Teledyne Technologies Incorporated

Ladies and gentlemen, thank you for standing by. Welcome to the Teledyne Third Quarter Morning Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. If you should require assistance during the call, please select star, then zero. As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr. Jason Van Wees. Please go ahead. Mary Beth.

Good morning, and thanks, everyone. This is Jason Van Weese, Executive Vice President, and I'd like to welcome everyone to Teledyne's third 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 Morabian, President and CEO, Al Pacelli, Senior Vice President and CFO, Sue Main, and Senior Vice President, 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's Robert.

Thank you, Jason. Good morning, and thank you for joining our earnings call. I want to open with the following comments. First, all of our 70 worldwide manufacturing sites, as well as our corporate office and research laboratory, remain operational, and only 16% of total employees are working from home. Our short cycle environmental and test and measurement instrumentation businesses rebounded from the trough in the second quarter, growing approximately 6% and 5%, respectively, quarter over quarter. Third, we believe our longer cycle commercial markets, such as marine instrumentation and medical imaging, bottomed in the third quarter. Fourth, Our government businesses continue to grow and generally remain in attractive niches such as space-based imaging, manned and autonomous subsystems, and electronic warfare. Despite the market turmoil and lower sales in 2020, we have successfully demonstrated gap margin improvement. For example, The second quarter gap operating margin increased sequentially over 150 basis points. Specifically, operating margin of 16.4% was the second highest in the company's history. In addition, we achieved greater margins compared to last year in nearly every major business category except commercial aerospace. where sales have declined nearly 50%. We also achieved record third quarter free cash flow and all-time record free cash flow for any first nine months period. Finally, our balance sheet has never been stronger and our acquisition pipeline is healthy. As the overall demand environment continues to improve, Our substantially lower cost structure, for example, we're operating with 9.3% fewer employees. Our lower cost structure should provide significant operating leverage in future quarters. Coupled with acquisitions, we expect earnings and cash flow to continue compounding for years to come. Before turning to Al to report on the third quarter performance by segment, I want to comment briefly on two important items. First, the OneWeb satellite program, and second, the potential acquisition of Photonis. Over the last few weeks, the OneWeb situation has improved considerably. First, OneWeb, parent of our customer, Airbus OneWeb satellite, secured $235 million of interim financing in late September. Second, we received a substantial advance payment in the month of October, and third, we recently signed a new, more favorable contract for which we have resumed limited production. While some risk remains, including a successful exit by OneWeb from bankruptcy, we currently expect a modest charge of approximately $3 million in the fourth quarter versus the potential $40 million noted earlier during the work stoppage. Now, regarding Photonis. On September 28, we paused our efforts to acquire the business and voluntarily withdrew our application for authorization by the government of France. In summary, we determined at that time that an acquisition under the proposed conditions of the French government was not feasible at the seller's valuation expectation communicated to Teledyne. However, in recent days, The seller's valuation expectations have significantly moderated, and we have renewed our acquisition efforts. At this time, we are hopeful to conclude the negotiations and announce the acquisition before the end of the year. Al will now comment on the performance of our four segments.

Thank you, Robert. In our instrumentation segment, Overall third quarter sales decreased 6.9% versus last year. Sales of environmental instruments decreased 2.1% from last year. However, sales increased 6.5% sequentially from the trough in the second quarter. Compared with last year, sales of certain products such as laboratory instrumentation for life science applications increased. However, this was more than offset by year-over-year declines in sales of selected industrial products such as ambient air monitoring instrumentation. Sales of electronic test and measurement system decreased 6.5% year-over-year. Again, however, sales increased 4.6% sequentially. Sales of protocol test instrumentation in particular for PCI Express and USB test solutions increased from last year. but sales of general purpose oscilloscopes declined. Sales of marine instrumentation decreased 11.3% in the quarter. However, operating margin was stable due to headcount management and business simplification initiatives. Overall, instrumentation segment operating margin increased 86 basis points despite the lower year-over-year sales. Turning to digital imaging segment, third quarter sales decreased 1.8% 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 and 3D geospatial imaging systems. Sales of industrial and scientific cameras and sensors were largely flat with last year. with continued strength in semiconductor inspection and markets in Asia, largely offsetting some weaknesses in Europe and North America. Gap segment operating margin was 19%, an increase of 210 basis points year over year. In the aerospace and defense electronics market, third quarter sales declined 18.2%, 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 increased 621 basis points sequentially, given a significant lower cost structure. In the engineered system segment, third quarter revenue increased 2.9%, primarily due to greater sales from space, nuclear, and other manufacturing programs, as well as electronic manufacturing services. Segment operating profits increased 17.9%, with margin 158 basis points higher than last year. I will now turn the call to Sue, who will offer some additional commentary regarding the third quarter and our 2020 outlook.

