Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Teledyne Technologies Inc (NYSE:TDY)
Q3 2020 Earnings Call
Oct 21, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Teledyne Third Quarter Earnings Conference 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. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mr. Jason VanWees. Please go ahead.

Jason VanWees -- Executive Vice President

Good morning and thanks everyone. This is Jason VanWees, Executive Vice President. And I'd like to welcome everyone to Teledyne's third quarter earnings release conference call. We released our earnings earlier this morning before the market opened.

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.

But of course, 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 one month.

Here is Robert.

Robert Mehrabian -- Executive Chairman

Thank you, Jason. Good morning and thank you for joining our earnings call. I want to open with the following comments. First, all of our 70 worldwide manufacturing sites as well as our corporate office and research laboratory remain operational and only 16% of total employees are working from home. Second, our short cycle environmental and test and measurement instrumentation businesses rebounded from the trough in the second quarter, growing approximately 6% and 5% respectively quarter-over-quarter. Third, we believe our longer-cycle commercial markets such as marine instrumentation and medical imaging bottomed in the third quarter. Fourth, our government businesses continued to grow and generally remained in attractive niches such as space-based imaging, manned and autonomous subsea systems and electronic warfare.

Despite the market turmoil and lower sales in 2020, we have successfully demonstrated GAAP margin improvement. For example, the second quarter GAAP operating margin increased sequentially over 150 basis points. Specifically, operating margin of 16.4% was the second highest in the Company's history. In addition, we achieved greater margins compared to last year in nearly every major business category, except commercial aerospace where sales have declined nearly 50%. We also achieved record third quarter free cash flow, an all-time record free cash flow for any first nine-month period. Finally, our balance sheet has never been stronger and our acquisition pipeline is healthy.

As the overall demand environment continues to improve, our substantially lower cost structure, for example, we are operating with 9.2% fewer employees -- our lower cost structure should provide significant operating leverage in future quarters. Coupled with acquisitions, we expect earnings and cash flow to continue compounding for years to come.

Before turning to Al to report on the third-quarter performance by segment, I want to comment briefly on two important items. First, the OneWeb satellite program and second, the potential acquisition of Photonis.

Over the last few weeks, the OneWeb situation has improved considerably. First, OneWeb, parent of our customer Airbus OneWeb Satellites, secured $235 million of interim financing in late September. Second, we received a substantial advance payment in the month of October. And third, we recently signed a new, more favorable contract for which we have resumed limited production. While some risks remains, including a successful exit by OneWeb from bankruptcy, we currently expect a modest charge of approximately $3 million in the fourth quarter versus the potential $40 million noted earlier during the work stoppage.

Now, regarding Photonis, on September 28 we paused our efforts to acquire the business and voluntarily withdrew our application for authorization by the Government of France. In summary, we determined at that time that an acquisition under the proposed conditions of the French government was not feasible at the seller's valuation expectation communicated to Teledyne. However, in recent days the seller's valuation expectations have significantly moderated and we have renewed our acquisition efforts. At this time, we are hopeful to conclude the negotiations and announce the acquisition before the end of the year.

Al will now comment on the performance of our four segments.

Aldo (Al) Pichelli -- President and Chief Executive Officer

Thank you, Robert. In our Instrumentation segment, overall third quarter sales decreased 6.9% versus last year. Sales of environmental instruments decreased 2.1% from last year. However, sales increased 6.5% sequentially from the trough in the second quarter. Compared with last year, sales of certain products such as laboratory instrumentation for life science applications increased. However, this was more than offset by year-over-year declines in sales of selected industrial products such as ambient air monitoring instrumentation. Sales of electronic test and measurement system decreased 6.5% year-over-year. Again, however, sales increased 4.6% sequentially. Sales of protocol test instrumentation, in particular for PCI Express and USB test solutions increased from last year, but sales of general purpose oscilloscopes declined.

Sales of marine instrumentation decreased 11.3% in the quarter. However, operating margin was stable due to headcount management and business simplification initiatives. Overall, Instrumentation segment operating margin increased 86 basis points despite the lower year-over-year sales.

Turning to Digital Imaging segment. Third quarter sales decreased 1.8% and primarily reflected lower sales of X-ray detectors for dental and medical applications, partially offset by greater sales of infrared detectors for the defense market and 3-D geospatial imaging systems. Sales of industrial and scientific cameras and sensors were largely flat with last year with continued strength in semiconductor inspection and markets in Asia, largely offsetting some weaknesses in Europe and North America. GAAP segment operating margin was 19%, an increase of 210 basis points year-over-year.

