Teledyne Technologies Inc (TDY) 2011 Q3 法說會逐字稿

Ladies and gentlemen, good morning. Thank you for standing by and welcome to the Third Quarter Earnings call. At this time, all lines are in a listen-only mode. Later there will be an opportunity for your questions, and instructions will be given at that time. (Operator Instructions) And as a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mr. Jason VanWees. Please go ahead.

Thank you, and good morning, everyone. This is Jason VanWees, Vice President in Corporate Development and Investor Relations at Teledyne. And I'd like to welcome everyone at Teledyne Technology's Third Quarter 2011 Earnings Release Conference Call. We released our earnings earlier this morning before the market opened.

Joining us today are Teledyne Technology's 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 let everyone know that 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.

In order to avoid potential selective disclosure, this call is simultaneously being webcast, and a replay, both via webcast and dial-in, will be available for approximately one month. Here is Robert.

Thank you, Jason, and good morning, everyone. Before discussing our individual business segments I have some general comments.

Third quarter sales of $496.4 million increased 21.1% on earnings per share from continuing operations of $0.91, increased 12.3% compared to last year. In addition, earnings per share included a charge of $0.08 per share for a one-time investment write-off.

During the quarter, we continued our emphasis on higher-margin commercial and international markets, and gross margin increased 278 basis points. In order to drive organic growth, we have also increased our focus on new product development. As a result, internal R&D spending in the third quarter increased approximately 75% to about $25 million. In addition to internal R&D, we benefit from roughly $100 million annually of related customer-funded R&D.

For example, in the second quarter, we received our largest oil and gas development contract, to date, for high-power electrical subsea interconnect. We were also recently awarded an important order for development and qualification of our low-dosage medical x-ray sensors from a leading medical equipment supplier.

Today Teledyne is primarily a producer of highly engineered commercial products, which are enabling technologies for attractive industrial growth markets.

Organic growth has accelerated throughout 2011, and in the third quarter organic growth in our instrumentation, imaging, and electronic businesses was collectively 9.1%

Sales in our government -- sales to the US government now represent approximately 34% of revenue. While such sales declined in the quarter, we were awarded government contracts, including our largest to date, with (inaudible) totaling almost $1 billion providing a stabilized outlook in our Engineered Systems business.

We continue to reposition our government businesses, focusing on Defense Electronics for C4ISR, underwater vehicles and other new manufacturing contracts.

I will now comment on our business segment, after which Dale Schnittjer will review some of the financials in more detail and provide the outlook for the remainder of the year.

Third quarter sales in our instrumentation segment increased 10.2% to $157.1 million. Sales of the environmental instruments grew 17.8% while sales of marine instrumentation grew 5.8%. Overall, organic sales growth in the instrumentation segment was 8.4% compared to last year. Segment operating margins remained strong at over 20%.

Strong growth of the environmental instruments resulted from an increase of over 30% in international sales due, in part, to power and petrochemical activity in Asia and the Middle East. The increase in marine instrumentation resulted from sales of marine electrical and optical interconnect, both due to growth in deep water oil production as well as our ability to gain market share.

Share sales of hydrographic survey instruments increased nicely in the quarter as did sales of complete unmanned underwater survey systems; that is, ocean gliders and our new powered underwater survey vehicles. These gains were somewhat offset by lower shipments of geophysical sensors used for oil for the exploration.

Turning to digital imaging segment, third quarter sales increased over 200% compared to last year. While the bulk of the revenue was due to the acquisition of Dalsa in February of 2011, underlying organic growth was 16%. Segment operating margin decreased to 2.4%, largely as a result of increased R&D spending and approximately 290 basis points of acquisitions related in tangible asset amortization.

Growth resulted from a greater proportion of integrated in products of systems and cameras such as mid-wave infrared camera for small UAVs, and a short-wave infrared hyperspectral imager for the Predator UAV, which also uses, by the way, 3 Dalsa visible imaging sensors.

We continue to be funded by the DOD to develop next-generation infrared sensors including dual band -- that is two-colored sensors, and new strained layer superlattice detector technology, which has the potential to lower the cost of high-performance infrared detectors. We also gained significant momentum in certain classified imaging areas.

Sales of machine vision cameras by Dalsa used to inspect flat panel television displays declined, as anticipated, from second quarter. However, this was somewhat offset by demand for cameras used to inspect displays for tablet computers and smart phones including the most popular model.

