Teledyne Technologies Inc (TDY) 2002 Q3 法說會逐字稿

Operator: Ladies and gentlemen, thank you for standing by. Good morning, and welcome to today's Teledyne Technologies third quarter 2002 earnings release. At this time, all phone lines are muted for a listen-only mode, however, after the presentation today there will be opportunities for questions and the instructions will be given at that time. Should you require assistance during the release, you may reach an AT&T operator by pressing zero, then star, on your phone keypad. Today's call is being recorded for replay purposes, and that information will be given out at the end of today's meeting. With that being said, here is our opening remarks is Director of Corporate Development and Investors Relations, Mr. Jason Vanwees. Please go ahead, sir.

Good morning, everyone. There is Jason Vanwees. I'd like to welcome every tun to Teledyne Technologies third quarter earnings release conference call. We released our earnings earlier this morning before the market opened.

Joining me today are Teledyne Technologies Chairman, President and CEO, Robert Mehrabian, Senior Vice President and Chief Financial Officer, Bob Naglieri, and Senior Vice President and General Counsel and Secretary, John Kuelbs. After remarks by Robert and Bob, we'll ask for your questions. All forward-looking statements made this morning are subject to various assumptions, risks, and copy as noted in the earnings release and our periodic SEC filings, and actual results may differ materially. Also, in order to avoid potential selective disclosures, this call is being webcast and a replay by a webcast and dial-in will be available for about one month. Here is Robert.

Thank you, Jason. Good morning. Since you already have our earnings release, I will not go through all the details.

Although revenue growth was modest at 3.3%, compared to last year at 2% compared to the second quarter of '02, net income increased 21% compared to last year. Excluding non-cash pension income and charges in the second quarter of 2001, net income in the first nine months increased by approximately 50% year over year, and for the third consecutive quarter. In the first nine months of '02, cash from operations totaled $58.9 million, compared to cash usage of 18.8 million in the first nine months of 2001. As a consequence, we ended the third quarter debt-free, even after our 24 median cash acquisition of Monitor Labs.

Both our electronics and communications and systems engineering segments performed well during the quarter. At this time, we don't see a rebound in our short cycle electronics and commercial aviation businesses. However, we believe that our company with its reduced cost structure is well positioned to achieve significant earnings growth when the markets that we serve rebound.

In the meantime, our corporate strategies remain the same. First, continue our focus on operation of excellence and cost reduction. Second, maintain a strong balance sheet. And third, make synergistic acquisitions that build on our strength in electronics and instruments, and systems engineering. In the remainder of my comments, I will elaborate on the operating performance in our business segments. Bob Naglieri will then discuss more details about our financial performance and comment on our outlook for the fourth quarter of '02, as well as '03.

Turning to our business segments, Sales in the electronics and communications segment decreased 3% relative to last year, and were also down slightly compared to the second quarter of '02, primarily due to continued weakness in our short cycle electronics and our long cycle avionics products. However, operating profit in the third quarter of '02 increased 33%, compared to last year.

Excluding non-cash pension income, operating profit in the third quarter was up over 70%. This was primarily due to two factors. First, our cost reduction efforts, and second, a significant reduction in operating expenses associated with our electronics and broadband communication initiatives. As I discussed our electronics and communication businesses, I would break up my comments into three separate market categories, commercial short cycle electronics, commercial long cycle electronics, and defense electronics. First, in the company's short cycle electronic product line, we serve the general industrial semi-conductors and telecommunications markets, orders and sales relatively flat compared to the first and second quarters of '02.

In our electronics relays business, after some modest quarter over quarter increases, in the first half of the year, orders spent in the third quarter to levels similar to late 2001. Given the lack of demand in semi-conductor test equipment and telecommunications markets, we are not anticipating an upturn in the Relays business in either the fourth quarter of '02 or in '03. Nonetheless, even though sales in 2002 will likely be about 40% lower than in 200, we are operating near break-even profitability due to our cost reduction efforts and have been successful in incorporating our Relays in over 150 new products under development by our customers.

