Teledyne Technologies Inc (TDY) — Q1 2024 Earnings Call Transcript

All right. Thank you, and good morning, everyone. This is Jason VanWees, Vice Chairman. I'd like to welcome everyone to Teledyne's First Quarter 2024 Earnings Release Conference Call. We released our earnings earlier this morning before the market opening. Joining me today are Teledyne's Executive Chairman, Robert Mehrabian; CEO, Edwin Roks; President and COO, George Bobb; SVP and CFO, Stephen Blackwood; and Melanie Cibik, EVP General Counsel, Chief Compliance Officer and Secretary. After remarks by Robert, Edwin, George, and Steve, we will ask for your questions. However, before we get started, I want to remind 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.

Thank you, Jason. Good morning, everyone, and thank you for joining our earnings call. Today, we reported record first quarter non-GAAP operating margin, record adjusted earnings per share, and record free cash flow. While overall orders remained strong, sales were impacted by deterioration in some of our short cycle imaging and instrumentation market. We had previously assumed no full year sales growth in industrial automation as well as test and measurement market. However, those markets weakened more than planned in the first quarter, and we now forecast full year sales in those product families to decline meaningfully in 2024. Nevertheless, we believe such sales declines will be offset by our marine, aviation, and certain defense businesses, resulting in full year flat sales compared to 2023. Despite those anticipated sales reductions, in what are among our highest margin businesses, we believe overall operating margin will remain flat in '24 versus '23. Within the Digital Imaging segment, year-over-year sales declined due to significantly lower sales of machine vision sensors and cameras related to industrial automation. However, this was partially offset by organic growth and significant margin improvement at Teledyne FLIR. Given our unmanned system businesses' growth and the resiliency of our core infrared imaging business. Similarly, in instrumentation, we were relatively flat where significant reductions in sales of test and measurement instrumentation were almost entirely offset by Marine Electronics and unmanned underwater systems. And despite the overall flat sales, segment margin increased considerably. In our smallest segment, Engineered Systems, which is largely a U.S. government prime contractor, sales were impacted by the very late approval of the U.S. 2024 budget. We also revised estimated progress and cost to complete on certain contracts, resulting in some revenue and profit reversals. Finally, given our even stronger balance sheet with quarter end leverage at just 1.7x, combined with record free cash flow, we believe it's an appropriate time for us to add stock repurchases to our capital deployment plan. I will now turn the call over to Edwin and George, who will further comment on the performance of our core business segments.

Thank you, Robert. This is Edwin, and I will report on the Digital Imaging segment, which represents 55% of Teledyne's portfolio. And like Teledyne as a whole, this segment is a mix of longer cycle businesses, such as defense, space, and healthcare, 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. First quarter 2024 sales declined 4.1% compared to last year as certain products declined considerably, but were largely offset by those with meaningful increases. For example, sales to industrial machine vision markets declined approximately 30% year-over-year. On the other hand, unmanned air systems, unmanned ground systems, and integrated counter-drone systems collectively increased nearly 30%. Although year-over-year changes were less significant, they included continued growth in our space-based imaging business, Brazilian sales in healthcare, and strong infrared and maritime businesses alongside declining sales of semiconductor related microelectromechanical systems or MEMS. As Robert mentioned, the FLIR businesses grew organically and for the third consecutive quarter, were positive contributors to overall segment margin. Finally, segment orders were healthy, with the first quarter book-to-bill of 1.6x. George will now report on the other three segments, which represent the remaining 45%.

Thanks, Edwin. The instrumentation segment consists of our marine, environmental, and test and measurement businesses, which contributed a little over 24% of sales. So the total segment, overall first quarter sales decreased 0.9% versus last year. Sales of marine instruments increased 15.3% in the quarter, primarily due to strong offshore energy and subsea defense sales. Sales of environmental instruments decreased 5.8% with greater sales of processed gas emission monitoring systems in gas and flame safety analyzers, offset by lower sales of drug discovery and laboratory instruments. Sales of electronic test and measurement systems, which include oscilloscopes, digitizers, and protocol analyzers, decreased 18.2% year-over-year on the toughest quarterly comparison of 2024 versus 2023. Overall, Instrumentation segment operating profit increased in the first quarter, with GAAP operating margin increasing 183 basis points to 26% and 175 basis points on a non-GAAP basis to 27.1%. In the Aerospace and Defense Electronics segment, which represents 14% of Teledyne sales, first quarter sales increased 7.2%, driven by growth of commercial aerospace and defense microwave products. GAAP and non-GAAP segment operating profit increased year-over-year with segment margin increasing approximately 80 basis points. For the Engineered Systems segment, which contributes 7% to overall sales, first quarter revenue decreased 10.5% and operating profit was impacted by lower sales and the cost to complete estimate revision Robert mentioned earlier. I will now pass the call back to Rob.

