Teledyne Technologies Incorporated (TDY) Earnings Call Transcript

Hi, everyone. I'm Joe Giordano. I cover diversified industrials, automation and robotics here at Cowen. Thanks for joining me today. I always say, if you're only going to have 1 company come to a conference, make it a good one. So that's what I'm doing here. I'm happy to have Jason VanWees, Executive Vice President of Teledyne here. Jason, thanks for the time. Why don't you take us to your presentation and anyone listening in the audience, I think you have the access to drop questions in through the -- to the platform. So feel free to do that. I can put those in at the end, or if you want to email me at joseph.giordano@cowen.com, you can do that as well. Jason, take it away.

Great. Thank you, Joe. And I'll run through the slides relatively quick. I think a lot of the folks may know me, may know Teledyne, and I certainly want to leave room for some Q&A, either with regards to Teledyne standalone or, of course, the pending acquisition with FLIR. So let me get started. So of course, note that risk factors and forward-looking statements disclosure in our SEC filings, please. First, just a quick overview of Teledyne, and this also applies to FLIR and happy to discuss anything about our business or their business to the best I can. But essentially, what Teledyne is as a company. We've changed a lot. But what we are today is, we're a company that makes sensors. We like FLIR, incidentally, we make sensors for customers who want them. We'll make cameras or imaging devices for customers who want them incorporating those sensors or we'll make full systems that utilize both sensors and cameras and that may be an autonomous underwater vehicle, for example. But what is also unique is it's not just sensors, it's not just hardware. As customers don't want hardware, they want an image or they want information. And the devices we make also do that. In some part, that's where the real value is. And I'll discuss more about the businesses, but the ranges from a whole type of products from x-ray detectors for medical and dental application to specialty microelectromechanical systems or what's known as MEMS to some legacy aerospace and defense, but that today is only about 33% of our total portfolio, but I'll get into this in a bit more detail. So at the highest level, how would I describe Teledyne beyond a sensor and sensor system company. We do call ourselves a high-tech industrial business. We are a manufacturing business. And I think we fared pretty darn well with all the challenges that most manufacturers had in 2020, in COVID. In fact, we ended the year with more backlog than when we started and record quarters in Q4 of any period in Teledyne's history. The next bullet point, I think, is relatively important and is one of the reasons in addition to just management, which I'll address in a second, how we were able to fare in, not just this last cycle, but other previous cycles as well. It'd be too easy just to say we're diversified because sometimes diversified means complicated. We really are balanced, and we've done a lot of double down acquisitions to increase our concentration in 7 to 8, depending on how you define aerospace and defense as 1 or 2, but 7 to 8 key areas that -- whose proportion is complementary, but balanced. We -- not running from aerospace and defense business. Aerospace and defense businesses, especially on the defense side is a nice shock absorber in times of trouble like the COVID years. On the other hand, we never wanted to be 40%, 50% of the company like it was 20 years ago. Because it is no longer the shock absorber, it is the cycle that drives your company. So a nice mix of industrial businesses with a backbone of low beta government business. That's about 26% of sales is a portfolio we like. And it will be the same portfolio post FLIR. U.S. government sales for them is about 30%, where for us, it's 26%. So there's no change in the balance, no change in the portfolio, no change in the strategy, standalone Teledyne or Teledyne with FLIR. We're proud of our track record, and we're proud of the consistent, predictable performance, as it says here. In fact, we've never suspended guidance in any period, and that includes last year. And we've only missed our own forecast, in 85 quarters in the 21 years I've been here, 3 times and that includes periods like the 2001 recession, that includes COVID. Again, we've only missed around numbers 3 times in 21 years, including every possible event, and we've never suspended guidance. It's been a long road, you'll see some charts later on margins and continuous improvement, gross margin, EBITDA margin, free cash flow. But I don't think any of us consider our margins best-in-class. I mean, we're not lower quartile. I think we're average. But I don't think we're upper quartile either, and we've been working on that quite a bit. In fact, GAAP margins, despite a whole lot of nonrecurring restructuring charges, severance charges, lease termination costs to rightsize the business in 2020, we actually had margin