filings.toolsItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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You should read the following discussion in conjunction with "Selected Financial Data" and our Consolidated Financial Statements and related notes included in this Annual Report.
Overview
We are a diversified technology company. We operate businesses that design and develop software (both license and software-as-a-service) and engineered products and solutions for a variety of niche end markets; including healthcare, transportation, commercial construction, food, energy, water, education and academic research.
We pursue consistent and sustainable growth in earnings and cash flow by emphasizing continuous improvement in the operating performance of our existing businesses and by acquiring other carefully selected businesses. Our acquisitions have represented both additions to existing businesses and new strategic platforms.
In 2016, we acquired CliniSys Group Ltd. ("CliniSys"), PCI Medical Inc., GeneInsight Inc., iSqFt Holdings Inc. (d/b/a ConstructConnect) ("ConstructConnect"), UNIConnect LC, and Project Diamond Holdings Corp. (d/b/a Deltek Inc). The acquisitions both expanded and complemented our existing technologies.
Application of Critical Accounting Policies
Our Consolidated Financial Statements are prepared in conformity with generally accepted accounting principles in the United States ("GAAP"). A discussion of our significant accounting policies can also be found in the notes to our Consolidated Financial Statements for the year ended December 31, 2016 included in this Annual Report.
GAAP offers acceptable alternative methods for accounting for certain issues affecting our financial results, such as determining inventory cost, depreciating long-lived assets and recognizing revenue. We have not changed the application of acceptable accounting methods or the significant estimates affecting the application of these principles in the last three years in a manner that had a material effect on our financial statements.
The preparation of financial statements in accordance with GAAP requires the use of estimates, assumptions, judgments and interpretations that can affect the reported amounts of assets, liabilities, revenues and expenses, the disclosure of contingent assets and liabilities and other supplemental disclosures.
The development of accounting estimates is the responsibility of our management. Our management discusses those areas that require significant judgments with the audit committee of our Board of Directors. The audit committee has reviewed all financial disclosures in our annual filings with the SEC. Although we believe the positions we have taken with regard to uncertainties are reasonable, others might reach different conclusions and our positions can change over time as more information becomes available. If an accounting estimate changes, its effects are accounted for prospectively or through a cumulative catch up adjustment.
Our most significant accounting uncertainties are encountered in the areas of accounts receivable collectibility, inventory valuation, future warranty obligations, revenue recognition (percentage-of-completion), income taxes and goodwill and indefinite-lived asset analyses. These issues affect each of our business segments and are evaluated using a combination of historical experience, current conditions and relatively short-term forecasting.
Accounts receivable collectibility is based on the economic circumstances of customers and credits given to customers after shipment of products, including in certain cases credits for returned products. Accounts receivable are regularly reviewed to determine customers who have not paid within agreed upon terms, whether these amounts are consistent with past experiences, what historical experience has been with amounts deemed uncollectible and the impact that economic conditions might have on collection efforts in general and with specific customers. The returns and other sales credit allowance is an estimate of customer returns, exchanges, discounts or other forms of anticipated concessions and is treated as a reduction in revenue. The returns and other sales credits histories are analyzed to determine likely future rates for such credits. At December 31, 2016, our allowance for doubtful accounts receivable was $12.2 million and our allowance for sales returns and sales credits was $2.3 million, for a total of $14.5 million, or 2.3% of total gross accounts receivable. This percentage is influenced by the risk profile of the underlying receivables, and the timing of write-offs of accounts deemed uncollectible. The total allowance at December 31, 2016 was $2.1 million higher than at December 31, 2015. The allowance will continue to fluctuate as a percentage of sales based on specific identification of allowances needed due to changes in our business, the write-off of uncollectible receivables, and the addition of reserve balances at acquired businesses.
We regularly compare inventory quantities on hand against anticipated future usage, which we determine as a function of historical usage or forecasts related to specific items in order to evaluate obsolescence and excessive quantities. When we use historical usage, this information is also qualitatively compared to business trends to evaluate the reasonableness of using historical information as an estimate of future usage. At December 31, 2016, inventory reserves for excess and obsolete inventory were $37.2 million, or 17.0% of gross inventory cost, as compared to $34.0 million, or 15.2% of gross inventory cost, at December 31, 2015. The inventory reserve as a percent of gross inventory cost will continue to fluctuate based upon specific identification of reserves needed based upon changes in our business as well as the physical disposal of obsolete inventory.
Most of our sales are covered by warranty provisions that generally provide for the repair or replacement of qualifying defective items for a specified period after the time of sale, typically 12 to 24 months. Future warranty obligations are evaluated using, among other factors, historical cost experience, product evolution and customer feedback. Our expense for warranty obligations was less than 1% of net sales for each of the years ended December 31, 2016, 2015 and 2014.