Sales of sensors and inspection cameras for general, industrial, and life-size applications remains relatively strong as the customers wanted sensor development projects such as the low-dosage digital x-ray sensor contract mentioned previously.

Turning to our aerospace and defense electronics segment, third quarter sales increased 10.1% compared to last year due to higher sales of microwave devices, interconnect, aircraft information management systems, electronic relays, and electronic manufacturing services.

Operating profit increased 84% and segment operating margin increased 580 basis points.

Our commercial aircraft information management business, with 60% of its sales to international customers, has continued to see healthy orders as a result of new products, market share gain, and strong growth by international airlines.

Defense sales also increased in the quarter, and we expect some future stability in our defense electronics market. We believe microwave systems for UAVs and battle and satellite communications are likely to remain a high government priority.

We also have a broad base of products for legacy platforms that will require [sustainment] and upgrades particularly if new programs are canceled or scaled back.

Finally, we are continuously developing more highly integrated systems that have higher selling prices.

Turning now to our engineer systems segment, third quarter revenues increased 9.6% while margins declined 138 basis points. We continued to absorb significant government funding reductions to certain missile defense engineering programs and the cancellation of NASA's Constellation program.

However, early in the quarter, we received (inaudible) $3 million multi-year contract from the United States Special Operations Command for development and production of a new SEAL delivery vehicle. And on August 31st, we were awarded the Objective Simulation Framework contract by the missile defense agency with a potential value of $595 million over five years.

In conclusion, we are a diversified mix of industrial and growing international businesses, and we believe we are well positioned to navigate an environment of volatile capital markets and economic uncertainty. Given Teledyne's strong cash flow and balance sheet, we have ample flexibility not only to continue pursuing acquisitions but to also initiate a share repurchase program.

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 discuss our 2011 outlook.

On cash flow in the third quarter, cash provided from operating activities from continuing operations was strong at $52.9 million compared with $17.5 million for the same period of 2010.

Free cash flow was $43.2 million in the third quarter of 2011. Capital expenditures were $9.7 million in the third quarter compared to $6.1 million for the same period of 2010.

Depreciation and amortization expense was $16.7 million in the quarter compared to $12 million last year.

We expect to invest approximately $45 million to $50 million in capital expenditures in 2011 primarily due to the acquisition of Dalsa and the increased scale of our business.

Also, for the full year of 2011, we expect depreciation and amortization expense to be approximately $64 million. Of the $64 million, approximately $24 million will be intangible asset amortization expense. To put that in perspective, that's approximately $0.41 per share in amortization expense for 2011.

We ended the quarter with $251.4 million of net debt. That's $289.3 million of debt and capital leases less cash of $37.9 million.

As a reminder, in February we replaced our prior credit facility with a new five-year unsecured $550 million credit facility. The marginal borrowing cost on the new facility is LIBOR+125 to 250 basis points, depending upon our leverage ratio.

Given our $250 million of fixed rate senior notes, our credit facility is modestly drawn, and we have approximately $500 million of immediate liquidity.

While cash flow is expected to remain strong, we do expect to pay up to $46.9 million of income taxes in the fourth quarter related to the gain on the sale of our discontinued piston engine business.

Next on pension -- net pension income after recovery of allowable costs pursuant to the Government Cost Accounting Standards, was $1.4 million in the third quarter of 2011 compared to $1.2 million of net pension income in the third quarter of 2010.

On stock options, stock option compensation expense was $1.5 million in the third quarter of 2011 compared with $1.2 million in the third quarter of 2010.

Moving to our 2011 outlook, management currently believes that GAAP earnings per share from continuing operations in the fourth quarter of 2011 will be in the range of $0.84 to $0.86. We expect full year 2011 earnings per share from continuing operations of approximately $3.66 to $3.68, an increase from our prior outlook of $3.57 to $3.62.

As a reminder, full year 2010 earnings per share of $3.27 included $12.5 million, or $0.34 of US tax credits mostly related to nonrecurring prior-period research and development. Of the $0.34 of R&D credits in 2010, $0.24 was realized in the fourth quarter. As I mentioned previously, intangible asset amortization will increase to about $0.41 per share in 2011, an increase of $0.17 per share relative to 2010, primarily as a result of the Dalsa acquisition.