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 fourth quarter and full year 2020 outlook. In the third quarter, cash flow from operating activities was $153. million, compared with cash flow of $150.9 million for the same period of 2019. Record free cash Record third quarter free cash flow, that is cash from operating activities less capital expenditures, was $135.1 million in the third quarter of 2020 compared with $125.8 million in 2019. Capital expenditures were $15.2 million in the third quarter compared to $25.1 million for the same period of 2019. Depreciation and amortization expense was $29.2 million in the third quarter compared to $27.9 million for the same period of 2019. We ended the quarter with $332.2 million of net debt, that is $786.7 million of debt less cash of $454.5 million for a net debt to capital ratio of 9.9%. Stock option compensation expense was $5.7 million for both the third quarter of 2020 and 2019. Turning to our outlook, management currently believes that GAAP earnings per share in the fourth quarter of 2020 will be in the range of $2.56 to $2.86 per share. And for the full year 2020, our GAAP earnings per share outlook is $9.70 to $10.00 compared with the prior outlook of $9.45 to $10. The 2020 full-year estimated tax rate excluding discrete items is expected to be 22.7%, a 210 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. I will now pass the call back to Robert.

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

Thank you. Ladies and gentlemen, if you wish to ask a question, please select 1, then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1, 0 command. If you're using a speakerphone, please pick up the handset before pressing the numbers. Once again, if you have a question, please select one then zero at this time. One moment, please, for our first question. And our first question comes from the line of Joe Joriano. Please go ahead.

Hi, everyone. Good morning. Good morning, Joe. So some interesting stuff you said there, Robert, on OneWeb and Photonis that I wanted to touch on. On OneWeb, I was going to ask kind of Before we knew about that development, what's kind of your broader outlook for commercial space? There's obviously been a lot of kind of buzz around the sector recently with some other big companies, you know, like Microsoft the other day talking about it. Like, what are your future ambitions there in terms of growth, and is there new applications that you might, like, want to be involved in in that sector going forward?

Yes, Joe, thank you for the question. Let me note that for us, We have space programs both in the commercial and the defense sector. In the commercial sector, a lot of our instruments are used both for studying the universe as well as looking down at Earth for environmental measurements. On the defense side, on the other hand, we do have a large number of programs that address the needs for looking at weapons through satellites. While there are, of course, as you said, there's a lot of interest in communications in space, like the programs that you mentioned, our involvement right now is one web. The more interesting part to us is the defense imaging sector, where we've been winning contracts recently and where our programs are very healthy. For example, we're involved with the Wide Field of View program in the defense sector and the OPEAR program, which is a persistent overhead infrared classified program. I think going forward, we'll see what the outcome is on the OneWeb program. They have ambitions, of course, to increase the number of satellites in the future, but right now we're more focused on making sure that we make the products we promised to make and we get paid for them promptly. I know that answered your question, Joe.

It did, thank you. On Photonis, do the discussions with the French government, what kind of scope changes does that entail? Is the size of the business that you would potentially be acquiring kind of different now than what we initially thought given those discussions?

