Ladies and gentlemen, thank you for standing by, and welcome to the Teledyne second quarter earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will be given at that time. If you should require assistance during the call, please press star then zero. As a reminder, this call is being recorded. I would now like to turn the call over to our host, Jason VanWees. Please go ahead.
Thank you, and good morning, everyone. This is Jason VanWees, Vice Chairman, and I'd like to welcome everyone to Teledyne's second quarter 2022 earnings release conference call. We released our earnings earlier this morning. Joining me today are Teledyne's Chairman, President, and CEO, Robert Mehrabian, Senior Vice President and CFO, Sue Main, Senior Vice President, General Counsel, Chief and also Edwin Roks, Executive VP of Teledyne. After remarks by Robert and Sue, we will ask for your questions.
Of course, though, 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 their periodic SEC filings. 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 dial-in and webcast, will be available for approximately one month. Here is Robert.
Thank you, Jason. Good morning, and thank you for joining our earnings call. In the second quarter, sales increased nearly 21% to about $1.36 billion. In addition, our GAAP operating profit, operating margin, and earnings per share were all-time or second quarter records. Non-GAAP earnings declined slightly, but last year's non-GAAP margin and earnings resulted in part from a disproportionate amount of sales relative to costs near the end of the quarter at Teledyne FLIR, as well as lower share count, both due to the mid-quarter closing of the FLIR transaction in May 2021. Including increased foreign currency headwinds, which negatively impacted second quarter sales growth by over 1.7% or approximately $23 million, organic growth was 8.2% and accelerated from the first quarter of 2022.
Our short cycle commercial instrumentation and imaging businesses grew strongly in the quarter, and sales from our long cycle aerospace and marine businesses also increased. Finally, our U.S. government sales, including Teledyne FLIR, increased from last year, despite lower Defense Department outlays in the second quarter of 2022. In summary, year-over-year sales increased in all segments and reported product lines. Overall demand remained strong, and we achieved record quarterly orders with a total company book-to-bill of 1.08. Orders were particularly strong at Teledyne FLIR, where book-to-bill was approximately 1.25. Free cash flow improved from the first quarter, but planned inventory levels remained elevated to counter continuing supply chain risk.
Finally, our leverage ratio declined to 2.5, and having reached our targeted leverage range, we are again pursuing acquisitions and are pleased to have recently completed our first small bolt-on acquisition at Teledyne FLIR. Turning to our 2022 outlook, given the recent and significant appreciation of the U.S. dollar, ongoing supply chain constraints, and inflation, we believe it's prudent to revise our reported revenue and adjusted earnings outlook modestly for the remainder of the year.
Foreign currency translation impacts our three largest segments and approximately 20% of our total sales, with Digital Imaging and particularly Teledyne FLIR impacted considerably more than other segments. In addition, supply chain constraints continue to limit shipments. Electronic component and other material shortages negatively impacted second quarter sales by approximately $60 million, and we're assuming that a similar shortfall will continue in the remainder of the year.
We have countered both of these headwinds through our various procurement initiatives and strong execution. Nevertheless, we expect total company year-over-year reported organic sales growth of about 4% in each of the third and fourth quarters of 2022, compared with a prior outlook of roughly 5%-6%, resulting in full year estimated sales of about $5.47 billion. Despite these headwinds, we continue to see full year organic sales growth, which excludes FLIR, of just over 6% and full year sales from Teledyne FLIR slightly greater than the peak sales in 2020, which included over $125 million from cameras for elevated skin temperature testing. Finally, while foreign currency sales and costs are reasonably balanced at Teledyne, there is nonetheless an impact on earnings.
We also remain a bit cautious regarding cost impact of inflation. Therefore, we're modestly revising our full-year adjusted earnings outlook by $0.30 at the midpoint or approximately 1.7% lower than in April. I'm going to continue with our performance of our business segment. In Digital Imaging, second quarter sales increased 32.9%, largely due to FLIR acquisition. Organic growth in our combined commercial and government imaging businesses was also very strong at 10.3%. Sales growth was strongest for industrial and scientific vision sensors and systems, as well as for our low-dose, high-resolution digital X-ray detectors. GAAP operating margin was 15.2%, but adjusted for intangible asset amortization, segment margin was 21.2%.
In our instrumentation segment, overall second quarter sales increased 7.4% versus last year. Sales of electronic test and measurement systems, which include oscilloscopes, digitizers, and protocol analyzers, remained strong and increased 11.3% year-over-year. Sales of environmental instruments increased 2.4% compared with last year, with greater sales from certain human health and drug discovery products offset by lower sales of industrial and laboratory gas detection devices. Sales of marine instrumentation increased 9.9% in the quarter due to improved demand, record sales of autonomous underwater vehicles for both defense and commercial oceanography application. Overall, instrumentation segment operating profit increased 13.9% in the second quarter, with operating margin increasing 136 basis points, or 108 basis points excluding intangible asset amortization.
