Teledyne Technologies Incorporated
Q1 2010 Earnings Call Transcript

Published: 3 May 2010

[Operator:]

Ladies and gentlemen, thank you very much for standing by and welcome to the Teledyne first quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). And I would now like to turn the call over to your host, Mr. Jason VanWees. Please go ahead.

[Jason VanWees:]

Thank you and good morning, everyone. This is Jason VanWees, Vice President, Corporate Development and Investor Relations at Teledyne. I would like to welcome everyone to Teledyne's first quarter 2010 earnings release conference call. We released our earnings earlier this morning before the market opened. Joining you 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. 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 is Robert.

[Robert Mehrabian:]

Thank you, Jason, and good morning, everyone. Before commenting on the specific results of our individual businesses, I have some general observations about our market, our performance, and our performance during the first quarter. Those of our commercial businesses, which had been impacted most by the 2009 recession, recovered strongly in the quarter. Given this recovery, coupled with a leaner cost structure, our operating margin increased 107 basis points and our earnings per share grew 19.3%. As a reminder, in response to last year's recession, we lowered operating costs by over $80 million and reduced headcount by 9.8%. Due to some encouraging signs in our commercial markets and the stability of our defense businesses, we also increased our 2010 earnings outlook. Some key points including the following. First, sales from our commercial short-cycle electronic businesses such as instrumentation for environmental monitoring and industrial process control increased substantially and order activity remained strong. Second, all prices remained high and our marine instrumentation businesses are positively leverage – leveraged towards this trend. We are also beginning to receive orders for more integrated subsea power and process monitoring solutions. Third, our newly-developed defense microwave products for UAV and counter-IED applications are gaining traction. Fourth, due to dramatic gains in sales of aftermarket engines and parts, we nearly reversed last year's first quarter loss in our aviation engine businesses. And finally, we previously described the 2010 headwinds in three of our government programs. These are lower sales of missile defense engineering services, reduced deliveries of JASSM missile – cruise missile engines, and the lack of a loan guarantee for one of our customers in the nuclear domain. While not a factor for 2010, the long-term outlook for each of these areas has improved recently. The funding for the Ground-based Midcourse Defense program was cut from $1.5 billion in 2009 to $1 billion in 2010. The – but the budget request for GMD in 2011, which was issued in the first quarter, was $1.3 billion, a 30% increase. During the first quarter, we received incremental funding for JASSM engines that will start shipping in the fourth quarter of this year with continuous production thereafter. Lastly, as I'll describe later, we are now more optimistic that our ultimate customer for nuclear centrifuge modules will receive a loan guarantee, paving the way for a potential revenue growth in 2011. Now, I'll turn to our business segments and our Q1 performance. First quarter sales in our electronics and communications segment were flat compared to last year. However, segment operating profit increased 4.7% and segment operating margin increased 56 basis points. In the first quarter of 2010, sales of defense electronics increased 8.4% compared to the first quarter of 2009. The demand outlook for sales of defense electronics continues to look stable. Approximately half of our revenue in this market comes from sales of microwave devices and advanced interconnect products. Sales of these products increased 13.6% year-over-year and orders for newly developed microwave products such as an antenna subsystem for the Warfighter Information Network-Tactical radios program were particularly strong. In addition, we anticipate orders in the second quarter for newly designed UAV datalink and counter-IED subsystems. In our infrared and visible imaging businesses, we've been steadily evolving from historically a producer of space-based focal plane arrays, in other words components, albeit very sophisticated ones, into a provider of subsystem, instruments, and field [ph] camera products for space, tactical military, and some commercial applications. As part of this strategy, we acquired a minority stake in Optical Alchemy and also received an option to acquire the company in the future. Because Optical Alchemy's inertially-stabilized gimbal systems are very small and light, they are especially well-suited for UAV applications. In addition, beyond just delivering an image, the company systems are geo-referenced, which means they provide information about a target's specific location. Turning to our electronic