Teledyne Technologies Inc (TDY) 2006 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Teledyne first-quarter earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (OPERATOR INSTRUCTIONS). As a reminder this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Jason VanWees.

Good morning. This is Jason VanWees, Vice President corporate development and Investor Relations at Teledyne. I would like to welcome everyone to Teledyne Technology's first-quarter 2006 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 CFO, Dale Schnittjer and Executive 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 of both via webcast and dial-in will be available for about one month. Here is Robert.

Thank you, Jason, and good morning. I would like to make some introductory comments about the quarter followed by observations on the performance of the various segments. To begin Teledyne is off to a great start in 2006. Both revenue and GAAP earnings per share were at record levels, and year-over-year earnings per share increased for the 17th consecutive quarters. Sales grew 11%, while earnings per share increased 10.9% compared to 2005.

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-- margin, that is earnings before interest and taxes divided by sales, increased 25 basis points from last year despite a number of headwinds that impacted margins by approximately 110 basis points. This included 25 basis points in greater pension expense, primarily due to a lower discount rate, 42 basis points in non-cash FAS 123(R) option expense, 22 basis points due to increased amortization associated with our recent acquisition and 21 basis points due to some charges associated with the (indiscernible) productline. Again, we are quite proud of our performance this quarter and due to strong execution of our operational excellence initiatives, as well as focused acquisitions, our financial results improved despite the headwinds noted. Furthermore, we continue to believe that Teledyne is well positioned in a number of attractive, growing markets including defense electronics, commercial aviation, environmental monitoring and oil and gas exploration (technical difficulty) of last year. Excluding the acquisition of Teledyne Cougar and the microwave assets purchased from Avnet Inc., organic sales growth of defense electronics was approximately 11% as sales in several defense and electronic product and service categories increased compared to last year.

I should note that this was the fifth consecutive quarter of double-digit organic growth in our defense electronics businesses. We have continued to see strong growth in defense microwave products as well as increased manufacturing services resulting from the outsourcing of printed circuit card assemblies from defense prime contractors. Turning to our electronic instrumentation businesses, in the first quarter of 2006 year-over-year sales of our electronics instruments increased approximately 37% compared to last year from $55.1 million to $75.4 million due in part to the acquisition of RD Instruments and Benthos, Inc. Organic sales of instruments increased by 10.2%, primarily due to significantly increased sales of geophysical sensors which serve potential chemical exploration market. As a reminder, in August 2005 we acquired Teledyne RD Instruments, a manufacturer of highly sensitive acoustic instruments used to analyze the flow of water for the movement of objects in water. In this first quarter we completed the acquisition of Benthos, Inc., which further strengthened our capabilities in underwater acoustic instrumentation. Benthos is a leading provider of oceanographic products designed for port and harbor security services, the U.S. Navy, energy exploration and oceanographic research.

Taking into account RD Instruments and Benthos our acoustic instrumentation businesses now contribute approximately $100 million in annual sales. Finally, I'll discuss our avionics and other commercial electronics businesses. In the first quarter of 2006 sales from this business collectively decreased approximately 7% from the first quarter of 2005. The decreasing sales was primarily due to lower sales of commercial contract manufacturing services as we have positioned this business to focus on the defense electronics market. In fact, growth in defense related outsourced printed circuit card assembly services was nearly twice as great as the decline in commercial contract manufacturing services.

Turning to our government systems engineering segment, the first quarter of 2006, the revenues in this segment decreased 2.3% compared to last year while segment operating margin of 8.6% was down over 200 basis points. Excluding FAS 123(R) and pension headwinds in 2006, margins declined approximately 100 basis points from 2005. Furthermore, as a reminder, sales in the first quarter of 2005 were unusually high in part due to timing of selected government programs, and we saw quarterly revenue decline sequentially throughout 2005. Sales in the first quarter of 2006 for this segment increased 10% sequentially, and we believe we're at a reasonable level despite the reported year-over-year decline resulting from tough comparisons. The (indiscernible) decline in margin was principally related to lower contribution margins on some of our NASA work, which increased in the first quarter relative to last year.

Turning to our aerospace engines and components segment, sales in the overall segment increased 14.4% due to increased sales of aircraft piston and missile turbine engines, as well as aftermarket parts and services. In addition, operating profit increased over 90% due to higher sales, improved operating performance and lower warranty costs. Within this segment sales of piston engines were up 15.4% due to another record quarter of sales to OEM airframers such as Cirrus Design as well as in the aftermarket. Sales from military turbine engines which are used primarily in cruise missiles increased 7.6%. So overall aerospace engine business performed very well. Excluding the $2.5 million payment we received from Honda, the segment operating margin in the quarter was 7.2%, a substantial improvement over prior years.

