Mercury Systems Inc (MRCY) 2007 Q3 法說會逐字稿

Good day, everyone, and welcome to the Mercury Computer Systems Inc.

third quarter fiscal 2007 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 Ms.

[Leslie Schaeffer].

Please go ahead.

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

With me today are Jay Bertelli, President and Chief Executive Officer; Bob Hult, Senior Vice President - Chief Financial Officer; and Alex Braverman, Vice President - Controller and Chief Accounting Officer.

If you have 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 would like to remind you that remarks we may make during this call about future expectations, trends and plans for the Company and its business constitute forward-looking statements which involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated.

Additional information regarding forward-looking statements and risk factors is included in the press release we issued this afternoon reporting the Company's third 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.

We 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 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 their corresponding GAAP financial measures to manage the Company's business, to evaluate its performance compared to prior periods to 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 third 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.

Thank you, Leslie.

Good afternoon, everyone, and thank you for joining us.

As you know we reported our fiscal third quarter revenues of $55.7 million, a strong year-over-year increase against a weak year ago quarter but still well below our peak.

While there are signs of revenue stabilization we're disappointed with the book to bill ratio being below one for the third straight quarter and our lowering fourth quarter revenue guidance.

This reflects the same challenges we had been noting in previous calls.

We committed in January on our earnings release call to address our cost structure, given the unfavorable business conditions we've been experiencing.

Today I am informing you that most of the work has been completed on a major restructuring of the organization which is projected to provide cost reductions of approximately $15 million annually, starting in July of '07 or Q1 FY '08.

In early May we would expect to have a more detailed announcement of the specifics.

Management is committed to returning the Company to a solid financial position while ensuring that we retain our technology leadership which will position us for renewed growth.

We continue to make progress behind the scenes in some of our new product and new market initiatives.

Although these are still not materializing in the form of overall growth and revenues of bookings that we can report to you, activity levels are very strong and we continue to be optimistic that the investments we have been making will pay off over the next several years.

After Bob goes over financial performance and guidance for the quarter, I will discuss some of the areas about which I am most excited.

Bob.

Thanks, Jay.

Good afternoon, everyone.

I will review revenue for the third quarter of fiscal 2007 and company operating performance, discuss revenue details by business unit, balance sheet and cash flow results, and finish with a discussion regarding the outlook for the fourth quarter.

Third quarter revenues were $57.3 million, slightly above our guidance of $55 million.

Gross margins were approximately 55%.

Both revenues and gross margin represented a significant year-over-year improvement.

Operating loss was $8.5 million.

This includes stock-based compensation expense of $2.7 million and amortization of acquired intangibles of $1.9 million.

The net loss was $5.4 million and resulted in a diluted loss per share for the third quarter of $0.25.

On a non-GAAP basis, we reported a Loss From Operations of $3.9 million for the quarter.

The non GAAP net loss for the quarter was $2.4 million.

The non-GAAP diluted loss per share for the third quarter was $0.11 above our guidance of a loss of $0.18.

The book to bill ratio for the quarter was .86.

This book to bill reflects the debooking of one large order associated with a defense program.

Excluding the effects of this cancellation the book to bill would have been .96 for the quarter.

Ending backlog, including deferred revenue, was $85.6 million, a $16.5 million decrease from the same quarter last year and a $7.7 million sequential decline in the second quarter of this year.

But the ending backlog of $71.1 million or about 83% relates to shipments expected within the next 12 months.

Our Defense Business Unit reported revenue of $29.6 million or 52% of total revenues in the quarter.

Overall revenues in the Defense Business Unit continued to be adversely affected by the shift in government funding from procurement of intelligence, surveillance and reconnaissance ISR systems for more immediate and tactical requirements.

Our Commercial Imaging and Visualization Business Unit revenue for the third quarter was $9.8 million, representing 17% of total revenues.

Revenues from MRI and digital x-ray modalities were down year over year due to legacy 2-D products continuing to tail off as we have previously communicated.

Our 3-D -- new 3-D Visualization Business continues to gain market traction.

Our Advanced Solutions Business Unit's third quarter revenues were $13.1 million or 23% of Q3 revenues.

Our Modular Products and Services Business Unit's third quarter revenues were $4.8 million or 8% of Q3 revenues.

Turning to the balance sheet, (technical difficulties) cash-flow statement, cash, cash equivalents and marketable securities were $128 million at the end of the third quarter, representing an $8.5 million decline from last quarter of $136.5 million.

The decline includes an operating cash outflow of $6.6 million, (technical difficulty) .2 million in capital expenditures and an additional $300,000 net inflow for other investment and financing items.

