Teledyne Technologies Inc (TDY) 2004 Q3 法說會逐字稿

Welcome to Teledyne, third quarter earnings conference call. [Operator Instructions]. I would now like to turn the conference over to our host, Mr. Jason VanWees. Go ahead, sir.

Good morning, everyone. This is Jason Van Weiss, Director of Corporate Development and Investor Relations at Teledyne. I would like to welcome everyone to Teledyne's third quarter release conference call. We released our earnings earlier this morning before the market opened. Joining me this morning are Teledyne's Chairman, President and Chief Executive Officer, Robert Mehrabian, Vice President and CFO, Dale Schnittjer. And Senior Vice President, General Counsel and Secretary, John Kuelbs. After remarks by Robert and Dale, we will ask for your questions. However, before we get started, our attorneys have reminded me to tell you that all forward-looking statements made this morning are subject to various assumptions, risks and caveats as noted in the earnings release and our periodic SEC filings and, of course, actual results may differ materially. Also, in order to avoid potential selective disclosures, this call is simultaneously being webcast and a replay both by a webcast and dial-in will be available for about one month. Here's Robert.

Thank you, Jason. Good morning, everyone. Since our third quarter earnings release was issued earlier this morning, I won't go through all the details, but I'd like to make a few introductory comments, followed by observations on the performance of the various segments. To begin, let me note that this was another outstanding quarter for Teledyne. Earnings per share increased year-over-year for the 11th consecutive quarter. We're proud of the performance throughout the company. Overall sales increased 25% with organic growth of 10%. We continued to grow our electronics and communications segments through acquisitions, closing the acquisition of Arnolds industries on July 2 and the Solaritech's (ph) defense business on October 22. Sales in our systems engineering segment grew 22% and were at record levels.

In our aerospace engine segment, we received the first of four $2.5 million payments from Honda motor company, and in our energy systems segment, sales increased by almost 50%. Furthermore, margins improved, compared to last year in all business segments. Earnings per share increased 23% and, excluding pension expense and the tax benefit we received in the third quarter of last year, earnings per share increased 58%. In addition, we're once again raising our 2004 earnings per share outlook, this time by approximately 10%.

Turning to our growth strategy, simply put -- our strategies to achieve high-quality revenue and EPS growth. We do this by executing on two focused fronts. First, by strengthening and expanding our core electronics instruments and systems engineering businesses, through organic growth and targeted acquisitions. And second, by pursuing operational excellence and margin expansion initiatives to continuously improve earnings. Our long-term goal is to create a more focused set of businesses that are truly superior in their natures. The acquisition of Solaritech defense business is a good example. This business designs and manufacturers RFM microwave components and some assemblies for electronic warfare, radar and other military applications. It is one of the defense industry's largest suppliers of specialized solid-state amplifier products. These products utilize design and manufacturing technology, similar to our existing microwave business and are also complimentary with Teledyne's line of high-powered helix traveling wave tubes used in military electronic warfare, radar and communications applications. Further more, their defense business will be relocated to our nearby defense microwave facility in Mountain View, California.

As a reminder, earlier this year, we also acquired and relocated the microwave operations to the same facility. This type of facility consolidation and integration provides the best opportunities for realizing synergies. In the remainder of my comments, I'll elaborate on the operating performance of our business segments. Dale Schnittjer, our CFO, will discuss more details about our financial performance and comment on our outlook for 2004.

Turning to the business segments, third quarter sales in our electronics and communications segment increased almost 34%, compared to last year. And operating profit increased 59.8% compared to last year with operating margin up 160 basis points, compared to 2003. As I further discuss, our electronics and communications businesses, which going forward with total revenues in excess of $600 million, I'll break up my comments into three separate market categories. First, defense electronics. Second, electronic instruments. And, third, avionics and other commercial electronics. Each of these three groups currently contribute approximately one-third of our electronic and communication segment sales.