instrumentation businesses, first quarter sales decreased modestly as a result of – and as a result of second – as a result of record sales in the first quarter of 2009 of geophysical sensors for oil production. As mentioned earlier, sales of short-cycle environmental monitoring instruments and industrial instrumentation increased significantly, up 11% and 17%, respectively. While first quarter sales of marine instruments declined, given the tough comparison, we expect the full year 2010 sales would exceed 2009. The outlook for our subsea oil production remains attractive. Having integrated our acquisitions in this domain, we are now receiving orders for systems that provide all of the following; subsea power distribution, data acquisition and transmission, pressure and temperature sensing, and sand corrosion monitoring. Also, the subsea defense sector remains strong, both domestically and internationally. In the first quarter, we received orders totaling $17 million from Northrop Grumman and Lockheed Martin for interconnects related to new Virginia-class submarines, and we expect another order from General Dynamics' Electric Boat division. Finally, the remaining 10% revenue of – in this segment comes from our avionics and other commercial electronics businesses. In the first quarter of 2010, sales from these businesses collectively decreased 16% compared to the first quarter of 2009, primarily due to a decline in sales of telecommunication subsystems and commercial electronic manufacturing services. We have intentionally stopped taking orders in these businesses because these businesses are becoming commoditized. Revenue comparisons should ease throughout the rest of the year due to the healthy performance of our avionics and electronics relays businesses. Turning our engineering – engineered systems segment, in the first quarter of 2010, revenue decreased 11.8% compared to last year. The decrease in sales primarily reflected lower sales for nuclear manufacturing and missile defense engineering programs, partially offset by increased sales for environmental programs. Operating profit decreased 9.9%, while operating margin increased slightly. As I've stated previously, we expect reduced sales in this segment in 2010 given the lack of a loan guarantee for our ultimate customer of nuclear gas centrifuge service modules, reduced government funding for some of our missile defense engineering services, as well as changes in the government's policy regarding organizational conflict of interest. Nonetheless, there has been some recent positive news regarding USEC's American centrifuge project. In late March, the Department of Energy finalized $45 million of funding to USEC to continue centrifuge development. In addition, last week the DOE announced that it's doubling the loan guarantees for nuclear front-end processing, that is enrichment technologies like the American centrifuge, from $2 billion to $4 billion. We believe this raises the likelihood that DOE will ultimately support the USEC project, which could result in approximately $40 million of annual revenues to us after 2010. We continue to look at other opportunities also that leverage our nuclear manufacturing capabilities, including our nuclear quality systems and ASME stamps that we possess. In the first quarter, we received our first contract to manufacture hardware for commercial – for a commercial nuclear power generation. The $2,007 million [ph] order is for a prototype turbine emergency power generator system that will ultimately be delivered to Toshiba. In our aerospace engines and components segment, sales increased 31.9% compared to last year. Sales of OEM engines increased 5.4%, while aftermarket sales increased over 40%. During the first quarter, we reported a small operating loss of $400,000 versus an operating loss of $4.3 million in the first quarter of 2009. While this quarter's performance was likely aided by some restocking at distributors, we believe that we've gained market share and hence improved our competitive position. In addition, we do continue to invest in new product development such as our turbo diesel engine in order to increase overseas sales, particularly in Asia. Finally, in our energy and power systems segment, sales increased 3.9% compared to last year as a result of higher sales of commercial hydrogen generators and power systems for government applications, which were partially offset by expected declines in the military turbine engine business. First quarter segment operating profit increased slightly, largely as a result of higher sales. In conclusion, first, we see the macroeconomic environment and our short-cycle commercial businesses recovering in 2010. Second, while it's still very early, we are encouraged about the long-term outlook for our long-cycle government and nuclear businesses. Finally, given our strong balance sheet and our history of successfully integrating strategic acquisitions, we also expect to pursue acquisitions more aggressively in the future. I would now turn the call over Dale Schnittjer.