Yes. Initially, obviously, we were to acquire 100% of the business. The French government... as asking that we let a French government state-sponsored investment bank invest 10% in the company. In and of itself, we find that okay. We're going to work with the French government, especially the investment bank, to make sure that we have all of our procedures in place. On the more important thing that has happened recently, Joe, is that there was a significant change in price that we asked for and received, about 15% on U.S. dollar basis. And frankly, you can appreciate that owning 100% of an entity is very different than owning 90% of an entity, and that's why the price reduction. I think we have an agreement in principle right now, and we need to now finalize our detailed paperwork with the government and then see if we can proceed from there.

Well, that's definitely good to hear. Just two more quick ones for me. Can you guys give maybe your current views, because I know it's been shifting in the market, so your current views on the defense sector under a Biden administration, and what are you thinking early stage of your biggest margin opportunities into next year across the portfolio? Thanks.

I think in the short term, we're looking at, which I mean the really short term, and let's say midterm next year, We're looking at growth in the defense sector for our programs in the mid-single-digit range. If there is a change in administration, as you indicated, then I think in the future years, in the out years, we think things will remain relatively flat. Our job is really very simple. Regardless of which administration is in and which programs, are supported. Our job is to be able to get our share of the market and gain market against the competition. I feel very good about our defense programs because of the breadth of offerings we have from space imaging to electronic warfare to communication, etc. Having said all of that, defense today is about 20% of our sales, our portfolio. And I would say a little less than that, 20% of our operating income. Consequently, really my attention going forward, our attention going forward, is to expand our commercial businesses where we enjoy much higher margins. That's it, Joe.

Our next question comes from the line of Blake Gendron with Wolf Research. Please go ahead.

Yeah, thanks. Good morning. So I wanted to dig into the margin improvement into next year. You've quantified some of the costs out in the past, things that you're doing internally with the target goal of 20% gap even margins or better. I'm wondering if you could update us on both the cost capture to date and then additional opportunities moving forward and what the timeline of that would be. Thanks.

Sure, Blake, I'll try to answer that the best I can at this time. First, there are two primary changes in our cost structure. The first and the most important one is the lower number of employees. In general, we're down about 9.3%. That is after adding about 30, 40 people in our one web program in the UK. So we've done about 9.3%, which is about 1,100, a little less than 1,100 employees. The effect of that, maintaining that cost structure, is that it will help our margins approximately 130 basis points or so. The other thing is that we also have procurement initiatives which are helping us reduce our costs across the board as we procure. We buy about $1.2 billion worth of goods and services, and our procurement initiatives are aimed at reducing that. So we expect to get a little bit help from that domain as well. But by and large, I'd say the 130 basis points for next year is a good number that I gave you. I'm hoping that it'll be higher than that.

Understood. That's really helpful. Circling back on digital imaging, I'm hoping to better understand kind of roughly the end market weighting across things like machine vision, semis, life sciences, etc., It seems like life science demand could carry the segment into 4Q. You know, what specific end market considerations are baked into the segment outlook through year end? And what are some of the longer arc trends that you're focused on? We see a lot of product announcements and expansions, but it's tough to contextualize exactly where those fit across your end markets. So I guess just high level, how do you expect this to evolve?

