Teledyne Technologies Incorporated (TDY) Earnings Call Transcript & Summary

All right. So I'm going to start here, if that's all right. I think it's 9:15, right on the hour. So I'll give a quick introduction for those who don't know Teledyne, but just briefly, and then most of the other slides are as we would expect financial in nature, and we'll go through, obviously, that and then leave some time for Q&A. So of course, before I get started, everyone note our forward-looking statements, our risks factors and our SEC filings, please. So a very quick overview of who Teledyne is. At the highest level, we make a range of sensors and instrumentation with common technologies, but serving a pretty wide group of different end markets. Now it doesn't mean we're complicated. I'll get into that. I mean in fact, the same factory that makes specialty acoustic devices, sonars that are used for the navigation of unmanned underwater vehicles for defense, they sell those same products for our environmental applications, like Tsunami warning systems. The same business that makes specialty connectors that go on the Virginia-class submarine makes specialty connectors that go on subsea wellheads in the oil and gas space. So a nice range of end markets, a nice range of sensors, a nice range of data communication products, but again, serving a lot of different end markets from defense, to environmental science, to oil and gas, to commercial imaging and factory automation even. Again, you have the same factory for another example that would make a very specialty image sensor that might look out for an earth science or deep space application, may make the same kind of sensor that looks down on a classified satellite, for example. Now in words when we describe ourselves, we say we're a high-tech industrial company. Our -- the reason we say that is our legacy is in aerospace and defense. Aerospace and defense still is our single largest end market at about 1/3 of sales. But then, of course, the flip side is about 2/3 of the business is commercial and industrial. Now the next bullet there is we see a balanced portfolio in -- balance is an important word to us. It doesn't mean we're complicated, it doesn't mean we're highly diversified. In the reality, depending on how one wants to count, we really only have 7 different businesses. We have 4 reportable segments, a couple product lines in 1. And even though there's 1 segment president for aerospace and defense, let's call that 2 markets because air transport and defense are different businesses. But that's only 7. And by balance, what we mean is we like the fact that we're, frankly, 24% defense. Again, it used to be a much higher number. But the reason we say balanced is because about half of the company is long cycle or different cycle than global macro. About 24% defense; 8%, 9% commercial aerospace; about 6%, 7% offshore energy; about 10% medical, which is acyclical. So that half of the company being in different cycles other than global macro, it's a nice balance, a nice insulator against economic uncertainty. But also they're reasonable in their proportion. We actually didn't like it when we were 70% defense 20 years ago when I joined, because it's no longer an insulator, it is the cycle that drives your business. So again, being balanced, being half long cycle, half short cycle, global macro, and in that long cycle side, have reasonable proportion of things like defense, medical, energy is something that we really like. Then talk about our proven track record, our history. We are proud of our performance. We'll show some charts later. But we've only missed our own earnings forecast in 2 quarters in 20-plus years. So I think we're pretty predictable. And again, I think some of that is management. I think we can congratulate ourselves. And some of that is the balanced portfolio, where half of the business is long cycle, and we have very good visibility over 2, 3 quarters or so in that side of our business and that helps predictability. Again, we'll talk about our track record, show some charts. We certainly haven't stood still. There's been a lot of margin improvement over the last 20 years. But I think it's safe to say we're by no means best-in-class at GAAP EBIT, 15.5% for, again, an industrial company, not an A&D integrator, but a high-tech industrial. I don't think we're by any means best-in-the-class, and there's still some room to grow. And acquisition has been important for us. We've deployed essentially all of our capital on acquisitions over the last 20 years. So our book ROC is our acquisition ROC. We do hit our numbers. Even though some of the more recent acquisitions are actually some of our larger ones from a capital deployment point of view, our returns have been very good. And M&A is a big part of our story. In fact, about 75% of the current revenue, 80% of the current profit wasn't part of Teledyne when I joined. It's been acquired as we reshaped the company. So I'll go a little bit quickly here through some of these charts. This is just what our end markets