Business context and reporting period
Teledyne Technologies Incorporated filed this unaudited Form 10-Q for the quarter ended July 2, 2017. The filing reports second-quarter and first-six-month results compared with the corresponding 2016 periods. Its four segments are Instrumentation, Digital Imaging, Aerospace and Defense Electronics, and Engineered Systems.
The quarter includes e2v, acquired on March 28, 2017. Teledyne describes the acquisition as its largest to date; it expanded the Digital Imaging and Aerospace and Defense Electronics businesses, with a smaller contribution to Instrumentation.
Financial performance and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $671.1 million | $539.7 million | $1,237.2 million | $1,070.2 million |
| Operating income | $86.2 million | $53.6 million | $144.3 million | $114.5 million |
| Net income | $60.1 million | $46.9 million | $90.6 million | $85.9 million |
| Diluted EPS | $1.66 | $1.33 | $2.50 | $2.44 |
- Sales increased 24.3% in Q2 and 15.6% for the first six months; operating income rose 60.8% and 26.0%, respectively. Net income rose 28.1% in Q2 and 5.5% for the six-month period.
- Q2 cost of sales was 62.3% of revenue, unchanged year over year; six-month cost of sales was 62.4%, versus 61.8%. Reported operating margins were approximately 12.8% for Q2 and 11.7% for the first six months, compared with approximately 9.9% and 10.7% in 2016.
- Q2 effective tax rate was 21.3% versus 27.7%; the six-month rate was 22.6% versus 27.7%. 2017 rates benefited from discrete tax benefits. Excluding discrete items, management reported rates of 27.4% for Q2 and 27.7% for the first six months.
- Six-month operating cash flow was $140.4 million, down from $152.7 million. Investing used $766.7 million, including $742.6 million for e2v; financing provided $599.6 million. Cash declined $16.9 million to $81.7 million.
- At July 2, 2017, current assets were $1,038.7 million and current liabilities $619.8 million. Total debt and capital leases were approximately $1,255.8 million. Available capacity on the $750 million credit facility was $479.7 million; the company was in compliance with debt covenants.
Segment results
| Segment | Q2 sales change | Q2 operating income | Six-month sales change | Six-month operating income |
|---|---|---|---|---|
| Instrumentation | +6.2% | $30.8 million | +5.1% | $61.2 million |
| Digital Imaging | +89.6% | $26.4 million | +59.7% | $41.7 million |
| Aerospace and Defense Electronics | +9.4% | $32.4 million | +4.5% | $58.6 million |
| Engineered Systems | +22.2% | $9.1 million | +13.5% | $18.0 million |
Material changes versus prior periods
- Growth reflected organic gains and e2v. In Q2, recent acquisitions contributed $96.3 million of incremental sales, primarily e2v; organic growth contributed $35.1 million. Digital Imaging had the largest acquisition-related sales increase.
- Q2 operating income improved in every segment. For the six months, gains in each segment were partly offset by higher corporate expense.
- Higher debt following e2v increased net interest expense: $9.1 million in Q2 versus $5.9 million, and $17.3 million for six months versus $11.6 million.
- The 2016 comparison included a $17.9 million pretax gain on sale of a former facility. This contributed to 2016 other income, while 2017 reported other expense of $0.7 million in Q2 and $10.0 million for six months.
Outlook, commentary, risks and unusual items
- Management expected the 2017 effective tax rate to be 27.7%, excluding discrete items. It anticipated up to $80 million of 2017 capital expenditures; $24.9 million had been spent in the first six months.
- Management stated that operating cash flow and available credit were expected to meet requirements over the next 12 months. No domestic pension contributions were planned for 2017.
- e2v-related pretax charges totaled $25.2 million for the first six months, including transaction costs, inventory fair-value step-up amortization, bridge-facility fees, and a foreign-currency option expense. Purchase-price allocation remained preliminary. e2v added $98.3 million of sales and $7.8 million of operating income since acquisition, with the latter including acquisition costs and additional intangible amortization.
- A July 20, 2017 subsequent event: a subsidiary acquired Scientific Systems, Inc. assets for $31 million cash; the business is expected to join Instrumentation.
- Key risks cited include demand and funding for government programs, defense spending, energy-market conditions, commercial aviation fuel costs, foreign exchange and interest rates, cybersecurity, Brexit-related effects, and successful integration of e2v and other acquisitions. The filing reported no material change to previously disclosed risk factors.
- Environmental remediation reserves were $5.6 million at quarter-end; management expects remediation expenditures over many years. Management did not believe pending litigation was likely to have a material adverse effect, while noting outcomes cannot be predicted with certainty.
- Teledyne plans to adopt the new revenue-recognition standard on January 1, 2018, using modified retrospective transition. It expected earlier recognition for certain contracts as costs are incurred, with related changes to inventories, unbilled receivables, backlog, and retained earnings; the financial impact was still under evaluation.
- A 100-basis-point interest-rate increase was estimated to raise annual interest expense by about $5.4 million, assuming $537.5 million of variable-rate borrowings remained outstanding for a full year. Management cautioned that currency hedges may not fully protect against exchange-rate movements.
Important facts for investors to verify
- How much of revenue and operating-income growth is sustainable organic performance versus e2v and other acquisitions.
- Final e2v purchase-price allocation, integration progress, acquisition synergies, and remaining transaction or integration costs.
- Debt repayment capacity, refinancing needs, variable-rate exposure, and covenant headroom after the acquisition.
- Working-capital trends, particularly the increase in inventories and accounts receivable, and the outlook for operating cash conversion.
- The realized 2017 tax rate versus management’s 27.7% expectation and the effects of discrete tax items.
- The eventual impact of the 2018 revenue-recognition adoption and the progress and cost of environmental remediation.