[Dale Schnittjer:]

Thank you, Robert and good morning, everyone. I will first discuss some additional financials for the quarter not covered by Robert, then I will discuss our 2010 outlook. On cash flow, in the first quarter, cash provided from operating activities was $3 million compared with a use of cash of $7.6 million for the same period of 2009. The cash usage in 2009 resulted from pension contributions of $48.6 million net of tax compared to no pension contributions in 2010. Over the last two years, we have contributed approximately $170 million pretax to our pension trust and our pension plan is now approximately 90% funded on a GAAP PBO basis. Free cash flow for the first quarter of 2010 was a cash usage of $2.3 million compared to a cash usage of $20.7 million for 2009. Excluding the 2009 pension contribution, free cash flow in the first quarter of 2010 declined primarily due to higher working capital, which resulted from early collection of accounts receivable in the fourth quarter of 2009. Capital expenditures were $5.3 million in the first quarter compared to $13.1 million for the same period of 2009. Depreciation and amortization expense was $11.2 million in the quarter compared with $11.7 million last year. We ended the quarter with $230.6 million of net debt. Our balance sheet remains strong with a net debt-to-capital ratio of 25%. Our credit facility has $590 million of bank commitments and expires in July of 2010. We are planning to renew the credit facility prior to its scheduled maturity. In addition, we are anticipating issuing up to $250 million of unsecured debt pursuant to a private placement transaction in 2010. The proceeds would be used to pay down the existing revolving credit facility and for general corporate purposes including acquisitions. If I said it expires in 2010, it expires – the credit facility expires in 2011. Moving to pension, in the first quarter of 2010, gross pension expense was $1.3 million compared with gross pension expense of $5.6 million in the same period of 2009. Net pension income after recovery of allowable costs pursuant to Government Cost Accounting Standards or CAS was $1.1 million in the first quarter of 2010 compared with $2.5 million of net pension expense in the first quarter of 2009. Next, on stock option expense, in the first quarter of 2010, stock option compensation expense was $1.3 million compared with $1.6 million in the first quarter of 2009. The lower 2010 amount primarily reflects issuing fewer stock options for 2010 annual grant of stock option. Now, turning to the 2010 outlook, management currently believes that GAAP earnings per share in the second quarter of 2010 will be in a range of $0.69 to $0.71. We expect full year 2010 earnings per share of approximately $2.89 to $2.96, an increase from our previous outlook of $2.80 to $2.90. Regarding our pension, for full year 2010, we currently anticipate approximately $5.2 million of gross pension expense. However, given recovery of allowable pension costs from our CAS-covered government contracts, we expect net pension income of $4.4 million or $0.07 per share in 2010 compared to $0.17 per share of net pension expense in 2009. The decrease in full year 2010 pension expense reflects higher investment returns and the impact of pension contributions made in 2008 and 2009. As a reminder, full year 2009 earnings per share included $0.39 of prior-period research and development tax credits that will not reoccur in 2010. For the full year of 2010, we expect capital expenditures of approximately $35 million to $40 million and depreciation and amortization expense of $48 million. I will now turn the call back to Robert.

[Robert Mehrabian:]

Before we go to your question-and-answer period, I was just reminded that when I was talking about the commercial nuclear power generation manufacturing order, instead of saying $2.7 million order, I said $2,007 million, which will be over $2 billion in orders. I wish that were true, but unfortunately, it's not. So with that correction, I'd like now to start taking your questions. Operator, if you are ready to proceed with the question and answers, please do go ahead.

[Operator:]

Certainly. (Operator Instructions). And our first question comes from Michael Lewis with BB&T Capital Markets.

[Michael Lewis:]

Hi, Robert, good morning. A quick question for you with regard to the aftermarket part – portion of aircraft engines. Do you think that the 30%-plus revenue growth that you saw in the quarter is sustainable throughout the rest of the year?

[Robert Mehrabian:]

We are not counting on that, Michael. I think we probably will have in the range of about 20% overall growth if you pull total year-over-year in our orders. But I think it's going to be stronger than last year, but not as strong as 2008.

