Teledyne Technologies Incorporated

Ladies and gentlemen, thank you for your patience and holding, and welcome to the Teledyne Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later on, we will be conducting a question-and-answer session. Instructions will be given at that time. If you should require assistance any time during the call, please press star, then zero. I would now like to turn the call over to your host, Jason Van Wees. Please go ahead.

Thank you, Lori, and good morning, everyone. This is Jason Van Weese, Executive Vice President, and I would like to welcome everyone to Teledyne's second quarter earnings release conference call. We released our earnings earlier this morning before the market opened. Joining me today are Teledyne's Executive Chairman, Robert Moravian, President and CEO, Al Pacelli, Senior Vice President and CFO, Sue Main, and SVP General Counsel, Chief Compliance Officer and Secretary, Melanie Sivick. After remarks by Robert, Al, and Sue, we will ask for your questions. But 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 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 approximately one month. Here is Robert.

Thank you, Jason. Good morning and thank you for joining our earnings call. Before discussing our results, I want to emphasize that all of our worldwide manufacturing sites, as well as our corporate office and research laboratory, have been and remain operational. However, because our priority remains the health and safety of our employees, We're continuing social distancing, enhanced cleaning protocols, and usage of face masks and personal protective equipment. I shall now make a few comments about our performance in the current environment and our outlook for the remainder of 2020. Despite record economic contraction and a challenging operating environment for manufacturers, Teledyne performed extremely well in the second quarter. Our results reflect aggressive cost control and disciplined execution. In fact, although sales decreased approximately 5% compared to both last year and the first quarter of 2020, overall gap operating margin increased sequentially 150 basis points. Teledyne's business portfolio remains exceptionally well balanced across end markets and geographies. Also, our mix of long cycle and short cycle business provides a reasonable level of predictability and helped us, give us the confidence to provide our outlook in April. Looking back at the second quarter, The overall market and demand outlook played out as we had envisioned. In April, we predicted second quarter sales to decrease 5% year over year versus the actual results of negative 4.9%. That said, demand for instrumentation was better than forecast due to continued demand for test and measurement protocol analyzers, and a record quarter for OakGate business, which was acquired in January. These product lines serve technology markets related to solid-state storage and cloud networking, where capital spending remains relatively robust. On the other hand, digital imaging sales were slightly lower than forecast, not only in dental healthcare markets, where weakness due to COVID-19 was expected. But we also saw temporary declines in surgery and cancer radiotherapy due to one, deferred patient treatments, two, our customers destocking, and three, fewer new OEM equipment installations in hospitals. Otherwise, everything else from a sales perspective essentially occurred as expected. More importantly, operating margin, earnings, and cash flow each exceeded our April expectations. Ongoing simplification of our processes and margin improvement actions, including aggressive cost cutting in the first half of 2020, delivered superior results. Now, Looking forward to the balance of 2020. We remain positive overall. Just as commercial sales to Asia improved late in the first quarter, we expect a recovery in sales in Europe and the Americas later this year. However, in light of reinitiated shutdowns and travel restrictions, it is prudent to assume such recovery will begin in the fourth quarter. In other words, we expect the overall sales level in the third quarter to be very similar to Q2. As a result, we now expect 2020 full-year sales to decline approximately 3% from 2019. with sales of instrumentation and imaging increasing sequentially in the fourth quarter and defense electronics and engineer system sales continuing to remain robust throughout the year. We are not forecasting a recovery in commercial aerospace in 2020. However, this market will contribute less than 5% to our total revenue. Before turning to Al to report on the second quarter performance by segment, I want to emphasize the following. First, as we have repeatedly demonstrated in the past, we know how to be disciplined and perform well in challenging environments. Second, in prior cycles, when revenue was challenged, we protected earnings, while at the same time increasing cash flow. For example, in 2009, when revenue declined 4%, gap earnings were flat, and free cash flow increased over 50% from 2008 and was a record for Teledyne at the time. Likewise, in 2016, when total revenue declined 6%, Gap earnings were flat and free cash flow again increased over 50% from 2015 and was again a record for Teledyne at the time. More importantly, in subsequent years, we kept our lower cost structure, hence gap earnings nearly doubled over the subsequent three to four years. In addition, Following some periods of general market weakness, due to Teledyne's strong balance sheet, we were able to complete our largest and best acquisitions. For example, we announced the acquisition of Teledyne Dalsa in 2010 and Teledyne E2V in 2016, both of which were our largest acquisitions on those dates. Fast forward to 2020. We are aggressively managing variable costs as well as permanently reducing costs where appropriate. Our balance sheet is exceptionally strong with over $380 million of cash and cash equivalent and a borrowing capacity of over $1.2 billion. I will now comment on the performance of our four business segments.