In the Aerospace and Defense Electronics market third quarter sales declined 18.2% as greater defense sales were more than offset by a 49% decline in sales of commercial aerospace products as well as lower commercial space sales related to OneWeb. GAAP segment operating margin decreased due to lower sales, but increased 621 basis points sequentially given a significant lower cost structure.

In the Engineered Systems segment, third quarter revenue increased 2.9% primarily due to greater sales from space, nuclear and other manufacturing programs as well as electronic manufacturing services. Segment operating profits increased 17.9% with margin 158 basis points higher than last year.

I will now turn the call to Sue, who will offer some additional commentary regarding the third quarter and our 2020 outlook.

Susan L. Main -- Senior Vice President and Chief Financial Officer

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 fourth quarter and full year 2020 outlook.

In the third quarter, cash flow from operating activities was $150.3 million [Phonetic] compared with cash flow of $150.9 million for the same period of 2019. Record free cash -- record third quarter free cash flow, that is cash from operating activities less capital expenditures, was $135.1 million in the third quarter of 2020 compared with $125.8 million in 2019. Capital expenditures were $15.2 million in the third quarter compared to $25.1 million for the same period of 2019. Depreciation and amortization expense was $29.2 million in the third quarter compared to $27.9 million for the same period of 2019. We ended the quarter with $332.2 million of net debt, that is $786.7 million of debt less cash of $454.5 million, for a net debt to capital ratio of 9.9%. Stock option compensation expense was $5.7 million for both the third quarter of 2020 and 2019.

Turning to our outlook. Management currently believes that GAAP earnings per share in the fourth quarter of 2020 will be in the range of $2.56 to $2.86 per share and for the full year 2020 our GAAP earnings per share outlook is $9.70 to $10 compared with the prior outlook of $9.45 to $10. The 2020 full year estimated tax rate, excluding discrete items, is expected to be 22.7%, a 210 basis point increase compared to full year 2019 due in part to less R&D tax credits. In addition, we currently expect less discrete tax items in 2020 compared with 2019.

I will now pass the call back to Robert.

Robert Mehrabian -- Executive Chairman

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

Questions and Answers:

Operator

Thank you. [Operator Instructions] And our first question comes from the line of Joe Giordano. Please go ahead.

Joe Giordano -- Cowen and Company -- Analyst

Hi, everyone. Good morning.

Robert Mehrabian -- Executive Chairman

Good morning, Joe.

Joe Giordano -- Cowen and Company -- Analyst

So some interesting stuff you said there, Robert, on OneWeb and Photonis that I wanted to touch on. On OneWeb I was going to ask kind of before you knew about that development, what's kind of your broader outlook for commercial space? There has obviously been a lot of kind of buzz around the sector recently with some other big companies like Microsoft the other day talking about it. Like what are your future ambitions there in terms of growth? And is there new applications that you might like want to be involved in in that sector going forward?

Robert Mehrabian -- Executive Chairman

Yes, Joe. Thank you for the question. Let me note that for us we have space programs, both in the commercial and the defense sector. In the commercial sector, a lot of our instruments are used both for studying the universe as well as looking down at the -- at earth for environmental measurements.

On the defense side, on the other hand, we do have a large number of programs that address the needs for looking at weapons through satellites. While there are -- of course, as you said, there is a lot of interest in communications in space, like the programs that you mentioned, our involvement right now is OneWeb. The more interesting part to us is the defense imaging sector where we've been winning contracts recently and where our programs are very healthy. For example, we are involved with the wide field of view program in the defense sector and the OPIR program which is a persistent overhead infrared classified program.

I think going forward, we see what the outcome is on the OneWeb program. They have ambitions, of course, to increase the number of satellites in the future, but right now we're more focused on making sure that we make the products we promise to make and we get paid for them promptly.

I don't know if that answered your question, Joe.

Joe Giordano -- Cowen and Company -- Analyst

It did. Thank you. On Photonis, do these new -- the discussions with the French government, like what kind of scope changes does that entail? And like is the size of the business that you would potentially be acquiring kind of different now than what we initially thought given those discussions?

Robert Mehrabian -- Executive Chairman

Yes. Initially, obviously we were to acquire 100% of the business. The French government was asking that we let a French government state sponsored investment bank invest 10% in the company. In and of itself we find that, OK, we are going to work with the French government, especially the investment bank, to make sure that we have all of our procedures in place.

