Teledyne Technologies Inc (TDY) — Q3 2021 Earnings Call Transcript

Thanks, Brad and good morning, everyone. This is Jason VanWees, Vice Chairman of Teledyne, and I'd like to welcome everyone to our third quarter earnings release conference call. And of course, we released our earnings earlier this morning before the market opened. Joining me today are Teledyne's Chairman, President and CEO, Robert Mehrabian; Senior Vice President and CFO, Sue Main; and Senior Vice President, General Counsel Chief Compliance Officer and Secretary, Melanie Cibik. After remarks by Robert and Sue, we will ask for your questions. However, before we get started 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 and thank you for joining our earnings call. I'm very pleased with both our operational execution and our financial performance in the third quarter. We achieved record revenue 75.2% greater than last year driven by organic growth of 11.9% and the remaining 63.3% of sales increase contributed by Teledyne FLIR. Revenue increased organically in every major business group, but was especially strong in our Commercial Imaging and Electronic Test and Measurement Instrumentation businesses where organic growth for each was greater than 20% in the quarter. Furthermore, orders exceeded sales for the fourth consecutive quarter with a third quarter book-to-bill of 1.1. GAAP earnings per share of $2.81 increased 13.3% compared to last year and was $0.03 less than our record GAAP third quarter earnings achieved in 2019. However, excluding acquisition-related charges earnings were $4.34 per share in the third quarter an increase of 61.9% on a comparable basis from 2020. Cash flow was a third quarter record allowing repayment of $300 million of debt while our leverage ratio declined to 3.3% from 3.7% at the end of the second quarter. Teledyne FLIR performed strongly in its first full quarter. Integration efforts have been swift and we are increasingly excited about the long-term future with Teledyne. We continue to accelerate the pace of planned synergies and currently expect to achieve our annualized cost saving target of $80 million before the middle of 2022 as opposed to the end of 2022 as we described in our July earnings call and compared with 2024 as noted when we announced the transaction in January of 2021. Regarding our execution in the quarter, Teledyne is not immune to supply chain issues, inflation and other operational challenges. However, to date we've been successfully navigating and managing these issues. And today we are pleased to increase our full year sales, margin and earnings outlook compared outlook we presented in July. On a full year basis we now think a reasonable outlook for organic sales growth in 2021 is approximately 7% to 7.5% led by forecasted growth of almost 13% in Digital Imaging which excludes Teledyne FLIR. This translates to total sales of $4.59 billion with contribution of $2.4 billion from Digital Imaging including FLIR. I will now further comment on the performance of the four business segments. In our Digital Imaging segment, third quarter sales increased 217.3%, largely due to the FLIR acquisition, but organic growth in our combined commercial and government imaging businesses was also very strong at 17.9%. Sales of industrial and scientific vision systems were a record and healthcare sales returned to pre-pandemic levels. GAAP segment operating margin was 12.5%. But adjusted for transaction costs and purchase accounting segment margin was 23.9%. In our Instrumentation segment, overall quarter sales increased 9% versus last year. Sales of test and electronic test and measurement systems, which include oscilloscopes and protocol analyzers were exceptionally strong and increased 20.8% year-over-year to record levels. Sales of Environmental Instruments increased 7.6% from last year with sales related to human health and safety market such as drug discovery and gas and flame detection being strongest in the quarter. Sales of Marine Instrumentation increased 3.2% in the quarter. In addition, orders were the strongest in the last six quarters with a quarter book-to-bill of 1.13. Overall, Instrumentation segment operating profit increased 24.3% with segment operating margin increasing 270 basis points or 247 basis points excluding intangible asset amortization. In the Aerospace and Defense Electronics segment, third quarter sales increased 11.7%, driven by 8.4% growth in Defense, Space and Industrial sales, combined with a 27% increase in sales of commercial aerospace products versus last year's pandemic-related tough quarter. GAAP operating profit increased 34.5% with margin 375 basis points greater than last year. Finally, in the Engineered Systems segment, third quarter revenue increased 1.4% but operating profit and margin declined slightly, since we exited the higher-margin turbine engine business earlier this year. But before turning the call over to Sue, I want to comment on our margin and earnings outlook. For several years, we've been on a journey to move our overall operating margin from the low teens to over 20%. Over the last 2.5 years, we've made tremendous progress notwithstanding the pandemic and the recent supply chain and inflationary pressures. Today, the approximate $1 increase in our earnings outlook is primarily the result of further improvement in our full year 2021 forecasted operating margin, which excluding acquisition-related charges is 100 basis points better at approximately 21% from our 20% forecast in July. And now 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 fourth quarter and full-year 2021 outlook. In the third quarter cash flow from operating activities was $192.8 million, including all acquisition-related costs. Excluding acquisition-related cash costs, net of tax cash from operations was $194.9 million compared with cash flow of $150.3 million for the same period of 2020. Free cash flow, that is cash from operating activities less capital expenditures, excluding acquisition-related costs was $165.7 million in the third quarter of 2021 compared with $135.1 million in 2020. Capital expenditures were $29.2 million in the third quarter compared to $15.2 million for the same period of 2020. Depreciation and amortization expense was $90.2 million for the third quarter of 2021 compared with $29.2 million in 2020. In addition, non-cash inventory step-up expense for the third quarter of 2021 was $35.2 million. We ended the quarter with approximately $3.89 billion of net debt. That is approximately $4.44 billion of debt less cash of $561.8 million. Stock option compensation expense was $5.8 million for the third quarter of 2021 compared to $5.7 million for the same period of 2020. Resulting from the FLIR acquisition, restricted stock unit expense for FLIR employees was $1.8 million in the third quarter of 2021. Turning to our outlook. Management currently believes that GAAP earnings per share in the fourth quarter of 2021, will be in the range of $2.53 to $2.69 per share with non-GAAP earnings in the range of $4.07 to $4.17. And for the full-year 2021 our GAAP earnings per share outlook is $9.13 to $9.29; and on a non-GAAP basis $16.35 to $16.45 compared with our prior outlook of $15.25 to $15.50. The 2021 full-year estimated tax rate excluding discrete items is expected to be 23.9%. In addition, we currently expect less discrete tax items in 2021 compared with 2020. I'll now pass the call back to Robert.