Revenues related to the use of the percentage-of-completion method of accounting are dependent on total costs incurred compared with total estimated costs for a project. During the years ended December 31, 2016, 2015 and 2014 we recognized revenue of $241 million, $253 million and $266 million, respectively, using this method. Percentage-of-completion is used primarily for major turn-key, longer term toll and traffic and energy projects and installations of large software application projects. At December 31, 2016, $260 million of revenue related to unfinished percentage-of-completion contracts had yet to be recognized. Contracts accounted for under this method are generally not significantly different in profitability from revenues accounted for under other methods.
Income taxes can be affected by estimates of whether and within which jurisdictions future earnings will occur and if, how and when cash is repatriated to the U.S., combined with other aspects of an overall income tax strategy. Additionally, taxing jurisdictions could retroactively disagree with our tax treatment of certain items, and some historical transactions have income tax effects going forward. Accounting rules require these future effects to be evaluated using current laws, rules and regulations, each of which can change at any time and in an unpredictable manner. During 2016, our effective income tax rate was 30.0%, which was 60 basis points lower than the 2015 rate of 30.6%, The decrease was due to the recognition of $15.3 million in excess tax benefits in the current year in accordance with an accounting standards update related to stock compensation adopted in the first quarter of 2016 (see Note 1 of the Notes to Consolidated Financial Statements), as well as the non-recurrence of the 2015 taxable gain on the divestiture of Abel Pumps which was partially offset by discrete tax benefits from settlements of tax matters in 2015. We expect the effective tax rate for 2017 to be approximately 30%.
We account for goodwill in a purchase business combination as the excess of the cost over the estimated fair value of net assets acquired. Goodwill, which is not amortized, is tested for impairment on an annual basis in conjunction with our annual forecast process during the fourth quarter, (or an interim basis if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value).
When testing goodwill for impairment, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the estimated fair value of a reporting unit is less than its carrying amount. If we elect to perform a qualitative assessment and determine that an impairment is more likely than not, we are then required to perform the two-step quantitative impairment test; otherwise, no further analysis is required. Under the qualitative assessment, we consider various qualitative factors, including macroeconomic conditions, relevant industry and market trends, cost factors, overall financial performance, other entity-specific events and events affecting the reporting unit that could indicate a potential change in the fair value of our reporting unit or the composition of its carrying values. We also consider the specific future outlook for the reporting unit.
We also may elect not to perform the qualitative assessment and, instead, proceed directly to the two-step quantitative impairment test. The first step utilizes both an income approach (discounted cash flows) and a market approach consisting of a comparable company earnings multiples methodology to estimate the fair value of a reporting unit. To determine the reasonableness of the estimated fair values, we review the assumptions to ensure that neither the income approach nor the market approach provides significantly different valuations. If the estimated fair value exceeds the carrying value, no further work is required and no impairment loss is recognized. If the carrying value exceeds the estimated fair value, the goodwill of the reporting unit is potentially impaired and then the second step would be completed to measure the impairment loss by calculating the implied fair value of goodwill by deducting the fair value of all tangible and intangible net assets (including unrecognized intangible assets) of the reporting unit from the fair value of the reporting unit. If the implied fair value of goodwill is less than the carrying value of goodwill, an impairment loss would be recognized.
Key assumptions used in the income and market approaches are updated when the analysis is performed for each reporting unit. Various assumptions are utilized including forecasted operating results, strategic plans, economic projections, anticipated future cash flows, the weighted-average cost of capital, comparable transactions, market data and earnings multiples. While we use reasonable and timely information to prepare our cash flow and discount rate assumptions, actual future cash flows or market conditions could differ significantly and could result in future non-cash impairment charges related to recorded goodwill balances.
We have 33 reporting units with individual goodwill amounts ranging from zero to $2.2 billion. In 2016, we performed our annual impairment test in the fourth quarter for all reporting units, excluding those acquired in the fourth quarter of 2016. We conducted our analysis qualitatively and assessed whether it was more likely than not that the respective fair value of these reporting units was less than the carrying amount. We determined that impairment of goodwill was not likely in 28 of our reporting units and thus we were not required to perform a quantitative analysis for these reporting units. For the remaining five reporting units we performed our quantitative analysis and concluded that the fair value of each of these five reporting units was substantially in excess of its carrying value with no impairment indicated as of December 31, 2016. Recently acquired reporting units generally represent the highest risk of impairment, which typically decreases as the businesses are integrated into our enterprise. Negative industry or economic trends, disruptions to our business, actual results significantly below projections, unexpected significant changes or planned changes in the use of the assets, divestitures and market capitalization declines may have a negative effect on the fair value of our reporting units.