Also, as a result of the Dalsa acquisition, as well as higher interest related to the new credit facility and our private placement notes, interest expense is expected to be approximately $10 million greater in 2011 than 2010.

I will now pass the call back to Robert.

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

Thank you. (Operator Instructions) Mark Jordan, Noble Financial.

Our first question is -- or -- two questions on the instrument -- excuse me -- the engineering segment. The new missile defense simulation contract -- how much of that is -- in the first year is new business? And how quickly will that incremental new business ramp?

Thank you, Mark. I think that's going to be about $5 million in the fourth quarter of this year. And next year we expect it to be about $8 million-plus per quarter. So let's just say somewhere between 30 and 40.

Okay, and then, secondly, the SEAL contract you're now initially in a development phase -- what is the run rate of that in the development phase, and when would you conceivably go into a production mode?

I think that contract probably has got a year and a half of development before it goes into a low-rate initial production. So I would say in a couple of years it will be about $30 million a year, maybe a little less in the interim. It could accelerate if we are more successful or the demand is higher.

Okay. A final question on -- relative to the buyback that you announced today. Do you have -- are you making any statements as your -- you know, what pace you want to buy back or should we, in our modeling, just assume that, as a minimum, you will hold your shares outstanding flat?

Actually, we will probably file a 10B51 with it. Actually, we will. And what that will do is automatically, Mark, trigger buying the shares without [our] interference. I am hoping that we will have -- this will ensure kind of a very regulated and very disciplined buyback.

I can't tell you what the rate would be because, obviously, it's price-dependent when you do a 10B51. But having said that, we hope to buy more than we are issuing in compensation-related stock.

Jeremy Devaney, BB&T.

Good morning, gentlemen, nice performance on the EPS line in the quarter. Looking at the imaging systems EBIT, I was wondering if you could give us a little more color on where you anticipate seeing that margin go over the next couple of quarters? It's a little bit weaker this quarter than I anticipated.

Thanks, Jeremy. Let me start with one comment. The imaging segment consists of three businesses. One of them has to do with our R&D centers, which is about $50 million in revenue. In the R&D centers we intentionally don't take profits. We [plow] any profits in that unit back into R&D for our businesses. So there is a chunk of the imaging that we run at zero profit, as you'd expect, as an R&D program.

Then we have an imaging program in primarily cooled infrared imagers that are here in Thousand Oaks and then, of course, there is Dalsa in Canada.

We think that the margins next quarter will improve somewhat from this quarter. They were fairly low this quarter. But, as I indicated, and I think, overall, annualized, we should reach about 5%. But please note also in addition to not taking profit in scientific or our R&D center, we also have the intangible amortization, which is significant. This year that's increased over $9.5 million over last year, and that's primarily from the Dalsa acquisition. So those combinations will keep the margins relatively low but higher than this quarter.

Robert, on that 5% number, do you anticipate seeing that this year? Or is that more of a long-term target?

No, this is this year. Long term, Jeremy, we have to kind of make a decision how we treat R&D centers, and if we separate that out from the others, then I think the margins are going to be higher. Obviously, we are aiming for that.

All right. And then moving onto pension, I was wondering if you could help us with the outlook. I know there was brief discussion at the Analyst Day that there's definitely a pension headwind this year versus last year. How do you expect that playing out for the remainder of the year and then looking beyond, if you could?

If I may, I'll pass that back to Dale, please.

Well, as it plays out the rest of this year, we are seeing about $0.09 of pension income in the year for 2011. As we go out into next year, as you know, it will -- pension expense will depend upon three things -- one, the return that we receive on assets this year, as well as the discount rate that cannot be determined until 12/31, and then the projected rate of return for next year. And, certainly, the discount rate could be lower next year. I guess the guidance I could give you is that, as is in the 10-K, there's about $2.3 million of pretax difference for every 25 basis points in the discount rate.

Steve Levenson.

I would have thought, going up to now, that intelligence surveillance and reconnaissance equipment would have been untouchable. And then there was news that the EMARS program was canceled. Do you have anything like that, or do you see that as an opportunity for upgrades and replacements?

No, I don't think we have anything in that domain in the EMARS program. But, having said that, we are making some inroads in existing programs, especially with our mid-wave infrared sensor suite, which kind of is a very efficient way of looking at scenery by mimicking the human eye so you can analyze a small portion of the scenery that you're interested in. And then the hyperspectral imaging that (inaudible).