[Michael Lewis:]

Okay. And then just to circle back on the nuclear business and with regards to the loan guarantee, the differential versus this year's guidance for that business versus, say, fiscal year '11 and with the loan guarantee occurring, did you say it's about a $30 million swing in revenue upside?

[Robert Mehrabian:]

I would say about that. Last year, Michael, we had $36 million, but that wasn't a full production year. This year we expect, for that specific program, closer to $8 million. And we anticipate next year, if we go into full production, it would be close to $40 million for that specific program.

[Michael Lewis:]

Okay, thank you. And then just one more question. With regard to the breakout of the business, what proportion of the revenue is now government/defense versus commercial? And where do you see this split moving to, say, two years from now?

[Robert Mehrabian:]

Right now, I would say we are about 50-50. We've been that way for a long time. My estimate is that as a function of time, we would be more heavily oriented toward the commercial domain. Maybe in a couple of years, we would be at 55%, closer to 60% commercial.

[Michael Lewis:]

Okay. Thank you so much.

[Robert Mehrabian:]

Thank you, Michael.

[Operator:]

Thank you. And our next question comes from Steve Levenson with Stifel Nicolaus. Please go ahead.

[Steve Levenson:]

Thanks. Good morning, everybody.

[Robert Mehrabian:]

Good morning, Steve.

[Steve Levenson:]

Too bad it wasn't a $2 billion order.

[Robert Mehrabian:]

I'm glad I corrected it before somebody asked me about it.

[Steve Levenson:]

Well, I had a question about the nuclear fuel enrichment. It looks like the likelihood of a loan guarantee is getting better and it looks like it would also cover some business with AREVA. Do you have opportunities with AREVA similar to what you would have with USEC?

[Robert Mehrabian:]

Not at this time that we know of. On the other hand, they haven't begun their manufacturing processes like USEC has. To be very honest with you, Steve, we are very aggressively getting ready to participate in any projects that begin, primarily because we do have a very strong position, both in the quality domain, as well as the ASME stamps, requisite stamps that one needs for manufacturing. So we are talking to a large number of other potential people that would be producing nuclear products.

[Steve Levenson:]

Great, thank you. And second, it looks like the DOD is trying to accelerate the use of third-generation thermal imaging sensors. They've got a solicitation I think they're calling Vista out there. Does Teledyne plan to participate in that?

[Robert Mehrabian:]

On the third-gen, Steve, we are currently in discussions with the military and we do expect to receive some additional third-gen funding. We have the – the military, the army remains intent on continuing to promote a competitive environment for the low-rate initial production and other future programs and they show very strong support for our efforts. We are spending our own R&D dollars in technology development and have actually made some very good progress in building demo units for the army to test.

[Steve Levenson:]

Okay. Thank you very much.

[Robert Mehrabian:]

Thank you, Steve.

[Operator:]

Thank you. And our next question comes from Robert Kirkpatrick with Cardinal Capital. Please go ahead.

[Robert Kirkpatrick:]

Good morning and congratulations.

[Robert Mehrabian:]

Thanks, Rob.

[Robert Kirkpatrick:]

Dale, could you talk a little bit about kind of rates and timing on both the refinance of the credit facility, as well as the size, and also on the private placement.

[Dale Schnittjer:]

We are somewhat limited on what we can discuss right now. We are following the traditional process for issuing private placement debt. And I'd rather not comment any further so as not to violate the private placement issuance regulations at this time.

[Robert Kirkpatrick:]

So would that mean that it would, obviously, be probably in the next six months as opposed to right at the end of the year?

[Dale Schnittjer:]

Yes.

[Robert Kirkpatrick:]

And how about the bank debt market, how is that?

[Dale Schnittjer:]

Right now, with what we are seeing in the bank debt market, the – our banking partners speak very favorably about that and it looks like there is plenty of financing available with our partners.

