Mercury Systems Inc (MRCY) 2007 Q4 法說會逐字稿

Good day, and welcome, everyone, to the Mercury Computer Systems Incorporated fourth quarter fiscal 2007 earnings conference call.

Today's call is being recorded, and at this time, for opening remarks and introductions, I would like to turn the program over to the Manager of Financial Planning and Analysis, Ms.

Leslie Schaeffer.

Please go ahead.

Good afternoon, everyone, and welcome to the Mercury Computer Systems fourth quarter and 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 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 website at www.MC.Com or on the First Call Network.

I'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 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 fourth quarter and 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 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 in 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 contained in the Company's fourth quarter and fiscal year 2007 earnings release.

I'm 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.

This is a (expletive) of a day to be reporting out earnings with what's happened in the market today.

As you know, we reported our fiscal fourth quarter revenues of $59.5 million and for the full fiscal year for 2007 we reported $223.7 million.

For the last two quarters, we are seeing encouraging signs of revenue stabilization in our defense business, which remains our largest business, and our new products continue to gain traction in some new markets.

Leveraging our technology and expertise, we have also continued to find innovative solutions for problems in a number of areas in which Mercury has never been involved before.

Our new products are in the early adopter stage however, hence the OEM and prime adoption cycle of 15 to 24 months from initial design win, to early production is just getting under way.

We believe that the work we did in fiscal 2007 to increase market acceptance of these products such as our 3D PACS Thin Client/Server, our EDA solution for the semiconductor manufacturing market, and our ATCA products for the communications and semi industries have helped cement relationships with partners, generate more leads, and widen the number of customers who are aware of our solutions.

And we have more new products and services in the pipeline with introduction in fiscal 2008.

We have implemented major initiatives to lower our cost structure as we promised we would, so that when the new product and market development investments turn on, we will quickly return to our mid to high teens operating income as a percent of revenue goal.

We must stop the bleeding.

It is imperative that we return to solid financial performance now.

On a more strategic level, as we are changing our company in fundamental ways that should position us well for the long term.

Fundamental business model changes will enable us to create a more balanced portfolio of near term and longer term growth opportunities.

After Bob discusses the fourth quarter and full year financial results, I will talk about some of the winds of change blowing through Mercury's business.

I'm going to turn it over to Bob.

Thanks, Jay.

Good evening, everyone.

I will review revenue for the fourth quarter and the full fiscal year 2007, including details by business unit, then discuss company operating performance, balance sheet and cash flow results and finish with a discussion regarding the outlook for the first fiscal quarter and full year 2008.

I will then discuss the numbers on both a GAAP and non-GAAP basis.

Fourth quarter revenues of $59.5 million above our guidance of approximately 58 million.

Gross margin was 55.8%.

GAAP operating loss was 10.8 million.

This includes stock based compensation expense of 2.6 million, amortization of acquired intangibles of 1.8 million and a restructuring charge of 4.4 million.

The 4.4 million charge pertains to the restructuring actions we announced in May which primarily included severance related to employee reductions.

Of the 4.4 million, 1.2 million was paid out in cash during the fourth quarter and the remainder will be paid out over the next fiscal year.

We also took an additional $1.9 million impairment charge for royalties we have pre-paid to a third party technology supplier.

This impairment charge was offset in reported research and development expense by the Company's receipt of a $1.9 million cash refund from the same third party.

GAAP net loss for the fourth quarter was $19.7 million resulting in a diluted loss per share of $0.92.

The net loss in the fourth quarter includes a $13.1 million valuation allowance against deferred tax assets.

On a non-GAAP basis, we reported a loss from operations of $2 million for the quarter.

The non-GAAP operating loss excludes stock based compensation expense, amortization of acquired intangible assets, and the $4.4 million restructuring charge.

The non-GAAP net loss was $400,000.

The non-GAAP diluted loss per share for the fourth quarter was $0.02, above our guidance of a loss of $0.03.

