Teledyne Technologies Incorporated
Q2 2008 Earnings Call Transcript

Published: 28 Jul 2008

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Teledyne Second Quarter Earnings Call. For the conference, all the participant lines are in a listen-only mode. However, there will be an opportunity for your questions and instructions will be given at that time. (Operator Instructions) As a reminder, today’s call is being recorded. With that being said, I’ll turn the conference now to Mr. Jason VanWees. Please go ahead, sir.

[Jason VanWees:]

Good morning, everyone. This is Jason VanWees, Vice President, Corporation Development and Investor Relations at Teledyne Technologies. I’d like to welcome everyone to Teledyne Technologies’ second quarter 2008 earnings release conference call. We released our earnings earlier this morning before the market opened. Joining me today are Teledyne Technologies’ Chairman, President and CEO, Robert Mehrabian; Senior Vice President and CFO, Dale Schnittjer; and Executive Vice President, General Counsel and Secretary, John Kuelbs. After remarks by Robert and Dale, we will ask for your questions. However, before we get started, our attorneys have reminded me to tell you that all forward-looking statements made this morning are subject to various assumptions, risks, and caveats as noted in the earnings release and our period 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 one month. Here is Robert.

[Robert Mehrabian:]

Thank you, Jason. I should also note that we have with us three of our segment executives, the Presidents of our various segments, Rhett Ross, Rex Geveden and Al Pichelli. They’re offsite. And if there are any very difficult questions, I’ll pass it on to them. Before commencing on the specific results of the quarter, I would like to make a couple of introductory comments. In the past, we’ve noted that our mix of government and commercial businesses, many of which are leveraged to energy, environmental and government markets including defense, of course, would position us favorably in uncertain economic and financial markets. Now, I think that’s turned out to be the case at least in this quarter. Furthermore, our strategic investments in the core markets that I just mentioned to grow both organically and through acquisitions, coupled with our consistent emphasis on operational excellence, has been rewarding. Today, we’re quite pleased to report record sales, record operating margin, record earnings per share, especially in this current economic environment. We don’t mean to suggest that Teledyne is immune to economic cycles. In fact, we believe certain markets, including aviation-related businesses, could soften due to high cost of fuel. However, revenue from our marine instrumentation businesses, which have grown, as you know recently significantly, which also served the offshore energy exploration and production market, now exceeds the revenue generated by all of our commercial aviation businesses. Let me turn to our results. In the second quarter, Teledyne achieved all time record quarterly sales of $478.8 million, driven by overall organic growth of 12.1%, and all time record quarterly earnings of $0.89 per share, which increased 32.8% from last year. This was the 26th consecutive quarter, or a span of over six-and-a-half years, of year-over-year growth in earnings per share, and it was the 17th or over four years of consecutive quarterly double-digit growth in earnings per share. During the second quarter, overall GAAP operating margin increased 76 basis points to 11.7%, which was another record. 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 2008. Starting with Electronics and Communications, second quarter sales in this segment increased 18.9% compared to last year from 266 million to $316.3 million with organic growth of 7.6%. Segment operating profit increased 26% from 37.3 million to $47 million, and segment operating margin increased 84 basis points to 14.9%. Our Electronics and Communications businesses generated approximately two-thirds of Teledyne total sales. In this business, first, we have three market categories

[Dale Schnittjer:]

