance as an [aide] to role model development.

First, let me summarize total company first quarter results that we reported this morning.

First quarter 2005 revenues were 55 million.

This reflected growth of 35.7% over the prior year.

Operating income for the first quarter was $8 million or 14.5% of revenues.

Earnings per share for the first quarter were 23 cents, exceeding the top end of our previous guidance by 1 cent.

At this point I would like to drill down into operating performance, beginning with revenue details by business unit.

As you saw in our press release, first quarter revenues in total were 55 million.

Our defense electronics business unit reported revenue of 31 million or 56% of total revenues for the first quarter, up approximately 8% from the same period last year.

Within our three application areas, radar, signals intelligence, and defense technologies, the group experienced particular strength in signals intelligence and defense technology segments.

Our imaging and visualization solutions business unit revenues for the first quarter were $10.5 million, representing 19% of total revenues and up 46% from the same quarter last year including a $1.7 million contribution from the recently acquired TGS business.

During the first quarter, sales from the digital X-ray modality were particularly strong.

Our OEM solutions business units for first quarter revenues were $13.5 million or 25% of total revenues, up nearly 200% from the same quarter last year.

Growth was primarily driven by applications serving the semiconductor capital equipment market which accounted for approximately 83% of the OEM solutions revenues.

As multiple design wins move into volume production, we continue to experience strong shipments of our systems to semiconductor capital equipment OEMs for integration into their semiconductor inspection and mass generation systems.

Total backlog at the end of the first quarter was $83 million, this is up $19.6 million from the same quarter last year, a further data point, which gives us confidence with our full-year revenue guidance of $225-230 million for the full year.

Of the ending backlog, $73.3 million or about 88% relates to shipments expected within the next 12 months.

Gross margin was 64.6% for the quarter consistent with the mix of business by segment reported.

Total operating expenses were $27.5 million for the quarter slightly below our expectations.

You will recall from our fourth quarter conference call that operating expenses were expected to be approximately $28 million this quarter, which included a base run rate plus some uneven or program-related R&D expenses.

Within operating expenses, SG&A expenses were $16 million for the quarter, R&D expenses were $11.5 million for the quarter.

Amortization of intangibles related to acquisitions were $400,000 for the quarter.

Operating income of $8 million represented 14.5% of revenue for the quarter and exceeded our guidance of 12-13%.

Please note that there was a temporary increase in the Q1 tax rate due to the exploration of the U.S. federal [inaudible] tax credit which has since been reinstated in October.

As a result the tax rate for the first quarter was 34%.

We expect to chew this up in the second quarter to 30% year-to-date.

Net income of 5.1 million was 9.3% of revenue.

Turning to the balance sheet, operating cash flow was $11.2 million in the quarter.

Operating cash flow was comprised of 5.1 million in net income, 2.1 million of depreciation and amortization, and a 4 million net decrease in working capital and other non-cash items.

First quarter, DSOs were 50; this represents a 13 day improvement over the fourth quarter.

Inventory returns were 6.6 for the quarter, a slight improvement over the previous quarter.

Capital expenditures came in at 1.7 million for the quarter.

Cash and cash equivalents were 230.5 million at the end of the quarter, up 2.2 million from the fourth quarter.

At the end of the first quarter, total employee population was 662, essentially flat at the end of the fourth quarter.

As part of the previously authorized share repurchase program, the Company repurchased 300,000 shares for approximately $7.8 million at an average price of $26 during the quarter.

We expect to continue to utilize our stock repurchase program to purchase shares to offset dilution from our employee stock option and purchase plans.

I'd like to move on to the 2005 outlook.

First I will go through the second quarter guidance and then speak about the full year.

We expect the second quarter revenues for 2005 to be in the range of $56-58 million.

At this level the Company is again projecting one of the largest revenue quarters in its history having just reported its strongest two revenue quarters.

Based on the projected mix of business we expect that gross margins will improve to approximately 65%.

For the second quarter we project operating expenses of approximately $28.5 million.

This represents modest growth over the first quarter, largely driven by program-related R&D expenses and planned hiring during the quarter.

Second quarter operating profits are projected in the range of 15-16%.

A little housekeeping.