Finally, in our energy systems segment revenue in the first quarter of 2006 decreased by 12.7% due to reduced work on certain government contracts compared with the first quarter of last year. Operating profit declined primarily as a result of lower revenue. In addition, the break in performance also reflected greater bid and proposal and research and development expense as we're trying to capitalize on the increased demand for on-site hydrogen generation for manufacturing activities ranging from semiconductors to flow plus. On-site hydrogen generation is an alternative to receiving delivered cylinders of gas. The cost of delivered cylinders has increased as the price of fuel, which governs delivery and natural gas which is the pit stop for hydrogen reformation have increased.

In conclusion, as we progress through 2006 and beyond our goal for Teledyne is to continue profitable growth both organically and through acquisitions. Many of our largest markets, such as defense electronics and electronic instruments for oil exploration and environmental monitoring continue to exhibit some demand for our products. Other businesses, such as piston engine operation have begun to recover given the healthy commercial and general aviation markets. In addition, many of our markets remain quite fragmented, and we believe there is continued opportunity for bolt-on acquisitions. As we've done in the past, we believe such acquisitions will further strengthen our market position, allowing us to build businesses which are truly superior in their niches.

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. Then I will give an update on pension costs and discuss our 2006 outlook. In the first quarter cash provided from operating activities was $8 million compared with cash provided from operating activities of $2 million for the same period of 2005. The higher cash flow in the first quarter of 2006 was primarily due to operating cash flow from acquisitions made since the first quarter of 2005 and higher net income, partially offset by higher pension contributions.

In addition, the first quarter of 2005 cash flow from operations included $1.7 million in excess tax benefit related to stock-based compensation. In accordance with SFAS 123(R) excess tax benefit of $3.9 million in the first quarter of 2006 or stock-based compensation have been classified as financing cash flow instead of an operating cash flow. Free cash flow for the first quarter, which is often a cash usage quarter for Teledyne was positive $3.6 million. We ended the quarter with $57.4 million of net debt. Our balance sheet remains strong with a net debt to capital ratio of 13.9% which provides flexibility for future acquisitions in our strategic businesses.

As noted in our press release capital expenditures for the first quarter of 2006 were $4.4 million compared to $3.3 million for the same period of 2005. The first quarter of 2006 depreciation and amortization expense was $6.6 million compared to depreciation and amortization expense of $6.1 million in the first quarter of 2005.

Moving 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 FAS 87 pension expense, and a requirement to make pension contributions. However, subsequent to November 29, 2004 the Company is able to recover certain pension costs 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 sold to the U.S. government. The first quarter of 2006, FAS 87 pension expense was $4.1 million or a negative earnings per share of $0.07. This compares to FAS 87 pension expense of $3.2 million or a negative earnings per share impact of $0.06 in the same period of 2005.

In the first quarter of 2006 and the first quarter of 2005 pension expense allocated to contracts pursuant to CAS were each $2.4 million or a positive earnings per share impact of $0.04. As we have mentioned before, starting January 1, 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. Under stock option compensation expense in the first quarter of 2006 further requirements of SFAS 123(R) stock option competition expense was $1.4 million or negative earnings per share impact of $0.03. No stock option compensation expense was recorded before 2006.

Now let me turn to our 2006 outlook. Management currently believes that GAAP earnings per share in the second quarter of 2006 will range from $0.44 to $0.46. The full year 2006 earnings per share are expected to be in the range of approximately $1.90 to $1.95. It is important to note that 2006 includes two accounting related headwinds, a reduction in our FAS 87 pension discount rate and expensing of stock options. For the full year of 2006 we currently anticipate approximately $16.4 million or $0.28 per share in pension expense under FAS 87 or $6.6 million which is $0.11 per share in net pension expense after recovery of allowable pension costs from our CAS covered government contracts. Full year 2005 earnings include $12.7 million or $0.23 per share in pension expense under FAS 87 for $3.4 million which is $0.06 per share in net pension expense after recovery of allowable pension costs from our CAS covered government contracts. The addition of $0.05 to our net pension expense is due in part to a reduction in the assumptions for FAS 87 discount rate moving it to 6% in 2006 from 6.25% in 2005. The Company's 2006 earnings outlook also reflects $5.8 million or $0.10 per share in stock option compensation expense based on current assumptions regarding stock option issuances during the year and estimated fair value of stock option grants.