As we mentioned last quarter in an additional (inaudible) to monetize our non-performing assets, we have pursued a sale leaseback structure for our Chalmsford Headquarters campus.

We finalized this transaction on April 20 and it yielded a net cash inflow of approximately $26.5 million.

Third quarter day sales outstanding -- DSO -- were 69.

Inventory turns were four for the quarter.

At the end of the quarter the total employee population excluding contractors was down slightly to 817, compared to 822 at the end of the second quarter.

As we mentioned last quarter, given our ongoing profitability challenges we expect to take appropriate actions to better align our cost structure with our revenue outlook.

We are currently nearing completion of the work we have undertaken this past quarter to reduce our operating costs within a strategic evaluation context as we prepare to enter FY '08.

We expect that these cost reductions will be implemented and concluded during the June quarter.

Our goal is to improve FY '08 operating results without a dependency on large revenue increases.

If significant revenue increases do materialize then we would look forward to benefiting from operating leverage on a lower cost structure.

We expect the cost reduction to provide an annual cost savings of approximately $15 million.

However on this conference call we are not prepared to comment on the specific numbers.

I would now like to move to fourth quarter guidance.

We are lowering our fourth quarter revenue guidance by approximately $8 million to $58 million due to weaker than expected bookings in our third quarter.

This translates to a full year forecast of $222 million versus the $230 million guidance I provided you last quarter.

For the fourth quarter we currently expect gross margins to be -- to approximate 57%.

As the cost reduction actions I mentioned get underway during the current quarter, we do not expect them to have a measurable impact on reducing operating costs in the fourth quarter.

The GAAP tax rate will be approximately 35% (technical difficulties) diluted shares are projected to be approximately $21.3 million.

As a result, fourth quarter losses per share are currently expected to be approximately $0.18 and that's on a GAAP basis.

The impact of the stock-based compensation costs for the quarter is currently expected to be approximately $2.9 million and the amortization of acquiring intangibles will be approximately $1.9 million.

Our non-GAAP tax rate is 30%; the diluted shares are projected to be approximately $21.3 million.

The resulting non-GAAP losses per share for the fourth quarter are expected to approximate $0.03.

This guidance does not reflect the restructuring costs or potential savings associated with the upcoming strategic cost reduction action.

CapEx for full year 2007 is projected to be approximately $9.5 million.

Depreciation, approximately $11 million.

At this point I would like to call back over to Jay for his industry comments and additional context regarding our business outlook.

Jay.

Thanks, Bob.

Somebody picked up on the faux pas I made in giving you the wrong revenue number for the quarter.

Anyway, Bob corrected it.

Since January, the management team has been working diligently analyzing our product and market portfolios from a strategic perspective.

Once we complete the implementation of this plan, your Company will then the position to realize the benefits from the substantial R&D investments as well as the acquisitions we have made over the past three years.

Now let give you a little color on some of our initiatives by Business Unit.

Defense.

I'm happy to say that we have recruited a superstar to run our Federal Government business.

He will be joining us in mid-May at which time we will make a public announcement.

We believe we are starting to see some diversification in revenues and design wins that will make us less dependent on the high-end radar platforms.

While this is still projected to be a strong market for us, Aegis is a good example of that, over the next several years.

Investments we have been making in new products to address more tactile requirements are generating interest and are expected to produce new design wins over the near term.

Year to date, we have 19 design wins.

There are currently 17 major program opportunities in various stages of development that have revenue potential of approximately $300 million dollars over the next five years that we are actively engaged in pursuing.

We experienced the cancellation of a $10 million order which we received in FY '06 from a major European defense contractor.

This has had a major impact on our Defense revenue plan for FY '07 in the order of 7 to 8%.

Our [OCIB] Business Unit achieved its highest book to bill ratio of the fiscal year in Q3.

The 3-D products are getting traction in the OEM market as evidenced by the number of orders and new contracts and process.

We added four Life Sciences Design wins this quarter bringing the fiscal year's total to 14.

OEM products based on Mercury's solutions are shipping worldwide and volumes are starting to increase.

The Visage CS client/server is installed at five clinical reference sites in the U.S.

and Europe, helping large hospitals improve their workflow in radiology, ICU and ER departments.

Two more sites will become references this quarter.

Additionally the Business Unit is working with large medical [packs] OEMs regarding our 3-D client/server product and expects contracts this quarter.

The Unit's gross margin continues to improve every quarter as the product mix shifts from legacy business to more software and 3-D sales.

The (inaudible) business we are seen some market slowdown in one application area which has resulted in lower bookings than expected.

However, we are making significant progress on our new programs that will drive revenue growth in FY '08 and beyond, including a major design wins from a new customer in a new to us application space.