look like on the left. So again, that left side of the pie is basically the long cycle pie I talked about, U.S. government, offshore energy, commercial aerospace that tends to have up to 9 months of backlog. What's on the right, 2 biggest markets end up being analytical instrumentation. And then our commercial imaging businesses, things like factory, automation and whatnot. That's about half of the company. Our backlog right now is about $1.6 billion, $1.7 billion relative to the $3 billion, $3.1 billion of revenue, which sort of suggests 6 to 7 months, but there's really no business in Teledyne that has 6 to 7 months. That left side of the pie, tends to have 9 months to a year of backlog. The right side of the pie tends to have about a quarter. So again, very, very good visibility over 1 quarter and even reasonable visibility over 3 quarters or so when you look at the long-cycle businesses. And again, the geography is relatively balanced. See Asia Pac, they are 20%. People have been asking me about China, coronavirus. I mean China, last year was about 6.5% of sales. Maybe round that up a little bit to 8% of sales. If you look at sales that either go to Hong Kong or Singapore, that might end up in a China market, maybe 8%. So even that is, again, relatively balanced across geographies amongst various regions with commercial outside the U.S. being 44% of sales or commercial inside the U.S. is 32%. I won't talk about the full history. I'm happy to do that in any of the one-on-ones, but when I joined in 1999, you see the 2000 data there, we were -- everything, but that little 6% slice was aerospace and defense, including some businesses that were, frankly, not attractive, they're shown in gray, which we've subsequently divested. Today. We still have an Aerospace and Defense Electronics segment there in blue, it's about 22% of sales. And Engineered Systems to us is more of a defense integrator, a little more than 10% of sales. But today, we're mostly a commercial, industrial, instrumentation and imaging business that's been built through acquisitions over the last 20 years. And this has been our profile. It's been a lot of little work year in and year out. It's not like we made margins better through 1 transformational acquisition and got the accounting benefit of a high-gross margin business. It's certainly been a change in the type of company we are. There has been some of the gross margin improvement. But a lot of it has just been blocking and tackling every day, people being compensated for or not, based on reduction of scrap, rework, warranty and all the KPIs that good companies should track from on-time delivery, overtime dollars, overtime hours, things like that, just been a lot of work. Now notwithstanding, again, EBITDA margin of 19%, GAAP EBIT of 15.5% is not best-in-class. We were up on a GAAP basis, about 119 basis points in 2019, more than that in 2018. We started this year with a promise of 50 basis points. I hope we can achieve more, but with half of the business being short cycle, we don't want to overpromise out of the gate, which we didn't do, in my opinion, in January. So that's been in the earnings. It's been a trajectory we're proud of. And again, this is GAAP earnings, not adjusted earnings. The -- maybe a couple of things to point out is that we're very, very good at managing our costs when things go wrong. You see actually in the 2009 recession, earnings didn't go down, earnings actually went up, a little only. But nonetheless, we actually maintained earnings in the recessionary environment. We did have a series of tough years where you had sequestration, 2013, '14, '15, followed by offshore oil and gas blowup in kind of '16, '17. But again, we weathered all that, and earnings were largely flat. But then when you see coming out of periods where earnings are flat, we're good at keeping the costs that we've lowered, keeping them low. So you see a really nice trajectory coming out of 2010, and you've seen a very nice trajectory, obviously, since 2017 to now. And this has been the share price. I mean we're proud of it. It's -- but other than the commercial, I mean the reason we show it is the LTIP programs at Teledyne are a little bit unique. We do have an annual bonus program that's based on operating metrics, but the LTIP programs are either half based on relative return to Russell 1000, or in the case of restricted stock, they're solely based on relative return to Russell 1000 over a 3-year period. So a very good alignment with the buy side on actual returns to shareholders versus return to management through our LTIP programs. So where do we go from here? I mean we're actually very happy with where the portfolio is today. I mean there's been 20 years of reshaping who we are. But we like where we are. I don't -- we're not running from defense. Defense in its current proportion is something that we like, 1/4 of the company. So we're going to keep the business balanced, though. I don't think you're going to see a radical shift in portfolio over the next 5, 10 years. I think it's