Teledyne Technologies Inc (TDY) 2005 Q2 法說會逐字稿

Welcome to the Teledyne second-quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and- answer session. Instructions will be given at that time. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Jason VanWees. Please go ahead.

Good morning, everyone. This is Jason VanWees, Director of Corporate Development and Investor Relations at Teledyne Technologies. I would like to welcome everyone to Teledyne Technologies' second-quarter earnings release conference call. We released our earnings earlier this morning.

Joining me today are Teledyne's Chairman, President and CEO, Robert Mehrabian, Vice President and CFO Dale Schnittjer, and Senior Vice President and 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 this 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 via webcast and dial-in will be available for one month. Here is Robert.

Thank you, Jason. Good morning, everyone. The second-quarter earnings release was issued earlier this morning. I won't go through all the details, but I'd like to make some introductory comments about the quarter, followed by observations on the performance of the various segments.

To begin, this was another outstanding quarter for Teledyne, achieving both record revenues and net income. Furthermore, earnings per share increased year-over-year for the 14th consecutive quarter. Total organic growth during the second quarter was 14.4%. This was our fourth consecutive quarter of double-digit organic growth. Operating margins for the overall Company and our electronics segment also remained near record levels.

Favorable market fundamentals in the majority of our businesses, coupled with strong execution to our lean manufacturing initiatives, resulted in our outstanding performance during the quarter. Another important contribution to this performance is Teledyne's improving ability to successfully integrate acquisitions into our existing portfolio of businesses. In my comments later regarding the electronics and communication segment, I'll discuss the business we acquired at the end of the second quarter. Also, in the government systems engineering segment, I will comment on our initial success in reentering the UAV market.

I will now elaborate on the operating performance of our business segments, followed by Dale Schnittjer, who will discuss in more detail our financial performance and comment on our outlook for 2005.

Turning to our business segments. Second-quarter sales in our electronics and communications segment increased over 31% compared to last year, from 134.6 million to 176.5 million, with organic growth up 8.7%. Operating profit increased 46.5%, with operating margin up over 120 basis points compared to 2004.

As I further discuss our electronic and communication businesses, I'll break up my comments into three separate categories -- first, defense electronics; second, electronic instruments; and third, avionics and other commercial electronics. Each of these three groupings currently contribute approximately one-third to our electronics and communication segment sales.

In the second quarter of 2005, sales of defense electronics increased approximately 66% compared to the second quarter of 2004. Excluding the acquisitions of Reynolds Industries and Celeritek defense assets, organic sales growth in the second quarter was approximately 27%, as sales in the majority of defense electronics products and services grew at double-digit rates compared to last year. Examples include solid-state devices for electronic warfare and manufacturing services for printed circuit card assemblies used in infrared countermeasure systems.

On June 30, we completed the acquisition of Cougar Components, our tenth acquisition as a public company and our third acquisition related to the defense microwave market. The acquisition of Cougar fills a gap in our defense electronic and services offerings. Teledyne has a long history as a supplier of custom microwave, microelectronic and optoelectronic products for military and space applications. But that is only a limited range of standard products for these markets.

Cougar adds a line of catalog, RF and microwave amplifiers that is highly respected and one of the most extensive in the industry, permitting Teledyne to be the single source of supply for both commercial off-the-shelf (indiscernible) and custom products for electronic warfare, radar and communication systems. We also anticipate that already extensive Cougar catalog can be an expanded by adding new products, including modules that employ Teledyne's high-density packaging technology and Optoelectronic manufacturing capabilities.

Turning to our electronic instrumentation businesses, in the second quarter of 2005, year-over-year source total sales of electronic instruments increased 22% compared to last year, mainly due to sales growth through the acquisition of Isco. Organic sales, however, decreased 14.5%, primarily due to unexpected significant reduction in sales of our geophysical sensor product line, which serves the petrochemical exploration market. However, due to recent order activity, we expect to see improved sales in this business towards the end of 2005.

Finally, I'll discuss our avionics and other commercial electronics businesses. In the second quarter of 2005, sales from these businesses collectively increased 13% from the second quarter of 2004. This growth was all organic and resulted from increased sales in several product lines, most notably in broadband wireless assemblies, electronic relay and commercial contract manufacturing services.