Most of the opportunities we are pursuing within the Semi Business are driven by our [sell products].

Our partnership with [Metagraphics] and the electronic design automation space is developing the new business opportunities as expected.

Design wins announcements are gated by customer approvals.

(technical difficulty) SIM, particularly interesting although still very small is our Synthetic Vision product which we are currently applying to controlling unmanned vehicle systems for asset protection applications such as oil and gas pipelines, order monitoring, and forest fire detection.

We are also working on capabilities to prevent helicopter crash landings in adverse conditions such as sand or snow storms.

We believe this product has many potential applications in Commercial, Defense and Homeland Security markets.

Back to the cell processors.

The IBM cell processor architecture is particularly suited to video processing and at the recent National Association of Broadcasters Show -- NAB -- we generated over 200 qualified leads including a number of major players.

We demonstrated on a single cell the ability to do [H0264] decodes on 24 channels in real-time.

A number of knowledgeable users expressed amazement at our ability to extract this level of performance from the cell, attributed to Mercury's ability to architect ultimate performance from any given processor.

We will be developing this technology aggressively for Commercial and Defense video processing applications.

Overall I continue to believe that our strategic direction and our primary markets will produce significant shareholder value.

Our 3-D visualization capabilities are gaining traction with early adopters in Life Science and Seismic markets.

We are in the very early stages of introducing this capability into the Defense marketplace.

We have been redirecting some investments in Defense from the large platform ISR segment to the more tactical smaller system requirements, including communications capability to support network-centric warfare.

Our business in the semiconductor industry continues to expand in terms of new customers with new applications.

The need for specialized confrontation capabilities to meet the needs for design and manufacturing in the semi industry continues to increase dramatically.

We have demonstrated that Mercury is uniquely positioned to meet the most challenging computing requirements in multiple industries with a broad range of computing solutions.

Indications are that the OEM in prime adoption cycles for our leading-edge products have begun to pick up.

That concludes my remarks and I will now open the call for questions.

(OPERATOR INSTRUCTIONS)

Steve Levenson with Stifel Nicolaus.

I see the R&D is up this quarter.

Do you expect that to continue?

And obviously you have got a nice cash cushion to support that.

But in your restructuring did you eat it all into the technology staff?

I will parse your question a little bit, Steve.

No, it will not be up next quarter.

It was a specific project-related expense that just fell in this quarter.

So, no, it will go back the way it has been running.

It has been running in the 14 to 15 range all quarter.

That's the R&D comment.

Are you happy with that one?

Yes.

And the second part I think you were going to -- where is the restructuring coming out of?

Yes.

Across the board is the fairest answer I can give you.

Headquarter functions; R&D functions; all Business units; sales marketing.

It's a broad base reduction of both people and programs project spending dollars.

However, Steve, we look very closely at the impact of any of these reductions on our ability to meet customer commitments and have concluded that we can continue to satisfy those commitments.

Bill Benton with William Blair.

Just a question on obviously prior consolidation and if you have seen any sort of real impact in your markets from that consolidation that's taken place already?

You are referring to -- ?

Radstone and SPS type stuff.

Sure.

I don't believe that we can say that we've seen any significant changes from, certainly, with the latest one we achieved from not buying SPS and Radstone, for example.

I don't believe that we can say that we have seen any change in their go to market strategy, their additional products, if you will, they may have come out with.

So no effect.

And then in terms of -- if you don't mind in terms of the debooking on that one program.

Was that a cancellation in the program or can you offer any other color on that?

Or if there was another reason why that got debooked?

The customer had a couple of programs, multiple programs that they were pursuing, and they happen to have lost both of them.

In one case they lost to a competitor.

In the other case, their customer the department -- (inaudible) Department of Defense took the money away.

Okay.

Great.

Then, just quickly, it sounds like -- just to make sure I get this right -- you are looking to reduce expense by $15 million.

So basically you got an operating loss this quarter if you just kind of annualize it, basically you are saying we will keep -- we are assuming no improvement in revenue from current levels and let's get the business back to break even.

Is that the way you're thinking about it?

On a pro forma basis?

What we are communicating -- .

We are going to have more to say that this shortly but what we are communicating is in this earnings release is taking $15 million of cost out on an annual basis.

It will come out during this June quarter.

So when we turn the corner on FY '08 July 1, we are good to go.

We are going to get full yield, cost benefit yield in Q1.

We are -- is that helping?

Yes.

No.

That's good.

I appreciate tape.

We hope to do better than break even.

[Ronin Wolfstorff] with Cowen.

Thanks very much, everyone.