Business combinations can also result in other intangible assets being recognized. Amortization of intangible assets, if applicable, occurs over their estimated useful lives. Trade names that are determined to have an indefinite useful economic life are not amortized, but separately tested for impairment during the fourth quarter of the fiscal year or on an interim basis if an event occurs that indicates the fair value is more likely than not below the carrying value. We first qualitatively assess whether the existence of events or circumstances leads to a determination that it is more likely than not that the estimated fair value of a reporting unit is less than its carrying amount. If necessary, we conduct a quantitative review using the relief-from-royalty method, which we believe to be an acceptable methodology due to its common use by valuations specialists in determining the fair value of intangible assets. This methodology assumes that, in lieu of ownership, a third party would be willing to pay a royalty in order to exploit the related benefits of these assets. The fair value of each trade name is determined by applying a royalty rate to a projection of net sales discounted using a risk-adjusted rate of capital. Each royalty rate is determined based on the profitability of the reporting unit to which it relates and observed market royalty rates. Sales growth rates are determined after considering current and future economic conditions, recent sales trends, discussions with customers, planned timing of new product launches or other variables. Reporting units resulting from recent acquisitions generally represent the highest risk of impairment, which typically decreases as the businesses are integrated into our enterprise and positioned for improved future sales growth.
The assessment of fair value for impairment purposes requires significant judgments to be made by management. Although our forecasts are based on assumptions that are considered reasonable by management and consistent with the plans and estimates management uses to operate the underlying businesses, there is significant judgment in determining the expected results attributable to the reporting units. Changes in estimates or the application of alternative assumptions could produce significantly different results. No impairment resulted from the annual reviews performed in 2016.
We evaluate whether there has been an impairment of identifiable intangible assets with definite useful economic lives, or of the remaining life of such assets, when certain indicators of impairment are present. In the event that facts and circumstances indicate that the cost or remaining period of amortization of any asset may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future gross, undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down to fair value or a revision in the remaining amortization period is required.
Results of Operations
The following table sets forth selected information for the years indicated. Dollar amounts are in thousands and percentages are of net sales. Percentages may not foot due to rounding.
| Years ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2016 | 2015 | 2014 | ||||||||||
| Net sales: | ||||||||||||
| Medical & Scientific Imaging(1) | $ | 1,362,813 | $ | 1,215,318 | $ | 1,080,309 | ||||||
| RF Technology(2) | 1,210,264 | 1,033,951 | 950,227 | |||||||||
| Industrial Technology(3) | 706,625 | 745,381 | 827,145 | |||||||||
| Energy Systems & Controls | 510,223 | 587,745 | 691,813 | |||||||||
| Total | $ | 3,789,925 | $ | 3,582,395 | $ | 3,549,494 | ||||||
| Gross margin: | ||||||||||||
| Medical & Scientific Imaging | 73.2 | % | 74.0 | % | 72.1 | % | ||||||
| RF Technology | 56.7 | 53.4 | 52.8 | |||||||||
| Industrial Technology | 50.6 | 49.8 | 50.5 | |||||||||
| Energy Systems & Controls | 57.1 | 58.1 | 58.3 | |||||||||
| Total | 61.5 | % | 60.4 | % | 59.2 | % | ||||||
| Segment operating margin: | ||||||||||||
| Medical & Scientific Imaging | 35.0 | % | 36.4 | % | 34.8 | % | ||||||
| RF Technology | 30.8 | 30.2 | 28.5 | |||||||||
| Industrial Technology | 28.7 | 28.8 | 29.9 | |||||||||
| Energy Systems & Controls | 25.4 | 27.6 | 29.3 | |||||||||
| Total | 31.2 | % | 31.6 | % | 30.9 | % | ||||||
| Corporate administrative expenses | (3.4 | )% | (2.9 | )% | (2.8 | )% | ||||||
| Income from continuing operations | 27.8 | 28.7 | 28.2 | |||||||||
| Interest expense, net | (2.9 | ) | (2.4 | ) | (2.2 | ) | ||||||
| Other income/(expense) | (0.1 | ) | 1.6 | - | ||||||||
| Income from continuing operations before taxes | 24.8 | 28.0 | 26.0 | |||||||||
| Income taxes | (7.4 | ) | (8.5 | ) | (7.8 | ) | ||||||
| Net earnings | 17.4 | % | 19.4 | % | 18.2 | % |
| (1) | Includes results from the acquisitions of Innovative Product Achievements LLC from August 5, 2014, Strategic Healthcare Programs Holdings LLC from August 14, 2014, Strata Decision Technologies LLC from January 21, 2015, SoftWriters Inc. from February 9, 2015, Data Innovations LLC from March 4, 2015, Atlantic Health Partners LLC from September 4, 2015, Atlas Database Software Corp. from October 26, 2015, CliniSys from January 7, 2016, PCI Medical from March 17, 2016, GeneInsight from April 1, 2016 and UNIConnect from November 10, 2016. |
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| (2) | Includes results from the acquisitions of Foodlink Holdings Inc. from July 2, 2014, On Center Software LLC from July 20, 2015, RF Ideas Inc. from September 1, 2015, Aderant Holdings Inc. from October 21, 2015, Black Diamond Advanced Technologies through March 20, 2015, ConstructConnect from October 31, 2016 and Deltek from December 28, 2016. |
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| (3) | Includes results from Abel Pumps through October 2, 2015. |
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Year Ended December 31, 2016 Compared to Year Ended December 31, 2015
Net sales for the year ended December 31, 2016 were $3.79 billion as compared to sales of $3.58 billion for the year ended December 31, 2015, an increase of 5.8%. The increase was the result of contributions from acquisitions of 6.8%, negative organic growth of 0.3% and a negative foreign exchange impact of 0.7%.
