Ladies and gentlemen, thank you for standing by and welcome to the Teledyne Second Quarter Earnings Call 2021. As a reminder, today’s conference is being recorded. And I’d now like to turn the conference over to your host, Jason VanWees. Please go ahead.

Thank you and good morning everyone. This is Jason VanWees, Executive Vice President, and I’d like to welcome everyone to Teledyne’s second quarter earnings release conference call. And of course, we released our earnings earlier this morning before the market opened.

Thank you, Jason and good morning and thank you for joining our earnings call. For over two decades now, we have continuously improved our portfolio of businesses, our operations and our financial performance, and along the way, significantly compounded earnings, cash flow and shareholder returns. It is worth noting that just over 10 years ago, a major milestone occurred when we divested our aviation piston engine business and all of its associated liabilities. While initiated earlier, immediately following that divestiture, we accelerated our pace of change by making increasingly significant and successful acquisitions within our digital imaging and instrumentation businesses. Our recent acquisition of FLIR accelerates Teledyne’s evolution into a more attractive higher-margin industrial technology company, while at the same time maintaining our balanced portfolio, primarily focused on commercial markets, but with a resilient and predictable backbone of government businesses. For example, in the second quarter of 2021, 75% of total company sales were derived from U.S. commercial and international customers and 25% of sales from the U.S. government. In the past several weeks, we have made rapid progress integrating FLIR by implementing Teledyne processes such as acceleration of financial forecasting and reporting, increasing visibility of sales and costs across the organization while continuing to enhance compliance standards. Furthermore, we have eliminated significant corporate overhead, consultants and other third-party service providers. And as a result, we now expect to achieve our annualized cost savings target of $80 million before the end of 2022 as we approach 2024 as described in our final merger proxy.

Thank you, Robert. In our Digital Imaging segment, second quarter sales increased 143.9%, largely due to the FLIR acquisition, but organic growth was 17%. Segment operating margin was 14.6% and 27.5% when adjusting for transaction costs and purchase accounting, although this was unusually high as Robert mentioned earlier. In our Instrumentation segment, overall second quarter sales increased 10.6% versus last year. Sales of environmental instruments increased 19.6% from last year. Sales of most product categories increased and total quarterly sales were just slightly lower than the peak level before the COVID pandemic. Sales of electronic test and measurement systems were exceptionally strong and increased 24.6% year-over-year to record levels. Sales of our marine instrumentation decreased 4.5% in the quarter. However, orders were the strongest in the last five quarters with the second quarter book-to-bill of 1.13. Overall, Instrumentation segment operating profit increased 33.2%, with segment operating margin increasing over 360 basis points with or without intangible asset amortization. Moving to the Aerospace and Defense Electronics segment, second quarter sales increased 6.5%, driven by an 8.1% growth in defense, space and industrial sales, combined with flat year-over-year sales of commercial aerospace products. GAAP segment operating profit increased 62.3%, with margins 640 basis points greater than last year. In the Engineered Systems segment, second quarter revenue decreased 1.5%, primarily due to greater sales from missile defense and marine manufacturing programs more than offset by lower sales of electronic manufacturing services products and turbine engines as we exited the cruise missile engine business at the end of the first quarter. Despite slightly lower sales, segment operating profit and margin increased slightly when compared with last year. I will now turn the call to Sue who will offer some additional commentary regarding the third quarter and our full year 2021 earnings outlook.

Thank you, Al and good morning everyone. I will first discuss some additional financials for the quarter not covered by Robert and Al and then I will discuss our third quarter and full year 2021 outlook. In the second quarter, cash flow from operating activities was $211.3 million, including all acquisition-related. Excluding acquisition-related cash costs, net of tax, cash from operations was $278.0 million compared with cash flow of $155.8 million for the same period of 2020. Free cash flow, that is cash from operating activities less capital expenditures excluding acquisition-related costs, was $257.2 million in the second quarter of 2021 compared with $139.2 million in 2020. Capital expenditures were $20.8 million in the second quarter compared to $16.6 million for the same period of 2020.

Thank you, Sue. We would now like to take your questions. Operator, if you are ready to proceed with the questions and answers, please go ahead.

Yes, thank you. Our first question comes from Mike Maugeri with Wolfe Research. Please go ahead.

Hey, good morning. Thanks for the time. Can you just add some color around the operating performance at legacy Digital Imaging? You touched on it a bit with the six weeks versus the eight weeks, but can you just provide some detail on that performance?