Thank you, Robert, and good morning. I will first discuss some additional financials for the quarter and full-year, not covered by Robert. Then I’ll give an update on pension costs and discuss our 2008 outlook. In the second quarter, cash provided from operating activities was $38.5 million compared with cash provided from operating activities of $32.4 million for the same period of 2007. The higher operating cash flow was primarily due to greater net income and the contribution from recent acquisitions, partially offset by higher tax payments. Free cash flow for the second quarter was $28.7 million compared to $22.3 million for the same period of 2007. Capital expenditures were $9.8 million in the second quarter compared to $10.1 million for the same period of 2007. We ended the quarter with $278.7 million of net debt. Our balance sheet remained strong with a net debt to cap ratio of 31.5%. So far, we’ve been largely unaffected by problems in the credit markets. As noted in our press release, depreciation and amortization expense for the second quarter of 2008 was $13.1 million compared to depreciation and amortization expense of $8.9 million in the second quarter of 2007. Moving to pension, in the second quarter of 2008, FAS 87 and FAS 158 pension expense was $2.5 million or negative earnings per share impact of $0.04. This compares to FAS 87 and FAS 158 pension expense of $2.9 million or negative earnings per share impact of $0.05 in the same period of 2007. Pension expense allocated to contracts pursuant to Cost Accounting Standards or CAS was $2.4 million or a positive earnings per share impact of $0.04 in the second quarter of 2008 compared with $2.6 million or a positive earnings per share impact of $0.04 in the second quarter of 2007. As we have mentioned before, starting January 1, 2004, new hires have been added to an enhanced defined contribution plan as opposed to the company’s existing defined benefit plan. Now moving to stock option compensation expense, in the second quarter of 2008, for the requirements of SFAS number 123R, stock option compensation expense was $1.8 million or a negative earnings per share impact of $0.03 compared with $1.8 million or a negative earnings per share impact of approximately $0.03 in the second quarter of 2007. Before commenting on the outlook for the remainder of the year, I wanted to remind everyone that earnings per share in the second quarter were favorably impacted by $3.3 million or approximately $0.06 per share of settlements. As noted in our earnings release, $2 million was included in the Electronics and Communications segment and $1.3 million was included in the Energy and Power Systems segment. Now, let me turn to our 2008 outlook. Management currently believes that GAAP earnings per share in the third quarter of 2008 will be in the range of $0.77 to $0.79. The full-year 2008 earnings per share are expected to be in the range of approximately $3.20 to $3.25, an increase from our previous outlook of $2.98 to $3.06. Our outlook for the third quarter and full-year 2008 reflects an anticipated increase in expenses, including intangible asset amortization resulting from the acquisitions completed in early fiscal 2008. We expect full-year 2008 capital expenditures of approximately $45 million and total depreciation and amortization expense of approximately $48 million. For reference, intangible asset amortization is expected to be approximately $16 million in 2008, an increase of almost $10 million or $0.16 per share from the full-year of 2007. For the full-year of 2008, we anticipate approximately $9.6 million or $0.16 per share in pension expense under FAS 87 and FAS 158 or approximately $0.2 million in net pension expense after recovery of allowable pension cost from our CAS covered government contracts. Full-year 2007 earnings included $11.9 million or $0.21 per share in pension expense under FAS 87 and FAS 158 or $1.7 million, which is $0.03 per share in net pension expense after recovery of allowable pension cost from our CAS covered government contracts. The decrease in full-year 2008 net pension expense reflects the return on pension assets, as well as pension contributions made in 2007. The company’s 2008 earnings outlook also reflects $7.8 million or $0.13 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.

[Robert Mehrabian:]

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

[Operator:]

Thank you. (Operator Instructions) And first from the line of Michael Lewis with BB&T Capital Markets, please go ahead.

[Michael Lewis:]

Good morning, Robert. Another excellent quarter. And, Robert, I was wondering, actually I think this is a question for Al. Again, another just an impressive quarter of margin contribution coming out of E&C, and I guess my question here is with regard to forward expectations. I mean, does this look like the top bound or top range that you’re currently witnessing in E&C for the margin, for EBIT margin contribution here?

[Robert Mehrabian:]

Well, it may be close to it at least for the immediate future partially because we had that $2 million from the settlement, which contributed maybe 50 basis points to the margins. So, if we improve the margins in the subsequent quarters, you may get back up to that level without that contribution. So I think there is a little room, but this was a little unusual because of that settlement.

[Michael Lewis:]

So last quarter, Robert, you are saying that, if we kind of focus in around the 13% range, or I may be misquoting you here, so I apologize in advance, but my takeaway was around 13% is kind of safe margin assumption for that segment. Should we continue to kind of look at the 13 to, say 13.5 as a possible sustainable margin for this business going forward?

[Robert Mehrabian:]

In the first quarter it was 13.4. This quarter it was 49 with those 50 to 60 basis points from the settlement. So, Michael, I think around 14 might be a reasonable number, not as low as 13 though.