On the more important thing that has happened recently, Joe, is that there was a significant change in price that we asked for and received, about 15% on US dollars basis. And frankly you can appreciate that owning 100% of an entity is very different than owning 90% of an entity and that's why the price reduction.

I think we have an agreement in principle right now and we need to now finalize our detailed paperwork with the government and then see if we can proceed from there.

Joe Giordano -- Cowen and Company -- Analyst

Oh, that's definitely good to hear. And just two more quick ones for me. Can you guys give maybe your current views as I know it's been shifting in the market, so your current views on the defense sector under a Biden-led administration and what are your thinking early stage of like your biggest margin opportunities into next year across the portfolio? Thanks.

Robert Mehrabian -- Executive Chairman

I think in the short term we're looking at -- which I mean the really short term and, let's say, mid-term next year, we're looking at growth in the defense sector for our programs in the mid-single digit range. If there is a change in administration, as you indicated, then I think in the future years, in the outyears, we think things will remain relatively flat. Our job is really very simple. Regardless of which administration is in and which programs are supported, our job is to be able to get our share of the market and gain market against the competition. So I feel very good about our defense programs because of the breadth of offerings we have from space imaging to electronic warfare to communication etc.

Having said all of that defense today is about 20% of our sales, our portfolio and I would say a little less than that, 20% of our operating income. Consequently, really my attention going forward -- our attention going forward, is to expand our commercial businesses where we enjoy much higher margins. That's it, Joe.

Operator

Our next question comes from the line of Blake Gendron with Wolfe Research. Please go ahead.

Blake Gendron -- Wolfe Research -- Analyst

Yeah. Thanks. Good morning. So I wanted to dig into the margin improvement into next year. You quantified some of the cost out in the past, things that you're doing internally with the target goal of 20% GAAP EBIT margins or better. I'm wondering if you could update us on both the cost capture to date and then additional opportunities moving forward and what the timeline of that would be. Thanks.

Robert Mehrabian -- Executive Chairman

Sure, Blake. I will try to answer that the best I can at this time. First, there are two primary changes in our cost structure. The first and the most important one is the lower number of employees. In general, we are down about 9.3%. That is after adding about 30, 40 people in our OneWeb program in the UK. So we're down about 9.3%, which is about 1,100 -- a little less than 1,100 employees. That -- the effect of that -- maintaining that cost structure is that it will help our margins approximately 130 basis points or so. The other thing is that we also have procurement initiatives which are helping us to reduce our cost across the board as we procure. We buy about $1.2 billion worth of goods and services and our procurement initiatives are aimed at reducing that. So we expect to get a little bit help from that domain as well. But by and large, I would say the 130 basis points for next year is a good number that I gave you. I'm hoping that it will be higher than that.

Blake Gendron -- Wolfe Research -- Analyst

Understood. That's really helpful. Circling back on Digital Imaging. I'm hoping to better understand kind of roughly end market weighting across things like machine vision semis, life sciences, aero [Phonetic] etc. It seems like life science demand could carry the segment into 4Q. What specific end market considerations are baked into the segment outlook through year-end? And what are some of the longer-arc trends that you're focused on? We see a lot of product announcements and expansions, but it's tough to contextualize exactly where those fit across your end markets. So I guess just high level, how do you expect this [Technical Issues] to evolve?

Robert Mehrabian -- Executive Chairman

Okay. I'll try and answer that. Let us start with our Digital Imaging sales for this year, say about $985 million, $983 million, $985 million. Last year, they were about $990 million. So it's flat year-over-year. Now, the big chunk of that is our cameras and vision systems and sensors. They are used both for flat panel displays, just about any phone or any television that you look at has to be inspected and a lot of those are done by our cameras. And also our cameras are used in semiconductor industry for inspection. Overall, we sell both sensors and cameras now of course three-dimensional views of things. And that sales in that business is about $340 million and it's a fairly stable business. With all the problems with the pandemic that business has remained healthy. It's flat year-over-year. But having said that, the margins have improved.

The area that has hit us a little bit harder is in the healthcare area. Sales there are about $220 million. We make X-ray detectors both for dental as well as for looking at human anatomy. We also make some X-ray sources, but let's stay with the detectors.

As you know the detectors that we make in the dental -- for the dental industry, they're both inter-oral -- intraoral and extraoral, that's outside the mouth and inside the month, that has been very slow because dentists have not been very active up until very recently. Our intraoral detectors are picking up, our extraoral detectors would probably be a little while before they pick up. We think that business would start picking up at the end of the fourth quarter.