And then, finally, I have to say that the big mover for us is that the new sensors that are being developed both in enhancing mercad telluride performance as well as moving to the next generation of sensors, like I mentioned, the strained superlattice sensors. Those are going to give us an opportunity to keep pushing that frontier.

And then, finally, in that whole domain, as I mentioned, we are getting some strong traction in some classified programs.

Okay, on that mid-wave sensor you talk about, is that in addition to the imaging package or is that -- or are you taking that from somebody else?

No, that's our own. If you recall, Steve, we made a majority investment in a small company here in California called NovaSensors. That's their cameras, and they are going in a small UAV, and they are just now ramping up production on that.

Got it, thanks. One other thing -- based on the contributions you expected from Dalsa at the time you closed the deal, do you feel like you're above, in line, or below those thoughts from back in February?

Yes, I think one thing that's happened is that the model that we used in the acquisition assumed that first on revenue stream, which was closer to the revenue in 2010, the revenues this year have been higher than our expectations.

We have intentionally increased our R&D spending there, and I think, overall, it's meeting our model objectives, maybe a little higher. But we have higher expectations as we move forward since digital imaging is our new platform on which we want to build a significant part of Teledyne's future revenue stream.

Michael Ciarmoli, KeyBanc Capital Markets.

Hey, good morning, John. Thanks for taking the questions, nice quarter. Just a follow-up maybe on the buyback. I guess you guys had a million-share authorization back in 2005. I don't think you ever really executed too much on that. But it sounds like you're putting more teeth behind this buyback program, and you're more firmly committed to actually buying the shares. Does that seems like a fair characterization?

Yes, that's fair.

Okay. And I don't know if you're prepared to at this time, Robert, or not, but can you maybe help us out or are you willing to shed a little light on 2012? You know, maybe with specifics? We got some color around pension. I'm assuming that as both the OSS and the shallow water [co-mersible] ramp -- that's going to be at a lower margin so you might have some margin dilution there. Any kind of color you can give us in terms of -- ?

Yes, I'll try. First, as you know, we are -- right after this meeting, we are going to what we call our "operations reviews" for six days. We go through every business in depth. Having said that, what we have seen -- let me start with the government businesses that you started with.

Having seen the decline in missile defense and NASA's Constellation program -- we have taken big hits in our government businesses. To put it in perspective, year-over-year, quarter-over-quarter, let's say, decline in our missile defense and NASA programs were over 30%. What has happened is that our missile engineered systems business, as a whole, has gone down from what we expect for the year from about $335 million to less than $330 million this year.

We think now with this program and some traction that we have in manufacturing, that that business has stabilized. So while, as you mentioned, there is going to be a rampup period for OSS and for the shallow water vehicle, we think that business next year should be relatively flat with this year.

The problem that we have, because we still have 30% of our budget -- 34% is government, but about 30% is defense. The problem that we have is we don't really know what's going to happen to the budget, especially with the group of -- I don't know what they call the group, but the Republican and Democrats, if they can't come to any agreement, there might be some automatic budget cuts. So -- it's the supercommittee, I am told now.

So if we go through the rest of our portfolio, we always think that it should grow in the middle single digits, let's say 5% annually. And if we can keep our margins improving, we should be okay. Now, all of that is predicated, of course, nothing terrible happening in capital markets and otherwise. That's the best I can do at this time.

Okay, that's helpful. You've talked about, certainly, a ramp in spending on R&D, and I think at the Analyst Day, you mentioned the potential, you know, I think as you're just looking to improve efficiencies across the organization, maybe consolidating ERP systems. Is that something that's still on the table at this point, or how are you guys thinking about that?

Yes, we definitely are thinking about that. We are actually acting on it. There's two simultaneous programs underway. One of them is consolidating our businesses. We have naturally, because we've acquired so many companies, while we've integrated them, we haven't consolidated them as much as we could. And so our SG&A is higher than it should be. And we are doing that.

But in doing that, we simultaneously are going to go to a more common ERP system among our businesses. And that's going to be effective. The only thing about the ERP systems, as you well know, is that it takes time to implement, and they are costly. We have actually made the commitment now to do it. So in the first couple of years, it might soak up a little money, and it will pay back in years three and four.

Rob Takacs, Robinson Humphrey.

