Teledyne Technologies Inc (TDY) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Teledyne Technologies second-quarter earnings conference call. [Operator Instructions]. As a reminder, this conference is being recorded today, Thursday, July 27, 2006. I would now like to turn the conference over to our host, Mr. Jason VanWees, Vice President Corporate Development and Investor Relations. Please go ahead.

Hi, good morning everyone. This is Jason VanWees. I would like to welcome everyone to Teledyne’s second-quarter 2006 earnings release conference call. We released our earnings earlier this morning. 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 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 and good morning everyone. I’d like to begin first with some introductory comments about our strategy, especially in light of this morning’s announcement regarding the agreement to acquire Rockwell Scientific Company. Second, I will briefly address the overall performance of the Company in the second quarter. And third, I will follow this up with more-detailed observations about our four business segments.

Our strategy over the past five years has been consistent and targeted to achieve high-quality and revenue and earnings growth. We’ve done this through a two-pronged approach. First, by strengthening and expanding our core businesses with targeted synergistic acquisitions; and second, by aggressively pursuing operational excellence including the integration of our acquired companies to continuously improve our margins and earnings. I believe our record to date shows that we’ve been successful in the execution of this strategy.

Since 2001, we have made 13 [inaudible] acquisitions including two in the first half of 2006, for a total consideration of approximately $350 million. These acquisitions were primarily funded through internally-generated cash. Earlier this morning, we announced an agreement to acquire Rockwell Scientific Company, or RSC; a joint venture of Rockwell Automation and Rockwell Collins, for $167.5 million. This acquisition, which would be our largest to date, is consistent with our strategy of acquiring complimentary operations focused on our core electronics and engineering-services markets.

Rockwell Scientific’s technologies and operations are related to multiple Teledyne businesses, primarily those within our defense electronics group, but also within our systems-engineering segment. For example, roughly half of RSC’s business via its imaging division; based in Camarillo, California; relates to the production of specialized defense electronics subsystems. Specifically, RSC’s imaging division designs highly-sensitive sensors and subsystems for the attractive space-based imaging and tactical infrared imaging markets. Furthermore, the imaging division is one of only two companies selected by the US Army to develop manufacturing processes to support production of third-generation dual-band tactical infrared imagers for military applications.

By combining Teledyne defense electronics manufacturing capabilities with RSC’s advanced imaging technology, we believe that Teledyne may be able to accelerate RSC’s development and production of next-generation tactical infrared sensors and subsystems. In fact, Teledyne’s microelectronics division has been historically working with RSC’s imaging division on the electronics packaging of imaging subsystems.

Rockwell Scientific’s Research and Development division, based in Thousand Oaks, California; just south of the imaging division and about 30 miles north of our own headquarters, represents the other approximate half of RSC’s operations. Currently, greater than 50% of the sales from the R&D division are from prime contracts with the US government.

For Teledyne, RSC’s R&D division provides access to unique government-funded fundamental research in areas related to our core businesses and existing markets. For example, RSC is currently conducting government-funded R&D related to microwave and millimeter-wave semi-conductors and very high-speed mix-signal circuits, both of which are complimentary to Teledyne’s microwave components and subsystems businesses.

Moving now to Teledyne’s second-quarter performance; please note that the revenue growth of 14.8% was approximately evenly split between organic growth and acquisition. This quarter, record sales levels are a response to an annualized run rate of just under $1.4 billion.

Earnings per share increased 25.5%, and were also at record levels. This was achieved despite a total of $0.04 headwind from SFAS 123R stock-option and increased pension expense. Our strong performance and free cash flow enabled us to expand our revolving credit facility from $280 million to $400 million. While at the same time, we improved our price [increase] and lowered our marginal cost of borrowing.

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 the third quarter and the full-year 2006.

Turning to business segments; second-quarter sales in our Electronics and Communications segments increased 22% compared to last year, from $176.5 million to $215.4 million; with organic growth up 9%. Segment operating profit increased 34.1%, from $20.8 million to $27.9 million. Segment operating margin increased 117 basis points from 11.8% to 13% despite the negative 31 basis-point impact as a result of SFAS 123R stock compensation expense and pension headwind.

As I further discuss our Electronics and Communication businesses, I’ll break up my comments into three separate market categories; first, defense electronics which currently represents approximately 35% of our Electronics segment; second, electronic instruments which currently represents 40% of our Electronics segment; and third, avionics and other commercial electronics which currently represent approximately 25% of our Electronics segment.