growth on a GAAP basis, full year, and we had record all-time margins in Q4. And again, acquisitions and capital deployment have been a big part of our history. We'll continue to do that and very, very excited with the FLIR acquisition, and it's kind of icing on the cake after 21 years and 63 acquisitions before. And in that, we've never written off $1 of goodwill in 2 decades on the 63 deals we've done to date. So this is just a view of the overall business mix, which talks a little bit more about the balance we're in. Again, we're not diversified in my view. There's not 20, 30 wedges to this pie. There's just what you see here. But a few things to point out there on the left, I mean, the government business is just about 26%. That's down from more than 50%, 2 decades ago. So it's a nice shock absorber, nice backbone, long-cycle business that's predictable. We do have a couple of other cyclical businesses, but they're both at a trough in 2020. Offshore energy is tiny. It's at the lowest level it's been in years, just 5% of sales. Of course, commercial aerospace, that did take a disproportionate hit last year in 2020 given the pandemic, but that's only 4% of sales. So some of the more cyclical, long-cycle businesses like energy and commercial aero were actually coming off a trough year last year notwithstanding the best margin. So that's nice. But the rest of the business is commercial, industrial, and it's largely represented -- when we get to segment reporting later, largely represented in our instrumentation and digital imaging business segments, respectively. On the right, you see the diversity in the geography and the customer base. Again, U.S. government is 26%, but in that commercial industrial business, we actually have more sales to various geographies outside the U.S. than we do inside the U.S., so 45% international and just under 30% to U.S. commercial customers. So very global business. I probably won't dwell on the full history of Teledyne, but I'll sort of maybe give the before and after on this chart, Slide 6. So 20 years ago, our continuing operation sales was just about $650 million. We had some non-value-added businesses. We had some commoditized businesses, and we had businesses with product liability. We don't talk a whole lot about it, but we also had the United Auto Workers Union inside Teledyne. We had an underfunded pension. The businesses are not only better, you'll see it in the financial metrics today, but the company is structurally much more sound, much lower risk, no product liability issue anymore. I think there's 6 people in the U.S. that are under a collective bargaining agreement out of 10,000 employees. The pension is overfunded. Of course, it's been closed to new hires. There's 60% less participants in that plan than when I joined. It's been fully inoculated. So again, from a business point of view, a financial point of view, but even a risk point of view, substantially better today. Largely based on what we've acquired and what we sold. So this is just the history of that evolution in numbers. You see the gross margin. This was a legacy aerospace and defense, low gross margin business, 20 years ago when I joined sub 25% gross margin, now approaching 40%. Actually, mix was a little bit negative in 2020 from a profitability point of view because, again, some of the commercial businesses, like most others, shrank, especially in record GDP negative Q2. And the defense business grew, but defense business is lower margin. So you see gross margin come off a little bit based on what was a negative mix in 2020, but notwithstanding, there was record EBITDA margins and record GAAP margins on a full year basis, given the cost cuts that we took out, despite a little bit lower gross margin. R&D has continually gone up as we become a commercial industrial business, much more so than aerospace and defense. There's more IRAD in our markets, internal R&D. It's been about 6.5% of sales in each of the last few years, and I expect that to stay about the same. And then you see the representation of the customer mix on the international sales chart before on the lower right. Really last 5, 6, 7 years, we've been about 45% overseas relative to 55% domestic split between government and commercial. We're proud of this chart. This is also stock price performance. So other than being an advertisement for Teledyne, what I do like to mention here is that, we're a little bit unique in that the 2 LTIP programs that we have, in addition to, of course, stock options are directly correlated with relative return, formerly Russell 2000 and relative return to Russell 1000 and now relative return to S&P 500 is what our LTIPs are based on over a 3-year period. So it's very good alignment with the buy-side kind of a relatively unique set of programs here. This is something, I think, that we like to show. I mean, these earnings other than the 2 little wedges in '16 and '17, these are all GAAP. GAAP earnings that are burdened by $40 million and $0.80 a share of intangible asset amortization now in the terminal year, $25 