In our industrial instrumentation businesses, orders and sales were relatively flat in the third quarter of '02, compared to the second quarter of '02. On September 27th, we acquired Monitor Labs from Spiral PLC, this acquisition coupled with our earlier acquisitions of Advanced Solution Instrumentation in November enhances Teledyne's presence in the air quality monitoring segment of the environmental instrumentation market. This synergistic additions will increase the revenues of our instrumentation group within the electronics and communication segment to approximately $100 million. With particular attracted to the -- instrumentation market, as in this market we enjoy higher gross margins than the average of our other businesses.

Our focus on instrumentation is also driven by several other factors, including our expertise in high precision electronics components and sensors, and opportunities to leverage our Broadband Electronic Technologies, data acquisition system, as well as our low-cost manufacturing operations in Mexico. We continue to seek opportunities in the instrumentation area. Second, in the company's long cycle commercial electronic businesses, this businesses primarily serve the aviation and medical markets.

Sales off avionics were down approximately 20% compared to last year's, as sales of both new and replacement products have been impacted by the weak performance of domestic airlines. Nonetheless, Teledyne has continued to increase its market share and introduce new products. As we said previously, we currently expect our share of data acquisitions systems on new Airbus 8320 and 8330, 340 aircraft will improve up to 50% in the years 2005. Following some recent orders, we estimate our market share on these Airbus aircraft is now 20%.

In addition, increasing sales of new products such as our Optical Quick Access Recorder, smart cabin office high speed air to ground communications, and our latest communication management unit have been able to help offset some of the overall market weakness. We're continuing to pursue opportunities to apply our commercial aviation products to military aircraft.

Last year, we sold our first commercial off the shelf product for the C-17 military transfer air craft more recently we obtained a contract for data acquisition systems on the P-3 surveillance aircraft. In the medical arena, we provide manufacturing services for the medical systems manufacturers and custom microelectronic modules for implantable medical devices, such as pacemakers.

Sales to the medical markets increased in the third quarter and we continue to look for ways to expand this business. Third, turning to our defense electronic businesses, sales of defense electronics products in the third quarter of '02 were relatively flat, compared to the third quarter of '01. As Q3, '01 was particularly a strong quarter for sales of military microelectronics and traveling [INAUDIBLE].

We expect that organic sales growth for defense electronics will return to high single digit levels in the fourth quarter of '02, and throughout '03. For example, we expect to receive additional orders for a variety of microelectronic modules that are employed in military aviation and secured communication applications. Several traveling -- [INAUDIBLE ] using military radar and electronic warfare systems, as well as commercial satellite applications, have increased on average by approximately 10% per year over the last three years.

Finally, despite weakness in the overall electronics manufacturing services sector, our high mix, low volume contract manufacturing business, which primarily serves the military and medical customers, is performing very well. Sales in the third quarter of '02 were at record levels. We have recently improved our contract manufacturing capabilities in both our Tennessee and Mexico operations, and expect strong sales to continue in this business.

Turning to our systems engineering segment, in the third quarter, revenues in this segment increased by 12%, compared to last year, and were at the highest levels in the last six quarters. Sales of our core defense businesses, such as those related to the national missile defense, international space station, and certain classified programs, grew by approximately 17%. Additionally, in the third quarter, we achieved record operating margin of 12.8% in this segment. The improvement in operating margin primarily reflected the receipt of government awards and incentive fees based on collective performance achievements. In addition, during the first nine months of 2002, orders increased 25%, compared to last year, and were 14% greater than revenue.

Although 2002 performance has been very strong for systems engineering, we are being cautious on the outlook for this segment in 2003. First, there can be no assurance and recent government award and incentive fees will continue in '03. Nonetheless, on October 15, the most recent system level test of the ground base mid course defense system for GMV was a success. We participated as a sub contractor in the GMV program and over the last few years this program has represented an increasingly larger portion of our total services business. Besides the uncertainty associated with success based awards in this program, we are also cautious regarding 2003 revenue outlook due to shift in emphasis on the program from R&D to deployment. Also, the funding for the overall GMV program is expected to be significantly less in 2003 than 2002.

