Teledyne Technologies Inc (TDY) — Q4 2023 Earnings Call Transcript

Thanks, Tom, and thanks, everyone. This is Jason VanWees, Vice Chairman. I would like to welcome everyone to Teledyne's Fourth Quarter and full year 2023 earnings release conference call. We released our earnings earlier this morning. Joining me today are Teledyne's Executive Chairman, Robert Mehrabian, and our new yet familiar management team, CEO, Edwin Roks, President and COO, George Bobb, Senior Vice President and CFO, Steve Blackwood, and also Melanie Cibik, EVP and General Counsel, Chief Compliance Officer and Secretary. After remarks by Robert, Edwin, George, and Steve, we will ask for your questions. Of course, so before we get started, I've been reminded 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. 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, and thank you for joining our earnings call. In the fourth quarter, we achieved all-time record sales and GAAP and non-GAAP earnings per share. Sales increased primarily due to the performance of our Marine, medical, and aerospace businesses, which more than compensated for the previously announced headwind in the industrial automation and laboratory instrumentation market. Furthermore, overall record orders exceeded sales in every business segment but were particularly strong in our Marine and Defense businesses. Leverage declined further to 1.9%, and our balance sheet remains healthy. Finally, we continue to acquire complementary businesses, as shown by the acquisition of Zeno Networks in the fourth quarter. Compared with last year, fourth quarter and full year non-GAAP operating margin increased by 27 and 57 basis points, respectively. Our broad-based strength in orders was encouraging, especially in the uncertain global macro environment today. Nevertheless, it's worth noting that most of the increase in orders was in our backlog-driven longer-cycle businesses. So converting the orders to sales will take a little time. In terms of our 2024 outlook, we think the quarterly sales and earnings ramp will be slightly greater than in recent years. While we see annual 2024 sales growth of about 4%, we believe that typically seasonally low first quarter will be slightly under $1.4 billion or roughly flat with last year. I will now turn the call over to Edwin and George, who will further comment on the performance of our four business segments.

Thank you, Robert. This is Edwin, and I will report on the Digital Imaging segment, which is 56% of Teledyne's portfolio. Like Teledyne as a whole, this segment is a mix of longer-cycle businesses such as defense, space, and health care, combined with shorter-cycle markets, including industrial automation, semiconductor inspection, and infrared components and cameras for applications ranging from factory condition monitoring to maritime navigation. Fourth quarter 2023 sales were slightly lower compared to last year. Double-digit sales growth in each of X-ray products, FLIR surveillance systems, and space-based infrared imaging detectors offset a significant year-over-year decline in sales of industrial imaging systems and Micro Electro Mechanical Systems, or MEMS. Fourth quarter sales of unmanned systems were at the greatest level in 2023 but declined year-over-year due to a tough comparison. For the second quarter in a row, the FLIR business collective fleet were positive contributors to overall segment margin. In addition, FLIR quarterly sales increased year-over-year and were at the highest level in the last two years. George will now report on the other three segments, which will represent the remaining 44% of Teledyne.

Thanks, Edwin. The instrumentation segment consists of our Marine, test and measurement, and environmental businesses, which contributed a little over 23% of sales. Overall, fourth quarter sales in this segment increased 2.8% versus last year. Sales of marine instruments increased 14.7% in the quarter, primarily due to strong offshore energy sales but also continued growth in global defense and ocean science markets. Sales of electronic test and measurement systems, which include oscilloscopes, digitizers, and protocol analyzers, were flat year-over-year. We continue to see some softness in sales of analyzers for electronic storage and data center applications, but this was largely offset by continued strong sales of oscilloscopes and a small amount of incremental sales from the Zeno acquisition. Sales of environmental instruments decreased 7.3%, with greater sales of air quality and gas and flame safety analyzers more than offset by lower sales of drug discovery and laboratory instruments. Overall, instrumentation segment operating profit increased over 14% in the fourth quarter, with GAAP operating margin increasing 284 basis points to 27.1%, and 278 basis points on a non-GAAP basis to 28.1%, both all-time records for the segments. In the Aerospace and Defense Electronics segment, which represents 13% of Teledyne sales, fourth quarter sales increased 3.4%, primarily driven by growth in commercial aerospace products. GAAP and non-GAAP segment operating profit decreased approximately 5% year-over-year primarily due to a tough comparison with last year's all-time record segment margin. For the Engineered Systems segment, which contributes 8% to overall sales, fourth quarter revenue decreased 3.8%, but operating profit increased with margin up 325 basis points. I will now pass the call back to Robert.