In the Aerospace and Defense Electronics segment, second quarter sales increased 10.8%, driven by 3.4% growth in defense, space, and industrial sales, combined 43.9% increase in sales of commercial aerospace products. GAAP operating margin increased 55.2%, with margin 749 basis points rose. Finally, in the Engineered Systems segment, second quarter revenue increased slightly, but operating profit and margin declined primarily due to lower sales of fixed-price electronics systems. Before turning the call over to Sue, I want to make a few concluding remarks. We continue to focus on strong execution in order to minimize ongoing supply chain risks, inflation, and now increased currency headwind.
While the operating environment remains challenging, we're highly confident of our balanced and resilient mix of commercial and government businesses across a broad range of geographies and end market. Furthermore, uncertain times have traditionally created opportunities for Teledyne. For example, with change in interest rates, we were able to repurchase fixed rate debt issued just last year at a substantial discount. While relatively small, the cash paid for the first acquisition for Teledyne FLIR was negotiated and paid in euros. Given the strength of our management, operations, and balance sheet now, specifically with our leverage ratio at 2.5, which we expect to be further reduced in the balance of the year, we want to continue to seek similar and larger acquisitions in the future. Now I would 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 third quarter and full year 2022 outlook. In the second quarter, cash flow from operating activities was $196.9 million compared with cash flow of $211.3 million for the same period of 2021. The second quarter of 2022 reflected higher purchases of inventories and higher income tax payments compared with the second quarter of 2021.
Free cash flow, that is cash from operating activities, less capital expenditures, was $176.1 million in the second quarter of 2022, compared with $190.5 million in 2021, which included $66.7 million of after-tax cash payments related to the FLIR transaction. Capital expenditures were $20.8 million for both second quarter periods. Depreciation and amortization expense was $82.7 million for the second quarter of 2022, compared with $59.7 million in 2021, which reflected the timing of the FLIR acquisition midway through the second quarter of 2021. We ended the quarter with approximately $3.67 billion in net debt.
That is approximately $3.95 billion of debt, less cash of $278.8 million. Stock option compensation expense was $3.6 million for both the second quarter periods. Turning to our outlook. Management currently believes that GAAP earnings per share in the third quarter of 2022 will be in the range of $3.36-$3.54 per share, with non-GAAP earnings in the range of $4.20-$4.35. For the full year 2022, our GAAP earnings per share outlook is $15.13-$15.45, and on a non-GAAP basis, $17.45-$17.70. The 2022 full year estimated tax rate, excluding discrete items, is expected to be 23.1%. I'll now pass the call back to Robert.
Thank you, Sue. We would now like to take your questions. Operator, if you are ready to proceed with the questions and answers, please go ahead.
Thank you. Ladies and gentlemen, if you would like to ask a question, please press 1 then 0 on your telephone keypad. You may withdraw your question at any time by repeating the command of 1 then 0. Once again, if you have any questions or comments, please press 1 0. Our first question comes from the line of Greg Konrad with Jefferies. Please go ahead.
Good morning.
Good morning, Greg.
Interesting last name there. I mean, I guess it's uncharacteristic for Teledyne to cut guidance. I mean, a lot of times you have contingency and just low-balled ratings in your guidance. I mean, the commentary was helpful, but is there any way to maybe parse across the segments? I mean, it seems like A&D might be running ahead of your guidance, Digital Imaging below. Can you just maybe give us some more color around how you're thinking about the growth and margin outlook for the segments?
Right. It is uncharacteristic, Greg, you're right, and I admit it. There are three things that have happened. Two, we were dealing with fairly successfully, and that would be overall inflation and basically part shortages, which seem to be rolling $60 million every quarter over and over. In total, they continue at that level. The one that just hit us very hard was foreign currency. Foreign currency translation basically affects 20% of our business. The reason it hit Digital Imaging the hardest, that's where we have most of our foreign currency transactions. You're right, and we did well. Instrumentation did okay. Engineered Systems was down slightly, but Engineered Systems now is only 8% of our portfolio.
It's the foreign currency that hit us about 1.7% in Q2, or about $23-$25 million in revenue, and we expect it to continue in Q3 and Q4. I think that's the fundamental change that we saw, and it was mostly, of course, in Digital Imaging. We have not changed our guidance, this the fourth time in 22 years, and it's something we do not do except the three continuing headwinds that we see. We could handle two, but the third one just is too much at this time. Hopefully, we'll execute better as we move along in the rest of the year.