The book-to-bill ratio for the quarter was 0.88.

In defense, however, the book-to-bill for the quarter was just above 1.

Backlog including deferred revenue was $78.6 million, a $27 million decrease from the same quarter last year and a $7 million sequential decline from the third quarter of this year.

The majority of the backlog decrease came from the communications and semiconductor market.

Of the ending backlog, $61.4 million or about 78% relates to shipments expected within the next 12 months.

Full year fiscal 2007 revenues were $223.7 million, approximately a 5% decline from revenues of $236 million in 2006.

The gross margin was 55.6 versus 59 for the full year 2006.

Now I'd like to discuss our business by segment for the fourth quarter and full year 2007.

For the fourth quarter our Defense Business Unit reported revenues of 32.7 million or 55% of total revenues for the quarter.

A 14% decline from one year ago.

For the full year 2007, this segment had revenues of $111.3 million or approximately 50% of the Company's total revenues, a decline of approximately 15% year-over-year.

For the fourth quarter, our Commercial Imaging and VIsualization Business Unit reported revenues of 10.8 million or 18% of total revenues for the quarter, an 8% decline from the year ago period.

For the full year 2007, this segment had revenues of 42.1 million or approximately 19% of total Company revenues, a 19 % decline year-over-year.

The tailing off of legacy 2D programs affected us during the year, while we were not able to completely offset this decline with revenues from our newer 3D products, our 3D visualization, PACS and Client Server businesses continued to gain market traction.

For the fourth quarter, our Advanced Solutions business unit reported revenues of $11.6 million or 20% of total company revenues for the quarter, a 15% increase from a year ago.

For the full year 2007, this segment had revenues of 51.7 million or approximately 23% of company revenues, an increase of approximately 24% versus last year.

This growth is comprised of a slight rebound in our semiconductor business augmented by some early sales of our new EDA products were designed and manufactured for semiconductors and the contribution from new products in communication.

Our Modular Products business unit had revenues of 4.4 million for the fourth quarter which was 7% of total company revenue.

For the full year, this units revenues were $18.6 million or 8% of the Company, an increase of approximately 64% versus last year.

Turning to the Balance Sheet, and cash flow statement, cash, cash equivalents, and marketable securities at the end of the year were $157.1 million representing a $29.1 million increase from the end of the third quarter.

The increase includes a net operating cash inflow of $7 million and an outflow of $1.8 million for capital expenditures, a $23.4 million net inflow from the sale leaseback of our headquarters, and a $0.5 million net inflow of other investing financing items.

The fourth quarter DSOs were 55 days.

Inventory turns were 4.7 for the quarter.

At the end of the quarter, the total employee population, excluding contractors, was down over 10% due to the employee reductions we announced in May.

At the end of the fourth quarter we had 729 employees compared to 817 at the end of the third quarter and 836 at the end of last fiscal year.

Moving to guidance.

For the first quarter and full year 2008, for the full year 2008 we are currently expecting revenues to approximately $225 million with acceleration in the second half of the year.

We project a full year revenue mix of approximately 50% defense, 50% commercial.

Despite a relatively flat top line, the Company currently expects significant improvement in the bottom line as a result of the restructuring actions taken in the fourth quarter of 2007.

As a result, fiscal year 2008 GAAP losses per share are currently expected to approximate $0.63 reduce from a loss of $1.78 in fiscal 2007.

For the full year, fiscal 2008, we currently expect gross margins to approximate 57%.

GAAP, PACS expense rate will approximate 5%.

The low rate is the result of the significant valuation allowance we booked in the fourth quarter of fiscal 2007.

Our diluted shares for the full year are projected to be approximately $21.5 million.

The impact of stock based compensation for the full year will approximate $11 million.

Amortization of acquired intangibles approximately 7 million.

The non-GAAP effective tax rate will remain at 30% and the non-GAAP shares are projected to be approximately 21.5 million.

