Teledyne Technologies Q2 2021 Earnings Report

Teledyne Technologies EPS Results

• Actual EPS: $4.61
• Consensus EPS: $2.94
• Beat/Miss: Beat by +$1.67
• One Year Ago EPS: N/A

Teledyne Technologies Revenue Results

• Actual Revenue: $1.12 billion
• Expected Revenue: $1.00 billion
• Beat/Miss: Beat by +$117.20 million
• YoY Revenue Growth: N/A

Teledyne Technologies Announcement Details

• Quarter: Q2 2021
• Date: 7/28/2021
• Time: Before Market Opens
• Conference Call Date: Wednesday, July 28, 2021
• Conference Call Time: 1:58AM ET

Teledyne Technologies (NYSE:TDY) (NYSE: TDY), headquartered in Thousand Oaks, California, is a diversified industrial technology company that designs, manufactures and supports sophisticated electronic systems, instruments and imaging products. Founded in 1960 by Henry Singleton and George Kozmetsky, Teledyne has grown into a multinational provider of high-performance equipment and software for commercial, scientific and government customers. Its offerings are used in markets that include aerospace and defense, marine, industrial manufacturing, environmental monitoring and scientific research.

The company operates through businesses that develop precision instrumentation, digital imaging products, engineered systems and aerospace and defense electronics. Instrumentation products include sensors, analyzers and test-and-measurement equipment for process control, environmental monitoring and laboratory use. Its digital imaging lines provide cameras, detectors and machine-vision systems—expanded notably through strategic acquisitions—to serve automated inspection, scientific imaging and thermal imaging applications. Engineered systems encompass integrated platforms and services for marine and industrial customers, including sonar, submersibles and related underwater technologies, while aerospace and defense offerings cover avionics components, electronic subsystems and specialized sensors.

Teledyne serves customers around the world and maintains a largely decentralized operating model that emphasizes technology development and targeted acquisitions to broaden its product portfolio and geographic reach. The company supplies mission-critical products to commercial industry, research institutions and government agencies globally, and it combines hardware with software and data-analysis capabilities to support complex sensing and imaging applications. Teledyne is publicly traded on the New York Stock Exchange under the symbol TDY.

Teledyne Technologies Q2 2021 Earnings Call Transcript

Key Takeaways

• Teledyne accelerated its FLIR merger integration, cutting corporate overhead and targeting $80 million in annual cost savings by end-2022 (two years ahead of plan) with upside to $100 million.
• The company delivered a record Q2 with double-digit organic growth—17% in digital imaging and nearly 25% in environmental and test & measurement—and achieved a record non-GAAP operating margin of 22.8%.
• Full-year guidance was raised to approximately $4.58 billion in sales, with legacy organic growth of ~6.5%, nearly $1.3 billion in FLIR sales, and a non-GAAP EPS outlook of $15.25–$15.50.
• Q2 free cash flow surged to $257 million (up from $139 million year-over-year), with net debt at $4.05 billion and plans to reduce net debt/EBITDA to 3.3× by year-end 2021 and 2.7× by end-2022.
• Segment margins improved sharply: legacy digital imaging margin expanded ~280 bps, instrumentation sales rose 10.6% with a 24.6% jump in electronic test & measurement, and Aerospace & Defense Electronics saw a 640 bps margin increase.

Presentation

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to the Teledyne second quarter earnings call 2021. At this time, all participants are in a listen-only mode. Later, we'll conduct a question and answer session. Instructions will be given at that time. If you should require assistance during the conference, please press star then zero. As a reminder, today's conference is being recorded. I'd now like to turn the conference over to your host, Jason VanWees. Please go ahead.

