Mercury Systems Inc (MRCY) 2007 Q1 法說會逐字稿

Good day everyone, and welcome to the Mercury Computer Systems, Incorporated first quarter fiscal 2007 Earnings Results Conference Call. [Operator Instructions] For opening remarks and introductions I'd like to turn the call over to the Investor Relations Specialist, Ms. Jennifer Heizer.

Please go ahead, ma'am.

Good afternoon everyone and welcome to the Mercury Computer Systems first quarter fiscal year 2007 earnings conference call.

With me today are Jay Bertelli , President and Chief Executive Officer, Bob Hult, Senior Vice President and Chief Financial Officer, and Alastair Abraham, Vice President, Controller, and Chief Accounting Officer.

If you have not received a copy of the earnings release, you can find the earnings release on our website at www.mc.com, or on the FirstCall network.

We would 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 which involve risks and uncertainties that can cause actual results to differ materially from those projected or anticipated.

Additional information regarding forward looking statement and risk factors is included in the press release we issued this afternoon reporting the company's first quarter fiscal year 2007 results, and in the company's periodic reports filed with the SEC.

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.

In addition to reporting financial results in accordance with generally accepted accounting principles, or GAAP, we will also be discussing non-GAAP financial measures adjusted to exclude certain non-cash and other specified charges, which we will specifically identify.

Management believes these non-GAAP financial measures assist in providing a more complete understanding of the company's underlying operational results and trends, and management uses these measures along with our corresponding GAAP financial measures to manage the company's business, to evaluate its performance compared to prior periods and the marketplace, and to establish operational goals.

However, they are not meant to be considered in isolation, or as a substitute for financial information provided in accordance with GAAP.

A reconciliation of GAAP to non-GAAP financial results discussed in today's conference call is contained in the company's first quarter fiscal year 2007 earnings release.

I am now pleased to turn the call over to Mercury's President and Chief Executive Officer, Jay Bertelli.

Good evening everyone, and welcome.

We're going change the format slightly from what we've done in the past in that I'll be giving the color on it, if you will, for the quarter, and outlook for the year.

Then Bob will come in and talk about the details of the financials for the quarter and for the year.

While this quarter we obviously experienced a shortfall versus our expectations, we continue to believe we're investing in the right technology for the right markets and we are encouraged by our early interest in our new products, and this is evidenced by continuing growth that we see in design wins and a high level of engagement with many of our customers.

Defense procurement is still the most significant headwind we face.

Second to that, in our medical imaging business, 2D legacy systems are falling off faster than our new products can offset.

The adoption rate of our 3D technology continues to be slow, but we see encouraged levels of customer wins.

In our other commercial businesses on the OEM side we continue to enjoy design wins and engagements that should lead to more design wins.

But these have not been translated into orders that are large number to move the needle, given older programs that are falling off.

From this perspective, I would like to discuss what we're seeing on the horizon.

While we need more visibility on the timing and ultimate size of some of this business, we can cite a number of areas that we believe will start to turn at some point.

In defense we have 4 design wins for large radar systems for [MPRtip], AEGIS, [AWACS], and a large classified program.

The LRIP or low rate initial production phase for those programs are not scheduled to begin until our FY '08.

Our radar business has suffered recently from reprioritization of funding for the MMA, or the Multi-Mission Aircraft, which will impact the MPR temp program.

If the funding is shifted to technology insertions on existing platforms such as [Joint Stars] we could see an increase in business near term over what we are projecting.

We achieved 28 design wins in FY '06 in various defense market segments, and 3 more this past quarter.

Given the lengthy development and evaluation phases, significant revenues from these design wins will not be realized for a few years.

However when we add that to the FY '05 total of 35 wins, the estimated revenue potential of approximately $150 million over a 3 to 5 year period indicates to me that we have a healthy defense business across a broad range of applications and platforms, and we should see growth resume depending on funding priorities.

In our commercial business we had several design wins last year and built on that number this past quarter.

