Teledyne Technologies Inc (TDY) — Q1 2015 Earnings Call Transcript

Good morning, everyone. This is Jason VanWees, Senior Vice President, Strategy and M&A at Teledyne. And I’d like to welcome everyone to Teledyne’s first quarter earnings release conference call. We released our earnings earlier this morning. Joining us today are Teledyne’s Chairman, President and CEO, Robert Mehrabian; Senior Vice President and CFO, Sue Main; and Senior Vice President, General Counsel and Secretary, Melanie Cibik. After remarks by Robert and Sue, we will ask for your questions. However, 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 of our periodic SEC filings, and of course actual results may differ materially. In order to avoid potential selective disclosures, this call is simultaneously being webcast, and a replay, both via webcast and dial in, will be available for approximately one month. Here is Robert.

Thank you, Jason, and good morning everyone. Teledyne’s reported first quarter sales of $565 million. Excluding the impact of foreign currency, sales were largely flat with last year. Due to continued operating discipline and cost reductions, GAAP operating margin increased 40 basis points to 11.9%, and gross margin was at an all-time record. Despite lower revenue and a tax benefit of $0.06 per share in 2014, GAAP earnings per share were flat year-over-year. During the quarter, a number of technical and product introduction milestones were accomplished. We shipped our first uncooled microbolometers based infrared cameras that incorporate proprietary imaging algorithms. We have significant sales related to our new ultra-high power subsea connectors. We successfully demonstrated state-of-the-art guided munitions technology referred to as EXACTO. We received the largest single aftermarket avionics order in the company's history. Teledyne continues to have a broad and balanced portfolio of highly engineered products, and our business is diversified and resilient to changes in specific end markets. Given the oil prices and, more precisely, excess exploration vessel capacity, we expected a decline in certain offshore energy markets. In January of this year, we specifically mentioned that certain energy businesses, such as geophysical sensors used in offshore oil exploration, could decline as much as 25% to 35% in 2015. We continue to believe this will be the case, but for perspective, this particular business represents less than 5% of Teledyne’s total revenue. However, as all exploration-related revenue declined year-over-year, our business related to offshore energy production reported record sales, and the backlog remains healthy given strong orders for new products and market share gains. In other markets, environmental instrumentation and avionics grew nicely from last year, offsetting some declines in our U.S. government businesses. In the first quarter, sales to the U.S. government, which represented about 24% of total sales, declined, with much of the shortfall related to timing and orders and shipments and some gaps in ongoing programs. Foreign currency translation primarily impacted our instrumentation and digital imaging segments, but acquisitions helped mitigate these declines. In our commercial businesses, total sales increased slightly both in the U.S. and internationally. Reported revenue even net of FX translation was stable in all major global regions, with a notable exception of Europe. In the near term, we are not counting on a pickup in the global economy or a moderation in foreign currency headwinds. Also, last year we benefitted by approximately $0.50 per share in earnings from tax benefits, including the R&D tax credit and net legal settlements. Furthermore, despite freezing our non-qualified pension plan for the top 20 executives, non-cash pension expense has increased due to the lower discount rate in 2015. Because of these points, we believe a more cautious view on sequential earnings improvement is prudent. We have modestly adjusted our prior full year outlook by $0.11 a share, or just shy of 2%. Teledyne’s success depends on our ability to manage change, both operationally and strategically across our portfolio of businesses. In those businesses that are growing, we are continuing to invest. In others, we are staying nimble and aggressively managing costs. Also, we will continue to make acquisitions to generate long-term growth as well as attractive returns on invested capital through the implementation of operational excellence in our acquired businesses. I will now comment on our business segments, after which Sue Main will review some of the financials in more detail and provide an earnings outlook for the second quarter and full year 2015. Turning to the instrumentation segment, first quarter sales increased 4.4% from last year. Sales of marine instrumentation increased 5.9% despite a significant expected year-over-year decline in the sales of geophysical sensors that I previously mentioned. We also had, of course, a negative impact from foreign currency which impacted this group specifically. As I mentioned previously, sales to offshore energy production industry remained very strong, robust stores continued resulting in stable backlog in businesses primarily serving this market. In the environmental domain, sales increased 10.4%, which was all organic, and reflected increased sales of both laboratory and field instrumentation as well as greater sales of air monitoring and gas process analysis. Sales of electronic measurement systems declined, with roughly half of the decline due to foreign currency translation. GAAP segment operating profit increased, and operating margin improved 109 basis points due to higher sales and improved operating performance, especially within the environmental instrument group. Turning to the digital imaging segment, first quarter sales decreased 11.3% compared to last year's, primarily due to lower sales from U.S. government R&D contracts as well as specialty centers for remote sensing applications. These were partially offset by higher sales of x-ray sensors for medical imaging. Sales of cameras for general industrial machine vision applications increased slightly but were offset by declines in sales of cameras for semiconductor and electronic inspection. The year-over-year decline in government R&D is largely due to the conclusion of DARPA's extreme accuracy task ordinance program, also known as EXACTO or the guided bullet. Nevertheless, a milestone was reached in February during a live fire demonstration which showed that the EXACTO was able to hit moving and evading targets with extreme accuracy at sniper ranges unachievable with traditional rounds. We are hopeful that additional funding will become available for these and similar programs later this year. GAAP operating margin continued to increase and was 77 basis points greater than last year. Turning to aerospace and defense electronic segments, first quarter sales decreased by 7.9%, while U.S. government sales declined or commercial avionics businesses continued to perform very well. Operating profit declined due to lower sales and lower margins in a number of defense electronic businesses. However, due to cost reduction efforts and an increase in orders recently, we expect improved sales and margins in the balance of the year. Turning to the engineering systems segment, first quarter revenue increased 6.2%, and operating margin increased 35 basis points. Both sales and margin benefitted from the greater mix of marine and space manufacturing programs and higher sales of energy system products such as commercial hydrogen generators. In conclusion, through acquisitions and strong cost control we were able to mitigate headwinds from foreign exchange and the timing of certain government programs. We are also confident about sequential earnings improvement. However, we do not want to be overly optimistic or plan for a significant second-hand recovery in the global economy for our specific end markets. And finally, our strategy remains the same. First, focus on highly engineered products for specialized end markets. Second, a commitment to operational excellence to improve margins. And third, continued investment, including greater emphasis on acquisitions to grow our portfolio of businesses. I will now turn the call over to Sue Main.

