Teledyne Technologies Inc (TDY) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Teledyne Technologies third quarter earnings release conference call.

[OPERATOR INSTRUCTIONS]

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, Vice President Corporate Development and IR at Teledyne Technologies. I'd like to welcome everyone to Teledyne Technologies' third quarter 2006 earnings release conference call. We released our earnings early this morning before the market opened. Joining me this morning 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, both via webcast and dial-in, will be available for about a month.

Here's Robert.

Thank you Jason, and good morning everyone. I would first like to begin with some introductory comments about the overall performance of the company during the third quarter. Second, I would like to make some more detailed observations about each of our business segments, our acquisitions and key markets.

We had a number of significant achievements during the third quarter of 2006 compared to the third quarter of 2005. First, sales growth was 23.1% and each business segment experienced double-digit growth. Organic growth during the quarter was 13.6% and was balanced throughout our business segments as well. Record earnings per share increased 40% compared to last year. Excluding a non-recurring tax benefit of $0.09 a share as well as a $0.03 a shareholder expense from FAS 123R stock option compensation, earnings per share increased 26.7%, outpacing the sales growth of 23.1%. Finally, we closed three acquisitions, one in each of our core business areas which are Aerospace and Defense and Electronics, Electronic Instruments and Government Systems Engineering.

Our strategy over the past several years has been consistent and targeted at achieving high quality revenue and earnings growth by first strengthening and expanding our core businesses with synergistic acquisitions, and second by aggressively pursuing operational excellence, including the integration of acquired companies. Since 2001 we've made 17 bolt-on acquisitions, including 5 in the first nine months of 2006, for a total consideration of approximately $575 million. All of these acquisitions were funded through internally generated cash and our revolving credit facility. While our debt is at the highest level to date, we feel quite comfortable with our leverage, and net debt to book cap is approximately 36% and our net debt to EBITDA ratio is roughly 1.5.

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 fourth quarter and full year 2006. Turning to our business segments, third quarter sales in our Electronics and Communications segment includes 27.4% compared to last year, from $178.9 million to $228 million, with organic growth of 12.9%. Segment operating profit increased 34.6% from $20.8 million to $28 million. Segment operating margin increased 65 basis points from 11.6% to 12.3%, despite a negative 31 basis points head wind resulting from stock option compensation expense.

As I further discuss our Electronics & Communications businesses, I'll break up my comments into three separate markets. First, Defense Electronics, which on a round rate basis represents today approximately 40% of our electronics segment. Second, electronic instruments, which represents approximately 35% of our electronics segment, and third, Avionics and other commercial electronics which represents approximately 25% of this segment.

In the third quarter of 2006, sales of Defense Electronics increased approximately 28% compared to the third quarter of 2005. Excluding the acquisition of Rockwell Scientific Company, as well as small acquisitions of Microwave Assets from Avnet and KW Microwave, organic sales growth of Defense Electronics was approximately 15%. Sales of proprietary products, including microwave products and connected assemblies, as well as Defense Electronic manufacturing services, each increased considerably during the quarter.

During the third quarter we closed the acquisition of Rockwell Scientific Company, which was our largest acquisition to date. As a reminder, roughly half of Rockwell Scientific's business relates to the production of specialized defense electronics subsystems, specifically the Imaging division, renamed Teledyne Imaging Sensors, designs highly sensitive sensors and subsystems for the attractive space-based imaging and tactical infrared imaging market. Teledyne Imaging Sensors is one of only two companies selected by the U.S. Army to develop manufacturing processes to support production of third generation, dual band tactical infrared images.

Rockwell Scientifics Research and Development Division represents approximately the other half of its operations. The R & D Division, renamed Teledyne Scientific Company, provides access to unique government-funded applied research in areas related to our core businesses and existing markets. In addition, Teledyne Scientific Company provides access to different customers such as DARPA and the Air Force Research Labs, which are not traditionally served by Teledyne.

