Jan 26, 2012
Operator
Ladies and gentlemen, thank you for standing by. Just a reminder this conference is being recorded.
Operator
I would now like to turn the call over to Jason VanWees. Please go ahead.
Jason VanWees
Good morning everyone. This is Jason VanWees, Vice President, Corporate Development and Investor Relations at Teledyne.
And I’d like to welcome everyone to Teledyne Technologies fourth quarter and full year 2011 earnings release conference call. We released our earnings earlier this morning before the market opened.
Jason VanWees
Joining us 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.
Jason VanWees
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.
Jason VanWees
In order to avoid potential selective disclosures, this call is also simultaneously being webcast and a replay both via dial-in and webcast will be available for approximately one month. Here’s Robert.
Robert Mehrabian
Thank you Jason and good morning everyone. Fourth quarter sales was $474.5 million increased 12.6%.
Earnings per share from continuing operations was $0.99 compared to a $1 last year, note however that the fourth quarter 2010 included $0.24 of tax credit partially offset by $0.08 of acquisition and disposition expenses.
Robert Mehrabian
Before I discuss individual business segments, I have some general comments. 2011 was a decisive year in the history of Teledyne both financially and strategically.
Full year sales of $1.94 billion increased 18.1%. Earnings per share from continuing operations of $3.81 increased 17.2%.
GAAP operating margin was 11.7%, an increase of 84 basis points.
Robert Mehrabian
And free cash flow, excluding voluntary pension contributions was $221.8 million, an increase of 79% from 2010. All of these metrics were at record level.
Robert Mehrabian
Beyond the financial performance, the divestiture of our aircraft piston engine business in April 2011 along with its liabilities significantly reduced Teledyne’s risk profile, while the acquisition of DALSA was a major commitment to digital imaging.
Robert Mehrabian
Teledyne is a different company today. Following a decade of progressive change through acquisitions and divestitures and continuous improvements in operations, we enter 2012 as a company that serves primarily industrial growth markets.
Robert Mehrabian
We now possess high technology businesses, a greater research and development capability, and a portfolio of proprietary highly engineered products serving markets such as of offshore energy, global infrastructure, factory automation, transportation and communication.
Robert Mehrabian
U.S. Government sales now account for 35% of total revenues down from 47% just two years ago.
And the profile of our government business has also changed, with an increasing proprietary products over engineering services. Finally, given the greater profitability of our commercial businesses, the U.S.
Government today accounts for less than 25% of our income. We’ve also been growing our sales internationally, and in the fourth quarter this increased to 34% of our total sales.
Robert Mehrabian
I will now comment on our business segments after which Dale Schnittjer will review some of the financials in more detail and provide an earnings outlook for the first quarter and the full year.
Robert Mehrabian
Turning to our Instrumentation segment, as a reminder this segment which comprises our highest margin group of businesses provides advanced electronic instrumentation, including trace chemical analyzers, underwater vehicles, acoustic sensing and imaging systems and specialty subsea interconnects. This segment primarily serves the offshore energy, including deepwater exploration and production and global infrastructure market.
Robert Mehrabian
In addition to the high price of oil, other macroeconomic drivers for this segment include population growth and industrialization in the developing world. Industrial sales - international sales represent more than 50% of the revenue in this segment.
Fourth quarter sales in this segment increased slightly to $148.9 million.
Robert Mehrabian
Sales of environmental instruments grew almost 4% while sales of marine instrumentation contracted slightly. While the marine instruments declined slightly in the quarter, this was largely timing related.
We currently expect good sequential growth in the first quarter of 2012 as book-to-bill in this segment in the fourth quarter was 1.2 X.
Robert Mehrabian
Turning to the digital imaging segment. Before mentioning the results, I wanted to offer some historical perspective and comment on our strategy in digital imaging.
Teledyne entered the digital imaging market with the acquisition of Rockwell Scientific & Imaging in 2006, we were then and still remain the leader in very high performance sensors for land and space-based infrared astronomy. Today both our technical depth and the breadth of our product lines have increased dramatically.
We now offer a suite of sensors, cameras and software spanning the electromagnetic spectrum from x-ray to infrared.
