Teledyne Technologies Incorporated (TDY) Earnings Call Transcript & Summary

So good afternoon. I'm Rob Mason with the Advanced Industrial Equipment research team at Baird. Pleased to welcome Teledyne, back to the Baird Global Industrial conference. Teledyne is a $3 billion-plus revenue provider of sophisticated instrumentation and sensor technologies, serves a diverse set of end markets, ranging from medical imaging, environmental monitoring, automation, machine vision, electronics and satellite defense and aerospace. So I want to introduce Jason VanWees, Executive Vice President from Teledyne. He's going to walk us through the Teledyne's story. We'll likely have a few minutes for questions at the end. Also, there's going to be a breakout session afterward as well. So if you have any questions and like those posed, there is a question portal on the left-hand side of your screen, so submit those and we'll pass those along. So Jason?

Great. Thanks, Rob, and thanks, everyone, for being here today, and I appreciate the invite again to the Baird conference. So we'll be sharing a screen right now so that you can see slides. But before we get started, of course, I'm going to remind you that statements made today may have forward-looking statements. Please note the risk factors in our 10-K, 10-Q and our periodic SEC filings. So now just a quick overview for those who don't know Teledyne, who may be participating. Essentially, what we make is a range of specialty sensors in a variety of markets, could be image sensors, could be specialty sonars that acquire data, a data in typically harsh environments. Then we make devices that transmit that data. It could translate the data with an analog to digital converter, it can be a specialty interconnector. It could be an entire autonomous underwater vehicle that houses those sensors, and then it transmits and analyzes of information usually with software, either in the product for our customers or we do that on behalf of our customers. And I'm happy at the end of this presentation to get into any product we make, any market, any sector. I've been here 21 years. I'm very familiar, feel free to ask. The rest of the slides, as the nature of these conferences are, is mostly financial and, call it, investment thesis like. But I'd love to talk about any of the technology, if those are willing. Now we describe ourselves as an industrial company. And why do we do that? Well, our legacy -- and there'll be slides later -- go back to primarily in aerospace and defense company. 21 years ago, we were almost 90% aerospace and defense. Today, all things, aerospace and defense are only about 30% of the portfolio and substantially less of profit. So we really are a commercial, industrial business. That's the balance of the portfolio. Now with regard to the business portfolio, that's the next point, we always say we're balanced. And we choose that word intentionally because we're not a highly diversified business. We are actually the opposite. We're quite focused on the technologies in our individual segments and the technologies that are related to each other even across the segments. So we've never branded ourselves as a diversified industrial. We are diversified in some of our major end markets, but those end markets are limited to just a handful. But nonetheless, it is balanced when one says, well, what percentage of my business is long cycle versus short cycle. Today, it's probably about 60% shorter cycle businesses. But as a nice damper, if you will, in terms of rocky markets with that longer cycle part of the portfolio, which is about 40% of sales, things like U.S. government business, which is the single largest part of that 40% at about 26% of total sales. We talk about our track record. We've been -- the management team here, including myself, has been doing this for a couple decades. It's been consistent, cohesive, and we've had a long climb here from small-cap 600 to mid-cap 400 to now S&P 500 as of June. And frankly, we're proud of it. But the next bullet, on the other hand, we don't consider ourselves done by any means. Portfolio management, I think, has been outstanding. We're probably never done with that. We're maybe in the eighth inning. We're going to keep doing acquisitions, so you're never done. But we're probably a little bit behind some of our much more mature industrial peers just in terms of integrating the acquisitions in terms of commonality of systems, in terms of procurement, in terms of being wise on pricing. And I think it's one of the reasons why our margins are not best in class. In fact, they’re probably not lower quartile, but they're probably average at best. And there's a big emphasis on that now. Not like we've stood still. You'll see some charts later, but I think there's been increasing opportunity even year-on-year in Q3, despite negative organic growth as most people experienced in commercial, industrial or GAAP margins. And I mean, GAAP, not adjusted, were actually up year-on-year in our most recent quarter, despite some negative operating leverage. And M&A has always been a big part of the model. Free cash flow conversion has always been a big part and being wise on acquisition pricing was and remains very, very important. I