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

Good morning and great quarter.

Thank you, Greg.

Maybe just to start, I mean you talked about a lot of the higher outlook based on the margin. At least on the beat it seems pretty broad-based across segments. I mean how do you think about the drivers there and just sustainability given tailwinds or potential headwinds? And I think previously you've always had a target of how much margin expansion you'd like to capture per year. I mean has anything changed around that as margins have reset higher?

Our expectation is that our margins will continue to increase, as we projected. We believe it could be around 60 basis points per year above our current level. I previously mentioned 100 basis points, but our margins have now risen to 21% in Q3. While it may become a bit more challenging, we aim to improve our margins as we progress.

You mentioned that the FLIR synergies will accelerate in the middle of next year. What enabled you to bring that timeline forward, and what could this mean for the long-term potential to enhance productivity and reduce costs in the business?

I think, in addition to wages, which are significant at about $45 million in net benefits, the more important achievement has been reducing our reliance on third-party consultants, legal expenses, and lobbyists. As you know, we do not employ lobbyists at Teledyne. The Board fees, public relations, and similar areas contribute, but I would estimate the savings from third-party consultants and legal lobbyists to be between $28 million and $30 million.

You briefly mentioned inflation earlier. How are you addressing the offsets related to it? How much does it pertain to the supply chain, and are there specific areas in the business where you have more pricing flexibility? I'm trying to assess the overall risk related to price mix.

So far when we look at the PPI, inflations are pretty high. We're not experiencing as much as we anticipated in the price pressure to us from our suppliers. Having said that, some of our suppliers more recently have come out with 20% to 25% price increases. Good part of it is, we have long-term agreements with some of them. So those would moderate. As for ourselves, so far this year, we've been able to increase prices on average about 2%. What that means, in some businesses, we can't obviously increase prices, because we have long-term contracts, Greg. But in other businesses, we do have the ability to increase prices. So on average, we've increased 2%. Our intention is to continue doing that. And perhaps, especially, next year, we'll start early and see how much elasticity we have in our prices.

Thank you.

Thank you, Greg.

Hi. Good morning, everyone. Thank you for the time. So I'm just curious, within your government business, are there any watch items like new starts or programs with significant ramps that you're keeping a closer eye on while the U.S. is operating under this continuing resolution?