The tax rate for the second quarter, as I mentioned, is expected to be 26% which will then bring the year-to-date rate to 30%.

We further anticipate that the recently announced change in FASB accounting treatment relative to contingent convertible debt offerings will impact the Company’s earnings per share calculation.

This accounting change is detailed in the FASB Emerging Issues Task Force issue number 04-08 titled "accounting issues related to certain features of contingently convertible debt and the effect on diluted earnings per share" which is published on October 11.

This change in accounting treatment is schedule to become effective with the next quarter reporting cycle ending December 2004.

The impact of this new accounting treatment to contingent convertibles which is essentially the equivalent of the as-if converted method would be to, first, adjust net income by adding back interest expense and the amortization of debt issuance costs net of taxes, and then to increase the total shares outstanding by converting the debt to equivalent shares at the conversion price.

The new FASB regulation would impact Mercury’s reported earnings per share in the following way.

For the second quarter, net income would be adjusted up by approximately $600,000 and shares outstanding would be increased by approximately 4.1 million shares.

The resulting projection for earnings per share for Q2 would then be in the range of 25-28 cents for Q2.

Full year 2005, go through the guidance here, on the top line, we've built our operating plan under the assumption of revenue growth to a range of $225-230 million or 21-24% growth relative to 2004.

This revenue range is supported by business unit program level details to which we have good visibility.

As noted on our previous calls, this will represent the first time in several years that we are planning for subsequent revenue growth.

The assumptions behind this growth include the following -- consistent investment levels into Department of Defense transformation of programs; the successful integration of our TGS acquisition into the new Imaging and Visualization Solutions Group; modest interest rate increases, in the combination of recent semiconductor capital equipment design wins, these are Mercury wins, and more of these design wins moving into volume production.

We believe that these factors will continue to drive growth in our OEM Solutions Group, notwithstanding the recent weakness in the overall semiconductor capital equipment market cycle.

By business unit, we project our full year revenue mix as follows.

The Defense Electronics business unit will approximate 60% of total corporate revenues.

The Imaging and Visualization Solutions business unit will approximate 20% of total revenues and the OEM Solutions business unit will approximate 20% also.

In total, this will represent a mix of 60% defense and 40% commercial applications.

Moving through the P&L, we anticipate FY '05 gross margins to be in the 66-67% range.

Mercury remains committed to our continuing investment in research and development.

Accordingly we expect that R&D will remain within historical levels of 20-21% of sales.

With these assumptions, operating margins should approximate 17% for 2005.

We continue to plan with a 30% annualized tax rate for the full year.

We estimate the net impact of the pending FASB change in accounting treatment for contingent convertibles to be approximately 10 cents on our full year earnings per share.

We had previously projected a range of $1.20-1.25 for full year earnings per share.

Due entirely to the pending FASB accounting change related to contingent convertibles, the company now adjust this range to $1.10-1.15.

In terms of working capital, we expect to drive for improvements in our DSL to 45 days and inventory turns to 8 times.

CapEx for '05 is projected to be approximately $8 million compared to $6 million in 2004.

Depreciation and amortization will be approximately $10 million due to the increase in amortization from intangible assets.

In summary, for the full year, we project revenues in the range of $225-230 million or 21-24% growth over fiscal 2004.

We project gross margins of 66-67% and operating expenses to remain relatively flat throughout the year resulting in a full-year guidance for operating profit of 17%.

In closing remarks, our balance sheet is strong, we have the cash reserves to support our strategic growth initiatives, and we are well positioned to drive our top line 25% or better at a long-term sustained pace.

The performance in the past two quarters again demonstrated the Mercury capability to turn revenue into profit.

We remain focused on leveraging the skill set and we are committed to maintaining appropriate levels of spending relative to growth projections.

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

Thanks, Bob.

Over the past several quarters we’ve reported to you on our work to position Mercury for a significant growth.

Today, as the numbers demonstrate, I am pleased to tell you that our efforts are paying off.

As Bob outlined, we reported significant growth in each of our three business areas -- Defense Electronic, Imaging and Visualization Solutions, and our OEM Solutions Group.

Our growth initiatives are demonstrating traction and we feel confident in our growth strategy.