First, as a reminder, our defense electronic products and services range from traveling wave tubes and microwave assemblies to micro electronic modules to contract manufacturing of service of military electronic assemblies. In the third quarter of 2004, sales of defense electronics increased by approximately 13%, compared to third quarter of 2003. However, excluding the acquisitions of the Detronic Solid State business and Reynolds industries, sales in the third quarter decreased primarily due to lower sales of contract manufacturing services to defense customers. However, orders for these services are strong and we expect improved revenues in the future. Turning to our electronic instrumentation businesses, we manufacture a range of instruments used in environmental analysis and emission monitoring, industrial process control, petrochemical manufacturing, drug discovery, and energy exploration and production. In the third quarter of 2004, year-over-year total sales in electronic instruments increased approximately 100% compared to last year. This was due to both organic sales growth and the acquisition of Lehman Lords (ph) at the end of February and FISCO Incorporated in June 2004.

Organic sales were higher by approximately 27%, primarily driven by significantly higher sales of geophysical sensors, as well as sales growth in the majority of other instrument businesses. Sales of geophysical sensors, used in the highly cyclical oil expiration market, decreased sequentially about $5 million from record levels in the second quarter, and we expect sales of these sensors to decline sequentially in the fourth quarter of this year.

Our acquisition strategy and electronic instruments, which we've identified as one of our growth platforms, is focused on products and technologies that are first complimentary with our existing businesses and, second, participate in regulatories driven end market which we believe will grow faster than our traditional industrial process controlled markets.

Finally, I'll discuss our avionics and other commercial electronics businesses. In the avionics market, we develop and manufacture data acquisition and communication products for airlines and business aircraft. We also manufacture electronic components and we provide contract-manufacturing services for medical instruments and devices. In the third quarter of 2004, sales from this businesses, collectively, increased 14%, over third quarter of 2003. This organic growth resulted from increased sales in almost all product lines most notably by strong sales of broadband wireless assemblies, for cellular back hole applications, sales of relay used in wireless infrastructure, networking and semiconductor test equipment and contract manufacturing of medical devices.

Turning to our systems engineering segment, in the third quarter of 2004, revenues in this segment increased 22.6% compared to last year and operating margin was very strong at 11.8%. In the third quarter, sales were strong in our traditional missile defense businesses and systems engineering and technical assistance contracts. The SEDA contract assists government agencies with highly technical evaluation of strategy, program management and performance. In addition, sales in our environmental business were at record levels, driven by previous contract award, including the $20 million award in 2003 for the destruction of binary chemical warfare material, and we continue to see demand for environmental services, and we expect that this will be an important growth area for this segment. As a reminder, in August of this year, we were also awarded another contract, an engineering services contract, from the U.S. army Edgewood Chemical-Biological Center. The multiple idea accrued contract was for a five-year term and has $100 million ceiling. Under this contract, Teledyne brown engineering will perform, engineering, development, and technical management services in the areas of chemical and biological defense. Again, the profitability of this segment in the third quarter was outstanding, we do not anticipate maintaining these margins in the fourth quarter.

Turning to our aerospace engines and components segment, sales during the third quarter of 2004 for our aircraft piston engine business increased 6.6% relative to the third quarter of last year, and resulted from increased sales to both OEM and after-market customers. While after market sales where up slightly, sales to engines to OEMs were at record levels.

Operating profit and other segmenting income increased in part due to a $2.5 million payment pursuant to an agreement Honda motor company. While the terms of this agreement with confidential, we anticipate receiving $5 million in 2005 and another $2.5 million in 2006. As a reminder, we've been working with Honda for almost three years on the development of a new piston engine for the general aviation market. In the turbine engine business, sales decreased in the third quarter, compared to last year, primarily due to reduced revenue from Harpoon Cruise Missile Engines. Finally, in our energy systems segment, revenues in the third quarter of 2004 increased by almost 50% compared to the third quarter of last year, and operating profit was positive this quarter. Given the substantial multi-year government programs in this segment, we continue to expect that the segment will achieve approximately 50% growth in revenues in 2004, and remain profitable.

In conclusion, I'd like to note that our third quarter 2004 earnings per share were at the highest level since the first quarter of 2000. Going forward, we intend to build on this momentum of high-equal revenue and EPS growth by continuing our focus on operational excellence and margin expansion programs and to seek and successfully integrate acquisitions in the defense and regulated commercial markets. I will now turn the call over to Dale Schnittjer.