Besides our missile defense and other activities, NASA programs represent approximately 25% of total revenues for our systems engineering business. In the third quarter of '02, sales to the space market were an all-time high. As you may recall, in June of this year, we were selected as the single prime contractor for the design, development and operation and support of NASA's martial space flight centers future microgravity science payloads for the international space station. This new contract has a maximum potential 10-year value of over $500 million. Assuming that appropriate levels of funding and contract pass orders occur. However, on the international space station program, progress as it progresses from construction to operations, initial task orders on this new development on operations contract in 2003 may not fully offset current period revenues related to the construction of the space station.

Turning to our aerospace engines and components segment, sales during the third quarter of '02 for our aircraft piston engine business increased slightly relative to the third quarter of '01. Nonetheless, operating profits in the piston engine business was negatively impacted by net charges totaling 3.3 million dollars, related to high aircraft product liability reserves and increased insurance premiums.

Going forward, we know that the insurance premiums and current period reserves in the fourth quarter of '02 will account for approximately $1.2 million in additional expenses, compared to the fourth quarter of '01. Beyond that, it's difficult to project additional charges because they're based on negative claim experience related to prior periods. In the turbine engine business, sales and operating profits increased due to high revenues of spare parts or air force trained aircraft, as well as increased sales and operating profits from the turbine engines related to the JASSM program. The JASSM program is currently in pre-production, and we expect to enter low rate initial production in the next few months.

As we mentioned previously, given our primary focus on electronics and communications, and systems engineering software segments, we continue to explore strategic alternatives for the aerospace engines and components segment. However, given Teledyne's already strong balance sheet and free cash flow, we will balance the timing of this alternatives with the very weak market on fundamentals in the aerospace industry.

Finally, in our Energy Systems segment, revenues in the third quarter of '02 increased slightly to the third quarter of last year. The increasing sales was primarily driven by increased revenues from government programs. The operating loss reflected greater than anticipated costs on certain commercial hydrogen generators and higher selling and specially R&D expenses. Our goal in this segment is to keep break-even cash flow.

As we continue to focus on additional government contracts and sales of tangible energy technology products such as fuel cells, test stations, and hydrogen generation systems. To conclude, as I mentioned in our conference call last quarter, I want to emphasize that we are committed to continuing the high standards of accurate and detailed financial disclosure. I will now turn the call over to our CFO, Bob Naglieri.

Thank you, Robert. Good morning again. I'd like to start with some additional financials for the quarter, not covered by Robert. And also add some full-year data where warranted. Then I'll talk about the pension plan assets and the related impact to future earnings, and finally, I'll comment on our outlook for 2002 remainder of 2002 and 2003.

As Robert indicated, we're very pleased with our performance for the quarter. During the past two years, we have been focusing our efforts towards executing throughout the cycle. This includes major economic factors and market shifts such as the very weak current market conditions in the telecommunications and commercial aerospace markets. As well as such positive market shifts such as the recent build-up in defense products. Our third quarter of 2002 and full-year performance to date reflects our reasonable success at this imperative.

Some highlights for the quarter are as follows: free cash flow cash from operations less capital expenditures but before our recent acquisition was 22.5 million dollars for the quarter, and a little over $49 million year-to-date September. We continue to monitor our working capital requirements and expect to have positive cash flow in the fourth quarter, excluding any acquisitions. Although inventory and receivable have increased since the beginning of the year, our recent acquisition which by the way was closed on the last day of the quarter, accounted for approximately half of the increase.

Inventories continue to turn in the five to six range, while the aging of our customer receive able is in very good shape. Capital expenditures for the quarter were 3 million in 10 million on a year-to-date basis. We anticipate capital expenditures to be in the range of 16 to 18 million for the full year 2002, but below depreciation of 21 million, and below last year's expenditure level of approximately 26 million. We anticipate that 2003 capital expenditures will be in the same range as 2002, 16 to 18 million, and we'll continue to focus on cost reduction activities and new product development.