Before moving on, I'd like to emphasize some achievements related to our 2004 acquisitions. Because the deals did not close prior to the second quarter of 2004, the sales from Reynolds and Celeritek's defense operations and Isco operations do not appear in the strong organic growth numbers for this quarter. Nonetheless, each of these businesses today is recording sales in excess of their sales at the time of the acquisition.

This increase in sales has occurred concurrently with some major cost reduction efforts, such as the relocation of Celeritek's operation and the pruning of noncore businesses from Isco. The purchase and successful integration of these businesses has been a significant contributor to our recent earnings performance.

Turning to our government systems engineering segment, in the second quarter of 2005 revenues in this segment increased 14.9% compared to last year, while operating was relatively flat due to unexpected decline in the operating margin of this segment. Nevertheless, the operating margin of 10.6% is quite attractive for this cost-based government services business.

In the second quarter, sales increased in each of our major functional areas, including our traditional missile defense and space programs, as well as our newer environmental programs. As we forecasted in our recent outlook statement, we saw moderation in the growth of certain environmental programs related to the chemical weapons demilitarization.

As I noted earlier, a significant development for this segment is the announcement made two days of a $3.7 million first phase award of the Class 3 Unmanned Aerial Vehicle development and demonstration under Army's future combat system program. Teledyne's contract is one of three awards for this phase. Last year, we made a strategic decision to re-enter the UAV market when we formed an alliance with Rheinmetall Defense Electronics of Germany, who had developed a very modern autonomous UAV for the German army.

This vehicle, which already meets the majority of the Class 3 baseline program requirements, is the baseline for our prospector UAV, which will be further developed in this new program and be manufactured in Teledyne Brown's manufacturing facilities in Huntsville Alabama.

We believe Teledyne Brown's engineering (indiscernible), engineering and integration skills will ensure that the prospector system will have the flexibility to perform effectively in the complex system of systems environment of the modern battlefield. Furthermore, as the premier manufacturer of piston engines, Teledyne brings extensive design, testing and manufacturing resources to this class of UAVs, which generally use piston engines.

Now turning to our Aerospace Engines and Components segment, sales during the second quarter of 2005 for our aircraft piston engine business increased approximately 7% relative to last year, and resulted from record sales to OEMs. In the turbine engine business, sales increased by better than a factor of 4 compared to last year, primarily due to timing of shipments. Sales in this business tend to be especially cyclical and second quarter of 2004 was the seasonally lowest quarter of 2004.

Strong sales in the second quarter of 2005 resulted from increased sales of turbine engines for Improved Tactical Air-Launched Decoy Harpoon engines and JASSM programs. However, because of the favorable timing in the second quarter, we anticipate weaker sales in the turbine engine in the second half of the year compared to 2004.

Operating profit improved significantly in the second quarter of 2005 compared to last year as a result of both operational improvements in the piston engine business, coupled with strong deliveries of turbine engines.

Finally, in our systems engineering segment, revenues in the second quarter of 2005 increased by 40% compared to the second quarter of last year, and operating profit increased as well. Given the substantial multiyear government programs we have won and the recent improvements in orders for hydrogen generators, we continue to expect the segment to remain profitable despite R&D investments in hydrogen generation and fuel cell technologies. However, as we mentioned in our previous and current outlook statement, we continue to expect sales in the second half of 2005 to be lower than the second half of 2004.

To summarize, this was another outstanding quarter for Teledyne. Our strategy remains the same. First, continue to focus on operational excellence and margin expansion programs. Second, invest in organic growth initiatives and find and successfully integrate acquisitions in the defense electronic, system engineering and regulated commercial electronics market. I will now turn to 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. Then I will give an update on pension costs and discuss our 2005 outlook.

In the second quarter, cash provided from operating activities was $29.7 million, compared with cash provided from operating activities of $18.4 million for the same period of 2004. The higher cash flow in 2005 was primarily due to higher net income and reduced working capital requirements, partially offset by higher pension contributions.

Free cash flow was $25.6 million in the second quarter. Also during the quarter, we purchased Cougar Components for $26.5 million; however, 1.5 million will be paid at a later date. The acquisition of Cougar also included assumed net debt of $600,000. Finally, option proceeds received in the quarter were $600,000. The end result of these items was that net debt for the Corporation decreased $600,000 and we ended the second quarter with $57.4 million of net debt.

Our balance sheet remains strong with a net debt to capital ratio of 16%, which provides flexibility for future acquisitions in our strategic businesses. As shown in our press release, capital expenditures for the second quarter of 2005 were $4.1 million compared to $2.7 million for the same period of 2004. For the second quarter of 2005, depreciation and amortization expense was $6.1 million compared to depreciation and amortization expense of $5.8 million in the second quarter of 2004.

