Teledyne Technologies Incorporated

Standing by, welcome to the Teledyne Fourth Quarter Earnings Call. At this time, all participants are in a listen-only mode. If you should require assistance during this call, please press star then zero. I would now like to turn our conference over to the host, Jason Van Weest. Please go ahead.

Thank you, William. Good morning, everyone. This is Jason Van Weest, Executive Vice President at Teledyne, and I want to welcome everyone to our Fourth Quarter and Full Year Earnings Release Conference Call. We released our earnings earlier this morning. 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 Simic. After remarks by Robert, Al, and Sue, we will ask for your questions. Of course, though, before we get started... I want to remind everyone of the forward-looking statements made this morning are subject to various assumptions, risk 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 Webcast and Island, will be available for approximately one month. Here's Robert.

Thank you, Jason. Good morning, and thank you for joining our earnings calls. I'll begin by discussing our 2020 results, briefly comment on the outlook for 2021, and of course, comment on the pending acquisition of FLIR. We concluded 2020 with the best earnings, operating margin, and cash flow in the company's history. Compared to last year, fourth quarter earnings increased 13.7%, Operating margin increased 173 basis points, and free cash flow increased 50.7%. For the full year 2020, GAAP operating margin increased slightly, and free cash flow increased significantly, 39.1%, to 547.5 million. It is worth emphasizing the full year margin and cash flow performance occurred despite over $33 million in non-recurring charges. Record negative GDP in the second quarter and the constant challenges faced by manufacturers during the COVID-19 pandemic. For all of their efforts, I want to congratulate our employees as well as offer my most sincere thank you to them for transforming a difficult year into one of the most rewarding for our stockholders. We entered 2021 with a clear improvement in demand across the majority of our businesses. In fact, we received record orders in the fourth quarter and ended 2020 with record backlog. Q2 orders were $920 million or 1.14 times sales with year-end backlog of $1.7 billion. While it's still early in 2021, we're expecting continuing recovery in our commercial businesses as well as growth in our government businesses. In both cases, strongest within our digital imaging segment. Given some caution and conservatism related to the ongoing tug-of-war between shutdowns and vaccines, we think a reasonable outlook for the total company's organic growth is between 5 and 6% for 2021. Of course, the largely pre-COVID comparison in the first quarter will be the most difficult with revenue relatively flat. Finally, I want to comment on the FLIR acquisition. We've been watching FLIR since we first entered the space-based infrared imaging market in 2006 when we acquired Teledyne Scientific and Imaging. and we believe now that our infrared imaging technologies and market segments are uniquely complementary. As both companies evolved, we've grown to be even more complementary. For example, Teledyne entered the soft-seat drone business in 2008, and FLIR entered the airborne unmanned business in 2016, and more recently, the land-based robotics business. Perhaps more importantly, each company exited unattractive businesses, Teledyne in 2011 and FLIR in 2018. While our respective sensing technologies and market segments are different, the fundamental desire of our end customers is an image, or even better, information. This is true for X-ray imaging, infrared imaging, industrial machine vision, and even our underwater marine sonar imaging and software businesses. In other words, there is similarity and synergy in digitization, imaging algorithms, machine learning, and other related technologies across each of our organizations. I will conclude by noting that for 21 years, Teledyne has consistently and predictably compounded earnings and cash flow, and 2020 was no different. Nevertheless, I have never been more excited about Teledyne's future than I am today with the pending acquisition of FLIR. I will now comment on the performance of our four business segments.

