Jason VanWees - SVP, Strategy, Mergers & Acquisitions Robert Mehrabian - Chairman, President & CEO Susan Main - SVP & CFO.

Gregory Konrad - Jefferies James Ricchiuti - Needham & Company George Godfrey - CL King & Associates.

Ladies and gentlemen, thank you for your patience and standing by. Welcome to Teledyne's First Quarter Earnings Call. [Operator Instructions]. Just a brief reminder, today's conference is being recorded. And I'd now like to turn the conference over to Jason VanWees..

Good morning, everyone. This is Jason VanWees, Senior Vice President, Strategy and M&A at Teledyne. And I would like to welcome everyone to Teledyne's First Quarter 2018 Earnings Release Conference Call. We released our earnings earlier this morning.

Joining me today is Teledyne's Chairman and CEO, Robert Mehrabian; President and COO, 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 and Sue, we will ask for your questions.

However, before we get started, our 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 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 1 month. Here is Robert..

Thank you, Jason, and good morning, everyone. We began 2018 with an outstanding quarter. We achieved record sales, record earnings per share and record operating margin for any first quarter. Total sales increased 22.9%, including organic growth of 7.9%.

Our Digital Imaging segment performed exceptionally well again, with sales increasing 21.7% organically and 81.4% overall from last year. Within the Digital Imaging, we continued to benefit from industry-wide growth in machine vision and factory automation, along with new product launches and strong execution.

However, the largest year-over-year organic growth was achieved from our CMOS, that is complementary metal-oxide semiconductor-based digital X-ray detectors for medical and dental applications, which produced outstanding image resolution using lower-than-normal X-ray radiation.

Notwithstanding the excellent performance in our Digital Imaging segment, our strong results were well-balanced among all of our segments and within each of our segments. Sales increased organically in all segments.

Every segment also contributed to our all-time record orders, with segment book-to-bill ratio ranging from 1.09 to 1.57 for a total of 1.23 for the overall company. Even excluding 1 multiyear space program in our Aerospace and Defense Electronics segment, our overall book-to-bill still exceeded 1.1.

Now I'll comment on the performance of our business segments. In our Instrumentation segment, overall first quarter sales increased 2.7% from last year. Sales of marine instruments declined 4.8% and primarily reflected lower sales of sensors for energy exploration and unfavorable timing of U.S.

government sales, partially offset by higher sales of sonar systems. However, marine orders exceeded sales by 12%, and we believe the outlook for both subsea defense and offshore energy continues to improve.

In the environmental domain, sales increased 7.5%, largely as a result of increased sales of laboratory and life science instruments as well as continued growth in our pollution monitoring instrumentation, particularly in China. Sales of electronic test and measurement systems increased 12.1% overall and 10.4% organically.

Orders and sales of protocol analyzers continued to be very strong in the first quarter. Segment operating profit declined slightly due to -- in part, to costs associated with the relocation and consolidation of certain marine instrumentation facilities from the United Kingdom to the United States.

Nevertheless, operating profit for both environmental and electronic test and measurement instrumentation increased compared to last year. Turning to the Digital Imaging segment. First quarter sales increased 81.4%, and as I indicated, organic growth was 21.7%.

In addition to strong growth for X-ray detectors and industrial machine vision cameras, shipments of microelectromechanical systems, or MEMS products, for handheld devices, semiconductor processing and life science applications continue to increase.

Furthermore, sales of our infrared detectors for both commercial and government application also grew considerably. And finally, all of the e2v product lines were strong contributors to revenue and profit. We recently celebrated the 1 year anniversary of the acquisition of Teledyne e2v.

And I want to highlight to our employees, customers and shareholders that we could not be more pleased with the people, technologies and the financial performance that e2v has added to Teledyne. GAAP segment operating margin increased 349 basis points from last year.

While the first quarter of 2017 was impacted by some charges related to the e2v acquisition, 2018 operating margin, excluding these charges, would have still increased 130 basis points.

In the Aerospace and Defense Electronics segment, first quarter sales increased 13 -- 17.3%, due in part to the contribution from e2v but also strong underlying organic growth of 10.3%. Commercial aerospace sales declined slightly, given some very tough aftermarket comparisons.

