Teledyne Technologies Inc (TDY) — Q1 2020 Earnings Call Transcript

Great. Thank you very much, Greg. Good morning, everyone. This is Jason VanWees, Executive Vice President, and I would like to welcome everyone to Teledyne's first quarter 2020 earnings release conference call. We released our earnings earlier this morning before the market opened. Joining me today are Teledyne's Executive Chairman, Robert Mehrabian, President and CEO, Al Pichelli, Senior Vice President and CFO, Sue Main, and Senior Vice President, General Counsel, Chief Compliance Officer, and Secretary, Melanie Cibik. After remarks by Robert, Al, 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 our periodic SEC filings. And of course, actual results may differ materially. In order to avoid potential selective disclosures, this call is simultaneously being webcast and a replay, both via webcast and dial in, will be available for approximately one month. Here is Robert.

Thank you, Jason. Good morning, everyone. And thank you for joining our earnings call. Before discussing our results and outlook, I want to talk very briefly about our people, our response to COVID-19, and our business portfolio as a whole. Our first priority remains the health and safety of our employees and their families. Employees whose tasks can be done outside have been instructed to work from home. Currently, up to 40% of our total personnel are working remotely. Our corporate office is open, and all of our 70 manufacturing sites worldwide are operational. We are maintaining social distancing, enhanced cleaning protocols, and the usage of personal protective equipment where appropriate. Our businesses can remain open because they serve critical infrastructure sectors, such as the defense industrial base, water and wastewater, healthcare, and public health. Teledyne's business portfolio also remains exceptionally well balanced across end markets and geographies. Approximately one-half of our businesses are longer cycle, more predictable, and supported by a record quarter-ending backlog. Looking back to the first quarter, we did not suffer any widespread reduction in customer demand. In fact, orders actually surpassed sales in each month, including March, and our quarter-end backlog was a record at approximately $1.8 billion. Likewise, we did not incur any significant negative impact to our supply chain. Nevertheless, there were some first-quarter operational challenges in manufacturing and shipping product due to our policy of maintaining appropriate employee density at the workplace, balancing employee absenteeism, and the availability of our customers to accept product. These operational and HR matters, along with some demand and supply chain issues, likely reduced our first-quarter revenue by approximately $15 million. Nevertheless, organic sales growth was positive and overall first-quarter revenue increased 5.3% from last year. GAAP earnings increased 7.4%, and despite $10.4 million of pre-tax charges, GAAP operating margin also increased. Finally, revenue, earnings, and operating margin were all records for any first quarter period. Now looking forward to the second quarter and the full year. Operational challenges from the first quarter remain. However, there is no uncertainty regarding customer demand in 50% of Teledyne's businesses that are shorter cycles and generally tied to corporate capital expenditures and the global economy as a whole. In addition, some end markets, such as commercial aviation, although just 6% of sales in the first quarter, will be impacted beyond the next few quarters and into 2020. While many other industrial companies have withdrawn their earnings guidance for 2020, our total company has a relatively high degree of predictability and stability. Nevertheless, in the current environment, we find it prudent to both lower and widen our prior expectations for revenue and earnings that we provided on January 22, 2020. Our current outlook is based on the following assumptions: First, at the lower end of our earnings range in the second quarter, we've assumed overall revenue contraction of approximately 6% as well as year-over-year declines in each of quarter three and quarter four, albeit moderating by year-end. This would result in an overall full year-over-year revenue decline of approximately 2%. Second, at the high end of our earnings range in the second quarter, we have assumed overall revenue contraction of approximately 4%, with a more moderate contraction in Q3 and flat year-over-year sales in Q4. This would result in roughly flat year-over-year overall sales. By segment for instrumentation, which is our shortest cycle business group, we expect an overall revenue change in the second quarter ranging from negative 5% to flat. At the midpoint of our outlook range, we expect full year's segment sales to be flat, including incremental sales contributions of about $60 million from the Gas and Flame and OakGate acquisitions. We expect digital imaging to be more resilient, as nearly half of the segment serves defense-based healthcare and scientific markets. This segment also has greater exposure to 'back at work' customers in Asia. Given a weaker 2019 in those digital imaging businesses serving semiconductor inspection and factory automation, we have an easier comparison in 2020; hence, we expect to achieve positive—low single-digit segment full year's sales growth. In the other two segments, aerospace and defense electronics and engineering systems, we continue to see our defense businesses in this segment growing at mid-single-digit rates, perhaps even high single digits, despite the ongoing operational challenges mentioned previously. However, we are forecasting a collapse in commercial aviation in the aerospace portion of our aerospace and defense electronics segment. While less than 6% of our total sales in the first quarter, we are expecting a year-over-year decline of over 40% in commercial aviation due to significant air transport OEM and aftermarket declines. As a result, we expect total year-over-year segment sales to decrease by approximately $90 million. Before turning to Al to report on the first-quarter performance by segment, I want to emphasize the following. We do not know the depth and duration of the economic decline or the pace of the recovery. But as we have repeatedly shown in the past, we know how to be disciplined and perform well in challenging environments. We are aggressively managing variable costs, capital expenditures, and cash flow, and quickly and permanently reducing costs where a prolonged cycle is anticipated, such as in aviation. Finally, our balance sheet is exceptionally strong with over $230 million of cash and cash equivalents, and more than $600 million available under our credit facility maturing in 2024. Given our ample liquidity and the resilience of our business portfolio, we continue to review and pursue acquisition opportunities. Al will now comment on the performance of our four business segments, followed by Sue Main, who will give further financial details and present our outlook.