Yes, Mike. First, let me mention that our government business makes up about 26% to 27% of our total. We are closely monitoring two opportunities: one is underwater vehicles, and the government is currently soliciting proposals for a medium underwater unmanned vehicle, which we are bidding on through both our Engineered Systems and Marine businesses, similar to our approach with gliders and other projects. Additionally, we're expecting to bid on a large underwater vehicle. In the Digital Imaging segment, we see potential with the wide field of view early warning satellite, as well as with our next-generation overhead persistent infrared system. The only downside is that we need to re-bid on our NASA program, referred to as the Mission Systems program later this year, and although we haven't submitted our bid yet, the decision will come later. There is always a risk involved with re-bidding. Overall, there are numerous new programs available to us even with the continuing resolution in place.

Got it. And then, to the point in your release about the recovery in the longer-cycle business, now that you have that would you sort of be willing to talk about the early trends that you're seeing into next year within the business?

Right now, I would say that opportunities would be in our Marine businesses primarily, because the oil prices, as you're well aware, Mike, have moved up significantly. And we had a book-to-bill of 1.13 this quarter. We also think that we will have more opportunities in Aerospace and Defense businesses, especially on the aerospace side as people start traveling more. We think that Marine may have an upside next year of maybe $25 million and controls, which is our computers that go on various aircraft. That can have a similar number $20 million to $25 million. Those are longer-cycle businesses, and so far they look all right. On the shorter cycle which the other side of the Instrument, we enjoyed a 9% increase overall. And T&M, our test and measurement is doing well. And we hope that with our new products that we keep developing that will have some bump next year too.

Got it. Thank you.

Thank you, Mike.

Hi. Good morning. When we think about the FLIR integration and the acceleration and the timeline to achieving the initial cost savings, where do you think we could potentially see additional upside to, I think before the top side had been to $100 million. I mean how much additional headwind or how much additional headroom is there into achieving additional cost synergies and savings?

Elizabeth, let me start with, I hope I didn't misquote myself. Our top side savings for which we moved forward from 2024 to 2022 is $80 million. Having said that, there are other opportunities, but there would be more opportunities in developing products between FLIR's offerings and Teledyne's offerings. And as we move the revenue up and keep our cost down, we think that will help improve our margins. But we haven't factored that in the revenue synergies yet, because right now we're still integrating. We've integrated some of the businesses very quickly. Like, they make midrange vision systems and make high-end vision systems and those we've coupled right away and that's worked out really well. But we're still working on the rest of the stuff. Like in the Marine, Raymarine and our Marine businesses, there are opportunities. There are opportunities between their Raymarine businesses and our software businesses and underwater software businesses at Karas. We're working on all of those. As we do that I think those would create more savings as we go forward.

Okay. And then, as you continue to delever, how are you considering or thinking about the M&A environment and additional opportunities to grow inorganically?

Yes. Elizabeth, first on the delivering, we're not sitting at 3.3x net debt to EBITDA. We hope to take that down to about 2.7 by the end of 2022. That would be our marker. As we look at that when you're kind of start getting confident that you're going to go there you start looking at larger acquisition potentials because those things take a little time to get eight, nine months. But in the interim, we will look at and we are looking at smaller acquisitions. As we did back in 2017 when we acquired e2v, our debt to EBITDA ratio was pretty high. We very quickly delevered over the next three years. But in the interim we also bought about $500 million of smaller assets. So we'll do the shorter term. We'll do small acquisitions. In the longer term, we've promised the rating agencies that we won't do anything very big but we are sure we can hit our targets.

Okay. Thank you.

Thank you, Elizabeth.

Hi, good morning. Robert, a question on the FLIR business. Organic growth there looks like it was fairly modest. And I don't recall them having much of an EST contribution in last year's Q3. Is any of this either portfolio realignment? Their commercial business appears to be doing okay. I think the machine vision business probably was pretty healthy. Is it their government related business that was a little slower?

Jim, their EST business, which includes the sensors and solutions sectors, generated approximately $40 million in revenue during last year's third quarter, which had overall revenue of about $466 million. This year's third quarter revenue is $474 million, excluding any EST revenue. If we compare them directly, by removing the $40 million from last year's $466 million, we see around $426 million to $427 million last year, compared to this year's $474 million, indicating significant growth. Additionally, there has been a reasonable growth of about 3.5% in the FLIR Defense segment this year versus last year, primarily driven by unmanned systems. So, we are seeing growth in both the commercial and defense sectors, even after adjusting for last year's EST sales in the third quarter.