Okay, I'll try and answer that. Let's start with our digital imaging sales for this year. They're about $985, $83, $85 million. Last year, they were about $990, so it's flat year over year. Now, the big chunk of that is our cameras and vision systems and sensors. They're used both for flat panel displays, just about any phone or any television that you look at has to be inspected, and a lot of those are done by our cameras. Also, our cameras are used in semiconductor industry for inspection. Overall, we sell both sensors and cameras. Now, of course, three-dimensional views of things. That sales in that business is about $340 million, and it's a fairly stable business. With all the problems with the pandemic, that business has remained healthy. It's flat year over year, but having said that, the margins have improved. The area that has hit us a little bit harder is in the healthcare area. that sales there are about $220 million. We make x-ray detectors both for dental as well as for looking at human anatomy. And we also make some x-ray sources, but let's stay with the detectors. As you know, the detectors that we make for the dental industry They're both intraoral and extraoral. That's outside the mouth and inside the mouth. That has been very slow because dentists have not been very active up until very recently. Our intraoral detectors are picking up. Our extraoral detectors will probably be a little while before they pick up. We think that business would start picking up at the end of the fourth quarter. The one area that surprised us, frankly, in healthcare is that we make sources, we make magnetrons that go into radiotherapy instruments that are instruments that are used for cancer treatment. A lot of those instruments are also used for looking for cancer. And because of the pandemic, that area has significantly slowed down And so until that area comes back, we don't think our healthcare businesses would be as robust as they used to be. And we think that's going to happen, by the way, next year. The aerospace and defense, that includes both our imaging for classified programs here as well as studying space, both here and in Europe. That's been an increase for us this year. Year over year, I think we've got an 8% increase. We're about $270 million. That's pretty healthy. The last two items are the MEMS business. MEMS, the microelectronic systems, micro-mechanical systems. The revenue there is about $95 million. It's up about 12% from last year, primarily because we bought a small MEMS business. We are probably... the largest independent men's foundry in the world today, and we're very positive about that business. The issue there is it's a fab, very capital-intensive, so we're always balancing our capital investments against what kind of market share we want to have. The last area, of course, is our geospatial, where we make lidars and other devices. And that's a healthy business, but it's relatively small. It's of the order of $58 million. So I don't know if that answered your question. Directionally, I think we expect the digital imaging business to grow next year.

That's extremely helpful. I appreciate the detailed response. I'll get back in queue.

Thank you. Our next question comes from Greg Conrad with Jefferies. Please go ahead.

Good morning. Good morning, Greg. How you doing? I just wanted to follow up on two of the previous questions. I mean, first on healthcare, and you kind of talked about it, and in the release, it talked about kind of a recovery in late Q4. I mean, pre-COVID, that business seems to have just been straight up. You've picked up share in a lot of the new technologies. I mean, when we think about, you know, into next year, does that business kind of get back to, the normalized level and continue its growth trajectory? I mean, what type of opportunities do you see going forward?

Well, I think there's no question that that business has a very healthy future. And, you know, the reason is very simple. We make detectors, X-ray detectors, that have higher resolution than normal detectors, and therefore you use much less X-rays. to be able to project an image. Having said that, that's a no-brainer, that that is going to take off. The issue is at what time are hospitals going to be allowing patients in for other than serious surgery or cancer treatments or other things. We think that's going to happen next year. We even think overall in digital imaging we should have... A little increase from this quarter to next quarter, I would say as much as maybe $10 million. And we think for next year, we probably should see of the range of about 8% to 9% increase in revenue overall in digital imaging, which would be pretty good for us since it's one of our higher margin businesses.

And then just to follow up on the defense question, I mean, you mentioned space and unmanned and, you know, I think shallow water submersible, but we're also seeing, you know, a lot of new opportunities the Navy is talking about growing its unmanned portion. I mean, what is your content or opportunity with that, you know, whether it's larger systems or smaller ones and kind of just the outlook for opportunities within unmanned?

First up, You mentioned the shallow water submersible. Of course, that's for our Navy SEALs, and we're the sole provider of that. That program is going really well. As you move to the unmanned vehicles, from a defense perspective, we really have two sets of vehicles that are being used today. One of them is really a vehicle that is a glider that glides in the ocean. And in front of a battleship formation, they can use as many as 100 gliders in order to sample the salinity density of the water, which of course affects sonar transmission and reception. In that area, we've had... probably the largest programs from the Navy. Another area, of course, is that we make medium-sized autonomous vehicles, and we have sold some of those both to our military as well as overseas, and we're looking at more opportunities in that area, especially as a prime. Going back to the large displacement, AUVs, we are going to bid on that program probably as a subcontractor to someone else. But frankly, if you were to come and look at, if you were to look at a submarine and say, okay, what kind of vehicles are available today in the world to be able to exit be housed in a submarine and exit a submarine. The only new vehicle is ours, and that's the shallow water submersible vehicle. And, of course, coupled with our unmanned vehicles that I just mentioned and the technologies that go with it, we're fairly bullish for that area.