A couple of quick questions -- if you could talk a bit about an instrumentation, oil and gas production, exploration business and where you see that going over the next year or so? And maybe it's too early to tell, but are you seeing any signs of increased capital spending with the recent rise in the price of oil?

Yes, let me start by saying on the exploration side, if the price of oil goes to about $60 per barrel, there is going to be a decrease in activity -- probably activity levels are going to remain the same. As price of oil gets to $90-plus, then you see a lot more activity. Let's just first start with that.

The second significant thing that's happening in exploration is -- and I'll divide up exploration production, if I may. On the exploration side, a lot of the vessels that are used currently for the purpose of mapping the ocean floor using the streamer cables that we make, they have kind of upgraded their system. They are still doing a last bunch of vessels with our newest streamers. So I think that's part of our business, is kind of peaking and, over time, it will start declining.

To offset that, there is an important development underway, which we are very much involved in, and that is setting up these cables on the ocean floor to monitor reservoirs as you begin pumping the oil out of those reservoirs. And that kind of knowing where the oil is coming from in the ocean floor and being able to then increase the pressure in certain places to get more efficient use of the reservoirs -- that is becoming a big driver, and we have new programs in that.

So, overall, we think if oil exploration and production remains stable or grow a little bit, the exploration side of our business will stabilize. Ocean surface will decline, ocean bottom will increase, so that's the story.

On the oil and gas production side, where we've gone is really into the deep water. If you look at total oil production in the world, in 1990 25% of that global production was from offshore oil. Today it's more like 33%. So there's been a significant increase in offshore production.

But much more importantly, where our products go are in deep water, which would be a depth of, let's say, beyond 1,500 meters. And in 1990, there was zero deep water production. Today it's close to 9%, and that's the fastest-growing section. By 2020, it's going to probably go to 13% of total offshore oil production. And that's where the big bucks are going. Over the next four years, CapEx in that domain is probably going to increase by annual compounded rate of 15%.

So to summarize, we think our exploration will be fairly stable. Deep water production is going to increase, and that's our sweet spot.

Okay, and then just a quick follow-up -- as it relates to share buyback, does the thinking behind it, does it mark a sort of significant departure from previous capital deployments?

That's a good question. The answer is no. Here is what's happened to us between a few years ago and today. First, we've really repositioned our portfolio. With the piston engine business, with all its unknown liabilities, that was a drag on our portfolio -- part of our portfolio. We feel a little more comfortable about not having the significant liabilities facing us year after year.

Second, our cash flow is very healthy compared to previous years, and we feel comfortable that we can do both acquisitions, invest in our own businesses, and buy our shares.

Having said that, if a really opportunistic acquisition came along, then we would probably decrease share buyback and increase the amount of money we put in acquisitions. But that depends on the opportunity. Right now, M&A is down across the world. Markets are, of course, been gyrating. But people's expectations of what their properties are worth have not yet become realistic. That's why I think M&A activity has been down.

Chris Quilty, Raymond James.

First question, just for Dale as a follow-up on the pension issues. I know you had an optional pension payment last year. Do you anticipate, given the wonderful performance in the market and interest rates, you're going to have one of those somewhere in the near future?

Well, on each year, our goal is to make contributions to the pension plan that are equal to the payouts to the retirees, and certainly at this time we would continue to expect to do that, and that's probably in the vicinity of $40 million. So other than that, we don't have a decision right now.

Okay. And a question for Robert just concerning Dalsa. This was asked, but I'll ask it in a different way. Now that you've had your hand on the business for several months, what's been your biggest surprise in terms of the operations or products or culture of the company? And what do you see as the biggest opportunity (technical difficulty) that's coming?

Well, Chris, you cut out a little bit at the end, but I got the gist of it. First, let me just say that Dalsa, as you well know, was a public company before we acquired it. And so it's a very well run enterprise. As we do work on our audits and our SOX compliance, we find them probably the best-run company among all our acquisitions that we've had. So we are very pleased with that part.

The culture of the company is the people are close to our own. It's a small, agile company; their high technology that has to keep developing new products in order to be competitive. So we feel very comfortable about that.

The two or three big areas for their growth, kind of punching through the market, first and foremost is their ability to innovate in their smart camera domain and to go from line scan cameras, which, as you know, are sweeping across an image to area scan cameras. And they are just introducing in the fourth quarter a new product in the area of scan cameras, which is important for us to do.