Thank you, George. In conclusion, we were pleased with our record performance in 2023. In the near term, we will continue to focus on growth in those businesses with favorable markets while cutting costs and protecting margins in businesses that are more challenged. At the same time, we will be acquiring and integrating complementary businesses. When certain markets like laboratory instrumentation, industrial automation, or electronic test measurement recover, we will keep our cost structure in check and benefit handsomely. If there are global or macroeconomic shocks in 2024, we will do what we've done in the past: execute well, generate record cash flow, and complete some of our base and potentially larger acquisitions. I will now turn the call over to Steve.

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 first quarter and full year 2024 outlook. In the fourth quarter, cash flow from operating activities was $164.4 million compared with $237.7 million in 2022. Free cash flow, that is cash from operating activities less capital expenditures, was $124.2 million in the fourth quarter of 2023 compared with $203.6 million in 2022. Cash flow declined in the fourth quarter since we made $139 million of additional tax payments, which we were allowed to defer from the second and third quarter of 2023, due to IRS disaster relief. Without these catch-up tax payments, quarterly cash flow would have been at an all-time record. Capital expenditures were $40.2 million in the fourth quarter of 2023 compared with $34.1 million in 2022. Depreciation and amortization expense was $77.4 million for the fourth quarter of 2023, compared with $81.8 million in 2022. We ended the quarter with approximately $2.60 billion of net debt, which is approximately $3.24 billion of debt less cash of $48.3 million. Now turning to our outlook, management currently believes that GAAP earnings per share in the first quarter of 2024 will be in the range of $3.73 to $3.86, with non-GAAP earnings in the range of $4.55 to $4.65 per share. For the full year of 2024, our GAAP earnings per share outlook is $17.15 to $17.53, and on a non-GAAP basis, $20.35 to $20.68. The 2024 full year estimated tax rate, excluding discrete items, is expected to be 22.5%. I will now pass the call back to Robert.

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

I wanted to see if we could dig a little bit more into the way you see the year unfolding. It sounds like Q1 will have a little bit more seasonality. And I guess, with respect to the full year guidance, as you think about the balance of the year, are you making some assumptions of recovery in the shorter cycle business in the latter part of the year, particularly in some of the areas that have been weaker, like the lab instrumentation and the industrial automation, machine vision area?

Alright. Yes. We're currently expecting an uptick in those businesses in the second half of the year. We think that what will happen is that we will have a linear ramp in sales and earnings throughout the year, with an average revenue increase of about 4% and earnings as we've outlined up to $20.68, which would reflect an improvement in margin from this year to next year of almost 50 to 60 basis points. So yes, we're anticipating that. On the other hand, we're also adjusting our cost structure, and if necessary, we'll do more, so that our earnings remain healthy.

With respect to the margin improvement that you're anticipating, I'm wondering how should we think about margins by some of the major business units just directionally?

Sure. Jim, we are expecting margin improvement in every segment, a little lower in instruments, maybe 25 basis points. We already have very healthy margins there. On the other hand, in Digital Imaging, about 80 basis points. In Aerospace and Defense, we think we'll have 80 to 90 basis points. And Engineered Systems around 50 basis points. So overall, Jim, in the segments, we anticipate about 70 basis points margin improvement, and overall, for the company between 50 and 60 basis points. In a way, it's kind of similar to what we achieved this year, which was about 60 basis points over last year.

Maybe just to follow up on the last question, but on the revenue side, given the commentary around book to bill, 4% growth for the year. Can you maybe talk about the assumptions between long and short cycle or from a segment basis for growth in 2024?

Yes, Greg, let me give you the segment first. And then I'll try and answer the first question. From a segment perspective, we think instrumentation will grow about 3.5% this year over last year. The marine businesses with healthy backlog, as George mentioned, would grow about 6% to 6.5%, whereas environmental would be just under 3%, and we're expecting T&M to basically hold. Going to Digital Imaging, we believe that the overall sales increase would be above 4%. Aerospace and Defense, about 5%. Engineered Systems, about 4%. And when you add all of that up, we expect an average of about 4% at this time.

And then maybe if we can just dig into digital imaging a little bit more. I mean the commentary and the release around product lines on the call was helpful. But is there any way just for Q4 in 2023 to kind of level set or put some numbers behind growth in space and health care versus maybe the declines you've seen in other parts of the portfolio?

