Teledyne Technologies Incorporated

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Ladies and gentlemen, good morning. Thank you for standing by. Today's conference is assembled. Welcome to the Teledyne Technologies second quarter earnings call. At this time, all lines are in a listen-only mode. Later will be an opportunity. We'll give you the replay instructions at the end of the call. If you require any assistance today, please press star, followed by the zero, and an AT&T operator will assist you. At this time, it's my pleasure to turn the conference over to our host, Jason Van Weese. Please go ahead.

Thank you, Dom. This is Jason Van Weese, Vice Chairman. I'd like to welcome everyone to Teledyne's second quarter 2020. earnings release conference call. We released our earnings earlier this morning before the market opened. Joining me today are Teledyne's Chairman, President, and CEO, Robert Moravian, Senior Vice President and CFO, Sue Main, and Senior Vice President, General Counsel, Chief Compliance Officer, and Secretary, Melanie Sivic. Also joining us is Edwin Rocks, Executive VP. After remarks by Robert and Sue, we will answer your questions. Of course, though, 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 our earnings release and our periodic SEC filings. 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, and thank you for joining our earnings call. In the second quarter, we achieved all-time record quarterly sales, with overall sales increasing 5.1%. Furthermore, sales as well as gap and non-gap operating profit and operating margin increased year over year in every segment. For the total company, Gap and non-gap operating margins increased 105 and 73 basis points respectively. Excluding foreign currency headwind, which negatively impacted second quarter sales growth by approximately 40 basis points, growth in local currency would have been 5.5%. Gap operating margin of 18% was a second quarter record and non-GAAP operating margin was 21.4%. Second quarter GAAP earnings per share were $3.87, and non-GAAP earnings of $4.67 were also second quarter records. And finally, including continued debt repayment through July, which totaled about 620 million years to date, our consolidated leverage ratio declined to 2.1 times. I'll now comment a bit further on the performance of Teledyne FLIR and the announced cost reductions and the outlook for the balance of the year. In the two years since we've owned FLIR, We've resolved the most significant legacy tax matters, exited the consent agreement with the Department of State, consolidated leadership in marketing and operations for the FLIR defense portfolio, and corrected some historical product quality issues. As part of this effort, we also took a much more focused view of the defense business aggressively pursuing those opportunities where we have truly differentiated technology. I am pleased to report that the order book and backlog of FLIR, especially FLIR Defense, significantly inflected during the second quarter. For reference, the commercial business across digital imaging, both DASA E2V and FLIR, grew organically in the second quarter. While clear defense sales declined year over year, nearly all of this was low revenue in unmanned ground systems, as we achieved the milestone of shipping our 1,000th man-transportable robotic system increment to the U.S. Army. Orders at all of FLIR were 1.18 times sales and 1.5 times sales at FLIR Defense. Larger orders not only included the recently announced Black Hornet Nano UAV to the US military, but also additional UAVs for customers in Europe, as well as counter UAV systems and missile defense systems utilizing both FLIR imaging, radar, and AI-based software systems. Additionally, more surveillance imaging systems for the US and foreign customers. Having stabilized the business, including achieving stronger backlog, it is now time to focus on execution and additional margin improvement. The charges announced this morning are for the further reduction in the FLIR operating footprint and related headcount. We are accelerating the elimination of three leased sites, all of whose activities will be relocated to other FLIR defense facilities, most of which are owned locations. Today, we are reaffirming our prior 2003-23 full-year sales and non-GAAP earnings outlook, excluding the 10 to 12 million charges that I just covered. Supply chain challenges have continued to improve. We were once again able to exceed our original second quarter sales and earnings outlook by pulling forward some revenue from the third quarter. On revenue specifically, we continue to see total 2023 growth of approximately 5% or sales of approximately $5.73 billion, with the third quarter being roughly $1.4 billion. We continue to see non-GAAP earnings of $19 at and $0.10 at the midpoint of our guidance, excluding the charges referenced above. I will not further comment on the performance of the four business segments. Second quarter sales in our digital imaging segment increased 2.3%, with greater sales of X-ray products commercial infrared imaging components and solution, and industrial scientific cameras partially offset by lower sales of unmanned ground systems for defense applications. Gap segment operating margin increased 51 basis points to 15.7%, and adjusted for reduced intangible asset amortization Non-GAAP segment margin was 28 basis points higher at 21.5%. Turning to our instrumentation segment, overall second quarter sales increased 5.1% versus last year. Sales of marine instruments increased a healthy 10.5% in the quarter, primarily due to ongoing recovery in offshore energy markets, also greater sales of autonomous underwater vehicles. Sales of electronic test and measurement systems, which include oscilloscopes, digitizers, and protocol analyzers, collectively increased 4.9%. We encountered some softness in sales of analyzers for electronic storage and data center application but this was more than offset by sales for wireless and video protocols, as well as continued strong sales of oscilloscopes. Sales of environmental instruments were flat compared to last year, with greater sales of air quality, process gas, safety analyzers, offset by drug discovery and laboratory instruments. Overall instrumentation segment operating profit increased 10.6% in the second quarter, with gap operating margin increasing 123 basis points to 24.8%, and 80 basis points on a non-gap basis, excluding reduced intangible asset amortization to 25.9%. In the aerospace and defense electronics segment, second quarter sales increased 10.2%, driven by growth of both defense electronics and commercial aerospace products. Gap and non-gap segment operating profit increased over 20%, with margins approximately 250 basis points greater than last year. In the engineering system segment, second quarter revenue increased 18.5%, and operating profit increased 33.7%, representing a 112 basis points increase in margin from last year. In conclusion, our short-term, more economically sensitive businesses remained resilient in the second quarter, collectively growing year over year, although comparisons for some do become more difficult in the second half. In addition, our longer cycle medical, aerospace, defense, and marine businesses continue to perform very well. Quarterly operating margin in our instrumentation segment was an all-time record. Operating margin in our aerospace and defense electronics segment was a second quarter record and just slightly less than the fourth quarter of last year. And now, through a combination of sales growth, operating leverage, and the more aggressive cost actions mentioned earlier, I fully expect digital imaging margins to grow considerably over time. And now I want to turn the call over to Sue.

