Teledyne Technologies Inc

NYSE:TDY

Earnings Call Transcript 2018-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. And welcome to the Teledyne's second quarter earnings call. [Operator Instructions] And we are recording today.

I would now like to turn the conference over to Jason VanWees. Please go ahead, sir.

[Jason VanWees, executive]

Good morning, everyone. This is Jason VanWees, Senior Vice President, Strategy and M&A at Teledyne. And I'd like to welcome everyone to Teledyne's Second Quarter 2018 Earnings Release Conference Call. We released our earnings earlier this morning.

Joining me today are Teledyne's Chairman and CEO, Robert Mehrabian; President and COO, Al Pichelli; Senior Vice President and CFO, Sue Main; and Senior Vice President and General Counsel, Chief Compliance Officer and Secretary, Melanie Cibik. After remarks by Robert and Sue, we will ask for your questions.

Of course, before we get started, our attorneys have reminded me to tell you that all forward-looking statements made this morning are subject to various assumptions, risks and caveats, as noted in the earnings release and our periodic SEC filings, and 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 1 month.

Here is Robert.

[Robert Mehrabian, executive]

Thank you, Jason. And good morning, everyone, and thank you for joining our earnings call. Teledyne's second quarter results were the best in our history. We achieved all-time record sales, earnings and operating margin. Total sales increased 9.1%, including organic growth of 8.3%. I should note that for the first time, the organic growth included Teledyne e2v, which was acquired on March 28, 2017.

Our imaging and instrumentation businesses performed exceptionally well, while sales and orders of our defense and space electronics also increased significantly compared to last year. And each of these business groups achieved double-digit organic growth in the second quarter. Furthermore, our results continue to be well balanced among all of our 4 segments and within each individual segment.

Within Digital Imaging. We continued to benefit from industry-wide growth in machine vision and factory automation. However, the largest year-over-year growth was achieved from our complementary metal-oxide semiconductor or CMOS-based digital X-ray detectors for medical and dental applications. These detectors produce outstanding image resolution using lower-than-normal X-ray radiation.

Within the Instrumentation, sales on all 3 product lines, that is: environmental, electronic test and measurement and marine instruments; increased year-over-year.

Our overall defense businesses are winning large new awards and possess record-breaking backlog.

GAAP operating margin of 15.2% increased 288 basis points from last year, with margin increasing in all 4 business segments. And record earnings per share of $2.32 increased 39.8% compared to last year.

Finally, as I mentioned during last quarter's call, we're very pleased with our portfolio of businesses, our successful integration of acquired companies and the cooperation among our business and management. Of course, we will continue to invest in our current businesses and acquire new ones. However, at this point in Teledyne's maturity, we also see an opportunity for a robust effort to improve margins by focusing on our largest and most profitable customers and products and simplifying and streamlining all of our business and corporate processes.

I will now comment on the performance of our 4 business segments. In our Instrumentation segment, overall, second quarter sales increased 12.3% from last year. Sales of marine instruments increased 11% and primarily reflect higher sales of sonar systems and interconnect products. Sales of autonomous underwater vehicles also increased. In the environmental domain, sales increased 11.2%, largely as a result of increased sales of laboratory and life science instruments as well as continued growth in pollution monitoring instruments and industrial ozone analyzers.

Sales of electronic test and measurement systems increased 16.9% organically. Sales were strong across the range of our product lines, led by sales of protocol analyzers, which were exceptional. Growth in cloud network storage continues to drive demand for Teledyne Lecroy's market-leading protocol test tools. Overall, Instrumentation segment operating margin increased 253 basis points to 15.6% and benefited from strong sales as well as favorable product mix.

Turning to the Digital Imaging segment. Second quarter sales increased 12.5%, which was entirely organic. Sales of our propriety X-ray detectors increased significantly year over year. In addition, sensors and cameras for industrial machine vision application also grew considerably. Finally, shipments of micro-electromechanical systems or MEMS-based products and geospatial hardware and software and infrared detectors increased also.

GAAP segment operating margin increased 523 basis points from last year. While the second quarter of 2017 was impacted by some charges related to e2v acquisition, 2018 operating margin, even excluding these charges, increased 338 basis points.