Robert Mehrabian
Beyond our historical space of astronomy sensors that look out and capture infrared protons from the origin of the universe, we have begun making inroads into classified program where we did not previously participate.
Robert Mehrabian
With the acquisition of DALSA, we are now the leading provider of commercial ultra-high-resolution visible light sensors used for space and aerial photogrammetry that is the devices that capture the images available to you on Google Earth and Bing.
Robert Mehrabian
Our sensors and cameras are also used for tactical application, such as hyperspectral sensors that is used on the Predator UAV and a cool infrared camera that’s used on the ScanEagle UAV.
Robert Mehrabian
In the commercial domain, Teledyne DALSA is a leader in high performance visible and ultraviolet cameras for factory automation and is an emergent supplier of smart cameras for automated quality control in industrial processes.
Robert Mehrabian
Finally, medical and dental x-ray imaging is one of the highest priority in our digital imaging segment. Order intake for new X-ray high-resolution lower dose panels have been excellent from both our medical and dental customers.
Robert Mehrabian
Turing to the results, fourth quarter sales increased 187% 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 over 10%.
Robert Mehrabian
Segment operating margin increased, but remained relatively low on a GAAP basis largely as a result of one; increased R&D spending, two; approximately 290 basis points of acquisition related intangible asset amortization and three; and just as importantly the reclassification of Canadian R&D tax credit from above the line in segment’s income to below the line provision in U.S. GAAP for taxes.
Robert Mehrabian
Turning to the Aerospace and Defense Electronics segment, fourth quarter sales increased 2.6%, due to higher sales of microwave devices, interconnect and aircraft information management system. Segment operating profit increased 23% and segment operating margin increased 233 basis points.
Robert Mehrabian
Margins in this segment continued to grow nicely over last year, as a result of one; sustained operational excellence efforts, two; a mix shift towards higher margin commercial product and proprietary defense electronics versus lower margins manufacturing - government manufacturing services.
Robert Mehrabian
Turing to the Engineering System segment, as in our Aerospace and Defense Electronic segment, there has been a progressive and intentional mix shift in this segment. In this case, the shift is toward proprietary technology and manufactures products away from less - historically less differentiated government systems engineering and technical assistance program.
Robert Mehrabian
Fourth quarter revenue and margin declined as we have continued to absorb significant government funding reduction in certain Missile Defense Engineering Program and a pressured NASA budget. However growth in manned and unmanned underwater systems, an area in which Teledyne has become a leader was able to partially offset the decline.
Robert Mehrabian
While our Instrumentation Segment provides electronic subsystems as well as complete autonomous underwater systems for ocean science, oil and gas, and commercial hydrographic survey markets, our Engineered Systems segments provide unmanned autonomous gliding vehicles to the U.S. Navy and more recently was selected to develop and produce next generation of Navy SEAL Delivery Vehicles.
Robert Mehrabian
In conclusion, after a decade of acquisitions and divestitures, we now have a mix of high technology industrial businesses that are growing in international markets. We also have a much lower risk profile, a strong balance sheet and a hands-on management with a proven track record of ten consecutive years of earnings improvement.
Robert Mehrabian
Finally, the defense market now represents less than 25% of our earnings. Furthermore, we do expect some stability in earnings in this market as we have continued to position these businesses to be more aligned with surveillance market, unmanned systems and certain Navy programs which we expect to remain at relative priorities in the defense budget.
Robert Mehrabian
I will now turn the call over to Dale Schnittjer.
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 2012 outlook.
On cash flow in the fourth quarter, cash provided from operating activities from continuing operations was strong at $79.8 million compared with $60.2 million for the same period of 2010.
Dale Schnittjer
Free cash flow was $65.7 million in the fourth quarter of 2011. For the full year 2011, free cash flow was $177.8 million, adjusting for the pension contribution net of taxes, free cash flow was $221.8 million.
Dale Schnittjer
Capital expenditures were $14.1 million in the fourth quarter compared with $15.4 million for the same period of 2010. Depreciation and amortization expense was $16.8 million in the quarter compared with $12 million last year.
For the full year 2011, capital expenditures were $41.7 million and depreciation and amortization expense was $64.2 million. Of this $64.2 million, approximately $24 million was intangible assets amortization expense.