Finally, the Honda payment of $2.5 million received in the first quarter of 2006 was our final payment under the current agreement. Compared to 2005, total payments by Honda will be $2.5 million less in 2006. I will now pass the call back to Robert.

Thank you, Dale. We would like to now take questions, please, if you are ready to proceed.

(OPERATOR INSTRUCTIONS) Robert Stallard.

I've got a couple of quick questions. First of all on systems engineering, the margin was a little bit lower than we were looking to in the quarter. How do you expect this business to progress through the rest of the year, and what are some of the factors that are driving the margin around here?

Primarily I think we expect this business to perform at the level it is at now. As we've mentioned, Robert, in prior calls the margins in the last year were exceptionally high because of onetime award fees. And this year, of course, we have both increased pension and FAS 123(R) expenses. And we recovered more from pension last year from the government that we expect to get this year.

Pension expense will have to come down next year, you would have to see these margin improving?

If they do come down, yes, but right now we are not expecting pension expense to come down primarily because I think there is continues to be pressure on the discount rate.

What actually was your discount rate that you are currently using?

I will let Dale answer that.

The current discount rate is 6%.

Right, okay. Somebody has talked about in the past in the aerospace areas as being insurance costs. How is that currently progressing and what is your thinking on the future there?

Robert, on that our insurance comes up for renewal at the end of May. It is renewed annually. We, at the present time, we are expecting that it would remain at the same level as last year. There is some hardening in the -- overall the insurance market because of the hurricanes, but we believe with our better management, claim management efforts in collaboration with our providers that we will be hopefully able to keep our insurance costs at the same level as last year.

Finally, you mentioned about bolt-on acquisitions in the call. I was wondering if you could give us an idea of the scale of the target you may be looking at for the rest of 2006.

We look at, depending on the size of the acquisition, Robert, we look at anything from just several million dollars, if we can just take the product line and slap it down in one of our manufacturing operations -- to over 100 million. And of course if we find things beyond that we would certainly consider them.

Great. Thank you very much.

John Harmon, Needham & Co.

(inaudible)

Chris Quilty, Raymond James and Associates.

Good morning, gentlemen. Can you hear me?

Yes, Chris, we can hear you well.

I was hoping you could elaborate a little bit further on the strength in the aerospace engines business, both on the top line growth there as well as the margin performance and the potential for further margin expansion. And specifically if you can comment on whether you feel the end market strength was the primary contributor or you are actually gaining any marketshares.

I think, Chris, both. Primarily what has happened is that the new aircraft, which are composite aircraft as you know, are gaining significant market share. And we are the sole source engine for these new aircraft, such as Cirrus Design that I mentioned, but also Lancair and others. And as they gain market share our OEM sales keep improving. That's one. Two, the aftermarket has been this year at least so far, has been unusually strong for us. We have been able to capitalize on that through sale of spares and factory rebuilt engines. And finally, Chris, looking forward we have 35 electronic control systems for piston engines on a number of aircraft which reduce fuel consumption. And we believe with that addition to our portfolio of engines that would bode well for us into the future.

And I know this is all separate dynamics here, but touching on the military part of the business, thoughts on the JASSM program on-again, off-again, maybe some foreign sales on the agenda now, where that program stands.

So far it has been okay. When they reduced the number of quantity of buys in a given year, the price per engine goes up correspondingly, so it doesn't really have a negative effect on it. Of course Australia made a decision to deploy the JASSM missile which is going to be helpful. It will be the first foreign military sales for that missile. Also we are seeing continuing interest in some of our older engines going to harpoon missile, that's foreign military sale and some of our SLAM-ER, engines which are again really harpoon engines, slightly modified harpoon engines. And those foreign military sales still should be holding up.

Okay, and collectively when you look at the aerospace engine segment would it be fair to assume that this is probably more like a high single digit, low teens growth year given the good start?

I would say yes, probably. We think it is going to be in the high single digits, at least at this time. It is hard to kind of predict too far into the future but so far it is all right.

Okay, and if I can ask one more question with regard to the E&C segment, what sort of legs do you see on your defense electronics business in terms of you've had five straight quarters of double-digit growth, do you start hitting year-over-year comparables where we're going to see a slowdown, or are there specific programs that you are involved with that are sort of increasing in visibility or volume?

