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Banner Year Doesn't Translate Well for Shares of Mercury Computer Systems

Posted on: Tuesday, 16 August 2005, 21:00 CDT

Aug. 15--CHELMSFORD, Mass. -- You can forgive James "Jay" Bertelli for thinking his company is among the Rodney Dangerfields of the Nasdaq Stock Market.

It has trouble earning investors' respect.

Just over two weeks ago, after announcing record results for its recently completed fiscal year, shares of Mercury Computer Systems Inc. slumped.

It was, by all accounts, a blowout year: Revenues of $250 million, up 35 percent from fiscal 2004; net income of $30.2 million ($1.25 a share), up 32 percent from the previous year; and cash holdings of $228 million, or $9 a share.

Bertelli says that "even without acquisitions, we would have been up 28, 29 percent in revenue."

Nonetheless, shares of the company dropped $2, to $27.67, on July 28, the day of the earnings report. Their Friday closing price of $27 is still less than half their peak value, attained in 2000.

"First, you have to understand, a lot of companies had inflated values back then," Bertelli said. "I can't pick a point where our value should be; beauty is in the eye of the beholder. Our job is to keep putting numbers on the board, grow 25 percent a year, and grow profitably."

The past year or so has been a busy one at Mercury, which makes image-processing computer systems for the military and medical industries.

It has made several acquisitions, including one for German-based SoHard AG, a leader in Web-based picture archiving and communications systems for hospitals. More recently, it agreed to acquire Echotek, which will bolster Mercury's signals intelligence and and wireless communications offerings.

With the $228 million in cash on hand, Mercury has the resources to keep buying.

"I'm not going to say that it's not on our radar screen, but for now we're focusing on digesting what we've consumed," Bertelli said. "We'll stick to our knitting."

Part of that knitting is further developing a key partnership with industry titan IBM Corp. In June, Mercury announced that it and IBM will integrate cell microprocessor technology for future use in such applications as radar, sonar and digital X-ray.

"This is of great interest to a number of our customers," Bertelli said.

Most of Mercury's customers are related to the military. The company derives about 60 percent of its revenues from systems used in such gear as sonar and radar to translate data into images.

"Defense has consistently been our strongest generation of revenue, and it continues to be about 60 percent of it," Bertelli said.

The CEO was undeterred by a recent article in Barron's that suggested that government defense spending might soon level off or decline.

"The defense budget (is) so huge, about $440 billion annually, it's hard for me to care too much if it goes up or down a few percent," Bertelli said. "We're diversified across different services -- Army, Navy, Air Force, the Intelligence Agency. With that broad a base, I think we're pretty insulated from swings. And in surveillance, intelligence and reconnaisance, you can never have enough computing power."

Medical applications, which make up to about 20 percent of Mercury's business, include speeding up the processing of magnetic resonance, tomography and X-ray images. The company also has an original equipment manufacturing division that makes specialized products used in semiconductor wafer inspection and baggage scanning systems.

"We have a small part in that (scanning systems market), but the company we supply, a unit of General Electric, has a 50 percent market share," Betelli noted.

Mercury has grown consistently and profitably -- its last quarter marked the 58th consecutive period it delivered a profit. It also employs about 560 of its 750 worldwide employees in Chelmsford, making it one of the town's largest employers.

So why the stock slump?

As mentioned, Mercury has absorbed a few acquisitions, always a concern to analysts. And the Riverneck Road company did provide a cautious outlook for fiscal 2006 -- earnings per share of between $1.35 and $1.40 per share on revenues of between $295 million and $305 million. Analysts were forecasting earnings of $1.43.

One analyst, Steve Levenson of Ryan Beck & Co., said in a recent research note to clients that Mercury has had a history of issuing guidance that it can easily top.

"Our knowledge of Mercury's markets and customers, combined with the company's history of exceeding guidance, leads us to believe that management may be sandbagging," Levenson said.

He has a 12-month price target of $36 for Mercury shares.

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MRCY, IBM, 6680, GE,

Source: The Sun (Lowell, Massachusetts)

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