To put that in perspective that’s approximately $0.41 per share in amortization expense for 2011.
Dale Schnittjer
We expect to invest approximately $60 million in capital expenditures in 2012. Also for the full year of 2012, we expect depreciation and amortization expense to be approximately $70 million with amortization expense approximately $24 million.
Dale Schnittjer
We ended the quarter with $263.4 million of net debt. That’s $312.8 million of debt and capital leases, less cash of $49.4 million for a net debt to cap ratio of 21.2%.
Currently we have approximately $500 million available under our credit facility. The margin of borrowing cost on the facility is LIBOR plus 125 basis points to 250 basis points depending upon the leverage ratio.
Dale Schnittjer
While cash flow from continuing operations remain strong, we paid $46.9 million of income taxes in the fourth quarter related to the gain on the sale of the discontinued piston engine business.
Dale Schnittjer
Next on pension, net pension income after recovery of allowable costs pursuant to government accounting standards was $2.2 million in the fourth quarter of 2011 compared to $1.2 million of net pension income in the fourth quarter of 2010. On stock options, stock option compensation expense was $1.5 million in the fourth quarter of 2011 compared with $1.1 million in the fourth quarter of 2010.
Dale Schnittjer
Moving to our 2012 outlook, management currently believes that GAAP earnings per share from continuing operations in the first quarter of 2012 will be in the range of $0.88 to $0.91.
Dale Schnittjer
We expect full year 2012 earnings per share from continuing operations of approximately $3.90 to $3.96. As noted in the earnings release, the discount rate for our domestic pension plan will decrease to 5.5% in 2012 from 6.15% in 2011 and the expected rate of return for 2012 will remain at 8.25%.
Finally, the 2012 full year effective tax rate is expected to be 32.5% compared with 32.9% in 2011.
Dale Schnittjer
I will now pass the call back to Robert.
Robert Mehrabian
Thank you, Dale. We would now like to take your questions.
Stacy, if you are ready to proceed with the questions and answers, please go ahead.
Operator
(Operator Instructions) And we’ll go to Howard Rubel with Jefferies. Please go ahead.
Howard Rubel
Thank you very much. Good morning, Robert.
How are you?
Robert Mehrabian
Good morning, Howard.
Howard Rubel
Could you just talk a little bit more about some of the risks to your forecast and where, on one hand, there is some challenges and on the other hand maybe whether you see some opportunities?
Robert Mehrabian
Yeah, Howard, I think the primary risk and it is a small one is in our government businesses still. We potentially could take another 5% of revenue out of that, but as I indicated, the profitability of our government business is now comprised less than 25% of our earnings.
Robert Mehrabian
On the upside, because of our exposure to oil and gas and international market, I think we’re going to do pretty well there. And finally with at least the announcement that we heard today with increased emphasis on Special Operation Forces and their products that they use we are favorably inclined in that direction.
Robert Mehrabian
First, with our data link systems to UAVs. Second, with our new surveillance cameras both for the Predator as well as the ScanEagle as well as some of the submersible manned vehicles that we’re developing for the Navy SEAL.
So when you put all of those together, I think defense budget changes are going to be actually favorable to Teledyne.
Howard Rubel
I was actually thinking a little bit more in some of the instrumentation markets or in digital imaging in terms of either risks or - I mean risks or challenges?
Robert Mehrabian
In the instrumentation domain, as you know, we’re primarily environmental and marine, I don’t see risk, much risk in our marine. We may have a little bit of a headwind in our oil exploration.
But we’re shipping there from chambers that are drawn behind boat to reservoir monitoring and our new products that are coming out this quarter and next will be a buffer for that.
Robert Mehrabian
In the environmental instrumentation, obviously the problem is spending by municipalities and the government, but even there we’ve done all right. We’ve gotten some major awards for water quality monitoring in two large municipalities.
And of course overseas, we are getting, we are selling a lot of our environmental product. In the - and then we of course, playing the food and beverage, NA separation, which is important in China and water quality and everything et cetera.
Robert Mehrabian
So I think overall, I don’t see a lot of negative in our instrumentation. In digital imaging on the other hand, the one area that we have to be careful about is the semiconductor capital equipment industry to which especially we sell our standard products.
