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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by. Welcome to the Teledyne Fourth Quarter Earnings Call. [Operator Instructions]
I'd now like to turn our conference over to the host, Jason VanWees. Please go ahead.
Thank you, William, and good morning, everyone. This is Jason VanWees, Executive Vice President at Teledyne, and I want to welcome everyone to our fourth quarter and full year earnings release conference call. We released our earnings earlier this morning.
Joining me today are Teledyne's 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.
Of course, so before we get started, I want to remind everyone of the forward-looking statements made this morning are subject to various assumptions, risks, caveats as noted in the earnings release and our periodic SEC filings And of course, actual results may differ materially. In order to avoid potential selective disclosures, this call is simultaneously being webcast and a replay, both via webcast and dial-in, will be available for approximately one month.
Here's Robert.
Thank you, Jason. Good morning, and thank you for joining our earnings call. I'll begin by discussing our 2020 results, briefly comment on the outlook for 2021, and of course, comment on the pending acquisition of FLIR. We concluded 2020 with the best earnings, operating margin and cash flow in the company's history. Compared to last year, fourth quarter earnings increased 13.7%. Operating margin increased 173 basis points and free cash flow increased 50.7%.
For the full year 2020, GAAP operating margin increased slightly and free cash flow increased significantly 39.1% to $547.5 million. It is worth emphasizing, the full year margin and cash flow performance occurred, despite over $33 million in non-recurring charges, record negative GDP in the second quarter and the constant challenges faced by manufacturers during the COVID-19 pandemic. For all of their efforts, I want to congratulate our employees as well as offer my most sincere thank you to them for transforming a difficult year into one of the most rewarding for our stockholders.
We entered 2021 with a clear improvement in demand across the majority of our businesses. In fact, we received record orders in the fourth quarter and ended 2020 with record backlog. Q2 orders were $920 million or 1.14x sales with year-end backlog of $1.7 billion. While it's still early in 2021, we're expecting continuing recovery in our commercial businesses as well as growth in our government businesses. In both cases, strongest within our Digital Imaging segment.
Given some caution and conservatism, related to the ongoing tug of war between shutdowns and vaccines, we think a reasonable outlook for the total company's organic growth is between 5% and 6% for 2021. Of course, the largely pre-COVID comparison in the first quarter will be the most difficult with revenue relatively flat.
Finally, I want to comment on the FLIR acquisition. We've been watching FLIR since we first entered the space bay infrared imaging market in 2006 when we acquired Teledyne Scientific and Imaging. We believe then and we believe now that our infrared imaging technologies and market segments are uniquely complementary. As both companies evolved, we've grown to be even more complementary. For example, Teledyne entered the subsea drone business in 2008 and FLIR entered the airborne unmanned business in 2016, and more recently, the land-based robotics business. Perhaps more importantly, each company exited unattractive businesses, Teledyne in 2011 and FLIR in 2018.
While our respective sensing technologies and market segments are different, the fundamental desire of our end customers is an image or even better information. This is true for extra imaging, infrared imaging, industrial machine vision and even our underwater marine sonar imaging and software businesses. In other words, there is similarity and synergy in digitization, imaging algorithms, machine learning and other related technologies across each of our organizations.
I will conclude by noting that for 21 years, Teledyne has consistently and predictably compounded earnings and cash flow, and 2020 was no different. Nevertheless, I have never been more excited about Teledyne's future than I am today with the pending acquisition of FLIR.
Al will now comment on the performance of our four business segments.
Thank you, Robert. In our Instrumentation segment, overall fourth quarter sales decreased 6.2% when compared with last year. Sales of environmental instruments decreased 6.7% from last year. However, sales increased 6.9% sequentially from the third quarter. Compared with last year, sales of certain products, such as wastewater samplers increased. However, this was more than offset by year-over-year declines and sales of selected industrial products, such as ambient air monitoring instrumentation.
Sales of electronic test and measurement systems increased 3.7% year-over-year to a quarterly record of $70 million. Sales of marine instrumentation decreased 11.4% in the quarter, due in part to a difficult comparison with the fourth quarter of 2019. In spite of lower sales, overall Instrumentation segment operating margin increased 262 basis points to a record, 22.3%.
Now turning to the Digital Imaging segment. Fourth quarter sales decreased 2.3%, and primarily reflect the core sales of X-ray detectors for dental and medical imaging, partially offset by greater sales of infrared and visible detectors for space applications.
GAAP segment operating margin was 21.6%, an increase of 407 basis points year-over-year and also, a record.