Let me start by saying that right now we are projecting slight turndown from where we are, not in terms of our improvements year-over-year in the second quarter but moving forward, we think third and fourth quarter we're again going to have double-digit growth in the defense electronics businesses. We attribute these primarily to a number of factors. First we are introducing new products, such as the acoustic Doppler navigation systems and modems and hydrophones that go to the military. Second, some of our offering as we've added microwave product and moved up the food chain so we can do -- essentially build microwave assemblies, have enabled us to deliver higher level products to our customers. And finally, we think that the outsourcing trend in the military business especially in the printed circuit card businesses, is really increasing. And we seem to be doing all right. For example, what one Tier 1 defense customer made a decision in Q1 to reduce its outsourcing suppliers from 72 to 6, and Teledyne or the electronic manufacturing services was one of the 6 selected. So it seems that things are working in our favor in that direction.

Great. Thank you very much.

Mark Jordan, A. G. Edwards.

Good morning, gentlemen. Robert, I was wondering if you could address what level of visibility you have in the services area for growth. Clearly you focused a lot of activities in the Huntsville area, which should be an area of growth with the BRAC realignments. Also you've started to focus on UAV's and some vehicle initiatives. Is there an opportunity for that segment to move towards a double-digit growth at some point in time in the future?

Mark, except if we were to make acquisitions, which we are obviously considering now for that segment, we think at least for now revenues are going to remain relatively flat for this year. But I think BRAC and UAV markets will affect 2007 positively for us. But having said that, we are also doing a little better in our chemical (indiscernible) work and we are looking to participate in some of the management of the large government laboratories that are being outsourced. So I think for the time being we think given that relatively flat we will probably begin improving near the end of the year and in 2007.

Okay. If you are looking at the electronics and communications group obviously the first two-thirds of the businesses have been showing some positive trends, and that has really been diluted by your commercial electronics revenues. When do you see the commercial side? What is the issues there that are causing the declines, and when do you see that stabilizing and potentially moving back to a growth mode?

We have a number of variations in our commercial electronics. First, we make transceivers for point-to-point communication, cellphone communication, backbone of our cellphone communication. And that business remains healthy, especially in Europe and Third World countries. We also make some medical products. They seem to be fairly stable. We have intentionally, Mark, decided to reduce our exposure to commercial electronic manufacturing services, the circuit card, and we are also shutting down one small productline that was making equipment, solder leveling equipment for that market. And because the margins in commercial manufacturing services are really under pressure, so we switched our emphasis. We changed the emphasis of our factory into defense electronics, same equipment, same factory, same people. And we've gained market share in there. So I am not so concerned about declining the commercial side of our printed circuit work. On the flip side as you know we also make relays, and the top line growth in the relays was very healthy. It was over 15% in Q1. And that goes both to commercial and satellite and aviation instrumentation as well as some military applications.

So it's fair to say that the organic growth rate in this quarter is being a little bit artificially low because of a conscious effort to redeploy assets rather than just a weakening of business?

Yes, that is fair to say.

Okay. You mentioned that you obviously build a $100 million business in the underwater acoustical instrument area, and there also is growing interest or opportunity in the safe harbor concept homeland defense. How are you as a company going to position yourself with either partners or as a prime to be able to address that opportunity in the coming couple of years as it evolves?

Good question. We are doing a number of things. First, the tow arrays that we make for oil and gas exploration, which are the streamers that are pulled behind boats to send an acoustic signal to the ocean floor, and you pick up the acoustic signal with hydrophones, that business is beginning now to be used -- those similar arrays are being used for essentially sonar applications in the military. Second, we have some partnerships with other companies which help us in new programs with the Navy. Finally, some of these acquisitions, for example, RD Instruments have opened up some new customers for us. For example, divers, Navy seals use our underwater imaging system for guidance under water. And we also have some applications for our autonomous underwater vehicles using our sensors. So having said all of that, I think, we think this is a good area for us, and underwater unmanned vehicles of course, the communication capabilities, and when we combine that with Teledyne and solutions are doing with the UAV's, I think that is overall going to be a good area for us.

Final question, if I may. Obviously you have come to the end of your contractual agreement with Honda. Could you tell us how you see that relationship evolving over the next 18 months? And secondly, I believe I heard you comment in your prepared remarks that you started to see a real recovery in the aerospace group, which I think is probably the first positive comment on that group that I think I've heard from you in four years. Was that a purposeful statement that you have in fact seen a fundamental turn here?