Our Medical & Scientific Imaging segment reported a $147 million or 12% increase in net sales for the year ended December 31, 2016 over the year ended December 31, 2015. Acquisitions contributed 9%, organic sales increased 4% and the negative foreign exchange impact was 1%. The increase in organic sales was due to increased sales in our medical businesses, led by NDI and Verathon. Gross margin decreased to 73.2% in the year ended December 31, 2016 from 74.0% in the year ended December 31, 2015, due primarily to product mix. Selling, general and administrative ("SG&A") expenses as a percentage of net sales increased to 38.2% in the year ended December 31, 2016 as compared to 37.7% in the year ended December 31, 2015, due to a higher SG&A structure in our medical businesses. Operating margin was 35.0% in the year ended December 31, 2016 as compared to 36.4% in the year ended December 31, 2015.
In our RF Technology segment, net sales for the year ended December 31, 2016 increased by $176 million or 17% over the year ended December 31, 2015. Acquisitions net of the divestiture of the Black Diamond Advanced Technology business added 15%, organic sales increased by 3%, and the negative foreign exchange impact was 1%. The increase in organic sales was due primarily to increased sales in our software businesses offset in part by the completion of large service contracts in our toll and traffic businesses in 2015. Gross margin was 56.7% in 2016 as compared to 53.4% in the prior year due to product mix in our toll and traffic businesses as well as an increased percentage of sales at our software businesses which have a higher gross margin. SG&A expenses as a percentage of sales in the year ended December 31, 2016 increased to 25.9%, as compared to 23.3% in the prior year due primarily to an increased percentage of sales at our software businesses which have a higher SG&A structure. Operating margin was 30.8% in 2016 as compared to 30.2% in 2015.
Net sales for our Industrial Technology segment decreased by $39 million or 5.2% for the year ended December 31, 2016 from the year ended December 31, 2015. The divestiture of the Abel Pumps business in 2015 accounted for a negative 3.1%, organic sales decreased by 1.5% and the negative foreign exhange impact was 0.6%. The decrease in organic sales was due primarily to decreased sales in those fluid handling businesses that serve oil and gas markets, offset in part by increased sales in our water metering business. Gross margin increased to 50.6% for the year ended December 31, 2016 as compared to 49.8% in the year ended December 31, 2015 due to product mix. SG&A expenses as a percentage of net sales were 21.9%, as compared to 21.0% in the prior year, due primarily to negative leverage on lower sales volume. The resulting operating margin was 28.7% in the year ended December 31, 2016 as compared to 28.8% in the year ended December 31, 2015.
In our Energy Systems & Controls segment, net sales for the year ended December 31, 2016 decreased by $78 million or 13% from the year ended December 31, 2015. Organic sales decreased by 12% due to decreased sales in oil and gas products, including safety systems and valves, and the negative foreign exchange impact was 1%. Gross margin decreased to 57.1% in the year ended December 31, 2016 as compared to 58.1% in the year ended December 31, 2015 and SG&A expenses as a percentage of net sales increased to 31.7% as compared to 30.5% in the prior year, both of which were due negative leverage on lower sales volume. Operating margin was 25.4% in the year ended December 31, 2016 as compared to 27.6% in the year ended December 31, 2015.
Corporate expenses increased by $24.7 million to $127.5 million, or 3.4% of sales, in 2016 as compared to $102.8 million, or 2.9% of sales, in 2015. The increase was due primarily to increased equity compensation costs as a result of both an increase in the number of shares granted in the current year and increases in our common stock price and increased costs related to acquisitions.
Interest expense increased $27.3 million, or 32.5%, for the year ended December 31, 2016 compared to the year ended December 31, 2015. The increase is due primarily to higher average debt balances to fund current year acquisitions as well as higher average interest rates throughout 2016.