The book-to-bill is declined from 0.98 in last May to 0.83 this November. It’s stabilized and we think in the second half of 2012 that market will pick up again as it has historical cyclicality.
Robert Mehrabian
So we do have a little headwinds there, but again on digital imaging on the really positive side is that we have made significant inroads in the medical X-ray, both for medical and dental X-ray market. We’ve introduced new CMOS large panel X-ray sensors, which have much better resolution at significantly lower doses that’s what exists out there today.
And we have a lot of orders in that area and those are increasing, so we are bullish on that part of imaging. I hope that answers it better Howard.
Howard Rubel
Well, that was very helpful and then I just have one last question for Dale. To go back to the pension plan, what percentage are you funded today both for risk and for financial purposes?
Dale Schnittjer
The funding is at 91% today.
Howard Rubel
So there is no required contributions for the foreseeable future?
Dale Schnittjer
That’s right, there are not. Our policy has been to contribute to the pension trust an amount that’s equal to what we pay out to retirees each year, but there is no requirement for payments.
Robert Mehrabian
Maybe the other side of that Howard is that as you remember January 2004 we stopped all new entrance in our defined pension plan and today only 27% of our active employees participate in that plan.
Howard Rubel
Thank you gentlemen for your help.
Robert Mehrabian
Thank you.
Operator
We will go to Jeremy Devaney with BB&T Capital Markets. Please go ahead.
Jeremy Devaney
Good morning, Robert. Thanks for taking the call.
I wanted to start off taking a look at funded backlog. What was the total funded backlog at the end of the quarter and how did you see the pace of orders through the quarter for both your government customers and then separately more for your other end market customers, if you could comment specifically?
Robert Mehrabian
Q4 and our funded backlog Jeremy was $950 million, but of course that does not include our longer-term award such as the submersible vehicles for the SEAL Delivery or our OSF longer-term contracts. So those are things that materialize in the next 12 months.
Furthermore in instruments, our book-to-bill is 1.2, in digital imaging is slightly below 1, in general the only area that we are a little concerned about again is our engineering services, engineered services area, which segment, which the backlog at least a 12 month backlog is about 0.8.
Jeremy Devaney
All right, that’s very helpful. If we look out into next year, I know how everybody is talking with you a little bit about some unforeseen risks, how would you say you’re thinking about the defense budget as it relates to your specific businesses, I know special opportunities community its looking strong for you, do you think you fully baked in sequestration and its impacts to the full extent or you sort of just baking in the cuts that the OMB pass-back to DOD right now?
Robert Mehrabian
I think overall, we might have to take maybe a 5% cut if they keep doing what they are doing in 2012 in our government budget. I can’t tell you about the out years.
In 2013, I don’t think sequestration is going to have a effect on us. The reduction in spending in Afghanistan and Iraq will have little or no impact on Teledyne.
Robert Mehrabian
Any increases in UAV and battlefield satellite communication, which are high priorities, would be very positive for us, and really if we’re not going to build new platforms, we are simply going to maintain our older legacy platforms and that is really in some ways very good for us, because we have a lot of products that are going in those platform. So overall and finally we do have one program that is coming, which is a counter - complete integrated counter ID system that we are developing for European customers, which could have a very positive effect on our defense program.
Jeremy Devaney
Would that be through the engineered systems segment?
Robert Mehrabian
No, most probably that would be through our electronics, defense electronics group and it will be probably be in our, one of our European acquired companies.
Jeremy Devaney
Excellent, thanks for the detail. I’ll hop back in queue.
Robert Mehrabian
Thank you.
Operator
We’ll go to Mark Jordan with Noble Financial. Please go ahead.
Mark Jordan
Good morning, gentlemen. First question relative to the tax rate significant decline projected for next year at 32.5%, is that tied to Canadian tax benefits from DALSA?
Robert Mehrabian
Primarily that and some European and the fact that we have much more international sales.
Mark Jordan
Okay. Second question relative to pensions again.
As you said you’ve been making contributions roughly equal to the funds withdrawn, you’re $44 million this year up from 28.1, given that the demographics of your retiree pool when do you see that contribution peaking?