Thank you, Robert, and good morning. I will first discuss some additional financials for the quarter, not covered by Robert, plus add some full-year highlights when warranted, and then I will give an update on pension costs and discuss our 2004 outlook.

First on cash flow. In the third quarter of 2004, cash provided from operating activities totaled $30.3 million, compared with cash provided from operating activities of $26.8 million in the same periods of 2003. The primary difference was due to improved net income and lower aircraft product liability payments. During the third quarter of 2004, we generated strong pre-cash flow from operations, less capital expenditure, of $26.4 million compared with free cash flow of $20.7 million for the same period of 2003.

At the beginning of the third quarter, we completed the $45 million acquisitions of Reynolds industries. Despite four acquisitions in the first nine months of 2004, we continued -- we ended the quarter with just $551.1 million of net debt. This is $66.8 million of debt and capital leases less cash on hand of $15.7 million. Taking into account the $33 million acquisition of Solaritech's defense assets, which closed on October 22, pro form a net debt at the end of the third quarter, would have been $84.1 million or less than one times EBITDA.

Capital expenditures for the third quarter of 2004 were $3.9 million, compared to $6.1 million for the same periods of 2003. For 2004, we continue to see depreciation and amortization expense slightly above capital expenditures of approximately $20 million.

Now I will move to pension. As we have stated before, declines in the capital markets in prior years and adjustments in pension assumptions have resulted in an increase in pension expense and Requirement to make the pension contributions. In the third quarter of 2004, pension expense was $2.2 million, or a negative earnings per share impact of $0.04, compared to a pension expense of $1.7 million or negative per share earnings impact of $0.03 in the same period of 2003. Pension expense for 2004 is expected to be approximately $8.7 million, or a negative earnings per share impact of $0.16. As mentioned in the press release, anticipated pension expense of 2004 reflects a 50-basis point reduction in the discount rate from 7% to 6.5% when compared to 2003. As of January 1, 2004, new hires are being added to an enhanced defined contribution plan as opposed to the company's existing defined benefit plan. Furthermore, employees from each of our acquisitions this year participate only in our defined contribution plan. Additionally, we currently anticipate making an after-tax pension cash contribution of approximately $3 million in 2004. Subsequent to November 29, 2004, the company will be able to begin recovering certain pension costs from the U.S. government under various government contracts. Based on our current pension assumptions, we expect pension expense, that of recoverability from the government, to begin moderating after 2004.

Finally, let me turn to our 2004 outlook. Management currently believes that the 2004 GAAP earnings per share in the fourth quarter of 2004 will be in the range of $0.27 to $0.30. The full-year 2004 earnings per share are expected to be in a range of approximately $1.12 to $1.15, an increase from prior guidance of $1 to $1.05. We expect the EPS in 2004, excluding pension expense of approximately $0.16, will be in the range of $1.28 to $1.31 per share, as shown in the release. I will now pass the call back to Robert.

Thank you, Dave. We would now like to take your questions. Operator, if you are ready to proceed with the questions and answers, please go ahead.

[Operator Instructions]. The first question comes from the line of John Harmon with Needham. Please go ahead.

Hi. Good morning.

Good morning, John.

I guess a couple of questions, please. Could you talk a little more about your instrument business? One of your competitors that saw -- that reported yesterday didn't see quite such fantastic growth rates and they though the environmental sides of their instrument business was kind of flat and saw most of their growth from the process sides, from the materials analysis side.

Yeah. John, we -- I think some of the environmental products that we have instruments that we have are relatively modest in their growth. On the other hand, it varies from field to field. Some of the instruments that measured NOX and others are in particular are moderately down. But some of our flow meters and other instruments are up. So, it is a kind of a mixed bag between our various instruments. On the other hand, we also have geophysical instruments that go into gas and oil discovery and those have been up throughout the year, even though sequentially quarter-over-quarter they have been down. And finally, I should note that we have acquired two new instruments companies this year, which also have helped our growth. The first one is Lehman Labs, which basically is a laboratory in Organic Water Quality Analysis Instrument Company, compliments our earlier acquisition of Tekmar Indoor organic water analysis. And the second one is ISCO, which does water and waste water monitoring and analysis, but also sells flash clonography to the drug discovery market. So, what we are seeing is kind of a difference across our instrument market that varies from environmental to process, but also all the way to drug discovery. So, overall, the market seems to be healthy from our perspective.