Some of these new products went into production and are already shipping.

Others will take 2-3 years before going into full production.

We still don't have the pipeline to be able to name the exact point at which strong year-over-year growth will resume, but we see the momentum building.

Based on what we see for [CIV] in FY '07 we still expect modest growth in revenues and a return to profitability.

In this business, we now sell to end users as well as OEMs.

Our optimism is based on 17 new Life Science customer wins in FY '06, and more this past quarter, as well as the innovations in technology and capabilities we're developing for the multiple segments we serve.

A new design win for a next generation product at an existing customer will enable us to recover revenue we lost in the last product update cycle.

As a result of other major design wins, we currently expect our ASBU revenues to grow significantly in FY '07.

Heavy R&D investments in products designed around the Cell broadband engine will keep operating income as a percent of revenue in the single digits, but profitability will improve as we harvest these investments.

Now I would like to talk about Cell.

Because we believe that this technology more than anything else will help us start to turn around the revenue line.

In FY '06 we shipped evaluation systems to 13 customers, including several defense customers.

This quarter we booked approximately $4 million for cell development systems.

In anticipation of the slow adoption rate for new process or architectures, we are conservatively estimating low double digit revenues for Cell in FY'07 with a pipeline building for significant revenues beyond '07.

We note that this is on a small base and will not have much impact on total revenue growth for the year, but we are headed in the right direction.

We've discussed or strategy with your previous calls, but let me reiterate.

We address niche markets where there is a need for high performance computing solutions, and we have the benefit of years of investment in technology and people to help our customers enable their compute-intensive applications, particular those requiring visualization.

We continue to make these investments.

When we are successful it's because we deliver significant value in multiple dimensions.

In addition to investing in technology, we are seeking growth by expanding into new markets and in some of these markets we are climbing up the value stack and delivering more of the overall solution.

The most difficult challenge we face is not where to find new business, but rather it is to leverage our technology investments across these multiple markets so that we achieve profitable growth.

By remaining in niche markets where we add significant value, we enjoy strong gross margins and defensible competitive positions.

Going forward, our revenue mix will have a higher percentage for middleware and application software.

Also, as we leverage our R&D investments in Cell and FPGA technologies across our markets, we will be decreasing R&D expenses significantly as percent of revenue.

This will help drive the income margins back to our timeless business model goals of 16% to 18%.

Defense, specifically.

Our bookings came in stronger than expected in Q1.

Q2 is on track, and the pipeline is filling for Q3 and Q4, although visibility needs sharpening.

We are in a number of deployed programs that provide a $58 to $100 million a year base, depending upon the the technology insertion cycle.

Some of these programs have been announced such as Empire, River Joint, JSF or joint strike fighter, F-16, MPRtip on the Global Hawk, and others who has disclosure is restricted by our customers.

On the development side we have a very strong book of business building.

For example, we have 8 major opportunities that could generate anywhere from $40 to $80 million a year when in deployment.

The applications cover multiple markets such as ground based radar, signals intelligence, communication, missile guidance, missile defence, smart bombs, and others.

One example is a system announced by Harris Corp on Monday, October 23.

Where they are using a Mercury architected FPGA and PowerPC based computer combined with our mixed-signal module from our EchoTech division to combine adjacent wide band phased arrays which is applicable to communications and radar.

This is a proof-of-concept system.

However, the solution we delivered to Harris is leading to several significant opportunities in the wide band datalink area.

Mercury's leading edge multiprocessor system is based on powerful Cell and FPGAs processors combined with our EchoTech data conversion products are uniquely capable of solving the most complex signal processing problems which ultimately give our war fighters a competitive advantage.

Talk about CIV.

The driving forces in the life sciences market haven't changed.

The challenge is the market adoption rate for 3D visualization.

We have modified our distribution strategy to include a dealer-distributor network in addition to the OEM sales channel.

This will broaden our market coverage and enable us to get traction with smaller medical institutions that must have productivity improvements.