Thanks, George. In conclusion, orders have been strong for two consecutive quarters, with the increase almost entirely due to our longer cycle businesses such as defense and energy. However, given the nature of these businesses, converting much of the greater backlog to sales will not begin until the second half of 2024. At the same time, the pace of orders in our short-cycle instrumentation and imaging businesses did have a near-term sales impact in the first quarter and likely will continue to impact total sales in the second quarter of 2024. So while our current outlook for full year sales is flat with 2023, we expect second quarter sales to be sequentially flat with the first quarter and then increase in the second half of the year. The current market environment is reminiscent of the 2014 to 2016 period. During that time, total Teledyne sales and earnings were relatively flat, whereas market dynamics were the opposite of what we are experiencing today. Specifically, growth in certain short-cycle markets was partially offsetting declines in our longer cycle defense and energy businesses. Hopefully, this time, the recovery in the short cycle businesses will be shorter. During the 2014 through 2016 period, we executed approximately $400 million of opportunistic share repurchases, completed 10 acquisitions, and subsequently experienced significant sales and earnings growth when the market normalized. Today, we're pleased to renew our stock repurchase authorization and plan to begin repurchasing shares this quarter. At the same time, because of our strong balance sheet, we're continuing to evaluate a number of acquisition opportunities. I will now turn the call over to Steve.

Robert, and good morning. I'll first discuss some additional financials for the quarter not covered by Robert, and then I will discuss our second quarter and full year 2024 outlook. In the first quarter, cash flow from operating activities was $291 million compared with $203 million in 2023. Free cash flow, that is cash from operating activities less capital expenditures, was $275.1 million in the first quarter of 2024 compared with $178.6 million in 2023. Cash flow increased in the first quarter due to stronger working capital performance. Capital expenditures were $15.9 million in the first quarter of 2024 compared with $24.4 million in 2023. Depreciation and amortization expense was $78 million for the first quarter of 2024 compared with $82.1 million in 2023. We ended the quarter with approximately $2.33 billion of net debt, which is approximately $3.25 billion of debt less cash of $912.4 million. Now turning to our outlook. Management currently believes that GAAP earnings per share in the second quarter of 2024 will be in the range of $3.57 to $3.70 per share, with non-GAAP earnings in the range of $4.40 to $4.50 per share. For the full year 2024, our GAAP earnings per share outlook is $16.02 to $16.27. On a non-GAAP basis, it is $19.25 to $19.45 per share. 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.

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

First question, just given the weakness that you're seeing in some of the higher-margin areas of the short-cycle business. I wonder how you're thinking about gross margins over the next couple of quarters.

In terms of the gross margin, we're looking at relatively flat gross margins of somewhere around 43%. Yes.

All right. Robert, with the shift in and capital allocation. I'm wondering what does this really imply just in terms of the M&A pipeline? Are you still seeing more opportunities for the smaller deals as opposed to the larger M&A? Is that a fair way to characterize the environment right now?

Jim, kind of, but let me just start with some numbers that are significant. Our debt-to-EBITDA is at 1.7x now. We have one acquisition in the pipeline. Once we make that, we would have spent over $300 million since we bought FLIR in acquisitions. If we don't do anything else, by the end of the year, our debt-to-EBITDA ratio would be closer to 1.3x where it is at 1.7x today. So we think that it's an appropriate time, first, to look at our stock and repurchase some shares because since we bought FLIR, our shares have increased by almost 700,000 shares because of option exercises and restricted stock awards. We like to get that off the table first. But at the same time, we have a lot of capacity for acquisitions. We can spend up to $1.5 billion, $2 billion because we haven't touched our line of credit at all and we have cash on hand. So we are looking at acquisitions. The issue is that smaller acquisitions we may be able to complete this year; larger acquisitions, even if we find them with all the various regulatory hurdles that you have to go through, won't happen until next year. But the answer is we're going to do both. We're going to do exactly what we did in 2014 to '16. We bought our shares back. We bought 10 companies. And then some of our competitors didn't do as well in that constricted period. We were able to acquire them right after that because we had the financial means—they do not. So I don't know if that answers your question.

It helps. I mean, in the past, it was more recently, you've talked about valuations still being a bit on the risky side; do you see— as you look at the pipeline for some of the larger M&A, have you seen any change in terms of the prices out there that it's going to take to do some of these larger deals?

