Teledyne Technologies Incorporated (TDY) Earnings Call Transcript & Summary

Teledyne Technologies is a provider of sophisticated sensor and instrumentation technology. The company is approaching $6 billion in revenue and serves a diverse set of end markets ranging from medical imaging, automation, machine vision, electronics, satellite defense and aerospace. And we're pleased to have with us today Jason VanWees, who's Vice Chairman at Teledyne; and Edwin Roks, who is Executive Vice President and heads up their Digital Imaging business. Jason and Edwin are going to walk through a few overview comments, and then we'll go into some questions, be able to take your questions as well. So with that, I'll hand it off to Jason.

Thanks, Rob. And I'll give a little bit of a -- a little more detailed intro. So I've been at Teledyne for about 24 years, I'm the Vice Chairman. My principal responsibility is acquisitions for the company, of which we've done 67. Edwin joined us with what was our largest acquisition at the time in 2011, known as DALSA, it's our first really commercial Imaging business. Today, Imaging is about 60% of the portfolio, Edwin runs that segment. So the largest part of the operations, he is the President of that business. And we -- like I said, he joined us in 2011. He joined that company in 2005. So he's been at Teledyne or our predecessors leading the Imaging businesses for about 20 years or so. So with that, I'll make a few opening comments. And again, we'll try to do this half-half. I'll make a few comments, Edwin will make a few comments like Rob said, and then we'll turn it over to Q&A. So quickly, who is Teledyne. As Rob said, we're principally a sensor company. That's the founding -- that's the founding of a lot of the businesses we acquired. Of course, we've grown beyond that. So we still provide sensors. We utilize these sensors internally. We provide them to the third parties. But of course, that's changed quite a bit in the last decade or so. We're not just sensors but cameras, instruments incorporating those sensors, unmanned vehicles using those sensors. And it's kind of maybe the elephant in the room, a lot of people have been asking about AI. Where do you plan that? And I think it's a little bit overhyped to say the least, but be it AI, machine learning, edge processing. That's why maybe 2, 3 years ago now, we changed that first bullet on our slide deck, rather than saying a sensor and instrumentation company, we say sensing and decision support. Some customers want an image, some customers want data. But what we really want to provide our customers, what they really want is an answer, is a solution, is information. And there has been differential growth in those businesses correlated with information. There's been businesses that have had differential growth the last 3 years, our test and measurement business that Rob mentioned has been one of our fastest growers for advanced semiconductor development. They'll probably be amongst our fastest growers in the next 3 to 4 years. I guess I just don't fully believe has something changed in the last 2 weeks or the next 2 months of a step function change in semiconductor development or AI. If I'm wrong, that would be great. Because again, those have been differential things that have driven our business, a subset of our business the last 3, 4, 5 years, and I think it will be beneficial in the next 3, 4, 5 years. And again, it'd be our test and measurement business, be it parts of Digital Imaging that's used for semiconductor mask and wafer, advanced semiconductor development, more data communication, our protocol analyzer business inside test and measurement, all those things are great. I just don't want people to be a little bit measured in what has been growing fast over the last 3 to 4 years. And we'll be growing faster, I think, the next 3 to 4 years. Again, one of the corporate cliches is we don't like to be in businesses that are commoditized or subject to commoditization. That's what's meant by the second bullet, a broad portfolio of highly engineered products. Most of the businesses we're in, both on the long cycle, medical, aero defense as well as the short cycle, they talked about semiconductor wafer inspection. We talked about test and measurement. Most of those markets are oligopolies where ourselves and maybe 2 other competitors have commanding share of that nature of that market. That's most of what Teledyne looks like. Again, I have a proven track record. I've been here 24 years, Edwin's been here nearly 20, at our predecessor companies. We've done a pretty good job. That said, I think there's room for margin improvement. We've grown a lot in the last few years. There's room for that to continue. And again, we've done a lot of acquisitions. We do consider ourselves -- I think the market considers ourselves one of the compounders. Again, we've done 67 acquisitions over the years. We took a little bit of a hiatus to deleverage after the FLIR acquisition in May 2021. But since then, we've done 3 bolt-on acquisitions. So back to priority is acquisitions, is M&A, and that's obviously something that we want to do. And we're prudent, though, with capital deployment. When price gets too high or the asset is severely devalued, we won't participate. Again, just a very brief profile of our business. So today, on the left, the U.S. government is still our largest customer. Our legacy is Aerospace and Defense. Aerospace and Defense is still about 30% of our total revenue, but we're mostly a commercial industrial business. And Imaging, both commercial as well as some parts and defense is our largest business run by Edwin. In terms of sales by geography, again, in terms of the commercial markets that we're in outside the U.S. government, more of our business is global, is international, about 47% versus the domestic commercial market being 28%. Come a long way. When I joined, we really were an Aerospace and Defense company. Edwin will probably show a slide that looks at our evolution, but we were more than 50% U.S. government gross margins, were in the 20s. And a little arc there is proprietary electronic products, again, 2 decades ago. That was only about 1/4 of the company or a little over $200 million, over $657 million of revenue then. Today, we're a commercial and industrial business. Again, U.S. government is important. It's a nice shock absorber against global macro at 23%, but it doesn't dominate our top line. It's not like we're subject to the whole businesses, the DoD investment accounts. That was the case 2 decades ago. Today, we're commercial and industrial with a lower beta backbone of the U.S. government and defense business. That's really who we are today. And again, on a 2023 basis, our Street guidance is about $5.7 billion, and Edwin runs what is about 60% of the company. Acquisitions, the largest commercial business at the time was in sort of the center there in red. That's what was known formerly as DALSA, a public Canadian company. That's when Edwin joined us. And of course, we've acquired many, many more in Imaging, the last large one being FLIR in May of 2021. But through FLIR, we've done some bolt-on acquisitions now, so itself is a platform company. And again, we're proud of the track record here. Today, we've had no goodwill impairment on any of these acquisitions. Return on capital pre-FLIR was about 11%. FLIR, we probably, for Teledyne, maybe we stretched the purchase price a little bit, but we also recapitalized the company that was net cash at the time with $4 billion of sub 2% fixed rate debt in May of 2021. So on an ROE basis, I think FLIR will be as good as any other acquisition. And to date, the cost cuts and the EBIT have been actually on plan, a little bit ahead of plan. So that's probably a good segue to Edwin, who runs all those red circles there in our Imaging business. And I'll turn it over to him for a few interim comments.