As we have stated before, declines in the capital markets in prior years and adjustments and pension assumptions have resulted in an increase in FAS 87 pension expense and the requirement to make pension contributions. However, subsequent to November 29th of 2004, the Company is able to recover a certain pension cost from the U.S. government. Pension expense allocated to various contracts pursuant to U.S. Government Cost Accounting Standards, or CAS, can generally be recovered through the pricing of products and services to the U.S. Government.

In the second quarter of 2005, FAS 87 pension expense was $3.1 million, or negative earnings per share impact of $0.06. This compares to FAS 87 pension expense of $2.2 million, or a negative earnings per share impact of $0.04, in the same period of 2004. However, in the second quarter of 2005, pension expense allocated to contracts pursuant to CAS was $2.3 million, or a positive earnings per share impact of $0.05 compared with no allocation in the second quarter of 2004 because we were prohibited from charging CAS pension costs to the government prior to November 29th of 2004.

As we have mentioned before, starting January 1st, 2004, new hires have been added to an enhanced defined contribution plan as opposed to the Company's existing defined benefit plan. Furthermore, employees from acquisitions will participate only in our defined contribution plan.

Now let me turn to the 2005 outlook. Management currently believes that GAAP earnings per share in the third quarter of 2005 will be in the range of 36 to 38 cents. The full year 2005 earnings per share are expected to be in the range of approximately $1.67 to $1.71 compared to our previous outlook of $1.50 to $1.55, or $1.55 to $1.60, excluding stock option expense.

We currently anticipate $12.7 million, or 23 cents per share. in pension expense under FAS 87, or $3.4 million, which is $0.06 per share, in net pension expense, after recovery of allowable pension cost from our CAS covered government contracts.

Full year 2004 earnings included $8.7 million, or $0.16 cents per share, in pension expense under FAS 87, or $8.2 million, which is $0.15 per share in net pension expense, after recovery of allowable pension cost from our CAS covered government contracts.

The assumed FAS 87 discount rate is 6.25% in 2005 compared to 6.5% in 2004. Beginning with the first quarter of 2006, the Company plans to record expense for stock options in accordance with Financial Accounting Standard Board Statement 123R, which covered share-based payments. Since we now plan to expense stock options in 2006 as opposed to the third quarter of 2005, we have revised our outlook accordingly. That is, $0.05 of the increase in our current full year outlook is due to postponing the adoption of FAS 123R.

I will now pass the call back to Robert.

Thank you, Dale. We would now like to take your questions. Stacey (ph), if you are ready to proceed with the questions and answers, please go ahead.

(OPERATOR INSTRUCTIONS) John Harmon with Needham & Company.

Hi, good morning. Again, I think I have asked this a couple times, but they ticked down a little bit in the second quarter, but the margins on your systems engineering businesses still continue to defy gravity. What you think is the timing where they would revert to that normalized 8% level, if anything changed in that?

Well, as you know, they have declined from last year. Last year's second quarter, the operating margin for this business was 12.3%. This year it's 10.6%, as it was in the first quarter. We think by the end of the year that will go down closer to the 9% level. Maybe not 8, but perhaps the 9% level.

Okay, thank you. A second question. Just regarding your guidance, it looks like on both ends you raised it by about $0.16, and you said a nickel related to stock option expense. So that additional $0.11, does that relate to improved outlook in your business in the second half or just greater visibility?

Nine of that was really, John, the performance in the second quarter, which was above what we projected earlier. So I think if you put all of that together, including the stock option, we're raising our overall second half somewhere between $0.02 and $0.04 from previous guidance.

Okay. And just quickly, finally, stock option expense. If it would have been a nickel in the second half, therefore, would it be about a dime for 2006?

Yes, I think somewhere between 10 and $0.11 is our current estimate. The other thing in 2006 that would provide some negative comps to this year is that this year we received two Honda payments of 2.5 -- we received one Honda payment in the first quarter of $2.5 million and anticipate receiving a second one in the third quarter of this year. We anticipate receiving only one payment next year. So there is another nickel that in terms of direct comps that will come off next year because of the Honda payment.

Right. Thank you very much.

Thank you, John.

Mark Jordan with A.G. Edwards.