Not yet. On the other hand, I have to tell you, Jim, they haven't come out with their earnings. In this market, a kind of bifurcated market, I expect that some of those will come down, and there will be—just like it did before. Interestingly enough, history does repeat itself. It doesn't repeat itself on the time scale that we always expect, but it does repeat itself.

This is a bit of an unusual question, but one I've been getting from investors and in light of the uncharacteristic guidance cut, which there haven't really been many over the past 20 years. Is Teledyne different today than what has made it so successful thinking back over the past 20 years? Or what's really changed just given some of these uncharacteristic items? Or is this just you think about it as part of the normal cycle?

Well, two things. First, in the 25 years or so, we've only had this occasion in four earnings calls— almost 100 earnings calls and releases. We've experienced this four times, 4%. So it's not something that happens very frequently. The flip side of it is that the economy and the markets are not quite predictable. Some parts of the economy are doing well, like our marine businesses, which are performing exceptionally well, and defense, of course, is doing well with our recent passage, etc. We expect that to continue. What is unusual is that the prediction of the slowdown in industrial automation took us by surprise. We thought in January that we would be relatively flat for the year in our machine vision businesses, and now we are faced with projecting a 20% decline. Now that seems like a lot, but it's only $120 million. What is different today from the past is that Teledyne can absorb those kinds of shocks much more easily than it could before. In 2015 and '16, when oil went from over $100 down to $30, that was a shock to Teledyne because our revenue was only $2.5 billion to $2.6 billion. We had increased our marine businesses by almost 1/3 over a very short period of time. So what is different is that the shock absorption in Teledyne is a lot different and can absorb shocks like that. And we did this quarter; everything else being equal. When I look at it, I said, look, we have two hits that we took in the long term. So one of them was this significant decline in industrial automation. And some semiconductor, but the semiconductor sector seems to be recovering slowly. So we see signs of that. I think the machine vision will come back. We took another hit in our Engineered Systems business, which was unexpected. But we had to go in and look at everything and do some estimates and change our estimates to complete. That was a one-time event. So I'm not going to worry about that too much. What I am saying is that, look, yes, we took a hit, and we're taking our revenue down by $220 million. In the old days, when we would have taken a $220 million hit, that would have been just devastating. We can recover from those kinds of shocks; I think we'll recover this time as well, if not better, because we have the muscle, the ability, and the credit to buy companies when necessary and buy back our shares.

And then I appreciate that. And maybe just kind of a follow-up to that. I mean just thinking back to what Teledyne did out of the oil and gas downturn and there was the sequester before that and impacted Defense. I mean if I remember back, I mean you took pretty aggressive actions, and we saw with margins and growth out of those two downturns. I mean is there similar actions that you're undertaking on the short cycle side? Does that offer opportunity maybe to examine the margins where you have an even better trajectory coming out of market recovery?

Yes. First, if you look at the FLIR businesses, year-over-year, the margins are up almost 200 basis points. And the reason that happened is very simple. We took about $52 million worth of costs out last year, and we're taking an additional $10 million to $15 million of costs out this year early on. So that is affecting the margin. If you look at the DALSA e2v, which is our traditional businesses, our estimates are that by the end of the second quarter, we have taken another $40 million out of that. Altogether, we're talking about almost $100 million in costs. We anticipate that the DALSA e2v margins, which have been at their lowest for a long time, were at 19.5% in Q1. We expect that to recover. We expect the overall margins for Digital Imaging to be flat with last year on much lower revenues. It basically says that we have taken costs off, and if necessary, we'll take more. But I think right now, we're doing okay. We're just not very aggressive in our hiring.

Maybe I'll start by asking about the timing of this. Some of the pure players in vision faced significant declines last year, while you managed to do relatively well. Now, it seems like we might be on the verge of reporting, and it sounds like those companies are starting to show sequentially improving offload levels right now. However, it looks like you are beginning to see declines. I’m interested in your thoughts on this timing mismatch, as it appears to be a short cycle situation.

It is. We know a couple of businesses that took a pretty good hit, but their quarters are kind of a little different, and their yields are a little different from ours. They took a pretty big hit and lowered their numbers significantly. So now they're coming up from the bottom, slightly better. We didn't take a hit because we didn't have short-cycle declines of the magnitude. So we anticipated it would happen, but it happened fast. And we took the costs off. The flip side of it is that in digital imaging, we have, of course, the short-cycle businesses, but we also have long-cycle businesses like space and defense. And those markets are doing really well. So I have to be a little careful when we designate what is digital imaging. Basically, the average, we think in the second half, we will recover because of the space business.