The second area is the whole medical area. Their low-dosage, high-fidelity images are leading-edge products. That's why we have this major R&D program, as an example, one of our customers is sponsoring. But we also have our own funds in there, and that domain is moving from CCDs to -- which are charge couple devices, to CMOS, which are complementary methyloxide semiconductors. And they are moving there very rapidly, and they have to do that to stay ahead of the competition. And those would give the people that use the cameras dynamic ability to have dynamic images, just-in-time images of the patients both in surgery as well as now, they've moved to dental domain. So those are the first two.

And the last one is, as you know, it also has the fab, semi-fab, in (inaudible), which is -- not only makes products for our own use but also has -- is one of the top two independent MEMS fabs in the world. Right next to it, the Canadian government and the Quebec government have invested $170-plus million to put a facility that would be used by the University of Sherbrooke, ourselves, and IBM. And that's coming online in January, and so we'll be moving our MEMS R&D there. So MEMS is a big area for us, but to capitalize on top of that, they are moving in the uncooled infrared domain. We already have the requisite licenses for VOX, vanadium oxide, along wavelength uncooled. We intend to make those on a wafer level that you can then cut up into small pieces.

We think it will take us somewhere about 18 months to get our products up in line in our facility. And that's going to be an important future. So those are the three arms -- smart cameras, medical products, CMOS, and the uncooled.

And was it -- you were saying those cameras would be embedded in the iPhone?

No, I think you just made a joke, right?

Usually, you catch me quicker than that, Robert. One last question on the engineered systems business, two big contract wins. If I remember correctly, there was a third big one hanging out there.

There is actually -- there are four of them. The two that we just mentioned. There was a glider program, if you recall, with the US Navy. That's going really well. The fourth one is that nuclear program that's dependent on USEC getting their loan guarantee, and that's -- with that increased our nuclear manufacturing from what's currently about $40 million a year by another, let's say, $15 million, $20 million a year.

USEC has had some, let's just say delays, in getting their loan guarantee. The most recent development we heard about is that the government is offering to increase their investments in R&D to ensure that the processes are more robust, and they are committing to spend something like $300 million.

So we are not as encouraged in the production side as we have been -- we're in a kind of a maintenance mode right now in that program. So we (technical difficulty), Chris. It was the gliders, it was the underwater submersible shallow water vehicle, and the OSF [manned] USEC. Three of the four, we have been successful over. The fourth one really depends on the Obama administration. It is out of our hands.

Chris Quilty. You should suggest to USEC to rename the company Solartronics or something like that to get the loan.

The second joke, that's good.

Greg Konrad, Jefferies.

Just a quick question overall in terms of the economy. Are there any shorter cycle products where you've seen kind of a slowdown in orders other than what's already been mentioned?

Yes, there are a couple of them, Greg. One is in the flat panel display inspection system, which is Dalsa's inspection for television. There has been a significant slowdown there. It's -- as I said, it's been partially offset with -- it's been partially offset with the iPad type products -- you know, tablet-type products. But they haven't made up the difference, which, as you know, televisions are consumer electronic products driven by consumer spending, and that's a little bit in the doldrums right now.

We also are seeing our kind of canary-in-the-mine is our relays products that are going to semiconductor testing. We are seeing some slowdown there.

And, lastly, we do have some significant -- not significant, but some exposure to the whole semiconductor capital equipment market, both on Dalsa and other places in our programs including our instruments. And there, in May, the book-to-bill ratio was over 90%. Last month, it dropped to about 80%. So point A book to bill. That's a bad sign.

So we are very cautious about those markets -- semiconductor as well as some of the consumer markets that we have been involved in. And where we have had some success, obviously, is our instruments, environmental and others, in the Far East and in India, where we've enjoyed some market share gains, and there's been some robust spending in that domain.

And just second, I know you guys are obviously well positioned in defense, but from the calls that we've heard so far there is definitely a lot of uncertainty, and that kind of increases each month without direction in the budget. Have your discussions with customers changed at all over the last couple of months?

No, not really. You are right, everybody is cautious. We have intentionally, over the last number of years, walked very decisively to reduce our exposure to defense. This is way before people started getting nervous about defense. We've been doing this for a large number of years. And so our exposure to defense is just below 30%.