[Jason VanWees, EVP at Teledyne Technologies]

Thank you, good morning, everyone. This is Jason VanWees, Executive Vice President, and I'd like to welcome everyone to Teledyne Technologies' second quarter earnings release conference call. Of course, we released our earnings earlier this morning before the market opened. Joining me today are Teledyne Technologies' Executive Chairman, Robert Mehrabian, President and CEO, Al Pichelli, Senior Vice President and CFO, Sue Main, and Senior Vice President, General Counsel, Chief Compliance Officer, and Secretary, Melanie Cibik. After remarks by Robert, Al, and Sue, we will ask for your questions. Again, though, before we get started, attorneys have reminded me to tell you that all forward-looking statements made this morning are subject to various assumptions, risks, and caveats as noted in the earnings release and/or periodic SEC filings. Of course, actual results may differ materially.

[Jason VanWees, EVP at Teledyne Technologies]

In order to avoid potential selective disclosures, this call is simultaneously being webcast, and a replay via webcast and dial-in will be available for approximately one month. Here's Robert.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Thank you, Jason, and good morning, and thank you for joining our earnings call. For over two decades now, we've 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.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

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've 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 FLIR's compliance standards. Furthermore, we've eliminated significant corporate overhead, consultants, and other third-party service providers. As a result, we now expect to achieve our annualized cost savings target of $80 million before the end of 2022, as opposed to 2024, as described in our final merger proxy. Turning to the second quarter results, the second quarter was truly a record for Teledyne, with sales, operating margin, and earnings, that's excluding acquisition-related costs, all of these increased significantly from prior periods.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

We achieved double-digit organic growth for the total company, with sales from digital imaging, environmental, and electronic test and measurement instrumentation increasing from 17% to nearly 25% year-over-year. The operating margin of our legacy businesses collectively was an all-time record, and with FLIR, our non-GAAP operating margin of 22.8% was an all-time record in the second quarter. I should note that very strong non-GAAP margin and earnings performance in Q2 resulted partially from a disproportionate amount of sales from FLIR relative to costs. That is, given FLIR's current lack of linearity in shipments, we essentially benefited from eight and a half weeks equivalent of sales volume and contribution margin relative to only six weeks of fixed cost.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

In the second half, FLIR's quarterly sales relative to costs were normalized, resulting in somewhat lower margins, in all cases excluding transaction-related expenses. In addition, the average share count in the second quarter only partially reflected the stock issued in connection with the FLIR transaction, which will impact EPS in the second half. After a strong first half, we now think it's reasonable outlook for legacy Teledyne businesses organic growth in 2021 to be approximately 6.5%, led by forecasted growth of nearly 12% in digital imaging, excluding FLIR. With normalized sales for Q3 and Q4, we expect FLIR to contribute sales of just under $1.3 billion in 2021. Collectively, therefore, we now expect reported sales for the year of approximately $4.58 billion. Our new outlook, which excludes acquisition-related transactions, transaction and purchase accounting expenses, can be summarized as follows.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

In April, we provided a GAAP earnings outlook for legacy Teledyne businesses of about $12.10. On a comparable basis, our current outlook is approximately $12.40, which is $0.30 above the earlier outlook. Given the 50 basis points increase in organic growth from 6%-6.5% today versus April, and 40 basis points additional margin improvement, that's resulted in the overall $0.30 increase in our guidance. Intangible asset amortization from prior to FLIR transactions, divided by the pre-FLIR share count, would add around $0.80 to our earnings, resulting in a pre-FLIR outlook of $13.20. Now, incorporating FLIR, including its unusually strong partial period performance in Q2 and excluding transaction costs, results in full year 2021 accretion of over $2 per share, and thus, our current non-GAAP outlook is $15.25-$15.50. I will now just turn the call over to Al, who will comment on the performance of our business segments.

[Al Pichelli, President and CEO at Teledyne Technologies]

Thank you, Robert. In our Digital Imaging segment, second quarter sales increased 143.9%, largely due to the FLIR acquisition. 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 a second quarter book-to-bill of 1.13.

[Al Pichelli, President and CEO at Teledyne Technologies]

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.

[Al Pichelli, President and CEO at Teledyne Technologies]

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.