Many PACS companies and tier 1, 2 and 3 players will be demonstrating our Visage CS thin client server system at the Radiological Society of North America show starting November 26 in Chicago.

In all we will have 16 companies demonstrating our visualization and reconstruction products at their booths at RSNA.

We have experienced growth in our 3D visualization business, which has been masked by the erosion of the 2D reconstruction business.

Our digital breast tomosynthesis system continues in clinical trials.

Significant revenues are not expected until our FY'08.

Also, our MRI data acquisition system is undergoing trials in a number of research hospitals.

Again, significant revenues, that means to me more than $20 million a year, are not expected until FY'08.

During the quarter we continued to pursue our open innovation strategy.

We acquired a minority interest in a biotech startup company coming from a university.

Their computational chemistry system for drug design needs our cost effective computation, Mercury's Cell-based system, plus our multiprocessor architectural skills will enable this venture's value innovation to succeed.

Their mission is to provide optimized drug candidates in a preclinical stage for a range of therapeutic treatments, and to do so fast and cost effectively.

The core technology which enables this is computationally-based, fragment-based discovery and development platform.

As a start up we are not expecting significant revenues within the next 2 years but I expect this could be a home run.

We also acquired a small professional services team, Nav3D, for less than $1 million.

This team has expertise, contracts, and relationships with a number of defense contractors working in the synthetic vision space.

Their skills are consistent with our needs for the markets addressed by our NavSim business.

Use of synthetic vision in conjunction with various sensor inputs is in the very early stage of market development.

It is expected to grow rapidly for both commercial and defense applications, such as controlling UXB's for homeland security, early detection of forest fires, power and pipeline monitoring, crop analysis, defense surveillance and weapons systems, in addition to adoption by the general aviation industry.

Let me switch you over to our ASBU.

ASBU experienced significant growth year-over-year in revenue, and in gross margin primarily from the semiconductor industry customers.

This business unit has good visibility for the next few quarters, and is developing new business within the semi space around Cell processor based systems.

These applications are extremely computer intensive and therefore require multiple self-processes along with Mercury's architectural skills to extract maximum performance from the hardware.

Current estimate of the annual revenue potential in the semi space is $60 to $80 million annually.

ASBU is also pursuing multiple opportunities in commercial and defense communications.

Our press release briefly describes one of these design wins for the ATC system, or ancillary terrestrial component.

And then Monday's press release from Harris Corp. describes another application for the FPGA technology developed by this business unit.

The combination of our software defined radio expertise coupled with our scalable FPGA and DSP-based hardware platform has opened several opportunities for wide-band datalink systems, significant revenue potential estimated at anywhere from $50 to $100 million annually once these programs get into full production.

Let me switch over to operations.

On the operations front we are focusing on cash generation and preservation with renewed rigor to strengthen our position.

I can assure you that this will be a top priority.

We're also focusing on portfolio management from a product and market perspective.

It is imperative we adjust our operating expenses to the reality of gross margins at the corporate level in the 55% to 60% range.

With that, I'm going turn it over to Bob for discussion of the financial results.

Thanks, Jay.

Good evening everyone.

I will review revenue for the first quarter of fiscal 2007 including details by business unit, discuss company operating performance, balance sheet, and cash flow results, and then finish with a discussion regarding the the outlook for the full year 2007 and our second fiscal quarter.

I'll discuss the numbers on both a GAAP and a non-GAAP basis.

First quarter revenues of $48.9 million below the guidance range of $50 to $53 million that we had out there.

GAAP losses per share were $0.55.

Non-GAAP losses per share for the quarter were a loss of $0.17, meaning the low end of the guidance range of a loss of $0.17 to a loss of $0.11.

The book to bill ratio for the quarter was .82.

Ending the quarter, total backlog including deferred revenue stood at $96.8 million, an $8.8 million decline over the fourth quarter.

Of the ending backlog, $83.2 million, or about 86% relates to shipments expected within the next 12 months.