Thank you, Robert. In our instrumentation segment, overall second quarter sales were flat versus last year. Sales in marine instrumentation decreased 1.3% in the quarter. However, operating profit improved due to business simplification initiatives and improved pricing and procurement activities. As a reminder, while marine includes products sold to the energy industry, we expect this market to directly account for just over a third of total marine sales in 2020, or approximately $150 million of annual revenue compared to almost $400 million in 2014. In the environmental domain, sales increased 7.9%. as a result of our acquisition of the gas and flame detection business. While sales of certain products, such as medical-grade oxygen sensors, increased during the quarter, this could not offset declines in general industrial markets, such as stat gas emissions monitoring and wastewater flow and sampling. Sales of electronic test and measurement systems decreased 9.8%. While there was strength in our protocol solutions group, sales of general purpose oscilloscopes declined year over year, especially in Europe and the US. Nevertheless, order trends and sales leads in Asia and Europe have improved in recent weeks. Overall instrumentation segment operating profit and margin were flat with last year, despite $2.8 million in higher severance and facility consolidation costs. Turning to digital imaging segment, second quarter sales decreased 4.3% and primarily reflected lower sales of x-ray detectors for dental and medical applications, partially offset by greater sales of infrared detectors for the defense market. Sales of industrial vision systems were largely flat with last year. as strength in semiconductor inspection and markets in Asia largely offset some weakness in Europe and North America. Gap segment operating margin of 19.7% was the second highest quarterly margin ever achieved, but was 108 basis points below last year's all-time record of 20.8%. In the aerospace and defense electronics segment, Second quarter sales declined 18.7%, as greater defense sales were more than offset by a 49% decline in sales of commercial aerospace products, as well as lower commercial space sales related to OneWeb. Gap segment operating margin decreased due to lower sales, but also over 340 basis points of charges for severance and facility consolidations. In the engineered system segment, second quarter revenue increased 6.4%, primarily due to greater sales from marine, nuclear, and other manufacturing programs, as well as electronic manufacturing services. Segment operating profit increased 20%, with margin up 123 basis points. I will now turn the call to Sue, who will offer some additional commentary regarding the second quarter and our 2020 outlook.

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 2020 outlook. In the second quarter, cash flow from operating activities was $155.8 million, compared with cash flow of $83.2 million for the same period of 2019. The cash provided by operating activities in the second quarter of 2020 reflected improved collection of accounts receivable and $33.4 million of deferred tax payments partially offset by lower operating income. Free cash flow, that is, cash from operating activities, less capital expenditures, was $139.2 million in the second quarter of 2020, compared with $65.1 million in 2019. Capital expenditures were $16.6 million in the second quarter, compared with $18.1 million for the same period of 2019. Depreciation and amortization expense was $29.0 million in the second quarter compared to $27.1 million for the same period of 2019. We ended the quarter with $468.6 million of net debt, that is $851.4 million of debt, less cash of $382.8 million for a net debt-to-capital ratio of 14.0%. Stock option compensation expense was $5.7 million in the second quarter of 2020, compared with $5.8 million in the second quarter of 2019. Turning to our outlook, management currently believes that GAAP earnings per share in the third quarter of 2020 will be in the range of $2.25 to $2.45 per share. And for the full year 2020, our gap earnings per share outlook is $9.45 to $10, compared with the prior outlook of $9.30 to $10. The 2020 full-year estimated tax rate, excluding discrete items, is expected to be 22.8%, a 220 basis point increase compared to full-year 2019, due in part to less R&D tax credits. In addition, we currently expect less discrete tax items in 2020 compared with 2019. Please note that the estimates for third quarter and full year 2020 GAAP-diluted earnings per share exclude any potential charge related to Airbus OneWeb satellites. I will now pass the call back to Robert.

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

And ladies and gentlemen, if you would like to ask a question at this time, please press 1, then followed by 0. And our first question comes from Greg Conrad from Jefferies. Please go ahead.

Good morning. Good morning, Greg. Good morning. Just to start on margins, I mean, it seems like you maybe took down the organic growth outlook a little bit in Q3. EPS are kind of flat. I mean, should we think about similar margins in Q3 and then a ramp in Q4? And what type of assumptions have you made in terms of one-timers in H2, whether it's restructuring or anything embedded in the margins?

Sure, Greg. First, let's Let's go back to Q2. The margin was 14.8%, the operating margin. We think in Q3 the margin is going to go up to up to about 15.4%. And we think in Q4 it will go up further. So we should end the year around 15% considering the first quarter was pretty low at 13.3%. So we expect to have continuous improvement in margin. And forgive me, the second part of your question had to do with?

Oh, just have you embedded any additional restructuring? You kind of called it. Yeah, yeah.