Good morning. everyone. Talk a little bit about margins again in the electronics group. I mean, you have some moving pieces with acquisitions which seem to be having a favorable impact on margins. Also, looking out a little bit further, Boeing seems to be looking like they're going to be ticking up production, which would be advantageous for sales and margins in that sector.

Historically, you've been in sort of the 10 plus percent operating margin arena for this business. The first couple of quarters here you are sort of 11.6, 11.8. Given the acquisitions you've made and probable improvement at places like Boeing next year, is this business moving towards a middle 11% operating margin business?

Thanks, Mark. I think you are absolutely correct. Margins have improved year over year, especially in the first quarter. You know, we went from what in 2004 was 6.9% to 11.6. And as you noted we've also improved from second quarter to second quarter another 120 basis points. So we are at 11.8. We think the margins in this business might moderate down a little bit, but not below 11% for the remainder of the year.

Next year, not just Boeing but Airbus is doing okay too, and we've been gaining market share there. We think we should do all right. On the other hand, in our avionics businesses, we make substantial R&D investments in new products. Like right now we are developing the electronic flight bag, where we are sole source for Airbus aircraft. We are spending a significant amount of R&D in that domain, and we still have work that we are doing in the wireless ground link.

So we balance the earnings potential with the amount of significant dollars that we have to spend in developing new products in that area.

You had mentioned that you're expecting the final payment from Honda of 2.5 million. I assume that would be the first quarter of '06. When is the decision point relative to the next step that that relationship may take?

My guess sometime near the end of next year. They are hard at work with our help on a new engine. The concern on both parts is that if we're going to introduce a new engine, it should have substantial improvements in reliability over existing engines. Now, existing engines are already quite reliable because we've been at it for 75 years and we've made incremental improvements.

But their desire and our desire is if we're going to come out with a new engine that it have a significant advantage in one domain or another, including electronics controls. So it's taking us longer -- taking them longer to develop what both of us feel would be a really robust engine, way above the kinds of products that are available in the market today.

Okay. Talking again about your engine business, two questions. One, was there any hurricane damage in Mobile, with the hurricane that went through there early in the month? And secondly, if I remember, May is your traditional reevaluation or reupping of your insurance relationships. Could you tell us how that has evolved?

On the hurricane, Mark, we were fortunate both this year as we were in the prior hurricanes in the recent hurricane. We had minimal damage. Maybe about $100,000. But obviously, what the hurricane did is because of the evacuations, it set back our production about a week, and we have to come back and double our overtime to catch up. But I think overall, it didn't have a significant effect.

On the insurance renewal, we had a good experience this year on that. We were anticipating that the markets were hardened (ph) again, we're anticipating to get a little bump in our insurance premium. We actually got a slight decrease in our premium, keeping everything else the same. And over that, that really would result over an annualized savings of just under $1 million, which to us is significant because we are always worried about that insurance going up as it has historically.

Okay. A final question -- sort of a little more speculative one. Looking out to '06, you've quantified two sort of what I call semi nonoperating related items that are drags, being pension and Honda, on a net basis, being about a $0.15 incremental drag. You have had exceptional margins in systems, probably see a continuation of pretty good trends in the electronics group.

If you were looking at '06 versus '05, is your assumption that you could potentially generate -- is it a single digit kind of growth next year, given these swing factors, or a generic -- still a good shot for a solid double-digit growth?

Two things. The drag in next year, as Dale mentioned, is not on pension. We think pension is going to be year-over-year relatively flat. It's the option expensing --

Excuse me -- I meant (multiple speakers).

-- on the Honda, right. And so, between the two of those, we have about a 15 to $0.16 headwind. I think pension we may have another $0.02 out of that. So I think we would agree we have about $0.18 headwind from those. So let's put that aside.

It's a little early for us to be able to predict the earnings growth for next year. Because of a whole set of things that are happening, ranging from changes in the instruments market that -- within specialty life sciences market, that it is not as strong as it used to be. And we think we may have some declines in systems engineering in the second half and can't predict.

And the other thing is our acquisitions have helped a lot this year, including acquisitions that we made prior to the second quarter of last year. So finally, some of our communication products on these jets are getting long in the tooth, like MagnaStar. And there are some alternatives, so we are going to see some declines there. So when you roll all of that together, I'd like to at least stay with our mid single digits organic growth as we always have, and then pray for the best.

Okay. Thank you very much.

Chris Quilty with Raymond James & Associates.

Robert, that was a good job of downselling the future.

