Teledyne Technologies Incorporated

Ladies and gentlemen, thank you for standing by, and welcome to the Teledyne Fourth Quarter Earnings Call. At this time, phone lines are in a listen-only mode, and we will have an opportunity for a question-and-answer session. As a reminder, today's conference call is being recorded. If you should require operator assistance, you may press star and then zero. An operator will assist you offline. At this time, I'll turn the conference over to our host, Jason VanWees. Please go ahead.

Thank you, Nick. Good morning, everyone. This is Jason VanWees, Executive Vice President at Teledyne, and I'd like to welcome everyone to Teledyne's fourth quarter and full year 2018 earnings release conference call. We released our earnings earlier this morning before the market opened. Joining me today are Teledyne's Executive Chairman, Robert Mehrabian, President and CEO, Al Pacelli, Senior Vice President and CFO, Sue Main, and Senior Vice President, General Counsel, Chief Compliance Officer, and Secretary, Melanie Cibik. After remarks by Robert Allen Su, we will ask for your questions. Of course, 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 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 dialing, will be available for approximately one month. Here's Robert.

Thank you, Jason, and good morning, everyone, and thank you for joining our earnings call. I am exceptionally pleased with Teledyne's results. Fourth quarter and full year sales and gap earnings per share were all-time records. In the fourth quarter, sales increased 6.2%, all of which was organic. In addition, each business segment experienced growth in sales and operating profit with the vast majority of our commercial and defense businesses growing nicely. Earnings per share of $2.45 increased 33.2% compared to last year. Gap operating margin was 14.9% and increased 143 basis points from last year. Finally, annual free cash flow of $360.1 million was also a record and allowed us to end 2018 with the lowest leverage ratio in over four years. Before turning the call to Al Paceli, please allow me to digress for one moment. Today, the story of Teledyne is about consistent and continuous improvement in financial performance, continuous improvement in operations, and prudent capital allocation. It is a story about building a portfolio of related companies and related products with common underlying technologies but serving different customers and markets. Markets that are complementary subject to different business cycles and demand drivers. In other words, balanced. Balanced in a way to reduce volatility. For example, within digital imaging, strong sales of x-ray detectors and generators for healthcare applications more than offset some softness of standard products related to industrial machine vision. Within instrumentation, sales of environmental and electronic test and measurement instruments increased year over year, with electronic test and measurement particularly strong. This, again, more than offset a decline in sales of marine instrumentation. However, operating margin in each of those product lines improved. Finally, organic sales growth of defense electronics was 11.9%, which more than offset Some expected declines and very tough comparisons in our commercial aerospace markets. I will now pass the call to Al Pacelli, and he'll comment on the performance of our four business segments.

Thank you, Robert, and good morning. In our instrumentation segment, overall fourth quarter sales increased 3.4% from last year. Sales of electronic test and measurement systems increased 24% organically. Sales were strong across the range of our product lines, but were led by sales of protocol analyzers. For reference, protocol analyzers are designed to generate, capture, and analyze high-speed data communications across a range of protocols or standards, such as universal serial bus or USB. Other less familiar protocols are used in data storage and data movement applications. And we continue to benefit from growth in solid-state disk drives and cloud network storage. In the environmental domain, sales increased 3.7%, largely as a result of greater sales of selective laboratory and life science instruments, as well as continued growth in particulate monitoring instrumentation. Sales of marine instruments declined 7.5% in the quarter, but fourth quarter orders increased 50% year over year and full year orders increased 10%. Overall instrumentation segment operating profit increased 40% and margin increased 428 basis points as a result of greater sales of higher gross margin environmental and electronic test and measurement instruments and significant prior cost reductions in the marine domain. Turning to digital imaging segment, fourth quarter sales increased 9.3%, which was entirely organic. Sales of our proprietary medical and dental X-ray detectors increased significantly year over year. In addition, we also achieved robust year over year growth in X-ray generators for cancer radiotherapy. Finest sales of microelectromechanical systems, or MIMS, also grew due in part to increased shipments of consumables for life sciences and extreme UV lithography. Gap segment operating profit increased, but margin declined 94 basis points from last year due largely to non-operating items such as stock-based compensation and a $1.1 million purchase accounting gain in the prior fourth quarter. In the aerospace and defense segment, fourth quarter sales increased 2.8%, primarily due to strong growth across the majority of our defense electronic businesses. But in particular, sales of microwave devices for space applications, as well as specially high reliability semiconductors. Segment operating margins increased 81 basis points to 20.5%. primarily due to greater sales but also a favorable product mix. In the engineered system segment, fourth quarter revenue increased 16.3% with strong sales related to missile defense and nuclear aviation and marine manufacturing programs, partially offset by lower sales of cruise missile engines. Segment operating profit increased but margin declined 105 basis points solely as a result of lower sales of fixed priced turbine engines. To conclude, I want to briefly follow up on Robert's earlier comments. We appreciate that our business portfolio is balanced, but we also address issues quickly and decisively when market weakness occurs. For example, over the last three years, we have made variable as well as permanent cost reductions and our marine instrumentation businesses. These actions included a 30% decrease in the total workforce and the closure of 20 sites including four manufacturing sites in 2018. Finally, throughout this period, none of our earnings are adjusted for such cost actions which totaled nearly $30 million. I will now turn the call over to Sue.