In the second quarter of 2006, sales of defense electronics increased by approximately 17% compared to the second quarter of 2005. Excluding the acquisition of Teledyne Cougar and the microwave technical solution assets purchased from Avnet, as well as KW Microwave; organic sales growth of the defense electronics in the second quarter was up approximately 6% as strong sales of microwave products and connector assemblies more than offset a decline in defense electronic-manufacturing services.

We’ve continued to see strong growth in defense microwave products and we’re pleased to acquire KW Microwave during the second quarter. The addition of KW microwave’s capabilities for specialized microwave filters should strengthen our ability to design and produce multi-function microwave subsystems. KW Microwave has also manufactured miniaturized microwave filters for counter measures against improvised explosive devices or IEDs.

Turning to our Instrumentation businesses; in the second quarter of 2006, year-over-year total sales of electronic instruments increased approximately 60% from $52.7 million to $83.9 million, due in part to the acquisitions of RD Instruments and Benthos Inc.; both part of our marine instrumentation growth strategy. Organic sales of instruments increased 29%, due to strong sales growth of instruments used in air and water-quality monitoring; as well as significantly increased sales of geophysical sensors which serve the petrochemical exploration market.

Taking into account the acquisitions of RD Instruments and Benthos, as well as our geophysical sensor operation, the annual revenue run rate of our marine instrumentation businesses is over $100 million. In addition, we are continuing to pursue additional acquisition opportunities in this arena.

Finally, I’ll discuss our avionics and other commercial electronics businesses. In the second quarter of 2006, sales of these businesses collectively decreased approximately 5% from the second quarter of 2005. The decrease in sales was due primarily to lower sales of commercial contract manufacturing services as we have positioned this business intentionally to focus on our defense electronics market.

Turning to our Government Systems Engineering segment; in the second quarter of 2006, revenues in this segment increased 4.1% compared to last year; while segment operating margin of 9.6% was down 100 basis points. However, accounting for the SFAS 123R and pension headwind in 2006, margins increased approximately 20 basis points from the second quarter of 2005.

Revenue growth in our environmental programs was particularly strong during the quarter. As a reminder, our environmental programs are primarily related to services associated with the demilitarization and modernization of chemical weapons. For example, we saw an increase in revenue in the third quarter associated with a $10 million contract we won last year over the modernization of the white phosphorous processing plant at Pine Bluff Arsenal in Arkansas.

Turning to our Aerospace Engines and Components segment, I must first note that we are now celebrating the 100th anniversary of the first piston engine produced by our Teledyne Continental segment. Sales in the overall segment, which includes both pistons and turbines, increased 9.1% due to strong sales of both OEM and aftermarket aircraft piston engines and parts; partially offset by reduced deliveries of missile turbine engines.

In addition, operating profit increased 44% due to higher sales, improved operating performance and lower warranty costs. Within this segment, sales of piston engines and parts increased 23% due to another record quarter of sales to OEM air framers, which has CIRRUS design as well as strength in the aftermarket.

Sales from military turbine engines, which are used in cruise missiles, decreased from the second quarter of 2005, primarily as a result of timing, as unusually high shipments of improved tactical air-launched decoy and Harpoon engines occurred in the second quarter of last year.

Finally, in our Energy Systems segment, revenue in the second quarter of 2006 decreased by 21% compared to last year. This was primarily due to reduced work on certain government contracts as these contracts transitioned from engineering development to production. Operating profit declined primarily as a result of lower revenue.

In conclusion, this has been an exciting morning for Teledyne. We announced record revenue and earnings along with a health free cash flow. We believe our acquisitions to date have allowed us to build a significantly better-positioned and stronger-performing company. We feel the pending acquisition of Rockwell Scientifics is compelling, not totally due to its complimentary technologies and markets, but also because it provides to Teledyne a business platform, serving spaced-based surveillance and [balancing] imaging customers.

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. And then I will give an update on pension costs and discuss our 2006 outlook.

In the second quarter, cash provided from operating activities was $33.1 million compared with cash provided from operating activities of $29.7 million for the same period of 2005. The higher cash flow in the second quarter of 2006 was primarily due to operating cash flow from acquisitions made since the second quarter of 2005, higher net income, and the receipt of insurance proceeds; partially offset by higher pension contributions.