[Michael Lewis:]

Okay, that’s fair. And then just one more quick question, I’ll get out of the way here. Can we get an update on the program HIGH STARE? And I was wondering, if you have any idea what type of contribution this program alone would have, over say the next like 12 to 18 months as it starts to gain some more traction?

[Robert Mehrabian:]

The HIGH STARE program is relatively long-term, Michael, as you know, having visited us. Its R&D contribution is probably cost -- well, I know, it’s cost plus. So the margins would be in the -- I would say, 7% to 8% range. And it’s -- so far it is making smaller contribution in 2008. We hope that the contributions would increase in future years.

[Michael Lewis:]

The expectation though is that this could potentially be a significant program if the R&D effort goes as planned and milestones are met. Is that a safe assumption to make there?

[Robert Mehrabian:]

That’s a reasonably good assumption.

[Michael Lewis:]

Okay.

[Robert Mehrabian:]

This is a significant one, four years or so out. It would be significant for our Teledyne Scientific & Imaging, but in terms of all of Teledyne, it would not be that big a contributor.

[Michael Lewis:]

Okay. That was the key point you’re saying, like it’s a number of additional years out. Okay, that’s great. Thank you very much. I appreciate it.

[Robert Mehrabian:]

Thank you, Michael.

[Operator:]

And next from the line of Mark Jordan with Noble Financial. Please go ahead.

[Mark Jordan:]

Good morning, Robert. I wanted to talk a little bit about the centrifuge contract. The combination of the two that you received, the 92 in May, plus the 19.4 is about a 111 million. Is the -- and the production should be spread out over, say 12 quarters. Should we look at this as a 10 to $11 million sort of level production rate per quarter over the next couple of years in the engineering group?

[Robert Mehrabian:]

Yeah, I would take the 92, plus the 19, so let’s just say, 110. And I would take it out to 2011.

[Mark Jordan:]

Okay. So that would be about, again, 10 to 11 per quarter?

[Robert Mehrabian:]

Yeah. That’s my -- it would be about 30 million a year -- 30 million plus a year.

[Mark Jordan:]

Okay. Is that a cost plus or is the second contract, I think the first one was cost plus. Is the second contract fixed price or is there any opportunity, what’s the margin opportunity here?

[Robert Mehrabian:]

It’s got a -- it’s a cost plus, mixed fee. I think the fee is about 10%, Mark.

[Mark Jordan:]

Okay.

[Robert Mehrabian:]

By the way, I have -- as I mentioned before, I have Rex Geveden here, who heads up, one of the segments he heads is that Engineered Systems segment. And I’ll let him just make one comment about this. We’ve been fortunate to keep our ASME nuclear certifications for manufacturing and we’re planning to put more emphasis in that domain. Rex?

[Rex Geveden:]

All right, thank you. Yes, Teledyne Brown has actually an interesting history in nuclear manufacturing. As Robert mentioned, that we have maintained our American Society of mechanical engineers certifications, ASME certifications, for nuclear manufacturing. We have three stamps, so-called stamps, an N-stamp, which is a nuclear pressure vessel stamp; and NPT, which is for secondary structures; and a U-stamp, which is a standard pressure vessel type manufacturing cert -- these certifications are required for nuclear manufacturing and we possess those -- just in fact, completed another of the tri-annual audits required for this. So, we stand well poised to capitalize on the nuclear market as it reemerges.

[Robert Mehrabian:]

Thank you, Rex.

[Mark Jordan:]

Yeah, clearly, I guess that the question is, how do you leverage that? I mean, you are clearly -- with 30 to 40 million a year in business, you’ve got an infrastructure that you could build upon. What is the -- what do you view it would be the catalyst to allow you to materially expand beyond that run rate? I mean do we have to go back to building nuclear plants or is there the capability to leverage this, now that you’ve got it in place more quickly?

[Robert Mehrabian:]

I will try and just take a longer-term view here, Mark. I think obviously, there are nuclear plants going up in other parts of the world. I am not sure if we’d be able to leverage those because of the cost of transport of such large components, but it’s possible. But there’s no question at least in some peoples’ mind that sooner or later as a nation we are going to have to address this issue once more. And I think what Rex and his folks have done is position us well for that time. And by the way, at the same time, they have also been building canisters, stainless canisters, manufacturing them for the nuclear waste. And so, right now, we have the nuclear waste canister production and the fuel production portion. And of course, in the future we’re talking about potentially being active if power generation comes about.