Here are the revenue details for the first quarter by business unit.

Our defense business unit reported revenue of $22.3 million or 46% of total revenues for the first quarter, a revenue decrease of approximately 46% versus the same period last year.

Revenues in the defense business unit were adversely effected by the shift in government funding from procurement of intelligence, surveillance and recognizance ISR systems, to more immediate and tactical requirements.

Our commercial imaging and visualization business unit revenue for the first quarter was $10.2 million, representing 21% of total revenue, down approximately 25% against the same quarter last year.

Revenues from MRI and digital X-ray modalities were down substantially year-over-year due to legacy 2D projects failing off.

The new 3D visualization business was up significantly but still too small to offset the decline in our legacy business.

Our advanced solutions business unit's first quarter revenues were $12.8 million or 26% of Q1 revenues, a revenue increase of approximately 38% from the same period last year.

The year-over-year increase was due to strength in our traditional semiconductor business as well as new business in other commercial application spaces.

Our modular products and service business unit was up approximately 30% in Q1 '07, and contributed 7% of revenues.

We continue to win new business in the telecommunications space and are starting to gain traction with the defense applications as well.

Moving back to the total company, on a GAAP basis the operating loss was $13.7 million.

This includes a stock-based compensation expense and amortization of acquired intangibles.

Also this quarter we took a $3.1 million in-process R&D charge related a small biotech investment, and as well a $768,000 charge in restructuring and impairment.

The GAAP net loss was $11.7 million, resulting in a GAAP loss per share in the first quarter of $0.55.

FAS 123, our stock-based compensation expense came to $2.2 million in the first quarter, and amortization of intangibles relating to acquisitions was $1.8 million.

Results on a non-GAAP basis.

Non-GAAP gross margin for the quarter was 55% versus 64% last year.

Our gross margin continues to be adversely affected by lower volumes, and business unit and product mix.

On a non-GAAP basis we reported a loss from operations of $5.9 million for the quarter.

The non-GAAP net income for the quarter was a loss of $3.5 million.

The non-GAAP loss per share was $0.17.

Turning to the balance sheet and cash flow statement, cash, cash equivalent, and marketable securities were $152.7 million at the end of the first quarter, representing a $9.5 million decline from the last quarter of $162.2 million.

The the decline includes an operating cash outflow of $5.4 million, $2.5 million in capital expenditure, and an additional $1.6 million for other investments and financing items.

First quarter day sales outstanding, DSO, was 57.

Inventory turns were 3.8 for the quarter.

At end of the quarter the total employee population excluding contractors was 823 compared to 836 at the end of the fourth quarter last year.

I'd now like to move to full year 2007 and second fiscal quarter guidance.

For the full year fiscal 2007 we continue to anticipate revenues of $235 to $245 million.

We project a non-GAAP gross margin of approximately 57% for the full year 2007.

We expect operating expenses to approximate $130 million, and expect non-operating income to be $1.9 million.

Net of a $700,000 mortgage payoff fee.

The non-GAAP tax rate will be 30% for the full year.

The diluted shares for the full year are projected to be $21 million.

Given Mercury's net income does not meet the threshold for the convertible [inaudible] adjustments.

Based on the midpoint of the revenue range, the non-GAAP earnings per share are projected to be approximately $0.29.

The impact of stock-based compensation cost for the full year will be approximately $9.8 million.

Amortization of acquired intangibles will be approximately $7 million.

There was a Q1 in-process R&D charge of $3.1 million and a Q1 restructuring and impairment charge totaling $800,000.

The GAAP effective tax rate for the full year will be approximately 10%.

The decline from the previously guided 30% rate is driven by the exclusion of the federal R&D tax credit, which has yet to be extended, and the recent Q1 IPR&D charges, which is not tax deductible.

GAAP shares are projected to be 21 million, again given Mercury's net income does not meet the threshold for the convertible debenture adjustment.