The one area that surprised us frankly in healthcare is that we make -- we make sources -- we make magnetrons that go into radiotherapy instruments that are instruments that are used for cancer treatment. A lot of those instruments are also used for looking for cancer. And because of the pandemic that area has significantly slowed down. And so until that area comes back, we don't think our healthcare businesses would be as robust as they used to be. And we think that's going to happen, by the way, next year.

The Aerospace and Defense, that includes both our imaging for classified programs here as well as studying space, both here and in Europe. That's been an increase for us this year. Year-over-year I think we've got an 8% increase. We are about $270 million. That's pretty healthy.

The last two items are the MEMS business, MEMS, microelectronic systems, micro mechanical systems, the revenue there is about $95 million. It's up about 12% from last year, primarily because we bought a small MEMS business. We are probably the largest independent MEMS foundry in the world today and we are very positive about that business. The issue there is it's a fab, very capital intensive. So we're always balancing our capital investments against what kind of market share we want to have.

The last area, of course, is our geospatial where we make LIDARs and other devices and that's a healthy business, but it's relatively small. It's of the order of $58 million. So I don't know if that answered your question. Directionally, I think we expect digital imaging business to grow next year.

Blake Gendron -- Wolfe Research -- Analyst

That's extremely helpful. I appreciate the detailed response. I'll get back in queue.

Robert Mehrabian -- Executive Chairman

Thank you.

Operator

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

Greg Konrad -- Jefferies -- Analyst

Good morning.

Robert Mehrabian -- Executive Chairman

Good morning, Greg.

Greg Konrad -- Jefferies -- Analyst

How are you doing? I just wanted to follow up on two of the previous questions. I mean, first on healthcare, and you kind of talked about it and in the release you talked about kind of a recovery in late Q4. I mean pre-COVID that business seem to have just been straight up. You picked up share in a lot of the new technologies. I mean, when we think about into next year, does that business kind of get back to the normalized level and continue its growth trajectory? I mean, what type of opportunities do you see going forward?

Robert Mehrabian -- Executive Chairman

Well, I think there is no question that that business has a very healthy future and the reason is very simple. We make detectors -- X-ray detectors, that have higher resolution than normal detectors and therefore you use much less X-ray to be able to project an image.

Having said that, that's a no-brainer that that is going to take off. The issue is at what time are hospitals going to be allowing patients in for other than serious surgery or cancer treatments or other things. We think that's going to happen next year. We even think overall in Digital Imaging, we should have a little increase from this quarter to next quarter, I would say as much as maybe $10 million. And we think for next year, we probably should see of the range of about 8% to 9% increase in revenue overall in Digital Imaging which would be pretty good for us since it's one of our higher-margin businesses.

Greg Konrad -- Jefferies -- Analyst

And then just to follow up on the defense question. I mean, you mentioned space and unmanned and I think shallow water submersible, but we're also seeing a lot of new opportunities. The Navy is talking about growing its unmanned portion. I mean, what is your content or opportunity with that whether it's larger systems or smaller ones and kind of just the outlook for opportunities within unmanned?

Robert Mehrabian -- Executive Chairman

First, you mentioned the shallow water submersible, of course that's for the -- our Navy SEALs, and we are the sole provider of that. That program is going really well.

As you move to the unmanned vehicles from a defense perspective, we really have two sets of vehicles that are being used today. One of them is really a vehicle that is -- gliders that glides into the ocean. And in front of a battleship formation, they can use as many as 100 gliders in order to sample the salinity, density of the water which of course affects sonar transmission and reception. In that area we've had probably the largest programs from the Navy.

Another area, of course, is that we make medium-size autonomous vehicles and we have an opportunity -- we have sold some of those, both to our military, as well as overseas. And we are looking at more opportunities in that area, especially as a prime.

Going back to the large displacement AUVs, we are going to be doing that program probably as a subcontractor to someone else. Frankly if you were to come and look at -- if you were to look at a submarine, I'd say OK, what kind of vehicles are available today in the world to be able to exit, be housed in a submarine and exit a submarine. The only new vehicle is ours and that's a shallow water submersible vehicle. And, of course, coupled with our unmanned vehicles that I just mentioned and the technologies that go with it, we're fairly bullish for that area.

Greg Konrad -- Jefferies -- Analyst

And then just one more quick one. I think last quarter you talked about well in excess of $1 billion in capacity to do M&A. I mean, on the Photonis deal that seems to be well less than half. I mean, what are you seeing in the broader M&A market, whether just valuations, volume of potential opportunities, just given that you tend to be fairly conservative and prudent around M&A?