Thank you, Robert, and good morning. I will first discuss some additional financials for the quarter not covered by Robert and then I will discuss our second quarter and full year 2015 outlook. In the first quarter, cash flow from operating activities was $16.7 million compared with cash flow of $27.1 million for the same period of 2014. However, cash provided by operating activities in the first quarter of 2015 primarily reflected payments for legal matters, the payment of the scheduled earn-out obligations, and the timing of accounts payable payments, partially offset by lower income tax payments. Free cash flow, that is cash from operating activities less capital expenditures, was $9 million in the first quarter of 2015 compared with $15.4 million in 2014. Capital expenditures were $7.7 million in the first quarter compared to $11.7 million for the same period of 2014. Depreciation and amortization expense was $23.2 million in both 2015 and 2014. In February, we entered into an accelerated share repurchase (ASR) agreement for 1.5 million shares at an initial price of $94.68. We ended the quarter with $719 million of net debt, that is $830 million of debt in capital leases less cash of $110.2 million, for a net debt to capital ratio of 35.1%. Turning to pension and stock compensation expense, in the first quarter of 2015, growth GAAP pension income was $0.2 million due to a one-time gain of $1.2 million from the freezing of our non-qualified pension plans compared with growth pension income of $0.3 million in the same period of 2014. Stock compensation expense was $3.8 million in the first quarter of 2015 compared with $2.6 million in the first quarter of 2014. Finally, turning to our outlook, management currently believes that GAAP earnings per share from continuing operations in the second quarter of 2015 will be in the range of $1.30 to $1.34 per share. We expect full-year 2015 earnings per share of approximately $5.60 to $5.65. The 2015 full-year effective tax rate is expected to be 29.5%. I do want to emphasize a few items regarding our 2015 outlook compared to 2014. First, our pension assumption included a discount rate decrease of 90 basis points and changes in the mortality assumptions which will increase non-cash pension expense in 2015. Second, 2014 results benefitted from net legal settlements, significant discrete tax items including $0.06 in the first quarter of 2014, and the 2014 R&D tax credit which is not currently effective for 2015, as well as a slightly lower tax rate. I will now pass the call back to Robert.