[Mark Jordan:]

Okay. The Webb acquisition that you just completed, I heard that there might be a large DoD contract for gliders that would be awarded later this year, potentially in the $20 million range. Do you believe that Webb is well positioned for that? Since it’s a stable contract, your teaming with -- or agreement with Scripps position you better for that competition?

[Robert Mehrabian:]

We believe so. Of course, competition is, by its nature, undetermined on who is going to win, but we are bidding on it. We have, of course, the Webb, but just as importantly, we have all of our marine group’s sensors that would be brought to that enterprise. Just as importantly, we have Teledyne Scientific that does autonomous vehicle modeling -- software modeling, and we have Brown Engineering, that is pulling all of this together, because they are our systems house and systems integrator. So, while it’s important contract for us and we have bid on it and we have some really good outstanding partners with us in that, but it’s not a make or break contract for us. We think of Webb, Webb is the premier producer of gliders. And we are in association with Scripps. We think we are fairly well positioned for whatever platforms that come along.

[Mark Jordan:]

Okay. A final question, if I may. In your opening remarks that you re-aggregated revenues in a little bit different manner, just talked about the relative end-market sizes that you address, defense, marine, electronics and commercial aviation being the three largest specific markets. Could you quantify those as you see them, again, because they do cross segment boundaries?

[Robert Mehrabian:]

Yeah. Let me start with defense electronics. Defense electronics is about 26% of our total in dollars. Instruments, which includes both marine instruments and our other instruments, comprises about 30%. Marine is about 17% of the total. And when I talk about total, I am talking about total revenue of the company. Avionics and other commercial electronics are about 10%. So, when you aggregate that up, you end up with acquisitions that we’ve made and you add those numbers up, you end up with about 66% of our total revenue coming from Electronics and Communications. Aviation, now if you took some of the aviation -- avionics that we do in electronics, and then you took the piston engine businesses that we have and you combine those together, you could say that’s about 16%.

[Mark Jordan:]

Okay.

[Robert Mehrabian:]

So, I don’t know if that’s been helpful, Mark.

[Mark Jordan:]

Okay. Yes, thank you.

[Robert Mehrabian:]

Thank you.

[Operator:]

Our next question is from the line of John Harmon with Needham & Company. Please go ahead.

[John Harmon:]

Hi, good morning.

[Robert Mehrabian:]

Good morning, John.

[John Harmon:]

Robert, you addressed this sort of indirectly. So, let me see if I can ask you to put it all together. The question is just, how -- news we’ve been hearing about commercial aircraft order cancellation. How that’s affecting your avionics business? You said, it was down a bit year-over-year, which you didn’t really talk about it in that light.

[Robert Mehrabian:]

Yeah. What I did, John, I hope I haven’t -- I didn’t confuse people. Because I’ve lumped avionics and other commercial electronics together, because that’s the third part of Electronics and Communication. I said, those combined were down 5.8%. The avionics itself, which as you know is data acquisition systems and wireless ground links and so on, that Boeing commercial aircraft, that was actually up year-over-year about 10%. Now, we don’t think that’s sustainable because of what’s happening in that whole domain. But having said that, as you well know, the Boeing and Airbus aircraft productions/deliveries for this year are going to be about 8 and 9% above last year respectively, and business jets are going to be up about 8, regional aircraft up about 9. And so we see some upside for us there, and the flipside is that on the domestic passenger airlines, our exposure is less than 5% of our business, it’s about $5 million. So we may see some declines there.

[John Harmon:]

Okay, thank you. And, well, in that same category, you’ve talked about your strategy to hit more into growth, defense areas of electronic manufacturing; in other words, you’re not taking on anymore medical business. When could that business sort of bottom out and start to grow again?