[Sue Main, SVP and CFO at Teledyne Technologies]

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 costs. 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. Depreciation and amortization expense was $59.7 million for the second quarter of 2021, compared with $29 million in 2020.

[Sue Main, SVP and CFO at Teledyne Technologies]

In addition, non-cash inventory step-up expense for the second quarter of 2021 was $23.4 million. We ended the quarter with approximately $4.05 billion of net debt. That is approximately $4.74 billion of debt, less cash of $695.1 million. The higher debt balance at July 4th, 2021, included the debt incurred to fund the cash portion of the FLIR acquisition. Stock option compensation expense was $3.6 million for the second quarter of 2021, compared to $5.7 million for the same period of 2020. Resulting from the FLIR acquisition, restricted stock unit expense for FLIR employees was $4.4 million in the second quarter of 2021. Turning to our outlook. Management currently believes that GAAP earnings per share in the third quarter of 2021 will be in the range of $2-$2.15 per share, with non-GAAP earnings in the range of $3.55-$3.65.

[Sue Main, SVP and CFO at Teledyne Technologies]

For the full year 2021, our GAAP earnings per share outlook is $8.05-$8.45. On a non-GAAP basis, $15.25-$15.50. The 2021 full-year estimated tax rate, excluding discrete items, is expected to be 23.9%. In addition, we currently expect less discrete tax items in 2021 compared with 2020. I'll now pass the call back to Robert.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

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

[Operator]

Yes, thank you. Ladies and gentlemen, if you wish to ask a question, please press one zero. If you are using a speaker phone, please pick up your handset before pressing the number. Again, if you'd like to ask a question, please press one zero at this time. Our first question comes from Mike Maugeri with Wolfe Research. Please go ahead.

[Mike Maugeri, Analyst at Wolfe Research]

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 color in some of that performance?

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

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

[Mike Maugeri, Analyst at Wolfe Research]

Okay, that's great. What sort of drove that? Were there some sort of cost initiatives, or was it just mix? Any other color?

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

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

[Mike Maugeri, Analyst at Wolfe Research]

Got it. Thank you. Can you discuss your capital deployment priorities post-FLIR, if we should expect any sort of shift in your behavior, whether that's because of the higher debt balance or any sort of color that you can add there?

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

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 3.3.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

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 2.7, which is at the high end of what we feel is comfortable for us. Our immediate task is to generate cash, pay down debt. Having said all of that, we do have the capacity to make smaller bolt-on acquisitions that we've done historically, and we would do that if such opportunities arise.

[Mike Maugeri, Analyst at Wolfe Research]

Great. Thank you.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Thank you, Mike.

[Operator]

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

[Joe Giordano, Analyst at Cowen]

Hey, guys. Morning.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Morning, Joe.

[Joe Giordano, Analyst at Cowen]

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 if we start thinking about $80 million in run rate savings into next year?

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

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'll have an upside of about with $2-$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-$2.20. The only reason I say that is the full-year dilution we will experience from share count. Our share count in Q2 was 43.7%, 44 million shares. Next year, full year, we'll have a 48 million share count plus as we will have in Q3, Q4 of this year. There's going to be some of that.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Frankly, the other side of it, Joe, is that we haven't really had an opportunity to put all of our internal cost reduction inside FLIR for next year yet. These cost reductions we spoke about were generally related to corporate expenses, employee expenses costs, and third-party expenses and consultants. I hope that there'll be other opportunities that we can enjoy over the 2022. It's only eight weeks in. It's a little hard to predict right now.

[Joe Giordano, Analyst at Cowen]

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 longer-term there and maybe on revenue synergy potential from the deal?

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Yeah, I would say, Joe, I would raise that to $100 million, from $80-$100 on the upside. I would say from a revenue synergies, we haven't looked at that very carefully. There are areas that we intend to enjoy some synergies. Specifically, for example, FLIR has, as you know, a pretty strong Raymarine business and marine thermal products business. We have a very broad portfolio of marine underwater as well as sonar and other products. There should be some synergies there. There's also going to be synergies in our unmanned product. FLIR is very strong in UAVs and ground-based unmanned vehicles. Of course, we have a very tremendous portfolio for underwater vehicles. 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.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Finally, I would say FLIR does have an extremely good channel for some of their products, which we might be able to enjoy in some of our own infrared products through those channels.