going to look considerably like it looks today. We've done very good in cash flow. I'll show a chart later, but the M&A story is something that's important to us and continuing to deploy capital, getting good returns on that capital, getting good free cash flow, good kind of free cash flow conversion. Something that's a little bit newer is, as we built this portfolio over the last couple decades, it probably wasn't until a decade or so ago, halfway through this journey, that we actually had enough scale to not just do D of building the same product you did the previous year, but actually had enough scale to do R&D in some of these 7 major markets that we're in. 10 years ago, we had probably upwards of 60 different ERP platforms. That's not the case today. All the businesses in Aerospace and Defense Electronics are on one. All the businesses in Digital Imaging will be on one. All the businesses that are in cost-plus defense are on Deltek Costpoint. That wasn't the case 10 years ago. So where we are today? Even though we've been clawing away at this for 20 years, you've seen the margin charts, but certain things about reducing complexity, being smarter with pricing, being smarter with procurement, being able to look at purchase price variances across the company for various components, we didn't do that 10 years ago. We just haven't been as good at it. So I think there's -- I mean that's what we mean by reducing complexity, looking at pricing niche products appropriately. We haven't ignored it, but, I think, we haven't been as good as we should have been either on pricing or procurement. But we're getting better. This is just a graphic pictorial of our acquisitions. We've done 63 since I joined, about $3.6 billion. And again, most of that has been in instrumentation and imaging, which is the bulk of the company and the profits today. And if one is wanting to look at where has all that cash flow come from, the source of funds has been on the left. I mean more than $4 billion of all the cash we've spent has come from internal cash flow. Yes, we do have some debt right now, but leverage at the end of the year was 1.4x. So by no means we're highly levered, even though we have used our credit facility. It's been internally generated cash. And again, we have spent money on CapEx, $800 million, $900 million on CapEx, and we have done some opportunistic stock repurchases. See some pension contributions here. That's a -- we haven't done that probably since, I think, 2012. Our pension -- we're a little bit unique in having an aerospace and defense legacy as a company, and we have a fully funded pension. We have no post-retirement medical benefits. Our -- we have 8 members of our 11,700 workforce that are unionized. It's not a typical profile for someone within an A&D legacy. That hasn't come easy. We had to fund the pension. We had to divest some businesses along the way. But again, it's a bit of a unique profile to have, again, fully funded pension, no post-retirement medical, no environmental liabilities, no asbestos liabilities. We're very, very clean, and that's been another part of the journey over 20 years. And again, that acquisition capital there of the $3.6 billion, you just see on the right, that's gone not exclusively to instrumentation and imaging, but mostly to instrumentation and imaging, which is the bulk of our business. This has just been the revenue trend. A few things to point out, you see the contribution of the red and orange growing over time. That's the instrumentation and imaging businesses, which have received more capital, but they actually have grown faster, too. So it's not been all acquisition growth. There has been organic growth. In fact, organic growth last year, inclusive of currency headwind was about 4.4%. Some businesses were down, like factory automation and machine vision, but we were still up 4.4%. 2017 and 2018, most things in the businesses were up, so organic growth was 7.4% and 7.9%. That's kind of the high book end when most things are good. But because of the balanced portfolio in 2009 and 2016, kind of when things got really wrong, the bookend of organic contraction was about 7%. So that's kind of the bookend, and we have this balanced portfolio. But a really good year, 7%, 8% organic; really bad year 7% contraction. Last year was most things up, but a few pitfalls in factory automation, but we're still 4.4%, including 100 basis points of currency headwind on translation. That's been the free cash flow. Last year, we were just ever so shy of 100% conversion, with about $400 million of free cash flow. So it's obviously important for us to keep this up. And I already mentioned the balance sheet. Despite all the acquisitions we've done, including a pretty active last 12 months, we spent over $500 million the last 12 months in acquisitions. We're still 1.4x, given the strong cash flow at the end of the year. So I know that was relatively quick. But that's the high-level overview of where we've been, where we are in the financial metrics. So happy to take some Q&A. Please.