Robert Mehrabian
It will be a number of years from now Mark. On the positive side, we’re doing two things this year, which would have a positive effect on our pension.
First, about 27% of the people that are in the pension program who are vested have left Teledyne. And what we are going to do this year, we are going to make an offer to buy them out and that will take a significant liability of our pension.
Robert Mehrabian
Second, we made a modification to our pension plan now, which changes some of the calculations in terms of averaging every year’s pension income versus the final five year average, which will have another positive [pick up], potentially reducing our liabilities by 10%. So when we do both of those I think we have stabilized the pension for the future.
But I think we will continue putting in somewhere around $40 million to $42 million a year, because we expect that to be the amount that will be paid out to our retirees.
Mark Jordan
Okay. Final question, if I may.
Looking at the aerospace margins at 14%, do you see that as sort of an area where that segment will stabilize, or how do you see that that segment over the next year or two from an operating margin, profit margin standpoint?
Robert Mehrabian
I think that 14% is a good number. It might even go up a little bit.
We are bullish on that segment at least the part that serves the aerospace market. We have very strong positions in data acquisition and wireless transmission of data in both Boeing and Airbus and as you know, their businesses have significantly improved and their backlogs are at historical levels.
Actually, they are beginning to pull in some products from Q2 and Q3 into Q1. So I think because of our mix of our products that we have shifted both there and in defense, I think our margins are going to remain in that range or even slightly above.
Mark Jordan
Thank you very much.
Robert Mehrabian
Thank you, Mark.
Operator
We will go to Chris Quilty with Raymond James. Please go ahead.
Chris Quilty
Thank you. Speaking of margins Robert, can you give us, perhaps your general forecast for the growth rates in the margin performance by segment?
Robert Mehrabian
I’ll try, I just talked about the aerospace/defense, I think in the commercial domain, our margins should keep improving as it has in the past, maybe 100 basis points over time maybe a little more. In digital imaging, we have constrained a little bit from two perspectives.
First, as I mentioned in DALSA, when they were an independent Canadian public company, their margins were healthier because they took their R&D tax credits above the line. Now, we are taking it below the line, as Dale mentioned our taxes and as - was asked before our tax rates have gone down because of that, so we are not getting as much credit there.
Robert Mehrabian
The other part of imaging, which is our scientific R&D centers, we actually don’t take profit there, we intentionally reinvest the profit there in our R&D and that make - of course making the products, better products for the rest of our segments.
Robert Mehrabian
Overall, I would say that if you look at our 11.7% GAAP margin this year we should be able to increase that maybe 40 basis points, 50 basis points next year.
Chris Quilty
Okay and I mean you’ve had good improvement in the Aero-Defense segment margin wise. Are the current margin levels sustainable?
Robert Mehrabian
We believe so.
Chris Quilty
Okay.
Robert Mehrabian
And you have never had seen me be so bullish about anything, but I am.
Chris Quilty
That’s good. Another question just regarding DALSA, did you give the organic growth rate?
I may have missed that.
Robert Mehrabian
It’s about 10%
Chris Quilty
Okay. And regarding the buyback plan?
Robert Mehrabian
Yes
Chris Quilty
I guess you had mentioned that was sort of a trade off between the M&A opportunities and obviously the stock price. Have you seen any improvement in the pricing or valuations in M&A or would you be more inclined towards repurchase as a way to deploy the cash?
Robert Mehrabian
Both, we will buy back stock as the opportunity comes our way. As we have announced we are out to buy 1.5 million shares.
We have only bought about 650. On the other hand, we are seeing some opportunities in M&A right now.
Interestingly enough, we like properties that we see especially in Canada like, where we got DALSA. And so we expect to be active there too.
As Dale mentioned we do have about $500 million that we have access to and we’re generating really healthy cash. As you noted, we generated over $220 million this year.
Chris Quilty
Final question regarding energy, I know most of your activities are focused on the offshore. So I guess a two part question here.
Do you have opportunities in the fracking market, which seems to be one of the faster growing areas and alternatively the growth of that type of energy extraction take away from the growth in the offshore?
Robert Mehrabian
Yeah, I don’t think it will take away from the offshore at all. We do participate a little bit in the fracking, you will see us increase our participation there both from our capability to offer product on the top side as well as use some of our environmental instruments, which of course as you know are in need there.
