Teledyne Technologies Incorporated

Ladies and gentlemen, thank you for standing by, and welcome to the Teledyne second quarter earnings call. During the conference call, phone lines are in a listen-only mode. We will have an opportunity for questions and answers later on. If you should require operator assistance during the call, you may press star and then zero, and operator will assist you offline. As a reminder, today's conference call is being recorded, and I'd like to turn the conference over to our host, Jason VanWees. Please go ahead.

Thank you, and good morning, everyone. This is Jason VanWees, Executive Vice President, and I'd like to welcome everyone to Teledyne's second quarter 2019 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 Pichelli, Senior Vice President and CFO, Sue Main, and Senior Vice President, General Counsel, Chief Compliance Officer, and Secretary, Melanie Cibik. After remarks by Robert, Al, and Sue, we will ask for your questions. Of course, though, before we get us 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 by a webcast and dial-in will be available for about one month. Here is Robert.

Thank you, Jason, and good morning, everyone, and thank you for joining our earnings call. Today, we reported the strongest quarter in Teledyne's history. Sales and earnings per share were all-time records. Operating margin was also an all-time record, and each of these exceeded prior records by significant magnitude. Specifically, in the second quarter, sales increased 6.8%, including approximately negative 1.2% of currency headwind. Organic growth was 3.6%. Earnings per share of $2.80 increased 20.7% compared to last year. Also, we have increased our emphasis on margin improvement, while at the same time continuing our proven strategy of disciplined capital deployment for compound growth in earnings and cash flow. On that point, we are pleased to announce the acquisition of 3M's gas and flame detection businesses during this quarter. We expect to close this acquisition in the third quarter. Teledyne continues to benefit from our balanced portfolio of common technologies serving different but complementary end markets. Our 2019 outlook reflects strong growth in our life sciences and defense imaging businesses, which are more than offsetting declines in some industrial machine vision businesses. In addition, our defense and space electronics businesses should far more than offset some lower sales of avionics to certain commercial air transport platforms. Finally, our balance sheet remains exceptionally strong. In fact, our quarter end leverage ratio of 1.4 was the lowest in five years. I will now pass the call to Al, and he will comment on the performance of our four business segments.

Thank you, Robert. In our instrumentation segment, overall second quarter sales increased 0.6% from last year. Sales of electronic test and measurement systems increased 12.2% organically. The strong growth was once again led by sales of protocol analyzers. Sales of oscilloscopes also increased at double-digit rates. In the environmental domain, sales increased 2.0%, largely as a result of greater sales of selected laboratory and scientific instruments. Sales of marine instruments decreased 6.1% in the quarter, but the book the bill was 1.21 with quarterly orders and backlog, the largest in four years. In addition, profit margins improved as we benefited from aggressive cost reductions and business simplification initiatives. Overall instrumentation segment operating profit increased 19.8% and margin increased 298 basis points with margins increasing in each product grouping. Turning to digital imaging segments, The second quarter sales increased 11.5%. Sales of our proprietary medical and dental x-ray detectors increased significantly year-over-year. Sales of microelectromechanical systems, or MIMS, also grew significantly. Sales of advanced infrared detectors and data converters for space and defense increased over 10% compared to last year. The scientific and industrial cameras acquired from Roper performed nicely in their first full quarter, with sales increasing 5.7% from the comparable pre-acquisition period in 2018. The strong growth in these businesses, more than offset, expected declines in the portion of our industrial machine vision business, which serve consumer electronics and factory automation markets, especially in Asia. GAAP segment operating profit increase and margin increased 167 basis points to 20.9%, a record for the segment. I should note, however, that our sales mix was especially strong in the second quarter and in part due to final shipments of non-recurring products. However, we do expect segment operating margin in the second half of the year to resemble the overall level for the first half of 2019, just not at the level of the second quarter. In the aerospace and defense electronics segment, second quarter sales increased 10.1%, primarily due to strong growth across the majority of our defense electronics businesses. But in particular, sales of microwave devices and their interconnects for radar, Electronic Warfare, and Satellite Communications, as well as especially high-reliability semiconductors. Segment operating margin increased 120 basis points to 20.6%, primarily due to greater sales, but also due to margin improvement across the majority of our aerospace and defense businesses. In the engineered system segment, Second quarter revenue increased 6.3% with strong sales related to space and nuclear manufacturing programs, partially offset by lower sales of cruise missile engines. Segment operating profit declined slightly year over year, but improved significantly from the first quarter of 2019. Before turning to Sue, I want to offer some additional commentary regarding our increased 2019 outlook. We continue to believe that organic revenue growth in the full year 2019 will be approximately 4%, inclusive of roughly 120 basis points of currency headwind in the first half of 2019. Along with the contribution from the scientific cameras acquisition, That translates to revenue of just over $3.1 billion for the full year 2019. The increase in our earnings outlook primarily reflects greater anticipated full year margin improvement. I will now turn the call over to Sue.