Thank you, Robert. In our instrumentation segment, overall first-quarter sales increased 11.2% from last year. Sales in marine instrumentation increased 3.9% organically in the quarter. Backlog continues to grow and it was at the highest levels since early 2015. In addition, operating profits improved significantly. As a reminder, while marine includes products sold in the energy industry, we expect this market to directly account for just over one-third of total marine sales in 2020, or approximately $150 million of annual revenue compared to almost $400 million in 2014. In the environmental domain, sales increased 26.5% as a result of our acquisition of the Gas and Flame Detection business. In addition, we achieved organic sales growth of certain laboratory instrumentation products, but this was offset by lower sales of other industrial instruments. Sales of electronic test and measurement systems increased 2.5% due to the acquisition of OakGate. Nevertheless, organic sales were flat given continued strong demand for our protocol test instrumentation. Overall instrumentation segment operating profits increased 27.3% in the first quarter, and margin increased 226 basis points with margins increasing for test and measurement and marine instrumentation. Excluding the Gas and Flame Detection acquisition and related purchase accounting, margin was flat for environmental instrumentation. Turning to the digital imaging segment, first-quarter sales increased 6.2% and included higher sales of infrared detectors for defense applications, MEMS products, and x-ray detectors for life sciences. Sales of all machine vision products collectively decreased slightly, but nevertheless stabilized with improved orders and sales for advanced inspection camera systems. GAAP segment operating profit increased 19.7%, and margin increased 201 basis points, generally as a result of the increase in sales volume. In the aerospace and defense electronics segment, first-quarter sales decreased 6.2% as positive 9% growth in sales of defense electronics was more than offset by a 35% decline in sales of commercial aerospace products. GAAP segment operating margin decreased due to lower aerospace sales, including 525 basis points of charges for severance, facility consolidations, and certain contract cost adjustments. In the engineering system segment, first-quarter revenue increased 7.6% with greater sales related to marine, space, and nuclear programs, as well as electronic manufacturing and turbine engines, partially offset by lower sales from missile defense programs. Segment operating profits increased 460 basis points, largely due to higher sales and a greater mix of higher-margin manufacturing programs. I will now turn the call to Sue, who will offer some additional commentary regarding the first quarter and our 2020 outlook.

Thank you, Al, and good morning, everyone. I will first discuss some additional financials for the quarter not covered by Robert and Al, and then I will discuss our second quarter and full-year 2020 outlook. In the first quarter, cash flow from operating activities was $76.4 million, compared with cash flow of $80.1 million for the same period of 2019. The cash provided by operating activities in the first quarter of 2020 reflected the timing of accounts receivable collections, partially offset by the impact of higher operating income, lower income tax payments, and incremental cash flow from recent acquisitions. Free cash flow, that is cash from operating activities less capital expenditures, was $56.2 million in the first quarter of 2020 compared with $58.8 million in 2019. Capital expenditures were $20.2 million in the first quarter compared to $21.3 million for the same period of 2019. Depreciation and amortization expense was $29.3 million in the first quarter compared to $27.6 million for the same period of 2019. We ended the quarter with $618.3 million of net debt, that is $849.7 million of debt minus cash of $231.4 million, for a net debt to capital ratio of 18.3%. Stock option compensation expense was $7.4 million in the first quarter of 2020, compared with $8.9 million in the first quarter of 2019. Turning to our outlook, management currently believes that GAAP earnings per share in the second quarter of 2020 will be in the range of $1.90 to $2.05 per share. For the full year 2020, our GAAP earnings per share outlook is $9.30 to $10. The 2020 full-year estimated tax rate excluding discrete items is expected to be 22.8%, a 220 basis point increase compared to full-year 2019 due in part to fewer R&D tax credits. In addition, we currently expect significantly fewer discrete tax items in 2020 compared to 2019. Please note that the estimates for second quarter and full year 2020 GAAP diluted earnings per share exclude any future potential charge related to Airbus OneWeb Satellites. I will now pass the call back to Robert.