I appreciate that. I mean, I guess everything you're saying is more on the supply side, let's say, rather than the demand side. You mentioned the book-to-bill, but you know, maybe there are areas that have risk. I mean, I'm thinking about tech spending and what we've heard from, you know, some of the tech companies. I mean, anywhere where you've seen any demand deterioration or kind of concerns, or is this really all, you know, more supply and FX driven?
Yeah, I think the quick answer is no. Our demand has been very strong. Maybe as a function of time we may have some demand decline, especially in our discretionary businesses, which are really primarily Raymarine. There, I think demand was softer, but across the board, the demand's been pretty good.
Just last one for me. I mean, you mentioned FLIR bookings. You know, I guess they were 25% above sales. We've seen some nice awards there. How does that maybe intersect with the supply chain and kind of ability to deliver on these? When we just think about defense getting better, is that more of a 2023 item just given supply chain or how you're thinking about the kind of the cadence there?
I think that we have supply chain challenges there as we have across our businesses. I think what we're looking at is improving our revenue there in the third and fourth quarters better than we have in the first two quarters, and mostly in the fourth quarter. We have the same problems across the board. At FLIR, the unusual situation that we've had to slowly, and we're correcting, Edwin Roks, who runs our Digital Imaging businesses, is working very hard on it, is to linearize the sales over the quarters. That's been hard because FLIR has historically always sold more in the last month and the last week of the quarter than early on. That causes issues, especially if you have some supply chain issues that can cause you to miss last-minute revenue. We're taking all of that into consideration in what we've put out in our earnings release.
Thank you.
Our next question is from Joe Giordano Cowen. Please go ahead.
Joe, how are you?
Hey, I'm doing well. Thanks, guys. Good morning. Can you just talk a little bit about price and what you guys have been doing in the quarter and maybe more recently, given FX changes, is this changing the way you're going to market a little bit?
Yeah. Our price increases for the year, we anticipate it to be about 3% of sales. It's a little more in the Q3 and Q4 than it was in Q2. In Q2, it was less than 3%, which has not been really, we're just putting some increases in prices, especially in some of our instrument businesses where we could, and that would be in Q3. Overall, I'd say, Joe, it's about 3%. The flip side is that, the cost increases due to inflation and also wages that we have exceeded that, I'm gonna say by 0.5-0.6%, and that's causing us some issues. You know, we kinda knew that would happen, and we kind of worked on that very hard. The thing that kind of suddenly came out at us was the change in the exchange rate starting in April. That was the hard part.
When I look at margins, you know, running hot in AD&E just on the mix with their lower OE content and then running now lower than people would have thought in imaging, as you start thinking about the next couple quarters, you know, what's like a good. None of those are probably totally representative of, like, the normalized. Like, how do we think about margins, you know, coming out of this in a more normal situation?
Well, I mean, let me start with versus April, which would be a good way to go. As I said before, in Instrumentation, for the full year, we expect margins to improve about 50-55 basis points. In Digital Imaging now, we expect it to be lower by 130 basis points from what for the full year. In Aerospace and Defense, we have a good run there, primarily because, you know, commercial airspace is coming back. We expect improvements in margin of 150 basis points. Lastly, as I said, in a smaller segment, which is our Engineered Systems segment, maybe 60 basis points decline. When you add all of that up, it's about 45 basis points decline across the company. That's I think that's versus April. That's what the summary is.
If I was to think about coming out of this, though, like, you know, I know it's too early to look at 2023 guidance, but, like, if I was to think about coming out of this versus the second half run rate that imaging and aerospace specifically are gonna have, like, is the aerospace margins a level from which to grow from? Or is that, like, too hard of a comp and vice versa? Does the imaging second half provide a pretty attractive, like, exit rate for you to improve on? Thanks.
I think you're correct on aerospace and defense. It already has full year margins of 25.5%, which is pretty high. It could go up a little bit. I think the opportunity is gonna be in Digital Imaging and also in Engineered Systems. The margins in Instrumentation are already pretty healthy, approaching 25%.
Thanks, guys. I'll pass it along.
All right. Our next question is from the line of Elizabeth Grenfell , Bank of America. Please go ahead.
Hi, good morning.
Hi, good morning, Elizabeth.