In the second quarter, in accordance with SFAS 123R, excess tax benefits for stock-based compensation of $1.3 million have been classified as a financing cash flow instead of an operating cash flow. Free cash flow for the second quarter was $28.3 million. Through the end of the second quarter of 2006, we made two acquisitions for $42.7 million and we ended the second quarter with $37 million of net debt.

Our balance sheet remains strong with a net-debt-to-capital of 8.8%. We increased our credit facility to $400 million from $280 million. This amended credit facility will expire in 2011. This amended credit facility provides flexibility for future acquisitions in our strategic businesses.

As noted in our press release, capital expenditures for the second quarter of 2006 were $4.8 million, compared to $4.1 million for the same period of 2005. For the second quarter of 2006, depreciation and amortization expense was $6.5 million, compared to depreciation and amortization expense of $6.1 million in the second quarter of 2005. We still expect capital expenditures of $28 million in 2006.

Moving to pension; as we have stated before, declines in capital markets in prior years and adjustments in pension assumptions have resulted in an increase in SFAS 87 pension expense and a requirement to make pension contributions. However, subsequent to November 29, 2004 the Company was able to recover certain pension costs from the US government. Pension expense allocated to various contracts pursuant to US government Cost Accounting Standards or CAS can generally be recovered through the pricing of products and services sold to the US government.

In the second quarter of 2006, SFAS 87 pension expense was $4.1 million, or a negative earnings-per-share impact of $0.07. This compares to SFAS 87 pension expense of $3.1 million or a negative earnings-per-share impact of $0.06 in the same period of 2005.

However, in the second quarter of 2006, pension expense allocated to contracts pursuant to CAS was $2.5 million, or a positive earnings-per-share impact of $0.04; compared to $2.3 million or a positive earnings-per-share impact of $0.04 in the second quarter of 2005.

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 benefits plan.

Under stock-option compensation expense, in the second quarter of 2006 per the requirements of SFAS 123R, stock-option compensation expense was $1.5 million, or a negative earnings-per-share impact of $0.02. No stock-option compensation expense was recorded prior to 2006.

Now let me turn to our 2006 outlook. Management currently believes that GAAP earnings per share in the third quarter of 2006 will be in the range of $0.48 to $0.50. The full-year 2006 earnings per share are expected to be in the range of approximately $2.04 to $2.08.

Our 2006 earnings-per-share outlook reflects anticipated expenses such as intangible asset amortizations, following the closing which is expected to occur late in the third quarter of 2006, of the pending Rockwell Scientific acquisition. Also, sales of geophysical sensors are currently expected to decline in the third and fourth quarter of 2006 compared to the second quarter of 2006.

It is important to note that 2006 includes two accounting-related headwinds; a reduction in our SFAS 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 SFAS 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 SFAS 87 or $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 additional 5 cents of net pension expense is due in part to a reduction in our assumed SFAS 87 discount rate 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.

I will now pass the call back to Robert.

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

Thank you. [Operator Instructions]. Our first question comes from the line of Michael Lewis with BB&T Capital Markets. Please go ahead.

Good morning, impressive results this morning. You disclosed that the missile turbine engines were down due to some timing. However, on another call this morning, a contractor who actually builds the composite shells for the JASSM missile said that they expected more JASSM missiles to be procured over the next few years than what’s currently projected. I was wondering if you have any comment with regard to the customer’s planned procurement for the missiles going forward.

Michael, thank you for your comment. First, actually our JASSM deliveries were up in the second quarter. As I noted, we also produce engines for ITALD, which is a decoy; and for [SLAB] which uses a Harpoon engine. Most of that is for foreign military [chains]. And those were the ones that were done and it was a timing issue; this would be last year.

Okay. And Dale, could you help us frame some expectations with regard to the Electronics and Communication segment once the Rockwell acquisition is fully closed? And were you giving segment guidance there for us?

Well, at this time, we are looking at that as being sort of flat; maybe down a little bit due to some of the expenses I mentioned for the amortization of intangible assets. And we won’t have much impact during 2006. The third quarter won’t have much impact at all because we expect to close near the end of the quarter. But we would have sort of some impact in the fourth quarter.

And the current guidance does take into account your expectations with Rockwell? I just want to make sure that’s clear.

Yes it does.

Okay, thank you very much.

Thank you. Our next question comes from the line of John Harmon with Needham and Company. Please go ahead.