[Robert Mehrabian:]

Well, we have actually -- we have been fortunate with the outsourcing that’s coming our way from the primes. We have launched about 30 products in Q2 in our electronic manufacturing services in the defense area. And we have good orders, and I anticipate that in the second half we should be ramping that up. We have record backlog in that area, we’re reasonably well positioned. In the medical domain, we have -- obviously as we said, that’s an area that we expect to decline over time and we’ve said that repeatedly. And we did have some comparables that were down year-over-year, I think last year Q2, we did about 6.6 million in medical EMS and medical micro, this year, I think we did more like 4. So while we ramp one down, we are ramping the other up.

[John Harmon:]

Okay. Thank you. And just finally, more of a financial question. Excuse me, your guidance did call for sequentially lower earnings in the second half and in the third quarter, is that assumption just having made so many acquisitions in the first quarter or any of them, especially dilutive?

[Robert Mehrabian:]

No, no. I can tell you that our acquisitions have not so far been dilutive. It’s just that in second quarter we have about, as Dale mentioned, we had about $0.06 contributions from various settlements. So if you take that out, and then we have a little concern obviously, as we have mentioned about the aviation market, with the gas prices where they are. So we’re taking a little haircut there to make sure that we are -- as you well know, we always are relatively conservative. And Dale just pointed out to me that, we don’t expect that the margins in our Engineered Systems group will continue at the higher level off that we enjoyed in the second quarter. So settlements, a little lower margin in TBE and potentially a little downturn in our avionics businesses and the aerospace and avionics business, those three I think are contributing. And I would remind you that last year’s second quarter, we had $0.13 tax, one-time tax, R&D tax credit that we took. So, if you take that out of last year’s second quarter and look year-over-year, the guidance is pretty strong.

[John Harmon:]

Okay. Thank you very much.

[Robert Mehrabian:]

I am sorry, third quarter. I meant, third quarter, not second. Thank you.

[John Harmon:]

Thank you.

[Operator:]

Our next question is from the line of Ryan Rackley with Raymond James. Please go ahead.

[Ryan Rackley:]

Good morning, gentlemen. Robert, looking at organic growth for electronic instrumentation, obviously another strong quarter. Are you thinking now that, you guys may comment about the, your previous estimate of 8 to 9% organic growth for the year?

[Robert Mehrabian:]

Well, right now, this quarter, I think our Electronics segment’s organic growth was about 11%, in the instruments, 7%. I think going forward it’s going to go down a little bit, as well. We don’t think we can keep it up at the rate that it’s been going.

[Ryan Rackley:]

Okay. And for the defense business, defense electronics, are you looking at 6 to 7% range for the year, organically?

[Robert Mehrabian:]

Yeah, that’s a good range.

[Ryan Rackley:]

Okay, great. And actually that does it for me. Thank you, guys.

[Robert Mehrabian:]

Thank you.

[Operator:]

(Operator Instructions). And we’ll go to line of Steve Levenson with Stifel Nicolaus. Please go ahead.

[Steve Levenson:]

Thank you. Good morning. And thanks for all the detailed disclosure in your press release and on the call so far.

[Robert Mehrabian:]

Thank you, Steve.

[Steve Levenson:]

In terms of nuclear power, are you particularly tied to one reactor design, one producer’s design like the Westinghouse or the Areva or GE, for example, or do you have opportunities across the board?

[Robert Mehrabian:]

Yeah, I don’t think we’ve tied to anyone, because we would essentially -- with having the nuclear stamps that Rex mentioned, our capability would be to produce whatever our customers would need. So far, obviously, we’re focused on what business that was available, which was the waste canisters and fuel, part of the reactors. Power generation is not something that people are addressing at this point, but we are not limited to any one design.

[Steve Levenson:]

On the assumption that there will be some reactors going in, and some of your peers who make other parts have already received some orders. Do you have the capacity available, should you get the call or is there anything you’re going to have to do to -- anything you’re going to have to spend to prepare to manufacturing of those items?

[Robert Mehrabian:]

Well, it depends on the items. Right now, we do have a 240,000 square foot new facility that Rex has built, and it’s fairly well equipped for the purposes and the -- right now, I think we have the capacity, but the long-term potential still, as you well know, depends on what happens to the various permits that everybody has been applying for.

