Teledyne Technologies Inc (TDY) — Q4 2020 Earnings Call Transcript

Thank you, William, and good morning, everyone. This is Jason VanWees, 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 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.

Thank you, Jason. Good morning, and thank you for joining our earnings call. 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 that 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 by the infrared imaging market in 2006 when we acquired Teledyne Scientific and Imaging. We believe then 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 subsea 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.

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 reflect the core sales of X-ray detectors for dental and medical imaging, partially offset by greater sales of infrared and visible detectors for space applications. GAAP 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 Systems 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.

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 to cash flow of $167.9 million for the same period of 2019. Record free cash flow, that is cash from operating activities less 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 significant net discrete tax items in 2021 compared with 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.

Good morning. I'm Greg Konrad.

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 head 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%. Engineered Systems had a great year – the best year among all of our businesses in terms of improving sales. So there, we expect their sales to improve very modestly, less than 1%. 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-FLIR close, is there any reason to think that level of conversion changes?

Well, let me start without FLIR first. We anticipate that our free cash flow will be relatively flat year-over-year, possibly slightly down, due to the exceptional conversion we experienced. Last year, we also had a benefit from a payroll tax of about $24 million. Even though that will be accounted for, it doesn't impact our already strong cash flow, so we will have to repay some of that next year. That said, excluding the one-time charges and expenses from the FLIR acquisition, we expect our cash flow to remain relatively flat, possibly a bit down next year, but still very close to the record we set this year. Regarding FLIR, it's a bit challenging to determine the exact cash flow right now. However, based on historical trends, we believe that on an adjusted basis, the combined adjusted EBITDA after the acquisition would be around $1.2 billion. That's about the best estimate I can provide at this time based on what I currently 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, for which we have a commitment. And the remainder of the $4 billion that we need will come in corporate bonds, and that we will do after we have obtained a rating for ourselves from the rating agencies, Moody's and S&P. And I think we will get an 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-EBITDA multiple to 4.8, and we think this would conveniently put us in a position where we will have cash on hand after the acquisition. And our covenants are about 4.75% to about 4.8% in net debt. And the last thing I would say is that we managed to also get a commitment to increase our line of credit from about what it is now $750 million to over $1.1 billion. So that's about the best I can do.

Thank you.

Sure, Greg.

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 business starts to recover?

Well, there are two parts to that. There's the X-rays for dental imaging, which already are recovering. Then there's the X-ray for cancer treatment, 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 these 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%. At least 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 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 Q4, was there any of the major segments unusually strong that led to a...

Yes, 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 our Aerospace and Defense businesses and our micro electro mechanical systems foundries.

Got it. Okay, thanks very much.

Sure, Jim.

Thanks for taking the questions. I'll start just on Aerospace and Defense Electronics. Given what's happened in that space, and I know you're being conservative about the ramp back on the commercial side. How do we think about margin recovery in that business, given the costs that you took out? 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 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 a Swiss contract. Just curious like, I think you mentioned Engineered offered a good year as kind of a flat outlook. What's the path over the next few years in Engineered Systems just based on the pacing of contracts that you've won and the deployment schedules there?

Yes. First, I want to mention that we anticipate a reduction in our business. We manufacture turbine engines for missiles, specifically harpoon missiles, and this line will conclude at the end of the first quarter. Consequently, we expect a decrease in turbine engine sales, which are also profitable, impacting our revenue by approximately $20 million next year. On the expansion front, we are hopeful to maintain our revenue year-over-year, as we had a strong performance in 2020. We have secured several multi-year contracts, some of which have been announced in our press releases. We estimate around $0.5 billion in new contracts or renewals from last year. Specifically, concerning the Swiss contract, our ongoing programs are projected to total roughly $250 million. Additionally, we received a foreign military sales contract for new boats amounting to about $35 million, with an advance of $40 million. This is a positive development for that sector, and we are enthusiastic about it since that underwater vehicle employs many sensors we've developed within our marine businesses. I hope this answers your question adequately.

Yes. Yes. Yes. 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 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 the very high side of that business. I think we're going to go down to closer to 10.5% next year.

That makes sense. And then just last for me. Any update on how you're thinking of presenting FLIR once you close it? 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 the incremental operating performance plus the one-time costs associated with it?

Yes. We'll set aside the one-time cost, which is expected to be significant, around $175 million, possibly a bit more. Assuming the merger occurs on July 1, we can view the acquisition in two ways. On an adjusted basis, considering only the intangible amortization, it will be accretive almost immediately, with significant accretion in the first full year, potentially around $2.50. After accounting for an estimated $40 million in tax and cost savings in the first full year, we expect it to be marginally accretive on a GAAP basis. In terms of combined revenue, the 2020 pro forma shows about $5 billion, while including FLIR for the first full year would result in approximately $5.2 billion in revenue. We'll continue to present free cash flow similarly to how we do now, likely on a non-GAAP basis, as our agreement with lenders excludes the one-time costs from our net debt-to-EBITDA calculations. We will provide a detailed table of free cash flow to clarify all of this.

Thanks, guys.

Thanks, Joe.

Morning, guys.

Good morning, Andrew.

I wanted to ask on, 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 deliver better than that. For us, as a stand-alone company, again, excluding any one-time charges, which are 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 time, or last quarter, a little bit—I guess your expectations around the Biden administration would not be great for your defense business. Have you given that much more thought now that's coming to fruition? Broadly, it sounds like defense still has some legs into 2021. But I guess, what's your outlook beyond that?

Well, 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 defense spending because they obviously don't want to 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 on the defense side. There are other things, of course, that will affect us, which would be interest rates if they went up. And of course, taxes will hit all corporations if they were to go up.

Okay. And last one, this might be a little out there, but you guys sounded really excited about potential M&A this year, pre-FLIR. 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. If something really attractive came along, and we thought we could do it while being as busy as we are at this time in going to be integrating, we would have the capacity. As I mentioned, we would have another almost $1 billion that we can spend. But I don't—I would say it's not likely at this time because of the amount of work we have. Now on the other hand, if it's a small bolt-on that we can tuck away into one of our businesses, yes, we could do it.

Okay, thank you.

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 the news releases are available on our website. And of course, should you have follow-up questions, my numbers 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.