Teledyne Technologies Incorporated (TDY) Earnings Call Transcript & Summary

Good morning. I'm Greg Konrad. I'm part of the equity research team at Jefferies. Welcome to the Jefferies 2022 Industrials Conference. I'm very excited to have Jason VanWees, Vice Chairman of Teledyne, with us today. Thank you, Jason. We'll have a fireside chat and maybe a little bit of time for questions at the end.

But Jason, maybe just to start, you're coming off a solid quarter, 8% organic growth. 6% or a little bit over 6% organic growth rate expected for the year. You did, however, temper expectations for the back half moderately. Can you maybe talk about some of those risks around inflation, FX and the supply chain?

Yes, sure. So just thank you, too, first. So organic growth was 8.2%. And historically, we never really even talked about currency because with 50% of sales overseas, only 20% is actually done in local currency. A lot of our businesses are U.S. dollar markets. But that said, there was some translation, and we usually bake that in. So that was about 1.7%. So as most people report, organic growth is actually about 9.9 in Q2. So we had a pretty good quarter. And even some government contractors or government business grew, and ours grew on a reported basis and unbilled AR went down. So we actually shipped more quarter-to-quarter than we actually recognized. In terms of expectations, yes, we did take it down a sliver , about 1% on the top line and about 2% on earnings for the year relative to our prior guide. And part of that was FX. Part of that was also kind of an attempt to be conservative. We had some folks, not Greg, but there were folks considerably above our outlook range, both in revenue and EPS. And we sort of had to make a decision: do we deal with the known issues that are out there in terms of supply chain? I think we had that covered, price/cost inflation. I think we had that covered. Now some currency translation both on the top line, a little bit on the bottom line in terms of earnings impact, and then not only exceed our prior range but overachieve our prior range given where consensus was. We thought that was a little bit too risky and not right. So we wanted to revise just enough to kind of get back a little bit of contingency but also just enough to try to get folks on the sell side who are not within our range back within what we thought was reasonable. So that said, again, it was pretty minor. I mean 1% on the top line, 2% on the bottom line. Again, we weren't happy to do it. It was only the fourth time in the 23 years that I've been at Teledyne that we've actually changed our outlook lower, including all periods. But that was the right thing to do. That's it.

And then just on the FX, I mean, how do you think about revenue versus margin impact? And the question I get a lot is, does this change competition at all when they're competing with maybe a local competitor who doesn't have the same issues?

Yes. So costs are reasonably well balanced. It's not like we have a big mismatch with local currency revenue and a U.S.-heavy cost. We have international operations. So it's probably a little bit of a net margin impact. All things being equal, 1% less sales, maybe 1.25% less profits just given still some U.S. dollar-heavy costs. But again, we're reasonably well balanced, so we don't have a mismatch of any consequence. And where we do in occasional businesses like in our Instrumentation segment, we have some other markets that we're selling into, albeit it's only 4% of sales. But energy, we're getting both volume and price to more than offset some of the inflation as well as some of the translation impact there. So again, it's a little bit of a hit, but it's -- again, it's more just on a translation, less dollars, less cost, less profit than there is any kind of mismatch. In terms of competition, I think we were a little bit hesitant. I think it's fair to say where we had positive price/cost despite headwinds and actually record margins in our Aerospace and Defense segment and in our Instrumentation segment, there was a little bit of a sequential decline in our Digital Imaging business. And there was some hesitancy, I think, in the back half of the quarter to adjust U.S. dollar prices in markets where there may be competition: in Germany, Korea, Japan. Some of that, we've -- call it right or wrong, we've corrected some of that, put in more price in Q3. But we had both positive price and volume in Q2 in some of those businesses. So a little bit tough to criticize. But it is fair to say in Digital Imaging in Q2 inflation was maybe linear and pricing was a little bit more punctuated. And towards the end of the quarter, we've had a little bit of negative price/cost and a little bit of sequential slip from Q1 to Q2 in margin in Digital Imaging. The other segments had record margins, 2% to 4%.

And then just following up on price, I mean, for the most part, you seem very efficient with passing on pricing. You talked a little bit about price/mix. But, I mean, how do you think about price in general trending versus some of your peers? Maybe it wasn't up as much, but it seems like you had positive price/cost. I mean how do you think of that as a lever going forward?

Yes. So again, it depends on the segment. If you looked at Teledyne overall, which you can do, but it's a unique situation in each segment, you kind of break even this year. Year-to-date, wage inflation has been about 3.8% in dollar terms. I mean some of the percentage might be higher, but then there's been attrition or workforce reductions. It's been about 3.8%. In terms of cost inflation, it's been 5% to 5.25%. And again, given the gross margin, given the SG&A level, you kind of need about 3.25%, 3.5% on pricing in order to make that price/cost neutral. We had more than that in the Aerospace and Defense Electronics segment, and that's one reason why the margins were higher. We had more than that collectively in Instrumentation. Again, some of that was more in the marine and in the energy domain, which contributed to the segment. In Digital Imaging in Q2, we were probably under that a little bit in terms of price/cost. But we did get volume. I mean legacy Teledyne organic growth in imaging, inclusive of currency, was 10.3% in Q2. So we had good volume and good price. But did we dip below that? Probably back end of the quarter on the Teledyne portfolio and some of the FLIR commercial thermography or Raymarine, probably we're a touch light on price/cost. And that's the sequential slide, which, again, I think there'll be a sequential bump. Again, nothing major, but I think we'll kind of get back to where we were in Q1 in Q3 in imaging.