Sure. Okay. Thank you, Jason. Yes, this is a very simplified overview. Hopefully, there are not too many physicists in the room. But again, it covers the whole spectrum of what we do. Starting on the, let's say, in the middle, the visible spectrum, you're all familiar with that. But if you go to the left, you end up with gamma cameras, camera sensors. And those are used in scientific applications. And if you move to the far right, you get into radio frequencies where it's all useful communication. And if you look at the whole spectrum, you see X-ray, for instance, we do a lot of medical systems, we do a lot of medical X-ray systems for all kinds of detection, be it surgery, be it dental. Coming back to Jason's remark about AI, that's typically an area where you use AI. You want to look, let's say, at certain defects in a human body. Could be cancer, correct? And you see that these machines are much better in defining these things than a human being. So that's a very good way and a good example of using AI. Getting into the ultraviolet here, you get more in semiconductor inspection systems. If you want to make chips, you need masks and these need to be inspected, and that's what you do with ultraviolet. And then infrared, you get into heat, the heat signature of certain things. Think about an infrared image you're very familiar with, you see that on the top. And that's, of course, with the acquisition of FLIR, we've got much more infrared technology on board. Microwave radio, as I said, mostly communication-related. The spectrum is nice, but you want to make products because -- products you can sell. And some of these products have all kinds of algorithms on board and sometimes even AI on board. Starting on the left-hand side, you see wafers. We have 2 MEMS fabs where we produce wafers, both in Canada. And think about CHIPS Act, it's very -- might be the next buzzword by the way, after AI. The CHIPS Act, already happening, we want to play in that, yes. These chips -- these wafers might go to 300 millimeter, and we want to play in that. So that's a very important thing to keep in mind. Then the sensors and the cameras you see there on the left-hand side, the thermal cameras and even getting into full systems. On the right-hand side, you see a [ gimbal ] system. If you look at the helicopter and you see the gimbal below the helicopter, in many cases, that's produced by us. And on the close to the right-hand side there, that's a LiDAR system, where you make a 3D image of the world basically. So that's -- these are some examples of many products we have. If you make sensing products, you need also platforms to work with these sensors. And sometimes, that platform is part of the sensor itself. If you look at where we play, we have these underwater vehicles, which are unmanned underwater vehicles. The one on the left-hand side can go 6,000 meters deep and also, by the way, come back to surface, that's also a very important thing. The middle one, you see ground vehicles. Think about the Ukraine, the war at Ukraine, think about the mines have to be removed, done with our systems at the moment, while we speak. On the right-hand side, you see these drones. That's even not the most sexy one. We have a very small one, which is 30 grams. It's called the Black Hornet and is being used in Ukraine, while we speak. Some examples of payload below. Again, these are used as sensors. They are sensing devices. Then continuous improvement, but this gives a good view of who we are at Teledyne. First of all, the gross margin. I think the gross margin is giving you the best view on how competitive we are. Yes, we want to be leading edge. We don't want to be commodity, and that's very visible in these nice gross margin metrics there. R&D, we've spent enough R&D. We have a very good focused R&D. We try to be very, very focused and very disciplined in our R&D expense. And you see that it is slightly above 6% there. Our international sales, we're becoming more and more a global company, and maybe you hear my accent, I'm Dutch. And I spent 50% of my time in the U.S. and 50% of my time in Europe. And still -- the remaining percent in Asia, by the way. International sales is becoming more and more important. If we want to grow, we have to step back from, let's say, being a pure U.S. company. So we are investing in that. And then if we do everything right, you will see at top right in the EBITDA margins. This is the history. This is the track record of Teledyne. And this is indeed the reason that I joined in 2011, and Jason has started way before that. So I think it's a very well track record and a very solid performance. And again, doing everything right, you see it in the EPS, being very disciplined and making sure you invest in the right things, which are growing. And that's, I think, not only the two of us here, but that's a good management team, a very good team of 15,000 people managing these businesses. And again, cash flow, if you want to continue to acquire companies, you need to generate cash, and you see that, that is also very healthy, very -- that's it.