Sure. Let me start with Q4, please, and then I'll go to some of the others. In health care, we had really nice Q4. Revenue increased about 13.5% to 14%. In Aerospace and Defense, it increased about 5%. This offset the weakness in our industrial and scientific vision systems. The flip side, if you go over to our FLIR businesses, we have vigorous growth in our surveillance systems, about 16.5%, and some of our detection products. Overall, in Q4, FLIR revenue defense increased about 4.8%. Now going forward, to the future, I’ll make a little distinction between DALSA e2v and FLIR. We think that DALSA e2v would have modest growth of about 3%, offset by about 4.5% in FLIR. As mentioned earlier, clear defense especially is experiencing really good order intake, and we expect the growth there to exceed that of the rest of the imaging. So I can give you more detail, but that's basically a summary of it.

This is Jordan Lines on for Ron. I wanted to ask, for the backlog growth in the defense wins that you guys are seeing, how are you all thinking about the risk of the CR?

Certainly. CR is always an unfortunate situation for us. Currently, we are only focused on the orders we have in-house and are not considering future orders. The book-to-bill ratio has been strong, as these are long-term programs. We have some promising new products in testing, such as the Black Hornet 3 nano drones, which have performed well over the past five to six years. We recently introduced the Black Hornet 4, and it is already gaining traction. Additionally, we have solid programs with the space development agency and our international sales in that area are robust. Therefore, while CR is a negative experience, we have effectively managed similar situations before and our backlog remains healthy.

Got it. And then on the Unmanned Systems – Air systems that you guys cited as being lower for DI. Is that related to just sunsetting programs? Or what was driving that change?

I think basically it’s tough comps rather than real declines. We think our drone businesses are healthy. We also have some businesses that are anti-drone or flame detection systems, which we’re selling in Europe, which are very healthy. So I think it’s just a matter of tough comparisons. Other than that, we feel very good about our drone businesses.

How are you doing?

Good, Joe. Good.

I'll begin with free cash flow. It seems that it ended up being somewhat lower than expected for the full year. Could you discuss your outlook for 2024 and provide insights on working capital for the year?

Yes, you're right. It came in a little lighter, but we made some good progress in the third quarter and especially in the fourth quarter regarding our managed working capital. We had significant improvement in our efforts to reduce our inventory. The downside is that, like most companies, we are always struggling to secure cash for our R&D. I’d estimate that impacted us by around $60 million to $75 million. However, if you look at our cash situation, we paid down $680 million of debt in 2023. Our net debt-to-EBITDA ratio is about 1.9. Looking ahead to 2024, we believe we'll perform a bit better than we did in 2023. We hope to achieve a 100% conversion, acknowledging that we will always face this R&D challenge. Even though there is broad agreement in Congress that the R&D program should pass, it seems nothing is progressing. Nonetheless, we anticipate we will be in the range of $900 million to $1 billion. If we reach those figures, which we believe we will, our debt-to-EBITDA ratio should decrease from 1.9 to around 1.1 to 1.2, placing us in a strong position for both small and mid-sized acquisitions.

That's really helpful information. For my last question, we've discussed this quite a bit, but could you provide some perspective on how much the industrial and scientific vision was down for the full year of 2023? What impact did that have on margins? Also, how did FLIR's margins for the full year compare to the previous year?

Okay. Let me pick the first part. Industrial and scientific vision, I'm going to say, were down about 2% year-over-year, larger declines in Q4 than that. In terms of the margins, FLIR margins actually improved significantly year-over-year. It went from 20.3% in 2022 to 22.1% in 2023, which was very healthy. As a consequence, we were able to hold the overall margins in Digital Imaging relatively flat.

And you'd expect FLIR to expand margins again in '24, correct? Just inherent in that margin commentary?

Yes. We think FLIR would have some margin expansion. But if you look at it as a whole segment, that is our Digital Imaging segment, we expect margins to increase somewhere between 50 and 100 basis points in 2024.

Robert, last year, you talked about some facility consolidation at Digital Imaging. You're also talking about 80 basis points in margin expansion this year for the segment. How much of that is from this consolidation or the floor integration? And how much of that is from better price-cost? And ultimately, could we expect to see higher margins there if you have additional cost takeout you could do this year?