And then just one more quick one. You know, I think last quarter you talked about, well, in excess of a billion dollars in capacity to do M&A? I mean, on the Photonis deal, that seems to be, you know, well less than half. I mean, what are you seeing in the broader M&A market, you know, whether just valuations, volume of potential opportunities, just given that you tend to be, you know, fairly conservative and prudent around M&A?

Yeah. We've demonstrated both the characteristics, both being very prudent, but also when opportunities are afforded to us to be able to be more aggressive. I'll just mention to you that when we went through the downturn in 2008 to 10, the financial crisis, right after we came out of that, we acquired two very strong companies. One was LaCroix and the second one was Dalsa. Fast forward to the crisis in 2014 to 16, which was an oil crisis for us. We lost about $200 million in revenue. We improved our cash flow, just like we're doing now. As soon as we came out of there, we acquired D2V, which was our largest acquisition to date, which is about $780 million. And that's done really well. We started with margins there of 7%, 8%. they're almost reaching 20% today. Now, going back now to your observation and question, I said before our ability, we had a billion dollars or a little more than that. Because of our cash flow, that has significantly increased today. So I think it's closer to one and a half. I think it could go as far as $2 billion, depending on how much of an EBDA we acquire. Our debt-to-EBDA ratio limit is about 3.5. Today, we're sitting around 1.4. And with more cash generation in the fourth quarter, we should be a little better than that. So I would say... 1.5 to 2 billion, 1.9 billion is the range that we are capable of doing. Now, if you take Photonis, which is going to cost us, at least for our best estimates, closing costs, et cetera, it's going to be about $450, $460 million. To subtract that out, that leaves us with 1 to 1.4, 1.5 billion additional capability. So we're looking. We're looking very hard. As we come out of this year, I think people are having a difficult time, and some of the boards, obviously board and management, as I said before, are always looking in the rearview mirror saying how well their stock used to be, whereas shareholders are always looking, at least my view of it, is they're always looking forward through the front window saying where things are and what kind of an offer would be attractive. So having said all of that, I think we think this is a good environment for us to make acquisitions.

Thank you.

Our next question comes from the line of Andrew Buscalia with Birenberg. Please go ahead.

Good morning, Andrew. Operator, I don't think Andrew is on.

Okay, we'll move on to the next one. Our next question comes from the line of Jim Rutici with Needham and Company. Please go ahead.

Good morning, Jim. For some reason, operator, we're not getting the people. There's something wrong at your end because I can hear you, but the questions are not coming through.

Robert, I think that one was on me, Robert. I had my phone on mute. That's my apology. If I may, Robert, you sound a lot more confident about closing on the Photonis acquisition. And I wonder if maybe you could talk a little bit about what you find so attractive about this business. I think, you know, in some respects, it looks a little bit reminiscent of Photonis. of the acquisition that you did of EQV, but I wonder if you could talk a little bit about it to the extent you can.

Sure. First, I'm a little more positive about it because we've had some discussions with the French Investment Bank, and we find them to be much more business-oriented than government-oriented. Of course, they're going to have a say in making sure that the technology doesn't move out of France. But I feel better about it because I think we can live with that enterprise as a minority shareholder for a number of years. The second part is that that business seems to, we have to yet do a final due diligence check, that business seems to have held up pretty well during this difficult period, just like our defense businesses. Because primarily, it provides non-ITAR image intensifiers for night vision systems. Now, what we bring to it is all of our digital imaging capabilities, which are all complementary and not duplicative of that. That field is moving more towards digitization, which we are experts in. So we think we bring substantial synergistic value to the enterprise, which has been missing in the recent past because it's been owned by a private equity firm. Therefore, it didn't have sister companies to interact with. There's a small part of the business also that has to do with commercial laboratory instrumentation. for very low light using photon multipliers, same technology used for the night vision. That's attractive to us also because we bought the scientific camera businesses which serve laboratories, instruments, and academic instruments across the world, and we think that is really attractive to us because they bring the best mass spectrometry detectors to the field, and it'd be a very nice overlap with our existing businesses that we acquired last year in that area. So those are some of the specifics about that acquisition, Jim.