OK. Thank you and secondly, the margins on your systems engineering business keep defying gravity. You keep telling us they are going to trend down to 8% and they just don't seem to be doing it yet. Has something changed, or when is this -- do you think this could happen?

Well, you know, I am embarrassed to say one more time that I think they're going to come down. And the reason is really a bit on proposal expense that we keep contemplating with the spending more on that just getting pushed a little ahead. So, we know that in the fourth quarter, they are going to be lower. Whether they will be 8% or 9%, I can't tell at this time. But they will be lower than they were this quarter.

OK. Thank you very much.

Thanks, John.

Thank you. Our next question comes from the line of Mark Jordan with AG Edwards. Please go ahead.

Good afternoon or good morning. Could you talk a little bit about the Honda relationship? I would assume that you must have been doing some R&D on Spec and that when you did receive this payment that it flowed through, you know, in effect payment for prior work and, therefore, was a catalyst for the improved profitability in that segment this quarter?

Well, it's true that we have been doing development work with Honda since 2001 on the ground and flight-test evaluation of a prototype engine that was developed by Honda. But we have also been getting some payments for that work. The $2.5 million payment and two other similar payments that were going to be made in the future, this really is, in a broader context of our ongoing relationship with Honda, unfortunately, Mark, the terms of the agreement with Honda are confidential and I am not at liberty to discuss anymore than what I have just said. But I must again note that our long-term goals is, again, to see if we can certify a new engine and if we do that, then we'll establish a joint venture to manufacture, sell, and service the new engine.

Would one assume that, therefore, at the middle part of '06, following the fourth payment, that, you know, if you make that next step, that's when it would occur?

Then or maybe a little later. But I think the important thing is that they are just committed to this program and they are working very hard to develop a really exceptional engine from a very liability and performance and lower-emission perspective.

Since there seem to be some offsetting expenses, then, does the improved profitability at the engine business, is that a signal that the underlying business excluding Honda has turned a corner?

I think the underlying business, Mark, is stabilized. Let's just put it that way. And the primary reason I attribute that to, is that our insurance premiums and reserves have stabilized. You know, for a number of years, those were moving up at pretty significant clip and we didn't get much of a bump in our premiums this year and, of course, what we reserve is based on a what a - our historical experiences are. On the underlying business, we really are doing very well in the OEM. Market. And we keep picking up shares there, primarily because Cirrus, well which is the new advanced composite aircraft, is enjoying very healthy backlog and revenues and has our engine in it. So, I don't know if it's going to get much better, but I think it's stabilized.

OK. In the electronics group, you've been showing 10% operating margins. Obviously you've seen an improvement in some sectors, but you have also made acquisitions in instrument companies, which generically have a little bit better margin structure. Given the acquisitions that you've made, do you think looking into '05 that, you know, it's a reasonable goal to achieve a 10% operating margin in that sector?

I think that's a reasonable goal. But it comes both from the acquisitions, which have healthier margins, by and large, but also I must note there are two other things that enter into that, one is that we have been taking a lot of costs out of our job, manufacturing operations, as you know, by continuously emphasizing reduction in costs on our performance, 20% a year. The second is that some of our other businesses, like relays, which have both commercial and a military component, the commercial side of that has come back. We haven't seen markets, I can't say they're excellent, but they're better than they've been since about 1998-1999. So, we're getting a little pickup there. And, you know, because we have a pretty large fixed cost basis, as the revenues improve, our margins that improved significantly. And lastly, as I mentioned before, our geophysical instruments business has been enjoying phenomenal growth this year. I don't think that's sustainable. But oil and gas discoveries picked up obviously because of the gas prices and I just, this is getting to be a very long answer to a short question, but I think some of the consolidation of facilities are helping a lot.

OK.

So, that's it.

Two last quick questions. The systems engineering group, you mentioned, you know, a few contract wins over the last six months or so. You clearly had a top-line kind of revenue break out. You've been trailing somewhere in the $55 to $58 million quarterly run rate and now with this quarter being at $65 million, should we see that as a result of these contract wins and pickup in the environmental area that's been dormant for a while, that the systems group ought to be in sort of a quarterly revenue run rate in the $60 million range?