Hello, good morning. I’d like to just follow up on that last question. Does the change to your guidance reflect only the change to profitability from the acquisition? In other words, what I’m trying to get at is- what is the profitability of that business and what would the effect be on a full-year basis?

Let me John, I’ll try and answer it; this is Robert, obviously, the best I can. And Dale maybe can add some color. First the guidance that Dale just mentioned, the guidance has some decline in the earnings, a few pennies, from the acquisition primarily because of amortization of intangibles in the fourth quarter. To go back to the acquisition itself; we said we paid—we intend to pay once closed $167.5 million. That’s around 10 times trailing EBITDA. That’s also before factoring in any tax benefits associated with purchase of [LOC] interest, etc.

Nevertheless, even though the EBITDA margins at the [Sci] center, scientific company, are 12 to 15%; currently EBIT margins are lower than those that we have at Teledyne because of the larger depreciation and amortization that RSC has because of substantial capital investments that they’ve made in the imaging division.

So, in the short term, we expect a little dilution because of the substantial amortization of intangibles because of the – frankly the amount of R&D that they have in their background now. Going forward, we just have to look much more carefully as to what the results would be later on in 2007.

Thank you. That’s very helpful. And just one follow up please; once the acquisition closes, would it be integrated completely into your Electronics and Communications segments? You mentioned that it does fit well with other parts of your – for example [inaudible] System Engineering segment.

Yes, I think two things on that, John. First, it would become a core business of Teledyne. It will be reported as part of our E&C Electronics and Communications segment in terms of its revenues and profits, etc. But it will report directly to me because of my experience in running those kinds of businesses.

Okay, congratulations. Thank you very much.

Thank you, John.

Thank you. Our next question comes from the line of Howard Rubel with Jefferies and Company. Please go ahead.

Thank you very much. Robert, with the outlook you talked about the decline in the geophysical sensors. Could you elaborate a little bit on that and is this just timing or is this some other factor?

Thank you, Howard. First, let me say that when you look at the full-year 2006, we are going to be up from 2005 significantly; even the second half is going to be higher than 2005. It’s just that the second half is going to be somewhat lower than the first half. I believe that’s our take right now.

As you know, we do two kinds of businesses there. We produce essentially streamer cables and the streamer cables we both make new ones as well as repair old ones. And we at the current time, our outlook is such that we think we’re not going to make as much in the second half as we did in the first half. On the other hand, I must say that that might change. Because while we have certain visibility it’s not all that clear as to what the orders that will come last-minute, will be in the second half.

You don’t see any slowdown in this market? If that’s a fair statement; and the new products seems to selling well, that’s fair, right?

Yes, the new product, which is the gel-filled cables, are selling really well. And we don’t expect slowdown in the market in general. But we did have just a very, very successful second quarter—first half I should say. So, still when we add up the year-over-year, we think the year is going to be up over 50% compared to last year.

And I was thinking 30 so, okay. And could you talk about Benthos for a moment? I mean this is also one of your larger acquisitions and how is the integration going there? And are you finding some synergies across the product lines?

Yes, as you know we acquired Benthos in January of this year. The acquisition is going really well. Its top line is about $25 million. They make [board devices] products for port and harbor safety, as well as they make the mostly operated underwater vehicles for energy exploration. We are using some of their modems in our oil exploration business and some of their underwater communication devices are also going to be used. And we’re kind of combining a lot of their sensors and telemetry products with our RDI instruments, which you’re familiar with. So all in all, we feel pretty good about that acquisition.

I have just two more questions. One is- are you continuing to see some outsourcing opportunities from the larger prime contractors in some of your defense electronics business?

Yes we are. And actually our orders in that domain have been pretty good in the second quarter. As I may have mentioned at the last conference call, one of our [tier one] defense customers in Q1 reduced the number of outsourcing suppliers from 72 suppliers to 6, and REMS was fortunate to be one of the six selected. So we fell pretty good about that.

And then last, when you talk about piston sales; first might you address insurance? It looks it’s less of an issue. And then second, could you sort of talk about the tone of the market and any new installations you might have?

First, you are right Howard. I think in terms of the insurance, we got renewed at the end of May of this year. And we were essentially flat, it went a little down; our insurance from last year, but nothing significant. But at least it didn’t go up, which to us is a very positive move for us. In terms of the market itself, since we are the prime supplier to the new aircraft that are being manufactured- the composite aircraft, we are a sole source on the engines; we’re enjoying a good market. Of course that market depends on the economy, and with the gas prices moving up, we’re kind of expecting a little softening in that market. But we haven’t seen that much of it yet.