won't go through all of these markets. But again, this kind of just lays out what our long-cycle versus short-cycle on the left. Commercial imaging is our biggest end market right now from a product category point of view. And that's a wide range of different sensors. But basically, what we do in imaging is we make sensors for things that are hard to see. Some people tend to think, boy, your -- Teledyne is very complicated. Well, it's kind of my fault sometimes if you want to know about every user of our sensors. But what we make is sensors for things that are hard to see. That could be a sensor that is in space, looking down at Earth for a classified mission or it could be, or maybe you want a few feet or a meter of resolution, or it could be a very specialty sensors that just is an inch or 2 above a semiconductor wafer because nanometers and microns matter. But it's high resolution, high sensitivity, high-speed imaging. It could be an X-ray sensor that makes a very good image with a very low dose. A patient wants low dose, the doctor wants low dose. But that's what we do. So sometimes our end markets look complicated, but the underlying technology of what we manufacture in each of these wedges in the number of sites we have that make these things. It's not nearly as complicated as sometimes people think. It's the standard markets are diverse, the technology, the know-how, the manufacturing is not nearly as diverse as sometimes people think. Moving to our other markets, analytical and electronic test and measurement. That's a portfolio of trace chemical analyzers for a variety of applications like ambient air monitoring, air quality reports that you might see, people have heard about PM2.5, 2.5 micron particles that are damaging, maybe carrying COVID and things like that. We're the leader in terms of particulate monitoring domestically, at least, and we're a major player internationally in that market. And then you'll see some of the other markets. But again, U.S. government is still a nice damper when times are challenging, that's 26% of sales. If you move to the right geography, we're mostly international on the commercial side. Collectively, it's about 45% of sales or so is overseas, evenly split between Asia Pac and Europe. And even Asia Pac, well diversified, China is about 6%, 7%. But we also, given the type of markets that we serve, I mentioned the semiconductor one before, some of the research and science markets, Korea and Japan, Taiwan, all big markets for us as well. So tariffs and/or reciprocal tariffs never really were big issue for Teledyne. And I'll briefly talk about the portfolio evolution. Like I said, I joined 21 years ago today, and that -- which was not aerospace and defense was only 6% of sales. Today, we're mostly in imaging and instrumentation company. That's essentially 2/3 of the portfolio, almost 3/4 right now is instrumentation and imaging, and most of that is, like I said, commercial, industrial. We have divested a few businesses along the way that we inherited, but we tend to be very focused with our acquisitions. Of the 63 companies we've acquired, we've sold 0. And I'll get to acquisitions a little bit later. So like I said, notwithstanding the fact that I think our margins aren't best in class, and there is some margin improvement. You'll see, again, over the last couple of decades, we certainly have not stood still. And this has not been all a function of just M&A. I would say that generically speaking, we have bought businesses with higher gross margins than our existing ones over time. But more than half of this has been true organic improvement in terms of margin improvement, both gross and EBITDA. You'll see R&D expense, though, it does not come at the expense of R&D. The DNA of the company changed a little bit in that 2006 through 2010 time frame where, back then, we were a highly diversified spinco from a spinny in late 1999, and we really didn't have the scale to do R&D. We basically did just D, make another variant of a product you've always made forever. As we started getting a little bit bigger, as we started doing double down acquisitions, building businesses of scale, we really began doing R&D and organic new product development in that 2010 to 2013 time frame. So that's why I say sometimes that we've been at this 21 years, and we're really, really happy with the portfolio. The level of maturity in terms of organic growth, integration, margin improvement, procurement, pricing, purchase price variances, strategic pricing, we're still a relatively immature company in the grand scheme of things, but we're working on it, and we're getting better. This has been the earnings. I think the one thing we are actually quite mature at is protecting margin when times get tough. You'll see the 2009 recession, earnings didn't go down. They actually went -- they went up. And these are GAAP earnings. These are not adjusted. The only adjustments were when we did our largest acquisition, there are some numbers that you see in 2016 and 2017. But again, in 2013 through 2016, you had a little bit of a meltdown in the energy markets. You had sequestration, defense spending declining. And again, we protected margins, we protected earnings and kept them flat. And then