Turning to our pension plan, we know the current capital market trends in the obvious impact pension has to assets that have been indexed to these markets. This volatility has resulted in three consequences: The first, based upon the September quarter closing date, and anticipated reductions in our expected rate of return and discount rates, our non-cash pension expense in 2003 is projected to be approximately 8 million dollars or negative 15 cents per share, as compared to 2.3 million of pension income this year or positive 4 cents, 2002. Second consequence, assuming the capital markets did not improve in the fourth quarter of '02 or in '03, the pension funding holiday that we have experienced to date will not continue. As a result, we do not anticipate a cash contribution until 2004.

Finally, the third consequence, FAS 87 requires a minimum pension liability be reported if the value of pension assets is less than the accumulated benefit pension obligation, typically called the ABO, at the end of the year. ABO is the current liability for a pension plan, not the future liability discounted. That is, it's today's value of Teledyne's pension liability. If this condition exists on December 29, 2002, the company would record a non-cash charge to stockholders equity equal to the value of the pre-paid pension asset currently recognized on the balance sheet and the required minimum pension liability. Both of these being that deferred taxes.

The effective such non-cash charge would be a reduction in stockholders equity, and not affect earnings. If the performance of the equity markets does not improve relative to September 29th, 2002, the company may record such a non-cash charge to equity of approximately $30 million.

Let me move on to near term, 2002 full-year outlook and 2003 outlook. Let me start with 2002 outlook. We're narrowing our previously announced earnings per share guide an of 70 to 78 cents to the upper end of the range, or to 76 to 78 cents. We have narrowed this guidance range at the top of our previously announced ranges for the second consecutive quarter, and we are reaffirming this outlook despite continued weakness in our short cycle electronics and commercial avionics businesses and softness in the general aviation market. Our cost-cutting in manufacturing improvements coupled with defense spending have allowed us to achieve increase in earnings in last three-quarters, even with a significant reduction in non-cash pension income.

Excluding this non-cash pension income of narrowed guidance range, assumed to increase of approximately 40 to 45% earnings for the full year 2002, compared to full-year 2001. Let me talk about '03. Although earnings visibility into '03 is limited are our management believes that 2003 earnings per share excluding pension expense, will be in the range of approximately 75 to 85 cents earnings per share, compared to 72 to 74 for 2002. Including approximately 15 cents per share of non-cash pension expense, we estimate full-year 2003 earnings per share will be in the range of approximately 60 to 70 cents.

Our '03 outlook reflects anticipated growth in the defense electronics and instrumentation businesses, but no recovery in the company's short cycle electronics and commercial aviation markets. In addition, in our government engineering services business, there can be no assurance of recent government award and incentive fees, which have driven record profitability in the last two quarters, will continue in 2003. I'll pass the call back to Robert so we can both answer your questions.

Thank you, Bob. We would like to take your questions now. Brent, if you're ready to proceed with the questions and answers, please go ahead.

Certainly, doctor. It would be my pleasure. Ladies and gentlemen are as you just heard, if you do have any questions or comments, queue up at this time just by pressing the 1 on your phone keypad. You will hear a tone, indicating that you have been placed in queue, and just as a note you may remove yourself from the queue by pressing the pound key. Once again, to queue up form a question, ladies and gentlemen, please press the 1 on your touch tone phone. Representing Sidoti and Company, the line of Steve Workman.

Good morning.

Good morning, Steve.

Couple things regarding your '03 forecast. In terms of these incentive fees and continuing charges, can you give us an idea what you have baked into the forecast? For next year.

I'll let Bob take that question.

The -- what we -- question is, really, relating to fees only or sales?

Well, just the incentive fees boosting the profits at systems engineering, and I guess the charges at piston engine, how do you see those things playing out, given your forecast?

Yeah, let me start with the fees. Just give you a little information. This year, sales generally about -- sales this year -- generally about $60 million. We start with about 8 or 9% generally in our engineering services business, and this year we're having 12%. We don't see next year that the 12% is as realistic based on these fees. So we think the 8 to 9% level is the correct level. That's the scope of how we're looking at it now. Sales could be a little bit down based upon scope and reduction in the DOD budget.