And then, I mean, just thinking a little bit forward, assuming inflation eventually does come back, we'll see, how sticky is pricing? I mean I remember the dynamics in oil and gas several years back. In the downturn, you took out costs and then you end up with record margins because you hold on to price as the market recovers. I mean how do you think about that impacting going forward assuming whatever happens with inflation?

Yes. Again, it's a little bit of a mix across the segments. But generally speaking, I mean, we're not a consumer-exposed company. I mean at the first order, automotive is very small should that ultimately weaken. It's classic industrial, high reliability. We actually have a corporate cliche, both for the businesses we own and the acquisitions, that we don't want to be in businesses subject to commoditization or where you have to make it up on volume. So historically, we've been quite sticky on price, and I think that will continue. Now again, if inflation abates strongly and customers complain, we shall see. But we have no intention of rolling back prices.

And then maybe just on the supply chain, I mean, I get a lot of questions on that, just to clarify. It seems like you have an impact. But on a quarter-to-quarter basis, it's rolling, meaning you've been able to recapture those sales, which get replaced by the other headwind. Can you just go over that a little bit? And then when we do think about at some point this will normalize, does that all get recaptured right away and you see a bump?

Yes. So, I mean, to quantify first, you're right, the constraint kind of rolls each quarter. I think the numbers we actually used on the conference calls were maybe $45 million or so in Q4 of last year that couldn't ship because we had the hypothetical 9 of 10 things you need, but the one thing you don't in order to ship a product. And then, okay, that didn't go in Q4, but it goes in Q1. But then there was maybe another $70 million that couldn't ship in Q1 because we didn't have a component. That left in Q2, and the number we used in Q2 was maybe $60 million, $62 million. So it's not cumulative, but there's kind of this rolling $60-ish million that's been hard to get out the door. And each quarter, the backlog builds. I mean we talk our -- the Ks and Qs have our remaining performance obligations, which is basically backlog, and you see that creeping sequentially quarter-over-quarter-over-quarter. So the backlog keeps building. But yes, that just sort of a constant $60 million that's been kind of choked for the last 9 months. And yes, I'd like to think when there's normalization of supply chain, not only does that help you on the shipments and the incrementals, but what is rare for us is we actually built inventory. After reducing inventory quite a bit in 2021, from year-end 2021 to June 2022, we actually increased inventory. Again, cash flow positive Q1, Q2, but we increased inventory about $70 million. So there should be not only a sales and earnings benefit, there should be a working capital and a conversion benefit. That said, right now, we really don't see that in 2022. Perhaps 2023 when, we shall see. But -- we don't see supply chain getting worse, but we don't necessarily see it getting better for industrial high rail components, electronic components, primarily.

And then just on the FLIR side, it's been a little bit over a year since close. Kind of what's been accomplished? What's in front of you still in terms of integration? And maybe how has the business trended versus what you initially expected?

Yes. So we closed the deal mid-2021. The cost takeout was a lot faster. We did a little bit underpromise, overdeliver. We had said we'd save about $80 million over a 4-year period. That $80 million of cost is gone. It's actually probably a little bit higher. In terms of major things we wanted to accomplish, cost takeout happened; corporate costs, gone. There were some nagging items that we knew were there. It was part of the transaction. But FLIR had some, call it, foreign tax issues or, as one might consider it, evasion. That was settled in Q1. They had a 4-year consent agreement with the U.S. Department of State for export sins of the past. That was to end in April 2022 should they pass all the audits, which they did. That's gone. So again, all the cost takeout has been good. The structural issues that we know we inherited, you're never completely done, but the major items are done with regard to those. In terms of the top line, we're pleased. Can I pick on one thing here that was maybe a little bit lower, one thing here that's considerably better? Yes. I mean I'll give you a few examples. But this year, even though it's more currency translation, which is more acute at FLIR, we think they're going to be higher than their peak revenue, which was 2020 when FLIR actually had a lot of coated tailwind doing infrared cameras for elevated skin temperature screening. That was between $125 million and $100 million of revenue. And all that's been clawed back, and we think they'll be higher than that peak revenue. We've, on the other hand, done a little trimming around the edges, call it, product line pruning, businesses that might have leaned a little bit commodity, low cost, less proprietary UAVs and the like. They bought a small business in December 2020 during our due diligence. Weren't particularly thrilled with that. That's changed now in terms of the workforce and products at that business. Also, there's a Raymarine business that fits good with us. FLIR at one point was trying to sell it. Again, some of the product pruning around the edge or we call it industrial boating, tugboats and the like, commercial shipping, freshwater fishing. That's a sort of consumer-type business. Again, that's of less interest to us. So we had a little bit of product line pruning, but all the major business groups, the core thermography business. The defense business, why I think Teledyne and FLIR and most of the industry kind of chewed into backlog a little bit on long-cycle government Q3, Q4, Q1 with U.S. DoD outlays being negative, USD outlays were still negative in Q2, but both FLIR and Teledyne actually grew in Q2. And again, it was good organic growth. Sequentially, unbilled revenue actually went down from March to June. So it was good unit volume, true growth in Q2. And the bookings were good in Q2 also in FLIR. I mean FLIR again, why they chewed into some government backlog, Q2 bookings were 1.25; total Teledyne, about 1.08 in Q2, so.