Turning to our Electronic Instrumentation businesses, in the third quarter of 2006, year-over-year sales of electronics instruments increased by approximately 55% from $56 million to $86.5 million, due in part to the acquisition of RD Instruments, Bentho's and a majority stake in Ocean Design Incorporated. All three are part of our Marine Instrumentation growth strategy.

Organic sales of instruments increased 24% due to strong sales growth of our instruments used for air and quality monitoring, as well as significantly increased year-over-year sales of geophysical sensors, which serve the petrochemical exploration market. Nonetheless, as we highlighted in our previous outlook statement, sales of geophysical sensors declined approximately $4 million sequentially from the second quarter and we expect this trend to continue in the fourth quarter of this year.

During the third quarter, building upon our previous acquisitions of R.D. Instruments and Bentho's, we purchased a majority stake in Ocean Design Incorporated, a leading manufacturer of subsea wet mateable electrical and fiber optic interconnect systems used in offshore oil and gas production, oceanographic research and military applications. These products are closely related to both our expanding line of undersea acoustic instruments and to our military high voltage connector assemblies. ODI's unique connectors are designed to operate at full ocean depth and are used to reliably deliver power and communication to subsea well heads on the ocean floor.

In the offshore oil and gas market, ODI's strong position in energy production compliments Teledyne's capabilities in exploration, exemplified by hydrophones and streamer cables manufactured by Teledyne Bentho's and Teledyne geophysical instruments, as well as acoustic current profiler instruments manufactured for offshore drilling platforms by RD Instruments. We anticipate ODI, which also serves the [developed] industry, will benefit from Teledyne's broad capabilities and presence in the Defense Electronics subsystems market.

Finally I'll discuss our avionics and other commercial electronics businesses. In the third quarter of 2006 sales from these businesses collectively were flat compared to the third quarter of 2005. Increased sales of products, including electronic relays and commercial microwave assemblies using cellular infrastructure applications, were offset by lower sales of commercial contract manufacturing services, as we have positioned this business to focus on the Defense Electronics market.

Turning to our Government Systems Engineering segment, in the third quarter of 2006, revenues in this segment increased 12.4% compared to last year, with organic growth of 9%. Segment operating margin of 8.3% was down 228 basis points. Accounting for the FAS 123R and pension head winds in 2006, segment operating margins still declined by 122 basis points from the third quarter of 2005. As noted in our earnings release, margins were affected by sales mix that is some of the sales growth this quarter was from contracts that carry a lower overall margin.

In addition, the acquisition of CollaborX increased revenue a bit, but added little to the operating profit, due in part to the front-loaded nature of intangible asset amortization. The capabilities of CollaborX fit squarely within our Systems Engineering segment core competencies with Defense Systems Engineering. CollaborX is headquartered in Colorado Springs, which is the joint warfighting center for missile defense and the missile defense companion city to Huntsville, Alabama, where much of Teledyne's existing operations are located. CollaborX's strong presence with the Air Force also compliments our efforts with the Army and the Navy.

Furthermore, much of Teledyne's engineering services are focused on sustainment and support of systems, while CollaborX has worked on early stage concept and technology development at defining systems requirement. Following the acquisition, we believe that Teledyne will be more capable of providing systems engineering services throughout a systems acquisition life cycle from the concept development of a defense system to the sustainment and support of such a system.

Turning to our Aerospace Engines and Component segment, sales in the Aerospace Engines segment increased 22.3% due to strong sales both in OEM and after-market aircraft piston engines and parts, as well as a modest year-over-year increase in deliveries of cruise missile turbine engines. In addition, operating profit increased 9.7%, due to higher sales and improved operating performance.

While reported operating margin declined 70 basis points from last year, the third quarter of 2005 segment operating profits included a $2.5 million payment from Honda Motor Company. Excluding this non-recurring payment, segment operating margin essentially increased from break-even to 6.1%. Finally, in our Energy Systems segment, revenue in the third quarter of 2006 increased 15.6% compared to last year, primarily due to increased sales of commercial hydrogen generators. Operating profit also increased due to the higher sales level.