Thank you, Al, and 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 third quarter and full year 2019 outlook. In the second quarter, cash flow from operating activities was $83.2 million, compared with cash flow of $107.9 million for the same period of 2018. The cash provided by operating activities in the second quarter of 2019 reflected higher working capital requirements, including the timing of accounts receivable collections, partially offset by the impact of higher operating income and lower income tax payments. Free cash flow, that is, cash from operating activities, less capital expenditures, was $65.1 million in the second quarter of 2019, compared with $80.5 million in 2018. Capital expenditures were $18.1 million in the second quarter, compared to $27.4 million for the same period of 2018. Depreciation and amortization expense was $27.1 million in the second quarter compared to $27.6 million for the same period of 2018. We ended the quarter with $683.6 million of net debt, that is $791.7 million of debt plus cash of $108.1 million for a net debt-to-capital ratio of 21.7%. Stock option compensation expense was $5.8 million in the second quarter of 2019, compared with $5.4 million in the second quarter of 2018. Turning to our outlook, management currently believes that GAAP earnings per share in the third quarter of 2019 will be in the range of $2.50 to $2.55 per share. and for the full year 2019, our GAAP earnings per share outlook is $9.86 to $9.96, an increase from the prior outlook of $9.45 to $9.55. The 2019 full year estimated tax rate excluding discrete items is expected to be 21.9%, a 60 basis point increase compared to full year 2018. In addition, we currently expect less discrete tax items in 2019 compared with 2018. I will now pass the call back to Robert.

Thank you Sue. We'd now like to take your questions. Nick, if you're ready to proceed with the question and answers, please go ahead.

Thank you. If you would like to ask a question today, please press star then 1 on your telephone keypad. You will hear a tone indicating that you have been placed in queue. If you're using a speakerphone, we do recommend picking up your handset before pressing the buttons. and if your question has been asked and answered, you may remove yourself by pressing the pound key. Again, now and going forward, you may press star and then one. We do have a few questions in queue. The first question is from Greg Conrad with Jefferies. Please go ahead.

Good morning and great quarter. Thank you, Greg. I was hoping you could maybe baseline the margins for the other segments outside of digital imaging. and maybe your expectations for the year. I mean, both instrumentation and electronics also had nice step ups and just trying to get a sense of how MIX maybe plays into those margins and maybe some of the initiatives that you've done around margin.

Sure, Greg, I'll try. First, as Adam mentioned, We expect some improvement in margin, but fairly consistent with the overall first half of the year. But let me walk you through the various margins. If you look at the instruments, the first half of the year, the margins were about 17.1%. We expect the year to finish off in total a little better than that at 17.3%. And I'll remind you that in April, I mentioned that that was 16.5%. So we have some improvement moving up. In digital imaging, first quarter was low at 15.7. Second quarter was higher. And we ended up with average margin for the first half of 18.4%. We think the full year, as of right now, should be about 18%. In aerospace and defense, we had a really good quarter, second quarter. The average for the first half of the year was about 19.7%. We were probably expecting that to tick up a little bit to about 19.9% for the year. Going to engineered systems, we had a modest margin in the first half of 8.1%. We expect that to improve somewhat to about 9.5% by the end of the year. And lastly, if you add all the segments up together, we expect the year total margin for operating margin for the segments to be about 17.4%. That's against the backdrop of 17% that I mentioned in April. And then for the total company right now, we're expecting a margin, operating margin of about 15.3%, which is up from 15%. in April at the end of the first quarter. I hope that answers your question, Greg.