That's helpful, Robert. I wonder if you might also may have missed it, but did you give any information on orders, the book-to-bill, and maybe a little color around book-to-bill for segments? You also, I think, gave a little bit of color about what you're anticipating for the digital imaging business in Q4. I wonder if there's any color you could provide on some of the other business units.

Let me start with the book to build. The book to build in Q3 is about 0.95, maybe a little more than that because our engineered systems is a very lumpy business that we get a big book-to-bill, but excluding that, it's a little over 0.95. We expect next quarter to exceed one in book-to-bill, based on everything that we see so far in the quarter. And we expect to end the year just below one, maybe 0.98, 0.97. Now, Q4 revenue, which I talked about digital imaging being up somewhat. Q4 revenue should increase over Q3 by about 4% or so, or $40 million, let's say. That's a little higher than 4%. That would be very attractive for us because In Q2, where we had, I think, about 743 in revenue, I said I expected Q3 to be equal and very similar to that. It ended up the revenue was about $7 million, $6 million higher, and the income was about the same, the EPS, even though we didn't have many one-time benefits in the third quarter. Just to digress for a second, if you take the third quarter of this year versus the third quarter of last year, there's a $0.29 income difference from taxes, one-time tax items, and against one-time charges to benefit last year's income. third quarter. So if you kind of do an apples to apples, which we never really do non-GAAP measures, but if you do that, we've only done about seven, eight cents from last year's third quarter. So going into the fourth quarter, I think if we can increase the revenue in various groups and achieve about $40 million of increase in overall revenue, A couple to what is now our better margin that we're achieving. Our margin this quarter was 16.4%. And so we think what will happen is that we will have better earnings as well, which is what Sue alluded to as we raised the midpoint of our earnings earlier today.

Got it. Thank you. That's very helpful.

Our next question comes from the line of Noah Popanek with Goldman Sachs. Please go ahead.

Hi. Good morning, everybody.

Good morning, Noah.

Robert, sort of following up there, and in your prepared remarks, you mentioned that you think you've seen a bottom in your cyclical businesses. Can you just elaborate on that? comment? I mean, is that an exit rate versus entry rate into the corridor, or order action, or any more detail to help us get comfortable that's happened would be helpful.

As Al Pacelli mentioned earlier, we've seen five and six percent, and I said it also, we've seen five to six percent improvement in revenue in the environmental and test and measurement businesses. Our book-to-bill in those two areas are over 1, about 1.02 to 1.04, so 2 to 4 percent above what we sold. And we think, as a consequence, we think that those businesses are going to do okay going forward. We expect some margin of sale improvements in our total instrumentation business, maybe as much as 15 million or so. But more importantly, I think we're seeing some – of course, China is coming out of their downturn and doing well. But we also see some new products that we're offering in the pharmaceutical area as well as water sampling area that are encouraging for us. The instrumentation would be the one in digital imaging I think I've already spoken about. It could be as high as 10 to 15 to maybe even $20 million in Q4 versus Q3. I think in aerospace and defense, I think we're going to be fairly flat primarily because I don't think there's going to be any much movement in the aerospace and our defense is already pretty healthy. In the engineered system, we may have some uptake in revenue, but we'll have some pressure on our margins. But generally, we think if you add all of that up, we could have about $40 million increase quarter over quarter because of the things that I mentioned.

Okay, that's helpful. Trying to piece together the margin commentary you've made today, it kind of looks like the segment operating margin at the total company level, full year 2020, is going to come in around 17%, depending on exactly where the fourth quarter is. And then are the comments that you made earlier sort of officially targeting 130 basis points of improvement in that next year And then I can't quite tell if you've provided a long-term 20% target or not, but it certainly sounds like you expect more improvement beyond that. I mean, are we kind of looking at something in the zone approximately of 100 basis points of segment operating margin improvement for a few years?