However, sales of defense electronics increased significantly versus last year due to greater sales across a number of microwave, interconnect and manufacturing service product lines. Segment operating margin increased 146 basis points to 17.8%, primarily due to greater sales as well as improved margins.

In the Engineered Systems segment, first quarter revenue increased 6.5%, largely driven by greater marine defense programs. We also enjoyed increased sales related to ballistic missile defense. Operating margin declined slightly, primarily as a result of lower fixed-price turbine engine deliveries.

I should briefly comment on the new pension accounting rules. New guidance requires splitting net pension expense for income into two components, service cost and expense, which is now included in our operation; and retirement benefit cost or income, which is now below the operations on a separate line in our income statement.

Our legacy pension remains overfunded and has been closed to new participants since 2004. But I mentioned this here since the new accounting rules affect our historical businesses the most, especially the Engineered Systems segment, where it impacts margins by approximately 200 basis points.

For reference, we have included historical data before and after the accounting change in our earnings release. To conclude my comments, I want to first offer some perspective in our businesses and our 2018 outlook. For a number of years, I've talked about the progressive transformation of our business portfolio.

First, we have exited commoditized and liability-prone businesses such as aircraft piston engines. Second, we have built scale to bolt-on and larger acquisitions, especially in high-technology instruments and digital imaging, which now comprise 64% of our portfolio.

Third, we have demonstrated our ability to rapidly and successfully integrate acquired businesses, both financially and operationally. Fourth, while we are pleased with our current business portfolio, we are also continuing to pursue acquisitions, both small and large.

And finally, we have matured as a company, as evidenced by our consolidated business units, strong operations management, integrated ERP systems and a lean corporate culture.

Our efforts have now shifted to improving margins by focusing on our largest and most profitable customers and products and improving and streamlining all of our business processes. Lastly, we currently believe that the organic revenue growth in 2018 will be approximately 4% compared to the 3% that I stated in February of this year.

I will now turn the call over to Sue..

Thank you, Robert, and good morning, everyone. I will first discuss some additional financials for the quarter not covered by Robert, and then I will discuss our second quarter and full year 2018 outlook. In the first quarter, cash flow from operating activities was $71.6 million compared with cash flow of $53.4 million for the same period of 2017.

The higher cash provided by operating activities in the first quarter of 2018 primarily reflected the impact of higher operating income and cash flow from Teledyne e2v. Free cash flow, that is cash from operating activities less capital expenditures, was $51.8 million in the first quarter of 2018 compared with $40.8 million in 2017.

Capital expenditures were $19.8 million in the first quarter compared to $12.6 million for the same period of 2017. Depreciation and amortization expense was $28.8 million in the first quarter compared to $22.8 million for the same period of 2017.

We ended the quarter with $949 million of net debt, that is approximately $1.03 billion of debt and capital leases less cash of $79.9 million, for a net debt-to-capital ratio of 31.6%.

Our leverage ratio was 2.2x at the end of the first quarter of 2018 compared to 2.3x at the end of the fourth quarter of 2017 and 3.0x immediately after completing the e2v acquisition one year ago. Stock option compensation expense was $4.9 million in the first quarter of 2018 compared with $4.1 million in the first quarter of 2017.

As noted in the earnings release, the first quarter of 2017 included pretax charges of $21.2 million in acquisition costs related to the e2v transaction, of which $2.5 million was recorded in the Digital Imaging segment, $10.4 million was recorded to corporate expense, $2.3 million was recorded to interest expense and $6.0 million was recorded as other expense or approximately $0.42 a share.

Turning to our outlook. Management currently believes that GAAP earnings per share in the second quarter of 2018 will be in the range of $1.85 to $1.90 per share. And for the full year 2018, our GAAP earnings per share outlook is $7.67 to $7.77 compared to our prior outlook of $7.51 to $7.61.

The 2018 full year estimated tax rate is 21.4% before discrete items, which we -- are currently expected to be lower in 2018 than in prior period. I will now pass the call back to Robert..