Yeah, I think Greg, sorry about that. We have about 19 million years to date. We are still reducing our workforce. By the end of the second quarter, we were down about 660 people. We expect by the end of the year to be down about 1,000. Out of 11,800, that's 8.5%. So we'll be below 11,000. when the year ends. Consequently, we think we'll have maybe another $4 to $5 million of charges in Q3 and Q4 collectively. Let's just say five.

And then you kind of called out digital imaging maybe being a little bit worse than expected with instrumentation a little bit better and kind of a ramp into Q4? I mean, when we think about towards the end of the year, is digital imaging maybe where there's the most opportunity to kind of see increases, you know, kind of as we exit the year?

Yeah. Let me... The surprise in digital imaging was the following. We expected that the dental... market for our sensors to be down because people are not going to dentists in the current circumstances. What was a little surprising to us was the down slope in radiotherapy that cancer treatment and equipment services that we provide upgrades. What we found out was that in the cancer therapy, really most of the downside was because of people that would be tested for cancer or colon cancer or various types, and that shrank quite a bit. Now, having said that, we think that Q3 would be relatively flat with Q2, and we think that We'll have another maybe upwards of $20 million in Q4, primarily in digital imaging as well as, I should say, in instrumentation. So collectively, we expect those two to do much better in Q4 than they did in Q2.

And then just last one for me. I mean, pre-cast flow is kind of running ahead of expectations where you kind of laid out

last quarter any update there and then kind of tied to that you had mentioned m a i mean any change in terms of your near-term appetite and kind of what you're seeing in terms of opportunities let me start with the cash i think in april greg i mentioned that we expected cash to be of the order of 375 free cash flow to be outdoors of 375 million dollars for the year I'm going to up that now to probably about $400 million, maybe a little more, but let's just say Ron numbers $400 million of free cash flow. In current circumstances, that would be a record for us. Last year, we had $394 million. So if we can exceed that, that would be a record. Now, going back, as I mentioned in my comments, we have the capacity to buy things excluding acquired EBDA of the order of $1.2 billion. Anything we buy is going to obviously have some EBDA associated with it, so it could be higher depending on what we buy. I'm going to hazard the guess by the end of the year we may have as much capacity as $1.5 billion, having said that. There's the one acquisition that's been sitting out there for Taurus, which the situation's still undecided. That would take up about 550, maybe a little more because of the change in the currency. And then we have appetite for other acquisitions, I hope significant ones, in this environment. Just like we did with DALSA in 2010, and E2B in 2016. Under those economic conditions, those businesses were not performing very well, and we were able to acquire them at a reasonable price. So our appetite, I think, will improve with time as our cash position improves with time also. Thank you. Thank you, Greg.

And our next question comes from Jim. Rashudi from Needham and Company, please go ahead.

Thank you. Maybe just to follow up on that comment, Robert, if you look at that M&A pipeline, are there areas in the business where you would like to focus more of the M&A activities in digital imaging, or are there still opportunities for you to look at instrumentation acquisitions as well?

You're right on, Jim, both areas. I think digital imaging, obviously, Photonis would be a complimentary acquisition, a really good complimentary acquisition if we were able to make it to digital imaging. On the other hand, in the instrumentation area, that's our second high-margin business, and we would like to make acquisitions there, too. Those are the two main areas, as you noted.

Okay. And maybe just in general terms, how were the booking trends in the quarter? Can you give us any color as to the book-to-bill? And I assume there's been some variability in the book-to-bill in the different segments.

Yeah. Let me start again. Let me go back to Q1. We had a really good book to build in Q1. We were about 1.09 in Q1. In Q2, things went south. We dropped to about 0.85. But collectively, we think we'll end the year just below 1. Q3 should improve over Q2, and Q4 should be a little over 1. We think we'll end the year by maybe 0.98 of that order. That includes pretty lumpy orders, especially in our engineered systems. So I think you have to take into consideration that our aerospace business, the book-to-bill is pretty low because of the decline in that order. In TNM and instruments, I think instruments in general in Q2, we were just a little north of one. And we think Q3 would be one and Q4 would be one. So we should be okay there. Digital imaging, we should end up a little over one. With aerospace and defense, defense will pick up. So we should be just under one by the end of the year. even with aerospace being done. And engineer systems is lumpy, so I think, you know, it doesn't matter. It's going to be around one in the end.

Okay. That's helpful. And, Robert, maybe as a final question, just in light of the economic environment, you obviously have less visibility on the short cycle of business. You do have, it sounds like, in some of the other businesses, but As you look at the portfolio, where is there potentially more uncertainty relative to that full year kind of sales decline of 3% that we need to at least be mindful of?