Thank you, Robert. In our instrumentation segment, overall fourth quarter sales decreased 6.2% when compared with last year. Sales of environmental instruments decreased 6.7% from last year. However, sales increased 6.9% sequentially from the third quarter. Compared with last year, sales of certain products, such as wastewater samplers, 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 systems increased 3.7% year-over-year to a quarterly record of $70 million. sales of marine instrumentation decreased 11.4% in the quarter, due in part to a difficult comparison with the fourth quarter of 2019. In spite of lower sales, overall instrumentation segment operating margin increased 262 basis points to a record 22.3%. Now, turning to the digital imaging segment, Fourth quarter sales decreased 2.3% and primarily reflected lower sales of x-ray detectors for dental and medical imaging, partially offset by greater sales of infrared and visible detectors for space applications. Gap segment operating margin was 21.6%, an increase of 407 basis points year over year, and also a record. Now, in the aerospace and defense segment, fourth quarter sales declined 14.8%, as greater U.S. defense sales were more than offset by a 45% decline in sales of commercial aerospace products, as well as lower commercial space sales related to OneWeb. The GAAP segment operating margin decreased due to lower sales, as well as 5.8 million in severance facility consolidation, and other contract charges. In the engineered system segment, fourth quarter revenue increased 26.8%, primarily due to greater sales from defense, nuclear, and other manufacturing programs, as well as electronic manufacturing services. Segment operating margin increased 175 basis points compared with last year. I will now turn the call to Sue, who will offer some additional commentary regarding the first quarter and full year 2021 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 first quarter and full year 2021 outlook. In the fourth quarter, cash flow from operating activities was $236.4 million, compared with cash flow of $167.9 million for the same period of 2019. Record-free cash flow, that is, cash from operating activities plus capital expenditures, was $217 million in the fourth quarter of 2020, compared with $144 million in 2019. Capital expenditures were $19.4 million in the fourth quarter compared to $23.9 million for the same period of 2019. Depreciation and amortization expense was $28.7 million in the fourth quarter compared to $29.3 million for the same period of 2019. We ended the quarter with $105.4 million of net debt, that is $778.5 million of debt less cash of $673.1 million for a net debt-to-capital ratio of only 3.2%. Stock option compensation expense was $5.9 million for the fourth quarter of 2020 compared to $5.7 million for the same period of 2019. Turning to our outlook, management currently believes that earnings per share in the first quarter of 2021 will be in the range of $2.55 to $2.60 per share. And for the full year 2021, our earnings per share outlook is $11.25 to $11.45. In each case, these do not reflect the pending acquisition of FLIR and related acquisition and financing costs. The 2021 full-year estimated tax rate, excluding discrete items, is expected to be 22.3%. In addition, we currently expect significantly less to speak tax items in 2021 compared to 2020. I will now pass the call back to Robert.

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

Ladies and gentlemen, if you wish to ask a question, please press 1 then 0 on your touchtone phone. You may remove yourself from the queue at any time by repeating the 1-0 command. Once again, if you have a question, please press 1-0 at this time. First question will come from the line. Greg Conrad, please go ahead.

Good morning and great quarter.

Thank you, Greg.

You mentioned 5% to 6% organic growth in 2021, but how are you thinking about that on a segment basis, just thinking about the different recovery cycles across the business?

Good question. Let's start with the instruments. In the instruments, we think our sales would increase about 5%, maybe just a hair over 5%, with our environmental and test and measurement businesses leading those. In digital imaging, The theme for digital imaging for us is recovery, and even though our revenue only went down 1% this year, we expect next year to recover and go up about 9% in digital imaging. Aerospace and defense, we had a tough year, especially in aerospace, and we expect some improvement. especially in our defense businesses, I would say about 4%. Engineer Systems had a great year, the best year among all of our businesses in terms of improving sales. So then we expect their sales to improve very modestly, less than a percent. And the way I've laid it out, Greg, so far, it adds up to something like 5.5% to 5.6%. I hope that's helpful.

That's very helpful. And, I mean, the other thing that just stood out on the quarter and the year, I mean, just looking at free cash flow conversion, I think it was like 136% in 2020. I mean, how are you thinking about conversion going forward? And maybe this is too early, but just kind of post-FLEER close, is there any reason to think that, you know, that level of conversion changes?

Well, let me – Greg, let me start with – without FLIR first. We think year over year our free cash flow is going to be relatively flat, maybe a little down because, as you said, the conversion was phenomenal. There is, of course, we have the benefit of payroll tax, about $24 million last year. Even though you put that in, it doesn't affect our jobs. really outstanding cash flow. So we've got to pay some of that back next year. But having said that, I think absent the one-time charges and expenses that come with the FLIR acquisition, our cash flow would be relatively flat, maybe a little dumb next year, but it will still be very close to the record that we accomplished this year. Now, The way I can describe that is on an adjusted basis, if I may, because it's difficult for us to right now determine what their cash flow would be. But based on historical trends, we think together we would have an adjusted EBDA. after the acquisition of about $1.2 billion, ours and theirs. And that's about the best I can do at this time, knowing what I know.

That's helpful. And then just one quick cleanup question. In terms of the debt financing for FLIR, I mean, any thoughts around kind of timing and rate on that? Thank you.