Perfect.

Yes? Let me give it back and go to Q&A.

Again, if anybody has any questions, those can be set up via [email protected], and we'll work those into the conversation. So maybe just to start off, we'll bring us current around how things are playing out this year, how you are seeing things play out this year. The company got off to a very good start in the first quarter from a results standpoint. We did keep the outlook for the year intact, noting maybe we derisked a little bit, but there's also uncertainty. I think a number of companies are trying to separate signal from noise in terms of what they're seeing in their order book, lead times coming down, normalization from order queuing. Just maybe high level, what you're seeing. Maybe we'll start with the order side as...

Yes. So let me sort of define it. 40% of the company, in descending order, that's U.S. government, medical and Edwin's business, aero, commercial aerospace, energy, we really -- I don't want to say fully booked, but we're largely booked for the balance of the year. It's really about execution. The swath of all possible outcomes for that 40% of the business is relatively limited. Again, those markets are strong, they're all growing. The order book is good. It's really about execution in that 40% of the business. And the backlog, while we report backlog in our 10-K, it suggests about 6, 7 months of backlog. In reality, that 40% tends to have about 9 months to even 15 months at the tail. So very good visibility, good backlog, execution. Execution is not easy, but getting a little bit easier. Supply chain is a little bit better now than a year ago. So I don't want to say I'm not worried about that 40%, but that 40%, I feel pretty good about it. And we said in our call in April that incrementally, we're a little bit more positive on that. The 60% is what we generically we call the short cycle business. That's the commercial imaging, the test and measurement, the trace chemical analyzers and what we call environmental instruments. There's really no objective data point in April and even sort of sitting here in June to say we should be concerned. Book-to-bills have been good. I mean good being 0.99, 0.96, they're not 4 weeks of 0.8, 0.8, 0.8, that's what's happening, there's no objective data point. On the other hand, maybe it's sitting in California, which is sort of the epicenter of tech layoffs and regional banking crises. We said, let's just not be more optimistic in April versus January, let's maybe be a little bit more reserved. That was really sort of a top-down opinion. The bottom-up data has been reasonably okay. Again, probably on the margin preferred book-to-bills of 1.01 then 0.99. But nonetheless, there hasn't been a shoe to drop, if you will, in the short cycle. But we did say we're a little bit more reserved, that's why we didn't raise the forecast in light of the Q1 being good in light of the long cycle being good. We said, let's just be a little bit more reserved on that for the time being. But that was more a top-down opinion. And I think that kind of remains a top-down opinion. Who really knows what's going to happen? But from a bottom-up point of view, there hasn't been any -- for any major part of Teledyne, any significant concern on the short cycle. On the other hand, we are pretty conservative, we're pretty reserved, because to ignore some of those top-down things would be foolish in my opinion.