came out of it, again, nearly doubled earnings until this year got a little bit challenging. And yes, revenue is going to be down maybe 5%, 5.5% organically, 3% GAAP. But now just 3%. That's what we're looking at for a revenue decline In 2020. But again, we reasonably protected EPS as well, GAAP EPS. This has been our shareholder return. I mean we're proud of it. But the reason I show it is not just the fact that it's been attractive, been successful. But we're a little bit unique that the 2 LTIP programs, long-term incentive plans, that we have are long-term plans based on relative return to an index. It was formerly Russell 2000. It's now Russell 1000. We were graduated to that, I think, in 2017. That's a little bit unique. And the plan for the most senior management, there's no upside leverage if you end up beating the index over a 3-year period, you receive your shares, they vest. If you do not, you start forfeiting and you may forfeit all of them. So I think management is very incentivized with the buy side and long term in view. And again, the track record, like I said, it's been a fun journey from small-cap 600 to mid-cap 400 to S&P 500, the 20 years I've been here. Now sometimes people say this is boring because the strategy hasn't changed. It's been kind of the same slide for a couple of decades here, but that's such a good thing. That's not a bad thing. It's keep the portfolio balanced and focused. You're not going to see us do a single market deal of $2 billion, $3 billion. I mean we like the fact that we have this balanced portfolio. We -- obviously, everyone talks about some form of lean or some form of business systems, some form of Six Sigma. Of course, we do that. But even though we're not as mature. This company, other than financial metrics, tracked no KPIs prior to 2003. Now okay, that's 17 years, but on-time delivery, linear production, overtime dollars, overtime hours. Any KPI that you could think other than just order sales, cash flow really, frankly, didn't exist from a management philosophy until 2003, and continuous improvement of those is still relatively new when you're talking corporate history. But the goal is, ultimately, its customers, its employees and its shareholders and compounding the growth in free cash flow is something that we've done quite well, and we plan to continue doing. What is a little bit new, like I said, though, is that second set of data on being a little bit mature on reducing complexity, reducing legal entities, getting smarter with procurement, getting smarter with strategic pricing on sole source contracts, I think, we've realized the last couple of years with some very, very unique product we have. We've been a little bit of a martyr sometimes and left money on the table, and we're getting better at not to doing that the last 6 months or so. Acquisitions are a big part of the strategy. And again, doing acquisitions, but always keeping a strong balance sheet. We've never had leverage more than 3x debt to EBITDA. That's the highest it's been after our largest acquisition. So we've always had a investment-grade pricing on -- in the bank markets for all of our transactions and kept leverage relatively low. And frankly, right now, it's the lowest it's ever been at less than 1x net debt to EBITDA. Even on a gross basis, it's 1.3 -- 1.38 to be precise. This is the acquisition history. So again, we've acquired 63 companies, progressively increasing size as we ourselves have grown and have had more cash flow. But again, they've all been quite focused to double down acquisitions of new product in markets that we're already in. Never say never that we may not deviate from that or buy something in an adjacent market. But common markets, common customers, but new products where you can add scale, complementary products, that has been our thesis since we started. And we spent about $3.6 billion on these acquisitions over the years. Now where that has come from? Again, like I said, we've never been highly leveraged, but the $3.6 billion we’ve spent on acquisitions, that's in the center, the use of funds there has primarily come from the left. It's been all internally generated cash flow. We have a little bit of net debt right now, but it's only $300 million. There has been some noncore divestitures. It's only $160 million. But from a pure financial point of view, the overwhelming thesis has been internally generated cash flow, we will opportunistically buy back stock. We have done that. At one point, we had a legacy pension that was underfunded. We still have a legacy pension closed to new participants in 2004. But even now, it's over 100% funded. And of course, we spend on CapEx. And that's one thing I might just mention, when I say I was very, very happy with the portfolio, it's not just about the businesses and markets and products we're in, which I am very pleased with. It's also structurally we've cleaned up the company. You could -- I encourage you if you wanted to dig through the footnotes and risk factors. I mean we don't have -- we've, I guess, had a fully funded pension. We don't have collective bargaining agreements. We -- domestically, we don't have environmental problems. We've been a very, very structurally clean company. But that wasn't