Thank you, Alan. Good morning, everyone. I will first discuss some additional financials for the quarter not covered by Robert and Al, and then I will discuss our first quarter and full year 2019 outlook. In the fourth quarter, cash flow from operating activities was $125.5 million compared with cash flow of $126.4 million for the same period of 2017. The cash provided by operating activities in the fourth quarter of 2018 reflected the impact of higher operating income offset by higher income tax payments. Free cash flow, that is, cash from operating activities less capital expenditures, was $106.8 million in the fourth quarter of 2018 compared with $108.4 million in 2017. Capital expenditures were $18.7 million in the fourth quarter compared to $18 million for the same period of 2017. Depreciation and amortization expense was $29.3 million in the fourth quarter compared to $25.6 million for the same period of 2017. We ended the quarter with $608.1 million of net debt, that is $750.6 million of debt and capital leases left cash of $142.5 million for a net debt to capital ratio of 21.4%. Stock option compensation expense was $4.9 million in the fourth quarter of 2018 compared with $3.2 million in the fourth quarter of 2017. As noted in earnings release, the fourth quarter of 2018 included $2.5 million of pre-tax severance and facility consolidation costs Compared with last year's $0.7 million of similar charges offset by a $1.1 million purchase accounting gain related to the E2V transaction. The fourth quarter of 2017 also included provisional charges of $4.7 million as a result of the Tax Cuts and Job Act of 2017 or the Tax Act. In the fourth quarter of 2018, the company finalized its assessment of the Tax Act, resulting in a decrease of $0.8 million to the provisional charge. Turning to our outlook, management currently believes that GAAP earnings per share in the first quarter of 2019 will be in the range of $1.87 to $1.92 per share. And for the full year 2019, Our GAAP earnings per share outlook is $9.25 to $9.35. The 2019 full year estimated tax rate is expected to be 22.3% before discrete items, a 100 basis point increase compared to 2018. In addition, we currently expect significantly less discrete tax items in 2019 compared with 2018. I will now pass the call back to Robert.

Thank you, Sue. Nick, we'd like now to take questions from the audience. If you're ready to proceed with the question and answer period, please go ahead.

Thank you. If you would like to ask a question today, you may press star and then one. You will hear a tone indicating that you're in the question queue. We do recommend picking up your handset if using a speakerphone. We'll go to our first question. It's from Greg Conrad with Jeffrey. Please go ahead.

Good morning. I was hoping maybe if you could just give a little bit of color around your organic growth expectations for 2019 and maybe just on a segment basis what the expectations are.

Thank you very much and good morning to you. This is Robert. First, let me start with the overall organic growth for 2019. It's a little lower than what I said in October.

In October, I said it'd be, three months ago, I said it'd be about 5%.