Sure, sure. On the execution side, how do you think about the margin expansion opportunity that you've laid out for the year around 40 basis points at a high level? But it varies by segment, how much is kind of volume and recouping some of the I'll say, inflationary aspects are overcoming that versus other initiatives you have going on in...

Yes. So Q1 and Q2 it's certainly more about being positive on price/cost. I think this is a little bit of incremental volume, even ex pricing, there was positive volume, not a lot, but there was, even more than overcoming currency even, which is a little bit of a headwind turning into a tailwind in Q3 and Q4. So in Q3 and Q4, we would expect that there'll be both operating leverage as well as a little bit of incremental price versus cost. The biggest component where we're probably a little bit underwater price cost last year was a premium paid in the gray market for electronic components was extreme. It was probably purchase price variance versus an OEM price, total company, in part, more concentrated in imaging and instruments, we probably paid $90 million of purchase price premium, and you can do the math with the $90 million on last year's trailing $5.5 billion. I mean it was a significant impact to margins last year. But we got some of that back in price. We probably didn't get all of it, close, we were probably a little bit underwater on price cost, but we had volume. And we ended up on volume and the margins went up. In Q1, that changed. Now you really don't see it too much in Q1 because of the purchase price variance and the broker premiums was significantly less, about half of what it was last year, but that went into inventory and why we're not abysmal returns. We're not great, I think it's safe to say in these high reliability in niche markets, but some of that will hit the COGS in Q3, Q4. So there's no big second half margin boost, but I do think second half margins on a little bit more volume and some of that already captured better purchase price variance will go from inventory to COGS in Q3 and Q4. So that's kind of what's behind -- none of those individually being extreme. Why does revenue ramp marginally throughout the year? Why does margins ramp marginally throughout the year? It's electronic components being positive on price cost and a little bit of incremental volume and operating leverage. That's really what's behind that. And the growth largely is on that 40% longer-cycle portfolio. If short cycle holds up or is actually positive in the second half versus the first half, then there's probably some room for outperformance. We have not baked on that yet. We baked on more sort of sequentially flat, which in some markets, would actually be negative comps in Q3, Q4. But sequentially about flat in the short cycle with some incremental growth in the long cycle walk. That's kind of the...

Very good. Very good. We'll maybe just go to FLIR. That was obviously a very large transaction for you. You have changed the mix of the company a little bit as a result of that. Just give us a progress report on where that -- you mentioned some of the cost synergies that have played out. I'm curious as well how the growth initiatives around the top line played out thus far or maybe what is -- still lies ahead.