Our overall objective is to drive sustainable long-term revenue growth of 25% or better.

Much of this growth is driven by Mercury strategy of [helping] innovation; that is seeking out the best ideas and opportunities that help us to both sustain and increase our value-add inside or outside of our own four walls.

We are proceeding with the integration of the two organizations we acquired in the last fiscal year.

The RF Center of Excellence representing the knowledge and products of the Advanced Radio Corporation is already a vital part of the Defense Electronics organization and it is a significant resource in our signals intelligence and software radio programs.

Similarly, the Imaging and Visualization Solutions Group is a full pipeline of new solutions for medical imaging, biotechnology and scientific and commercial applications that leverage the software and expertise we gained with TGS.

Many of these are coupled tightly with our Intel-based XR Series modular systems demonstrating the smooth integration of our longstanding hardware engineering expertise with the software and domain knowledge of this leading provider, TGS.

A key example of our commitment to developing alliances that provide more value-add to our customers is our collaboration with the Massachusetts General Hospital.

Mercury teamed up with MGH's physicians and researchers in the breast imaging division on a new highly-effective mammography technique developed by MGH.

This technique, known as Digital Breast Tomosysthesis or DVT, synthesizes 2D images to create a single 3D composite image.

DVT involves a vast amount of computer processing, which on a conventional computer could take up to 5 hours to process one image -- far too to be clinically useful.

Mercury's engineers reduced the processing time to 5 minutes.

DVT eliminates the obscurity of growths that would otherwise go undetected enables doctors to formulate a more accurate diagnosis with less re-imaging, saving time, and reducing cost.

One in every women is diagnosed with breast cancer and DVT makes fairly accurate detection more attainable.

When you receive our annual report, you will see more information in the annual report dedicated to this achievement.

Open innovation has led directly to break-though products for today's customers.

Our recently announced Ensemble platform is a fragrant example of this.

Let me recall, Ensemble is our RapidIO-based development system that enables telecommunications equipment providers to benchmark applications before they move into deployment.

Ensemble is a fully-integrated system that leverages Mercury's architectural expertise with industry's standard technologies and components such as the Enea Embedded Technology's OSE real-time operating system, which was announced in September.

Mercury's support of the established powerful OSE operating system in Ensemble provides another level of value-add for our customers, the rich features set that broadens the interoperability of the assembled platform.

A key growth driver that generates open innovation is our commitment to the creation and adoption of commercial off-the-shelf, or COTS technology.

Moreover, we are particularly pleased when we repeat this in programs that already contain Mercury's [plat] to content.

A recent example of this is our selection for the upgraded Surveillance Radar on Canada's CP-140, Aurora Maritime Control aircraft.

This sale to the Telephonics Corporation follows a sale to array systems in 1998 in which Mercury also helped to update the Aurora Radar.

Even though the customer may change, the end users still require solutions that only Mercury can enable.

Other notable accomplishments this quarter include the introduction of the first multi-chassis, RapidIO-based multi-computer that enables our customers to address the increasingly larger computational challenges in commercial and defence applications.

The availability of field-programmable gate array and the 3U CompactPCI space which allows us to increase performance density into even smaller boxes and the introduction of the latest version of Open Inventor from Mercury's TGS operation, a widely used object-oriented, cross-platform 3D graphics applications, programming interface for C++ and Java developers.

So to sum up before we take the questions, management is pleased to report our 55th consecutive quarter profit, and the growth that we've worked to create.

We are proud of this achievement and have begun the year well positioned to reach our full year revenue guidance of $225-230 million.

We feel confident in achieving our longer term objective which is to sustain 25% of better long-term revenue growth.

With a very strong quarter, we are not stopping to celebrate, so go Red Cross, go Mercury, and looking forward to seeing you in our Annual Investor Conference next week at Boston at the Museum of Science, that's Tuesday the 19, at 9 o'clock in the morning.

Thank you, and we will turn the call over now for questions.

Thank you, sir.

If you would like to ask a question, please, press “*” “1” on your telephone at this time.

If you are using a speakerphone, please, be sure that your mute function is turned off to allow that signal to reach our equipment.

We would please ask that you limit yourself to one question and a follow up question.