In conclusion, this was a great quarter for Teledyne. We announced record quarterly revenue and earnings per share and we believe our acquisitions to date have allowed us to build a significantly better position and stronger performing company. 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 third quarter, cash provided from operating activities was $21.4 million compared with cash provided from operating activities of $28.4 million for the same period of 2005.

The lower cash flow in the third quarter of 2006 was primarily due to the timing of income tax payments, virtually offset by operating cash flow from acquisitions. Additionally in the third quarter of 2006, in accordance with SFAS number 123R, excess tax benefits for stock-based compensation of $2.6 million were classified as a financing cash flow instead of an operating cash flow. The third quarter of 2005 included the receipt of a $2.5 million -- up $2.5 million pursuant to an agreement with Honda Motor Company. The last of the four $2.5 million payments from Honda was received in the first quarter of 2006.

Free cash flow for the third quarter was $14.3 million. We have made five acquisitions in 2006 for $255.4 million and we ended the quarter with $231.1 million of net debt. Our balance sheet remains strong with a net debt to capital ratio of 35.8%. As noted in our press release, capital expenditures for the third quarter of 2006 were $7.1 million compared with $4.9 million for the same period of 2005. For the third quarter of 2006, depreciation and amortization expense was $7.8 million compared to $6.3 million in the third quarter of 2005. We expect capital expenditures of $28 million in 2006.

Moving to pensions, as we have stated before, declines in the capital markets in prior years and adjustments in pension assumptions have results in an increase in FAS 87 position expense and a requirement to make pension contributions. In the third quarter of 2006, FAS 87 pension expense was $4 million or a negative earnings per share impact of $0.07. This compares to FAS 87 pension expense of $3.2 million or negative earnings per share impact of $0.06 in the same period of 2005. However, in the third quarter of 2006, pension expense allocated to contracts pursuant to US government cost accounting standards, or CAS, was $3 million or a positive earnings per share impact of $0.05 compared with $2.3 million or a positive earnings per share impact of $0.04 in the third quarter of 2005.

As we have mentioned before, starting January 1st of 2004, new hires have been added to an enhanced defined contribution plan as opposed to the company's existing defined benefit plan. Under stock option compensation expense, in the third quarter of 2006, further requirements of SFAS number 123R, stock option compensation expense was $1.5 million or a negative earnings per share impact of $0.03. 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 fourth quarter of 2006 will be in the range of $0.47 to $0.49. The full year 2006 earnings per share are expected to be in the range of approximately $2.20 to $2.22. Our full year 2006 earnings per share outlook reflects anticipated sales growth in our Defense Electronics and Electronic Instrumentation businesses, due primarily to contributions from the three 2005 acquisitions made between June and December of 2005, and the five 2006 acquisitions made between January and September of 2006.

While third quarter gross and operating margins increased from last year, margins declined slightly sequentially compared to earlier in 2006. Our fourth quarter earnings outlook reflects some additional margin pressure, which is expected to result in part from the fact that the recently acquired Rockwell Scientific and CollaborX businesses were performing at a lower gross and operating margin than Teledyne as a whole.

This lower margin performance is compounded by the front-loaded amortization of intangible assets, which will affect G&A expense. In addition, results from these businesses will be included on a full-quarter basis during the fourth quarter, as opposed to a few weeks for which they were accounted during the third quarter. Additionally, sales of Geophysical centers are currently expected to decline in the fourth quarter of 2006 compared with the third quarter of 2006. It is important to note that 2006 includes two accounting-related head winds, a reduction in our FAS 87 pension discount rate and expensing of stock options.

For the full year of 2006, we currently anticipate approximately $15.4 million or $0.27 per share in pension expense under FAS 87, or $4.9 million, which is $0.09 per share in net pension expense after recovery of allowable pension costs from our cash-covered government contracts. Full-year 2005 earnings included $12.7 million or $0.23 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 costs from our cash-covered contracts.