The good thing, if there is a good thing, is that we have kind of gravitated in two areas. First, in our systems engineering business, we did a lot of service work -- systems engineering and technical assistance type work. And intentionally or unintentionally that's been significantly reduced. Where we've moved to is compete for some prime contracts. And smaller, more agile companies that have very strong technologies like us can actually compete there with some of the big primes. An example of that, obviously, you see is the OSS win.

On the other side of the ledger is our microwave business, and in the microwave businesses, we've again intentionally moved to more complex, highly integrated products, communication, and we also enjoy, as I said, this very strong base of legacy communication and radar products.

So if the decision is made to reduce new platforms, they still have to maintain their existing platforms and upgrade those. So we sit in a relatively sweet spot.

Having said all of that, we are hoping to be able to maintain our revenue base in defense and not experience significant decline. We don't expect it to grow.

Jeremy Devaney, BB&T.

Taking the follow-up question -- earlier we were talking about the ERP upgrade underway. I was wondering if you might help us out with costs anticipated on that? Are they significant? Or what should we be thinking in terms of percent of revenue?

It's significant. Any ERP system you try to put in today is going to be significant. What we are going to do is we are going to really start by putting it in our commercial businesses, especially instrumentation business. When you think about that, and you think about multi-year, you're talking about, secondly, somewhere between $20 million and $30 million. But you hope always to save that as you implement it. And then in that, [think], Jeremy, you've got to keep in mind that a lot of that is capitalizable. There is, of course, some hit to P&L because you are using people to do that, but there is a lot of ERP expenses can be capitalized.

Right, that's really helpful. And then on two of your drilling down into two businesses, I was wondering if we could get some more detail on the glider business. I know last quarter you had indicated it was a really strong grower for you, and you were looking to go more into an integrated product on the glider side implementing your sensors and in offering a full product.

And then also on your Aerojet partnership, have you seen any traction with that, especially with Aerojet's business appears to be picking up a little bit?

Yes, let me start with the glider program. There are three or four programs that we're involving. First, the big one is, you know, is the Navy Littotal Battle Space Sensing glider. These are gliders that are in front of the battleship formation. We have a $53 million contract there. We have delivered about 20 of these gliders. A full program would buy about 100 (inaudible) of them.

On the other side of the ledger, there is a program from the government, an ocean observation initiative, both shallow water and deep water. We've been successfully winning both of those programs that also use gliders. We think our overall glider sales, while modest by most measurements, would go from, let's say, $3 million to $4 million to $8 million -- $7 million to $8 million over the next year or so.

The other thing is, on the sensors that you mentioned, I'll give you two specific examples. We have a Doppler velocity log that measures speed, and there we've incorporated that into or gliders that are going to this ocean observing program. And then we also have Inertial Navigation Systems that we produce in our British facilities, and we have sub-bottom profilers, which profile the ocean floor. We are using those on our -- one in our gliders; the other one on -- well, both of them, actually, now are motorized AUEs, which is the acquisition we made last year. So we are putting sensors on what we call the trucks that carry them.

By the way, the dollar number that I gave you on the glider program, the $6 million or $7 million or $8 million, that was per quarter not for a full year. So it's higher for the year.

Coming back to your question with the Aerojet, as you may know, that's an AJ26. It's a LOX kerosene engine. It's the Russian engine. We are helping Aerojet with that, and while the dollars are small at this time, we think that there are opportunities for that in next-generation upper stage rocket engines, et cetera. So we are hopeful on that one.

Michael Ciarmoli, KeyBanc.

Robert, just a point of clarification -- engineered systems -- you're thinking that's going to be flat next year in 2012?

Yes, Mike, with respect to this year.

Okay, so when I look at, you know, sort of, the gross profile, I know you guys are thinking kind of 10% to 11%. It seems like there are some pretty big pressure points across the enterprise. You know, defense flattish, you mentioned semi, consumer, you know, we really didn't talk about, I guess, European exposure yet. I mean, it seems like, you know, getting to that 10% consolidated, you know, I guess, acquisitions aside, you know, call it 5% to 6% organically, it seems like you're facing some pretty tough headwinds there.

What can I say, Mike -- you're right.

Okay.

We just have to work harder.

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Operator, thank you very much. And thank you, everyone, for your questions. I'll now ask Jason to conclude our conference call.

Jason VanWees. Thanks, everyone. If you have follow-up questions, please feel free to call me at the number on the release, and, Operator, if you could go ahead and close out the call with the replay information, we'd appreciate it. Thank you, everyone.

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