Chris, thank you.

We know what that means, though. A question for you. You mentioned some gains in savings from acquisitions. Can you give us a look back on some of the larger acquisitions, like the Isco one that you did. You had quantified some savings out of the SG&A of those organizations, and what the actual outcome was. Was it in line, better or worse than expected?

I tell you, Chris, let me just go over Isco in particular. When we make an acquisition like that, we have a model that we present to our Board. And what happened is that we did meet our model's goals, but now we've exceeded it, because Isco had two product lines that were not profitable. And we sold those product lines, and there was some R&D associated with that and brought down some of our SG&A also. So overall, Isco's performance -- and driven by market -- has improved significantly.

And then the other thing about Isco which we had in our model, of course, was they were a public company and their public cost between $ .5 million and $1 million, and that also helped us.

Going to Reynolds, which is another reasonably sizable acquisition with revenues of about 40 million plus, there we've again enjoyed some improvement, and really there primarily the improvements have come from unexpected improvements in the production of cable assemblies for joint helmet mounted cueing system. This is a helmet that a pilot can look at a target and be able to discharge the weapons. That market overall for Reynolds has also been very advantageous for us. So I would say those are two examples of where acquisitions have worked better than we have anticipated.

So net-net across the board, if you rolled in the last two years of acquisitions where you have gotten more aggressive, the overall experience has been better than you projected?

Yes.

Okay. On a go-forward basis, is there a particular area of acquisition that is looking relatively more attractive? You've been active in defense and instruments as the two primary --.

We are also beginning, Chris, to look at systems engineering acquisitions in the systems engineering domain, primarily because the prices there have moderated somewhat, especially in the smaller acquisition. And so we are actively looking there also.

Okay. Speaking of systems engineering, does the pickup in NASA activity, albeit maybe abbreviated after this launch, does that have any implications for your systems engineering business?

No, I don't think so. I think those programs are very long-term programs that we have there. I don't see a pick up. We've never had a big slowdown or a big uptick. I mean, it is a little early to tell. One area that I mentioned is system engineering, which may not contribute to our profitability in the immediate future, is our initial success which we are very excited about is Teledyne's reentering in the UAV market. And that I think in the long-term has -- if we are successful after Phase I -- that has some very positive outlook for us.

Okay. On ground-based missile defense or missile defense in general, that budget has generally been taking a hit in most forward projections. Does that have any impact on the Teledyne Brown operations?

We think so. We think there is going to be some short-term negative impact. But in the longer-term, assuming BRAC plays out the way it has been slated to play out, the missile defense activities are going to be focused -- the administrative and structure is going to be focused in Huntsville. A lot of those activities are moving to Huntsville. But that will be in the 2007 time frame. So, if you look at the longer term, assuming BRAC plays out the way it does, we think it will be good for Brown.

Great. Thank you very much, gentlemen.

Thank you, Chris.

Karl Oehlschlaeger with Banc of America.

Another great quarter just blowing out the numbers here. I guess looking into the second half of the year, you see some moderation in the results. I guess even including this Honda payment, you'd expect -- you'd guess to kind of come down quite a bit. That is kind of where you are comfortable. What is the probability that you are going to have upside? You've had it so much over the last couple of quarters and have been really impressive. What sort of -- I don't know the best way to kind of talk about it. But what is the probability that you could do better than you are expecting?

Well, we think the organic growth we've experienced, double-digit organic growth, is going to decelerate. By the way, we did up -- even if you look at -- as Dale mentioned -- even if you look at the significant improvement in earnings that we had in the second quarter over last year and over what we projected, and you put back the nickel from stock option expense, we have raised our third and fourth quarter 2 to $0.04 over what we had three months ago.

So relative to the second quarter and the first quarter, you are right, we are seeing some deterioration. But relative to our earlier projections, we are actually increasing the second half.

We think that we are going to have some slowdown in our instrument businesses, especially in things like life sciences. A lot of the companies, pharmaceutical companies, are under some pressure. And we think there is going to be some negative effect on our programs there, in a variety of instrument programs, especially in our flash chromatography. Also, turbine engines, we see a decline in the second half because we've pushed out a lot of the product earlier in the second quarter.

We think Energy Systems is going to go down somewhat. That is just a problematic issue, timing issue. And we've talked about systems engineering.