always the way. Again, more than 2 decades ago, we've divested certain businesses and certain products to not be in that position. And most, the capital deployment, I already mentioned, we were -- used to be an aerospace and defense company. We haven't neglected or ignored those markets. We have deployed a little bit of capital there, but we’re overwhelmingly have been and are becoming even more so an instrumentation and imaging business, serving multiple markets in each of those. That's the revenue profile of the company. What you'll see is the -- more so than just the growth, you'll see the evolution where just even as recently as 2006 we had virtually no imaging and instrumentation was only 1/3 of the company, where today, like I said, it's 2/3 to 3/4. Free cash flow. You see the free cash flow there in red relative to GAAP and net income, conversion has been in almost every year, there's maybe a couple exceptions there, more than 100%. Year-on-year, we're up in free cash flow in the first 9 months despite having an organic decline like most folks in this COVID time. And we think this year, we'll actually have record free cash flow, well over $400 million, despite the challenges by just being prudent, being wise with working capital and CapEx. And just quickly on the balance sheet. Like I said, the balance sheet has never been stronger. At the end of Q3, net debt to capitalization was less than 10%. Immediately available liquidity, just the cash on hand and our credit facility was almost $1.1 billion. If you just went up to the capacity of our covenants and assume there was 0 acquired EBITDA if you were buying a business, that's about $1.7 billion. Of course, there'd be well over $2 billion if you actually were buying something that was profitable, which, of course, we wouldn't consider anything but that. But that's the financial overview. And I know I kind of talked quick and maybe went a little bit fast here. But I'd be more than happy to talk about the financial profile or, frankly, any of our products or markets.

That's great. That's great. We'll jump into that. But maybe just to start off real quick. We've been trying to probe each of our companies here at the conference. And just to get their opinions on a couple of topics. The -- so obviously, COVID presented challenges for everybody. And as we've come through that and things have started to go down a recovery path, for Teledyne, has there been anything that you would call out as positive surprises that you think structurally could maybe be more enduring as we go forward? Long lasting?

Yes. Well, I think what's been surprising, but I just don't want to call it a COVID-related thing. I think most things from a top line point of view played out almost exactly like we thought with only one exception, which is now changing, is the businesses that you would naturally think would be down were down a bit. Aviation is a prime example. That part of our portfolio used to be 8% of sales. Now it's 4% of sales. It's $90 million of revenue we lost, 2019 to 2020. Then there were little surprises here and there. We actually make oxygen sensors for ventilators, small product line, but go figure, that was up. Again, we figured that x-ray detectors for dental would be down, who is going to be going to a dentist in peak COVID, made complete sense. A couple of little surprises, I would say, is some of the government business has actually been better. And that's not because of government budgets because of some unique programs, especially with regard to autonomous underwater vehicles and then space-based imaging to actually be probably more precise or significant from a dollars point of view. But pretty much everything else top line has played out. I’d say what gives us more confidence, and it's been more in our dialogue lately, even in my speech lately is the margins. Because if you sort of looked at the most recent quarter, but even the evolution throughout the last 3 quarters, we put a lot of actions in that I talked about on pricing, procurement, really sort of starting in 2018. But even some of those actions would go into the supply chain, go into inventory or the pricing would go into backlog, and they're kind of starting to just hit the P&L now. And so if you look at sort of Q3 and weren't at record margins for us. They're still not -- I mean they're not the highest, but either GAAP. They were close to a record, but that was despite having negative operating leverage and having negative mix because the government businesses aren't as profitable as the commercial businesses. So the confidence on margin improvement throughout the year, heading into 2021 and 2022, I think, this has made us -- has surprised us in a good way and given us more confidence. Yes.

Okay. We were talking just before we started, though, a little bit about maybe some of the momentum that you have seen as you exited the quarter and how that's been encouraging, certainly relative to maybe sequential momentum during the summer months. So -- and your guidance reflected that as well. So just could you call out a couple of the areas or any areas that you want to highlight in particular that's going to support that sequential increases as we go through this quarter in revenue?