Thank you, Robert, and good morning, everyone. I will first discuss some additional financials for the quarter not covered by Robert, and then I will discuss our third quarter and full year 2023 outlook. In the second quarter, cash flow from operating activities was $190.5 million. Free cash flow, that is, cash from operating activities less capital expenditures, was $163.2 million in the second quarter of 2023, compared with $176.1 million in 2022. Capital expenditures were $27.3 million in the second quarter of 2023, compared with $20.8 million in 2022. Depreciation and amortization expense was $80 million for the second quarter of 2023, compared with $82.7 million. We ended the quarter with approximately $2.99 billion of net debt, that is approximately $3.35 billion of debt less cash of $364.2 million. Stock-based compensation expense was $8.4 million in the second quarter of 2023, compared with $6.4 million in 2022. Turning to our outlook, management currently believes that GAAP earnings per share in the third quarter of 2023 will be in the range of $3.76 to $3.90 per share, with non-GAAP earnings in the range of $4.70 to $4.80, And for the full year 2023, our GAAP earnings per share outlook is $15.60 to $15.88. And on a non-GAAP basis, we are maintaining our prior outlook of $19 to $19.20. Both the third quarter and full year non-GAAP outlooks exclude estimated pre-tax charges for further FLIR integration costs The 2023 full-year estimated tax rate, excluding discrete items, is expected to be 22.3%. I'll now pass the call back to Robert.

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

Thank you. Ladies and gentlemen of the phone lines, if you'd like to ask a question today, please press 1 followed by the 0, 1 followed by the 0. And our first question today will come from the line of Jim Ruschetti. Please go ahead.

Thank you. Hopefully you can hear me okay. I wanted to talk a little bit, Robert, if I may, about digital imaging. If we exclude the acquisitions, it looks like your revenues were down year on year and sequentially. And some of this may be partly due to what you're seeing at FLIR, but I wonder if you could just expand on what you're seeing in digital imaging, just because it's a large category that covers a lot of ground.