And then just a follow-up on the question earlier about whether Teledyne is different today. I think what you guys have been known for so long is being very good estimators of your own businesses with high precision. And when you think about all the M&A companies you've done, does that become just inherently more challenging today versus a decade ago just because you have so many more businesses? And is there maybe—does there need to be a tinkering of the process with how you communicate upwards from the businesses towards management to fine-tune the budgeting process in light of some of these being caught off guard here?

You're correct in saying that estimating short-cycle businesses has always been difficult. However, the fact that we have many businesses works to our advantage, as it expands our platform for making acquisitions. This will continue to be the case. We're focused on avoiding unwise acquisitions at high prices that won't add value. We're positioned to make strategic acquisitions, like the recent one in our Marine business in the U.K. and a digital imaging company in the Netherlands. The imaging business differs from our short-cycle operations because it specializes in custom imaging designs and has a strong presence in the defense sector. I believe this is a favorable time for us. We'll wait to see the overall impact on earnings and costs. We didn’t make significant downward adjustments to our forecasts. If we had, we would be seeing better results now. What we're indicating is that we expect to remain flat compared to last year, with our margins staying the same by year-end and revenues remaining steady without any new acquisitions. Additionally, after our share buybacks, we expect to finish the year with a debt-to-EBITDA ratio below 1.5, which is below our target range. Overall, I think we're in good shape, and I'm not concerned.

So I wanted to get a sense of how much this guidance is really derisked. Maybe number one, are you assuming buybacks in the guidance? And then secondly, why should we have confidence given the low visibility that there's not another step down here in some of the shorter-cycle areas?

A very good question, Andrew. First, no, the buybacks are not built into the numbers, primarily because we buy back, it's really going to affect next year's EPS not this year's. So that's fairly neutral for this year, depending on, of course, how much we bought. So I would put that aside. The second part of the question, we've struggled with that mildly over the last 10 days and with our Board in the last 2 days, trying to decide how conservative we should be or how aggressive we should be. We've ended up being somewhere in between the two. We think that we have derisked some of the downside. On the other hand, we haven't derisked it all. Conversely, our defense businesses have relatively good backlog, and the overall backlog in the company is 1.06. So the defense space businesses are going to come back in the second half. So they'll balance that. In a situation like this, you can do one of two things. You can really lower the numbers and just play it very safe or you can do what is a reasonable judgment of what you see in the market and go forward. We've taken the latter approach.

Yes. I think some investors are confused about the small portion of sales. It appears that a small aspect of digital imaging is causing significant declines. Could you explain the situation within digital imaging? We know that machine vision is weak, but that's likely only a minor percentage of that segment. Can you detail the other factors apart from machine vision and indicate their contributions as a percentage of that segment's sales? This could help clarify what is influencing the overall decline.

Sure. First, let's focus on machine vision specifically. It's projected to generate approximately $600 million in 2023, but we're anticipating a decline of about $120 million. This decline impacts other areas because machine vision is one of our highest margin businesses within digital imaging. Overall, when considering both DALSA e2v and FLIR, our total revenue is expected to decrease by about 1.5% by year-end. While 1.5% may seem small, it represents a significant amount given our total revenue of over $2.1 billion. By year-end, we anticipate that the overall decline will be 1.5%, with FLIR increasing and DALSA e2v decreasing as a result. I hope that clarifies your question. While the figures may appear large at first glance, in the context of our total revenue, a decline of 1.5% is not substantial.

Yes. Okay. And beyond machine vision, what other areas or short cycle that are out of favor?

Well, the only other one that I would say is out of favor. I wouldn't call it out of favor. I would say it is declining, is test and measurement. Test and measurement is the oscilloscopes and protocol solutions that we have. Last year, we had $340 million of revenue there. We expect right now that in January, we thought it would remain flat. Now we're expecting it to go down about 10%. So that's a $30 million decline in revenue. The good part of that is that its margins are remaining very healthy and at the very high end of all of our margins, and we can take that decline in revenue without having a big hit anywhere because Marine is making up those sales decline. The last area, which is a little different, is the engineered system. In 2023, we had $440 million in revenue. Right now, we're projecting about a 10% decline, or about $35 million to $40 million decline. If there is a good part to it, it's that that's only 7% of our portfolio, and it's our lowest margin business at 10% or less. So that's why while the surprise here is that yes, we do have declines. What we're saying is we are going to keep our revenue the same as last year. And our operating margins are going to be the same as last year in an environment that's a little more constricted for our digital imaging short cycle business.