Yes, Kristine, let me see if I can address this clearly. We are in the process, for example, of space consolidation. What we're doing is we're getting out of leased spaces and moving to owned spaces. For example, in Massachusetts, we have an owned space in Bevrica. We're getting out of a leased space there, and that should be effective in March. That will help us save something of $500,000, $600,000, $700,000. The overall issue we have with consolidation is helpful, but it's the growth of our businesses and the lower costs that we have put in place this year that should be more helpful. So when Edwin talks about margin improvement, he is looking at really a lower cost structure which we've achieved while maintaining that and getting some growth, especially from our longer-cycle businesses. So it's a combination of those. I would say, lower cost and growth trumping just the space consolidation.

Great color. And in terms of industrial automation and the laboratory instrumentation markets, you've talked about a rebound for the second half of the year. What metrics are you looking at? What indicators are you following to keep an eye on that end market?

For industrial automation, it's a combination of things. We're seeing some improvement in the semiconductor market now, with projections for improved semiconductor market recovery. We're also seeing some pickup in smartphones now, which is our consumer-related businesses, affecting our micro electro mechanical systems (MEMS) programs. In the other markets, especially laboratory instrumentation, we don't have as much visibility; frankly, we haven't seen these kinds of declines before. So we think those should come back, but we are not counting on them a lot. We think there's a flip side of our environmental businesses, which is the air quality and water quality monitoring, that have been very healthy. We have a nice backlog, and we think the combination of those two will help us in that part of our instrumentation business.

And last question for me. Your current leverage position gives you flexibility to pursue larger deals? You've recently closed the Zeno acquisition. But in terms of larger deals, are valuations starting to look more attractive? And how is the 2024 pipeline shaping up?

Yes. I have to tell you, valuations on the larger deals have not come down as much as we would like. We've looked at some of the prices that our competitors have paid for large ones, those are out of our range of what we would consider. On the flip side, we see some opportunities in smaller bolt-on acquisitions, what we call 'single pearls', which are available, and we will be pursuing those. If you looked at our past acquisitions, we recognize that these string of pearls are the easiest to integrate. We can fit them in and we can improve their margins as we go. The larger deals, we have to be a little more patient because prices are still high.

I wanted to ask if digital imaging margins are expected to decline year-over-year, and does that indicate a bottom for that segment as sales begin to improve from there?

No. The answer is no. I don't expect Digital Imaging margins to go down. I think that should go up a little bit in Q1 and then pick up throughout the year. As I mentioned before, Andrew, we think Digital Imaging as a whole should have margin improvement in 2024, somewhere between 50 and 100 basis points. We’re likely more towards the higher number. But nevertheless, no, I don’t think we're expecting to see a decline because as we've done before, when some of our markets soften up, we take costs out and that helps maintain our margins. When the markets come back, we really enjoy the margin improvement. So no, I don’t think digital imaging is going to go down.

And you mean up year-over-year or up sequentially?

Well, I think year-over-year first, it's going to be between 50 to 100 basis points. I think sequentially, it will improve, but I don’t expect things to go down.

And in past quarters, you sort of broke out the book-to-bill versus legacy Teledyne book-to-bill. Do you have that? And then wondering your view on potential incremental defense awards as the year progresses?

Sure. If you look at instrumentation, which is all legacy Teledyne in some ways, which is marine, environmental, and test and measurement, the book-to-bill in Q4 was 1.12, which is very healthy, driven primarily by Marine, which was really good. Digital Imaging, excluding FLIR, was just over 1. Aerospace and Defense was closer to 1.2. That's our historical paradigm. Engineered Systems was just over 1. If you look at FLIR, which is our big acquisition, it was just over 1. So, all in all, whether it's our historical Teledyne or Teledyne Plus FLIR, if you look at Q4, our book-to-bill was closer to 1.07%.

Okay. And then a question on your feeling on incremental defense awards throughout the year. Is there still a lot you're tracking?

Yes, the answer is yes. We have a pretty good read on what's coming. We have some new products. I mentioned the Black Hornet 4. I mentioned the space Tranche 2. We are up to speed with all of the primes that have gotten their awards in the last week, and we feel good about that.

Robert, your full year 2024 framework is assuming 4% full year organic revenue growth. Is that correct?

Yes, about 4%.

And can you just repeat what you said about the first quarter top line revenue dollars or organic revenue growth?

Yes. I think it will be above $1.4 billion or a little under if that's going to be our lowest quarter. I'm saying that because of the short-cycle businesses that we're seeing. We have orders on long-cycle businesses. However, our short-cycle businesses, we're assuming will not recover much in Q1, and so it should be flat year-over-year in terms of revenue, then pick up.