Well, thank you. I think what you're referring to is in the organic growth or decline year over year, it was a little over 1% decline, 1.5% to be exact. We see several things. First, there are government programs that we have in digital imaging, especially in FLIR, that decline year over year. On the other hand, as I mentioned, we had a very successful first half, especially second quarter, in getting orders for products both here and in Europe. So we feel that that part of the business is stabilized. On the rest of digital imaging, if you look at health care, which is part of our business there, there's been significant expansion in health care and medical. If you look at commercial, Arrow, any parts of digital imaging that deal with, let's say, satellite communication, there has been expansion. I think there is some headwind in the commercial part of digital imaging in the Far East. But our exposure there is not that high. And we're making that up with new products that include some of our artificial intelligence capabilities. So we feel comfortable with our commercial aspects of our digital imaging. So in summary, I would say that there is a little pressure on parts of our digital imaging in the Far East, especially China, but this is offset by This is offset by other products that we manufacture for Europe and the U.S. So I would say machine vision, which is what I'm referring to, is going to be relatively flat, maybe a little down year over year, but the other parts of digital imaging are going to be healthy, and we feel pretty good about that. So all in all, It's a big part of our portfolio, but it's a pretty varied portfolio, ranging from space to medical to machine vision for automated semiconductor inspections, flat panel displays, et cetera. So it's like Teledyne. It's pretty resilient to various economic conditions.

Thank you for that. And follow-up question. I wonder if you could talk a little bit about just an update on the rate at which you may be burning through some of that higher cost component inventory that you had. And just in general, it sounds like supply chain has gotten better and how you're seeing that part of the business.

Yeah, I think you're right. As I mentioned earlier, our supply chain issues have increased. significantly moderated. We're still paying some premiums, but perhaps as much as years to date, 65% to 70% lower than we did at the first quarter, second quarter of last year. So that's a positive. But we're still paying some premium. And our inventory remained fairly flat between first quarter and second quarter. But as this supply chain issues relax, we're going to reduce our inventory for the remainder of the year. So I feel good about how we've dealt with the supply chain. We really didn't lose a whole lot of revenue because of that.

And if I could just slip one more in, apologies, but you did talk about some pull-in from Q3. I wonder if you would size that for us.

I'm going to say... approximately $10 million, not a whole lot, but when we have the opportunity, and I hope we will have in the future courses, we're going to try and do that. The flip side of that, Jim, is that a lot of our customers also ordered a lot of inventory, anticipating shortages, so they're a little resistant about letting us ship all the stuff that they've ordered before. But we're balancing that because, again, our balanced portfolio help us along in all of those directions.

Got it. Thanks very much.

Thank you.

Our next question will come from the line of Joe Giordano, representing TD Collin. Please go ahead.

Good morning, guys. I want to continue first on DI because I'd say 90 plus percent of the questions I get from investors are about the margins there. So, I mean, I think they, over the last couple of quarters, they've probably come in and the outlook has come in a little bit below what you thought. I know there's some elements, you know, high margin machine vision, probably market declines there, but can you talk about what's been slightly different than you thought on the margin side and how should we really think about that business kind of into 2024, like what's realistic for like a baseline margin assumption?

Let me start with second quarter margin. Actually, second quarter digital imaging margin is up about 28 basis points, let's say 30 basis points year over year. And we think for the year, It will be probably flat, maybe down about 10 or 15 basis points, but relatively flat. I think what's going to happen is that the FLIR margins are going to increase somewhat, and the historic or legacy digital imaging, they're going to decline a little bit. Basically, we think year over year it's going to be flat. We've had, as I mentioned before, we've had a slower revenue and lower revenue in defense in the first half of the year. But as I mentioned earlier, that's turning around now. So I think that's going to help us for the rest of the year. That's about really all I can say about the margins. I think second quarter year over year, we saw an improvement. about 28 to 30 basis points for the whole year. It might be flat or down maybe 15 basis points, but not much. And again, the balanced portfolio is really going to help us. The flip side of it is, if you look at our aerospace and defense segment, their second quarter margins increased 247 basis points And for the year, we're projecting 80 basis points of expansion. So sometimes when we look at defense, yes, we differentiate defense that's in digital imaging, what I've talked about before. But we have a whole bunch of defense programs in our aerospace and defense portfolio which are doing really well. So overall, I think we're okay. Okay.

Just one quick clarification. I know DI margins are up year on year, but sequentially they were down on higher revenues. So was there like a mixed change going on there? And then I have a quick question on test and measure.

I don't know. They were down sequentially, what, about 20 basis points? I'm not so concerned about that. There's so many moving parts in there. that it just balances itself out. That's not something that worries me. Okay. That's all I'll say about that. Go ahead with your other area, please.