Okay, thank you very much.

Thanks, Howard.

Thank you. Our next question comes from the line of Chris Quilty with Raymond James. Please go ahead.

Good morning gentlemen, and congratulations on the results.

Thank you, Chris.

A question for you on the Rockwell acquisition; can you give us a sense of the breakdown of how much of that is actually product business verses people renting long-term contracts? And how specifically are you going you going to allocate the revenues? In other words, is part of that business going to be pushed into the Systems Engineering and part of it in Electronics and Communications? And then within Electronics and Communications which of the three buckets?

Let me just start by saying that it—in generally it’s half and half. Half of it is in the imaging division and half of it is in the R&D division; so 50% approximately in each.

Second, I think at the present time, it’s going to be reported within the Electronics and Communications segment. And we will probably have 80% of that whole thing, would be in defense electronics. Now we may report some other things in sensors. But it will be primarily in defense electronics. If we report anything in the Engineering Services segment, that would be if we did some new joint work with them, within that sector. We see some opportunities there. But right now, are intention is to report it within E&C.

Okay. And the operating margins that you gave for the business in sort of the 12 to 15% range; that obviously reflects that the imaging portion of the business is a product business with I’m assuming mid-to-high teens margins and that the R&D division is more of a classic 8 to 10%?

I hope I didn’t mislead you there, Chris. The 12 to 15% is the EBITDA margin, not the EBIT margin. So EBIT is closer to 6 to 8, primarily because they have significant investment in the imaging capital in the imaging division. As an example, in the past few years, they have invested about $40 million in state-of-the-art facilities for the imaging division. So we expect that the margins would be much lower than the EBITDA margins; at least in the foreseeable future. Having said that, obviously we are going to work on that in both the manufacturing operations as I mentioned before; I don’t know how much we can do about the contracts because they’re caused by contracts, especially in the next-generation imaging, which have lower margins. We’ll see how that works out.

Okay, but it’s probably fair to assume that relative to something like Benthos, which is a pure product company, you’ve got less opportunity for going into Rockwell and doing the good stuff that you do in terms of lean manufacturing and cost reduction and consolidation?

Yes, that’s fair to say. But what we hope to do is that they have just begun progressing, at least in the imaging division, they’ve just begun the progression from a development to a production house. And we think that we can bring some of our manufacturing capabilities to speed that along and make it more of a production house than it is today.

On the flip side also, personally I’m encouraged that we’ll be able to take some of the DOD R&D work that they’re doing and transition it into products. As I mention, they’re working in some areas that are related to our microwave communication. We hope to be able to transition those also into products for ourselves in our various manufacturing facilities. So there are two pieces to that puzzle.

Okay, very good. And you mentioned that in the aviation- avionics and other electronics business segment you were down 7% due primarily to shifting your contract-manufacturing activity from commercial to defense. If you excluded that, how is the balance of the business doing?

First I think the shift- that the decline, Chris, was only about 5%. And if I exclude that, if I exclude basically the contract manufacturing commercial, it was flat.

Okay. And given what we’re seeing in new aircraft orders, should we expect that certainly the data acquisition portion of your business has a pretty good outlook over the next year or two as orders go into production?

Yes and no. I think in the data acquisition business we see some up ticks, especially with gains from a foothold in Embraer 170 and 190 families with our data-acquisition systems and our wireless ground link. On the other hand, some of our telephony products that went into business [jet] market; they’re coming to kind of the end of the life period. So we see some declines there. And overall, we think this business will remain healthy but we don’t expect it to be very robust, enjoy very robust growth rate.

Okay, there was one thing in the press release that just didn’t make sense to me and you’re going to have to explain it. What is a multi-mission radioisotope thermoelectric generator?

What it is—

Never mind, I’m just kidding.

It’s a mouthful, isn’t it? There’s too many M’s in it.

You must get paid by the length of the acronym.

Yes, what it is—is we have been making historically energy devices or energy sources I should say, for deep space probes. Some of our devices thermoelectric generators are fundamentally, you hit one end—it’s like a [inaudible] in reverse. You hit end one of two of these similar metals that are attached together and you create a voltage on the other end. So you can generate electricity by having a thermal [inaudible]. Now, in deep space probes, you use radioisotope [DK] to create that electric current. And some of our small power systems have been in deep space probes that have flown 40 continuous years. Now in the multi-mission radioisotope it’s just the same thing. It’s a radioisotope thermoelectric generator; but the purpose is that it will go into deep space and be able to do multiple missions in deep space and go for a very long time.