No. Thanks for clarifying that. You're right. They did about $90 million in Q2, and even though it was down to $40 million Q3 that's still a fairly significant contribution. Thanks for pointing that out, Robert. On the test and measurement business, you guys have performed really well there. And what I'm wondering is structurally is there anything changing in that business in that market? Is it market share gains? Is it the activity you're seeing in the protocol analyzer business? Are you gaining share, do you think, in the scopes business?

Yeah, Jim, both. First of all, we're performing exceptionally well in our protocol analyzer business. When you combine our protocol analyzer and oscilloscope sales, we achieved an all-time record this quarter. There's very strong demand for our protocol analyzers like PCI Express, as well as high-definition multimedia video products. Additionally, we've successfully integrated our oscilloscopes with our protocol analyzers, which significantly reduces the time engineers spend developing interfaces between products. This has been a major advantage for us. So, we have a solid market for oscilloscopes, a strong market for protocol analyzers, and additional benefits when we combine the two with new products.

Got it. And two quick final questions. This next question may be difficult to answer, but you seem to be navigating the component environment fairly well. I'm wondering if you can indicate whether there has been any identifiable disruption to revenues. In other words, are there revenues that you might have been able to achieve in the quarter but are challenging to realize due to difficulties in obtaining parts?

Yes, that's a great question. I can respond because we monitor that closely. In the quarter, we likely missed out on about $40 million in revenue, not due to shortages. Fortunately, due to the structure of our business portfolio, we can compensate for this in other areas. We have a balanced portfolio, and these shortages are not affecting everything we do. These are not lost sales; they are just delayed until Q4. We anticipate a similar situation in Q4 and see similar issues for Q1 next year. It’s a shifting scenario, but we offset it by drawing from other segments of our portfolio. Additionally, we have a very active procurement program, with a significant focus on procurement automation. Our procurement team is collaborating with suppliers in the Far East who supply us with PCBAs. They have access to the necessary components and are assisting us in acquiring some of the computer chips and other parts we need. We also have dedicated personnel in the Far East working on this as well. So, we push the $40 million forward, take another $40 million from this current quarter and push it forward, and pull in whatever we can. As I mentioned before, we're managing it well, and I think so far, we’ve done okay.

Got it. And last question Robert, you alluded to a fairly strong book-to-bill in Marine. Can you give us a sense of book-to-bill in the various segments Digital Imaging and the A&D?

Sure, Jim. Let me start with Marine. In environmental and test and measurement, it's 1.05 in Q3. We had record sales in T&M in Q3, so 1.05 is pretty good. For Digital Imaging, it's 1.12; for our Defense and Aerospace businesses, it's 1.06; and for Engineered Systems, it's 1.05. Overall, that brings it to about 1.1.

Got it. Thanks very much. Congratulations on the quarter.

Thank you, Jim.

Good morning, guys.

Good morning.

On that book-to-bill comment, can you indicate how bookings are for FLIR within Digital Imaging?

They're modest, but they're in the 1.1 in the Digital Imaging side.

Okay. Okay. So still above 1 though?

Yes.

Okay. And then, sorry, what was that?

No, I mentioned it regarding the Digital Imaging side. The total is yes.

You mentioned positive developments regarding government contracts and that you're still securing a fair share of government awards. Can you share any insights related to FLIR? Additionally, while it may not be immediate, do you foresee any opportunities in 2022, considering that securing meaningful new awards has previously been a challenge for them?

Yes, I want to share that we are maintaining our position. Things have slightly shifted in timing, but we received some solid orders, particularly in US border control with the delivery of light vehicle surveillance systems. We also have a DARPA program that could lead to further developments in personal protective biosystems. Overall, I believe we are doing well and I expect us to perform adequately. Importantly, if you observe our government operations with FLIR, we possess a well-balanced portfolio. Unfortunately, their performance may have been slightly impacted due to a narrow focus. We have a diverse mix including our Engineered Systems, FLIR’s unmanned ground and aerial systems, and integrated systems, along with our Defense programs in Aerospace and Defense. In Q3, we saw about a 3.5% increase in our government programs. While this may seem modest compared to our overall organic growth of 11.9%, I am satisfied with it. If we can maintain this momentum going forward, we should be in good shape.

Okay. And maybe just lastly, you're seeing some of your longer-cycle businesses pick up a bit. I know it's small, but can you just comment on what's going on with Energy specifically your sales tied to Energy exposure?