Robert Mehrabian
So we see that being very positive for us and as you know that’s primarily at least gas or very heavy oil in this country. In deep water energy production, we don’t see any slacking of that, actually the most recent data that I have looked at shows that the Christmas trees which are the structures that sit at the ocean bottom.
Robert Mehrabian
The number of them from 2011 to 2012 should go somewhere from 350 to about 600 and that’s very positive and a lot of that is deep water, which is where we excel and we have a whole bunch of new products including high power feed-through’s that can carry 6000 volts and over 200 amps. So we’re very bullish about that area.
Chris Quilty
Great, thank you for the comments.
Robert Mehrabian
Thank you.
Operator
Now we’ll go to Robert Patrick with Cardinal Capital. Please go ahead.
Robert Kirkpatrick
Good morning. Could you explain to us why CapEx is going to be going from kind of the $40 million to $60 million number?
Are there certain opportunities you’re trying to take advantage or you just more bullish on the American economy, the world economy? Help us understand that a little bit better please.
Robert Mehrabian
There’s two primary reasons. One, as we’ve indicated before we are developing large capabilities in our DALSA semiconductor facility in our Vermont facility, to begin production of uncooled long wavelength infrared products.
And those would be VOx based and we’re making commitment to capital there.
Robert Mehrabian
The second is that historically because of all the acquisitions that we have made and all the various businesses that we have. We have put together a series of ERP systems that are not the most efficient for a company that is now evolved to where we are.
So we’re going to probably invest somewhere about $10 million or so next year in upgrading our ERP system across the company and that kind of investment would continue over a number of years.
Robert Kirkpatrick
And would there be operating expenses associated with that as well, that are substantial the later one, the ERP upgrade?
Robert Mehrabian
No, I don’t believe so. There are some expenses, those would be offset by savings as we go forward.
Net-net overtime I think that would pay for itself, because as you improve your ERP systems, you reduce the number of things that you have to do to get the financials up.
Robert Kirkpatrick
Okay. And then maybe a question for Dale specifically.
Your pension expense this year and your projection for it next year, as it runs through the income statement?
Dale Schnittjer
Well, as we pointed out in our Q for 2010, the pension expense associated with the 25 basis point change in the discount rate goes up by $2.2 million. So you can calculate what the difference would be in expense associated with a discount rate change.
Robert Kirkpatrick
Super, thank you so much.
Operator
We’ll go to Kevin Ciabattoni with KeyBanc Capital. Please go ahead.
Kevin Ciabattoni
Good morning, guys.
Robert Mehrabian
Good morning.
Kevin Ciabattoni
Looking first at specifically the OSF and SEAL Delivery Vehicle. You’ve mentioned I think last quarter you saw the OSF at kind of $30 million to $40 million for next year running about $8 million plus a quarter.
Is that still the case?
Robert Mehrabian
Yeah, I would say about $8 million a quarter. Could be a little more, and the SWCS, which is the delivery vehicles, next year it is going to probably be still in the development phase, about $12 million to $15 million.
Kevin Ciabattoni
Okay, that’s helpful. And then looking at the DALSA business, at their kind of more commercial industrial end markets, what did you see there in the quarter and what are you looking at for ‘12 in terms of I guess kind of directionally?
Robert Mehrabian
I think in the first quarter, we’re looking at first and may be part of the second quarter. We’re looking at reduced sales in our standard products, which are going to let’s say flat panel display inspection.
We think that will pick up later in the year. We think that in the special products that we develop for our customers, we have a whole suite of products that are specially developed for customers, where they pay for NRE, there we’re going to do fine.
We have a lot of projects underway. And as I indicated before, the X-ray area is going to be really our big growth area.
We expect that area to substantially grow year-over-year.
Robert Mehrabian
To summarize short-term, we think semiconductor is going to be semiconductor inspection flat panel. Even though we do play in the tablet computers that’s not sufficient to make up for the flat panel display.
We’re going to see a positive in Asia, in security maybe slightly negative in Europe in semiconductors.
Kevin Ciabattoni
Okay. And that X-ray business that you guys are funding is any of that R&D customer funded there?