The increase in full-year 2006 net pension expense is due, in part, to a reduction in the assumed FAS 87 discount rate to 6% in 2006 from 6.25% in 2005. In addition, the current anticipated net pension expense of $0.09 for the full year of 2006 is lower by $0.02 than our previous outlook due to the surplus pension assets of approximately $37 million assumed in the acquisition of Rockwell Scientific Company.

The company's 2006 earnings outlook also reflects $5.9 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 turn the call back to Robert.

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

Thank you. [OPERATOR INSTRUCTIONS] And, our first question comes from the line of Mike Lewis from BB&T Capital Markets. Please go ahead with your question.

Good morning, Robert and Dale. Robert, I was wondering if after visiting with Rockwell Scientific last month, it was obvious to me that there's a lot of high-tech, advanced technologies at play there, but if we look past the third generation, infra-red systems, can we talk about a little bit some of the other near-term opportunities that you think you can take from Rockwell and get into Teledyne's production over the next few quarters?

Yes, thank you Mike. And, thank you for visiting. I think in general, what Teledyne does, as you well know is, we serve the merchant market, very specific niche markets in a variety of domains. And those would be both defense as well as some industrial. And what Rockwell does is it brings technologies that can be -- that we can exploit in those markets. I think what my current thought process is that there's not, other than improving some of the manufacturing, some of the things that they're doing will take a few quarters for us to bring to market. It won't be immediate.

But just give you some examples, they're working on mixed signal integrated circuits and microwave components, which tie into our microwave technologies and our microwave products, both integrated circuits and others. They also work on Ocean wave energy harvesting. As you know, we have a fairly concentrated effort in our ocean strategic initiatives. I think also, they do have -- as you saw, they do have a new development in advanced laser eye protection for air crew laser eye protection, which is just now entering production. And, we think we can bring some of Teledyne's operational excellence into that domain and hopefully improve that.

There are a number of other things that are happening there, but we've only had that acquisition for about a month. And, we're still identifying various programs and activities that we can work together on. Thanks, Mike.

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

Hi, good morning.

Hi, John.

Good morning. I hate to ask this, but recently in New York City, there was this public event with an airplane accident. Do things like that raise your insurance rates? Or are they kind of expected and factored in?

Well first, the insurance rates really are affected by pay-outs of core accidents. The accident that was reported, there's really, to date, as has been reported in the press, there's no evidence that it was due to a mechanical engine malfunction. Nevertheless, the engine's being shipped to our Continental Motors facility and it's going to experience a full tear-down and examination under the direction, by the way, of National Transportation Safety Board. And as usual, we fully cooperate with both NCSP and NSA, but until and if there are pay-outs in specific cases, our insurance rates are not -- I don't expect them to be affected.

OK, thank you. If I could ask just one more please?

Sure.

Clearly, it's hard to predict the frequency of acquisitions. They seem very lumpy. There was a period during the beginning of this calendar year where you were talking about higher multiples for bigger acquisitions, and you hadn't announced any. And now, there have been quite a few. How do you feel about the environment and your pipeline?

Well John, first, the pipeline is fairly robust. As to whether things would come out of the bottom of the tunnel, we are still -- we can't predict. We spent a lot of time in the first nine months of this year closing our various acquisitions, and more importantly, working on integration which as you know, is the key to the process. I think we're just kind of -- while we have things in the pipeline, we're kind of taking a little breather while we integrate what we have. Having said that, if an opportunity arises because of our net debt to capital ratio is relatively low, and especially our debt to EBITDA ratio is only 1.5. If opportunities arise, we will act upon it.

OK, thank you.

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

Good morning, gentlemen. Robert, your defense electronics group had an exceptional quarter with 15% organic growth. Could you talk about what are the stronger product lines within that segment that's generating that organic growth? And is this a function of market growth? Or, are you gaining share?