Just curious on if you have any color on like the order intake for things like oscilloscopes versus the revenue delivery now. Like I know the revenue is strong. Are orders starting to slow there? I'm just curious, like, what that revenue trend looks like. Like, how much backlog do you have? How fast is that kind of coming out? And is it being replenished at the same pace?

Yeah, as you know, on the test and measurement, we have two distinct product lines. One is oscilloscopes. The other is protocols. And both of those are relatively short-term products. revenue, so big backlog doesn't make a whole lot of difference. Our oscilloscope revenue in Q2 was outstanding, really good. Our protocol revenue was relatively flat, and partially that's because new protocols are coming out in September, and we expect that revenue to pick up. If you look at the whole year, We think that we're going to have something like 3.5% to 4% growth in our oscilloscope and protocol products. We think third and fourth quarter are going to be all right. They may not expand as much as the first quarter, but year over year, we're going to be fine. In terms of just answering your question on backlog, Book-to-bill in that test and measurement is very close to one. It's 0.98. So I would say it's one. So again, it's not something that concerns me right now. Thank you.

Our next question will be from the line of Greg Conrad with Jefferies. Please go ahead.

Good morning. Good morning, Greg. Maybe just one clarification. I mean, it seems like you brought down, you didn't change guidance for the year, but brought down digital imaging. You talked about the strength in A&D. Has there been any change to the overall company margin guidance for the year, just given it seems like A&D is tracking ahead and instrumentation continues to be maybe slightly above expectations?

Yeah, I'd say if you went back to April guidance, versus today, probably margin is going down 10 basis points. Again, nothing significant. For the full year, we expect margin to go up about 26 to 30 basis points year over year. So overall, that's not something that concerns me. Because as I've mentioned several times, Because of our diversity of our products, for example, instruments margin will go up 80 basis points year over year. Aerospace and defense, similarly, 80 basis points. Even engineered systems will go up about 38 to 40 basis points. So a flat digital imaging doesn't change anything at this time.

And then, I mean, you talked about clear defense and kind of what you're seeing on the order front, and, you know, in the performance, top line was really strong in the quarter. I mean, what are you seeing across Teledyne as it relates to defense, and how are you kind of thinking about runway, just given orders and, you know, some of the 23 budget money coming through?

Yeah, as you mentioned, there's been a change in the budgets For a long time, the budgets looked healthy, but money wasn't coming through, and it started to come through more recently. Overall, I'd say we are fairly comfortable with our defense businesses, probably across everything, mid-single digits growth year over year. are enjoying actually pretty good margins and orders in our legacy defense businesses. And as I mentioned, Flea's defense businesses are turning around and had a good book to build in Q2. It's not just the U.S. defense. If you look at defense also in NATO countries, The expenditures are increasing, and we have a significant amount of sales overseas in both our defense as well as our defense, including things like traveling wave tubes for missile defense products in places like South Korea. So it's a pretty healthy environment right now.

I'll leave it at that. Thank you.

Thank you.

And we'll give another reminder, one foul by zero if you have questions on today's call. And let's go to the line of Jordan Lanois with BOA. Please go ahead.

Hey, good morning. This is Jordan with Bank of America. I just had a quick question on the backlog for defense. Are you guys seeing any specific constraints that could put the deliveries at risk? And also, too, for those wins, should we expect the majority of them to come through for 23 or extend it into the out years?

Some will come through in 23, and some will come through starting in Q4. For example, let me just give you one example or two. We do have some... Contra drone products that are going to Europe, probably about $25 million, $26 million. Most of that will come in 2023. On the other hand, the Black Hornet III that we just announced for the US Army, it's $94 million. Only about 10% of it will come this year. The rest will come in future years. It's a balance. I think we'll get some of it this year and a lot of it in future years.

Got it. Thank you.

Thank you. And we'll go to the line of Guy Hardwick with Credit Suisse. Please go ahead.

Hi. Good morning. Robert, I think you said in your prepared remarks that digital imaging margins should grow considerably over time. Could you flesh that out a little bit for us, what is over time, and could this mean that digital imaging margins exceed the sort of 24% levels I think that you delivered in 2021?

Yes. The answer is yes. And the reason I say that is the margins in our legacy businesses are already around that and even higher than that. And I think flare margins will increase, especially as we take the cost out that I just mentioned. And overall margins for digital imaging this year, we're projecting to be 22.3%. So to go to 24, 170 basis point expansion, yes, we can do that.