plus million of stock compensation in the terminal year, but this is full GAAP. Other than just emphasizing that the growth and the GAAP profile, it's worth spending a few minutes on this to look at the 2008, 2009 financial crisis. We weren't immune. We were balanced in the business portfolio, but we weren't immune, revenue declined. Not a lot, organic revenue decline was about 7% in 2009, but earnings were flat. They actually grew a little bit. And then when we came out of that period, kept that low-cost structure, did some good M&A. The earnings had a very strong trajectory. Then again, things happen sometimes. So there was sequestration of the defense market. There was the energy crisis of 2014 through 2016, our revenue went down once again. Again, not a lot. Organic contraction in 2016 was just a little over 7%. But again, we managed to protect earnings. We managed to actually have record cash flow in each of 2009 and 2016. And then again, we were able to do a good acquisition with a strong balance sheet come out of there and the earnings, again, were very good trajectory. And I'm hoping history repeats itself again. We had record cash flow in 2020. We ended the year with net debt of only $100 million. I think probably in a few weeks from now, it will be 0, and we're doing a big acquisition. And I hope the next 4 or 5 years look like that 2010 through 2014 and that 2016 through 2020 profile. So that's the goal. And again, just to emphasize on the revenue slide, what I just mentioned, you see that we weren't immune to some contraction in the 2009 recession. We weren't immune to contraction in the 26 (sic) [ 2016 ] time frame with energy. But again, in both cases, we came out very, very strong, on both top line and bottom line. But even in the depths of those troughs, we protected earnings, and we grew cash flow. And to that point, you see free cash flow conversion, that's the red relative to the blue, has been very, very good in almost every year, more often than not over 100%. But you see in 2009, when the world went to hell on the financial crisis, we actually generated more cash flow than at any previous time. Same thing happened in 2016. We generated more cash flow than any previous time. And during 2020, the COVID year, we had more free cash flow than any previous time. So we're very good with operating during difficult periods and then using that as leverage to do M&A and grow out of the trough. That's the balance sheet. Like I said, at the end of the year, net debt was just about $105 million. I think as of yesterday, it was $60 million. And I think probably by the end of this quarter, if not by the end of this month, it may be 0. So balance sheet has been very strong, and that allows us to do things like the FLIR acquisition that is pending. This is the M&A track record. Again, I won't go through every little acquisition, but we're a very experienced acquirer, having bought 63 companies over the last 20 years. And again, never written off $1 of goodwill. Essentially, all the M&A has been from internally generated cash. You see on the left pie, the source of funds for where we've been the last 2 decades has been cash flow. We sold some noncore businesses. Incidentally, we've never sold anything that we've acquired. We just sold some of the businesses that we inherited as the Spin E in a spin-off process. And you see that's [indiscernible] to $160 million, but the rest of our cash flow has just been internally generated and most of it has gone to M&A. We've done a few opportunistic share repurchases, but nothing since 2015. And most of the M&A has gone towards instrumentation and imaging, you see there, on the right. That's been more than 90% of the capital allocation it has been in those 2 higher gross margin, better businesses. I'll talk a little bit just about the FLIR transaction. This is using some of the slides we did the day we announced the deal, January 4. So this is just a repeat of what we have already showed. So the transaction value is about $8 billion, almost exactly, including fees. This is the first time and only time that we've actually issued equity as part of consideration. We're doing that to be conservative, to keep the leverage down. So pro forma leverage at close, you'll see there in the second bullet is expected to be about 4x net debt-to-EBITDA at close and then getting to less than 3x during -- in 2022, with, of course, the goal being to have an investment-grade -- solid investment-grade statistics and pricing for the debt package. Near-term synergies, we communicated, we think, are going to be about $40 million out of the gate. I'd say -- I've been telling people right now, since we announced the deal and have had greater access to management insights, I think that number will be higher. It may be more like $50 million immediately, so I think it's pretty conservative. We -- I mentioned that our earnings track record before were pretty consistent with underpromising and overdelivering. And I think that's also true with regard to the synergy numbers. And the transaction of -- of