Thank you, Sue. Greg, if you're ready to proceed with the question and answer session, please go ahead.

Good morning. I just wanted to start with something that's maybe a little more topical. I think there was a release out last week on thermal cameras for non-contact fever screening. How big of an opportunity is that and what type of interest are you getting just kind of what's going on in the world?

Hi, Greg. Good morning to you also. The cameras are long-wavelength infrared cameras. They are made with our own sensors produced on a wafer-level packaging. They are 640 by 480 with a 17 micron pixel size. We are just beginning the manufacturing of those cameras, as we announced. We are getting interest from a large number of manufacturers. While it's still speculative, we are positively motivated to increase production of those cameras. So how big an opportunity it is, it's too early to tell.

Thanks. And then, I mean you kind of talked about the size of the oil and gas market within marine, but given oil price fluctuations and CapEx rationalization on the part of customers, I mean, have you seen any change to expectations or push out of shipments in that market?

Not yet. The short answer is not yet. But I have to put that in perspective. The marine businesses today are really expecting the midpoint to be over $425 million. Only $150 million of that, or 35%, is in offshore oil exploration and offshore oil production, and very little on land oil. Most of our marine businesses we already see, 65% is in defense, construction, and other areas. Going back to oil and gas, we do have good orders so far for the year. It's over $1.1 billion, and we don't see any cancellations yet. Having said that, that's in oil production. In oil exploration, we're seeing a little bit of softening in our orders. Considering the price of crude and what's happened to Brent, we expect to have some softening later in the year. So we're taking that into consideration in our guidance, but the good part is that there is a good part to this for us versus 2014, when oil collapsed in '15 and '16. At that time, the majority of our marine sales were in oil and gas, and today it's only 35%.

Thanks. And then, just last one for me. Can you update us on expectations for margins for the year and given your report on a GAAP basis and had some restructuring in Q1. Do you have any other restructuring contemplated in the guidance for the rest of the year?

Yes. So let me start from the latter part of your question, which is do I expect more restructuring? In the first quarter, we had about $0.21 of restructuring. We are doing a little cost takeout right now in the second quarter. We expect that if things don’t change or get worse, we will have to take some more out. Overall for the year, including the first quarter, we think it can range between $0.40 and $0.50; $0.40 on the lower side. The margin effect is very interesting. Our margins at the midpoint—we will always work with the midpoint of our guidance—which would get us about $965 in earnings and EPS, and about $3.14 billion in revenue. With those numbers, I think instrument margins in the instrument segment should increase slightly, maybe as much as 15 basis points. Digital Imaging year-over-year, we believe margins can go as high as 90 basis points above last year. In the aerospace and defense segment, it's a very different issue. Defense is going to do okay, but aerospace is going to be down significantly, and that's one of our highest margin businesses, so we think margins year-over-year would go down as much as 700 basis points. Engineering systems will go up probably 75 to 80 basis points. Overall, segment margins will go down because of aerospace primarily, about 100 to 110 basis points. But we have cost control in the corporate domain. So overall in the midpoint, we think margins can go down as much as 80 basis points. But that, of course, is based on preliminary data on everything we know right now.

Thank you. Good morning, and thanks for the detailed outlook. I'm not sure there are many companies in a position to offer that in this environment. Question I had, Robert, was regarding the defense business. There have been at least we're seeing more reports of supply chain disruptions in the defense market. I guess what I'm wondering is, is there any potential risk as you look at that business in the second half, where there could be an issue for you or even the broader government business, normally have a pretty good line of sight there.

Yes. We are seeing a little disruption right now, especially in our specialized printed circuit board supply chain. The flip side of it is, while we have hiccups, we have a very strong procurement initiative underway that started two years ago to reduce procurement costs, and they're shifting their emphasis to working with our suppliers to ensure that we do have a reasonable supply chain. Hiccups, yes, but I expect that we'll have more—but so far nothing very serious. What’s been troubling on the defense side is the availability of some of our customers to approve products that we're delivering to them. For example, just a simple example, in our shadow water combat submersibles, which are the boats we make for Special Ops. We would have the boat ready to test but because of COVID's restrictions, our divers and the government divers can't test them. So they can't take complete delivery without getting paid in full. We have those kinds of things happening all over. But going back to something I mentioned earlier, Jim, we know how to deal with these issues. We've done it before. We did it in 2015 and '16 when oil collapsed; we did it in 2008 and 2009 during the financial crisis. So we're taking this into consideration with our guidance.