Again, that is “*” “1”.

We will take our first question from Steve Levenson with Advest.

Good morning.

Good morning.

Can you give us a little information about in relation to signal intelligence some of the governments initiatives and I guess what they are calling measurement and signature intelligence and how your products might play that area?

I am not sure of the specific comment that you refer to there measurement and signals intelligence Steve so, if you add something specific I would like to know what it is.

In general –

This was image processing on a great looking things that might have been there one day or appear the next or vice versa?

Well, we have been involved with that for a long time.

In general, I would say that the increase in signals intelligence business that we have seen well, I can’t point specifically to programs certainly, as a result of the increased spending that we are seeing driven by 911.

So there is lot of activity in that space and we are certainly taking advantage of it.

Okay.

Second of all, can you give us an update on your acquisition pipeline please?

Well, with -- right now we are trying to silence the outside landscape included -- has decided to clean the sidewalk with blower so I hope that that’s not causing too much noise.

Can hear you.

We had a very active and full pipeline of candidates if you will that we are pursuing not just from an acquisition standpoint Steve but also from an alliance standpoint.

There were opportunities out there that we are looking at to fit in with this open innovation theme if you will where alliance is more appropriate than acquisitions and we are pursuing several of these in each of our three business units.

But we are clearly not ready to announce anything yet.

You will about it as soon as we are ready to say something.

Okay, thanks.

Looking forward to seeing you on Tuesday.

Our next question comes from Bill Benton with William Blair.

Good morning guys congratulations on a strong quarter.

And I guess, you know, even though if stocks are not working for you at least the numbers are working for you, Jay?

They are not -- they are not true yet.

Lets see, is there any one contract I guess in either the idea [inaudible] area that may be driving the ramp in those businesses sequentially, I guess if you could just kind of comment on how many design wins, I guess, are now in production with semiconductor?

You asked three questions at least -- with regards to the semiconductor -- we over the last couple of years I think announced the total of somewhere between 12 -- design wins.

Most of them not all of them are in production, some of them have recently gone into production and the result of that is that we showed good growth in that segment even though the semiconductor industry doesn't look too good these days if you will but our business is still very strong there because we came from a base of zero basically.

So, that I think answers your question there, with regards to IVS there is a whole series of new opportunities that the TGS software including a Amira is getting us into on a rate to 0.2 any significant design wins yet but we had a several of them in the queue and as far as defense is concerned the design wins we announced them when we get them and I don’t recall specifically how many we put out last quarter but there isn’t anyone program basically that’s, that I would say is driving this -- it’s a number of programs in each of the segments.

Okay and then just one quick one, I guess [inaudible] Argon close your merger just wondered if you could just comment on how that plays into your business?

Well, Argon is a major customer of ours, I believe that you have seen the annual report and I recall whether it was number one or two but they are right up there and we would expect that the integration of Argon and Sensitech is going be positive for our business.

Argon did it for obvious reasons to increase the opportunities that they have within the signals intellegence space.

We had not done any business in the past with Sensitech so we are looking forward to seeing if there are going to be opportunities there for us now as a result of the strong relationship we have with Argon.

Okay.

Well great, I will see you guys on Tuesday.

Hopefully [inaudible] I will pick it up there.

We will go next to Scot Robertson with Stanford Financial.

Thank you.

Great quarter, gentlemen.

Curious, I wanted to touch back on the OEM solutions business again, 85% sequential increase, I mean how should we thinking about that business going in the Q2 or is it sustainable at this level or are you expected some tapering off of that in the second quarter?

I think you should probably go with our guidance and do it as a business unit that will be approximately 20% of our revenues for the full year.

I think when you reduce that down to a revenue number per quarter, simplistically, yes, it’s sustainable at the level that just performed at.

Okay and then in terms of the share count in Q2, should we -- as I think with the new FAS regulation, will you be using a $26 million base starting in December?

That’s correct.

Okay.

Thank you very much.

We will go next to Tyler Hojo with Sidoti & Company.

Hey, good morning.

My question is based on your current EPS guidance, what are your projections for interest income, right now?

I don’t think we've actually given a projection for interest income as a single line item.

We -- what do you get in that Tyler?