Right. Thanks Mike. On the legacy Digital Imaging business standalone, the margins were 24.4%. And that of last year, if you add back the intangibles, the margins were 21.5%. So in the legacy Digital Imaging, the margins improved about 280 basis points.

Okay, that’s great. And what sort of drove that? Were there some cost initiatives or was it just mix? Any other insights?

Both. Our cost from a labor perspective were maintained flat year-over-year and sales increased 17%, and the other factor was the mix margin. We had a better mix of machine vision, which has our highest margins.

Yes. Our primary objective this year, Mike, in capital deployment is to reduce our debt as fast as we can. We expect to generate more cash the rest of the year, and we anticipate that by year end this year, our debt-to-cap would be better than what we projected or about 3.3x in terms of ratio of net debt to EBITDA. We also expect that by the end of 2022, we can reduce that net debt to EBITDA to 2.7x, which is where we feel is comfortable for us. So, our immediate task is to pay down debt — generate cash, pay down debt. Having said all of that, we do have the capacity to make smaller bolt-on acquisitions that we have done historically and we would do that if such opportunities arise. Great. Thank you.

Thank you, Mike.

Our next question comes from Joe Giordano with Cowen. Please go ahead.

Hey guys. Good morning.

Good morning, Joe.

So I know it’s early to talk 2022, but can you just give us some high-level thoughts on how FLIR contribution starts to look on a normalized basis for a full year once we consider the $80 million in run rate savings into next year?

Well, let me start with what we have this year, Joe, if I may. As I mentioned before, we think that on a non-GAAP basis, we will have an upside of about $2 to $2.20 in terms of earnings. If we can maintain that momentum for next year, where we would enjoy probably the full year benefit of the cost reduction, I would say we may be able to increase that to as high as $2.50 from this year’s $2 and $2.20. The only reason I say that is the full year dilution we will experience from share count. Our share count in Q3, Q2 was 43.7%, 44 million shares. Next year, full year, we will have a 48 million share count plus as we will have in Q3, Q4 of this year. So there is going to be some of that. And frankly, the other side of it is that we haven’t really had an opportunity to put all of our internal cost reduction strategies in place for FLIR for next year yet. These cost reductions we spoke about were generally related to corporate expenses, employee expenses, and costs and third-party expenses and consultants. I hope that there’ll be other opportunities that we can enjoy over the ’22, but it’s only eight weeks in. It’s a little hard to predict right now.

So you brought the $80 million in two years basically. What are your thoughts on upside to that target? I know it’s still pretty early, but thoughts on like longer term there and maybe on revenue synergy potential from the deal?

Yes. I would say, Joe, I would raise that to $100 million from $80 million to $100 million on the upside. As for revenue synergies, we haven’t looked at that very carefully, but there are areas that we intend to enjoy some synergies. Specifically, for example, FLIR has, as you know, a pretty strong marine business and marine thermal products business. We have a very broad portfolio of marine underwater as well as sonar and other products, so there should be some synergies there. There is also going to be synergies in our unmanned products. FLIR is very strong in UAVs and ground-based unmanned vehicles. And of course, we have a tremendous portfolio of underwater vehicles, so we think there might be revenue synergies for both of us there. That’s the beginning, we’re kind of looking at it right now. And finally, I’d say FLIR does have an extremely good channel for some of our products, which we might be able to enjoy in some of our own infrared products through those channels.

And then just last for me. I know you mentioned FLIR, you expect $1.3 billion in sales this year. What does that look like? If you had owned it for the full year, what do you think organic for FLIR is in 2021? And what do you estimate a more normalized growth rate is once we get over the comparisons from like the thermal sensing with COVID?

Yes. I think, as you know, last year, the full year revenue was $1.923 billion. We expect it, on a full year basis, to remain flat at about $1.915 billion, $1.9 billion, $1.92 billion. So flat. Having said that, as you mentioned, Joe, the big headwind that we have year-over-year in Teledyne FLIR is that last year, they enjoyed about $100 million of elevated skin temperature product sales. This year, that’s essentially gone away. So we’re making that up with other products, some of it in the solutions business, some of it in marine and some of it in the defense business, especially in the unmanned integrated systems businesses. So that kind of sets the tone year-over-year of no growth but being able to offset the $100 million headwind. Having said that, I am looking forward to enjoying the same kind of growth that we enjoyed this year, excluding ESP. If you take that out of the $1.92 billion, the rest of the portfolio grew about 5% organically. So my expectation would be that if everything else is equal and no complications arise, we will be able to enjoy that next year.