[Robert Kirkpatrick:]

So would you anticipate reducing the size of the commitment or would you keep it roughly the same?

[Dale Schnittjer:]

We will look at that when we get to the point of renewing, but at this point, we would look at somewhere in $400 million to $600 million maybe in the revolving credit.

[Robert Kirkpatrick:]

And would you – you would do the debt facility after the private placement, correct?

[Dale Schnittjer:]

That's correct.

[Robert Kirkpatrick:]

Great. And then, Robert, I was wondering if you would perhaps shed a little bit more light for us on two topics; one, the Optical Alchemy [ph] acquisition and how that came about; and then secondly, the new sets of products that you are seeing demand for, for both UAV datalinks and for counter-IED. Thank you.

[Robert Mehrabian:]

Thank you, Rob. What – as I mentioned before, we have historically participated in making very sophisticated focal plane arrays for space applications. Those would be focal plane arrays that have 2Kx2K array of pixels. And now, of course, we are even making 4Kx4K – we are beginning to develop 4Kx4K pixel FPAs for both civil space, as well as ground astronomy. Now, what we did about two years ago is we bought a small company called Judson in Pennsylvania to start moving more towards merchant supplier of not just FPAs, but packages. Judson specializes in packaging of FPAs and sells commercially. Where we were doing units of 10s and 20s, Judson was producing units of over 1,000 a month of this product. So we wanted to get into the commercial domain. And as a part of that, as we then moved into the third-gen infrared, it became necessary to start integrating dewars and coolers into our product so that we would produce a subsystem of FPA that was packaged and included coolers and dewars with it. And ultimately, obviously, these become cameras. Now, where Optical Alchemy comes in is that they actually make gimbals, very light-weight gimbals that are geo-reference-capable, which is once you look at a target, you can also give the GPS coordinates of the target to the viewer. And what that enables us to do now is move up the food chain to become a merchant suppliers of cameras that include – that are included in the gimbals. Matter of fact, we are developing what we call a high-temperature infrared camera, which operates at about 150 degrees for a specific application in that one of the small gimbals that Optical Alchemy makes. So it's kind of a very – Rob, it's a very intentional strategy to become a merchant supplier of cameras and gimbals to people that integrate them into large systems. Now, second question that you asked dealt with counter-IED and UAV applications. In the UAV domain, we have a – we are expecting high-power amplifier orders in the second quarter that will enable datalink for the updated Shadow UAV upgrade. And also in the IED domain, we are – one of the acquisitions that we made was in the U.K. and we are working with a customer there on the development of an integrated subsystem for an IDP – IED jamming system that has large production potential. The system is currently in trials with the U.K. MoD and we are expecting low-rate production orders in – later this year. I hope that answers the two questions, Rob.

[Robert Kirkpatrick:]

Yes, thank you so much.

[Operator:]

(Operator Instructions). And our next question comes from Chris Quilty with Raymond James. Please go ahead.

[Chris Quilty:]

Good morning, gentlemen. I wrote slow, so I'm going to ask you, Robert, if you could perhaps help me with the numbers again. And perhaps – I think in the past when you've given the break – breakdown on the E&C segment, you've gone ahead and sort of given us the year-over-year revenues on defense electronics, electronic instruments. Could I get those from you?

[Robert Mehrabian:]

Sure. I'll give you any numbers you want, Chris.

[Chris Quilty:]

What's the real number for fiscal '10?

[Robert Mehrabian:]

I always give you real numbers, Chris. That's very good. The defense electronics year-over-year Q1, if you look at last year, it was about $126 million. I think that does not include scientific and imaging – yes, it does, actually. It's about $126 million. This year, it's closer to $137 million.

[Chris Quilty:]

Okay.

[Robert Mehrabian:]

On instruments, last year, it was about $145 million. This year, it's closer to $141 million, the overall instruments. And then the last, which is avionics and other electronics, as I mentioned, we are not taking orders in commercial – manufacturing of commercial communication products and some of our medical products. So what we've seen is a decline from about $39 million to $32.5 million in that area year-over-year. But as I mentioned, we think that will stabilize as the year goes on.