Could you talk about the current environment for acquisitions? What kind of valuations are you seeing? And what potential [indiscernible] are you kind of looking for?

Sure. So yes, yes, so the current acquisition environment, I'd say there's probably never been as much available as there is right now, in part, because valuations are high. I think we've done a few nice small acquisitions. I think entrepreneurs, it's a good time to sell your business. And it's a good time for us to be a buyer. I think corporate tax reform helped certain corporates with fear of tax leakage on divestitures. So we were able to do 2 carve-outs last year, which I think was kind of new. We've always looked at doing corporate carve-outs, but we haven't really been able to execute them to any large degree into the last 12 months. So that's good. A lot of private equity exits, but the flip side of all that availability is that pricing is high, and we're disciplined on price, and we're disciplined on returns. So I'd say the average -- I'd say the acquisition environment is average. Many, many things available, financing still attractive, but then you put a filter on the funnel, if you will, to what can be bought at a reasonable price and fits well with us because fit's the most important even before we talk about size -- price. And kind of the corporate cliche internally is, does it fit? And what that really means -- everybody says that, but what it really means is, if the entire management team left, can we still run the business the next day. Do we really, really understand it? And who's going to run it? There was a point in time when I joined, we had 15 independent businesses, all reporting to our CEO in different products in different markets. We don't want more complexities [indiscernible] who's going to run it, where does it go. And that's the most important thing. So -- but in general, it's been a good environment the last 12 months. An average year for Teledyne has been about $200 million of deployment. Last year was $500 million. So I'm optimistic, but valuations are high. Please.

Industrial machine vision, any time you got [indiscernible]

Sure. So just general outlook on industrial machine vision. So let's call it vision systems, not necessarily machine vision. That's about $355 million of annual revenue for our Digital Imaging business, which this year will be about $1.40 billion. So it's a relatively large vertical. But let's kind of parse that vision systems business. There's about $100 million or so that I'd say is the higher beta consumer electronics and/or semi-cap equipment-type end market. That was the one that was down in 2019. And there's about $100 million worth of sensors more towards general factory automation, ubiquitous 2D barcode here even at this conference, that's about $100 million of revenue. Then there's sort of $150 million, $155 million that even though it's vision systems or machine vision, it's relatively stable. It's things like retinal scans, if you've been to a high-end optometrist and an ophthalmologist and you've gotten a retinal scan, that camera was probably a Teledyne camera. We have very, very strong share there, for example. Or someone's looking through a microscope and wants to take a picture of what they're looking at, that's a life sciences application. That's a scientific camera. Again, we're in the specialty niches, where that's a low-light environment, high magnification, unique product, that's what we make. Now to the question that $100 million that's been the higher-beta consumer electronics semiconductor. The semiconductor side picked up. I think that bottomed actually in Q3 '19. Again, that's small, maybe $50 million of annual revenue. But I think that bottomed in Q3 '19, actually had decent growth in orders and sales in Q4 '19. So I think the semiconductor part is up and has come back. I think the part that does specialty cameras for FPD, or flat panel display, consumer electronics, smartphone inspection, I think, that may have bottomed, but that is not picking up. So there's really no growth in that or a second half recovery baked into our outlook. Some of the pure plays in that market and the sell-side folks have optimism on that segment. And I hope that happens because that would be good late 2020 or 2021, but we've got a nice table in the health care, med tech side, decent growth on the factory automation or barcode-side logistics. I'd say our outlook right now for consumer electronics is flat. But semiconductor is picking up, and it has picked up, so it's not unwarranted optimism.

And then maybe just one on pricing. Sort of across the board, how do you feel like pricing could be in 2020? [indiscernible]

Generally, with regard to, say, price volume, there's never a perfect year. I'd say, '17 and '18, we had both price and volume over most of the portfolio. Of course, in 2019, we did not. In industrial machine vision, we had both contraction as probably also competing for share. I'd say generically, I think 2020 will be similar. There will be pockets in the portfolio where we have volume and price. Despite Brent crude being down a little bit right now, the backlog in energy for us is very good. And the pricing in the backlog is better than it was certainly 2 years ago. So I think our marine business, especially the energy part of it, will have both volume and price. I think on the defense side, we've been a little bit wiser. And so we're going to get probably volume and price. The rest of the markets are a little bit mixed. I mean it goes without saying that we're going to have negative volume and ship sets for 737 MAX this year. It's going to cost us $30 million to $35 million of revenue year-on-year, at least. We're kind of assuming a worst-case scenario. So there are, yes, certainly, no price and negative volume. So it's a mix bag, but I think, total company, yes. And I think 2020 will look like 2019, where net-net, there's probably a positive price and positive volume, but there's pockets that are better and there's pockets that are worse. Yes, please.