In the Aerospace and Defense Electronics segment, second quarter sales increased 7.7%, primarily due to organic growth across the majority of our defense electronic businesses. Segment operating margin increased 130 basis points to 19.4%, primarily due to greater sales as well as improved margins.

In the Engineering Systems (sic) [ Engineered Systems ] segment, second quarter revenue decreased 6.4%, primarily due to tough year-over-year comparison, with last year's sales being the strongest quarter. Nevertheless, operating margin increased 28 basis points.

To conclude, I want to offer some perspective on our record quarter performance and our 2018 outlook. Our performance across the company was exceptional, not only in the second quarter but the entire first half of 2018. And given the first half results, we currently believe that organic revenue growth in the full year 2018 will be approximately 5.5% to 6% compared to our projection of 4% in May and 3% in February of this year.

I should mention though, while orders were strong, the greatest bookings relative to sales were among our defense businesses with a number of a multiyear orders for infrared detectors, electronic warfare and communication subsystems as well as missile defense engineering. Finally, the product mix in each segment was also unusually favorable in the second quarter. Thus, while we expect year-over-year growth in sales and operating margin to continue in the second half, we do not currently expect the following quarters to be as strong as the second quarter.

I will now turn the call over to Sue.

[Susan Main, executive]

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 third quarter and full year 2018 outlook.

In the second quarter, cash flow from operating activities was $107.9 million compared with cash flow of $87 million for the same period of 2017. The higher cash provided by operating activities in the second quarter of 2018 primarily reflected the impact of higher operating income, partially offset by higher income tax payments.

Free cash flow, that is cash from operating activities less capital expenditures, was $80.5 million in the second quarter of 2018 compared with $74.7 million in 2017.

Capital expenditures were $27.4 million in the second quarter compared to $12.3 million for the same period of 2017. Depreciation and amortization expense was $27.6 million in the second quarter compared to $33.2 million for the same period of 2017.

We ended the quarter with $850.6 million of net debt, that is, $952 million of debt and capital leases less cash of $101.4 million, for a net debt-to-capital ratio of 28.8%. Our leverage ratio was 2.0x at the end of the second quarter of 2018, compared to 2.2x at the end of the first quarter and 3.0x immediately after completing the e2v acquisition last year.

Stock option compensation expense was $5.4 million in the second quarter of 2018 compared to $3.7 million in the second quarter of 2017. As noted in the earnings release, the second quarter of 2017 included pretax charges of $4.0 million in acquisition costs related to the e2v transaction, of which $3.7 million was recorded in the Digital Imaging segment and $0.3 million was recorded to the Aerospace and Defense segment, or approximately $0.08 a share.

Turning to our outlook. Management currently believes that GAAP earnings per share in the third quarter of 2018 will be in the range of $2.01 to $2.06 per share. And for the full year of 2018, our GAAP earnings per share outlook is $8.18 to $8.28 compared to our prior outlook of $7.67 to $7.77. The 2018 full year estimated tax rate is 21.3%, before discrete items, which we currently expect to be lower in 2018 than in 2017.

I'll now pass the call back to Robert.

[Robert Mehrabian, executive]

Thank you, Sue. We would like to take your questions now. Art, if you are ready to proceed with the questions and answers, please go ahead.

[Operator]

[Operator Instructions] We have a question from the line of Greg Konrad with Jefferies.

[Greg Konrad, analyst]

Great quarter. You gave us your updated thoughts around organic growth for the rest of the year. I mean, is there any way to parse your expectations around longer-cycle businesses versus short cycle? And does the forecast for a slower back half organic growth represent just a more conservative forecast around some of the shorter-cycle businesses?