Robert Mehrabian
Oh, yes.
Kevin Ciabattoni
Okay.
Robert Mehrabian
Frequently.
Kevin Ciabattoni
Okay. And then lastly, you’d mentioned that you were seeing some improvement in the M&A kind of pipeline, is it fair to say you guys would be looking at more commercially focused acquisition there and continuing to shift away from the government defense business?
Robert Mehrabian
That’s very fair.
Kevin Ciabattoni
Okay, that’s all I had. Thanks.
Robert Mehrabian
Thank you.
Operator
We have a follow-up from Jeremy Devaney from BB&T Capital Markets. Please go ahead.
Jeremy Devaney
Hey, Robert, I just wanted to circle back. Earlier you’d said you were on a consolidated basis, you are looking for about 40 to 50 bps increased EBIT margin.
And you were also talking about the ERP system that you’re going to begin putting into place. Are those two tied together?
What are you seeing as the largest driver of that margin expansion, really?
Robert Mehrabian
It’s not the ERP system. I can assure you of that.
The ERP system will pay for itself, hopefully if we do everything right. The margin improvement is primarily because of the shift in our product mix.
First, shift in the commercial domain to higher margin businesses, the instruments, oil and gas, international.
Robert Mehrabian
Second, even in our defense businesses, we are moving more towards higher value-added products, the kinds of things that OSF and submersible vehicles for troops, gliders and also for data link to UAVs battlefield communication. And finally, I think in the commercial aerospace, we are bullish on that area only because most of our products are communication devices, data acquisition and wireless communication for commercial aircraft.
And there we own significant chunks of the market, in things like the 737, 777 and those are where we see our margin improvements coming.
Jeremy Devaney
Hey, that’s fair. Continues to be very granular than do you see the instrumentation business being able to go 20% plus margin next quarter and within the engineered systems business, do you think that’s going to be 9% plus?
Robert Mehrabian
This year, the instrumentation business was 19.9% to be exact. We think it will remain around there [19.9%, 20%] over the next year.
Those are healthy margins because we are also investing in R&D there. On the engineered systems, we think that will probably go down somewhat, it’s a little over 9%, it will probably go down to a little over 8%, and frankly the guidance that we’ve given out today as you saw is as usual it takes all the risk into consideration and we don’t have for example any - in our engineered system business.
We don’t have any revenue baked in for our USEC nuclear manufacturing that goes for that business in there. So those margins would be a little under pressure.
Jeremy Devaney
And you actually brought up, one last good question; I don’t want to hog all the good questions here. But USEC, where do we stand today, I know we’ve seen some press releases out of their entity, but it seems like it got pushed out of the budget for ‘12.
What are you seeing, Robert?
Robert Mehrabian
They got a little funding release. They got $44 million recently for some of the reserves that they had for the nuclear products.
They may get some reprogram money for development and I think they are positive about that. From our perspective, the way we run this company as you know historically we don’t count on things we don’t know about, and so that’s not in our budget right now.
Jeremy Devaney
Is that $30 million to $40 million a year if and when it comes through at full rate?
Robert Mehrabian
Yeah, I mean, it’s not in our projections. I can’t, you know with this administration, you can’t put things like that in the projection.
Jeremy Devaney
Thanks Bob. Thanks for all the detail.
Robert Mehrabian
Thank you.
Operator
Thank you. At this time, there are no questions in queue.
Robert Mehrabian
Thank you very much operator. I’ll now turn the call over to Jason to conclude it.
Jason VanWees
Thanks Robert and thanks everyone for joining us on the call this morning. And if you do have follow-up questions, please feel free to contact me at the number on the earnings release.
Operator, if you could give us the replay information and then conclude the call we’d appreciate it. Thanks again.
Operator
Sure will. Ladies and gentlemen, this conference will be available for replay after 12 o’clock pm today running through February 26 until midnight.
You may access the AT&T Replay System at anytime by dialing 1-800-475-6701 or 1-320-365-3844 and when prompted enter the access code of 222575. Those numbers again 1-800-475-6701 or 1-320-365-3844, access code 222575.
Operator
That does conclude the conference for today. Thank you for your participation and for using AT&T Executive Teleconference.
You may now disconnect.