I think -- I don't think so. I think it will moderate down somewhat from there; primarily this was an unusual quarter for them. I think in the $60 million range, it would be more appropriate, maybe even a little bit below that, and as you well know, one of things that we're watching very carefully is the effect of next week's election on what will happen to our defense programs, especially as they relate to the broad-based missile defense programs which we have, we enjoy significant participation in.

Right. Final question, what would be the normalized D&A run rate for the company in the fourth quarter, assuming that Solaritech had been part of Teledyne for the entire quarter.

Let me suggest that -- Dale will answer that.

I think that the -- we've got about $18 million on a year-to-date basis and next quarter would be in the vicinity of $7 million.

You were at $7 million in the third quarter. Again, you're picking up Solaritech, or depreciation and whatever intangibles, amortization there.

Yes, they're not heavy capitalized. And the first quarter -- the fourth quarter write off associated with the intangibles, we don't know that that will be a very large number at this point. We're not anticipating it to be a large.

I guess, I am excluding that I just thought it was the normalized run rate. You would still think you would be in the low $7 million range on a quarterly basis?

Yes.

And '05 CapEx number?

We're still reviewing that at this point. It will be higher than our $20 million. But may be in between $20 and $25 million.

Thank you very much.

Thank you, Mark.

Thank you. Our next question comes from Carlos, Bank of America.

I'm sorry, operator, you're fading.

Hi, guys. This is Carlos from Bank of America. Can you hear me?

Yes, we can hear you very well.

In next quarter, I just had a couple of questions, if I can. The first, I guess you mentioned missile defense and it's something you're watching for next week and Kerry said he'd, you know, maybe would cut that in half. What is your exposure to that overall on your business?

I think we have about $50 million in our activities there. There is, though, one thing that in that program that is unique in our case. As you know, the current program is heavily aligned to deployment and we do some work there in terms of simulations, etc. Prior to deployments in Alaska, we were heavily involved in the R&D sides of that. So, my -- we have to wait and see whether if there are costs. If they're heavily oriented towards deployment, then I think the R&D side, if it's maintained, I don't think it should have a major effect on us. Because most of our work is not in the deployment side, most of our work is with simulation and the development side. So, we'll have to see how that program changes. That's assuming Senator Kerry's elected.

Right. OK and then another question, just a follow-up on the Honda payments. How should we be thinking about these $5 and $2.5 million over the next two years in terms of margin contribution? I mean, is this going to be incremental to kind of what your run rate is right now and aerospace?

I think this quarter is an indication of what the contribution would be to that. If you look at this year's aerospace earnings, we doubt that contribution and then add the $5 to next year, that would be an appropriate probably base from which to work.

So, if we do that, is that the full $2.5 that we would strip out for the third quarter?

Yes, as you look at the year, strip out the $2.5 million and then add $5 for the next year would be a starting base.

Can you talk about what your expenses have been in R&D related to this program, kind of the run rate over the last three years has been?

We actually haven't been spending a lot of our money on this specific program because we've been reimbursed for our work in the specific practice. Of course, we do some of our own R&D in the engine business, specifically within the last four years. We've been spending funds to develop electronic controls for our piston engines comparatives piston engine and those electronic controls will also be used on the new engine.

OK. And then just one final question, if you could talk a little bit more about your M&A activity, kind of going forward. It looks like you might have another two to three more deals of the Solaritech size ahead of you. Is that what you're thinking? May be just what are the targets out there? You mentioned it briefly, but if you could add a little more color, that would be great.

Sure, Carl. Basically, let's start by saying we're looking in the defense electronics and instruments and probably now we'll also start looking in the systems business, primarily because more recently, the multiples there have come down to more moderated somewhat from what they were. Our target, really targets, I should say are to find focused assets that are complimentary to what we have. And I and that hesitant to say what the quantity would be. This year, we were fortunate in that we found a number of assets that we could -- that were very attractive to us. We are going to make acquisitions that I can tell you. But as to what the quantity would be, I cannot. Well, we'd like to bolt on acquisitions, but if something larger came along, we would look at that seriously also.