Alright, thanks. I will jump back in queue.

Sure.

Our next question comes from Jim Ricchiuti with Needham & Company. Please go ahead.

Hi, good morning.

Good morning, Jim.

Congratulations on this first quarter with FLIR. Robert, I wonder if you could talk a little bit about how we might think about the gross margins of the combined company going forward as you really move through the integration process?

Well, that’s a very good question. So let me see if I can answer it properly. Our gross margins as Teledyne, as a standalone company, historical margins have been around 39% – 38% to 39%. Last year, it was up 38.3%. This year first quarter was 38.9%. And second quarter, on a non-GAAP basis, excluding the one-time costs. I think what’s going to happen at the gross margins, if you take ours in 2020 at 38.3%, I think it’d be safe to say that we can move that up to 43%, maybe 43.3%. And that would be a nice 4% improvement in gross margin with Teledyne FLIR. That’s about the best I can do at this time going forward this year. We are right now looking at what will happen in the future. Again, let me go back and emphasize one thing. Because of the nature of revenue in Q2 at FLIR, the SG&A for Q2 was significantly lower than it normalized should be. It was more like 20% and it really should be between an average of about 25% to 27%. So, that’s I’m factoring those in at this time.

Got it. That’s helpful. And what can you say about this performance from FLIR in Q2? What contributed to that? And if I may, just a question, and then I’ll jump back into the queue, could you provide any flavor for how your bookings look for the combined company? Thank you.

Sure, Jim. First, regarding performance. I think that’s been a historical practice at Teledyne FLIR. They have always shipped more in the last two weeks of the month than in the first two weeks of the month. And the last two weeks of the quarter, I should say, and the last two weeks of the year. Now we’re not exactly totally blameless ourselves. I can’t say our revenues are totally linear, but we’ve worked very, very hard over the years to create more linearity in our revenues within the month and within the quarter. We expect strong order bookings, especially in instruments, and I believe it will be about 1.7. That includes very strong orders in marine. In Digital Imaging, excluding FLIR, it was about 1.16 in Q2. But FLIR is below 1. So combined, we think we will be slightly above 1 in Q2, maybe 1.03, 1.04. Aerospace and Defense in Teledyne has good orders bookings, the book-to-bill is about 1.2. Engineered Systems, which is very lumpy, is about 1.17. So overall, I’d say including Teledyne FLIR, we’re going to be over 1 in Q2, maybe 1.06, 1.07.

Got it. Thanks very much.

Sure, Jim.

Our next question comes from Greg Konrad with Jefferies. Please go ahead.

Good morning.

Good morning, Greg.

Just to start on organic growth. I mean, you brought up the forecast for the year a bit to 6.5, which is a little bit of acceleration from what you saw in Q2. You gave some color around Digital Imaging. But can you maybe talk about different segments and expectations for organic growth and maybe how that changed and maybe where there are risks and opportunities in the back half of the year?

Sure. Greg, first, if you go back to January of 2021, we projected net organic growth of about 5.5%, 5.6%. In April, things started improving with projected organic growth of about 6%. And in this earnings, we’ve moved that up to 6.6%. That’s overall what I would say, legacy Teledyne, excluding the FLIR acquisition. If you break that down into its components, instruments, we anticipate with some risks in there to be about 6.2%. Digital Imaging, 11.8%, almost 12% for the year, that’s our fastest moving business. We think in Aerospace and Defense, especially now, we’re seeing a little more recovery in the aerospace businesses. We think that will be about 4.4%, 4.5%. And we see a slight decrease in Engineered Systems, something of the order of 1.5%, primarily because, as Al said, we don’t have the turbine engines for the rest of the year. So, rolling all of that up, we end up with about 6.5%, 6.6%. Now, if the economy continues to improve at a pace that it’s going, especially in our Instrumentation and Digital Imaging businesses, we could improve on that somewhat. But right now, to the best of our ability to project, we’re projecting revenue for the year about $3.290 billion, and with FLIR about $4.582 billion.

That’s very helpful. And you gave a little color on Digital Imaging margins, but Instrumentation was also very impressive in the quarter. How do you think about margins there? Was that mix? And obviously, marine was down a little bit. How do you see those margins playing out?