Hi. As we think about things that have slipped to the right because of supply chain challenges, are those gonna be able to be shipped later at a later date? Or,
Yes. Yes, good question. Very good question. First, let me back up a second. When we started Q2, we had supply chain challenges, and we have a very strong program in procurement. We were able to offset about $120+ million of supply chain challenges by buying through brokers, by buying our own buyers in Asia by a variety of techniques. So we offset $120 million plus of revenue that was endangered. That left us with $60 million that we couldn't. That $60 million is rolling in a way, quarter to quarter. It's not additive.
What happens is that we think that right now that's gonna continue for the next two quarters, and that's where our estimates are coming from, but having said that, because we have elevated our inventory over time, that this is gonna dissipate. There's no question about that. Whether the over time is gonna be early next year or later next year. Over time, it's not lost revenue, and it's not lost inventory. It's just lost revenue for the time being, so it's gonna improve.
Great. Thank you very much.
Thank you.
Our next question is from James Ricchiuti, Needham & Company. Please go ahead.
Hi. Thank you. Good morning. Robert, I can appreciate the sudden change in currency, but you know, I wanted to go back to supply chain. You know, have you guys perhaps underestimated the impact of supply chain or in that maybe you thought it would improve a little sooner? Or is this just something that, you know, you've been tracking and it's just not getting better, and this was in line with what you'd expected?
Jim, yeah. It's improved only because we're able to find more parts. For example, if you look at year-to-date, we're missing about 900, what we call important critical parts. They range from computer chips that go into our vision systems to FPGAs, et cetera. Out of the 900, we've actually located 800, and through the various processes. Sometimes we redesign the product if we can, if it's easy to redesign. Sometimes we buy a part, and we have to obviously qualify it. Sometimes we just buy parts through brokers. What we didn't estimate was that the broker purchases would be as expensive as they are.
We're paying sometimes as much as 70% premium for the same part when we buy through a broker because they're going out and finding the part. You know, that's not unusual. If you create a vacuum, eventually air comes in, right? You got these brokers that are doing pretty good work and making a lot of money. When that happens, supply chain is gonna change eventually, and it is. The only places that I would say we may be underestimated is that some of the very high-end and complex components where the orders our suppliers are quoting are 12-24 months out. They're also asking for us to put in non-cancelable orders. You have to be very careful in the latter, of course.
I don't think we underestimated it's just that things didn't get better at all, and we're not counting on it getting better in the rest of the year. I think 2023 is gonna be different. If some of this stuff continues the way it is, we will redesign more products. I mean, just the way it is. We'll redesign and eventually come out of it. I don't think it's gonna go way beyond 2023.
Got it. One of the things I was struck by was the defense business. I thought you might have shown a little bit more growth in Q2. Is this just more indicative of the pattern we've seen at FLIR over the years, where it's just going to be skewed more toward the Q4 period?
Yes. Here's the problem: While defense budgets are up, the outlays are not. It's kind of like a constricting dam that's constricting the flow. The flip side of it is that if you look at the second quarter, and you look at FLIR particularly, the defense side of FLIR actually increased 8%. It's the commercial side of FLIR that was flat or just slightly down, primarily due to Raymarine, the maritime that I mentioned, which are discretionary. The defense side increased year over year. Actually, if you looked at FLIR Q2 of last year, full Q2 of last year, versus Q2 of this year, that is, look at how much they sold before we acquired them, how much they sold after we acquired them, versus how much they sold this quarter.
Overall, FLIR's revenue was up 2.8%, primarily because of their defense business being up 8%. With this recent award, we feel very good about that, and we have very strong leadership in our defense businesses under JihFen, who used to be with us, went to the Department of Defense, ended up at the very end of her career there to be acting Deputy Secretary of Research and Engineering. We feel good about that, and we're expecting things to improve there.
Got it. Last question from me, and I'll go back into the queue, is just you mentioned Raymarine, you know, potentially as the macroeconomic environment deteriorates that could be impacted. But just given the way the portfolio has changed now with FLIR, as you look at the broader portfolio, which areas of the business might potentially be precursors of some change in demand that you might see if the economic environment changes more quickly?
I think, the canary in the mine, if you want to say, put it that way, is going to be some of our commercial digital imaging products. We saw some declines in certain areas. There are different reasons for it. For example, in our healthcare digital imaging, because of COVID, things went soft. Now it's growing very fast and doing really well and taking market share. I would say some of our commercial digital imaging would be a good signal for a stronger market perspective. Because we have relatively small, very limited exposure to consumer demand, we don't see that affecting us. 50% of our portfolio is defense, aerospace, medical, energy. Those markets are gonna be fine.
Thank you.
Our next question comes from the line of Andrew Buscaglia, Berenberg. Please go ahead.