As a result, fiscal year 2008 non-GAAP earnings per share are projected to be $0.17 compared to a loss of $0.29 in fiscal year 2007.

CapEx for 2008, 7 million.

Depreciation, 9 million.

For the first quarter we currently expect revenues of $48 million.

The sequential decline from Q4 of '07 is due to the book-to-bill ratio this past quarter being below 1 as well as some seasonality.

The first quarter for Mercury has historically been our lowest revenue quarter of the year.

We currently expect gross margins in Q1 to approximate 57%.

Our GAAP tax expense rate is expected to approximate 2% in the quarter.

The diluted shares are expected to be 21.3 million.

The resulting GAAP loss per share is expected to approximate $0.33.

The impact of stock based compensation cost for the quarter will be $2.6 million, amortization of acquired intangibles 1.8 million, non-GAAP tax rate again 30% and the non-GAAP diluted shares 21.3 million.

As a result, the first quarter fiscal 2008 non-GAAP losses per share, we currently expect to approximate $0.08.

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

Jay?

Thanks, Bob.

As Bob discussed we've been taking significant steps to better align our cost structure with the current revenue run rate.

We remain committed to restoring profitability in Mercury.

However, we have not been working entirely on the cost side.

Since January, the management team has been analyzing our product and market portfolios from a strategic perspective and instituting changes to be better positioned to realize the benefits from the substantial R&D investments as well as the acquisitions we made over the past three years.

Improving the effectiveness of our R&D investments so as to realize a more near term return is a top priority.

One thing will drive growth which is why we have placed a number of business areas under a new unit that we are calling the Advanced Computing Solutions or ACS.

With this structure, we should be better able to leverage our technology across all markets in which there are heavy computing and visualization needs.

While giving our Life Sciences group the independence it needs to pursue a different business model.

We are forming a wholly owned subsidiary, Visage Imaging to pursue our Life Sciences business primarily in the PACS segment.

This subsidiary will be led by Marcelo Lima.

In May of this year, Terry Ryan joined us as Senior Vice President and General Manager of Mercury's newly formed Federal Government Business Unit.

Terry will lead the charge in extending Mercury's capabilities into national intelligence and Homeland Security markets and to help position Mercury as a key enabler to winning the war on data.

Terry is well suited for this role with 16 years in the intelligence business preceded by ten years of military service with the U.S.

Marine Corps and the U.S.

Office of Naval Intelligence.

His remarkable background also includes three years as Director of Intelligence, Surveillance, and Reconnaissance Systems for the DOD as well as a selection by the White House to oversee the development of the Domestic Emergency Response Information Service.

Terry's deep experience has given him unique insight into the current technology challenges the defense and intelligence communities face.

The most pressing of these is the ability to quickly filter the massive amounts of data the government gathers every day, so it can be used to identify genuine threats and to locate enemies with few false alarms.

Since much of this information is gathered by sensors in radar, sonar, and camera equipment, there's a crucial need for sensor computing applications that are powerful, flexible, connected, and rugged enough to deal with harsh environments such as the one we face in Iraq today.

While the traditional computer suppliers are not adequately equipped to fulfill this need Mercury is ideally suited to help the government solve this issue.

With decades of experience and proven solutions in the sensor computing market we believe the marriage of Mercury's technical experience with Terry's domain expertise should position us to significantly impact how the National Intelligence and Homeland Security Agencies respond to complex threats in today's dense data environment.

Terry will lead our Mercury Federal wholly owned subsidiary which we organize to do business directly with the Federal Government and the DOD in Homeland Securities markets.

The plan is to leverage our R&D investments in our core business so that the incremental start up costs are minimized.

Now let me give you a little color on some of our initiatives by business unit.

In defense, we believe that we are seeing some stabilization of revenues.

In FY '07 we closed 32 design wins including 17 major program opportunities that have revenue potential of approximately $260 million over the next five years.

Our Q4 book-to-bill was slightly over 1, and our FY '07 bookings were 19% greater than FY '06.