Well, let me start with Instrumentation overall. Yes, marine was a little down, but it was down in revenue. The margins were pretty healthy overall. Instrumentation margin in Q2, on a non-GAAP basis. The reason I’m doing this non-GAAP is we do have some intangibles that come in all of these groups. To compare year-over-year, if I do it non-GAAP, it excludes Teledyne legacy GAAP intangible amortization. Last year, Instrumentation overall margin was 20.4%. This year Q2 is 24%, and we expect to finish the year at 23.2%, which would be almost a 200 basis point improvement, 193 basis point improvement over 2020. I would attribute that to the fact that the mix of businesses is very good. Our environmental businesses are doing well and our test and measurement businesses, which have really high margins because of our oscilloscopes and protocols, those margins are superior. So almost 200 basis point improvement year-over-year in Instruments margin, including Marine, we’re very happy about that. In legacy Digital Imaging, again, our margins for Q2 were really good at 24.4% versus last year’s Q2 of 21.5%. We anticipate to end the year, that is excluding Teledyne FLIR, with margins of 23.1% versus last year’s of 21.5%, 21.4%, so an improvement of 175 basis points. FLIR, of course, we had tremendous margin in Q2, just slightly over 30%. I think that will come down closer to 22% as the year goes on based on the nature of revenue that I described before. Overall, Digital Imaging should end up about this year about 22.7% with Teledyne FLIR. Our Aerospace and Defense businesses are doing really well, but year-over-year comparisons, we think we will end the year at 18.8% margins, which is 492 basis points improvement over last year, but last year we took some one-time charges, and we took a lot of costs out of that side of the business, but nevertheless, that’s almost a 500 basis point improvement in margin. I expect Engineered Systems to be relatively flat. Rolling all of that up, we should enjoy margins of 21.3% based on everything I know right now, versus last year, 18.7%. And if you throw in the corporate expenses, on a non-GAAP basis, we will end up about 20% in margin versus 16.8% last year, which is over 300 basis points improvement. Does that help?

Yes, that’s perfect. And just one last one for me, kind of big picture. I mean, Teledyne has always been consistent with, let’s say, biased to the upside, whether that’s margin expansion each year or organic growth through the cycle. How do you think about this — the FLIR acquisition changing the enterprise? I mean, I get a lot of questions about 2022. You already pulled forward the synergies from when you first expected. How does it kind of change the opportunity set, whether it’s annual margin expansion or organic growth as we go forward?

Well, let me start by saying behaviors don’t change. We are going to be the same. We are not going to change. We are going to be conservative in our projections. We are always going to try and do better than that. We don’t like taking risks by being too effervescent in our projections. Having said that, I’ve met more of the FLIR executive team, and they make presentations to the Board. All of them are going to be working with us. They are really good. They have three outstanding executives that report to our Executive Vice President, Edwin Roks. And we anticipate they will be the same as the rest of Teledyne. Focus on cost, focus on improving margins, focus on growing their top line, and where appropriate, we will make small acquisitions until we pay down our debt. I don’t expect our behavior to change. We will keep improving.

Thank you.

Our next question comes from Andrew Buscaglia with Berenberg. Please go ahead.

Good morning, Andrew.

Good morning, Andrew.

Hey, Robert, thanks for your comments on the call. I was wondering, could you talk a little bit about what are you seeing with FLIR that has surprised you, whether it’s good or bad? It sounds like some of these managers are surprising you in terms of the quality of how they are operating. But is there anything you would like to disclose that you didn’t expect since having made the acquisition or vice versa where you are surprised by some growth potential you see where you didn’t expect that to be the case when you initially bought FLIR? Anything you could add there would be great.

When we look at the FLIR portfolio, there are really four segments made out of former eight businesses. Three of the segments, which would be the Solutions segment, the Components or OEM segment, and the Unmanned Integrated Systems segment, comprise about $1.5 billion of the $1.9 billion. We are pleasantly impressed with those three segments. They have good leadership in the three segments with Roger Wells leading UIS, Paul Clayton leading OEM and Components, and Rickard Lindvall leading the solution businesses. These are really healthy businesses. I was very pleased not only with what we have seen from their performance but also their presentations to the Board were just superb. The fourth sub-segment, however, has some issues, which is the Surveillance segment, about $400 million. What’s happened there is that they have had multiple leadership changes, almost annually for the last four to five years. They have not paid attention to new product development as much as they should. We have brought in a Teledyne executive that worked for us before back to run that business. Her name is JihFen Lei, who is regarded to lead the Surveillance business. She used to be one of our executives in our digital imaging business. She went to the government to DoD to work in research and technology groups. She joined us two weeks ago. I am confident she will fix that with her knowledge and will get new products in there and put that on a healthy footing. Having said that, once we solve that, the four sub-segments should perform well with the leadership and the synergies we can enjoy. We have great aspirations for the combined company.