I think last quarter you'd pointed out negative mix, lag of price increases, I think, in the medical business. So was there any other mixed effects other than defense that you talked about in Q2? Is there anything else that we should be aware of which may have held back margins? Because I think three months ago you did expect sequential improvement and 30 basis points up for the full year.

Yes. I think in the healthcare business, things are really good for us. We've had significant expansion, both in our X-ray products, that is panels, as well as components that we put out for X-ray systems. And as I said before, there is some slowdown in China. If you look at China as a whole, they... They have had some contraction, even though you don't hear about it. There's been some contraction there. On the other hand, less than 10% of our portfolio is sold to China. So, again, our balanced portfolio helps us. The flip side also is that we've gotten some really good... higher margin product development programs that are helping overall digital imaging. Shipments have been a little slower, but I think bookings are OK. So again, it's not something that worries me. Where we don't have, let's say, a commercial imaging system that somebody would buy in China, On the flip side, we have custom products that we're developing which are very profitable, actually more profitable than commercial. I sit here today and I'm just looking at our portfolio, and I wouldn't change it with anybody else's considering all the uncertainty around the world. One area may go down a little bit, but we pick it up somewhere else, and that's the resilience of our earnings year over year, quarter over quarter.

Thank you. Just one last one for me. In aerospace and defense electronics, I think previously you'd mentioned that you benefited from a particularly good mix there. Is that, presumably that is continued in Q2 and is assumed that continues in the second half given your guidance for the margin?

Yes, we think we may have a little lower revenue in the second half. On the other hand, the products that we make in aerospace go primarily in commercial aircraft. And that market's expanded, as you well know, very close to pre-COVID. Q3, Q4 margins for aerospace and defense might be a little lower than Q2, but it'd be higher than Q1. So again, I don't see major inflections in that area. Thank you. Thank you.

And we'll go to the line of Jim Rusciutti with a follow-up from Needham. Please go ahead.

You gave us some book to bills, and I'm just wondering if you could perhaps provide us the book to bill in the different segments. I feel like I've got pieces of it.

Sure. Jim, in the instruments, our book to bill is about 1.05, so over 1. led by our marine businesses, which are doing really well, both in underwater vehicles as well as oil discovery and production. In the digital imaging as a whole, the book to build is about 1.07. In aerospace and defense, that's a little more, and engineer systems, those are much more lumpy orders. So quarter over quarter, book to bill may change, but it's not affecting revenue that much because we expect both revenue in both segments to grow. Overall, across the company, our book to bill is about one.

And last question from me, just given the debt pay down, I'm wondering how, if anything has changed with respect to thinking about acquisitions, including any change in areas that you might be pursuing, and I know you can't be specific, but I'm just wondering, just in general, what, your appetite is for M&A as you look out over the next several quarters?

Well, as I mentioned earlier, Jim, we paid down $620 million this year, effective today, let's say. That's taken our net debt-to-BDA ratio to 2.1. We have... About $60 million of debt left that's variable, which we pay 6% out of the $3 billion plus that Sue mentioned. The rest of our debt is all fixed. So other than that $60 million, our interest payments are 2.1% in future years. which is a very healthy place to be because we haven't really touched our line of credit. So we have a lot of capability to do acquisitions. Last year, even as we were paying our debt down, last year we did three bolt-on acquisitions and spent about $160 million. We'll expect to continue that bolt-on acquisitions. On the flip side is that because if we don't do anything else, if we don't make acquisitions, if we don't do anything, our debt-to-EDDA ratio is going to go less than one in about a year, a year and a half. So we're bullish about acquisitions, including larger ones, if we can find them. And, of course, we're continuously looking at that. The last question was what areas. Right now, I would say in the general instrumentation area is what's very attractive. We have done some digital imaging acquisitions. As you know, we made the ETM acquisition. We made the acquisition for our chartboard acquisition. But I think it'd be nice if we could find some things in our instrumentation area.

Got it. Thanks very much.

And we have no other participants queued up at this time.

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

Thanks, Robert, and thanks, Tom. If you give the replay information to the audience, I would appreciate it. And again, all our news releases are available. And for those who want to talk to me, please feel free to call me at the number in the earnings release. Thanks, everyone. Bye.

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