Now in the Aerospace and Defense segment, fourth quarter sales declined 14.8% as greater U.S. defense sales were more than offset by a 45% decline in sales of commercial aerospace products as well as lower commercial space sales related to OneWeb. The GAAP segment operating margin decreased due to lower sales as well as $5.8 million in severance facility consolidation and other contract charges.
In the Engineered Systems segment, fourth quarter revenue increased 26.8%, primarily due to greater sales from defense, nuclear and other manufacturing programs as well as electronic manufacturing services. Segment operating margin increased 175 basis points compared with last year.
I will now turn the call to Sue, who will offer some additional commentary regarding the first quarter and full year 2021 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 first quarter and full year 2021 outlook.
In the fourth quarter, cash flow from operating activities was $236.4 million compared to cash flow of $167.9 million for the same period of 2019. Record free cash flow, that is cash from operating activities less capital expenditures, was $217 million in the fourth quarter of 2020 compared with $144 million in 2019.
Capital expenditures were $19.4 million in the fourth quarter compared to $23.9 million for the same period of 2019. Depreciation and amortization expense was $28.7 million in the fourth quarter compared to $29.3 million for the same period of 2019.
We ended the quarter with $105.4 million of net debt, that is $778.5 million of debt less cash of $673.1 million for a net debt-to-capital ratio of only 3.2%. Stock option compensation expense was $5.9 million for the fourth quarter of 2020 compared to $5.7 million for the same period of 2019.
Turning to our outlook. Management currently believes that earnings per share in the first quarter of 2021 will be in the range of $2.55 to $2.60 per share. And for the full year 2021, our earnings per share outlook is $11.25 to $11.45. In each case, these do not reflect the pending acquisition of FLIR and related acquisition and financing costs. The 2021 full year estimated tax rate, excluding discrete items is expected to be 22.3%. In addition, we currently expect significantly net discrete tax items in 2021 compared with 2020.
I will now pass the call back to Robert.
Thank you. We would now like to take your questions. William, if you're ready to proceed with the questions and answers, please go ahead.
[Operator Instructions] Our first question will come from the line of Greg Konrad. Please go ahead.
Good Morning. I'm Greg Konrad.
Thank you, Greg.
You mentioned 5% to 6% organic growth in 2021, but how are you thinking about that on a segment basis, just thinking about the different recovery cycles across the business?
Good question. Let's start with the instruments. In the instruments, we think our sales would increase about 5%, maybe just a head over 5% with our environmental and test and measurement businesses leading those. In Digital Imaging, the theme for Digital Imaging for us is recovery. And even though our revenue only went down 1% this year, we expect next year to recover and go up about 9% in Digital Imaging. Aerospace and Defense, we had a tough year, especially in Aerospace. And we expect some improvement, especially in our Defense businesses, I would say, about 4%. Engineered Systems had a great year, the best year among all of our businesses in terms of improving sales. So there, we expect their sales to improve very modestly less than 1%. And the way I've laid it out, Greg, so far, it adds up to something like 5.5% to 5.6%. I hope that's helpful.
That's very helpful. And I mean, the other thing that just stood out on the quarter and the year, I mean, just looking at free cash flow conversion, I think it was like 136% in 2020. I mean, how are you thinking about conversion going forward? And maybe this is too early, but just kind of post-FLIR close, is there any reason to think that, that level of conversion changes?
Well, let me -- Greg, let me start with -- without FLIR first. We think year-over-year, our free cash flow is going to be relatively flat, maybe a little down because, as you said, the conversion was phenomenal. There is, of course, we had the benefit of a payroll tax, about $24 million last year. Even though you put that in, it doesn't affect our already outstanding cash flow, so we've got to pay some of that back next year. But having said that, I think absent the onetime charges and expenses that come with the FLIR acquisition, our cash flow would be relatively flat, maybe a little down next year. But it will still be very close to the record that we accomplished this year.
Now with FLIR. What -- the way I can describe that is on an adjusted basis, if I may, because it is -- it's difficult for us to right now determine what that cash flow would be. But based on historical trends, we think together, we would have an adjusted EBITDA after the acquisition of about $1.2 billion. Ours and theirs. And that's about the best I can do at this time knowing what I know.
That's helpful. And then just one quick cleanup question. In terms of the debt financing for FLIR, I mean, any thoughts around kind of timing and rate on that? Thank you.
Sure. Let me start by noting where we are today and what progress we've made to date. We have interacted with our banking institutions and we have secured financing for our term loans. First, we have $1.25 billion of term loans, which we have a commitment for. And the remainder of the $4 billion that we need will come in corporate bonds and that we will do after we have -- after we've obtained a rating for ourselves from the rating agencies, Moody's and S&P. And I think we will get an investment-grade rating, after which we will do that financing.