[Joe Giordano, Analyst at Cowen]

Just last from me, I know you mentioned FLIR, you expect $1.3 billion in sales this year. If you owned it for the full year, where do you think organic for FLIR is in 2021, and what do you think a more normalized growth rate is once we get over the comps from the thermal sensing with COVID?

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

I think, as you know, last year, their full year revenue was $1.923. We expect it, on a full year basis, to remain flat at about $1.915, $1.92. 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 gone away. Essentially, it's disappeared. We're making that up with other products, some of it in the solutions business, some of it in Raymarine, and some of it in the defense business, especially in the unmanned integrated systems businesses. That kind of sets the tone year-over-year of no growth, but being able to offset the $100 million of headwind in UIS, I mean, in EST.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Having said that, if I'm going to look forward to just enjoying the same kind of growth that we enjoyed this year, excluding EST, you take that out of the $1.92, the rest of the portfolio grew about 5% organically. My expectation would be that if everything else being equal and no wheels come off the truck, that we'll be able to enjoy that next year.

[Joe Giordano, Analyst at Cowen]

Perfect. Thanks. I'll jump back in queue.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Sure.

[Operator]

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

[Jim Ricchiuti, Analyst at Needham & Company]

Hi, good morning.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Good morning, Jim.

[Jim Ricchiuti, Analyst at Needham & Company]

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.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Well, that's a very good question. Let me see if I can answer it properly. Our gross margins as Teledyne, as a standalone company, historical margins have been around 38%-39%. Last year, it was 38.3%. This year, first quarter was 38.9% and second quarter on a non-GAAP basis, excluding the one-time cost. 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%. That would be a nice 4% improvement in gross margin with Teledyne FLIR. That's about the best I can do at this time for this year. We are right now looking at what will happen in the future. Again, let me go back and emphasize one thing.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Because of the hockey stick nature of the 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 about 25%-27%. I'm factoring those in at this time.

[Jim Ricchiuti, Analyst at Needham & Company]

Got it. That's helpful. What can you say about this hockey stick performance from FLIR in Q2? What contributed to that? If I may, just a question, then I'll jump back into the queue. Could you just give us any flavor for how your bookings look for the combined company? Thank you.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Sure, Jim. First, the hockey stick nature. I think that's been a historical practice at Teledyne FLIR. They've 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. We're not exactly totally blameless ourselves. I can't say our revenues are totally linear, but we've worked very hard over the years to linearize our revenues within the month and within the quarter, month-over-month. Everybody has to report on their revenues and bookings weekly. This is an issue that doesn't have an overnight answer, but we're going to work very hard to introduce some of our own practices, working with the FLIR segment execs, sub-segment execs, which by the way, are really outstanding, and get that linearized, the shipment.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

The danger of doing that is that you come down to the end of the month or end of the quarter, something happens or something doesn't get shipped. Now you really suffer. You suffer in revenue, you suffer in earnings. We're going to work on that. Let me go back to book-to-bill, the question you asked. In terms of Teledyne standalone first, what I'd call legacy Teledyne at this point. We expect that our book-to-bill will be above one, especially in instruments, I think it'll be about 1.07. That includes very strong orders in Marine, as I mentioned, in the second and third quarter. In digital imaging, excluding FLIR, it was about 1.16 in Q2. For FLIR, it's below one. Combined, we think we'll be slightly over one in Q2, about 1.03, 1.04. Aerospace and Defense in Teledyne, good orders, bookings. The book-to-bill is about 1.2.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Engineered Systems, which is very lumpy, is about 1.17. Overall, I'd say including Teledyne FLIR, we're going to be over one in Q2, maybe 1.06, 1.07.