Yes, I hope so. I'm going to get some looks in on the table from my various segment operators and others, but Let me go back for a second. If we do what we have just said we would in the fourth quarter, we should end the year with segment operating margins of about 17%, which is what you noted. Because early in the year, of course, Q1, it was 15.2, and we've continuously improved. If we do that, then the total company operating margin, which was about 15% in the end of Q2, which is what I thought it would be, should improve to about 15.2 to 15.3%. Now, going forward into next year, because of the actions that we spoke about, both people and procurement and a whole bunch of other 80-20 programs that we have, We expect to bump that up 130 basis points next year, our operating margins. And frankly, if you put it on 17 and we put it on 15, it's the same thing because the percentage of corporate costs are fairly fixed. Having said that, and going forward, I think that would moderate somewhat because we took a lot of cost off this year and we're going to enjoy the fruits of that next year. But I would be disappointed if we can't continuously improve our margins somewhere between 80 to 100 basis points in the next few years.

Okay. That's helpful. And then finally, I just wanted to ask about the cash flow statement. Is it possible to quantify or bracket the October advance payment related to OneWeb that you mentioned? And then it certainly looks like you'll come in ahead of the full year, $400 million of free cash flow that you had discussed previously, if you're willing to provide an update to that. And then the conversion to net income is pretty high for the year. CapEx is down. I guess maybe if you would just speak to I guess we're just assuming the conversion is 100% into perpetuity. Is there any reason not to expect that?

Let me start from the read end of that question because that's the easier one to answer for me. Over 100% conversion, yes. And we anticipate that that will continue because of all the programs that we have in reducing managed working capital and reducing costs in general. Now, going to the cash flow for the year. In Q2, I said it'd be a little over $400 million. In Q3, where we enjoyed $135 million of free cash flow, that also included $15.8 million that we had to repay the government for the CARES Act. So the 135 is a really very healthy cash flow for a company like ours. If we can continue that momentum, I expect that by the end of the year, we will be over 400. 425, I think that's within reach, maybe a little higher than that. And I expect if we can do all of that, then our net debt should drop around $200 million, a little north or south of $200 million, which puts us in a really good position for the future in terms of acquisitions.

Very helpful. Thanks so much.

Sure. Our next question comes from the line of Blake Gendron with Wolf Research. Please go ahead.

Yeah, thanks for getting me back on here. Feel free to pump me from the call if there's not enough time here. Just two quick follow-ups, first on instrumentation. You know, it looks like the shorter cycle industrial recovery is starting to plane out a little bit. If environmental outperforms testing next year, what would that do from a margin mix perspective? And how does the three stack up, really, marine versus environmental versus testing?

Let me start, though. The marine businesses are fairly flat year over year, and they're going to remain so for a long time, primarily because we've moved more away from some of our oil and gas markets to defense markets. And until the oil and gas markets, even though they're okay now, until they come back, we don't expect revenue increases. Having said that, The marine businesses, if you look at the total instrumentation business, the marine businesses have lower margins in general, even though the margins are improving significantly, but they're still about 200 basis points lower than the others. Environmental is about 100 basis points above the average, so is test and measurement. Those are very healthy businesses. Combined together, it kind of flattens out. But I think we'd encourage that our higher margin businesses are the ones that we're looking forward to growing.

Understood. And then one just quick one on M&A. You wouldn't rush a deal announcement, obviously, and Fotana is notwithstanding because that's TBD. But as you think about the election and maybe the tax regime in a Biden administration, does that maybe accelerate your M&A pipeline processes at all, or do you expect valuations to kind of normalize with any change in tax? Thanks.

Boy, that's a difficult one. I can only answer the following. We're not going to hurry up to do anything, never have, never will, regardless of which administration is occupying the White House. I think taxes will change up or down, but I think we will buy the businesses that we're looking at, the ones that we're looking at, we'll buy them because they're good businesses in the long term and we can improve their margins. And I wouldn't rush about it, not because of the election or subsequent to the election. On the other hand, I wouldn't be very slow about it either because, you know, things are going to improve next year and everybody's... Prices are going to go up, so this might be a good opportunity.