Thank you, Susan. We would now like to take your questions. Linda, if you are ready to proceed with the questions and answers, please go ahead.

Good morning.

Good morning, Greg.

How are you doing? Just want to start with your update. In your prepared remarks, you mentioned that most markets were stable with the exception of Europe. Can you maybe give a little bit more color around that in terms of just different end markets?

I think Europe was down, Greg, but I would say about 5% to 6%, somewhere in between those two overall. Approximately 10% of our sales are in foreign currency, and in the first quarter, the foreign currency translation basically overall impacted our revenue by 1.5%.

That makes sense. And then just in terms of U.S. government, you mentioned imagers for remote sensing were down in the quarter. Was that tied to any specific program, and what is the opportunity pipeline for that business?

The first one that I mentioned on the government is we have a very successful demonstration of our program called EXACTO, which is basically a 50-millimeter bullet that can be guided by a sniper team. That program came to an end, and that was a pretty large program for us in our scientific business here. We expect some additional funding later, but there is a gap in funding there. We also have some gaps in our space programs, especially classic wide, and if you mine or shortages in our microwave businesses, but we expect these to pick up between Q3 and Q4. So I think most of the government program declines are temporary and timing-related.

Thank you.

Thank you, Greg.

Thank you. Good morning. I was wondering if you could, Robert, perhaps elaborate on the growth you are seeing in environmental. You cited that as being one of the areas that’s strong and same with commercial avionics, which I guess has been strong now for a couple of quarters.

Right, let me start with the environmental and then go to commercial avionics, Jim. On the environmental, we have a variety of programs ranging from water to air quality to pharmaceutical laboratory techniques to some food and beverage techniques. In food and beverage, I think should be using our processes to detect impurities. By and large, we’ve seen improvements in our air quality monitoring program in both China and India. China recently adopted a cap program for sulfur dioxide and NOx mass emissions which provides sales opportunities for us. We also have a stack flow monitoring system. Air quality monitoring in China has stabilized, but it has picked up more in the U.S. ambient air quality monitoring, and it's better than it was last year. There are also some new APA standards for ozone, ground level ozone detection. So all of these are helping us. In the remainder, if I move over to commercial aircraft then avionics, as you know, Jim, there is a tremendous backlog at both Boeing and Airbus in 2015 that’s anticipated to be about 11,500 planes with a potential additional backlog this year of about 1,500. Now we have content on various aircraft that is substantial for the size of the business that we have. Our backlog means some of these programs that I just mentioned exceed $600 million, and it's a multi-year backlog. And of course, we have self-sourced on a number of programs at Boeing. And so this is gaining market share, by the way, in the retrofit domain, especially with our wireless grounding products. So we’re kind of bullish about this business. The industry is doing well, the aircraft manufacturers have tremendous backlogs, and the airlines are actually making money, expected to make maybe $25 billion this year. So that’s a good business for us.

Okay, and one final question. I wonder if you can comment on the bookings in the quarter, and to the extent you can, maybe talk a little bit about how the bookings were in the various segments.