We're now projecting between 3.5% and 4%. So put that as a bucket for the overall anticipated growth. And part of the slight decrease is because of China tariffs, government shutdown, currency headwinds, et cetera. But let me now go to the segments. We think in the instrument segment, we will have something of the order of 3.5, 3.6% in organic growth. Marine, a little lower. We'll have a little pickup in marine, but it'll be just below 3%. In other instruments, environmental, we expect to pick up about 4%, and in test and measurement, about 4.5%. Digital imaging, while we're enjoying very strong revenues and growth, in our medical and dental products. We have some headwinds in the vision system, machine vision system. So overall, we think revenue growth would be of the order of 4%. Aerospace and defense will continue to have a little headwind in aerospace. We expect defense to more than make up for it, and the two combined in that segment should be above 4%. And then engineered systems, I think we'll see some moderation of the growth from this year to next, probably about 2% to 2.5%. If you add all of those up, it comes to about 3.7%, so I set the range between 3.5% and 4%.

Thank you. That's helpful. And then not to harp too much on guidance, I mean, just your thoughts around margins in 2019. I mean, just looking at how you exited the year, there was a nice pickup in instrumentation. You know, digital imaging has been a little bit more volatile throughout the year. I mean, maybe just your thoughts around margins in 2019.

Yeah, I think overall, if I go to gap margin, We'll moderate some because we picked up some really nice margins this year, as we mentioned. I think it'd be between 50 and 55. We anticipate at this point between 50 and 55 basis points improvement in gap operating margin. But going forward, we do have some other headwinds, some in taxes below the margin line. Assuming Taxes, primarily because we're not going to have as much foreign tax benefit and we're going to have less R&D benefit. And Sue's guidance also is based on the fact that we will have about 400 basis points we expect right now, 400 basis points lower in discrete tax items. To conclude, I think from a segment perspective, our margins in instruments will improve a little bit. Digital imaging will be flat. Aerospace and defense will be slightly up, and engineer systems slightly down. Balance all of that, we expect the operating margin overall to go up. about 50 to 55 basis points.

Thank you. That's helpful. And then just last one for me. I mean, you mentioned the government shutdown. Is that, I mean, I know Defense Department, you know, remains open. I mean, is there other exposure? I know in the past you've maybe had, you know, EPA or just any impact you're seeing from the shutdown.

Right now, I don't see an impact to Q1. But having said that, If this goes on for a long time, some of our programs will be affected. We will not get renewals. And we're being a little cautious obviously between that and what's happening with the trade disputes that we have. So we're being a little cautious at this point.

Thank you.

Thank you.

Once again, if you have a question, you may press star and then one. We'll now go to the line of Jim Ricciuti with Needham & Company.

Hi, good morning. Just given the full year guidance for revenue growth, do you anticipate stronger growth as the year progresses, starting off a little slower, just given some of the headwinds you alluded to?

Yeah, I think, Jim... Both in revenue and in earnings, if you go back, I just went back and looked at earnings first, going back to 2011. And I noted that every quarter, our earnings in the first quarter have been lower than the second. Most of the time, we've had a continuous improvement in earnings. and part of that is because we've had continuous improvement in revenue. So at this point, sitting where we are, I think that 3.5% to 4% is a good number for earnings. But if things turn up, if the trade disputes begin to diminish, I think our revenues would go up and our earnings should go up. As it is, we anticipate earnings growth quarter over quarter anyways. That's how, if you add up the 925 to 935 and the guidance for Q1, you can conclude that we're anticipating earnings to grow anyways.

Got it. And then with respect to marine instrumentation, fairly significant increase in bookings in the quarter. So should we assume that things have finally begun to turn in that part of the business? And certainly the comparisons get easier this year. Is that fair to say?

Yes, it is.

I'll let Al expand on that. Sure. Good morning, Jim. You're absolutely right in terms of the booking situation. No matter if we look at the book-to-bill ratio for marine for the entire year, it was 1.06%. But if you look at just Q4, our book, the bill order is 1.27. And we look at that space in a couple of different ways. First of all, the seismic exploration space. Our equipment's been there for quite a while. We think there's a need for replacement, but that's probably another year or so away. So we think that that part is going to be relatively flat in 2019. and then in the offshore production side there seems to be some good activity generating now, but these are large projects that have to be engineered and so in terms of actually seeing the sales come from that, likewise we think that's probably late 19 and and probably next year. On the positive side, there are a couple other areas. When we think about the defense and security, as you know, we provide quite a bit of equipment on areas like the Virginia-class submarine. And those are orders we have in-house. The content is growing each year. And so that gives us a pretty healthy growth on that side. That could be as much as 8% to 10% just on that submarine program. And then we're looking at and other areas, an area of using autonomous underwater vehicles for science, for infrastructure, for military application. And we have a broad suite of vehicles in that space, and all of those seem to be doing pretty well. And that's where we see the upside coming. So the sort of historical deep water, oil and gas, flattish, The remaining parts of the marine, though, we do see some improvements, and hence you see a little bit of the upside that Robert talked about.