No, that was very helpful. And then just one more. I mean, the last two deals you've done have been carve-outs from larger corporations. I mean, is that an opportunity maybe that you're seeing more today versus a year ago and just general views on kind of the pipeline to continue to do M&A?

We have a healthy pipeline, Greg. The reason we like the carve-outs is that the valuation expectations are more reasonable. Usually, the larger companies that we're dealing with have reasonable P ratios, and their expectations when they carve something out is not as high as standalone companies. So we like that a lot. Having said that, that's kind of opportunistic. While we look for it, we were lucky to be able to hit two of them in one year. Having said that, in general, we do have a reasonably healthy funnel of potential acquisitions, and we anticipate to move forward some small and and hopefully some medium-sized acquisitions in the future.

Thank you, I'll get back to you.

Thank you, Greg.

Next, we'll have a question from the line of Jim Ricciuti with Needham & Company.

Hi, thank you. Robert, I wonder if you can give us a little bit of color on the book to bill for the various segments and then I've got a couple of follow-ups. Thank you.

Yeah, I'll try, Jim. In the instruments businesses, the book to build is over one, it's 1.08. It's primarily, as Al mentioned, it's driven by our marine instruments that are about over 1.2. So instruments is over one. Digital imaging is under one somewhat. We think probably about 0.9, 0.95. Aerospace and Defense is a little different than the others because the orders there, especially in defense, are lumpy. We had a good first quarter book to build, and we think for the full year they'll probably be just under one, maybe 0.98, 0.99. Engineered Systems is, again, lumpy. As you know, we have big programs. First quarter, book to bill was 1.43. Second quarter is about 1. We expect we'll end the year at a little over 1, maybe 1.03. And overall, we think the book to bill for the year would be about 1, maybe 0.99. So, fairly stable. You know, we have some ups and downs, but because of our balanced portfolio, we believe we'll do all right.

So book to bill for the quarter, it sounds like, around one?

It's about 0.96, 0.97, but it's kind of, as with everything else, you have to balance it versus first quarter. First quarter was 1.07. So when you balance those two, it's slightly over 1.

Great. That's helpful. I keep anticipating you to call out some slowing in the test and measurement business, but you continue to show strong results there. How sustainable is that, what you're seeing, particularly with even the scopes business showing pretty good growth in this quarter?

Yeah, Jim. There are two, as you know, there's the, there are two parts to it. There's the scope business and the protocol businesses. In the protocol businesses, we had really good growth this quarter, about 15%, and primarily that's driven by our increased emphasis on serving the cloud computing industry. and we developed our next generation of PCI Express which are protocols and the growth in cloud computing and connectivity of internet of things to the cloud are helping us a lot and we're continually developing new products. On the scope side, we've had reasonably good growth. and we anticipate for the year though not to be as robust as we indicated in the second quarter, but still we should have a growth in excess of perhaps 5.5% in overall test and measurement. So we like that area and frankly we're putting a lot of money, R&D money in that area On the average, across Teledyne, we spend about 6.1% of our sales in R&D, and then we get two to three from outside. When you come to T&M, especially, we spend over 18% in R&D. And I think that's what's driving the new products, which are helping us gain market share.

Got it. That's helpful. Robert, do you think we're seeing a bottom yet in your industrial machine vision business?

I don't think so. I think it's difficult to predict. Some of it depends, of course, on what happens between us and China. I think you have to look at our machine business as different areas that we endeavor in. In the flat panel displays, which is about $50 million of our overall machine businesses, digital imaging businesses, that area has been hit hard. To offset that, though, as you know, we have a whole bunch of other things that we do in digital imaging from x-rays and so on. But even in that specific segment, we're trying to move into and we have moved into adjacent markets such as line scan sensors for food inspection. We're looking at intelligent traffic systems. We have some sales there. and we're seeing some interest in our cameras in vehicle batteries and consumer electronic batteries. And then as you know, we did acquire the scientific camera businesses from Roper and those are kind of immune to that part of the market. So yeah, I don't expect much recovery. I'm not counting on any recovery at this time. That's why we're a little, are all very conservative in our machine vision businesses or digital imaging businesses. Having said all of that, excluding acquisitions, we still expect somewhere between two and a half to 3% of organic growth in that segment of digital imaging. Plus, we'll get another 3% of organic growth eight or nine and a half percent, maybe as high as nine and a half percent from the acquisition. So in this market where everybody's kind of negative on overall digital imaging, we expect to end the year at over 12% growth in that segment.