Robert Mehrabian -- Executive Chairman

Yeah. We demonstrated both the characteristics, both being very prudent, but also when opportunities are afforded to us to be able to be more aggressive. I'll just mention to you that when we went through the downturn in 2008 to '10, the financial crisis, right after we came out of that we acquired two very strong companies. One was LeCroy and the second one was DALSA. Fast forward to the crisis in 2014 to '16 which was oil crisis for us, we lost about $200 million in revenue. We improved our cash flow just like we are doing now. As soon as we came out of there we acquired e2v, which was our largest acquisition to date, which is about $780 million and that's done really well. We started with margins there of 7%, 8% there almost reaching 20% today.

Now going back now to your observation and question, I said before our ability -- we have $1 billion or a little bit more than that because of our cash flow that has significantly increased today. So I think it's closer to $1.5 billion. I think it could go as far as $2 billion depending on whether how much of an EBITDA we acquire. Our debt to EBITDA ratio limit is about 3.5. Today we are sitting around 1.4. And with more cash generation in the fourth quarter we should be a little better than that.

So I would say $1.5 billion to $2 billion, $1.9 billion is the range that we are capable of doing. No, if you take Photonis, which is going to cost us at least, to our best estimate, closing costs, etc., is going to be about $450 million, $460 million. Subtract that out, that leaves us with $1 billion to $1.4 billion, $1.5 billion additional capability. So we're looking. We're looking very hard.

As we come out of this year I think people are having a difficult time and some of the boards, obviously boards and managements, as I said before, are always looking in the rearview mirror saying how well their stock used to be, whereas shareholders are always looking, at least my view of it is, they're always looking forward through the front window saying where things are and what kind of an offer would be attractive. So having said all of that, I think -- we think this is a good environment for us to make acquisitions.

Greg Konrad -- Jefferies -- Analyst

Thank you.

Operator

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

Robert Mehrabian -- Executive Chairman

Good morning, Andrew. Operator, I don't think Andrew is around.

Operator

Okay. We'll move on to the next one. Our next question comes from the line of Jim Ricchiuti with Needham & Company. Please go ahead.

Robert Mehrabian -- Executive Chairman

Good morning, Jim. For some reason, operator, we're not getting the people. There is something wrong at your end because I can hear you but the questions are not coming through.

Operator

[Speech Overlap] line is open.

Jim Ricchiuti -- Needham & Company -- Analyst

Robert, I think that one was on me, Robert. I had my phone on mute. That's my apology. If I may, Robert, you sound a lot more confident about closing on the Photonis acquisition and I wonder if maybe you could talk a little bit about what you find so attractive about this business. I think in some respects, it looks a little bit reminiscent of the acquisition that you did of e2v. But I wonder if you could talk a little bit about it to the extent you can.

Robert Mehrabian -- Executive Chairman

Sure. First, I am a little more positive about it because we've had some discussions with the French investment bank and we find them to be much more business oriented than government oriented. Of course, they are going to have a say in making sure that the technology doesn't move out of France. But we think -- I feel better about it because I think we can live with that enterprise as a minority shareholder for a number of years.

The second part is that that business seems to, we have to yet do a final due diligence check, that business seems to have held up pretty well during this difficult period, just like our defense businesses, because primarily it provides non-ITAR image intensifiers or night vision systems.

Now, what we bring to it is all of our digital imaging capabilities which are all complementary and not duplicative off that. That field is moving more toward digitization, which we are experts in. So we think we bring substantial synergistic value to the enterprise which has been missing in the recent past, because it has been owned by a private equity firm therefore it didn't have sister companies to interact with.

There is a small part of the business also that has to do with commercial laboratory instrumentation and for very low light using photon multiplier, same technology used for the night vision. That's attractive to us also because we've got the scientific camera businesses which serve laboratories, instruments and academic instruments across the world. And we think that is really attractive to us because they bring the best mass spectrometry detectors to the field and it will be a very nice overlap with our existing businesses that we acquired last year in that area.

So those are some of the specifics about that acquisition, Jim.

Jim Ricchiuti -- Needham & Company -- Analyst

That's helpful, Robert. I wonder if you might -- also may have missed it, but did you give any information on orders, the book-to-bill and maybe a little color around book-to-bill per segments? You also, I think, gave a little bit of color about what you're anticipating for the Digital Imaging business in Q4. I wonder if there is any color you could provide on some of the other business units.