Other expense of $1.5 million for the year ended December 31, 2016 was composed primarily of foreign exchange losses at our non-U.S. based companies, offset in part by royalty income. Other income of $58.7 million for the year ended December 31, 2015 was composed primarily of the $70.9 million gain from the divestiture of Abel Pumps (see Note 2 of the Notes to Consolidated Financial Statements included in this Annual Report), offset in part by a $9.5 million impairment charge on a minority investment.
During 2016, our effective income tax rate was 30.0%, which was 60 basis points lower than the 2015 rate of 30.6%. The decrease was due to the recognition of $15.3 million in excess tax benefits in the current year in accordance with an ASU related to stock compensation adopted in the first quarter of 2016 (see Note 1 of the Notes to Consolidated Financial Statements), as well as the non-recurrence of the 2015 taxable gain on the divestiture of Abel Pumps which was partially offset by discrete tax benefits from settlements of tax matters in 2015.
At December 31, 2016, the functional currencies of most of our non-U.S. subsidiaries were weaker, and the Canadian dollar was stronger, against the U.S. dollar compared to currency exchange rates at December 31, 2015. The net result of these changes led to a pre-tax decrease in the foreign exchange component of comprehensive earnings of $115 million in the year ended December 31, 2016. Approximately $52 million of this amount related to goodwill and is not expected to directly affect our projected future cash flows. For the entire year of 2016, operating profit decreased by less than 1% due to fluctuations in non-U.S. currencies.
The following table summarizes our net order information for the years ended December 31, 2016 and 2015 (dollar amounts in thousands).
| 2016 | 2015 | change | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Medical & Scientific Imaging | $ | 1,399,007 | $ | 1,235,143 | 13.3 | % | ||||||
| RF Technology | 1,278,246 | 1,024,999 | 24.7 | |||||||||
| Industrial Technology | 704,622 | 731,810 | (3.7 | ) | ||||||||
| Energy Systems & Controls | 514,300 | 555,672 | (7.4 | ) | ||||||||
| Total | $ | 3,896,175 | $ | 3,547,624 | 9.8 | % |
The increase in orders was due to orders from acquisitions which added 8%, organic growth of 3% and a 1% negative foreign exchange impact.
The following table summarizes order backlog information at December 31, 2016 and 2015 (dollar amounts in thousands). We include in backlog only orders that are expected to be recognized as revenue within twelve months. The increase in backlog was due to acquisitions which added 37% and internal growth of 10%.
| 2016 | 2015 | change | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Medical & Scientific Imaging | $ | 423,616 | $ | 373,213 | 13.5 | % | ||||||
| RF Technology | 991,212 | 538,877 | 83.9 | |||||||||
| Industrial Technology | 65,259 | 68,002 | (4.0 | ) | ||||||||
| Energy Systems & Controls | 92,309 | 90,365 | 2.2 | |||||||||
| Total | $ | 1,572,396 | $ | 1,070,457 | 46.9 | % |
Year Ended December 31, 2015 Compared to Year Ended December 31, 2014
Net sales for the year ended December 31, 2015 were $3.58 billion as compared to sales of $3.55 billion for the year ended December 31, 2014, an increase of 1%. The increase was the result of contributions from acquisitions of 4%, negative organic growth of 0.3% and a negative foreign exchange impact of 3%.
Our Medical & Scientific Imaging segment reported a $135 million or 12.5% increase in net sales for the year ended December 31, 2015 over the year ended December 31, 2014. Acquisitions contributed 11.5%, organic sales increased 3.8% and the negative foreign exchange impact was 2.8%. The increase in organic sales was due to increased sales in our medical businesses, led by Verathon and Managed Health Care Associates ("MHA"). Gross margin increased to 74.0% in the year ended December 31, 2015 from 72.1% in the year ended December 31, 2014, due primarily to additional sales from medical products which have a higher gross margin. Selling, general and administrative ("SG&A") expenses as a percentage of net sales were relatively unchanged at 37.7% in the year ended December 31, 2015 as compared to 37.4% in the year ended December 31, 2014. Operating margin was 36.4% in the year ended December 31, 2015 as compared to 34.8% in the year ended December 31, 2014.
In our RF Technology segment, net sales for the year ended December 31, 2015 increased by $84 million or 9% over the year ended December 31, 2014. Organic sales increased by 6%, acquisitions net of the divestiture of the Black Diamond Advanced Technology business added 4% and the negative foreign exchange impact was 1%. The increase in organic sales was due primarily to growth in our toll and traffic and freight matching businesses. Gross margin was 53.4% in 2015 as compared to 52.8% in the prior year due to leverage on higher sales volume and product mix. SG&A expenses as a percentage of sales in the year ended December 31, 2015 were 23.3%, a decrease from 24.3% in the prior year due to operating leverage on higher sales volume. Operating margin was 30.2% in 2015 as compared to 28.5% in 2014.