[Chris Quilty:]

Okay. And did I detect a nuance there on the commercial side? I mean, you guys had already abandoned the medical products market and pure commercial EMS. I thought I heard you also say that you are de-emphasizing some of the telecommunications products also.

[Robert Mehrabian:]

Yes, some of the backhaul products like point-to-point cellular backhaul, we were making transceivers. We are getting out of that business, primarily because what – what's happened is the customers are pushing for cost reductions of 15%, 20% a quarter and just that's not the business we want to be in. By the way, if you look at our history over the last five, six years, we probably exited $60 million to $70 million worth of markets in which the margins have declined, markets have become commoditized, customers want to push us to manufacture overseas and that's not where we want to be. So we continuously exit markets that we don't think are in our interest to continuing.

[Chris Quilty:]

Now, on the flipside you've seen an increase in your defense related EMS, and can you give us some color there? Is there specific programs or product lines or OEM customers where you are seeing those gains?

[Robert Mehrabian:]

Yes, we very methodically decided a few years ago to switch over since the facilities really were operating commercial and defense side by side, same equipment. We very methodically moved to the defense [ph] domain. In – for example, just to give you specifics, termination of the DD(NYSE

[Chris Quilty:]

Okay. And separate question, it still hasn't shown up in the jobs numbers, but are you seeing any of that stimulus money with your customers in the government side, environmental?

[Robert Mehrabian:]

Very little. We've seen a little bit of ARRA money, especially in some of our environmental programs, but the primary improvement that we've seen in our environmental programs have been overseas, in India and China.

[Chris Quilty:]

Okay. And the proposed Obama NASA budget-killing constellation, but extending the space station, net-net, good, bad?

[Robert Mehrabian:]

I think net-net, it might not be bad for us. Let me just kind of go through a little detail on that. We – the – we have about – give or take, we have about $90 million with NASA in our programs. About half of that is in the – tied to the space exploration. What – I think we are better positioned than most of our competition in the space programs, because what we have are flexible task order contracts with broad scopes and we don't hold large prime contracts, hardware development programs. Now, the shift that they – that the White House has announced recently – I think it was in April – on April 15 in Kennedy Space Center. The Orion program continuation, that doesn't affect us, because we are not participating in that. But the heavy lift launch, that could have a positive effect on us. And extending the space station would be – to 2020 would be good for us since we do about $23 million of science payload operations there. So all in all, I'd say the whole thing would probably be okay for us. The – the Robotic Precursor Program, that'd probably be good for us. I think with our engineering support structure and the contracts that we have in place that the whole change should be neutral to positive for Teledyne.

[Chris Quilty:]

Okay. Very good. That's my list of questions, other than I wanted to know if you could say "dewars and coolers" three times quick for us.

[Robert Mehrabian:]

If I could do that, I would be an analyst.

[Chris Quilty:]

Cheers.

[Operator:]

And there are no further questions in queue. If you have any closing comments?

[Robert Mehrabian:]

Thank you, operator. I really appreciate you all participating. I'll now ask Jason to conclude our conference call.

[Jason VanWees:]

Thanks, everyone. And if you have any questions, please feel free to call me at the number on the earnings release. And again, all our releases are available on our website. Operator, if you could conclude today's call and give the replay information, we'd appreciate it. Thank you, everyone.

[Operator:]

Certainly. Ladies and gentlemen, this conference is available for replay starting today at 10 a.m. and will run until May 29th at midnight. You may access the replay service by dialing 1-800-475-6701 and entering the access code of 145598. You may also dial 320-365-3844 and enter the access code of 145598. Those numbers again are 1-800-475-6701 and 320-365-3844 and entering the access code of 145598. That does conclude your conference for today. Thank you very much for your participation and for using the AT&T Executive Teleconference. You may now disconnect.