Yes, let me start with the latter part of the question. I think it has been a positive environment. Our OEM sales have improved about 35% year-over-year. Our aftermarket has improved about 7%. So the overall revenues have improved about 15% in piston engines and this is really the first time in several years that we have begun seeing some reasonable margins. As I said over 7%. We have also introduced the same operational excellence programs that we have in electronics and communication in our piston engine business to reduce what we call price of nonconformance, scrap warranty and rework by 20% a year and they are making progress there.

Turning back to your first question regarding Honda, our relationship with Honda continues. The payments were the payments as part of our initial agreement, we just got the last one as Dale mentioned. But our relationship continues; as a matter-of-fact our people were in Japan only last week, and are meeting with them two weeks hence. The collaboration is very positive. They're developing a new engine with us, with our help. And we don't see any changes in the first year. But future -- except I should note is that as we expected, things are moving a little slower than we had initially anticipated in terms of introducing a new product in this domain.

Since you are continuing this relationship in support of a program, would it not be unreasonable to assume that at some point in time there should be some follow-on contract relationships, payments of some sort?

Yes, it could, but I think our biggest opportunity is we have agreed that when an engine is ready for introduction that we would do it together in this country. And we hope to use our manufacturing facilities to introduce a complete new engine that will be both fuel efficient, as well as use regular automobile gasoline as opposed to 100 octane gasoline that are used in today's environment.

Any feel for when that will occur? Is it 18 months or 36 months out?

I think it is more of the latter. Primarily because to introduce a new engine as you know, Mark, you've got to go through the whole FAA qualification process -- certification process.

Thank you very much.

John Harmon, Needham & Co.

I'm trying again. I hope you can hear me. It works better with the mute button off on your headset. You said that your avionics and electronics business was down, but you said much of the decline was in exiting commercial electronics manufacturing. Was avionics up excluding the piece of business that you are reducing in size?

I think if you exclude the electronic manufacturing --commercial electronic manufacturing services, in general our market was relatively flat in avionics. But I think that is primarily because we have pretty tough comp comparisons to last year. And we are at the end of life period for some of our air-to-ground telephony system. But we think our book-to-bill is very healthy. In avionics it is about 1.5. So we are positive in this domain going forward. And finally, as you know, Airbus and Boeing are both projecting increased production forecasting; increased production shipments of 36% up for Boeing from 2005, 16% for Airbus. And we think that is overall going to be okay. And we are our introducing new products as the wireless GroundLink product, the Electronic Flight Bag product and, as well as cooperating with Airbus to develop data analysis systems for some of the data that we collect in our computers.

Okay. Thank you and then finally, just let me kind of combine two questions into one. Are there any areas in instrumentation were you have big holes in your product portfolio? And I know people have asked about the acquisition pipeline. You've closed ones, you kind of have nothing announced, how many acquisitions do you think you could close this year and what does the pipeline look like?

I always like to close a lot of acquisitions, but wanting and doing are two different things. I think we will close a number of them this year. I believe we have yet to kind of build up our defense electronics. There are a lot of opportunities there. Both in microwave as well as we have been doing really well with our acquisition of RD Instruments in the connector area. And we think that in the instruments area we have a lot of opportunities. It is a fragmented market, as you know. We hope to close several deals. They can be anywhere between $5 to $100 million this year. But it all depends on how aggressive our competitors are going to be in the bidding process whether we can do that, by buying things from private entities which usually like to sell to us because we take good care of their employees after acquisition.

Thank you very much.

(OPERATOR INSTRUCTIONS) Mark Jordan, A. G. Edwards.

Good morning again. Robert, could you estimate what the free cash flow generation that you may produce through the balance of the year, and assuming no acquisitions, where your debt level would be down to as you exit the year? A second question, what is your CapEx plans for the balance of the year?

I'm going to let Dale Schnittjer answer those two questions, please.

First, we still expect our capital for the year to be about $28 million. And we would expect that the cash flow would sort of mirror our net income.

For the last three quarters?

That's correct.

Thank you very much.

Thank you, Mark.

(OPERATOR INSTRUCTIONS)

Devon, that's fine. Thank you. What I would like to do now is ask Jason to conclude our conference call.

Thanks, everyone, for joining us this morning. If you have follow-up questions please feel free to call me at the number on the earnings release. And again all the news releases are available on our website Teledyne.com. Operator, if you would end the call and give the replay information we would appreciate it. Goodbye.

Ladies and gentlemen, this concludes today's conference call; thank you for your participation. And the replay information for the teleconference is as follows. Please in about three hours you may dial 1-800-475-6701, and the access code is 826028. (OPERATOR INSTRUCTIONS) Thank you, and have a nice day.