In terms of the Teledyne aerospace engines and components, that's a difficult thing for us to look at. We know it's a litigious environment. We know we have insurance expenses that will be higher. Our insurance policy expires in mid-year of '03. And it's up a couple million dollars this year. So we have baked in our forecast. So it's reducing earnings. The item we just don't know about is the litigious environment regarding claims, and these are claims we don't even know about at this point in time. They just happen. But the difficult question to answer, the best we can -- that's about the best we can look at.

Okay. Going over to cash flow for a moment, the inventory increase on sequential basis, you can give us the breakout acquisition versus core business?

Sure. The year over year of -- there's about 6 million dollars of additional inventory, because of the two acquisitions, the one we made in the fourth quarter and then the recent acquisition, we just made on the last day of the month. And the remainder of the inventory is volume driven by a lot of defense electronics business. And it really is September a difficult period, we're not dissatisfied with the level of inventory. It's based on timing of shipments and some of the long-term contracts.

Okay.

And it turns five to six times a year, and our focus this year has been turns.

Uh-huh. And going over to the piston engine business in general, judging by your comments, I would guesstimate there's not an eminent sale and you're waiting to play out of market conditions for a firmer pricing in the business.

Let me have Robert discuss that issue with you.

Steve, the piston engines business is competing in a relatively difficult market. Our prime competitor is having some crankshaft issues. And it's a soft market, and what we are doing is we're still looking for strategic alternatives, but as I said in my opening remarks, Steve, because we have such a strong balance sheet and we have good cash flow, we're only going to do this in a timescale that is good for us and our shareholders, and not rush that.

Given the crankshaft problems they're having, it's still a manufacturers' decision from an airframe perspective, not a customer decision. I assume you don't expect to see any positive impact from that in the near term?

Well, that is, of course, the issue -- there are two issues with that. One of them has to do with overhaulers and the other has to do with the manufacturers, OEM's, using the engines. The main issue in switching to engines from one manufacturer from us to them or them to us is that you have to certify the new engine, within that specific aircraft. And that takes some time. Obviously, OEMs are interested in having more than one engine in an aircraft, with an expensive proposition. Having said that, let me add that when you come to advanced aircraft that are gaining the market share in the domain, and those two are made by Cirrus, which already holds 20% the market there, and Lance Air, which is now increasing its market share, both of those aircraft have our engines in them, with the source for those OEMs.

Okay. Thank you very much.

Thank you, Steve.

Thank you. Next to the line of Mark Jordan with AG Edwards. Please go ahead.

Could you first talk about, what is the revenue run rate of monitor and aggregate, what is the run rate of the instrument businesses with monitor added?

The round rate on monitor, Mark, is about 28 million, give or take a little bit. It was in 2001. We anticipate about the same this year. So if you put that together with the other instrument businesses that we have within the segment, we anticipate that our revenues going forward with the approach about 100, as I said before.

Okay. With the pension income, the specific guidance that you gave this quarter versus last quarter was for a 5 cent additional drag. Is the difference between your second quarter and third quarter guidance related to the projected decline in your assumed rate of of return?

Yes, this is Bob Naglieri. There's really two reasons. Assets dropped dramatically on the second quarter, by about 8 or 9%. That's about 20 million, almost 25 million for us, plus the second point we did, we are planning to drop our rate of return from 9 to 8.5%. I might add that the discount rates going from 7.5% to 7%. So couple items in there. The biggest drop is the assets.

Looking at -- it's my understanding and I think it was -- talked about it the journal today, in terms of pension accounting, that most of industries in the 8 to 9% range, and obviously many people be revisiting that, assumed rate of return assumption. Where do you feel that 8 1/2 will be in terms of the spectrum of rates used by corporate America, moving into '03?

The latest data that we've seen from our actuaries in this domain is that 8 1/2 is in the mid-range of the earnings rates being used.

Okay. And a final question on the pension area, is there some way -- I mean, to look at that and normalize the expense, you know, and again given a longer time frame, is it -- could you say that a normal range would be typically between plus and minus a nickel a share per year, as typically the normalized or do you have any thoughts on that area?