We got a contract about-- I’d say four years ago, for somewhere between $50 and $60 million to produce this generator for NASA. And we’re in the middle of that cycle. We’ve just gone from engineering to production of our first prototype.

Okay. Actually on a more relevant note I think, the energy systems business, I mean given where we’re at $70 oil and focus on hybrid electrics and hydrogen cars and other stuff like that; have you been able to leverage any of the government-funded technology that you have there? Or is there an opportunity to leverage that on a commercial side?

We actually get government funding for our fuel cell development. We have a proton exchange membrane fuel cell system that we’re developing with government funding at the same time. We also are, as you may know, we make hydrogen generators. We make actually, commercially-available hydrogen generators that are primarily used for semi-conductor, [inaudible] glass, steel processing and other plants throughout the world. At the present time, I don’t think anyone, including us, is enjoying commercial success from the fuel cell business because of the oil prices. That may change. But at least we don’t see that.

On the flip side, I think as the hydrogen distribution costs, because of the oil costs- transportation costs to take bottled hydrogen to various plants goes up, I think localized hydrogen generation then becomes more viable because—and couple that to hurricane activities that we experienced last year, semi-conductor plants can’t afford to go down because they lack hydrogen. So we’re getting some orders in that domain for generators that can make hydrogen for the plant locally rather than bringing it in through trailers.

Okay, well congratulations on the results and the guidance once again.

Thanks, Chris.

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

Good morning, gentlemen. First of all, the systems- or the electronics group within Systems Engineering had higher than expected operating margins. And your guidance would imply that those pull back to more towards traditional guidance, back around 100 basis points each in the third and fourth quarters. Could you explain why that you had such a strong quarter and the delta pulling them back in your expectations for the second half?

First, going back to—we are [inaudible] in Electronics and Communications, we’re not quite pulling it back 100 basis points, maybe more like 50 basis points; primarily because in the second quarter we had very high relative revenues from our oil and gas exploration which have very high margins once we go beyond a certain level of sales. And we expect that to go down a little bit.

And the Systems Engineering, we did have an overhead claim from 2004 that settled, and that bumped the margins up because of that, temporarily. We don’t expect to have such a claim in the future; consequently, we expect a little decline in the margins there because that was a one-time event. And then finally, when you look at what we said about amortization of intangibles; if we are successful in the acquisition of Rockwell Scientific, we expect some pullback because of that in our Electronics and Communications segment. So it’s a combination of those three things. Obviously we’re going to work very hard to offset that.

Okay. Second question relative to pension funding; there’s discussion in Washington about generally accelerating cash payments into pension funds. But there’s kind of a move afoot that could potentially delay implementation of that for three years for defense contractors. What are you plans relative to cash needs for funding your pension accounts through the balance of this year and ’07?

I’ll let Dale answer that please.

We don’t see any change for the remainder of this year related to that potential legislation. Our contributions run in the—before recovery from the government in the vicinity of $20 million. And we recover a portion of that and that’s before the tax impact also. Due to the fact that, that’s sort of in flux, it’s pretty hard for us to forecast or tell you what the outcome will be. But it’s ahead in the direction that they talk about. We’re funded at greater than 80% of the liability so we won’t have the accelerated funding, but we would have somewhat higher funding. But we don’t know where the legislation is going at this time.

Okay. Could you just talk, Robert, philosophically about what your strategy is from a capital-structure standpoint? Obviously with this transaction, assuming you fund it with debt under your expanded bank line, you have a couple hundred million dollars worth of bank debt and an equity position of just under 400 million. What is the role debt moving forward in terms of your permanent capital structure?

Mark, if you take another way of looking at it is to look at our capability in terms of debt-to-EBITDA ratio. Even with this acquisition, assuming it’s successful; our debt-to-EBITDA ratio is going to be about 1.3. Our debt-to-Cap is going to be about 35%, maybe 36%. I feel very comfortable with that. We could go higher than that. Our covenants on our borrowing are 3 debt-to-EBITDA. I don’t think we’ll go that high. I don’t feel very comfortable up there. But I think somewhere less than 2 or around 2, I have no problem with that because as you know, we’re generating good cash. Dale mentioned before that we spent $42.5 million in two acquisitions in the first two quarters and we ended last year with the same level of net debt as we did in the end of the second quarter. So we generate good cash and I don’t have a problem with it.