If you do not count the $10 million international order that was booked the last day of FY '06 and cancelled in early FY '07.

Following the money, we have redirected some investments to more tactical smaller systems to include battlefield communications capabilities to support network centric warfare.

We believe that our new thrust into national security and intelligence with our Mercury Federal subsidiary will help our government business over the long term by enabling us to participate directly in the 40 to $50 billion intelligence budget.

This will enable us to create a serious market position in addition to the large systems radar market.

One area that is particularly interesting although still very small is our Synthetic Vision product, NavSyn which we are currently applying to controlling unmanned vehicle systems for asset protection applications such as oil and gas pipeline and border monitoring, also forest fire detection.

We're also developing under contract to a prime capabilities to prevent helicopter crash landings in adverse conditions such as sand and snowstorms.

We believe this product has many potential applications in commercial, defense, and Homeland Security Markets.

In Life Sciences Mercury has the software and the Thin Client/Server technology to enable hospitals to deploy cost effective 3D diagnostic imaging in the PACS and modalities applications.

The 3D products are beginning to get traction in the OEM market as we continue to attract more customers including some of the larger OEMs.

From a hospitals point of view, a Thin Client PACS with clinical applications removes technical barriers between different modalities and departments, creates a much more homogeneous and manageable IT infrastructure, and helps to exploit existing modality and work station equipment in other IT resources.

For radiologists, clinicians, and referring physicians, the Thin Client PACS provides a significant increase in productivity and flexibility through instant access to all diagnostic imaging data anywhere, any time.

We added five life science design wins in Q4 bringing the fiscal years total to 20.

The Visage CS Server is installed at ten clinical reference sites in the U.S.

and Europe, helping larger hospitals to improve their work flow in radiology, ICU, and ER departments.

3D medical products FY '07 bookings and revenue grew 30% and 15% respectively over FY '06 with a book-to-bill of 1.13.

In Life Sciences we now serve a diverse OEM customer base , including segments such as diagnostic medical imaging which includes the modalities and PACS.

Dental imaging, surgical, and interventional imaging, and pre-clinical imaging to include microscopy, micropet and micro CT lab research and molecular visualization for drug design.

Most of these market segments are growing above 10% a year on a worldwide basis.

In FY '07 we extended our international end-user dealer distributor network, gaining the regulatory clearances to market Visage CS and Visage PACS and obtained ISO certification for the unit.

In the Semi business we have seen some market slowdown in one application area, which has resulted in lower bookings than expected, however we are making significant progress in our new programs that will drive revenue growth in FY '08 and beyond including a major design win from a new customer, and new to us application space.

We also have a design win based on sell in the vertical inspection market.

Most of the opportunities that we're pursuing within the Semi business have driven by ourself products.

Our partnership with Mentor Graphics for instance in the electronic design automation space is an interesting and developing new business opportunity that's in the early adoption phase.

All the world is starting to talk about multicore chips and multiple multigrow processors in the system.

The markets that need realtime are near realtime and those that are dealing with the explosion of data will migrate to the new multicore, i.e.

cell or its equivalent, multiprocessor systems.

However, the challenges of programming these beasts will slow market adoption.

Mercury has been dealing with the complexity of multiple processes of different varieties we refer to as heterogeneous for 20 years.

It is our reason for being.

We have developed software tools and deployed our system engineering resources to help our customers adopt, to sell, and GPU based systems in their applications.

Mercury's value add is evident in the performance improvements achieved by our customers when they engage us as a partner in their development program.

Since Mercury's beginning, most of our customers have been arguably niche markets, i.e.

low volume, requiring realtime signal and image processing that demanded multiprocessor systems.

Now we have seen the need for multiprocessor systems built on multicore chips, through a broader range of applications, ranging from models for Wall Street to consumer electronics with video streaming and advanced visualization for games and medical imaging.

We are well positioned with our unique knowledge of how to extract performance from this next generation of multicore processor chips.