On the upside, it is possible that our relays and some of our avionics programs will keep the momentum up. We think that in the second half on the upside, we may have better sales of our stimel (ph) cables for offshore drilling. You know we had a very weak second quarter compared to last year. So that could be an upside.

And we also think that it's possible that our programs that we have especially in high voltage connectors will continue in the second half of the year, the improvements we have seen. So there is some upside, but there is balance versus the downside. And when we issue guidance, we go through fairly detailed analysis of upside and downside. And sometimes both of those happen the way we projected; sometimes one happens and the other doesn't. That is the best answer I can give.

Okay. You spoke briefly about M&A and you're focusing on systems engineering, I guess, as a focus. Can you talk a little bit more about that and kind of your strategy and how the market looks now, what pricing is like for the assets that are out there that you are targeting?

First, our biggest customer in that area is the Army. As we look at the strategy -- and we're also Huntsville-centric; we have a lot of work in Huntsville. As we look at that, we'd like to do two things. We'd like to expand our customer base to be able to serve other branches of the military, the Navy and the Air Force specifically. And we also would like to expand our base broader outside Alabama somewhat, even though if we find some something exciting in Alabama, we would certainly consider that.

The other is environmental opportunities. And now that we've reentered the UAV market, you may or may not recall, Teledyne had very strong programs in UAV. Teledyne Ryan Aeronautics, we developed the Global Hawk, flew it. And unfortunately, that business was sold to Northrop before our spinoff. So we have a long history in the UAV market, and if we find something interesting there, we may acquire.

Working the intelligence domain is another area that is consistent with the kind of things we have done before. And then finally, in terms of price, on the smaller acquisitions, multiple of 10 on EBITDA is likely. It has higher than what we are used to paying. On the average, everything we've done -- if you roll everything we've done so far, we've paid about 8.1 times EBITDA for the last ten acquisitions. So again, maybe 10 to 20% higher than that, that is our guess.

Okay. That is it for me. Thanks, guys.

Stephen McBoyle with Lord Abbett.

Thank you. Perhaps to first approach the guidance and the outlook in the back half a different way. To the extent that you, absent the puts and takes, have increased it by 2 to $0.04, perhaps another way of asking it is, what is it that you are anticipating is going to be better in the back half than what you had originally expected, that what account for that 2 to $0.04 pickup?

Stephen, the primary thing in the electronics domain is going to be geophysical instruments, which we think will improve in the second half versus what we previously thought. And that's because we have some orders in hand at the present time.

The other two things are that we are getting better orders in our wireless ground link, which is the product that we provide airlines, especially on Airbus, that enable the airlines to send flight data from the sensors and operations to their operating centers as the aircraft lands. We have better orders there. And those are the two areas.

The other one is that, as I discussed before, we do have some positive comps after May in our insurance for our piston engines, so we are making that into the outlook.

Maybe just take a couple of those in parts. The geophysical instruments, you've often talked about that reducing over time here. Maybe you can just refresh me -- I think at one point in time that it was a $30 million business. Is that to infer that it has troughed and is there any possibility of an indication in terms of a book-to-bill that would give us a sense of just how much it may pick up in the back half relative to what the current run rate is today?

The second half year-over-year, the second quarter in geophysical instruments was not actually above (ph) $5 million.

And that is year-over-year?

Year-over-year. It went from what was last year's first-half -- let me just go first half to first half. Last year first half was about $19 million. This year first half was more like 15.5 million. And that has got a fixed cost base, so profitability improve significantly as the sales improved.

Third quarter, we think is going to be about what it was last year's third-quarter. So while we don't see a lot of improvement, we don't see deceleration. Last year we had a pretty slow fourth quarter; we think this year we will have a better fourth quarter in that domain. And it is primarily because we are doing two things -- we are benefiting from the outsourcing of our customers, who are focusing more on exploration rather than manufacturing, so that we've gotten recently some good orders in that area.

And just curious, are those from existing customers or new customers? Does the addressable market actually increase?

Both.

Both?

Both. And we've also introduced a new product there. Historically, these steamers have been oil-filled. And the newer product that we've introduced is gel-filled, which is a harder substance, less likely to have leakage. And others have tried to put what they call solid steamers, and not successfully. The product that we have introduced has been relatively successful in initial trials. And that has helped us.

You talked about that, I guess, a couple of quarters back. Is that in trial, is it in commercial use? And should one think of that as a substitute or is that actually increasing the market size?