Got it, and thanks. The question on the industrial machine vision business. You talk about stability; it sounds like you're seeing some pickup, maybe on the semi side. I'm just wondering, is this more of a case of easier comparisons, or is there some improvement that you're seeing in some of these markets, including the factory automation, which seems a little surprising, but just curious about that?

Yes. Let me start with the first part, which is last year we had, this is one of those cases that—good case, as we usually say—where we had tough comps. Last year, semiconductor and factory automation were relatively weak, so our comps this year based on last year are better. Overall, we think machine vision—this machine vision system part of our overall digital imaging should be flat this year. We think overall digital imaging will increase. But I think the vision system will be flat, and there's some good gives and takes. Our flat panel display orders are pretty good right now. Our scientific cameras are doing well. Semiconductor orders are catching up. We do have some incremental sales from acquisitions that we made: the site cam from Roper and Microline in Canada, which makes MEMS products. We think some of the other aspects will do well. Our aerospace and defense businesses in machine vision are doing well and we expect them to continue. So overall, I would say the semi-factory automation; we were lucky because last year we had such weak revenue, so the comparisons are easier to make, and the others we’ve done okay.

So, Robert, for businesses like commercial aerospace and energy, which are obviously much more challenged now, you're taking actions. There seems to be kind of debate or confusion around when these things actually bottom. Are these markets now likely worse in '21 than they are in '20? How do you characterize the likelihood of recovery in these markets over the next 12 to 24 months?

Let me start with energy first, if I may. As I mentioned before, our oil and gas part of the business is about $150 million and it's less than 5% of our revenues today. In that market, the products that we make lag the overall market. Our orders presently are good and will continue for the next two quarters, but we think it will soften in Q4. While the primes are suffering today, I believe our suffering will come a little later. The same happens with recovery; if recovery comes, it depends on the overall economy; and we will be lagging the recovery. Having said all of that, in the overall marine businesses, which we look at as our energy businesses, we have really strong programs in the defense area—both vehicles and other areas like mine confirmations, et cetera. We see some downside for us. I don’t know when we should bottom, but I think recovery for us will come later. We’ve all suffered the consequences of the current downturn perhaps later in the year. Going to commercial aerospace, I can’t guess right now. We’re lucky—it’s 6% of our sales, and we have a $90 million decline that we’re projecting from last year to this year, from about $211 million to about $120 million or so. Again, we also lag the market; just look back to what happened after 9/11 in 2001. Aviation didn’t really recover until 2003. That marked a two-year hiatus, and we ended up suffering the consequences of that. If that's an indication of how long it might take before we start to see things turning up, it’d probably be another two years before we see a recovery. Frankly, that's the way we are treating these businesses. We are taking costs out, Joe, permanently. We’ve already taken almost 20% of our folks out in that business, plus the other employees are on furlough and in other situations. So, to summarize, the recovery in both segments suggests that aerospace should take a longer timeframe than energy in my view. We likely won't suffer much from energy, but we are taking a hit from the aviation downturn.

Now that's clear, and it's very helpful. On the free cash flow side, can you talk about your expectations for the year? Let's not—you could strip out the potential for OneWeb write-downs and things like that. But just outside of that, how do you look at your working capital performance outlook for the year? When you think about conversion, will you guys be able to accelerate cash flow as you bring in cash by liquidating backlog this year?

Let me start by saying that, of course, we're lowering our earnings outlook right now, so our free cash flow should be a little lower than last year. Last year, we had about $400 million. This year, I think it’ll be about $375 million, maybe even a little less. We are taking strong actions now to reduce our inventories across our businesses, and the success will depend on how well we execute. If we do all the things we've outlined, we might keep last year's free cash flow. But I will say this: if you look at 2009 versus 2008, in 2008, free cash flow was fairly low at about $111 million; in 2009, when we came out of it, our free cash flow almost doubled to $190 million. The same scenario played out from 2015 to 2016, where free cash flow jumped from $160 million in 2015 to $250 million in 2016. So, the bottom line is, I think we will do okay this year. If we execute correctly, we'll be around $375 million, maybe a little better. If history is any lesson, we'll come out of this next year much stronger because of our discipline. Our capital expenditures will be lower this year than last year; Al is kind of controlling that project by project for justification purposes. So I think we should be alright; we do have cash in the bank.

And maybe last for me, can you just touch a little bit more on what you're seeing out of China for respective businesses like test and measurement and some of the environmental businesses there?