Okay. Are there any payments from Honda [inaudible] flowing through the aerospace engine group in the second half?

No.

Okay. And could you give us some kind of ballpark number to potentially start penciling in, in terms of revenues from this Rockwell acquisition? Shall we assume it’s relatively flat as verses last year’s run rate over the near term or some kind of growth?

We think there will be a very modest growth from the run rate that was in the earnings release, but again, we haven’t had the opportunity to dive into it. And we obviously also have – we’ve done our due diligence. But we have to be careful not to get too involved in the business until the acquisition is complete. But I’d say it will be slightly ahead, but nothing serious.

Okay. And let’s see; I guess that takes care of me for now. Thank you.

Thanks, Mark.

Thank you. [Operator Instructions]. We do have a follow-up question from the line of Michael Lewis with BB&T Capital Markets. Please go ahead.

Robert, I was wondering if in the second half; do you see any headwinds that could potentially slow down the microwave side of the business in defense electronics?

We don’t see that at this time Michael; we haven’t seen anything. Our orders seem to be okay. And given our commercial orders in that domain have been pretty healthy. So right now I can’t see it.

And you did—if my numbers are correct, you said that the internal growth in E&C was 9% in the quarter. Is that correct?

That’s correct.

Okay, and now if you were to strip out the geophysical sensors out performance; was there still positive internal growth in that segment?

Yes.

Can you give us any—was it low single, mid single?

I’ll have to do some quick calculation here. My guess would be the low single.

Okay, thank you very much.

Thank you, Michael.

Thank you. We do have a follow-up question from the line of Mark Jordan with A.G. Edwards. Please go ahead.

Hello again. Talking about the acquisition, you mentioned that you’re positioned well for the next generation imaging and that you now seem to be in—they seem to be in the R&D prototyping stage. When would that move into a production mode and could you try to size the market for us?

Sizing the market is hard there, but I think at least at the present time, some of those products are supposed to go in limited production in 2007, especially in airborne vehicles for the army. In the 2009 and 2010 timeframe they’ll go into full production.

Any sense of what they’re spending in that type of product to date or for second generation?

I do have it. Let me take a look at that. I don’t have it handy to be able to answer that question accurately and I don’t want to hazard a guess, but if you look at—let me study that and come back to you.

Thank you.

You bet.

Thank you. And our next question comes from the line of Chris Quilty with Raymond James. Please go ahead.

Thanks. Just a follow up on the guidance you provided and I was looking at the explanation here. Just to be clear, it seems that with your earnings guidance, the full-year earnings guidance you provided, you’re including potential amortization costs and whatnot from the acquisition.

You haven’t put out a revenue range but you’re assuming some implied dilution here from the acquisition being complete?

Yes, in the fourth quarter especially.

And obviously—with no guidance here on the revenues, you’re not changing the overall guidance for the revenues in the core business and we would just tack on the acquisition?

Yes, if you wish to do that. As you know we never guide revenues, but that would be an accurate way of looking at it.

Okay, typically I’m not going to put in the model or change the model until the acquisition is closed, but—in Hart-Scott-Rodino any issues anticipated?

At this time, Chris, we don’t anticipate any. On the other hand we have to yet file and you never know on that until they take a look at what we’re proposing.

And then this is obviously—there’s no shareholder approval required on the sale?

No, that was formed 50-50 between Rockwell Automation and Rockwell Collins. [Inaudible].

Alright, thank you.

Thank you, Chris.

Thank you. And there are no further questions at this time.

Thank you, Operator. And thank you everyone. I’ll now ask Jason to conclude our conference call.

Thanks, everyone again for joining us today. If you have any follow-up questions please feel free to give me a buzz at the number on the earnings release. And as always, all news releases are available on our website Teledyne.com. Operator, if you would go ahead and close the call and give the dial-in replay, I’d appreciate it.

Thank you. Ladies and gentlemen, this conference will be available for replay after 1130 am Pacific Standard Time today through August 27th, 2006 at midnight Pacific Standard Time. You may access the AT&T TeleConference replay system at any time by dialing 1-800-475-6701 and entering the access code 835848. International participants dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844 with the access code 835848. That does conclude our conference for today. Thank you for your participation and using AT&T Executive TeleConference. You may now disconnect.