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

[Operator Instructions]. First, we have the line of Greg Konrad of Jefferies..

It seems like e2v has exceeded your expectations. And I mean, I know, at least how we're modeling it, it exceeded our expectations, too.

Just so we can get some comparison, I mean, maybe how much e2v grew last year and then this year given we only have, I think, half a quarter of contribution a year ago? I'm just trying to think about what the organic growth on that business has been..

I would say, Greg, about 7%, maybe a little more..

7% last year or this quarter?.

I would say from the 2017. And a little bit this year, a little more this year. It was -- it contributed, Greg, about $88 million to our overall revenues, which is about 12.7% of the total in Q1..

That makes sense. And then you lifted your organic growth target, and I understand 8% is probably not going to be something you're going to do every quarter.

But just when you think about the segments, how you expect organic growth to play out for the rest of the year?.

Well, let me just go through that the best I can. I think, in the Instruments segment, we had a little shrinkage in marine in the first quarter. But I think that would kind of work its way out because we think it will be better going forward. So marine should be about 2.5%, and total Instruments would be over 3%.

Digital Imaging should stay over 7%, maybe 7.3%. These are organic numbers I'm giving you. Aerospace and Defense, the defense part will increase, the aerospace part would probably shrink a little bit like it did in Q1, but it should be over 1%. Engineered Systems, relatively flat, maybe up 1.5% with a total of about 4%.

Greg, I would just preface this by saying we are obviously a little cautious about our revenue and organic versus other growth, primarily because half of our portfolio is short-cycle businesses. And we can't predict what will happen to the various markets. But so far, it's worked for us pretty well..

I appreciate that. And obviously, it was a great quarter. And I guess just last one for me. With the fiscal year '18 budget, I mean, you have a couple of development programs, but any insight to kind of how the budget aligned to maybe where your focus is on defense? I'm just think about funding levels..

Yes. I think the budget has been really good for us. First, the budget overall grew about 10%, 10.2% to be precise. But where we have seen the most positive effect has been in our Defense Electronics. Our Defense Electronics grew about 31% year-over-year. Of course, e2v contributed about 10.3% of that, over 7% of that. But that's been really good.

We've grown in our microwave businesses, interconnect businesses and as well as in our manufacturing. And the reason for this is the budget for a change has got a very healthy increase in electronic warfare, which helps us a lot because that's what we do in most of our products. And also, there are two other things.

One is Virginia-class submarine program where we have a significant business in, that's going to continue about two per year. And Missile Defense is up, which is where our Teledyne Brown Engineering, which is part of our Systems Engineering segment, does a lot of work. So overall, I would say the defense budget increases have been very healthy for us.

I must conclude by saying, because the budget came in late, there are some issues about being able to -- for the government to be able to get the numbers out, to get the awards out. So the awards and contracts are lagging the 10% so far. I'd say they're closer to 5%..

Next, we have the line of Jim Ricchiuti of Needham & Company..

Robert, I'm a little surprised that you see the kind of organic growth over the balance of the year and the Digital Imaging segment being as strong as it is.

Is that mainly coming from the X-ray detector and MEMS businesses? I would assume you've got tougher comparisons ahead in the industrial machine vision area, or you just see that as continuing to be a good growth area over the balance of the year?.

Thanks, Jim. Let me just note first, on a larger picture, our Digital Imaging ground rate right now is about $800 million. Of that, machine vision is about $285 million, or about 6% of that or less than $50 million is in flat panel displays. As you know, there's a little bit of concern about flat panel displays.

When you look at the overall budget in Digital Imaging, that business, that part of the business, is only 6% of Digital Imaging and less than 1.8% of Teledyne as a whole. So if that goes up and down, goes down a little, it's not going to change things for us.

Where we are enjoying really good uplift is in a lot of barcode IDs, sensors, cameras for identification. We also have a very strong ophthalmology digital program. We have also -- where we do -- provide cameras for optical coherence tomography. We have other things in printing, factory automation.

And of course, we have a strong program in defense and space. And we have some -- we also play some in food and solar, recycling and other sensors.