[Jim Ricchiuti, Analyst at Needham & Company]

Got it. Thanks very much.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Sure thing.

[Operator]

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

[Greg Konrad, Analyst at Jefferies]

Good morning.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Good morning, Greg.

[Greg Konrad, Analyst at Jefferies]

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

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Sure. Greg, first, if you go back to January of 2021, we projected a net organic growth of about 5.5.6%. In April, things were starting improving. We projected organic growth of about 6%. In this earnings, we've moved that up to 6.6%. That's overall what I would say legacy Teledyne, that excluding the FLIR acquisition. If you break that down into its components, instruments, we anticipate with some risks in there, 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 our aerospace businesses. We think that'll be about 4.4.5%. We see a slight decrease in engineered system, 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.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

You roll all of that up, you end up with 6.5%, 6.6%. 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. Right now, to the best of our ability to project, we're projecting revenue for the year of about, without FLIR, about $3,290, and with FLIR, about $4,582.

[Greg Konrad, Analyst at Jefferies]

That's very helpful. You gave a little color on digital imaging margins, but the instrumentation was also very impressive in the quarter. How do you think about margins there? Was that mix? Obviously Marine was down a little bit. How do you see those margins kind of playing out?

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Well, let me start with Instrumentation overall. Yes, Marine was a little down, 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, exclude Teledyne legacy GAAP, I mean intangible amortization. Last year, Instrumentation overall margin was 20.4%. This year, Q2 is 24%, we expect to finish the year at 23.2%, which would be almost a 200-basis point improvement, 192-basis point improvement over 2020. I would attribute that to the fact that the mix of businesses are very good. Our environmental businesses are doing very well, our T&M businesses, which have really high margins because of our oscilloscopes and of course, our protocol analyzers, those margins are superior.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

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 21.4%, so an improvement of 175 basis points. FLIR, of course, we had tremendous margin in Q2, just 30%, but slightly over. I think that'll come down closer to 22% as the year goes on based on the hockey stick nature 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.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Last year, we took some one-time charges. We took a lot of cost out of the aerospace side of the business. Nevertheless, that's almost a 500 basis point improvement in margin, and I expect the engineered systems to be relatively flat. Roll all of that up, from a segment perspective, on a non-GAAP basis, we should enjoy margins of 21.3% based on everything I know right now, versus last year's 18.7%. If you throw in the corporate expenses, again, I should reiterate, on a non-GAAP basis, we'll end up about 20% in margin versus 16.8% last year, which is over 300 basis points improvement. Does that help?

[Greg Konrad, Analyst at Jefferies]

Yeah. That's perfect. Just one last one for me, kind of big picture. Teledyne's 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 the FLIR acquisition changing the enterprise? I get a lot of questions about 2022. You've already pulled forward the synergies from when you first expected. Yeah, how does it change the opportunity set, whether it's annual margin expansion or organic growth as we go forward?

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Well, let me start by saying behaviors don't change. We're going to be the same. We're not going to change. We're going to be conservative in our projections. We're 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, having met now the FLIR executive team, and they've made presentations to the board yesterday, and over the next three days, 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. We anticipate that they will do the same as the rest of Teledyne, focus on cost, focus on improving margins, focus on growing their top line, and where appropriate, we'll make the small acquisitions until we pay down our debt. I don't expect our behavior to change.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

We'll keep improving.

[Greg Konrad, Analyst at Jefferies]

Thank you.

[Operator]

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

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Good morning, Andrew.

[Andrew Buscaglia, Analyst at Berenberg]

Good morning. It's Berenberg.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Sorry.

[Andrew Buscaglia, Analyst at Berenberg]

Hey, Robert.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

You ought to try Mehrabian sometimes.