[Robert Mehrabian, executive]

Greg, let me just start with the last question -- the last part of your question. The answer is yes. We are a little conservative because the comps are pretty tough compared to last year. But having said that, let me answer the first part of your question. We think that -- I'll do it by segment, and if you wish, I can go into subsegments. We think Engineered Systems segment is going to be relatively flat year-over-year, maybe up 1%, 1.5% for the whole year. Our Aerospace and Defense segment, which is a little more long cycle, as is the Engineered Systems, we think we'll be up for the year, maybe 4%, 4.3% or so. Let's say between 4% and 5%. On the Digital Imaging, recognizing the fact that in Q1, we had acquisition-related uptake because of e2v from last year's Q1, we had a 10% uptake. From an organic perspective, we think we will be, for the whole year, about 11%. But if you throw in that 10% that we picked up from the e2v acquisition, so overall, it'd be 21%, about. And finally, in instruments, which is our shortest-cycle business, especially in environmental and test and measurement, we believe the organic growth would be of the order of 5% to 5.5%. We have a little bit of acquisition tailwind there, about 1.3%. So overall, about 6.5%. We had a little bit of tailwind as you go back in our Aerospace and Defense, about 1.8% from, again, e2v acquisition. So the 4.3% I gave you included that. Organically, I think we we'd be about 2.5%. I don't know if that answers your question, Greg.

[Greg Konrad, analyst]

No. That's great. I mean -- and I guess that kind of leads to the margin question. I mean, it seems like every time mix has been favorable in Digital Imaging, I mean, sequentially, you end up doing even better margins. With mix favorable again, I mean, I guess, just on the margin outlook for Digital Imaging, how should we think about some of the mix benefit in Q2? And maybe, structurally, the margins of that business?

[Robert Mehrabian, executive]

I think, overall, I would say the first quarters of Digital Imaging, which have margins of about 16.4%, that's probably what I'd expect to end the year. So this quarter, it was up, I think next 2 quarters, it will be down a bit with the average ending up about 16% to 16.4%. And that's primarily due to mix. Overall, segment operating margin, last year we ended with 14.8%, as you know. And Q1 of this year, we were 14.6%. Q2, everything worked in our favor, we were up 17.1%. I think that will moderate as the year goes on, closer to 16% to 16.5%. We should end the year at 16.1%. And if we do that, we still gained 130 basis points in segment operating margin year-over-year.

[Greg Konrad, analyst]

That's really helpful. And then just last one for me. In terms of machine vision and Digital Imaging, I mean it seems like there is a lot of tailwinds for that business and you called out warehouse automation. I mean, any thoughts around the end markets within kind of that machine vision and maybe kind of backlog and visibility as we go forward for that business.

[Robert Mehrabian, executive]

First, let me just break Digital Imaging down a bit. We have 4 different areas, 5 different areas there. Machine vision is our largest one. On an annualized basis, we anticipate that that will have revenues of approximately $275 million. And those are mostly sensors and cameras. And less than $50 million in flat panel displays. Healthcare, which is our X-ray detectors and our X-ray sources for cancer treatments, radiotherapy, those should have annualized revenue of about $225 million. There, we have a little more backlog visibility than we do in sensors and cameras. And we get longer-term programs there. And we are gaining market share with our CMOS very sensitive high-resolution detectors. Aerospace and Defense, again, we do have visibility in our backlog, Greg, and we think that should end up about $245 million. That includes our Teledyne Scientific & Imaging here in California. And the last 2, MEMS, which is our microelectronic mechanical systems foundry that's in Bromont, we expect that to have about $75 million in revenue. By the way, that was ranked as the second largest independent MEMS foundry in the world recently. And it's growing, and we're making investments there. And then we have a geospatial business, which includes LiDARs and software for hydro -- for oceans. I think, there, we should have about a -- $50 million in revenue annualized. We're a little worried about the flat panel display market because we think that will be a little down in the second half of the year. On the other hand, we see the logistics and robotics market increasing. So overall, as I mentioned before, when we annualize the revenue across Digital Imaging, organic growth of a little over 11% is pretty healthy. I hope that answers the question.

[Operator]

And next, we have the line of George Godfrey with CL King.

[George Godfrey, analyst]

Excellent job on the quarter. Robert, you called out the orders, the overall book-to-bill rate greater than 1.1. But it's particularly strong in defense and space-related contracts. Would Digital Imaging and Instrumentation book-to-bill is also over 1, 1.0?

[Robert Mehrabian, executive]

Yes, it is. We expect it to be about 1.1, of that order. In Q2, it was pretty healthy, it was 1.19. But I think it will moderate in Q3. And this is in Digital Imaging, of course. And it should be about 1.1 by year-end.