Sure. Let me start by noting where we are today and what progress we've made to date. We have interacted with our banking institutions and we have secured financing for our term loans. First, we have 1.25 billion of term loans, which we have a commitment for, and the remainder of the 4 billion that we need will come in corporate bonds, and that we will do after we have a, after we obtain the rating for ourselves from the rating agencies, Moody's, and SMP, and I think we will get a investment grade rating, after which we will do that financing. The other thing that's important is that we have increased our net debt to EBBA multiple to 4.8, and we think this would conveniently put us in a position where we'll have cash on hand after the acquisition. And our covenants are about 4.75 to plus about 4.8 in net debt. And the last thing I'd say is that we've managed to also get a commitment to increase our line of credit from about what it is now, 750 to over 1.1 billion dollars so that's about the best I can do in terms of weight average borrowing rate that you asked about our best guess at this time it's going to be two point two five percent maybe two point three percent of that order thank you sir

Our next question will come from the line of Jim Gucci. Please go ahead.

Hi. Thank you. So I wanted to pursue, Robert, if I may, just the improvement that you're expecting in the digital imaging business in 2021. Are you seeing signs yet of the recovery in the x-ray detector business, or are you just assuming as we get the pandemic behind us that that business starts to recover? Sure.

Well, there are two parts to that. There is the x-rays for dental imaging, which already are recovering. Then there's the x-ray for cancer treatment, but in that case, we make components that go into machines, and that's recovering a little slower. But we're seeing some recovery in our x-ray imaging where we have this CMOS image sensors. We're seeing some recovery there. So overall, I'm going to say that we will see recovery in our healthcare, I would say, of the order of 6%. I think that's our guess right now. Maybe a little more than that.

Got it. And what kind of recovery are you assuming in the industrial machine vision portion of the business?

I think if you look at this year in the total machine vision, which would include scientific cameras, we expect about a 10% recovery in that domain.

Got it. And so the bookings that strength that you saw in the in Q4. Was that, were any of the major segments unusually strong?

Yeah, I'm sorry, I should let you finish your question.

No, please, please, go ahead.

I think the strongest, again, was in digital imaging. It was about 1.2. And that bodes well for us because it cuts across all of the businesses there, including on our aerospace and defense businesses and our microelectrical electromechanical systems boundaries.

Got it. Okay. Thanks. Thanks very much. Sure, Jim.

And our next question will come from . Please go ahead.

Hey, it's Joe. I'm not sure if that's me. Guys, do you hear me?

Yeah, we can actually hear you loud and clear as they say.

I'm not sure what name that was. But anyway, thanks for taking the questions. I'll start just on aerospace and defense electronics. Like, just given what's happened in that space, And, you know, I know you're being conservative about the ramp back on the commercial side, but how do we think about margin recovery in that business given the cost that you took out? Like what kind of run rate of revenue do you need to achieve to get back to where we were in margins before?

Well, the revenue, of course, is one story. We don't expect at this time much recovery in our aerospace businesses. On the other hand, we do expect some improvement in our defense businesses. But coming back to the question of margin, last year we took a, in 2020, we took a real hit in our margin in aerospace and defense. In 2019, we had margins of 20.8%. In 2020, we have 13.7%. So the margin went down almost 700 basis points. We expect, based on all the costs that we've taken out of that business, we expect the margins to improve to a little better than 18% from 13.7, or about 450 basis points, approximately. even though we don't expect much recovery in the aerospace side of the business. It's just primarily cost takeout and improvement in everything else that we're doing.

Perfect. That's really helpful. I saw that there was an expansion awarded on the SWIX contract. Um, so just curious, like, you know, I think you mentioned engineered off a good year as kind of a flat outlook, you know, what's the path over the next few years in engineered systems, just based on kind of the pacing of contracts that you've won in the deployment schedule there.

Yeah. First, let me back up and say what business there is going to shrink. And that's, uh, we are doing, you know, we make a turbine engines for missiles, specifically harpoon missiles. And that will be going away at the end of the first quarter. So I think that in terms of sales of turbine engines, which also are profitable businesses, it should impact our revenue about $20 million next year. So that's on the contraction side. On the expansion side, which will keep us hopefully flat year over year, since we had such a great year in 2020. On the expansion side, we wanted a number of contracts, multi-year contracts, some of which we put out news releases. And We think that we had about half a billion dollars in total of new contracts or renewal of contracts last year. For example, coming back to the SWICs, what we have is we have our existing programs, which are about rough numbers. Let's say they'll add up to about $250 million. Then we receive the foreign military sales contracts. for new boats, which is about 35 or so million dollars with the entire . And that's a plus in that business. We're very excited about that business because, as you know, that underwater vehicle also uses a lot of our sensors that we develop in our marine businesses. So that's, I don't know if that answered your question as well as you wanted.

Yeah, is the margin profile for that business kind of similar on a similar run rate revenue you expect next year?