This is Gaby on for Kristine. So I was just wondering if you can provide a little bit of color if you've been seeing improvements in the supply chain and your expectations for the supply chain going forward and how that's going to impact throughout the year?

Thank you very much. Great question. The supply chain improved in 2023 significantly versus 2022. It has improved further this year. Just to give you an exact number, we—when we buy from brokers, we pay higher percentages of price. Last year in the first quarter, we bought about $10 billion for electronic buyers broker. This year, the first quarter, we only bought a little over $2 million. So I think there's been significant improvement. Having said that, there are a couple of suppliers that make very sophisticated boards or semiconductor devices that are still lagging and it's more of a delay problem rather than a price problem. So I think the supply chain is okay. We're experiencing some delays of some sophisticated parts. Other than that, I think that's behind us.

Robert, you mentioned the second quarter revenue is projected to be about flat from the first, but the year-over-year rate of decline would need to accelerate. Is that right? Is that what you're anticipating?

Right now, we're anticipating that it will be flat only because—yes, only because we don't think our—where we have really good backlog, it's got to kick in until the third quarter. The decline about, 4.5% from last year year-over-year in the second quarter, yes.

Okay. Yes. And then I guess that would imply kind of mid-single-digit organic revenue growth year-over-year in the back half. I was going to ask—you just alluded to it, but I was going to ask how much of that is kind of purely visibility from longer cycle things in the backlog versus what's the assumption embedded in that on the short cycle side?

I think primarily, it's what we have in the long cycle, the majority of that recovery is in what we have in our backlog—maybe 3.5% to 4% improvement in revenue in the second half. There is a little bit of positivity in some of our short type of businesses only because our larger customers or platforms on which we serve like semiconductors. The data shows that it's better than it was last year and improving. So we have a little of that in mind. So I think that's there but we're not counting on industrial automation or other things to improve significantly because frankly, we have no visibility.

Okay. What are the pieces of the Engineered Systems margin in the quarter? Is there some kind of cumulative catch-up adjustment mark-to-market write-down in that?

Yes. In that business, we are required to perform accounting in a specific way, which involves estimating costs and completion timelines. Upon reviewing our figures, we noticed that some costs were higher than expected, so we made adjustments accordingly. This negatively impacted our sales. When you lower sales by a few million dollars, you also have to reduce the profit by the same amount, and that's what we experienced. However, we understand the situation clearly. We will address it, and we expect to move past this as we progress.

Do you know the size of this markdown you took in the quarter?

Well, in Q1, we took about a $7 million EBIT hit, which was basically $0.10 to $0.11. So if that didn't happen, we would have made our earnings.

Okay.

Despite the downturn in short-cycle imaging. We'll fix that.

Got it. That's helpful. Last one, I guess, given how much you've now deleveraged your balance sheet, net debt-to-EBITDA post FLIR integration. You're still going to have pretty healthy free cash flow despite tweaks you're making here today. If you're coming out with a share repurchase, I guess the number you're talking about is kind of small relative to your forward annual free cash flow generation, how much balance sheet firepower you have if you were to take leverage a little higher, a little bit of like if you're going to lay up, layup type of thing. I guess I'm surprised that you—maybe part of it is you formulated all of this before the moving stock today. Is there a scenario where you reevaluate something more aggressive in 2024? Do you need to keep room for the M&A pipeline? How would you respond to that?

Well, two ways. First, we'll put out the case about our authorization. If you look at that, we have authorization to go from what we said was $200 million to $250 million to $300 million. We can go up to $1.25 billion in buybacks. As you know, Noah, that depends on the stock price and how the market reacts. But at the lower stock price that I'm just looking at this morning, that would be a significant number of shares. We can do that if we choose. We still have enough capacity to make acquisitions. Frankly, that part of our portfolio doesn't bother me. If you look at the final data point you may want to know is we have only $150 million of fixed debt that we have to pay in the second half of 2024, which is due in October, $150 million. We just paid $50 million. The next payment doesn't come due until 2026. In the next 3 or 4 payments, our average borrowing cost of those payments is more like 2.35%. So that's about as good as you can have. As we generate cash, we can buy the shares and we can make acquisitions. We haven't even touched our line of credit yet. From that perspective, I feel pretty comfortable.

Thank you very much. We would like to conclude the conference operator; I will now ask Jason to do so.

Thank you, John, and thanks, everyone, for joining the earnings call this morning. Again, all the earnings release are on our website. The reply is available. And for those on the call, please feel free to reach out to discuss further. So thank you, everyone.