Okay, overall bookings for the company varied from a higher 1.3 to 1.4 down to a lower 0.85. Fundamentally, if I went through the segment, I would say that aerospace and defense is close to one, insurance by and large are about 0.95, environmental is slightly over one, digital imaging is under one at about 0.85, and our engineering system business is significantly over one because we want some long venture programs there.

Good morning, Mike Ciarmoli here. Robert, regarding the guidance, it seems there's some caution regarding the economy. Is there a specific reason for the $0.11 figure? Is it purely conservatism, or are you observing particular weaknesses in certain areas? If I'm not mistaken, this is the first time you've indicated a year-over-year decline in GAAP earnings, at least since 2000.

Let me just make two comments. It's going back to 2001. But I wouldn’t say it's conservatism; I would use the word prudent as a more appropriate word. We are not counting on any tax benefits. You can't put tax. We have a very small amount of tax benefit compared to last year we had about $0.38 between tax and one-time tax benefits and R&D. And you can predict earnings based on that. If the R&D tax credit doesn’t pass or if we get some audit letter or something happens, then you can count on that. So we kind of exclude most of that. Second, every day whether you read the paper or listen to the Fed or read other industrial companies like ours, everybody is cautious because of what the foreign exchange. We haven’t seen foreign exchange changes of this magnitude for a long time. And the other thing we have to be cautious about is that our tax rate changes depending on how much foreign earnings we have, and with Europe being in the tank right now, we can’t just really count on that either. So we are taking the guidance down less than 2%. I think it is prudent at this point with everything that’s going on in the world and with the oil price being half of what it was last year at this time.

Okay, that’s fair. And should we think about was the pension gain in the guidance for the year, and should we assume that you guys do the full buyback on the ASR?

Yes, let me answer the second one first. ASR is done for practical purposes. You basically reach an agreement with a financial institution, you take the shares and they buy those shares over time, and the difference in the price of the shares either becomes a positive or a negative number in terms of cash. But the shares are out. In terms of the pension, because of the change in this contract, as Sue mentioned, we expect overall a pension headwind of about $0.06 for the year versus last year. Now if you look at it and say, we also have frozen our non-qualified pension. Excluding that, it’s more like $0.08. By freezing the non-qualified pension and providing compensation for the employees like myself, we were able to shave off a couple of pennies of that negative number. So by and large, we do have a pension headwind of $0.06 year-over-year, including the non-qualified franks.

Got it. I mean on the order front, especially on the subsea, I mean you guys it sounds like with new products gaining share, you guys seem pretty confident. I know there is some press out there, but maybe more so on the offshore drilling side that we could see cancellations. But in terms of I guess your sub, your order flow production, I mean it seems like backlogs everything holding up fairly well?

Backlog is about 0.95 right now. And as you will know, about 62% of newer discoveries since 2010 have been in deep water, and that’s where we excel. And those programs have long legs on them, they're multiple years, tens of billions of dollars investment that you can’t shut them off quickly like you do in fracking. And there we have both new products, and we have, for example, new high-power products which we are gaining market share with these products that go, let’s say, 6 kilowatts with 900 amps, and we also have pressure temperature sensors. We also have Ethernet products, optical and electro-optical products, so we are increasing content and gaining share.

Got it, perfect. Thanks guys, I’ll jump back in the queue.

Thank you.

Thanks, good morning everybody.

Good morning, Steve.

On the government revenues where you said there was a timing difference, can you tell was that administrative or was it related to funding? Is it something that will continue or something that will catch up?

It’s both. Some of it is administrative, and I would say those are just programs that are getting pushed off a little bit. Some of it is like funding gap at the present time. I mentioned the EXACTO program, and some of it, Steve, is on us. We have agents' travelling wave tubes to program that is really looking for strong production. And in Q1, since we hadn’t made these travelling wave tubes for a number of years, we stumbled a little bit. We've solved the problem now, and some of it is on us. And so it’s a mixture of three things; you didn’t mention to stumble, but I will. But we’ve recovered now, and that program is moving ahead as it should be.