Based on the midpoint of the range, the fiscal year 2007 GAAP losses per share are projected to be approximately $0.50.

The decline from the previously guided fiscal 2007 -- a loss of $0.37 -- is a result of purchase accounting associated with two small acquisitions which closed in the first quarter, and again a change in the calculated tax benefit rate.

CapEx in 2007 is projected to be approximately $12 million, and depreciation approximately $11 million.

For the second quarter we project revenues of $52 to $54 million, a non-GAAP gross margin of approximately 55%, our non-GAAP tax rate remains at 30%.

The diluted shares are 21 million, resulting non-GAAP losses per share projected to be in the range of a loss of $0.23 to a loss of $0.19.

The impact of the stock based compensation cost for the quarter will be approximately $2.6 million and the amortization of acquired intangibles will be approximately $1.7 million.

The GAAP tax rate will be 10% and the GAAP diluted shares $21 million.

As a result second quarter GAAP losses per share are projected to be in a range of a loss of$0.48 to a loss of $0.43.

I would now like to move us to our question and answer session

[OPERATOR INSTRUCTIONS] We'll go first to Rob Stone with Cowen and Company

Hi guys.

I wonder if you could comment on the competitive environment.

In the past for instance when you missed a product cycle in the medical imaging area, that was a loss to a competitor as opposed to a shift in the market.

With respect to the ups and downs you're seeing in fiscal year '07, can you comment on whether this is more driven by funds shifting as you mentioned in the defense space, or potentially some some situations where you've had some competitive losses as well?

Well, Rob, a few of the comments that I can recall from my script that you may have picked up to ask that question, the companies that we were doing business with really designed their own system to replace us, if you will, utilizing racks full of Blades.

So the in-house design teams continue to be the strongest competitors we have, certainly for the high end systems.

At the lower end and more of what you might think of as the commodity marketplace, certainly there is competition there.

We see it with our momentum products that's, okay, that's why we acquired that company obviously was to be able to give us an offering down at the lower performance end.

And so we do run into the traditional competitors in that space.

So it depends upon where you are playing in terms of the competitive environment.

I wouldn't say that it has increased for us any more now than it has been for the last few years.

But specifically in the defense space, the in house designs you referred to were in the imaging area, correct?

Yes.

You have not seen competitive losses per se in the defense space, there it's more just about funding priorities?

The competitive losses we have experienced a few over the last couple of years.

So, again, where the requirements come in at the low end of the range of what we typically provide, it's not uncommon for it to be a very competitive situation and frankly some of these losses, a few of them, if we had been able to crank up the momentum operation fast enough I think we would have been able to put the momentum products into these particular opportunities.

But that's changing.

But my question more specifically was with respect to the major dynamic in your defense segment, which in the past the high end defense systems have been your biggest segment, best margin business.

So to narrow the scope to that specifically, is what is going on a funding situation or something else?

At the high end is where we're seeing the loss of funding or the procurement dollars moving around.

It's the high end aerial surveillance platforms, if you will, the ISR platforms where we have historically been very strong.

And it's not competition up there.

It's the, as I said, the dollars moving around.

Thank you.

We'll go next to Jonathan Good with William Blair.

Hi guys, this is Jonathan Good for Bill Benson.

Just a quick question on I guess the back half of the year.

Can you guys give us some additional color as far as your visibility into kind of a continued ramp?

Particularly with the backlog weakening a little bit how do you guys feel about the last two quarters this year?

How do I feel about the two quarters of the year?

Yes.

Well, the focus is right now on this current quarter of course, but we're looking out and I think we've got enough visibility to give us the confidence to hold the guidance where it is for the year.

So that gives us what we believe to be some view into the future here that doesn't show up necessarily in the backlog.

Yes, just an additional comment on that, on the commercial side, the advance solutions business unit I think we've got a lot of confidence there, and it's based on design wins and projects that we're already starting to deliver on.

As you have seen in the numbers, that business has picked up year-over-year.