Robert Mehrabian -- Executive Chairman

Let me start with the book-to-bill. The book-to-bill in Q3 is about 0.95, maybe a little more than that because our Engineered Systems is a very lumpy business that we get a big book-to-bill. But excluding that it's a little over 0.95. We expect next quarter to exceed 1 in book-to-bill, based on everything that we see so far in the quarter. And we expect to end the year just below 1, maybe 0.98, 0.97.

Now Q4 revenue, which I talked about Digital Imaging being up somewhat. Q4 revenue should increase over Q3 by about 4% or so or $40 million, that's a little higher than 4%. That would be very attractive for us because in Q2 where we had I think about $743 million in revenue, I said I expected Q3 to be equal and very similar to that, given that the revenue was about $7 million, $6 million higher and the income was about the same, the EPS, even though we didn't have many one-time benefits in the third quarter.

Just to digress for a second. If you take the third quarter of this year versus the third quarter of last year, there is a $0.29 income difference from taxes -- one-time tax items and -- against one-time charges to benefit last year's third quarter. So if you kind of do an apples to apples, which we never really do non-GAAP measures, but if you do that, we are only down about $0.07, $0.08 from last year's fourth -- third quarter. So going into the fourth quarter, I think if we can increase the revenue in various groups and achieve about $40 million of increase in overall revenue, coupled to what is now are better margin that we are achieving, our margin this quarter was 16.4%. And so, we think what will happen is that we will have a better earnings as well, which is what Sue alluded to, as we raised our midpoint of our earnings earlier today.

Jim Ricchiuti -- Needham & Company -- Analyst

Got it. Thank you. That's very helpful.

Operator

Our next question comes from the line of Noah Poponak with Goldman Sachs. Please go ahead.

Noah Poponak -- Goldman Sachs -- Analyst

Hi. Good morning, everybody.

Robert Mehrabian -- Executive Chairman

Good morning, Noah.

Noah Poponak -- Goldman Sachs -- Analyst

Robert, sort of following up there, in your prepared remarks you mentioned that you think you've seen a bottom in your cyclical businesses. Can you just elaborate on that comment? I mean, is that an exit rate versus entry rate into the quarter or order action or any more detail to help us get comfortable that's happened would be helpful?

Robert Mehrabian -- Executive Chairman

As Al Pichelli mentioned earlier, we've seen 5% and 6% -- and I said it also, we've seen 5% to 6% improvement in revenue in the environmental and test and measurement businesses. Our book-to-bill in those two areas are over 1, about 1.02 to 1.04, so 2% to 4% above what we saw. And we think as a consequence we think that those businesses are going to do OK. Going forward we expect some marginal sales improvements in our total Instrumentation business, maybe as much as $15 million or so. But more importantly I think we are seeing some -- of course China is coming out of their downturn and doing well. But we also see some new products that we're offering in the pharmaceutical area as well as water sampling area that are encouraging for us. So in the Instrumentation would be the one. In Digital Imaging, I think I've already spoken about, it could be as high as $10 million to $15 million to maybe even $20 million in Q4 versus Q3.

I think in Aerospace and Defense, I think we are going to be fairly flat primarily because I don't think there is going to be much movement in the aerospace domain and our defense is already pretty healthy. In the Engineered Systems, we may have some uptick in revenue, but we will have some pressure on our margins. But generally, we think, if you add all of that up, we could have about $40 million increase quarter-over-quarter because of the things that I mentioned.

Noah Poponak -- Goldman Sachs -- Analyst

Okay, that's helpful. Trying to piece together the margin commentary you've made today, it kind of looks like the segment operating margin at the total Company level full year 2020 is going to come in around 17% depending on exactly where the fourth quarter is. And then, are you -- the comments you made earlier sort of officially targeting 130 basis points of improvement in that next year. And then I can't quite tell if you've provided a long-term 20% target or not, but it certainly sounds like you expect more improvement beyond that. I mean, are we kind of looking at something in the zone approximately of 100 basis points of segment operating margin improvement for a few years?

Robert Mehrabian -- Executive Chairman

Yes. I hope so. Let me -- I'm going to get some looks around the table from my various segment operatives and others but let me go back for a second. If we do what we have just said we would in the fourth quarter, we should end the year with segment operating margins of about 17%, which is what you noted because early in the year of course, Q1 it was 15.2% and we've continuously improved. If we do that, then the total Company operating margin, which was about 15% at the end of Q2, which is what I thought it would be, should improve to about 15.2% to 15.3%.