Given that, like, you're not looking to build out another whole platform or something and you tailed imaging out. What are some of the obvious adjacencies that kind of make sense [indiscernible]?

Sure. So like notwithstanding my comment about liking the portfolio and not changing a whole lot, I mean people have kind of been joking with me. I mean every -- you sort of never say never. I mean we had no imaging business before 2006. We had no electronic test and measurement business until 2012. So it's one of those things that every 6 to 8 years, we, for a lack of a better term, add a new platform or new wedge to the pipe. But even those are very similar to what we've currently had in the portfolio. So we're still looking at instrumentation and imaging as the areas where we want to grow and not straying too far from our niches. I mean what we do in instrumentation even if you look the marine side or sort of specialty chemical analyzers and environmental, specialty electronic test and measurement, those are areas that we like. Instrumentation, generically speaking, is the most fragmented. This is kind of a generic way of saying it, but there's no universal sensor company. That's why you see the size of those acquisitions. It tends to be nichey and will cease the environmental end market. Someone will say, I need to look at trace contaminant X and process Y and industry Z, and it's a $20 million a year business or product line. There's a whole lot of those. And those are great fits to fill what we do. So there's more acquisitions in instrumentation. You're probably going to see more like that because actually there's not a lot of companies upscale. Even the ones upscale are kind of assemblies of smaller businesses. And so that will probably look the same. In imaging, we're very focused. I mean we like what we do. We're not looking to get into commoditize. We do specialty cameras, but we have no interest in making cameras for cell phones. We have no interest, really, we do make some, but we're not chasing in a big way, speculative markets, like autonomous driving. We actually have some products there organically, but we're not making big acquisitions to try to get into consumer low-end LIDAR. But within that, imaging being a little bit more consolidated, I think you're likely to see more acquisitions there, but it might look just like that chart, fewer but larger bubbles as we round out the portfolio. But right now, to sort of answer the original question, I don't anticipate a new wedge being added. And there's still enough area to go fish in what we're currently in. Yes.

Maybe can you go into like some of the space and NASA-type applications that [indiscernible] growing part of the budget [indiscernible]. So can you kind of talk a little about your position there? And where you see opportunities in the next couple of years?

Yes. So inside imaging, aerospace and defense is a vertical. I talked about machine vision, our vision systems, as I call it, being about $355 million of annual revenue. Aerospace and defense, truly defense, in imaging, is about $255 million a year of revenue. And that's a mix of both infrared sensors as well as visible light. Yes, and right now, the outlook is pretty good, especially for the infrared imaging side of it for defense applications. I mean the budget came out. I'm sure everybody saw just a few days ago. And when we were in a number of programs, there's no, I'd say, huge, heavy hitter for us in that domain, but there are things like that are called out in the budget that are not classified, like called OPIR, Overhead Persistent Infrared. It's a successor to SBIRS, the space-based infrared program, for things like missile tracking or tracking of hypersonic weapons. And those kind of programs are good for high-spec, space-based infrared sensors, which is what we make. So the outlook there is good. But I think generically, I mean we actually had probably the most organic growth in 2019 in the Defense Electronics side of the portfolio, where we make specialty products for radar and electronic warfare or jamming. U.S. government business in aggregate, organically, grew more than 10% in 2019. So that was a big contributor to the 4.4% is that 24% of our portfolio grew double digits organically. Some of that was space. Space was up double digits. But defense and electronics is up double digits too for the electronic warfare and radar. Yes.

And about the budget initial looking, you guys take kind of -- it substantiates a similar level of growth go forward, what do you think?