On the commercial imagining and visualization group, Life Sciences group if you will, you can see our 2D, reconstruction business tailing off, we have been talking about that for well over a year and a half now.

Having said that, the new 3D business is definitely getting traction.

We're not quite off setting this past quarter and we probably won't offset exactly in the second quarter but it looks like we're crossing the chasm as they say here in '07 in that space from 2D to 3D and that's pretty exciting.

So again, visibility is coming into view there on that.

Defense?

Well, you heard Jay on defense.

We know the programs are in and to a certain extent it's all about the funding.

Having said that, we've really filling up the pipeline with an awful lot of earlier opportunities where we can ship development systems.

When you can't get the production orders because of funding, you go where the action is, so a lot more activity on our part on the the development systems side.

Speaking of, I guess, additional funding visibility, are you anticipating extra help from the supplementals that are coming up, or do you guys have any visibility into that.

I cannot say I have got any visibility into it.

I thought the supplementals had more to do with supporting activities on the ground in Iraq and Afghanistan.

OK.

We have seen some indicators that ACS may be coming back online as well.

Have you guys heard anything on that front?

Well, you are probably seeing the same thing I have, which is that there is a conference scheduled for the end of this month and beyond that I don't expect to see any monies in the '07 budget.

Certainly it's not there.

May be it will find it's way into a week remains to be seen.

[OPERATOR INSTRUCTIONS] We'll go next to Steve Levenson with Ryan Beck.

Good afternoon, Jay and Bob.

Hi, Steve.

I think everybody understands the timing issues here, with the stock depressed as it is and your bonds trading at a discount, have you thought about using some of that cash to buy in some of the bonds?

To tender for the bonds.

To tender for the bonds?

As you know the market is somewhat if not very illiquid over on that side, but we keep an eye on it.

The price has been in the high 80s if you will.

At a discount to par that's about all we've done is just keep an eye on what is going on over there.

Not a great return at those prices.

Remember we've got a 2% coupon rate on those bonds and they're not putable to the company until '09, May of '09. so we're obviously holding on to the belief here that we'll be calling those bonds in the '09 time frame because we'll have the performance that will allow us to do that.

I hope you're right.

It sounds a little optimistic to me right now, but I hope you're right.

Does that mean you're keeping the cash on hand too because you are still looking at the acquisition pipeline?

Yes, sir.

I want to make that clear.

Right from the get go, we put the cash from the bonds, the $125 million, safely aside invested very very conservatively so that should the need ever arise or the opportunity present itself, we have the cash to retire the whole instrument.

We have been clear we would not spend that cash on the acquisition side of our growth strategy.

We'll take our last question from Tim Hynes with Fairfield Greenwich.

Yes, I'm wondering what you expect amount of cash to burn through for the year, given your guidance?

We obviously consumed some cash here in Q1, our net cash position is down to the high teens approximately $19 million.

This is net of the convertible debenture in the mortgage instrument.

We'll burn again in Q2.

I expect to be down around $10 million net cash at the mid year mark, and then as we get into quarters 3 and 4 and return to profitability, which our guidance and forecasts suggest we'll do, we will start to generate cash again and our expectation is that we will earn the year with net cash back into the high teens approaching $20.

That's not with any radical improvements in working capital.

We do plan for some modest improvements there but nothing that really moves the meter on what I just said.

Okay, thank you.

And at this time we have no more questions in the queue.

I'd like to turn the conference back to Mr. Bertelli for concluding remarks.

Thank you all for participating.

I appreciate your time.

We have a financial conference coming up, the AEA Conference in Monterrey in early November.

Hope to see you out there, if you can't make that, our investor conference is the being conducted in the Museum of Science in Boston on November 21, from 8:30 until approximately 1 o'clock.

We'll have the business General Managers presenting and there will be a series of demonstrations.

It should be a very interesting morning and I would encourage you all to stop by and chat with us.

Thank you all, goodbye now.