That's helpful. Al, you alluded to the book to bill in this part of the business. I wonder if you can give us any color on just broadly speaking book to bill information. for the quarter and maybe some of the segments. Thank you. Sure.

Sure. I can do that, Jim. Our orders input were pretty strong for a year as a company. We had to book the bill at 1.11. And if you go through the math, that means we added about $320 million to the backlog. And of that, you know, segment by segment, I mentioned the marine for the quarter, about 1.27 million. from there you go to our EMU environmental and our test and measurement businesses and as you know that's a short cycle book and burn business and it's about one I think the environment was just a hair under one our test and measurement centered around La Croix is one so that doesn't change too much from period to period in the digital imaging we have a book to build a little bit below one 0.97 and again I'm talking about Q4 now as 0.97 in Q4 and a sort of 1.05 for the year. Aerospace and Defense is where the majority of our orders come, keeping in mind that a number of these programs in this space are multi-year programs. In fact, I'd probably say half of the extra orders are programs that will go out for the next three to four years. But in Aerospace and Defense Electronics, we had a book to build in Q4 of 1.37, that's fairly healthy, and 1.29 for the year. And then when you move down to engineered systems, keeping in mind engineered systems has very large programs, and so the orders from one month or one quarter are a little bit lumpy. But the orders in Q4 were 0.81, but for the year, the orders are 1.08. And I think in engineered, more so than anyone else, I think you have to look at the at the total orders for the year. So if you add all that up, as far as book to bill in Q4, we have a 1.09 and for the year, a 1.11. Hope that helps.

It does help. Thank you. And just the last question from me, you alluded to potentially some impact from the shutdown. And I'm just wondering, with respect to the pending acquisition, does that... Do things get potentially delayed there?

Yeah, I'll take that one, Jim. Two things there. First, that part of the government programs is affected. Nevertheless, we're going through the process. We've submitted our HSR filings. We did that right at the beginning of the year. We have an examiner that's looking at it and asking questions, but at this point it's unpredictable. We expect to be able to close the transactions in Q1, but that's one part that could get affected, even though so far our examiner seems to be very engaged with us, and we're very pleased with that.

Robert, how's the pipeline for other acquisitions looking out over the balance of the year?

It's not bad. Let me go back and say because of what Sue mentioned, because of our net debt to EBDA, net debt getting down to about $600 million, our combined EBDA this year is going to get up to and many more. We have a lot of financial muscle this year, more than I've seen in a long time. I think we have something of the order, we will have in 19, something of the order of 1.3 to 1.5 billion dollar capability. So let me put that as being an opportunity for us. We are looking at both small and large acquisitions, medium size for others, for us large. Having said all of that, We're going to continue to be fairly disciplined in that process. We have to keep looking at the balance, keeping the balance of our businesses, not get out of whack so that if one market goes down, it takes the company's revenue and earnings in one direction too much. Having put all of that together, I think we're going to probably be a little more aggressive than in the past.

Thank you at this time.

There are no further questions in the queue.

Thank you very much, operator. I'll now ask Jason VanWees to conclude the call.

Thanks, Robert. And again, thanks, everyone, for joining us this morning. If you do have follow-up questions, my number is on the earnings release. Please feel free to call. Nick, if you could conclude the conference call and provide the replay details to the audience, I would appreciate it. And again, thank you, everyone. Bye-bye.

Certainly, today's conference call is being recorded and will be available for replay beginning at 10 a.m. Pacific time today and running through February 23rd. You may call into the AT&T replay system by dialing 1-800-475-6701 and enter the access code of 457-983. If you are calling from outside of the U.S., you may dial 320-365-3844. Again, those dialing numbers are 1-800-475-6701 or 320-365-3844 with a common access code of 457983. That does conclude our conference for today. We thank you for your participation and for using AT&T Teleconference. You may now disconnect.