Sure. So I'll talk from a high-level point of view, but Edwin is really running the business and closer to the details. I'll let him mention it. From a high-level point of view, I mean, FLIR is actually ahead on margin even on profit versus forecast. Sales are a little bit lighter. If you were to ask me when we were doing due diligence in December of 2020 that government outlays would be largely negative until March, April of 2023, I would have said, no. And if you had definitely asked me a year ago after the invasion of Ukraine, government outlays would still be negative for the next 12 months, the answer is no. So revenue has been a little bit lower, and there's been some 80-20-ing, if you will, on our side. There were a few product lines that were EBIT negative, frankly, in the FLIR portfolio. We're not married to that, so those no longer exist. And that's EBIT-enhancing, margin-enhancing where we're actually a little bit above. But obviously, there's a minor impact on revenue, nothing huge, $30 million, $40 million on an annual basis of $1.9 billion. But nonetheless, it's a couple of percent of revenue disappears. When you're 80-20, something that's actually losing money, which we did. Again, we weren't married to it. So return on capital has been good. Again, absolute profit, absolute margin. The government business, which is about 30%, 35% of FLIR if you count the international defense, that's been a little bit slower. However, we just started getting some more orders in April for that. I think that will inflect a bit in Q3, Q4, when FLIR will become actually probably positive to overall Teledyne growth in Q3, Q4 and beyond, [ down where ] it's been a little bit of a drag the last couple of quarters. But in terms of business by business, I don't know if you want to...

No, exactly. That's the best way to describe it. I think if you look at the commercial industrial business, which is the 45% -- over 50%, I must say, commercial industrial business, yes, that was pretty much intact when we bought the company. We only had to make sure that the new product introductions were on track. So we invested in that. It was a bit underinvested, I think, commercial industrial. You saw it also with sensor leadership. it starts with sensor leadership. We invested, I -- think the first day, we invested $15 million in the fab in Goleta to make sure we maintain that, and that's very successful. These sensors are being used, not only by us but also some of the other drone makers. So that's going very well. So I'm pretty positive about commercial industrial. The Defense business, we have more work to do. We had to reestablish the whole sales organization there were basically two defense companies in the form of FLIR, which we had to migrate to one. They were basically sometimes in competition. So it's now one FLIR defense sales group and we're making good momentum there. We lost some of the Middle East business. We are gaining that back. You see the contract now in Ukraine. We're supporting that with our solutions. So I think that business is coming up. But again, we're dealing with governments, we're dealing with -- sometimes with multiple governments. So it takes a lot of time to get this business in. But again, we have a good track record, and we're getting there. We measure it every day, I would say, and see where we are. And it's going in the right direction.

The government -- your overall government exposure did increase with the FLIR transaction up to, I think, you said 30% now. Is that a ceiling for Teledyne? Or how do you manage that?

Yes. So it increased a little bit. But I mean, the narrative at FLIR and part of this was a function of having 3 CEOs, 5 CFOs and 3 general counsels in the 10 years before we bought the business and compressing their financial reporting from 6 segments to 4 segments, to 3, to 2. Well, what really is FLIT. The narrative, for the better part of a decade ago was all about commercial, commercial democratizing infrared, ADAS systems or automotive, et cetera, home security cameras. A lot of that was sold in February 2018. Then the narrative became all about defense. Opened a second corporate office in Arlington, be a DoD contractor. But one of the appeals of FLIR was that FLIR was really a lot like Teledyne. In the 2020 10-K, immediately prior to rebuying it, we were 74% commercial, 26% U.S. government; they were 70%, 30%. They had a little bit more international defense. That's why I say rather than 30%, maybe 35% because they did have some formulas that's not U.S. government. They were always a lot like Teledyne. The continuing upside we bought, not the stuff they sold in 2018, that was commodity business that we wouldn't have wanted been in, that was really a poison pill. But a commercial industrial higher-margin business with the backbone of lower-cycle government, that's who we were, that's who they were. So it did change our mix a little bit. But with the commercial and industrial actually holding up with that having differential growth in Q1, actual U.S. government sales were only 23%. So actually, the mix has actually gotten a little bit less. I do think defense will grow and will inflect a bit in Q3, Q4, but we're very comfortable with the continuing ops that we acquired at FLIR. Okay, we 80-20 a few things that were unprofitable, then maybe pet projects and things like that. But the business itself was very, very familiar to who we were, what we were both at the unit level, the infrared sensors, both at the fab level, Edwin's background with the semiconductors. But even at the highest corporate level being sort of the 70-30 commercial industrial or the backbone of defense, that's who we are. And so that really wasn't an issue at all. Now in terms of -- we like those businesses, as I say, with a backbone, a shock absorber, I use those terms, would we do a huge acquisition in defense? Probably not. Would we do a huge acquisition in energy? Definitely not. Those businesses are good, high-reliability markets in their proper proportion, they're good. So I mean, is it a ceiling if it goes to 30%? Maybe, but there's bolt-ons in our M&A pipeline right now that are aerospace, there's bolt-ons that are defense. We do some, but again, we're unlikely to do a large acquisition outside of imaging it is from this.