Net sales for our Industrial Technology segment decreased by $82 million or 10% for the year ended December 31, 2015 from the year ended December 31, 2014. Organic sales decreased by 4%, the negative foreign exhange impact was 4% and the divestiture of the Abel Pumps business accounted for a negative 2%. The decrease in organic sales was due primarily to decreased sales in those fluid handling businesses that serve oil and gas markets. Gross margin decreased to 49.8% for the year ended December 31, 2015 as compared to 50.5% in the year ended December 31, 2014 due to negative leverage on lower sales volume. SG&A expenses as a percentage of net sales were 21.0%, as compared to 20.5% in the prior year, due primarily to negative leverage on lower sales volume. The resulting operating margin was 28.8% in the year ended December 31, 2015 as compared to 29.9% in the year ended December 31, 2014.
In our Energy Systems & Controls segment, net sales for the year ended December 31, 2015 decreased by $104 million or 15% from the year ended December 31, 2014. Organic sales decreased by 10% due to decreased sales in oil and gas products, including safety systems and valves, and the negative foreign exchange impact was 5%. Gross margin was relatively unchanged at 58.1% in the year ended December 31, 2015, compared to 58.3% in the year ended December 31, 2014. SG&A expenses as a percentage of net sales were 30.5% as compared to 28.9% in the prior year due negative leverage on lower sales volume. Operating margin was 27.6% in the year ended December 31, 2015 as compared to 29.3% in the year ended December 31, 2014.
Corporate expenses increased by $4.6 million to $102.8 million, or 2.9% of sales, in 2015 as compared to $98.2 million, or 2.8% of sales, in 2014. The increase was due primarily to increased costs related to acquisitions.
Interest expense increased $5.6 million, or 7.1%, for the year ended December 31, 2015 compared to the year ended December 31, 2014. The increase is due primarily to higher average debt balances offset in part by lower average interest rates throughout 2015.
Other income of $58.7 million for the year ended December 31, 2015 was composed primarily of the $70.9 million gain from the divestiture of Abel Pumps (see Note 2 of the Notes to Consolidated Financial Statements included in this Annual Report), offset in part by a $9.5 million impairment charge on a minority investment. Other income of $0.6 million for the year ended December 31, 2014 was composed of royalty income and foreign exchange gains at our non-U.S. based companies, offset in part by losses from asset disposals.
During 2015, our effective income tax rate was 30.6%, which was 70 basis points higher than the 2014 rate of 29.9%. The taxable gain on the divestiture of Abel Pumps led to an increase of 130 basis points, and was offset in part by discrete tax benefits from settlements of tax matters.
At December 31, 2015, the functional currencies of most of our non-U.S. subsidiaries were weaker against the U.S. dollar compared to currency exchange rates at December 31, 2014. The net result of these changes led to a pre-tax decrease in the foreign exchange component of comprehensive earnings of $146 million in the year ended December 31, 2015. Approximately $62 million of this amount related to goodwill and is not expected to directly affect our projected future cash flows. For the entire year of 2015, operating profit decreased by approximately 2% due to fluctuations in non-U.S. currencies.
The following table summarizes our net order information for the years ended December 31, 2015 and 2014 (dollar amounts in thousands).
| 2015 | 2014 | change | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Medical & Scientific Imaging | $ | 1,235,143 | $ | 1,081,190 | 14.2 | % | ||||||
| RF Technology | 1,024,999 | 955,831 | 7.2 | |||||||||
| Industrial Technology | 731,810 | 808,921 | (9.5 | ) | ||||||||
| Energy Systems & Controls | 555,672 | 692,136 | (19.7 | ) | ||||||||
| Total | $ | 3,547,624 | $ | 3,538,078 | 0.3 | % |
The increase in orders was due to orders from acquisitions which added 5%, offset by negative organic growth of 2% and a 3% negative foreign exchange impact.
The following table summarizes order backlog information at December 31, 2015 and 2014 (dollar amounts in thousands). We include in backlog only orders that are expected to be recognized as revenue within twelve months.