I think it's a combination of both. The more -- the really, the first one, Mark, I think is that we're seeing some significant growth in our job connectors, high-voltage connected assemblies, especially as that relate to -- remember, we acquired Teledyne Reynolds Industries, and part of what they do is they make the connectors, the cables, to the joint helmut-mounted, queuing system. This is a system, as you know, that -- it's incorporated in the visor-projected, heads-up display to queue weapons and sensors to the target so that the pilot doesn't have to maneuver the aircraft before weapons release. And, this is one of the more important technological advances that have, we've -- we're told for the war riders in an aircraft. So that has been a significant growth.

The second is that they've increased outsourcing by our timed customers, and we were fortunate in both our electronics manufacturing services and our microelectronics businesses to be one of the handful of down-selects from over 50 to 70 suppliers. We were one of the few down-select in both businesses. I think in one case, there were -- in both cases, there were only six suppliers that were identified as a troop supplier, and we were fortunate to be selected. And, we expect that to help us going forward as well.

Now finally Mark, our microwave, defense microwave businesses have been healthy. And, I think that's partially due to the acquisition of [Filtronics] system, the microwave system and the [Solaratech] microwave system and the fact that we've been able to integrate those and develop microwave assemblies that we can supply to our customers who really want to outsource a lot of that work. So those are the three main areas I can point at.

OK. Back on sort of the acquisition and funding area, is -- if we were to look at the company, say at year-end '07 versus right now, where you've got net debt about 231, would it be reasonable to assume that you could pay down debt through the end of '07 in the $70 million to $80 million range and that therefore, exit -- if you did nothing, you would exit the year with about a debt load of about $150 million?

Yes. I think perhaps maybe generate a little more cash, Mark, maybe $100 million. And if we did nothing, then, everything else being equal, I think as Dave mentioned, our net debt today is about $231 million. So if we dropped $100 million, it will go to $130 million. But, I'd be surprised if we just did nothing.

Second part to that question, if you were to look at that point of inflection where you felt uncomfortable with your debt load or feel that you had as much as you would like to carry, how much debt could you support at the end of '07 and still be right at that threshold of pain?

Well, there's -- obviously, I have personal comfort levels. But, I can tell you our debt today, and we -- our ability, we have a $400 million line of credit with a expansion on top of that. We would like to remain investment grade, and we act and we are -- we price our debt. It's priced on an investment grade, and as long as we keep our debt to the EBITDA ratio below three, we should be OK.

OK. In '06, your FAS 87 pension expense increased primarily because of dropping of the discount rate. Looking into '07 is it fair -- should we assume a relatively flat year-over-year 87 pension expense because of raising rates that would probably negate a need to readdress your discount rate?

I'm going to let Dale answer that.

We would expect that our 2007 pension expense would drop somewhat due to the fact that we acquired the Rockwell Scientific and they had some surplus assets over liabilities. So, we expect the pension expense in 2007 to be maybe about half, or down some of -- down some from where we are now.

OK. And then again, with the cash offset that should grow modestly given the higher level of government related work that you do?

Cash will be about the same as it is this year.

OK, thank you very much.

Thanks Mark.

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

Good morning gentlemen, this is actually [Tassos] sitting in for Chris Quilty this morning. Congratulations on another strong quarter.

Thanks, Tassos.

You're welcome. Just looking at your EBIT margins for electronics and communications, you mentioned that the amortization expense associated with the intangibles from the acquisitions was more front-end loaded. And, I'm just wondering if you can maybe describe the distribution of that amortization expense going forward and maybe quantify what we should expect for Q4?

I think what we had was about a $1 million increase in expense compared to Q2 because of that. We expect this to continue in the next quarter, and certainly early 2007. The intangibles are going to be with us for a while, but in a way, it does hurt the earnings. On the other hand, it's a reflection of the health of the businesses we bought because it's -- primarily some of it is because you're amortizing the backlog that you've inherited.