Got it. Thanks. Congratulations on the quarter.

Thank you very much.

Next, we'll go to the line of Andrew De Gasperi with Barenberg.

Yes, thank you. I guess my first question would be on your partnership with Viasat for Connected Flyback Services. I know that they plan or they service 1,300 aircraft today, I think close to 2,000 by the end of the year. How big of an opportunity is this for you?

I think it's a good opportunity for us, but I have to tell you, Andrew, it's a little early for me to quantify that. We're delighted to be partnering with them, but on the flip side, it's a little early for me to estimate how successful and how robust it's going to be. It's a new area, as you know, streaming data from flights over SATCOM. We're familiar with that domain. We have other customers in the SATCOM domain. So we hope we'll go a little early to estimate how robust that would be.

Thanks. And maybe on the marine side, I know your comps are getting easier going into the second half. Do you expect sort of growth to return at this stage?

Yes. The answer is yes. We expect that for the year that we will have approximately a little over 4%, maybe as high as 4.3% growth in the marine domain. As you know, we had contraction in the second quarter, but as Al mentioned, Our orders are very robust. They were over 1.2. And the other thing that's happening is both offshore production and exploration are picking up. There's data that indicates the exploration and production numbers, growth numbers would be somewhere between seven and 9%. And so we're kind of tracking that. There's some good orders coming in Christmas trees. The number of Christmas trees projected for this year are the highest that we've seen in the last three years. So we do expect growth of over 4%.

Got it. Maybe lastly, 3M's gas and flame detection business. I was just wondering, do you have an idea of how that's been growing or what are you expected to do once you absorb it?

Yes, it's a low single-digit growth business. We think that it should be a little better than that for us, primarily because the markets that they play in, while they're very different from us, the underlying technologies are very complementary, and there's synergy between the area of the world that they serve in and the areas of the world that we serve in in our environmental products. And we think we'll be able to piggyback some of their products onto ours. So I think single digits right now, low single digit, but we think that that should improve as, by the way, did the scientific camera businesses after after we acquired it. So right now, we're hopeful that we can improve on what they're doing. Great. Thanks, Robert. Thank you.

Next, we have a question from Joe Giordano with Cohen.

Hey, good afternoon, guys. Good morning for you. Good morning, Joe. Hey, so I want to start on instrumentation margins. You know, you've got a lot of different businesses within there, but I think margins came in obviously much harder than most people were modeling, but I think also a lot higher than you guys were anticipating as well. So what kind of happened in the quarter there? Was it just mixed? Was there something else that came through that you weren't expecting or cost savings coming through faster? Can you maybe talk us through that a little bit?

Yeah, I would say, Joe, the best thing that happened in the instrumentation area from a margin perspective was the improvement in our margins in our marine businesses. We've been kind of suffering from reorganization, cutting our workforce, reducing our footprint, but I think now things are getting colder and our margins improved significantly there. The surprise part of it is really in the test and measurement area. You know, we acquired LaCroix about 2012. And when we look back at what's happened to their margins during this span of time, we've had a 500 basis points improvement in margin. and that helped us. So because revenues were higher than we anticipated in both protocols and oscilloscopes, our margins were significant for surprisingly significant in the second quarter. So overall instruments margin as you know in the Q2 was about 18.6% versus 15.6 in the Q3. in the first quarter. We expect that we won't probably stay at 18.6, but for the full year, we'll go at 17.3, which is still pretty good compared to 2018. That's a 280 basis points improvement over the 14.4% that we had in 2018.

Can you just scale for me? So you mentioned marine margin, so that was up in a, I assume up nicely year on year on a quarter where marine revenues were down. Can you scale, how far below segment average is marine currently?

Let me see. The marine margins right now are approximately 15%, 15.5%. whereas the segment, as I just noted, was over 18%. Having said that, the improvement in marine is hopefully sustainable because the cost that we have had and also because we expect the second half to pick up in revenue and end the year in marine Organic Growth over 4%, which would be very nice for us.

And it's right to say that when this business was really humming back a couple years ago, that business was higher than segment average, correct?