Good morning, Andrew.
Morning, guys. Morning. Last quarter, you guys sounded a little bit, you know, more net positive on the outlook in defense, obviously with what's going on in the world. You know, what is your view at this point? Do you foresee, you know, some potential awards or projects that aren't currently embedded in your guidance moving forward, maybe before year-end?
Well, yes. As you know, Andrew, we've had a succession of awards recently in defense that have been. We've put news releases out on most of them. Most of them in the FLIR area. We think some of our European awards are a little delayed. As you know, to get, for example, things to Ukraine, you have to go through one of the other NATO countries, and some of those are taking time. The flip side is that some of the larger awards that we've had, for example, US Army's Family of Weapon Sights for individuals which are mounted devices that go on rifles.
Now, that's a $500 million award, but we're in the early phase, so we expect that the increased revenue for that will come in future periods rather than immediately. We had a major award from the Danish Ministry of Defense for mobile sensor system. We also had, as we announced, we had a really nice award for our very small UAVs, which are the Black Hornet from the Norwegian government. With those awards, while they've been made, the shipments are starting to come now. We expect those awards will lead to more revenue in the future as we move forward from small prototype to production or small scale production to full rate production. We feel very good about that, about the awards that we've had and some that we're gonna get, especially in Europe.
How much of this new activity is solely dependent on the Russia-Ukraine conflict continuing? Or, you know, put another way, if that dies down, do you see some of this activity or interest in your products evaporate?
No, I think the programs we're participating in, they're really just greater budgets in the US and NATO countries, and I don't think that's gonna go away in any foreseeable future. As you can judge, the invasion of Ukraine has been a lesson to everybody that you cannot be in a situation where you are reliant. I think those budgets are here to stay. The NATO alliance is getting tighter, and their budgets are going up. US budget's going up in all domains. There are programs in the US that we participate in related to high-performance infrared sensors in space to track missiles. I think that's here to stay.
Okay. Maybe one more, if I may, just because, you know, on this topic, you talked a little bit more positively about M&A now that your leverage is at a target. What areas interest you? Are you targeting areas in defense or is it more outside of Digital Imaging to broaden the balance of your portfolio?
I would say in all areas. I would probably exclude strictly government services businesses-type businesses. We're seeing things that cross our segments, so it's not necessarily pure one segment or another. Our emphasis has been Digital Imaging will continue, and we like instruments, but there are certain areas of aerospace and defense like in our connector businesses, where our margins are superior to everything else. We would not exclude that. We will not participate in something in the government services business, for example.
Okay. Thanks, Robert.
Thank you.
Ladies and gentlemen, once again, if you have any questions or comments, please press one then zero. The next question is from the line of Kristine Liwag, Morgan Stanley. Please go ahead.
Hey, good morning, everyone.
Good morning, Kristine.
you know, you've mentioned to return to M&A now that you've hit your target leverage range. With a sharp increase in interest rates, have you seen asset prices come down to preserve your return thresholds? Also, in terms of timing, there's a lot of economic uncertainty. Do you think now is the time to look at these assets or wait and see how the economic environment unfolds?
A great question, Kristine. Let me first go to the first part of the question. I think some of the expectations out there have moderated, and will continue to moderate, especially with the stock market down. S&P is down almost 15-16% this year. Expectations are moderating somewhat. Let me go to the second part, which has to do if we don't do anything, our ratio which is now 2.5, will continue going down. By year-end, it'll be 2.3. If you don't do anything by the end of next year, it'll be 1.7, and so on and so forth. We do have, by the way, the liquidity to buy things.
Right now, if we look at our liquidity, we can buy things from our line of credit going over $1 billion. Having said that, we've always been very careful not to overstretch ourselves and not to overpay for things. I think things are getting better. We'll look at some bolt-ons. If you look further forward 12 months or so, what happened last time when the markets and the economy declined, same thing is happening now. We come out of this stronger. Some people don't, and that's when we're able to buy them because their market prices have declined. It's a continuing process. Right now, if we look at our debt profile, we have almost no exposure to increased interest rates at this time because 93% of our debt is fixed. The other 7% that's floating, we have cash against that, which is also floating. So we have 100% fixed debt at this time. We have a good line of credit.
Thank you for all the color.
Thank you, Christine.
At this time, there are no other questions in queue.
Thank you, operator. I would now ask Jason to conclude our conference call.
Thanks, Robert. Again, thanks everyone for joining us this morning. If you have follow-up questions, please feel free to call me at the number on the earnings release or email me directly. Roxanne, if you could conclude the call and give the replay information, we would appreciate it. Thank you.