Certainly. If I may, you didn’t ask it, but I think in the machine vision business, due to this back to work framework, we’re also doing okay there. In test and measurement, we are lagging a little bit. On the other hand, our protocol in our test and measurement businesses has two legs to it. One part is oscilloscopes and affiliated systems for looking at electronic hardware. The other part—the protocols, which are the standards by which digital imaging systems communicate—is doing really well, both here and in China. Therefore, I think for our test and measurement segment, while we expect it to be essentially flat this year, it's probably going to be down by about 3% or 4%. But China is not our problem; our problem right now is Europe and North America. Moving to environmental, that's a different story. We are seeing some compression in China for two reasons: one, we make a lot of product that goes into air quality monitoring and measurements of air quality, and continual monitoring of that and measurement show weaknesses. The second reason, which is even more troubling, is the Chinese government's emphasis that Chinese companies should buy Chinese-made products. That's not as much discussed in the United States. We have had initiatives like Buy America initiatives earlier, but the emphasis in China is significant. Frankly, I don’t mind assembling products there; I don’t want to manufacture products there due to other concerns. We are seeing some pressure there, and that is of concern, but we do have new products, and we will compete with everyone to secure our market share.

Can you delve into the thermal sensor for skin temperature monitoring? I don’t know if you guys have talked about this much before, so can you remind us about your capabilities for that? Is it a handheld scanner? Is it something that could scan crowds? Just maybe a little more details on that. And then secondly, how fast do you think you can ramp production given all the supply chain issues?

Yes. Let me start with the second part of the question, Andrew, if I may. As I mentioned, unlike other companies that are making such devices, we produce the sensors ourselves in our MEMS foundry in Canada in Bromont, and we manufacture it on a wafer-level packaging scale. So, we have control over our supply chain, which is a good part. The cameras called Caliber, and we've been producing various versions of the Caliber camera for over a year. The specific models we’re discussing are handheld; they are our newest product, which we just commenced manufacturing. I can't tell you how quickly we can scale up production, but we are going to do our best to increase production as fast as we can. The sensors we use that we produce are vanadium oxide-based sensors, which are high quality sensors, 17 microns in pixel size. In contrast, many products worldwide are made from amorphous silicon. Therefore, we believe we have a niche there. Some other companies have gained a lot of publicity because of this domain, but I do not know whether this will significantly move the needle for a $3.2 billion revenue company.

Okay. Can you talk about the potential Photonis acquisition, the rationale behind it, and where do you sit with the French Ministry in getting that approved?

Yes. Let me start with the rationale. Photonis primarily makes night vision products for the war fighters, and they do it for almost the rest of the world that has to have an ITAR-free product; whereas our two companies in the U.S. do not have ITAR restrictions. The second part, business-related, again, is in life sciences, but 80% of their business is in defense. They have nice products, nice processes, but they have lacked the ability to significantly invest or acquire digital imaging companies that would complement it. Almost everything we do in our digital imaging is complementary to what they have, including the infrared sensors I just mentioned. So we believe we will add significant capabilities to that product. Now, where are we? Unfortunately, on March 31, we were verbally notified by the Foreign Investment Office of France that they were going to have a negative opinion from the Minister of Economy, essentially stating there will be a total transaction. Everything has gone quiet since then. There are indications that the Minister of Economy may be reconsidering, but we don’t know. Ultimately, one of two scenarios can develop. They will reaffirm the verbal denial, requiring a written confirmation from them; or they will come back and agree to the transaction but put certain conditions on it, which we are accustomed to. We bought two businesses in France and had operations there, e2v which we purchased several years ago, and we took over the Gas and Flame Detection business from 3M last year. In both cases, there were particular conditions related to the delivery of product to the French government, etc., in terms of how long we kept the businesses, etc. We agreed to those conditions because they were favorable as well. We have a good relationship with the Ministry of Economy and its offices in that domain, and we have a strong track record with them. If the conditions aren’t too onerous for us to run the company, we can complete the transaction. If the conditions would hurt our ability to operate, we would not be able to proceed. So that’s the best answer I can give you. We expect to hear from them; I don’t know if it will be shortly or if it will take several months.

Thank you. If I may, I'll ask Jason now to conclude our conference call. Jason?

Great. Thank you, Robert. And again, thanks, everyone, for joining us this morning. If you have any follow-up questions, my number is on the earnings release, please feel free to call me. Of course, all our news releases and periodic SEC filings are on the web and available. So thank you, everyone. Greg, if you could give the replay information to the audience, we’d appreciate it, and we shall sign off now. Bye-bye.