Got it. Okay. I wasn't clear before, but now I understand. In those short-cycle businesses, have you seen any concrete evidence of when that will pick up? Or are you just making an assumption based on everything you know about the business? Additionally, you'll likely have easier comparisons.

That's very good. We look at our pipeline; we don’t necessarily say we have better orders at this time, but we're talking to our customers, and we're looking at their inventory levels, which they share with us. We see that inventories are declining. Consequently, we expect that we will start getting the orders. Long-cycle businesses are, of course, easier because we already have the orders, and we feel good about that. For short cycles, we look at the generator trends that are being projected in the semiconductor industry in the past several quarters and what people are projecting. We believe that environmental and test and measurement will eventually pick up. We also see some pickup in MEMS already in flame infrared as well as our maritime businesses, which is encouraging. We see declining inventories for our customers and some pickup in certain unique businesses of ours.

Okay. That makes sense, and that's helpful. If I go to the 4% organic for the year and then I do what you said with the segment margins, I think most of the things between that and the EPS are pretty straightforward. I get something above your EPS guidance. Is it safe to assume that you've just embedded some degree of conservatism relative to the lack of visibility in short cycles in the EPS range?

Yes. You said it better than I could. We're always a little conservative. There's one other thing I should mention. When we look at our segments, we need to consider that the new management, which is Edwin and George, will have their costs reflected in the corporate portion. We're also seeing a little higher medical and insurance premiums. So corporate margins are expected to increase about 50 to 60 basis points.

Last one, some of your commentary makes it sound like the M&A pipeline is pretty full and pretty active and you're optimistic about what you see. Other things you've said suggest there's a bid-ask spread and maybe it's a little tougher. So I guess, can you put a finer point on it in terms of how likely we are to see deals this year?

Yes. Let me just say that the confusion may have arisen because I was answering two questions simultaneously. The first part was larger acquisitions, because our leverage ratio is going down and it will decrease faster this year. The larger acquisitions we look at right now are pretty expensive; people are paying prices we cannot afford. On the other hand, smaller acquisitions are available, and we expect to pursue some this year. We'll be patient for the larger ones, as we always have been, but we will make some smaller acquisitions this year. We have a reasonable product line.

Just one small one on A&D electronics. Strong growth as expected for next year and another 80 to 90 basis points of margin expansion. Just curious how you’re thinking about the growth split within commercial aerospace between new builds and then MRO? And then how should we think about the puts and takes on margin there if MRO is a little pressured next year?

A significant portion of our aerospace revenue comes from the aftermarket due to our extensive embedded base across various aircraft, which we believe will be advantageous for us. In addition, we have a product line related to the 737 that we expect will benefit us, despite the current challenges with builds. On the defense front, we are experiencing positive developments in modernization and stockpile replacement programs, which we anticipate will also aid us. We expect to see balanced growth in both aerospace and defense, likely around 5% to 6% in each area.

And then on capital allocation, you got a full funnel, probably looking to do some smaller acquisitions. Absent anything large, would you have any interest in buying back stock? And would you consider a stock split to tighten the bid-ask spread and make it easier to trade?

Split, no. And the reason I say that is that it creates issues for our investors. And 90-plus percent of our investors are institutional investors. We don't want to cause problems for them. We have a very small fraction of retail investors. Regarding buybacks, we currently think our investment returns are better reflected in acquisitions than in stock buybacks. I don’t want to say never because if stock goes down a lot, then it may become attractive, but I'm hoping that doesn’t happen. We do have open authorization if we wanted to do that, but for now, I don’t see it, as long as we have attractive acquisitions, even small ones.

Just wanted to ask about the pricing environment because I know you mentioned that maybe you took less price than you probably could have to maintain share. And I'm curious how the pricing environment has evolved since you made those comments and how price is part of your guidance for next year?

First point, in '23, we had some nice price increases, broadly around 2% to 3%. We expect the same in '24. In certain areas, obviously, we were able to increase prices more than 3%. But in some areas like government contracts that are not peak, the cost-plus contracts are not easy to increase prices on. So I think we’re looking at 2% to 3% for '24.

Thank you very much, Tom. I'll just ask Jason to please conclude our call.

Thanks, Robert. Again, thanks everyone for joining us this morning. If you have follow-up questions, please feel free to call me at the number on the earnings release. And Tom, if you could give the replay information, just a conclusion, that would be ideal.