And maybe to add here, the acquisitions we did for FLIR and acoustics, [indiscernible] are doing very well, very well integrated. Yes. And there is no difference anymore between FLIR and Teledyne. It's completely integrated.

Very good. We do have a couple of questions. I'll try to somewhat similar, so maybe I'll blend these. How do you work from a cultural organizational standpoint to ensure that acquisitions are value created from a shareholder perspective as they grow? And then as you grow, the acquisitions become larger, probably have to pay a higher multiple. There's another question kind of relates to just changes that you made from a cultural or organizational standpoint at FLIR itself.

Yes. I'll let Edwin talk about the cultural one. About the M&A process, not that I think this is good, I have a bias obviously being 2 decades plus here. But I remember reading another sell-side note and was describing an M&A process for a company that maybe would look at $400 million, $500 million companies a year, sign 300 NDAs, due diligence on 30, buy 1 or 2. That's not us. I mean there's probably, at any given point in time, order of magnitude, 100 companies, probably less. Every year, we buy 1, 2, 3, more, maybe a little bit more. Maybe every year, someone buys 1, 2, 3 or a few more get added to the list because we buy another business that -- which we can add. But it's a very patient process. Pretty much everything we acquired, we've been hogging for years. The first meeting with FLIR management, even though it was sort of theoretical, was 2011. It was 10 years before we did the acquisition. So again, we're very, very methodic. And I think that gets to the point on risk and return, is that we only buy something if we feel we know it really, really well and it is an internal champion. It's not another link to this tool, if you will, something that has a home in Teledyne. It fits. If we understand it, that reduces risk. If the management all leave, can we still run it? We don't want that to happen, but can it be able to pick up and run? I think all of that is a commoditized -- not commoditized, all those things I actually talked about before price. And if it doesn't pass those gates, do we really, really understand it? Do we have a champion who really understands it and wants it? If the time is right and those pass, then we start talking about returns. And I think our track record, no good world breakdowns, et cetera, I think we had good financial returns. But the biggest, I think, risk reduction metric is the former, not the latter. I mean we don't overpay, don't get me wrong. But really understanding a business, really focusing on the business, patiently calling the management over and over, the entrepreneur, that's probably the biggest risk reductio and biggest shareholder return element, if you will, more so even than the price, although we're disciplined by it, don't get me wrong. And culturally?

Culturally, it's a bit like I said, from the first week, I think, the cultures were not that different between FLIR leadership and Teledyne. So all the general managers there who used to be general manager under the top management are now running these businesses and fit very well with the people we already have in term of -- and that's going well. The only thing what we do more and what we can do even more is localization. If you want to grow a business, like say, in Middle East, yes, you have to be there, you have to be there with local people. That's what you see more and more, and that's what we do more and more.

So again, culturally, at the operating level, we did -- one division, we did have to make some changes in defense. But at the operating level, the people are relatively long tenured. The gross margin was higher than Teledyne, the sales per square foot were higher than Teledyne, the titles per employee were higher than Teledyne. The revolving newer corporate offices had some challenges, and that doesn't exist anymore. We didn't really have a...

We changed one leader. It was defense -- defense group.

Yes. That's site level. The sites were well run, and we have -- they didn't require a lot of work. A couple did, but that was the minority, that was maybe $300 million to $400 million of $1.9 billion needed some work at the site level. But most of those have a nice well-run company, it's just poor capital allocation.

Yes. Perfect. Well, we're at time. We'll pull up there. There is a breakout session I'll mention afterward in Aster B and want to thank Jason, Edwin for the time.

Thank you.

Thank you. Bye.