The other thing that's important is that, we have increased our net debt-to-EBITDA multiple to 4.8, and we think this would conveniently put us in a position where we'll have cash on hand after the acquisition. And our covenants are about 4.75% to about 4.8% in net debt. And the last thing I would say is that, we managed to also get a commitment to increase our line of credit from about what it is now $750 million to over $1.1 billion. So that's about the best I can do.
In terms of rate -- average borrowing rate that you asked about, our best guess at this time, it's going to be 2.25%, maybe 2.3% of that order.
Thank you.
Sure, Greg.
Our next question will come from the line of Jim Ricchiuti. Please go ahead.
Hi. Thank you. So I wanted to pursue, Robert, if I may, just the improvement that you're expecting in the Digital Imaging business in 2021. Is -- are you seeing signs yet of the recovery in the X-ray detector business? Or are you just assuming as we get the pandemic behind us, lead that business starts to recover?
Well, there are two parts to that. There's the x-rays for dental imaging, which already are recovering. Then there's the X-ray for cancer treatment, both -- in that case, we make components that go into machines. And that's recovering a little slower, but we're seeing some recovery in our X-ray imaging where we have these CMOS image sensors, we're seeing some recovery there. So overall, I'm going to say that we will see recovery in our healthcare, I would say, of the order of 6%. At least that's our guess right now, maybe a little more than that.
Got it. And what kind of recovery are you assuming in the industrial machine vision portion of the business?
I think if you look at this year in the total machine vision, which would include scientific cameras, we expect about a 10% recovery in that domain.
Got it. And so the bookings, that strength that you saw in Q4, was that -- were any of the major segments unusually strong that led to a...
Yes, I'm sorry, I should let you finish your question.
No. Please, please go ahead.
I think the strongest, again, was in Digital Imaging, it was about 1.2. And that bodes well for us because it cuts across all of the businesses there, including our Aerospace and Defense businesses and our micro electro mechanical systems foundries.
Got it. Okay, thanks very much.
Sure, Jim.
Our next question will come from the line of Joe Giordano. Please go ahead.
Thanks for taking the questions. I'll start just on Aerospace and Defense Electronics. Like, so given what's happened in that space, and I know you're being conservative about the ramp back on the commercial side. Like what -- how do we think about margin recovery in that business, given the cost that you took out. Like what kind of run-rate of revenue do you need to achieve to get back to where we were in margins before?
Well, the revenue, of course, is one story. We don't expect at this time much recovery in our Aerospace businesses. On the other hand, we do expect some improvement in our Defense businesses. But coming back to the question of margin, last year, we took a -- in 2020, we took a real hit in our margin in Aerospace and Defense. In 2019, we had margins of 20.8%. In 2020, we have 13.7%. So the margin went down almost 700 basis points. We expect, based on all the costs that we've taken out of that business, we expect the margins to improve to a little better than 18% from 13.7% or about 450 basis points approximately, even though we don't expect much recovery in the Aerospace side of the business. It's just primarily cost takeout and improvement in everything else that we're doing.
Perfect. That's really helpful. I saw that there was an expansion awarded on a Swiss contract. So just curious like, I think you mentioned Engineered offered a good year as kind of a flat outlook. What's the path over the next few years in Engineered Systems just based on kind of the pacing of contracts that you've won and the deployment schedules there?
Yes. First, let me back up and say what business there is going to shrink. And that's -- we are doing -- we make turbine engines for missiles, specifically harpoon missiles. And that will be going away at the end of the first quarter. So I think that in terms of sales of turbine engines, which also are profitable businesses, it should impact our revenue about $20 million next year. So that's on the contraction side.
On the expansion side, which will keep us hopefully flat year-over-year since we have such a great year in 2020. On the expansion side, we won a number of contracts, multiyear contracts, some of which we put out news releases. And we think that we had about $0.5 billion in total of new contracts or renewal of contracts that last year. For example, coming back to the Swiss, what we have is -- we have our existing programs, which are about, rough numbers, let's say, they'll add up to about $250 million. Then we received a foreign military sales contract for new boats, which is about $35-or-so-million, and put the advance, it's $40 million. And that's a plus in that business. And we're very excited about that business because, as you know, that underwater vehicle also uses a lot of our sensors that we develop in our marine businesses. So that's -- I don't know if that answered your question as well as you want it.
Yes. Yes. Yes. Is the margin profile for that business kind of similar on a similar run rate revenue you expect next year?