course, we think it's going to be accretive and that even means on a GAAP basis in 2022, on a non-GAAP or free cash flow per share basis. Most of the sell-side folks are thinking that the accretion, be it either cash EPS or free cash flow per share in the neighborhood of 15% to 20%, and we have not dissuaded anyone from those kind of metrics or targets. I'll talk a little bit about the businesses and I think people who know us and know FLIR have understood and been very, very supportive out of the gate. What's really unique, and why we've been talking to the company since 2011, off and on, we've been looking at this, and our Chairman, first spoke, like I said, in 2011, nearly a decade ago, is the businesses are truly complementary from a product point of view and an end market point of view, that's on both the sensor side. But even we've grown closer to each other over the years. Teledyne migrated into the marine business; and in 2008, we migrated into the autonomous subsea vehicle business. And FLIR migrated also into autonomous systems, but exclusively air and land. It's pretty -- uniquely complementary as we've grown. It wasn't always that way. FLIR had some consumer businesses that we were not attracted to. They were commoditized. In fact, there's a little bit of a poison pill. And why are we talking about this acquisition now and not earlier. But those businesses were all sold in 2018. And that really made the business attractive, and we've been watching it much closer since. The business models are the same. I already made reference to it. They sell a sensor, sell a camera, sell a sensor system. They go to the market the same way we go to the market. We just go to the market with different products. And the geographies are very, very similar as well. Now I'll talk a little bit just about the underlying businesses, not in a huge amount of detail, but Teledyne is in the infrared space. We've been in the infrared space since 2006. We're largely relegated to a small, albeit very high-value niche in space-based imaging. So think Hubble Space Telescope looking out, classified things looking down with very, very sensitive sensors for either faint photons from deep space or small features, perhaps on earth. That's what we're very good at doing. In fact, a testament to what FLIR is good at doing and they're larger markets, now still high value markets. I know this pyramid goes down to automotive, consumer, security, the commoditized businesses were sold. So these are still larger markets, but they're still high-value markets and a testament to the strength of FLIR's products, FLIR's brand and FLIR's channel. One is its gross margin. I mean, FLIR's gross margin is 50%. Teledyne's last year was 38%. These are nice high-value businesses with strong IP that command a high gross margin and a testament to the technical strength and market strength as we spent the last 5 years trying to get into FLIR's markets organically. And we've been marginally successful. In fact, the overlapping revenue on a total company basis, on a pure product to product is about $1.3 million on 2020, trying to break into FLIR's markets has not been easy. But it really shows why they can command the margin that they do on a gross margin basis. Now I probably won't dwell on this chart, Slide 19 in extreme detail, but it's probably worth mentioning, people have said and asked me, well, if you're -- if everything is complementary and the sensors are different and, they are for different applications, where is the synergy? I don't understand if it's complementary, but what does that mean? Where do you get the synergy? Well, other than corporate costs and public company costs, which are pretty significant here, is analogue out? And I'll tell you what I mean by that, the businesses are different. Teledyne designs x-ray detectors. We don't build them. They're made with CMOS technology at third-party foundries, but we make x-ray detectors. Yes, we make detectors that are in the visible light domain for lots of applications, including commercial machine vision and industrial automation. Of course, I already mentioned infrared, where we make sensors primarily for space, microwave detectors there, but we also make, not on this chart, is -- we make sonars. Now what's common about all of these, both with Teledyne and now especially with FLIR, the outside of the sensor may pick up a different photon. In the case of a sonar, the transducer may pick up a pressure wave, but immediately beyond the analogue face on all these sensors, everybody wants an image, everybody wants information. They all have things like readout integrated circuits, analogue to digital converters, digital signal processing. Every one of these businesses from x-ray to sonar has a digital side. The digital side is common throughout. So we're very excited. We haven't promised revenue synergies. We haven't quantified them. I think that's all going to be upside. But the ability to make better products, the ability to make more new products, the ability to give the customer what they want and not only