Well, I think you hit it on the head. We think that the declines must be most pronounced in aerospace and defense. as has been. We think in Q3, for example, that would be done about 20%. And for the year, it could be as much as 14.5%. I think where we have some risks is in the environmental instruments and some of our test and measurement. So even though the protocol analyzers are doing really well, We're seeing some encouraging signs in early July, as Al alluded to. It's early to tell, but I'm hopeful that some of the environmental and TNM, as is beginning to pick up in China, will also pick up in Europe and subsequently in the U.S. But the danger really is... has to do with environmental. Digital, I think, would be okay because we've got a very diverse portfolio. We think throughout the year, for the full year, we might be down a percent, which to me is acceptable, especially since as we go along, we're also improving margins in digital imaging. We think that by the end of the year, the margin there would improve 130 or so basis point. So a 1% decline is acceptable.

Got it. Thanks very much. Sure, Jim.

And our next question comes from Joe Giordano from Cohen & Company. Please go ahead.

Hey, guys. How are you doing? Good morning, Joe. Can you talk about cost savings in the quarter and how you kind of characterized them and how much was more structural in nature versus how much was more due to volume declines and temporary savings that may have to come back into the business as things start to pick up?

Yeah, the primary savings, Joe, come from people. We spent approximately $1.2, $1.3 billion of people expense. What What happened there is that we have a turnover, and so we haven't been replacing those folks except where we have really good, strong orders. And then we've cut folks. And so the big change for the year is in people, and I think that savings, when we roll it forward, net of charges that we take, could be as much as $40 to $50 million. Now, having said that, it is our full intention to keep that low-cost structure into next year, as we've done previously. The other area of cost savings is we have very strong initiatives in procurement. And we have a target of saving over $25 million in procurement this year, and that is not savings because we're buying fewer stocks. It's savings because we're buying them at a lower cost because we're signing contracts with our favorite suppliers. If we can get that done, that will save us another $20 million. In terms of the 1,000 people that I mentioned, I'd say half of it was maybe because of market demand going down, like at controls where market tanked to 50% of what it was. And the other half is really proactive on our part in reducing complexity in our operation. And we intend to keep that. And we've done that in prior years. We've kept our lower cost as we move forward. I hope that answers your question.

No, it does. Thank you. I also wanted to ask on China. You said you're seeing some of the better signs there over the last couple months. How would you categorize that as a – how much of that is like a restock off of low levels versus actual pull-through of real demand?

I think it's demand-driven. It's not – It's not as good as it was last year, but it's improved over the first two quarters. I think the upside is that they have increased their back-to-work efforts. Having said that, China as a whole is only 8% of our total sales. So there's also improved demand beyond China in Asia overall, in Taiwan, in Korea, other places. So we see a continuing improvement in demand there, and we're kind of projecting that we'll pick some of that up in Europe first, and then finally in the Americas.

And then maybe last for me, it sounds like you're looking pretty actively on M&A, and you talked about what you were able to close on in prior downturns. I guess what color can you give us here? This is a weird downturn where economics of companies have gone down dramatically, but prices of the businesses have not. So what are you seeing in terms of valuation and how people are thinking about selling their companies and what price they deserve?

Well, you know, that's an excellent question. Everybody looks in the rearview mirror, right? Even though prices have not gone down as much and some of the P's have expanded over time, those that have gone down, let's say by 30%, 40%, people keep looking back in the rearview mirror and saying, you know, that's the price that they deserve. Having said that, it's an opportune time. Most of these companies have shareholders, and shareholders have various degrees of patience, and they don't look in the rearview mirror as much as the management and the boards do. So I think there are going to be opportunities for us. There are opportunities for us. We may not be able to get something at the marketplace, price that it's trading at but we're certainly not going to pay what they were a year ago so you know um we'll uh we're kind of searching our way through that opportunity list to see what's possible good thank you guys sure and as a reminder ladies and gentlemen if you would like to ask a question

please press 1, then followed by 0.

Laurie, if there's nobody else asking a question, what I'd like to do is I'd like to end the call and ask Jason to conclude the conference call, please.

Thanks, Robert. And again, thanks, everyone, for joining us today. Of course, if you have follow-up questions, please feel free to call me at the number listed on the earnings release. Lori, if you'd give the replay information and close the call, we would appreciate it greatly. Thank you.

And ladies and gentlemen, your replay is available through August 22, 2020, until 1159 p.m. Pacific Daylight Time. And USA callers may dial 866-207-1041 and enter the access code 324-5794. International callers may dial 402-970-0847 using the same code. The access code is 324-5794. And once again, those numbers are USA callers may dial 866-207-1041. International callers, 402-970-0847. 970-0847 and enter the access code of 324-5794. And that does conclude our conference for today. Thank you for your participation and for using the AT&T Executive Teleconference Service. You may now disconnect.