No, I think margins will go down somewhat. We had just a blowout margin year this year in that business, primarily because of turbine engines and some of our manufacturing programs. We ended the year at about 12%. That's on the very high side of that business. I think we're going to go down to closer to 10.5% next year.
That makes sense. And then just last for me. Like any update on how you're thinking of presenting FLIR once you close it? Because, I think the $1.2 billion EBITDA run rate that you were talking, I assume that's kind of like a full year equivalency. So as that comes in at some point during '21. How do you think you're going to present like the incremental operating performance plus the onetime costs associated with it?
Yes. What we'll do, Joe, is we'll take the onetime cost and put it aside, as you know. But that's going to be significant. It's going to be -- I'm going to guess. My guess right now is about $175 million. It could be a little higher than that. So put that aside because there's nothing we can do about that. Then you go to, let's assume, the merger happens, the acquisition happens on July 1. Then what we're looking at is -- you can look at that two ways. You can look at it with as an adjusted basis.
And when I talk adjust that I'm only speaking about adjustment for intangible amortization, nothing else. If you look at it that way, then the acquisition is going to be accretive almost immediately. And the first full year is going to be accretive significantly. It could be as accretive as $2.50. With the $40 million, the tax takeout, the cost takeout that we're estimating for the first full year, we think on a GAAP basis, it should be accretive after the first full year, marginally accretive.
So the way we presented is what is the combined revenue going to be? At this point, I would say of the -- if you look at the 2020 pro-forma, you're looking at $5 billion. If you look at '21 plus FLIR for the first full year, you're looking at $5.2 billion in revenue. And then we will work on the free cash flow same as we do now. We'll probably present it on a non-GAAP basis. Only I say that because in our agreement with our lenders, in terms of what they have agreed to in terms of our debt -- net debt-to-EBITDA, they're excluding the onetime costs that we're going to incur in that business. So we'll have a table of free cash flow to lay all of that out.
Thanks, guys.
Thanks, Joe.
[Operator Instructions] Our next question comes from the line of Andrew Buscaglia. Please go ahead.
Morning, guys.
Good morning, Andrew.
I wanted to ask on, I believe last quarter, you provided sort of a soft target for this year's margins to be expand about 130 basis points and you kind of walked through a couple of segments, but do you still stand by that initial take?
Well, you said it was a soft target, 100 basis points improvement? Okay. I think we'll deliver better than that. I -- for us, as a stand-alone company, again, excluding any onetime charges, which were going to happen. I think our margin should improve about 120 to 140 basis points in 2021 versus 2020.
Okay. Okay. And then -- and Robert, you sounded last time or last quarter a little bit -- I guess, your expectations around the Biden administration would not be great for your defense business. Have you given that much more thought now that's coming to fruition. Broadly, it sounds like defense still has some legs into 2021. But I guess, what's your outlook beyond that?
Well, it's very interesting. One of our directors made an observation yesterday, which I agree with, that I don't think, by and large, democratic administrations have been against defense spending because they -- obviously, they don't want to be -- appear as being soft on defense. And with the world situation as it is today, we think defense is going to be stable. And we have long-term programs in very critical areas, including space infrared programs that are going to be healthy. That's about all I can say on the defense side.
There are other things, of course, that will affect us, which would be interest rates if they went up. And of course, taxes will hit all corporations if they were to go up.
Okay. And last one, this might be a little out there, but you guys sounded really excited about potential M&A into this year, pre-FLIR. And I know you got your hands full with FLIR, but is M&A off the table completely this year outside of FLIR until you digest that one?
Yes and no. M&A is never off the table. If something really attractive came along, and we thought we could do it while being as busy as we are at this time in going to be integrating. We would have the capacity, as I mentioned, we would have another almost $1 billion that we can spend. But I don't -- I would say it's not likely at this time because the amount of work we have. Now on the other hand, if it's a small bolt-on that we can talk to -- tuck away into one of our businesses, yes, we do it.
Okay, thank you.
At this time, we have no further questions in queue.
Thank you, William. I'll now ask Jason to conclude our conference call, please.
Thank you, Robert. And again, thanks, everyone, for joining us this morning. All the news releases are available on our website. And of course, should you have follow-up questions, my numbers there, please do feel free to call me or send me a note to set up a time to speak. Thanks, everyone.
William, if you could give the replay information, please, that would be great. Thank you.
Ladies and gentlemen, this conference will be available for replay after 10 a.m. today through February 27. You may access the AT&T teleconference replay system at any time by dialing 1 (866) 207-1041, entering access code 5989502. That does conclude our conference for today. Thank you for your participation in using AT&T conferencing services. You may now disconnect.