It is both. First, it is commercial now. Second, it is substituting for existing steamers' cables and it is also increasing our market share because it is a new product. The older product generally that we were chip producing would be in the repairs of existing steamers that we have. They probably will not flip over to the new technology.

Okay, great. Maybe the second part. The wireless ground link, obviously you have had some success there and you've been gaining share at Airbus. Is that just a continuation of, again, same market being addressed and benefiting from past share gains, or is there anything else structurally or competitively changing in your favor there?

The wireless ground link is a fairly new product. It's only been there a couple of years and it is not widely used. We have new customers that we have recently signed on in that, customers like air Berlin, China Eastern, etc. So it is really expansion of the market for a new product.

Okay. On the insurance, the third point that you mentioned. So that renewal occurred in May and you're effectively assuming a $1 million savings in the back half over '04 second half -- is that correct?

We are not assuming, we know what it is. It is about $1 million, slightly under 1 million over 12 months, which would be June to May.

June to May, okay.

This is our premium. We still are reserving what we've reserved historically.

Yes, and that is where I was going to go next. To the extent that you were, I think, previously reserving some 26 million, based on the renewal experience that you had, is there a meaningful amount that comes out of reserves or is that effectively what is occurring in the back half that's netting out and giving you the savings?

Stephen, I'm going to let Dale answer this, because the reserve is not 27, 26, 27 -- that is the combination of the premium and the reserves.

Okay.

The self-insurance reserve is the 25 million that has been talked about before, but we do not reserve that amount on a regular basis. And as Robert said, we look at our experience in the past to determine what the reserve should be. And the $1 million reduction or thereabouts, we will only see half of that in the last half of the year.

Okay. Just turning to defense electronics. Generally speaking, the organic rate of growth there has continued to impress me and accelerate. And I'm just curious how sustainable that is, knowing that it likely isn't. But what on a go-forward basis would you assume is an appropriate organic growth rate? And the organic growth rate that you had been showing, are those specific programs that you are benefiting from there? And if so, what are they?

First, let me answer the first part of the question. Organic growth, excluding acquisitions that we've made within -- we count acquisitions -- if we made an acquisition in the full second quarter of last year, then that would be full second quarter of this year. On the other hand, if we've made an acquisition and the third or fourth quarter, like Celeritek, then we don't account that in the organic growth.

Organic growth year-over-year has been essentially in the 20% range. This quarter it was 27%. And the other thing is that last year versus 2003, we had some declines in the organic growth year-over-year. So the comps have become a little easier than they were. So that is one part. So the organic growth (technical difficulty) somewhere between 16 and 20% is what we are experiencing because of those.

The flip side of it is that we are seeing a number of areas where we are doing okay. And first, overall, we are seeing some demand for our traveling-wave tube business consistent with replacement rather than a fairly new product. And that keeps going on.

The other thing is the primes (ph) are outsourcing more. We've switched the emphasis on our electronic manufacturing to be much more focused on our military customers, and we've enjoyed some successes in that domain.

And the other thing is that the acquisitions that we've made, especially in the microwave area, and now more recently the Cougar acquisition, has enabled us to go to our existing customers with a broader spectrum of products than we had before. So we now have an acquisition that doesn't have exposures to a given customer that we're already dealing with that we are able to put a broader range of products in front of them, so are able to grow the market for that acquired company better than it was before. And that was one of the reasons I mentioned earlier that we've had some success in that domain.

And then lastly, as I mentioned before, there are specific examples like the pilot helmet program that we have that has also helped us in -- that was unexpected. On the other hand, it is a very successful program.

Great, that is very helpful. Just on Reynolds, I'm curious there -- always good to hear management (indiscernible) paying for business and being surprised on the upside. Can you just elaborate in terms of how much larger the market may have gotten there? Because as I appreciate it, it may be much larger -- and again, I recognize it's a small business, but maybe they are considering it for second seat -- maybe it is pilot-specific versus plane-specific. Just curious looking over the next 12, 24 months what the opportunity there is?

We think that -- both the U.S. Navy and the Air Force have reported favorable results for our joint-mounted helmet mounted cuing system. We also had had some very positive comments from the pilot. And some of the aircraft like the F-18 where you have two seats, so far that has been used in the front seat and it is quite likely that you would now want to put it in the second seat on the aircraft as well.

Long-term, we think there's going to also be support program for repair and refurbishing of this product. So overall, we are hopeful. Actually, this is one area that we think we should be looking for the connector -- sophisticated connector domain, we think we should be looking for acquisitions.