| 2015 | 2014 | change | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Medical & Scientific Imaging | $ | 373,213 | $ | 296,098 | 26.0 | % | ||||||
| RF Technology | 538,877 | 520,727 | 3.5 | |||||||||
| Industrial Technology | 68,002 | 97,507 | (30.3 | ) | ||||||||
| Energy Systems & Controls | 90,365 | 126,838 | (28.8 | ) | ||||||||
| Total | $ | 1,070,457 | $ | 1,041,170 | 2.8 | % |
Financial Condition, Liquidity and Capital Resources
Selected cash flows for the years ended December 31, 2016, 2015 and 2014 are as follows (in millions):
| 2016 | 2015 | 2014 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Cash provided by/(used in): | ||||||||||||
| Operating activities | $ | 964 | $ | 929 | $ | 840 | ||||||
| Investing activities | (3,753 | ) | (1,698 | ) | (348 | ) | ||||||
| Financing activities | 2,805 | 996 | (298 | ) |
Operating activities - The increase in cash provided by operating activities in 2016 was primarily due to increased earnings net of non-cash charges and higher deferred revenue balances due to an increased percentage of revenue from software and other subscription based products, offset in part by income tax payments in the first quarter of 2016 related to the gain on the sale of the Abel Pumps business in the fourth quarter of 2015. The increase in cash provided by operating activities in 2015 was due to increased earnings net of intangible amortization related to acquisitions, the collection of $49 million of receivables due from the Puerto Rico Highways and Transportation Authority and higher deferred revenue balances due to an increased percentage of revenue from software and other subscription based products.
Investing activities - Cash used in investing activities during 2016, 2015 and 2014 was primarily for business acquisitions. Cash received from investing activities in 2015 was primarily proceeds from the sale of the Abel Pumps business.
Financing activities - Cash used in financing activities in all periods presented was primarily debt repayments as well as dividends paid to stockholders. Cash provided by financing activities during 2016 was primarily from the issuance of $1.2 billion of senior notes and revolving debt borrowings for acquisitions. Cash provided by financing activities during 2015 was primarily the issuance of $900 million of senior notes and revolving debt borrowings for acquisitions.
Net working capital (current assets, excluding cash, less total current liabilities, excluding debt) was a negative $25 million at December 31, 2016 compared to $126 million at December 31, 2015, due primarily to increases in deferred revenue balances due to an increased percentage of revenue from software and other subscription based products. We acquired negative net working capital of $128 million through business acquisitions during 2016. The negative acquired working capital was due primarily to $203 million in deferred revenue balances.
Total debt was $6.2 billion at December 31, 2016 (51.8% of total capital) compared to $3.3 billion at December 31, 2015 (38.3% of total capital). Our increased debt at December 31, 2016 compared to December 31, 2015 was due to debt borrowings for 2016 acquisitions.
On December 19, 2016, we completed a public offering of $500 million aggregate principal amount of 2.80% senior unsecured notes due December 15, 2021, issued at 99.843% of their principal amount, and $700 million aggregate principal amount of 3.80% senior unsecured notes due December 15, 2026, issued at 99.984% of their principal amount. Net proceeds of $1.19 billion were used in the acquisition of Deltek (see Note 2 of the Notes to Consolidated Financial Statements). The senior notes are unsecured senior obligations of the Company and rank senior in right of payment with all of our existing and future subordinated indebtedness and rank equally in right of payment with all of our existing and future unsecured senior indebtedness. The notes are effectively subordinated to any of our existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness. The notes are not guaranteed by any of our subsidiaries and are effectively subordinated to all existing and future indebtedness and other liabilities of our subsidiaries.
The notes bear interest at a fixed rate of 2.80% and 3.80% per year, respectively, payable semi-annually in arrears on June 15 and December 15 of each year, beginning June 15, 2017.
We may redeem some or all of these notes at any time or from time to time, at 100% of their principal amount, plus a make-whole premium based on a spread to U.S. Treasury securities.
On September 23, 2016, we entered into a new five-year unsecured credit facility (the "2016 Facility") with JPMorgan Chase Bank, N.A., as administrative agent, and a syndicate of lenders, which replaced our previous unsecured credit facility, dated as of July 27, 2012, as amended as of October 28, 2015 (the "2012 Facility"). The 2016 Facility comprises a five year $2.50 billion revolving credit facility, which includes availability of up to $150.0 million for letters of credit. We may also, subject to compliance with specified conditions, request term loans or additional revolving credit commitments in an aggregate amount not to exceed $500 million. We recorded as other expense a $0.9 million non-cash debt extinguishment charge in the fourth quarter related to the early termination of the 2012 Facility, which represented the unamortized fees associated with the 2012 Facility.
The 2016 Facility contains various affirmative and negative covenants which, among other things, limit our ability to incur new debt, enter into certain mergers and acquisitions, sell assets and grant liens, make restricted payments (including the payment of dividends on our common stock) and capital expenditures, or change our line of business. We also are subject to financial covenants which require us to limit our consolidated total leverage ratio and to maintain a consolidated interest coverage ratio. The most restrictive covenant is the consolidated total leverage ratio which is limited to 3.5 to 1.