Understood. Thanks so much for the time.

Thank you, Blake.

Our next question comes from the line of Andrew Biscaglia with Birnberg. Please go ahead. Hey, guys.

Can you hear me now? I had some technical difficulties there. Yes, for sure. All right. Yes, everything's pretty picked over, but I'm curious high-level questions. you know, within digital imaging, you guys can see some pretty powerful growth in that segment. If you look back to 2017 or so, you know, you're able to grow over 20% organically there. I would think that, you know, kind of given the setup into 2021, you know, you've had a couple of years of more muted growth and specifically machine vision seems to be, you know, there could be some optimism of some upside brewing there given the semis and tech cycle. I guess, how are you thinking about that business? I guess, in a bulk case, in order of magnitude, where do you see that business going, and what are the differences between this entering 2021 and 2017?

Well, I think in 2017, obviously, that's the year that we also acquired D2V, so things got really bumped up that year because of the acquisition. But let's say absence any acquisition, I think right now I expect us to grow our top line in the higher single digits in the overall digital imaging domain. I will only put the caveat on it that this healthcare situation has hit us pretty hard and we are expecting that we've improved. If that were to happen, I think high single digits growth in revenue for digital imaging overall should be expected. And of course, as you said, if we make the Photonis acquisition, Daltroin and others, $150 or plus million worth of revenue. So the business is going to grow, that's for sure. The question is, can we get over the healthcare hump that we're experiencing right now.

Okay. Okay. And, you know, I know this piece is small, but your offshore oil and gas exposure went from being very optimistic for that outlook there to pretty pessimistic, I think, based on what's going on in energy. Any change in your view on, you know, strategically, you know, that segment and where you want to play in that business, if it's still viable in your mind as a long-term growth opportunity for you guys.

Yeah, I would say, obviously, there's two parts to our marine businesses. There's the offshore energy, which is both production as well as exploration. And then the second part is construction technology. science, hydrology, but more importantly, defense, where we are a major player in making penetrators for our submarine fleet. And then we have, of course, a lot of sensors program that are used, whether in our autonomous vehicles or others. So I think the defense sector of that business is healthy and will remain so and probably grow in future years. And if you're trying science and construction, et cetera, that's really going to be almost 60% of our business going forward. Now, the overall segment, the sub-segment, the marine sub-segment, has revenues of about $420 to $425 million. So the rest of it is offshore oil production and exploration. let's say about 150 million total. That is fairly stable for us, primarily because there is still, at $40 a barrel of oil, there's still developments going on, and we are winning because we have the best products, plus we have standardized products which people can buy, and we think that's going to be very stable. The area that has not come back is the offshore exploration, where we provide streamer cables and sensors. That used to be a pretty healthy business for us, even after the downturn in the oil industry. That has kind of not been that high recently, and if that comes back, if they put more vessels in the water for exploration, I think that will help generally our marine business. But looking forward, I'd say growth in the marine business is going to be relatively benign, where what we're going to do there, and we've done this continuously, is improve the margins. It's enjoying really good margins above the average margins of our segments right now.

I don't know if that answers it. Yeah, no, that's great detail. Thanks. Sure.

And there are no further questions.

Alicia, I will now ask Jason Van Wees to conclude our conference call. Thank you very much.

Thank you, Robert. And again, thanks, everyone, for joining us this morning. Of course, if you have follow-up questions, please feel free to call me at the number on the earnings release operator. Alicia, if you could give the replay information on the call and then sign off for everyone. Thank you.

Thank you. Ladies and gentlemen, this conference will be available for replay after 5 p.m. today through November 21, 2020. You may access the replay system at any time by dialing 1-866-207-1041 and entering access code 614-8591. International participants, dial 402-970-0847. Those numbers again are 1-866-207-1041 and 402-970-0847, access code 614-8591. That does conclude our conference for today. Thank you for your participation and for using AT&T Conferencing Service. You may now disconnect.