[Steve Levenson:]

Okay. Thank you. Second is, there are some solicitations out there for third-generation thermal imaging engines and that would seem like something you are in a pretty good spot to provide. Can you give us a little information on what you see for Teledyne there, please?

[Robert Mehrabian:]

Yeah. We have already delivered two prototypes, two-colored infrared cameras to the U.S. Army for field demonstration. And our efforts, I can tell you that we’re very successful and we expect that we would compete for that solicitation, going forward. So, all in all, I think in our infrared imaging business, we have -- we’re going to be a player in that domain. We have -- the flipside is, as you well know, Steve, there is a lot of competition for that one program. And they’re only going to choose one contractor, at least that’s what we hear.

[Steve Levenson:]

Okay. Thanks a lot. And last is on the acquisition pipeline or what’s your wish list, are you looking for more on the sensor side or more away from that?

[Robert Mehrabian:]

No, I think we have repeatedly said that, we have expanded that domain a little bit. We have defense electronics obviously, our instrumentation. We did an acquisition last quarter in the imaging Judson Technologies, that we bought in commercial imaging. And we could -- if we want something in our other segments that made sense to us, whether it’s in the Engineered Systems or even in our piston engine business, we would get it if it makes sense, if it increased our market share and if -- and the flip side of that is, of course, you know prices have moderated a bit and because of the credit crunch and strategic buyers like us are in a better position now.

[Steve Levenson:]

Sounds good. Thanks very much.

[Robert Mehrabian:]

Thank you.

[Operator:]

And next we go to the line of Robert Kirkpatrick with Cardinal Capital. Please go ahead.

[Robert Kirkpatrick:]

Good morning, and congratulations as well. Could you go into a little bit more of the new products on the contract manufacturing side that you are starting to produce and that you expect to ramp in the second half and why you’ve been particularly successful at offering those services?

[Robert Mehrabian:]

Overall, let me -- Rob, let me start by saying that, if you look at our contract manufacturing in terms of its contribution to our overall business, it’s not that big. So, let me start there. Probably, I would say on the order of 5 to 10% of our total sales, broadly. So, with that as background, what’s happened is that a lot of the clients are no longer producing components and subsystems. And we do have both printed circuit capabilities as well as box level capabilities and rigid/flex capabilities. And we’re getting orders in electronic content measures, in radar systems, in secured communication, some anti-jam navigation systems, and interestingly, there is a second element that’s happening. Historically, we’ve really been doing only build-to-print manufacturing. We’re getting now some development orders which are helping us a lot, so we can do some development and do the manufacturing. So, that’s helpful to us.

[Robert Kirkpatrick:]

The development orders that you are receiving from the primes or are they are directly from the government?

[Robert Mehrabian:]

Primes, generally. For example, we do have some of our electronic warfare and communication capabilities that we have include some design capabilities and we’ve been able to make more integrated components because of the increase that we’ve enjoyed in our microwave businesses. We have over, I’d say, we have 150, $160 million of microwave capability right now in the company. So that’s helping us.

[Robert Kirkpatrick:]

And is this a potential large opportunity for Teledyne?

[Robert Mehrabian:]

I would say, the higher margin businesses for Teledyne are when we make our own product and sell them versus doing contract manufacturing. The beauty of having contract manufacturing is that you enjoy using more of your assets in your factories. And so, you spread your costs across a broader range of products that you make your fixed costs. And -- but generally, we prefer to make our own products, because they are usually higher margin. So, they don’t make a contribution to our overall profitability.

[Robert Kirkpatrick:]

Great. Thank you so much.

[Robert Mehrabian:]

Thank you, Rob.

[Operator:]

And there no further questions, I’ll turn it back to the presenters for any closing comments.

[Robert Mehrabian:]

Thank you, operator. I’d now like to ask Jason to conclude our conference call.

[Jason VanWees:]

Thanks, Robert. And again, thanks everyone for joining us this morning. If you have any follow-up questions, please call me at the number listed on the earnings release. And as always, our news releases are available on our website, teledyne.com. Operator, if you could please conclude today’s conference call. Thanks.

[Operator:]

Certainly. And ladies and gentlemen, that does conclude your conference call for today. Thank you for your participation. You may now disconnect.