On December 2, 2016, we amended the 2016 Facility to allow the consolidated total leverage ratio be increased, no more than twice during the term of the 2016 Facility, to 4.0 to 1 for a consecutive four quarter fiscal period per increase (or, for any portion of such four quarter fiscal period in which the maximum would be 4.25 to 1 pursuant to the 2016 facility amendment, 4.25 to 1). In conjunction with the Deltek acquistion (see Note 2 of the Notes to Consolidated Financial Statements), we increased the maximum consolidated total leverage ratio covenant to 4.25 to 1 through June 30, 2017 and 4.00 to 1 through December 31, 2017.
At December 31, 2016, we had $4.3 billion of senior unsecured notes and $1.93 billion of outstanding revolver borrowings. In addition, we had $3.0 million of other debt in the form of capital leases and several smaller facilities that allow for borrowings or the issuance of letters of credit in foreign locations to support our non-U.S. businesses. We had $74.1 million of outstanding letters of credit at December 31, 2016, of which $34.8 million was covered by our lending group, thereby reducing our revolving credit capacity commensurately.
We were in compliance with all debt covenants related to our credit facility throughout the years ended December 31, 2016 and 2015.
See Note 8 of the Notes to Consolidated Financial Statements included in this Annual Report for additional information regarding our credit facility and senior notes.
Cash and cash equivalents at our foreign subsidiaries at December 31, 2016 totaled $557 million. Repatriation of these funds under current regulatory and tax law for use in domestic operations would expose us to additional taxes. We consider this cash to be permanently reinvested. We expect existing cash and cash equivalents, cash generated by our U.S. operations, our unsecured credit facility, as well as our expected ability to access the capital markets, will be sufficient to fund operating requirements in the U.S. for the foreseeable future.
Capital expenditures of $37.3 million, $36.3 million and $37.6 million were incurred during 2016, 2015 and 2014, respectively. In the future, we expect capital expenditures as a percentage of sales to be between 1.0% and 1.5% of annual net sales.
Contractual Cash Obligations and Other Commercial Commitments and Contingencies
The following tables quantify our contractual cash obligations and commercial commitments at December 31, 2016 (in thousands).
| Payments Due in Fiscal Year | ||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Contractual Cash Obligations1 | Total | 2017 | 2018 | 2019 | 2020 | 2021 | Thereafter | |||||||||||||||||||||
| Long-term debt | $ | 6,230,003 | $ | 400,003 | $ | 800,000 | $ | 500,000 | $ | 600,000 | $ | 500,000 | $ | 3,430,000 | ||||||||||||||
| Senior note interest | 719,557 | 139,900 | 129,325 | 106,608 | 85,025 | 67,269 | 191,430 | |||||||||||||||||||||
| Capital leases | 2,986 | 1,592 | 840 | 407 | 147 | - | - | |||||||||||||||||||||
| Operating leases | 248,530 | 60,536 | 46,080 | 35,341 | 29,726 | 25,177 | 51,670 | |||||||||||||||||||||
| Total | $ | 7,201,076 | $ | 602,031 | $ | 976,245 | $ | 642,356 | $ | 714,898 | $ | 592,446 | $ | 3,673,100 |
| Amounts Expiring in Fiscal Year | ||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Other Commercial Commitments | Total Amount Committed | 2017 | 2018 | 2019 | 2020 | 2021 | Thereafter | |||||||||||||||||||||
| Standby letters of credit and bank guarantees | $ | 74,071 | $ | 26,223 | $ | 1,961 | $ | 428 | $ | 104 | $ | 33,642 | $ | 11,713 |
| 1 | We have excluded $29 million related to the liability for uncertain tax positions from the tables as the current portion is not material, and we are not able to reasonably estimate the timing of the long-term portion of the liability. See Note 7 of the Notes to Consolidated Financial Statements included in this Annual Report. |
|---|
As of December 31, 2016, we had $521 million of outstanding surety bonds. Certain contracts, primarily those involving public sector customers, require us to provide a surety bond as a guarantee of its performance of contractual obligations.
We believe that internally generated cash flows and the remaining availability under our credit facility will be adequate to finance normal operating requirements and future acquisition activities. Although we maintain an active acquisition program, any future acquisitions will be dependent on numerous factors and it is not feasible to reasonably estimate if or when any such acquisitions will occur and what the impact will be on our activities, financial condition and results of operations. We may also explore alternatives to attract additional capital resources.
We anticipate that our businesses will generate positive cash flows from operating activities, and that these cash flows will permit the reduction of currently outstanding debt in accordance with the repayment schedule. However, the rate at which we can reduce our debt during 2017 (and reduce the associated interest expense) will be affected by, among other things, the financing and operating requirements of any new acquisitions and the financial performance of our existing companies. None of these factors can be predicted with certainty.
Off-Balance Sheet Arrangements
At December 31, 2016 and 2015, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Recently Issued Accounting Standards
See Note 1 of the Notes to Consolidated Financial Statements included in this Annual Report for information regarding the effect of new accounting pronouncements on our financial statements.
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