an image, but in terms of information and analysis, is completely common across FLIR and Teledyne, and we're very, very excited. Again, they're different sensors. They're different technologies. They solve different problems, but how they solve those problems in terms of the digital analysis, there's a lot of commonality, and we expect there'll be a lot of synergy. So this just shows what will be a continuing evolution of Teledyne. I mean, 20 years ago, we had 0 digital imaging, and we had 6% of the total company with instrumentation. Today, we're 2/3 imaging and instrumentation. With FLIR, we'll be 80% imaging and instrumentation. Still though with a backbone of lower beta government business, but again, more commercial, industrial, more imaging and instrumentation, the evolution that we've been on all along. And that's the end of the formal prepared comments. So I'm happy to -- Joe or others take any questions or, like I said, discuss the standalone Teledyne or our perspective on FLIR or our perspective on the combined company, I am more than happy.

Thank you, Jason. Yes, I think people will submit questions through me. I think that's how I -- that's kind of how it goes through this portal I have here. [Operator Instructions]. But I guess let's start with FLIR. Just in the context of your broader M&A strategy. You showed the slides you've done a lot of deals. You're very familiar with it. But like maybe talk us through kind of your approach broadly to M&A, and like how you look at companies, how you evaluate them? What kind of return metrics are you looking at? And then kind of how FLIR fits into that broader framework?

Yes, sure. So the -- most of the M&A, in fact, I think, almost all of the M&A that we've done has been very purposeful. Like I said, we've actually been talking with and looking at FLIR for a decade. That's been true for even some of the little bolt-ons where we've been cultivating an entrepreneur and talking with them and looking at the business for many, many years. E2v, our previous largest deal, I think were actually looking at the business and talking with executives -- various executives as they change over the years for 12 years in the case of e2v. So the very first metric, and I'll get into the financial ones. But frankly, what determines if we even get to the point to discuss valuation, the corporate cliches are that it's -- does it fit? And that sounds maybe trivial, but it's not -- what does it fit means is do we really understand the business. It's not -- I would like to own more software businesses. I would like to have recurring revenue. I'd like to have more high gross margin business, but we're not going to buy a company that we're -- in a market that we're not in, that we don't understand. We just think that's too risky. That's gambling with shareholders' dollars. We really want to understand the business and ask ourselves if for some reason, the entire executive team, our operating management team left the business or weren't there the next day, can we run it? Can we run it seamlessly? That's the first criteria that we have when we look at the business. The second, frankly, is who's going to run it. Now again, and that sounds trivial, but there was a time with great success even under the original founder, Henry Singleton, that Teledyne was a classic conglomerate. It was the diversified company, not the balanced portfolio, making forklifts, water picks, titanium bicycles, health insurance companies. We don't want to become more complicated. We don't want to have another business directly reporting to a CEO, get more complicated. We want a nice clear fit, do we understand it? And how is it going to fit within our existing segments and our existing businesses. Like, never say never, we've bought new segments. We weren't in imaging until 2006. But those are actually the most important metrics for us. Does it even get into the gate to talk about valuation is strategically, does it fit? Does it have a home? That's first. Then when it comes to financial metrics, what we show and what I show to the Board is a return on capital metric. Now the -- and you can look really actually on the chart before on capital allocation. Basically, all of our capital has gone to M&A as opposed to things like share buybacks. So our book ROC is our acquisition ROC. A lot of people talk about 10% after tax returns. I think that's rarely achieved. But we've earned it on the previous 63 deals. FLIR, I think, is going to be a little bit lower because the price is a little bit higher. But I think we took the opportunity to not just use the relative value of our currency versus their currency and stock, but to really recapitalize the company. Like I said, we basically ended the year with 0 net debt. So this is an opportunity to recapitalize the businesses at very attractive rates. And so maybe the absolute ROC will be a little bit lower. But I think given the opportunity to recapitalize and get some multiple arbitrage on a business that we frankly followed for a long, long time. Again, we're very excited. So...