A couple of years ago, it was 18 to 20. Well, it wasn't a couple of years ago. It was 2015, 2014, I would say it was. 18%, 19%. It's been as high as 20%. But let's just say on the average of 18% to 19%. So we're slowly climbing up to that plateau.

Okay. And then last for me on free cash flow, a little bit lighter in the quarter. The commentary sounds somewhat temporary with some working capital and some receivables. But can you maybe talk us through how that reconciles throughout the rest of the year?

We think it'll improve in the second half. We think it'll improve significantly. We think for the year, we should end up somewhere between 370 to 400 million. Cool. My CFO is looking at me saying, you told them too big a number.

Just make our life more challenging. That's fine.

What are you going to do?

Thanks, guys.

Thank you.

As a reminder, if you have a question, you may press star and then one. We'll go to the line of George Godfrey with CL King.

Thank you. Good morning, Robert. Good morning, Joe. As always, excellent job on the execution. My question relates to acquisitions and perhaps adding another leg onto the stool. Do you see the company remaining in these four areas or could you see a fifth area outside of the instrumentation, digital imaging, A&D, and engineered systems being added. And then looking at engineered system, the operating margin, pretty well below what the other three businesses are. Do you see the vestiges perhaps in that segment? Thanks.

Yeah, a good question. The fifth leg of a stool, let me just think about that one. Right now, I don't think so. George, it's a tough call to go outside what we know, recognizing the fact that our segments have a broad portfolio of products and markets. For example, if you look at our digital imaging segment, we serve About a third of it is in machine vision. We talked about that. We have about a quarter of that in healthcare. Then we have another quarter that's in aerospace and defense. And then we have, of course, the MEMS. And then we have LIDARs and geospatial, et cetera. So it's a broad portfolio of businesses. It'd be easier if we were to add to those because we're more knowledgeable. about that. And we also, in the medical domain, there are a lot of other things than just x-rays and the stuff that we do for medical devices for cancer treatments, radiation. Having said that, We think we can move away from some of those areas like we did in scientific cameras from Roper. So I don't think we need to go to a because we have a nice balanced portfolio of businesses. Regarding the second part of your question about the vestiture. our engineer systems segment. The margin is approximately 10%. Sometimes goes as far as 11%. I don't think we would divest those businesses. The reason being very simple. It's a very little assets in that business. And it kicks off about $20 to $25 million in IBT, which adds 50 to 60 cents of earnings. And I just don't see how we can make that up by divesting and paying taxes and trying to make that cash do the 50, 60 cents that we're getting from that business. The final area there is we do have a lot of engineering talent there, and they are helping us move into systems in other fields that we would have a problem going by ourselves. For example, we sell gliders to the Navy. for example, maybe deployed 140 of our gliders in one single operation this year. And that kind of a systems capability, we have it only in our engineered systems. So a lot of our glider sales and developments are coming there. And of course, as you know, we have a very big program, very strong program in underwater shallow water combat vehicles for our Navy SEALs. So the answer is not likely that we would sell that because things like the shallow water combat vehicles use a lot of instruments from our marine instruments, whether they're images, whether they're sonars for detecting Mines or Detecting Shores. So I don't see that. It first doesn't make sense. Second, it's a nice platform for us to get into systems businesses without other businesses.

Understood, Robert. Thank you for taking my question.

You bet. Thank you, George.

At this time, there are no further questions in queue.

Well, thank you, Nick. I would ask Jason to now conclude our conference call, please.

Thanks, Robert. And again, thanks, everyone, for joining us this morning. If you have follow-up questions, of course, please feel free to call me at the number in the earnings release. And all our news releases are on our website, as well as the replays on Teledyne.com. Nick, if you could conclude the call and give the replay information for everyone, we'd appreciate it. Thank you.

Certainly. Today's conference call will be available for replay beginning at 10 a.m. Pacific Time and running through August 24th. You may access the AT&T Playbacks system by dialing 1-800-475-6701 and enter the access code of 469739. International callers may use 320-365-3844. Again, those numbers are toll-free, 800-475-6701. Or for international callers, 320-365-3844 with a common access code of 469739. That does conclude our conference for today. We thank you for participating and using AT&T Teleconference. You may now disconnect.