Got it, thank you for that information. So that’s retrofit I take it for the most part.

Actually, regarding the agents program, these products are new. We have retrofit products, but we also make spare parts for existing radar systems. So while they are not retrofits per se, they are indeed spare parts.

Got it, last question on the strength of the dollar, are there any foreign acquisition targets that were too expensive for you before that maybe the strong dollar will help you with now?

Yes, just an example of that is earlier this morning we announced that we bought the remaining 49% of Optic, just to light our company laser company. That was what we initially decided to do, what we always wanted to buy out, but now it was 20% cheaper than it was when the first time we looked at it a while back. And there are other foreign acquisitions, especially in Europe, that we are looking at also when you have cash parts in Canada or overseas. That cash earns essentially nothing. We had over $100 million outside the U.S. So we intend to use that cash. Good question, thank you.

Thanks, Robert. I wanted to follow up on your comments earlier about the oil and gas market. I think you had said your geophysical sensors were predicting down 25 to 35, and my question was, are you sticking with that original guidance that you provided previously or have you ratcheted that down?

Yes, I believe it will likely be closer to 40%. It varies. We have a particular customer who is very successful due to the 3D accuracy of the streamer cables we produced for them, which allows them to obtain robust data. However, currently, all customers are parking their vessels, including our largest client, and we do not foresee any improvement in the situation. Specifically, it has decreased about 39% this quarter. On the positive side, similar cables are utilized in the military, and we are participating in bids for several large programs due to our unique capabilities in manufacturing these large streamer cables. As I mentioned, former Navy personnel understand that these cables are used around vessels to detect acoustic signals.

Okay, also you mentioned what percent of business was exchanged or revenues were exposed to foreign currency?

The thing is we have about 45% international sales, of which 10% are directly affected by foreign currency. And when we look at that carefully, that cost is about $8 million in revenue and about 1.5% of our revenue. The flip side of that also, also the negative side of that, as you note, no traces that, yes, you get less revenue because of the foreign currency. But you also are selling in foreign currency, and you have to lower your prices to be able to compete. So it’s a double whammy, but we’re weathering it. We are taking costs out, and we’ll be fine.

But how about with Canada? I mean you just got a nice discount on your cost to sales there with DALSA?

Yes, on Canada is the flip side that’s why I said 10% because we are 45% international sales. Canada is the flip side where we produce products in Canadian dollars and we sell them primarily in U.S. dollars. So that’s the flip side of the benefit that’s why it only comes down to 10%; otherwise it would be as high as 25%. When we entered the exploration market, it was about where our current projections are. The sales are slightly weaker than we anticipated, but not significantly. However, the operating profit is on track, and we are actively working on integration. As you know, once we start our integration processes, our margins stabilize. Therefore, the profits are in good shape. I wish I could say yes, but the fact is it was one of our - actually I think it was one of our customers that was testing it, and by the way, the shooters were engineers here, so it was an interesting experience.

Good morning, Robert. Question on the engineering services business. I know a few years back you had a couple of programs that had long gestation periods, for example, the special forces delivery vehicle. I was wondering, is there anything in that portfolio that may mature into volume productions in the latter part of the year that will move the needle for that segment?

Yes, I think, let me just make a broad comment. I think in that segment we expect incremental improvements in revenue as we go through the year. The first program underwater vehicle is called the shallow water or SWCS vehicle that’s used for navy Cos. We will go into low-rate initial production next year. I think we will have two boats, maybe three next year max, but these are very sizable boats, and we have test facilities which are the more important part of the program which is a very large water pool to be able to test these boats. That’s a very good program for us, very successful, and the total potential revenue in that program is about $380 million. The other program again related to underwater that we’ve had is our program for gliders, underwater vehicles that use buoyancy to go up and down. And in that program, we have about, so far up to the end of 2014, we received about $28 million. These are used by the navy for sensing in front of battleships, sensing the properties of the water so they can predict acoustic signals more accurately. We project that in the next five years we will have another $50 million of revenues in our glider program. So those are the two big programs that relate to water and underwater capabilities.