So all in all, what we anticipate is that we may have a little headwind as some people are projecting in FPD, but that's not going to affect as much because the business portfolio in Digital Imaging is very well-distributed among many industries and like the portfolio for all of Teledyne. And things are -- things look all right for us.

And we're integrating, of course, a lot of the stuff from e2v directly across with DALSA as well as our imaging programs here in Thousand Oaks..

Okay, that's helpful. Just shifting to the Instrumentation business. I wonder if you could size the costs, some of the unusual costs that impacted operating income, the facilities relocation costs..

I think, in the marine area, we're moving an operation, as I indicated, from the U.K. to Florida. It's just one -- it's a small business. It's -- because it makes very large systems, we've had some delays in shipping of the systems because we have to certify, I mean, in their existing factories.

We have taken about $2 million, $2.5 million hit from that. We expect a little continuation of that in Q2. But by the end of Q2, that should be behind us. And that's why I said I think in marine business, both our revenue will go up and I expect that our margins will improve as we move through the year..

Okay.

And wondering, was currency -- was there any benefits from currency in the quarter on the top line?.

It was very minor..

Okay. Okay. And last question for me.

Just I'm wondering on the M&A front, any more e2vs out there?.

I wish. I wish. No, there are some, maybe not exactly like e2v, because e2v was very unique. Everything they had kind of fit into one or another part of Teledyne. There are a few things we are looking at, but as you know, even with the current market going down slightly, everybody's looking in the rearview mirror and kind of have very high expectations.

But I think things are moderating. So we should have some opportunities..

[Operator Instructions]. Next we have the line of George Godfrey of CLK..

You highlighted a number of applications in the Digital Imaging, and the organic growth there is really strong.

Are those new products and applications replacing older equipment? Is it new devices? Are you gaining market share? It's like, what is the product being used and what is being displaced?.

Thank you. First, on a broader scale, historically, we've been in line scan devices. We are now moving into the larger market of area scan. Second, which is a nice mid-market for us, we also have a whole series of new products.

As one of our recent announcements indicated, both DALSA and e2v won awards at the recent Digital Imaging Show, gold and a silver medal in the new product introductions, both in line scan camera as well as in the optical coherence tomography camera, which I have mentioned before.

The other areas that, George, are really doing well for us is, first, in X-rays, as I mentioned, because we have introduced probably the most advanced X-ray detectors in the world, both for dental and medical applications.

That business is growing fast enough that we've had to increase our capacity in our Eindhoven laboratories so that we can have 2 X-ray detector production facilities, one in Waterloo and one in Eindhoven.

Second, the MEMS, as I mentioned, microelectromechanical relays -- microelectromechanical systems, there, we have increased -- we have had to increase a gain capacity. You saw our CapEx has increased a little bit.

That's partly -- again, we're having to increase capacity there by 900 -- 9,000 square feet with clean rooms in order to accommodate the increased demand from both life science; we make some very interesting products for life science applications, as well as for more semiconductor applications as well as machine vision applications.

So having said all of that, I think the distribution of growth is across our products. It ranges from MEMS to new products in sensors, new products in machine vision and also increased revenue from our RF products that are going into radiotherapy for cancer patients. So it's a broad portfolio, and it seems to be hitting on all cylinders so far..

That's great. And a question for Sue.

Is $80 million for CapEx a reasonable estimate for this year?.

Yes, we're thinking between $80 million, $90 million..

And at this time, we actually have no further questions in the queue..

Thank you very much, Justin. I'm going to ask Jason VanWees to conclude our conference call..

Thanks, Robert, and thanks, everyone, for joining us this morning. If you do have follow-up questions, please feel free to call me at the number on the earnings release. Justin, if you could conclude the call and provide the replay information, we would appreciate it. Thanks again..

Certainly. Thank you. So ladies and gentlemen, that does conclude the conference for today. We do thank you very much for your participation. The replay of today's event will be available for you by dialing 800-475-6701 and using the access code of 446200.

Alternatively, if you're dialing internationally, you can reach the same recorded replay by dialing 320-365-3844 and using the same access code of 446200. Again, we do thank you very much for all of your participation and using AT&T's Executive Teleconference service. You may now disconnect..