So I'm getting a couple of questions here on FLIR, so we'll just keep it there for a few minutes here. Some of them are related to the close. So I think you guys mentioned initially that there was a potential for China approval and that could maybe be managed given the size of that business, any update there, and what we should think on with China?

Yes. So well, with regard to the general regulatory environment, we're not anticipating any kind of issues or concerns just given the complementary nature and frankly, the near total lack of overlap. We have made a U.S. HSR filing. We've done some of the notifications in foreign countries regarding defense business. Those are notifications, not approvals, like a U.S. CFIUS. We do need other foreign antitrust approvals, one is China. The China threshold is very small. It's basically if a target company has more than USD 50 million of sales, you need China. So this is not out of the ordinary. We do think we're only going to need the "simplified process." There's sort of 2 roads in China if you were a simplified, antitrust and a more complicated one. We think this qualifies for the simplified one, given the relative sales are not that much over the threshold and the overlap in our markets is de minimis. Technically, I think that's only a 30-working-day process. But it's actually more than that because things have to be translated. You need certain approvals from other government agencies just as part of that process. But I think right now, we don't think that, that's going to be the absolute bottleneck, that the bottleneck might just be filing of the 10-Ks later this month, filing of the S-4. We're kind of assuming there'll be an SEC review. We don't know, but if there's an SEC review, then we have to respond to comments and then perhaps file an amendment and then schedule a shareholder vote. I mean, I think that regular public company process probably is the bottleneck as opposed to regulatory approval, China or otherwise. But that's to be determined, but we're still comfortable with a midyear close, that's what we said a month ago when we announced. Now is that as soon as mid-May or as late as July 4, I mean, we -- it's too hard to call, but I think that's mid-2021, close is still anticipated. So...

Okay, fair enough. Functionally, how do you see FLIR being integrated within imaging?

Yes. So we expect out of the box that it will be all within the imaging segment. So that's number one. I think number two, the good thing about FLIR, not the only good thing, I mean, I already mentioned the technical nature of the products, the high gross margin they command. I mean it's a very good business, but it's also a pretty discrete business. It's not in their most recent 10-K, but if you roll back a couple and just -- you look at the property list, there's really just about 6 major sites that are all owned that are 100,000 to 200,000 square feet that each pump out hundreds of millions of revenue. It's a relatively nice, discrete $2 billion of revenue and I think -- now, I don't want to say any M&A is going to be easy. But we've had a lot of practice. In fact, I've told people they're a little bit unique, not just the leadership at Digital Imaging and the leadership of Teledyne, but every operating lead in Digital Imaging, finance, contracts, accounting, legal, everyone in Digital Imaging and Teledyne has both been acquired and been an acquirer because it didn't exist before 2006. We've got a lot of people with a lot of practice. FLIR is relatively discrete in terms of its nice and big owned sites so I think, the operating is to actually run these businesses. We've been impressed. And it's going to fit relatively squarely into digital imaging, so we're pleased.

Is there particular -- oh go ahead.

Look, I mean, just like when we did e2v, maybe 2 years, hence, one of the businesses that might be more test and measurement focused, maybe there's a little bit of rejiggering of segments here or there, but we're not anticipating any divestitures. We're anticipating that it all goes into Digital Imaging and it all stays home in Teledyne.