Our growth will be driven by the market adoption rate of these multicore chip based systems.

Our goal is to increase the adoption rate by virtue of our software tools and systems engineering expertise.

Recently we teamed up with the Pacific Northwest National Lab, or PNNL to collaborate on applying multicore technology such as graphics processing units or GPUs and the cell processor to critical applications impacting national security.

PNNL is a DOE Office of Science National Laboratory that solves complex problems in energy, national security and the environment and advances scientific frontiers in the chemical, biological, materials, environmental, and computational sciences.

This formal alliance has resulted in the formation of a new computational center of excellence.

Our ATCA based ensemble platform is being used in high-end applications and wireless and satellite communications.

The ensemble platform has also been selected, their new application in the semi industry.

The Micro TCA extension of our ATCA product has been selected for a new application in the test and measurement market.

Our Micro TCA products position us to participate in new markets with higher volume potential such as test and measurement that have complex computing requirements.

If any of you are going to SIGGRAPH in San Diego this August, August 7 through August 9, I encourage you to stop by our booth and also the Sony booth to see demonstrations of software and advanced visualization and computation capabilities using cell, GPU based systems.

Mercury will have demos illustrating middleware, tools, and libraries that maximize cell PE processor performance as well as realtime, interactive, and photo realistic 3D rendering and realtime 3D rate tracing.

Mercury was selected by SIGGRAPH to present an exhibitor tech talk on Tuesday, August 7, on accelerating with cell programming, with the Mercury Cell Accelerator Board, and the cell BE processor.

Last but not least, as you saw announced a few weeks back , Bob Hult our CFO will be retiring at the end of September.

Over the last three years, Bob's financial, operational, and business experience, skills and insight have contributed greatly to Mercury.

We will continue to work to maintain the momentum he has helped to create in restoring profitability and growth for the Company.

We want to thank Bob and wish him luck in his next life and work after his tenure as CFO of Mercury and we are delighted that he will remain as a resource for the Company.

That concludes my remarks and I'll now open the call

Thank you.

(OPERATOR INSTRUCTIONS) Our first question this afternoon will come from Bill Benton with William Blair.

Hi, afternoon, guys.

Hi, Bill.

Just a couple of questions if I may.

Jay, you talked about kind of a slowdown in Advanced Solutions and I know you said at one application you mentioned kind of last quarter I presume that that was the impact that you're mentioning this quarter.

You also indicated that there was kind of a new application with a new customer coming.

I was wondering if you could just offer us any color on that situation.

That one has not been disclosed in any press release yet, but it's in the semiconductor industry and it's an application that is different from what we've done in the other applications within the Semi business.

Okay.

Are you competing kind of with in-house resources there relative -- just like you have historically or is there, did you compete with an external party and win that business?

It was primarily in house resources.

Okay.

And then I missed this and I apologize.

I think the R&D was notably lower sequentially and I think you mentioned a refund.

I was wondering if you could just clarify what that exactly was?

This was the cash refund that we received from a technology partner directly related to the impairment charge we booked.

We rearranged the working relationship between Mercury and the other party.

Net-net we think it's a good rearrangement, a positive one, but a particular development project was canceled replaced by others, and we had prepaid some royalties that were closely linked to that original development effort, so we impaired those.

You know that's a non-cash charge and we did get a cash refund, if you will, on those prepaid royalties, so net-net, it was a zero in terms of the accounting, but it actually was a $1.9 million positive cash inflow to Mercury.

Okay.

And then on the guidance, the $225 million, I know you talked about, I know you normally do start a little slower during the year and then tend to ramp.

Right.

I was wondering if you could just offer any color with regard to maybe anything particular that is expected to ramp in the back half.

Are there any specific design wins that are notable that could give you kind of more comfort with that back half ramp?

Well, we're not going to talk about the specific design wins, especially if they haven't been announced previously, but we're certainly looking to the CIV, I'm going back to last year.