Just a couple of questions.

If you could comment on the trends that you are seeing in the different Business segments perhaps by end market high level would be fine.

That's just to say that it seems to me that you've experienced sequential absolute declines in three of the four units and I am just trying to get a sense of what you expect there going forward?

And the second question has to do with just trying to understand a little bit your outlook for fiscal '08, which I understand you may not be guiding to too specifically.

But I want to just understand a little bit -- I think the consensus -- the consensus is looking for, roughly, 10% topline growth.

So thanks very much.

It's Bob here.

I will just get us going.

You mentioned sequential decline in three of our four Business units.

It actually didn't happen.

I mean, sequentially, our revenue was fairly flat.

57 this quarter, 58 last quarter.

In fact, our largest Business Unit, the Defense Business Unit is sequentially up.

So CIV is down a bit.

That's that legacy 2-D business tailing off, not completely being offset by the new 3-D business.

Our Advanced Solutions Business Unit which is heavily driven by Semiconductor but also this communication activity whatnot in there, that has been (inaudible) in 13, 14 all year.

So there was not much of decline there and the same with our marginal products business.

So I'm not trying to correct you as much as say it was very much a flat sequential quarter for us.

But there is still some underlying trends there that Jake will take you through that are important.

Within the medical business believe that Bob has thoroughly explained that, we have been talking about the 2-D transformation business, legacy business dropping off for several quarters.

That's why we reinvented the Life Science business the way we did and the focus in on the 3-D visualization for the Pax application more specifically doesn't mean we are not pursuing the reconstruction part of the business.

We are.

We have had a number of forays into the major accounts with the cell processor as an example.

There's some potential there.

So I believe that the Life Sciences Business is on its way to becoming a significant contributor to adding shareholder value to Mercury in the very near future.

The Semiconductor business has been very strong.

Has its up and downs every quarter, but right now things are looking solid in terms of the outlook.

We have gone into new segments of that business.

For years we were only into the wafer inspection.

Now we're into [radico] inspection.

Mass generation and a few other applications in the manufacturing space which I'm not ready to talk about yet because we haven't put out a press release on it.

In addition to the EDA marketplace with Mentor and we believe that that is going to be a significant revenue generator that the Semiconductor business for us for a number of years moving forward.

And the Defense Business, I'm tired of talking about the shifting and budgets; and what we have done to overcome that is to invest in products which are more appropriate for tactical situations, but it takes a little time to develop the products and to get them included into bids.

But we are at the point where that is now happening.

So as I said I believe that while it is taking us a while here, you just don't turn the ship around when it is dealing with OEMs and primes that have long design in cycles.

Once you get designed in you are there for a number of years.

That concludes my comments.

(OPERATOR INSTRUCTIONS)

[Jim McCarey] with [David J.

Greene].

Two cash-related questions.

One, on the restructuring could you give us a sense for what the -- if there are going to be charges involved with that what would be cash and non-cash?

Then on the quarter I know we were hoping to get to break even on a cash flow and it looks like working capital chewed us up.

Was that just timing or is there something else in that?

We will confirm this during the month of May when we come with the specifics of our restructuring, but you are asking a fair question and we showed you a $15 million cost savings for '08.

The restructuring charge which we will book in the June quarter, the work is not totally completed on that yet, but we are somewheres in the $3 million to $5 million range as a charge.

I think that is the first part of your question there.

Would that be a cash?

Yes.

Cash piece?

Yes that's the cash piece that was (multiple speakers) be paid out in the June quarter.

The second part of your question, I think, was a view on what just happened in March quarter and you're right.

We did tie up some cash in working capital, specifically in Accounts Receivable; and that was driven by an into quarter or back end of quarter skew in terms of our shipments.

So it is good.

So it's a timing issue?

Yes.

Okay.

I understand what you're saying now.

Yes, it's a timing issue on the receivables.

In terms of our net inventory position we actually flattened it out.

So there was some good news there.

Good.

Good.

And congratulations on the sale leaseback transaction.

Thank you.

(OPERATOR INSTRUCTIONS).

There appear to be no further questions at this time.

I would like to turn things that to Mr.

Bertelli for any additional or closing comments.

Thank you.

Just one last remark and that is that I want to make it perfectly clear to everybody that we are aiming to do a significantly better than break even in FY '08.

So that's not -- you should not have that in mind that it is only a break even exercise.

We have got a double-digit goal we are heading for here.

Thank you all and we look forward to our next call which is scheduled or will be scheduled for year end July some time, end of July.

That's it.

Thank you.

Goodbye now.

Once again.

that does conclude today's conference call.

Thank you for your participation.

You may disconnect at this time.