Well, I'll say a couple things, then I'll let Bob add to it. Let me start by saying at the present time, our pension assets are evenly split between bonds and equites. That's primarily because of the decline in the equity markets. But having said that, our downside is somewhat protected because of that. But then on the upside, we don't gain as much, if the market goes up. If you look at the S&P 500 today, yesterday, it was about 900. As to what happens in the future, Mark, it very much depends on what happens to that market.

When we looked at it in June, and we had about a 10 cents charge that -- from pension going forward, the market was a little higher, and also our assumptions for going forward on earnings and discount rate were higher also. As Bob said, once you change both of those things, then the pension expense goes up. Now, so it depends a lot on what the market does, not so much about what assumptions, what else we do. We do have some ability to smooth out both the upside and the downside. Over the five-year period. Which we attempt to do, obviously, like most other people. Bob you want to add to that?

I was going to say almost the same thing, Mark, it really depends on the value of our assets. As Dr. Mehrabian is alluding to. We had such a big swing in '01, 18 cents and now 15 cents negative. It's a big swing and if you looking at the assets, that's the big driver. To say it is normalized 5 cents, I'm not sure I know how to answer that. I would like to see when the market stabilizes and we can think the equity markets are coming back.

I will just finish this with one final question, answer or comment, Mark. Since the pension at least in the foreseeable future is non-cash issue for us in the next 16 to 18 months, and markets will do what markets will do, I think the more important perspective for us is to look at the health and the operating earning potential of the company and our various businesses. And if you look at it in that vein, excluding pension incomes or expenses, which we've already pointed out what they are, we feel pretty good about the strength of our operations and our operating businesses, because they keep increasing the revenue, quarter over quarter, year over year, and I think that's really where the health of the company is.

Okay. Final questions on the aircraft engines businesses, what were the absolute insurance premium costs in '01 and what are you projecting for this year?

Let me give you some rounded numbers here. In '01 the number was about 4 million dollars, and in '02 about 6 million dollars. The biggest issue that we have going forward is where our premiums going to go in '03? And our current premiums about 6 million right now, like I just mentioned, big increase. We just don't know where it will go. Currently work through through the first quarter of next year.

Yeah. And for the first nine months, you have recorded a number of non-premium liability and also reserves for prior years liabilities, product liability charges, in piston engine business. In aggregate, how much were those specific charges?

Let me give you some exact numbers. Through the first nine months of -- through the first nine months of this year. There's been about 7 million dollars of impact for the year, broken out into -- give it to you to in three pieces. First piece, we had about 800,000 dollars of net costs on the continuation of our crankshaft settlement. So that's about $800,000. We have about through September, this is timing as to when the premium start, with premium year, about a million dollars, with the balance of that about 4, 5 1/2 million dollars of additional reserves and actual claims adjustment and so far. So about 7 million altogether. 5 1/2 for additional reserves. And actual expenditures, and about a million incremental so far on premium insurance.

Okay. And at this point in time, for the historical periods, are you fully reserved?

For the historical periods, we reserve what we know. We look at that very, very carefully. I would love to tell you have I a big kitty but I do not. We finish a year thinking we're provided for and then unfortunately, a claim could happen that two years prior, and because of the litigious nature of the environment, we think it might be accident winds up to be wide squared the settlement. Right now, we are not fully reserved, but we do not know of any claims. So it's difficult to put a position on.

Okay. Thank you.

Sure.

Thank you. Ladies and gentlemen, are there any additional questions or comments? Just press the 1 on your touch tone phone. Along in a few moments, we have no further questions. Please continue.

We will now conclude the conference call. Jason.

Thank you, Robert. Again, thank you, everyone for joining us this morning. If have you any follow-up questions, please feel free to call me at the number on the earnings release, and all the releases, and the replay are available on the website, Teledyne.com. Brent, just conclude the call. Thank you again.

Ladies and gentlemen, your host is making the earnings release available for replay for one month, starting at 11:30 a.m. Pacific daylight time, October 24th, through 11:59 p.m. Pacific standard time November 24th. Please access AT&T's executive re-play service by dialing 800-475-6701. And the voice prompt enter the conference ID of 554907. And that does conclude our earnings release for this quarter. Thank you very much for your participation. As well as for using AT&T's executive teleconference service, you may now disconnect.