We're going to get tripped up on this, the Life Sciences, I was going to say CIV, the Visage imaging business to start to see some revenue traction and to grow that business, so that's where certainly some part of this is and then there are other opportunities that we're currently involved with and the commercial part of ACS for example, that we expect to start to see some revenue growth there too, so it's across-the-board, Bill.

Okay and then just a final question, just if you could update us on kind of what is the process on the CFO search, kind of where you're at, when you think you might or if you have gone through some folks so far kind of your timing and what you might be thinking about?

Well, we don't have anything to report other than the fact that the search has started.

We can't provide anymore detail than that.

Okay.

I appreciate it, guys.

Thanks.

Our next question will come from Steve Levenson with Stifel Nicolaus.

Good afternoon, Jay, and Bob.

Hi, Steve.

Hi, Steve.

Can you give us an idea of what might be in the current defense budget, the proposed budget where you have a crack of winning some business?

I know there have been some delays on things in reprogramming but it sounds like some of your radar products might be getting a little bit more active.

Do you have any news?

We don't have any news on any new program wins that we haven't already put out there.

Not necessarily new but upgrades or reorders on things like synthetic aperture radar and such?

Well, that as an application is always, let me say rumors about the upgrading certain platforms, and I'm sure that there's activity under way by the primes to in fact get the funding to make some of those things happen.

So until time we get a purchase order, I'm not putting it into the forecast.

Okay, thanks very much.

Thanks, Steve.

(OPERATOR INSTRUCTIONS) We go next to are [Ronin Wolfdorff] with Cowen & Co.

Your line is open.

Please go ahead.

Sorry, I had my line on mute excuse me.

Good evening.

Hi.

Just wanted to touch on a few different areas of the business.

Wanted to get a sense of in general how visibility has evolved over the past few months and starting with the defense business, there's been an uptick in the book-to-bill and I was just wondering what has accounted for that?

Well, I think it's multiple things, but the visibility has been improving over the last several months and I think we can now look at the pipeline that we have where it is roughly $190 million worth of opportunities that are in some stage of classification that are being pursued, so we think that that's a good number.

It's never been that high.

That said, it's a visibility into a lot of potential that may or may not be funded and we may or may not win, so we're not putting that in the win column yet.

So I think that's a big part of our enthusiasm, if you will, going forward is that we do see a lot of potential out there.

Okay, and just in terms of your restructuring efforts, I was just looking for a bit of an update.

You guys I believe have been targeting 15 million in cost savings in fiscal '08 and I just wanted to get a sense of how that's looking.

I think -- done.

The actions we took here this past quarter will deliver 15 in operating expense reductions in '08, and I think when you work through the guidance and build your model out, you'll be able to demonstrate that and prove that to yourself.

Okay.

Terrific, thanks.

And we'll move now to [Jonathan Ho] with William Blair.

Please go ahead.

Hi, guys.

Just a quick question on the decision to spin off Visage.

Or to do a subsidiary with Visage.

What types of challenges are you guys seeing, basically I guess within the 2D to 3D transition to want to do that?

Well, the reason and there's multiple reasons for doing that, but one is that as we looked at the business the way the business was developing, the business model, we started to see that it was really separating from the core significantly.

What I mean by that is primarily a software business.

That's number one.

Secondly, the sharing of the technology if you will, there was very little sharing and so it became pretty clear that we should be running it as a separate business, and just setting it up as a wholly owned sub just makes it easier I think downstream to be able to potentially do something with -- in order to optimize the shareholder value.

Okay, thank you, guys.

(OPERATOR INSTRUCTIONS) And we have no other questions standing by.

I'd like to turn the conference back to our speakers for additional or closing comments.

Well, thank you all for participating on this beautiful Friday afternoon or Thursday afternoon, sorry.

And we'll look forward to seeing you again in October.

Goodbye, now.

Thank you, everyone for your participation on today's conference.

You may disconnect at this time.