Now, going forward into next year because of the actions that we spoke about, both people and procurement, then a whole bunch of other 80-20 programs that we have, we expect to bump that up 130 basis points next year, our operating margins. And frankly if you put it as 17% and we put it on 15%, it's the same thing, because the percentage of corporate costs are fairly fixed. Having said that then going forward, I think that would moderate somewhat because we took a lot of cost out this year and we're going to enjoy the fruits of that next year. But I would be disappointed if we can't continuously improve our margins somewhere between 80 basis points to 100 basis points in the next few years.

Noah Poponak -- Goldman Sachs -- Analyst

Okay. That's helpful. And then finally, just wanted to ask about the cash flow statement. Is it possible to quantify or bracket the October advanced payment related to OneWeb that you mentioned? And then it certainly looks like you'll come in ahead of the full year $400 million of free cash flow that you had discussed previously. If you're willing to provide an update to that?

And then the conversion to net income is pretty high. For the year, capex is down. I guess, maybe if you would just speak to I guess, we're just assuming the conversion was 100% into perpetuity. Any reason not to expect that?

Robert Mehrabian -- Executive Chairman

Let me start from the rear end of that question because that's the easier one to answer for me. Over 100% conversion, yes, and we anticipate that that will continue because of all the programs that we have in reducing managed working capital and reducing costs in general.

Now, going to the cash flow for the year. In Q2, I said it'd be a little over $400 million. In Q3, where we enjoyed the $135 million of free cash flow that also included $15.8 million that we had to repay the government for the CARES Act. So the $135 million is a really very healthy cash flow for a company like ours. If we can continue that momentum we -- I expect that by the end of the year we will be over $400 million. $425 million, I think that's within reach, maybe a little higher than that. And I expect if we can do all of that then our net debt should drop around $200 million, a little north or south of $200 million, which puts us in a really good position for the future in terms of acquisitions.

Noah Poponak -- Goldman Sachs -- Analyst

Very helpful. Thanks so much.

Robert Mehrabian -- Executive Chairman

Sure.

Operator

Our next question comes from the line of Blake Gendron with Wolfe Research. Please go ahead.

Blake Gendron -- Wolfe Research -- Analyst

Yeah. Thanks for getting me back on here. Feel free to pump me from the call if there is not enough time here. Just two quick follow-ups. First on Instrumentation. It looks like the shorter cycle industrial recovery is starting to plain out a little bit. If environmental outperforms testing next year, what would that do from a margin mix perspective? And how does the three stack up really, marine versus environmental versus testing?

Robert Mehrabian -- Executive Chairman

Let me start. The marine businesses are fairly flat year-over-year and they are going to remain so for a long time, primarily because the -- we've moved more away from some of our oil and gas markets to defense markets. And until the oil and gas markets, even though they are OK now, until they come back we don't expect revenue increases.

Having said that the marine businesses, if you look at the total instrumentation business, the marine businesses have lower margins in general. Even though the margins are improving significantly, but they are still about 200 basis points lower than the others. Environmental is about 100 basis points above the average, so is the test and measurement. Those are very healthy businesses. So combined together, it kind of flattens out. But I think we'd encourage that our higher margin businesses are the ones that we're looking forward to growing.

Blake Gendron -- Wolfe Research -- Analyst

Understood. And then one just quick one on M&A. You wouldn't rush a deal announcement obviously and Photonis notwithstanding because that's TBD. But as you think about the election and maybe the tax regime in a Biden administration, does that maybe accelerate your M&A pipeline processes at all or do you expect valuations to kind of normalize with any change in tax? Thanks.

Robert Mehrabian -- Executive Chairman

Oh, boy, that's a difficult one. I can only answer the following. We are not going to hurry up to do anything, never have, never will, regardless of which administration is occupying the White House. I think taxes will change up or down. Well, I think we will buy the businesses that we're looking at. The ones that we're looking at we will buy them because they are good businesses in the long term and we can improve their margins.

And I wouldn't rush about it not because of the election or subsequent to the election. On the other hand, I wouldn't be very slow about it either because things are going to improve next year and everybody's prices are going to go up. So this might be a good opportunity.

Blake Gendron -- Wolfe Research -- Analyst

Understood. Thanks so much for the time.

Robert Mehrabian -- Executive Chairman

Thank you, Blake.

Operator

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

Andrew Buscaglia -- Berenberg -- Analyst

Hi, guys. Can you hear me now? Had some technical difficulties there.