Okay, given the currency headwinds which you face, could you make some comments as to what type of growth rate overall or by segments that you might expect for the year now?

I’ll share this in a straightforward manner. I believe the currency impact will remain consistent, affecting us by about 1.5% as it has throughout the year. I anticipate that on a GAAP basis, we might achieve positive revenue growth in the low single digits, between 1% and 2%. This means we could offset the 1.5% impact and gain an additional 1% to 2%. Regarding our segments, I expect digital imaging to remain flat, as it faces less foreign currency pressure. However, there is soft demand in that market, particularly in flat panel quality inspections in Southeast Asia. I predict our aerospace and defense segment will grow a couple of percent, engineered systems will also see a similar increase as in Q1, and instrument performance should be relatively flat, although currency fluctuations are impacting this segment more severely, with a 2.5% effect. Even so, I believe we should see around 1% growth overall. You bet, Mark.

Just wanted to follow up on the questions about acquisitions. Is it fair to say that looking at the portfolio, you are looking to perhaps ease up more of the instrumentation business? And I would assume that you probably full up in the energy area. So is that, would you look more in environmental and electronic?

You are correct, Jim. I would say there is a significant variation in instrumentation and digital imaging. For instance, we have LeCroy, which specializes in test and measurement. I am quite interested in this area because it aligns with our core competencies in digitization, microwave technology, and general digital signal analytics. We are eager to explore opportunities there. However, if we consider other traditional sectors, we are consistently on the lookout for environmental acquisitions. Concerning underwater initiatives, we might pursue projects, but these would not be oil-related; instead, they would focus on signal analysis or large-scale mapping of ocean currents and densities. Lastly, in the digital realm, we are seeing progress with x-rays. We have developed the world’s most sensitive CMOS x-ray sensors, which produce the best digital images with very low radiation dosages. We aim to make additional acquisitions in this area to enhance our capability to provide system-level products to our customers.

Got it, that’s helpful. And just on the subject of LeCroy, excluding currency, is that, Robert, is the business flattish?

Yes, it is probably down about a percent year-over-year, not because just of currency effect; it will be about 1.5%, maybe as much as 2%, but what affected is Europe has been the strongest market, and since Europe, regardless of currency, is relatively stagnant, we’ve taken a little bit of a hit there. The flip side of that is that they have introduced a significant number of new products, and we expect that those would do very well. They have, of course, the highest bandwidth, 100 gigahertz product at the very top, and then introduce some new products at the lower range. And there is the company that really developed a whole new market for a 12-bit scope. So we are very comfortable with that business staying where it is for now till Europe does better and until the FX problem is partially mitigated.

Hey, thanks guys, it's Mike again. Hey Robert, just real quick, the acquired revenue contribution issue from Bowtech and taking the remaining stake in Optic, is that a meaningful portion of revenues or can you talk maybe just in general how significant contribution or negligible?

The optic is none because we own 51%. As you know, you consolidate revenue and place earnings or losses for the portion you don’t own below the line. From a revenue perspective, it will not contribute since it has already been consolidated; it has been part of our revenue stream since we acquired the 51%. Regarding Bolt and our recent acquisition of Bowtech, which is an underwater visual camera company, we expect around $45 million to $55 million in revenue this year from those two acquisitions, and these are incremental. Operator, thank you very much. We will just stop there, and I’ll now ask Jason to conclude our conference call, please.

Thanks, Robert, and again thanks everyone for joining us this morning. If you have any follow-up questions, of course, please feel free to call me on the number listed on the earnings release. And all our releases are available on our website teledyne.com. Operator, if you could please conclude the call and provide the replay details, we'd certainly appreciate it. Goodbye everyone.