No, I think margins will go down somewhat. We had a, we had just a blowout margin year this year in that business, primarily because of turbine engines and some of our manufacturing programs. We ended the year at about 12%. That's on a very high side of that business. I think we're going to go down to closer to 10.5% next year.

And at the end of this last for me, like any update on how you're thinking of presenting FLIR once you close it? Because I think the 1.2 billion EBITDA run rate that you were talking, I assume that's kind of like a full year equivalency. So as that comes in at some point during 21, how do you think you're going to present like the incremental operating performance plus the one-time cost associated with it?

Yeah, what we'll do, Joe, is we'll take the one-time cost and put it aside, as you know. And that's going to be significant. It's going to be, I'm going to guess, my guess right now is about $105 million. It could be a little higher than that. So put that aside because there's nothing we can do about that. Then you go to, let's assume the merger happens, the acquisition happens. on July 1. Then what we're looking at is you can look at that two ways. You can look at it as an adjusted basis. And when I talk adjusted, I'm only speaking about adjustment for intangible amortization, nothing else. If you look at it that way, then the acquisition is going to be accretive almost immediately. And the first full year, it's going to be accretive significantly. It could be as accretive as $2.50. With the $40 million tax takeout, cost takeout that we're estimating for the first full year, we think on a gap basis, it should be accretive after the first full year. marginally accreted. So the way we present it is, what is the combined revenue going to be? At this point, I would say, if you look at the 2020 pro forma, you're looking at $5 billion. If you look at 2021 plus clear for the first full year, you're looking at $5.2 billion in revenue. And then we will... work on the free cash flow same as we do now, but probably presented on a non-GAAP basis. Only I say that because in our agreement with our lenders, in terms of what they have agreed to in terms of our net debt to EVDA, they're excluding the one-time costs that we're going to incur in that business. So, We'll have a table or pre-cash flow to lay all of that out.

Thank you.

Thanks, Joe.

Once again, if you have a question, please press 1 and 0 at this time. Our next question comes from the line of Andrew Pasquilio. Please go ahead. Morning, guys.

Good morning, Andrew.

I wanted to ask on, you know, I believe last quarter you – provided sort of a soft target for this year's margins to expand about 130 basis points. And you kind of walked through a couple of segments, but do you still stand by that initial take?

Well, you said it was a soft target, 100 basis points improvement. Okay. I think we'll do a little better than that. For us, as a standalone company, again, excluding any one-time charges, which were going to happen, I think our margin should improve about 120 to 140 basis points in 2021 versus 2020.

Okay. Okay. And then, Robert, you sounded last quarter, you know, a little bit I guess there are expectations around the Biden administration would not be great for your defense business. Have you given that much more thought now that it's come to fruition? Broadly, it sounds like defense still has some legs into 2021, but I guess what's your outlook beyond that?

Well, you know, it's very interesting. One of our directors made an observation yesterday, which I agree with, that I don't think by and large, democratic administrations have been against the defense spending because they, obviously, they don't want to be, appear as being soft on defense. And with the world situation as it is today, we think defense is going to be stable. And we have long-term programs in very critical areas. including space infrared programs that are going to be healthy. That's about all I can say about the defense side. There are other things, of course, that affect us, which would be interest rates if they went up, and, of course, taxes would hit all corporations if they were to go up.

Okay. Okay. And last one, this might be a little out there, but, you know, you guys sounded really excited about, you know, potential M&A this year pre-FLIR. And I know you got your hands full with FLIR, but is M&A off the table completely this year outside of FLIR until you digest that one?

Yes and no. M&A is never off the table. No. If something really attractive came along and we thought we could do it while being as busy as we are at this time and going to be integrating, we would have the capacity, as I mentioned, we would have another almost a billion dollars that we can spend. But I don't, I would say it's not likely at this time because, you know, the amount of work we have. Now, on the other hand, if it's a small bolt-on that we can talk away to one of our businesses, yeah, we'd do it.

Okay. Thank you.

At this time, we have no further questions in queue.

Thank you, William. I'll now ask Jason to conclude our conference call, please.

Thank you, Robert. And, again, thanks, everyone, for joining us this morning. All our news releases are available on our website. And, of course, should you have follow-up questions, my number is there. Please do feel free to call me or send me a note to set up a time to speak. Thanks, everyone. William, if you could give the replay information, please, that would be great. Thank you.

Ladies and gentlemen, this conference will be available for replay after 10 a.m. today through February 27th. You may access the AT&T teleconference replay system at any time by dialing 1-866-207-1041, entering access code 598-9502. That does conclude our conference for today. Thank you for your participation in using AT&T conferencing services. You may now disconnect.