And then finally, Stephen, the other thing is, as you know, we have a fairly well-defined very methodical program for taking manufacturing costs out of our plans. Every time we make an acquisition, we bring those programs to the new entities. And some of the trends that we enjoy are because of that.

Okay. Maybe last question. Just curious if you could elaborate a little bit more on the electronic instrument side. You made some comments with regards to life sciences slowing down, and obviously we are all aware of the poor, deteriorating pharma spend. Can you just talk about whether you are seeing that today or is that just a possibility, given commentary in the marketplace?

Because certainly, looking at some of these life science companies today, whether it is Waters, Millipore, you name it, they certainly seem to have had a change in their outlooks favorably more recently. So I don't know if that is a good indication for your business, but just curious if you could elaborate on that point. Thank you.

Thank you, Stephen. If you look at our instrument business, we have to break it up into its various components. As you know, we are involved in environmental products as well as pharma products. Staying with the pharma product, the demand for our flash chromatography has been very strong. But it has begun moderating recently. So we don't know going forward how that is going to play out.

We are introducing new products continuously. And we've had competition that has not done as well as they did previously, but we think they are going to obviously make a comeback. So we think that we will be adding new flash instruments, flash chromatography instruments to this domain.

On the other hand, if you look exclude Geo, which we said is a cyclical business and we -- as you and I talked, we had a significant downturn in the second quarter; expect to pick it up in the last half of the year -- if you exclude Geo, organic sales in the instrument business were flat year-over-year. And we are not to projecting that to improve at this time.

Obviously, we follow Waters, Varian and others -- PerkinElmer, Thermo. We follow those, but we see those results a little later than some of those guys.

Great. Thank you very much.

Thank you, Stephen.

Chris Quilty.

Just two quick housekeeping questions. First one, unless I'm running the calculation incorrectly, it looks like your common stock equivalents were down in the quarter despite what was a stock price moving up. Is that merely due to the exercise of options that moved into the weighted instead of the fully-diluted share base?

You mean quarter-over-quarter or year-over-year? Because year-over-year, our common stock equivalents went up about 4%.

No, quarter-over-quarter. It looks like they dropped by a little over a half million.

The quarter-over-quarter, actually they went up by 100,000 shares. They are at 34.5 this quarter and I think, fully-diluted, I think they were 34.4 in the first quarter. I'm having somebody check that. I hate to guess, because I know you probably have those numbers in front of you.

I may not have punched them into my model correctly. I've got like three different models going right now.

I think in the first quarter we have 34.4 and in the second quarter we have 34.5. We think that is going to go up in the next two quarters to 35, about.

Okay. And second question, I'm no pension guru, so can you just tell me in simple layman's terms the decision to delay CAS 23, what were the factors you considered in doing that? And obviously there is an EPS benefit, but is there any downside to that decision or longer-term ramifications?

We've never said we would do it in the second half. We said if we were going to do, it would be a nickel. Frankly, because of the changes that have occurred at the SEC, and we weren't sure what would happen to that domain. Now that the new incoming chairman of the SEC, assuming he gets confirmed, has indicated that he is likely to support the stock option expensing versus what he had set forth as a Congressman, which was opposing it, puts enough uncertainty that we think we ought to wait until the thing is mandated for sure. I think it was just the prudent thing to do.

Most of analysts, on the other hand, had taken that into consideration anyway. And I think we wanted to make sure -- not all of them, though, I must say -- we wanted to make sure that we had some consistency in the way we were doing first and second half and overall the year. Even though we are going to have difficult comps next year, we will have to deal with that.

Okay. Very good. Thank you, gentleman.

Thank you, Chris.

At this time, there are no questions in queue. Please continue.

Thank you very much, operator. I'll now ask Jason to conclude our conference call.

Thanks, Robert. Again, everyone, thank you for joining us this morning and if you have any follow-up questions, please call me at the number listed on the earnings release. And as always, all news releases are available on our website, teledyne.com.

Operator, if you could end today's conference call, please. Thank you.

Sure. Ladies and gentlemen, this conference will be available for replay after 11:30 AM today running through August 28 until midnight. You may access the AT&T replay system at any time by dialing 1-800-475-6701. International participants dial 1-320-365-3844, and when prompted, enter the access code of 787308.

Those numbers again 1-800-475-6701 or 1-320-365-3844, access code 787308. That does conclude our conference call for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.