Yes. The primary reason is the oil prices, and we anticipate a total sales increase of about 3% from 2021 to 2022, which translates to approximately $150 million rising to around $175 million. While that's slightly over 3%, it's closer to 2.1% when I consider it further. That said, I'll refer back to our portfolio strategy. We have gains in various areas such as Defense, Energy, our short-cycle businesses, and Digital Imaging, where we're performing strongly. We believe we will be in a good position. While there is potential for growth in Energy, I’m not relying on it to drive the company's overall performance. The overall performance will depend on the combination of the various segments we've developed, which also provide us with some protection against downside risks, as you know well, Andrew.

Okay. Thanks Robert.

Thank you. Do we have any other questions coming up.

Okay. Joe?

Guys can you hear me?

Yes. Yes.

So you kind of hinted at this already, but if you were to kind of think about FLIR ex the EST, what do you think is like the true growth rate that you're exiting 2021 into '22? And is that kind of a sustainable rate into '22?

Right now, if you subtract out EST which as I mentioned, we had no revenue this year, I think it would be in the mid-single digits, just like we think Teledyne should be.

Yes. And then, if you were to contemplate, go ahead.

No. I'll just say this. When we started the year, we said our organic growth would be 5.5% to 6%. As we got to July, we adjusted it to 6.6%. Now, I mentioned today that it would be between 7% and 7.5%, about 7.25%. So, I'm hopeful that when I refer to mid-single digits like 5%, that would indicate a strong start for us next year.

Yes. Understood. If you're talking about getting to like an $80 million run rate in savings by mid '22 for FLIR, what does that kind of imply for a margin there? I mean, if you want to talk EBITDA, whatever is easiest to talk about?

I mentioned earlier that we expect to improve our margins by 50 to 60 basis points across the company year-over-year. Whether considering non-GAAP or EBITDA, our current EBITDA is about 24.2% for this quarter. This should help enhance our non-GAAP margins. Currently, FLIR's margin stands at around 24%, which is significantly higher than our historical figures. For 2021, we anticipate our overall non-GAAP margin, excluding intangibles and costs related to purchase accounting, to reach 21%. If we can achieve an additional 50 basis points, especially from FLIR's contributions, we would be very pleased with that. As we approach January, assuming nothing adverse occurs globally, we hope to perform even better. However, for now, I am sticking with the 50 basis point projection.

Can you discuss the recent discussions about China's nuclear gliders and suborbital capabilities, and what implications this has for space-based detection and sensing? Additionally, how is your company positioned in this area and how might this market evolve in response to new threats?

Yes. I can provide two examples. One is from our Engineered Systems segment, where we are working on a contract to develop a wind tunnel for vehicles similar to those you mentioned. This is significant because testing hypersonic vehicles requires a hot wind tunnel. We have a small program worth $50 million, which we anticipate will lead to a larger program focused specifically on hypersonic vehicles. Additionally, in the A&D segment of FLIR, particularly in Digital Imaging, we are developing sensors that utilize edge computers on various vehicles for the detection of high-speed missiles. If this market expands, we have a range of products ready. Furthermore, we have multiple classified programs in our imaging business based in Thousand Oaks that involve locating infrared and other sensors on satellites and space vehicles. We are capitalizing on some excellent opportunities, which have contributed to the growth of our imaging programs.

Thanks, guys.

Thank you very much.

Hey. Thanks for letting me back on. Unless, I missed it somewhere Robert, would you be able to go around the horn on the change in growth rate at the segments that drove the change in guidance?

Yeah. Let me see. I can do that. So in July, we anticipated that the growth rate in Instruments would be about 6%, 6.2% and we expect that to continue. In Digital Imaging in July, we anticipated about 11.8%. We're raising that to about 13%. In our Aerospace and Defense segment in July, we anticipated 4.4% about and now we think it'll be closer to 6%. Engineered Systems we expect it to shrink about 1.7%, and it will shrink 1.7%. When you add those up, Mike in July we anticipated that our organic growth would be about 6.6%. If you add the numbers up that I just mentioned round them up, it'll be between 7% to 7.5% let's say, 7.25% organic growth. And that's kind of going around the horn as you mentioned.

Thank you.

For sure.

Thank you, Brad. I'll now ask Jason to conclude the conference call please.

Thanks, Robert. And again, if anyone has follow-up questions my number is on the earnings release. Please feel free to call and e-mail me. And Brad, if you could give the replay information and conclude the call we'd be appreciative. Thanks everyone.