Okay, that’s helpful. What — I am curious about decisions you put in digital imaging, why not break that up with your aerospace and defense exposure? Is that a possibility in the future?

Yes. I think the arrangements of the segments are a possibility. But it’s important to stabilize before you start thinking about redefining. So, right now, we’re keeping it where it is and drawing lines of communication and collaboration is what we are focusing on. For example, one of the things we have done very successfully over the last three years at Teledyne is our procurement initiatives. We have significant savings from procurement. We buy about $1.2 billion worth of products. FLIR buys another $700 million, $800 million of products. We are going to introduce procurement initiatives there. Eventually, we may do some realignment, but not at this stage.

Okay. And lastly, Robert, it’s impressive if you can hit these net debt-to-EBITDA targets that you put out there. Do you care to provide color on what free cash flow could be this year or how to think about that? I realize it’s kind of a messy couple of quarters.

Yes, it is. I think the way I look at it is where we are going to end the year, excluding charges. Sue mentioned where we were in Q2, we had a really good Q2. We think we will be around $750 million to $800 million, excluding charges. I want to increase our available cash to pay down our debt from what is now about $670 million to over $1 billion. On a go-forward basis, if we don’t have those charges and we look forward, I think $1 billion is a good number, and I feel comfortable saying that number may be realized in ‘22, perhaps in ‘23 would be healthier because of expenses in ‘22.

Okay. That’s helpful. Thanks, Robert.

Thank you.

Our next question comes from Mike Maugeri with Wolfe Research. Please go ahead.

Hi. Thanks for getting me back in. It’s contingent gears in your commercial aerospace business and I know that ACES is certifying 320 now, but have you seen any demand indicators that have them pointing toward a change in behavior on monitoring the cabin environment post-COVID? And then generally just those types of products. Do you sell those to the manufacturers?

Right. As products in the aftermarket coming out of controls, we have a decline Mike. We have at least two major airlines testing their cabin environmental sensors. We have great expectations for that. As you know we qualified the 737 before in March and then we have surveillance on A-320, which is the bulk of the carriers. We are currently introducing those just to give them for free use so they can test it. We have high expectations for that, similar to past experiences with significant projects in the aviation space. Overall, on the aerospace businesses, things are gradually picking up. We are seeing something like in the second quarter orders about a 1.2 book-to-bill. That’s very healthy for us because that’s a high-margin business. We are optimistic that this business will gradually recover.

Thanks.

Sure, Mike.

You have a question from Joe Giordano with Cowen. Please go ahead.

Hi guys. Thanks for getting me back on. I was going to ask about free cash flow, but Robert I think you just answered it a question ago. So, maybe I’ll just finish with maybe not a lot going on, but in your space launches and what’s happening in the commercial landscape. Can you maybe talk about what excites you in the space as opposed to you, whether it’s through NASA, the European Space Agency, or commercial? Where do you think you are best positioned? What excites you most?

Well, I think first and foremost, we really enjoy our job working in the space domain, anything to do with satellites. We practically supply all of the detectors for space-based observation, both looking out and observing the earth, including many environmental studies. We hold a significant share in that market. We are moving towards classified space initiatives; we have excellent imaging products in the classified space programs. Now regarding the private sector space endeavors, we make some products for equipment but are not heavily involved currently. Our focus remains primarily on sensors and information technologies for the immediate future, where we have a strategic advantage with engineering capabilities in infrared sensors while leveraging FLIR’s pathways to expand our infrared product operations. We see significant opportunities ahead.

Yes, definitely. And just one quick clarification, when you mentioned $1 billion in cash flow for ‘22, was that a free cash flow comment or is that operating cash flow? Thank you.

That’s free cash flow.

That’s what I thought. Thanks.

I moved it a year the minute you said free...

Thank you. In that case, I would like to ask Jason to conclude our conference call. And I want to thank all of you for doing so much homework to ask questions that kept me on my toes. Thank you. Jason?

Thanks, Robert. And again, thanks, everyone, for being on our call today. If you have other follow-up questions or seek more detail, you can always call me as usual with the number in the earnings release. So Amy, if you would go ahead and give the replay information. Thank you very much.

Thank you. This conference will be available for replay starting today at 10 a.m. Pacific through midnight on August 28. The dial-in number is 1-866-207-1041 with an access code of 1317751. That does conclude your conference for today. Thank you for your participation and for using AT&T Event conferencing service. You may now disconnect.