[Andrew Buscaglia, Analyst at Berenberg]

Yeah, right. Well, yeah, Robert, thanks. Appreciate your candidness on the call. I was wondering, adding on to the last comment, can you talk a little bit about what are you seeing with FLIR that has surprised you, whether it's good or bad? Sounds like some of these managers are surprising you in terms of the quality of how they're operating. Is there anything you'd like to disclose that you didn't expect since having made the acquisition? Vice versa, where you're surprised at 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.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Well, when we look at the FLIR portfolio, there are really four segments made out of the former eight businesses. Three of the segments, which would be the Solutions segment, the Components or the OEM segment, and the Unmanned Integrated Systems segment, which comprise about $1.5 billion of the $1.9, we are pleasantly impressed with those three segments. They have good leadership in the three segments with Roger Wells leading UAS, Paul Clayton leading OEM and component, and Roger and Rickard Lindvall leading the Solutions businesses. These are really healthy businesses. From a personal perspective, while I wasn't surprised because we visited them many times before the acquisition, I was very pleased not only with what we've seen, but also their presentations yesterday to the board were just superb. The fourth sub-segment is the one that has some issues, and that's the Surveillance segment, which is about $400 million.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

What's happened there in that segment is that they've had multiple leadership changes almost annually over the last four or five years. They've been kind of milking that cow for the last few years in terms of cash, and they have not paid attention to new product development as much as they should. In that case, what we've done is we've brought in a Teledyne executive that worked for us before back to run that business. We have a Teledyne executive, her name is JihFen Lei, J-I-H, capital F-E-N, Lei, L-E-I. We brought her to run 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 the research and technology groups. She ended up this year as acting deputy secretary for DoD's research and technology programs, which is a huge program.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

All of the laboratories, all of the businesses. She just joined us two weeks ago. I was fortunate to bring her back, and she has been here two and a half weeks. She will lead the surveillance segment, which is the one that we need to work on. I know she will fix that with Edwin Roks's help, and we'll get some new products in there and put that on a healthy footing. Having said that, once we solve that, I think the four sub-segments are going to be superb with the leadership, then with Edwin Roks leading it, then with the combination with the legacy Teledyne companies, with all the synergies we can enjoy. We have great aspirations and hopes for the combined company.

[Andrew Buscaglia, Analyst at Berenberg]

Okay. That's helpful. I'm curious, the decision to put FLIR all under digital imaging, why don't you break that up with your Aerospace and Defense exposure and tie it to that? Is that a possibility in the future?

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

I think rearrangements of the segments are a possibility, but you gotta walk before you start thinking about running. Right now, keeping it where it is and then drawing lines of communication and collaboration is what we're doing. For example, one of the things we've done very successfully over the last three years at Teledyne is our procurement initiatives. We have significant savings that have come out of our procurement. We buy about $1.2 billion worth of products. FLIR buys another $700 million-$800 million of products. We're going to introduce our procurement initiatives there. Eventually, we may do some realignment, but not right now.

[Andrew Buscaglia, Analyst at Berenberg]

Okay. Lastly, Robert, I thought it's impressive if you can hit these net debt EBITDA targets that you've put out there. Do you care to provide some 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.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Yeah, it is. I think the way I look at it is, where are we going to end up the year, everything else being equal? Sue mentioned where we were in Q2. We had a really good Q2. We think we'll be around $750 million-$800 million, excluding charges. I want to get there because we want to increase our available cash to pay down debt from what is now about $670 million, $680 million to over $1 billion, so we can do that. On a go-forward basis, if we don't have those charges and we go forward, I think $1 billion is a nice number. I feel comfortable if I can get that number maybe in 2022. Maybe, I think 2023 would be more appropriate because we have some more expenses in 2022.

[Andrew Buscaglia, Analyst at Berenberg]

Okay. That's helpful. Thanks, Robert.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Thank you.