I am just trying to get kind of an understanding of -- there was a quite a big jump up in interest income between the fourth quarter of last year and first quarter of this year.

So just trying to understand what’s going on.

We did our debt offerings, so --

No, I understand.

We had more money to invest, that’s the jump up.

So what are we earning on average right now?

We've increased [it] with the market rates that were a little bit over 2%, heading towards 3%.

I think a way to model it is we expect our interest income to offset our interest expense and we expect the non-operating income to be plus or minus a 100,000 net.

Okay.

We've been -- all that cash we have, we've been laddering it up expecting the rates to move up slowly, but definitively.

Okay.

Thank you.

One more question for you.

Based on this quarter where Defense Electronics came out about 56% of revenue, what can we expect going forward?

I know you said that for full year you are looking at about 60% Defense Electronics, do you think this is going to be some thing where, say, next quarter you come in at 65% or is it going to be sequentially improving?

Again, I think you are may be being a little bit too precise 60-20-20 should work for you on any given quarter.

Okay, thank you.

Yeah.

We will take our next question from Rob Stone with SG Cowen.

Jay, my question is about the XR Series and in particular application opportunities you are seeing using Intel or I guess, before too long you will also support AMD processors, can you comment on any application wins on non-RPC processor so far?

The interest that we are seeing for that platform is coming primarily of the IVS business segment.

And some of it is within oil and gas, for example, some of it is within the biotech, some of it is within medical.

So it is across the board within the IVS business that we are seeing opportunities to use the XR platform.

There will be more discussion of this on Tuesday.

So, is that a component of revenue so far or is it still at the stage of wins that may be shipping later?

There is no significant revenues generated from that yet, we are in the process of putting several platforms together that will be announced shortly based upon that product and again there will be more detail at the conference next Tuesday.

Great.

Thank you.

Just a reminder, if you do have a question, please press "*" "1" on your telephone at this time.

We will go next to Abel Beyene with Wells Fargo.

Thank you.

Can you hear me?

Yes.

Just a quick question on your IVS business, could you talk about what’s going on with CT products to see if you are gaining some traction back in that area of your business?

Well, I can tell you that there is a lot of activity and as usual, things have a way of slipping out -- expected by now that we would have some positive announcements to make, but things are moving a little bit to the right; however, still very positive.

So, I would expect that we would be able to within the next three months or so indicate whether or not we are going to be able to get back into that CT business.

Based on your engagement level with customers now, would you expect it to have meaningful contribution, say, for the fiscal year through IVS division?

We are not projecting any significant impact on IVS's revenues for ’05 from any design win.

As you know, it takes OEMs a while for -- to get the equipment incorporated into their system before they can ship it.

So revenues -- any significant revenues would not occur until FY '06.

Okay.

Thank you, gentlemen.

We will take our next question from Bill Benton with William Blair.

Hi, guys, just a couple of quick ones.

Why -- you mentioned operating expenses were lower than you expected, why exactly were they just -- I guess, I know you had -- they're a little bit higher as you [accrued on] a little bit of the catch-up basis last quarter.

Did you not, I guess, invested as much as you though you would or is there anything else going on there?

No, we had guided to $28 million OpEx for Q1.

Yeah.

They came in at 27.5.

That’s pretty close, but if you -- hopefully you did note that our work force has remained relatively stable over the last 90 days.

There are obviously some ins and outs, but I think the extent that we were modestly under-spent against our guidance, it was our hiring pace.

Okay.

Would you expect to pick up a little bit this quarter?

Absolutely, and it has been a big piece of why we moved the guidance up to 28.5 for the December quarter.

Okay and then just within the defense business segments, I know you can shift around between production and development, were there any large shifts between those kind of general categories?

I'm not aware of any that are significant, Bill.

Okay.

Okay.

Great guys.

Thanks.

There are no further questions and Mr. Bertelli, I will turn the conference back over to you for any additional or closing remarks.

Well, thank you all for joining us on this conference call and we hope to see many of you at the Museum of Science in Boston on Tuesday at 9 o'clock in the morning for our investor conference.

Thank you and we will look forward to seeing you then.

This does conclude today's conference.

We thank you for your participation.

You may disconnect at this time.