[George Godfrey, analyst]

Okay. And it's been such an outstanding organic growth rate in the first half of this year, and you've walked up the organic growth rate. Just from a bigger picture standpoint, some of the trends, longer cycle, some of the trends, shorter cycle. But particularly in Instrumentation, if I look at each of the 3 segments: marine, environmental and test and measurement, the trends that you're seeing now from where we were back in '15 and '16, how much is this related to the increase in oil prices? But also, how much do you feel like this has more of a tailwind on the positive side where we are today versus where we came from? And again, nice job on the quarter.

[Robert Mehrabian, executive]

Thank you, again. Let me start with environmental and test and measurement in Instrumentation, then go to marine last. In the test and measurement, we have a series of 3 companies, small companies woven together, that do protocol analyzers. These are rule-based test systems for people to be able to communicate among -- between devices and other things. For example, your Bluetooth that you get in the car with ConnectUP, that has certain rule-based programs. Those businesses are growing very fast. Actually, we think, in a little while, that might be a bigger business than our oscilloscope business, actually. And it's a very profitable set of businesses. On the other hand, our oscilloscope businesses have been growing very healthily. And we have -- there, we have our high-definition, 12-bit scopes that are doing really well in the market. And we've enjoyed significant growth there. So having said all of that, the test and measurement growth is going to almost approach -- organically, almost approach 11%, maybe 10.8%. The environmental business is the more difficult to predict. Those include, among many things that we do, including measuring quality of water as well as quality of air. Those have had a good run this year. But those are really short-cycle businesses. And we, for example, sell a lot to China there. They're buying both our monitoring systems for their environment as well as other products. And also, we also supply the semiconductor industry, which as you know, is really doing -- growing very well. Having said all of that, we're a little cautious about that business because it is such a short-cycle business. We think, organically, for the year, it will grow about 4% to 4.5%. Let me go back to marine. Marine business year-over-year, we expect it to grow about 3%. There are parts of the marine business that are doing really well. And those would be marine that deals with defense businesses, such as submarine connectors. And also, we have a lot of gliders that go into naval battlespace sensing. They're even talking about deploying 100 gliders in front of a battleship group at any one time, simultaneously. Those are doing great. If I move back to oil and gas, while the oil prices are hovering around $70 and the expectations are that this year's cap investments would be almost $90 billion versus maybe $40 billion in 2016, those are a little longer term by the time we get the orders. And frankly, what's happened is they've laid out so many people in those domains that they're having a hard time getting their purchase orders and their designs out. They're lacking engineers. So we think the recovery there is not going to come until close to the end of this year or most likely in 2019 and 2020. We think in the longer term, there's no question that that business is going to improve. And I think that will be very good for us. I will finish off by just saying that a lot of our marine businesses [indiscernible] non-oil and gas production. Overall, probably about $450 million that we expect for the year, only about $150 million of it comes from oil exploration and production. We do have a little bit of land business there. So if that picks up, it will be very good for us because we took it on the chin between 2015 and 2017. That business dropped about $200 million. So our expectations are that in the oil and gas domain, marine, that will be another year before we see a serious uptick.

[Operator]

[Operator Instructions] And at this point, no one else is queued up.

[Robert Mehrabian, executive]

Thank you, Art. Now I'll ask Jason VanWees to conclude our conference call. Thanks.

[Jason VanWees, executive]

Thanks, Robert. And again, thanks, everyone, for joining us this morning. Of course, if you have follow-up questions, please call me at the number listed on the earnings release. All our news releases are available on our website, teledyne.com.

Art, if you could conclude today's conference call and say the replay details for the individuals, that would be great. Thank you, everyone.

[Operator]

Ladies and gentlemen, this conference will be available for replay from 10:00 a.m. Pacific today and will run for 1 month. To access the replay, dial 1(800) 475-6701, then you'll be prompted for an access code. The access code is 451822. For international callers, dial [phone], and enter the same access code.

That does conclude your conference for today. Thank you for your participation, and thank you for using AT&T Executive TeleConference service. You may now disconnect.