OK. That's it for me. Thanks a lot, guys.

Thank you, Carl.

Thank you. Our next question comes from the line of Steven McBoyle (ph) with Lord Abbett & Company . Please go ahead.

Great. Thank you. A little bit late to the call so I apologize if repeating some of this, the Honda relationship, just curious on the terms of the contract, is there any takeout provision of certain milestones are met on your part?

I -- as I mentioned earlier, Steven, you may not have been on the line at the time the agreement is confidential. But on the broader scale, all I can say is the following -assuming that we certify the new engine that they're developing, our intention is at this time to form a joint ventures. A little bit akin to what they announced with G.E, except in our case, they would also do manufacturing and services for the new engine, but it would be through a joint venture, rather than some kind of a turnout.

OK. OK. Great. That's helpful. In the electronics segment, just curious if you could break that out commercial versus defense and whether you're seeing any incremental commercial strength of late.

Yeah. Let me just say that if you look at that segment, the defense portion of that is about a third maybe a little less than a third. In the instruments is about a third of the electronics and avionics and the rest is about a third. The three of them combined comprise about 57%, 58% of our revenues. In the commercial side, we've seen significant growth in our electronic instruments organically. We've seen about 26% organic growth and in the other avionics and other electronics, which include things like relays, transceivers for back and point-to-point radio transmission, we've seen about 14% growth, so and this is organic growth. So, in the commercial sectors, ranging from 14% to 26%, depending on which area we're looking at.

OK. That's great. And in your prepared remarks, you alluded to geophysical remaining strong, going back to last quarter where I think that portion of the business was operating at peak or record levels and I think you're expecting a revenue decline. Obviously you didn't see that. Obviously the backdrop is favorable for the product solution. But just curious in terms of the backlog or what you may be hearing from the customer set. Is that something sustainable period of time here?

I think what I mentioned in that area of geophysical instruments is that the second quarter was a record quarter for us and the third quarter came down about $5 million from the second quarter.

OK.

And we expect that to go further decline in the next quarter. Having said that, there's been a really phenomenal year for that and I think those are circumstances, unusual circumstances due to oil discovery activities picking up. Having said that, going forward, we think there are going to be more moderate revenues from this, but we have developed a whole new technology for that domain. These are towards the race, which are come out of a toll that is generally today filled with mineral oil and if it's punctured, it is not very environmentally friendly. We have developed a gel filled, a kind of solid throughout the ray, which is both environmentally friendly and it also helps improve the signal to noise performance of the rays. So, we expect to kind of have a reasonably good program there. And finally, we are taking some of these products into the military market. And that depends, again, how that develops. We think this is going to be a healthy business for us, but certainly not at the level we had this year.

And that new program that would start contributing when, do you think?

Well, we already have been producing some development products, which have been successfully tested by our customers.

Great. And on the systems engineering side, obviously on the operating margin question, I think you have alluded to bid and proposal costs. Obviously expecting that the margins would come down due to that. Can you give us a sense -- I always was under the impression that there is a good portion, also, being driven by these award fees related to the Boeing contract. Has that cycled now and really it's only the bid and proposal costs going forward that is going to hamper the profitability?

Pretty much you're accurate, yes.

OK and again the bid and proposal activities solely on the environmental side of the business?

No. That would be one apart. I think the bid on proposal activities are across the board. There are new opportunities in two of the three major areas, both environmental, as well as our technology operations.

And on the technology operations front, should I interim that as not missile defense, but more of the generic space programs?

No, it would -- it's not missile defense, but we do other work there. We do systems engineering and technical assistance programs, as I mentioned before, where we help the government in evaluating their own programs and the performance of their programs and that area has been growing for us. And so we spend money trying to get more programs in that area.

Great. Thank you for taking my questions.

Thank you.

Gentlemen, there are no further questions at this time.

Thank you very much and thank you all, operator. I'd now like to ask Jason to conclude the conference call.

Thank you, Robert and thanks everyone for joining us this morning. And if you have any follow-up questions, please feel free to call me on the number on the release and again all these releases are available on our web site www.Teledyne.com. Operator, please conclude the call.

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