[Operator]

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

[Mike Maugeri, Analyst at Wolfe Research]

Hey, thanks for getting me back in. Just kind of changing gears. In your commercial aerospace business, I know that ACES is certified on A320 now, have you seen any demand indicators ahead that would sort of point toward a change in behavior on monitoring the cabin environment post-COVID? Then generally just those types of products, do you sell those to the manufacturers or the airlines? Thank you.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Right. As with most of our products in the aftermarket coming out of controls, it goes directly to airlines. We have, at this time, Mike, we have at least two major airlines testing the cabin environmental sensors. We have great hopes for that. As you know, we qualified it on the 737 before in March, and then yesterday on the A320, which is the bulk of the carriers. We are right now introducing those. Of course, everybody wants us to give it to them for free so they can test it, but we're not going to do that. We have high expectations for that. Just like, in some ways, a mini version of when we introduced the Wireless GroundLink many years ago. Overall, on the aerospace businesses, things are picking up.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

We were relatively flat quarter to year-over-year, quarter-over-quarter. Things are picking up and 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 also. We're optimistic with Boeing putting their MAX in operations and some of the other airlines especially becoming profitable. We're optimistic that business will come back slowly but surely.

[Mike Maugeri, Analyst at Wolfe Research]

Thanks again.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Sure, Mike.

[Operator]

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

[Joe Giordano, Analyst at Cowen]

Hey, guys. Thanks for getting me back on. I was going to ask about free cash flow. Robert, I think you just answered it a question ago. Maybe I'll just finish with all the buzz going on with new space launches and what's going on in the commercial landscape, can you maybe just talk about what gets you excited in the space as it applies to you, whether it's through NASA or European Space Agency or commercial, where are you think you're best positioned and where are you most excited about?

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

I think first and foremost, we really like our work in infrared and visible in the space domain, anything to do with satellites. We practically supply all of the detectors for space-based observation, both looking out and looking to the Earth, including a lot of the environmental studies, whether it's carbon or whatever. We own a big chunk of that market. Now we're moving to the classified space. We have some great imaging products in the classified space programs. In the space travel, as however you want to call that, yeah, we make some products in terms of equipment, but we're not that involved in this right now. I think our focus has to be remained with sensors and information technologies for the immediate future, where we'd have a strategic advantage because we can make infrared sensors that nobody else can.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

With each of these visible sensors and now having other channels with FLIR for our infrared products, we think that would be the place I see an upside for us. I'm a little cautious on commercial space development. We do have some piece of communication in the OneWeb program, as you know. Everybody wants to now build thousands of satellites, and there's a funding risk, as you can imagine.

[Joe Giordano, Analyst at Cowen]

Yeah, definitely. Just one quick clarification. When you said $1 billion in cash flow for 2022, 2023, something like that, was that a free cash flow comment or was that operating cash flow? Thank you.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

That's free. In 2023.

[Joe Giordano, Analyst at Cowen]

That's what I thought. Thanks.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

I moved it a year the minute you said free.

[Joe Giordano, Analyst at Cowen]

I caught it.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

Thank you. Operator, are there any other questions?

[Operator]

There's no one else in the queue.

[Robert Mehrabian, Executive Chairman at Teledyne Technologies]

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?

[Jason VanWees, EVP at Teledyne Technologies]

Thanks, Robert. 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 at the number on the earnings release. Amy, if you would, go ahead and give the replay information. Thank you very much.

[Operator]

Thank you. This conference will be available for replay starting today at 10:00 A.M. Pacific through midnight on August 28th. To dial a number is 1866-207-1041 with an acces code of 131-7751. Again, those number 1866-207-1041 with an access code 131-7751. That does conclude your conference for today. Thank you for your participation and for using AT&T Event Conferencing service. You may now disconnect.

Participants

Executives

• Al Pichelli, President and CEO
• Jason VanWees, EVP
• Robert Mehrabian, Executive Chairman
• Sue Main, SVP and CFO

Analysts

• Andrew Buscaglia, Analyst at Berenberg
• Greg Konrad, Analyst at Jefferies
• Jim Ricchiuti, Analyst at Needham & Company
• Joe Giordano, Analyst at Cowen
• Mike Maugeri, Analyst at Wolfe Research