Robert Mehrabian -- Executive Chairman

[Indecipherable]

Andrew Buscaglia -- Berenberg -- Analyst

All right. Yes, so everything's pretty picked over. But curious high level within Digital Imaging you guys can see some pretty powerful growth in that segment. If you look back to 2017 or so you're able to grow over 20% organically there. I would think that kind of given the set up into 2021, you've had a couple of years of more muted growth and specifically machine vision seems to be, there could be some optimism of some upside brewing there given the semis and tech cycle. I guess how are you thinking about that business, I guess, in a bull case in order of magnitude? Where do you see that business going? What are the differences between this entering 2021 and 2017?

Robert Mehrabian -- Executive Chairman

Well, I think in 2017 obviously that's the year that we also acquired e2v. So things got really bumped up that year because of the acquisition. But let's say absence any acquisition, I think right now I expect us to grow our top line in the higher single digits in the overall Digital Imaging domain. I will only put the caveat on it that this healthcare situation hit us pretty hard and we are expecting that will improve.

If that were to happen, I think high-single digits growth in revenue for Digital Imaging overall should be expected. And of course if -- as you said, if we make the Photonis acquisition [Indecipherable] others $150 million-plus worth of revenue and we -- so the business is going to grow. That's for sure. The question is can we get over the healthcare hump that we are experiencing right now.

Andrew Buscaglia -- Berenberg -- Analyst

Okay. Okay. And I know this piece is small, but your offshore oil and gas exposure went from being very optimistic for that outlook there to pretty pessimistic, I think, based on what's going on in energy. Any change in your view on strategically that segment and where you want to play in that business if it's still viable in your mind as a long-term growth opportunity for you guys?

Robert Mehrabian -- Executive Chairman

Yeah. I would say -- obviously there is two parts to our marine businesses. There is the offshore energy, which is both production as well as exploration and then the second part is construction science, hydroc-fee [Phonetic], but more importantly defense where we are a major player in making penetrators for our submarine fleet. And then we have, of course, a lot of sensors program that are used whether in our autonomous vehicles or others. So I think the defense sector of that business is healthy and will remain so and probably grow in future years. And then [Indecipherable] and construction, etc., that's really going to be almost 60% of our business going forward.

Now, the overall segment, the sub-segment, the marine sub-segment has revenues of about $420 million to $425 million. So the rest of it is offshore oil production and exploration, let's say, about $150 million total. That is fairly stable for us, primarily because there is still $40 a barrel of oil. There is still developments going on and we are winning because we have the best products, plus we have standardized products which people can buy and we think that's going to be very stable.

The area that has not come back is the offshore exploration where we provide streamer cables and sensors. That used to be a pretty healthy business for us, even after the downturn in the oil industry. That has kind of not been that high recently. And if that comes back, if they put more vessels in the water for exploration, I think that will help generally our marine business. But looking forward, I'd say, growth in the marine business is going to be relatively benign. What we are going to do there and we've done there is continuously improve the margins. It's enjoying really good margins above the average margins of our segments right now. I don't know if that answers [Phonetic].

Andrew Buscaglia -- Berenberg -- Analyst

Thank you. Yeah -- no, that's great detail. Thanks.

Robert Mehrabian -- Executive Chairman

Sure.

Operator

And there are no further questions.

Robert Mehrabian -- Executive Chairman

Alicia, I will now ask Jason VanWees to conclude our conference call. Thank you very much.

Jason VanWees -- Executive Vice President

Thank you, Robert. And again thanks everyone for joining us this morning. Of course, if you have follow-up questions, please feel free to call me at the number on the earnings release. Operator -- Alicia, if you could give the replay information on the call and then sign off everyone. Thank you.

Operator

Thank you. Ladies and gentlemen, this conference will be available for replay after 5:00 PM today through November 21st, 2020. You may access the replay system at any time by dialing 1-866-207-1041 and entering access code 6148591. International participants dial 402-970-0847. Those numbers again are 1-866-207-1041 and 402-970-0847, access code 6148591. That does conclude our conference for today. Thank you for your participation and for using AT&T Conferencing service. You may now disconnect.

Duration: 61 minutes

Call participants:

Jason VanWees -- Executive Vice President

Robert Mehrabian -- Executive Chairman

Aldo (Al) Pichelli -- President and Chief Executive Officer

Susan L. Main -- Senior Vice President and Chief Financial Officer

Joe Giordano -- Cowen and Company -- Analyst

Blake Gendron -- Wolfe Research -- Analyst

Greg Konrad -- Jefferies -- Analyst

Jim Ricchiuti -- Needham & Company -- Analyst

Noah Poponak -- Goldman Sachs -- Analyst

Andrew Buscaglia -- Berenberg -- Analyst

More TDY analysis

All earnings call transcripts

AlphaStreet Logo