OK. And, would you be able to maybe provide some guidance on your full-year depreciation and amortization expense for '06?

For '06, I can let -- maybe Dale can answer that. Thirty -- I don't --.

The year is about $28 million or thereabouts. And capital would be in the same vicinity.

OK, thank you. And just another question here, can you provide us with your current blended cost of debt?

I think our cost today is about LIBOR plus 75 basis points, which would put us close to 6.5%.

That's great. And just one last question to clarify, did you say that the Rockwell acquisition revenues are going to be split between both the ENC and systems and engineering segments?

No. It's prime -- there are two things. First, management-wise, it's Teledyne Scientific and Imaging would report to me directly, but the revenues and income would be within the electronics and communications segment because most all of their work is in that domain.

OK, that's great. Thank you very much, congratulations.

Thank you, Tassos.

[OPERATOR INSTRUCTIONS] Our next question comes from the line of [Tim Bay] from T Rowe Price. Please go ahead with your question.

Congratulations on a great quarter, guys. Robert, a quick question on acquisitions. As you said in the beginning of the call, you've done, I think, five deals thus far in 2006. Can you comment on how integration is going with deals? I know Scientific is in early days. But, can you comment with regard to the others and kind of your parameters for doing acquisitions?

Yes. We -- thanks, Tim. Two things, first, we -- every time we do an acquisition, we present a model to our Board for their approval. And the two that we did earlier this year, which is KW Microwave and Benthos, they're going very well. As an example, KW Microwave has been integrated into our microwave businesses, and it's being relocated to a building where we have three of our other businesses in the San Diego area so we can share some of the overhead costs across the businesses.

The other one early in the year was Benthos in Massachusetts, and they do both acoustic sensors as well as some hydroformed work and they build some remote operated vehicles, underwater remote operated vehicles. That has really tied very well to our other operations at RD Instruments and our Geophysical Instruments. And we're selling products jointly across these businesses and that's part of our marine instrumentation. So we feel very comfortable that they're meeting their models that we've used.

On the other hand, the CollaborX is really new. It's only -- we acquired it in mid-August, and even then, they were already fairly well integrated into our Braun engineering operations, which is part of our systems group. So, I don't see any issues there. We just have to work on expanding their margins. ODI, which we just acquired again, I sit on the board of that company because there's also minority shareholders there. And we think their business is going to do very well and we're trying to do some collaborative work there. As an example, our Energy Systems, which makes remote thermal electric generators for remote sensing, they are a customer of ODI. And that's going to go well in my view.

And finally our largest, which is a form of Rockwell today, Teledyne Scientific and Imaging, that we are moving our headquarters from Los Angeles to Thousand Oaks where that facility is, and primarily because we think it's important to have direct presence in that facility to be able to work with those folks in full integration of those capabilities into our job product end market. So that one obviously is a month old, but we have what we think are -- we're taking the right steps in the integration.

Thank you.

Thanks, Tim.

[OPERATOR INSTRUCTIONS] And presenters, there's no further questions. Please continue.

Operator, thank you. I'll now ask Jason to conclude our conference call.

Thanks Robert, and thanks everyone again for joining us this morning. If you have any follow-up questions, please don't hesitate to call me. My number's in the press release. And anyway operator, if you'd go ahead and conclude the call and give the dial-in for the replay, we'd appreciate it.

Thank you. Ladies and gentlemen, this conference will be available for replay after 11:30 PM -- I'm sorry, 11:30 AM Pacific Time today through November 26 at midnight. You may access the AT&T Teleconference replay at any time by dialing 1-800-475-6701 and entering the access code of 846560. International participants can dial 320-365-3844. Those numbers once again are 1-800-475-6701 and 320-365-3844 with the access code 846560. That does conclude our conference for today. Thank you for your participation and using AT&T Executive Teleconference. You may now disconnect.