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
Teledyne Technologies Incorporated provides enabling technologies for industrial growth markets. We have evolved from a company that was primarily focused on aerospace and defense to one that serves multiple markets that require advanced technology and high reliability. These markets include deepwater oil and gas exploration and production, oceanographic research, air and water quality environmental monitoring, factory automation and medical imaging. Our products include monitoring instrumentation for marine and environmental applications, harsh environment interconnects, electronic test and measurement equipment, digital imaging sensors and cameras, aircraft information management systems, and defense electronic and satellite communication subsystems. We also supply engineered systems for defense, space, environmental and energy applications. We differentiate ourselves from many of our direct competitors by having a customer and company sponsored applied research center that augments our product development expertise.
Strategy/Overview
Our strategy continues to emphasize growth in our core markets of instrumentation, digital imaging, aerospace and defense electronics and engineered systems. Our core markets are characterized by high barriers to entry and include specialized products and services not likely to be commoditized. We intend to strengthen and expand our core businesses with targeted acquisitions and through product development. We continue to focus on balanced and disciplined capital deployment among capital expenditures, acquisitions and share repurchases. We aggressively pursue operational excellence to continually improve our margins and earnings. At Teledyne, operational excellence includes the rapid integration of the businesses we acquire. Using complementary technology across our businesses and internal research and development, we seek to create new products to grow our company and expand our addressable markets. We continue to evaluate our businesses to ensure that they are aligned with our strategy.
Consistent with this strategy, we made four acquisitions in 2014, four acquisitions in 2013 and five acquisitions in 2012. Our largest acquisition in 2014, Bolt Technology Corporation (“Bolt”) expanded our capabilities related to offshore oil and natural gas exploration, as well as increased our offerings of remotely operated robotic vehicles systems. We acquired the assets of The Oceanscience Group Ltd. (“Oceanscience”) to enhance our capabilities related to marine sensor platforms and unmanned surface vehicles. We acquired assets of Atlas Hydrographic GmbH (“Atlas”) to add marine sonar systems for mid
and deep water applications. We acquired Photon Machines, Inc. (“Photon”) to supplement our offerings of laser-based sample introduction equipment for laboratory instrumentation. In addition, in 2014 we made an investment in Ocean Aero, Inc.
In 2013, we acquired RESON A/S (“RESON”) to increase our capabilities related to multibeam sonar systems and specialty acoustic sensors for hydrography, global marine infrastructure and offshore energy operations. We acquired C.D. Limited (“CDL”) to obtain additional inertial sensing and navigation products, and to accelerate the development of real-time motion sensing and communication systems for our subsea oil and gas customers. We acquired SD Acquisition, Inc. d/b/a CETAC Technologies (“CETAC”) to expand our automated sample handling and sample introduction equipment for laboratory instrumentation capabilities. These three acquisitions are part of the Instrumentation segment. We acquired Axiom IC B.V. (“Axiom”) to add high-performance CMOS mixed-signal integrated circuits to our portfolio. Axiom is part of the Digital Imaging segment. In addition, in 2013 a subsidiary of Teledyne purchased the remaining 49% interest in Nova Research, Inc. (“Nova Sensors”).
Our largest acquisition in 2012, LeCroy Corporation (“LeCroy”), broadened our portfolio of analytical instrumentation with the addition of electronic test and measurement solutions. We acquired VariSystems Inc. (“VariSystems”) to expand our portfolio of rugged interconnect solutions. We acquired BlueView Technologies, Inc. (“BlueView”) principally to increase our instrumentation content on AUVs and ROVs used in oil and gas and marine survey applications. Through the acquisition of a majority interest in the parent company of Optech Incorporated (“Optech”), we added 3D imaging capability to our portfolio of visible, X-ray and ultraviolet sensors, cameras. Optech’s bathymetric LIDAR systems are used for coastal mapping and shallow water profiling also complement our marine survey sensors and systems. The acquisition of the parent company of PDM Neptec Limited (“PDM Neptec”) expanded our line of harsh environmental marine connectors. In April 2011, we completed the sale of our general aviation piston engine businesses and consequently classified our Aerospace Engines and Components segment as a discontinued operation.
During 2013, in an effort to reduce ongoing costs and improve operating performance we took actions to consolidate and relocate certain facilities and reduce headcount across various businesses, reducing our exposure to weak end markets and high cost locations. In connection with these efforts, in 2013, we incurred pretax charges totaling $24.0 million for severance and facility consolidation expense and environmental reserves. The charges were comprised of $10.4 million in severance related costs and $13.6 million in facility closure and relocation costs, which included $5.3 million of environmental reserves. The actions were substantially completed by year-end 2013, although we incurred $4.4 million of similar expenses in 2014. At December 28, 2014, we had $8.9 million in short-term reserves related to these actions.
Given the strength and diversity of Teledyne’s businesses, our consistent focus on operational excellence, as well as strategic acquisitions, we were able to achieve record sales and earnings in 2014. In 2014, sales and net income attributable to Teledyne increased by 2.4% and 17.7%, respectively over 2013 results. Diluted earnings per share in 2014 increased 18.1% over 2013. In 2014, sales totaled $2,394.0 million, compared with sales of $2,338.6 million in 2013. Net income attributable to Teledyne for 2014, was $217.7 million or $5.75 per diluted share, compared with $185.0 million or $4.87 per diluted share in 2013. The increase in revenue included incremental sales from acquisitions of $53.8 million. Net income for 2014 and 2013 also included net discrete tax benefits of $8.9 million and $21.3 million, respectively.
With the recent acquisition of Bolt in 2014 and acquisitions made throughout 2011 through 2013, as well as growth in our commercial markets, our business mix has continued to evolve. We have worked to transform our product portfolio into that of a high technology industrial company that is less dependent on U.S. Government business. For 2014, Teledyne’s sales were approximately 75% to commercial and international customers and 25% to the U.S. Government. This has changed from about 68% commercial and international customers and 32% U.S. government in 2012. Our international sales also increased to 45% of total sales in 2014, compared with 39% in 2012.
Recent Acquisitions
The Company spent $195.8 million, $128.2 million and $389.2 million on acquisitions and investments in 2014, 2013 and 2012, respectively.
On November 18, 2014, Teledyne acquired all of the outstanding common shares of Bolt for $22.00 per share payable in cash. The aggregate value for the transaction was $171.0 million, excluding transaction costs and taking into account Bolt’s stock options, other liabilities and net cash on hand. Bolt is a developer and manufacturer of marine seismic data acquisition equipment used for offshore oil and natural gas exploration. Bolt is also a developer and manufacturer of remotely operated robotic vehicles systems used for a variety of underwater tasks. Bolt had sales of $67.5 million for its fiscal year ended June 30, 2014.
On October 22, 2014, a subsidiary of Teledyne acquired the assets of Oceanscience for $14.7 million, net of cash acquired. Oceanscience designs and manufactures marine sensor platforms and unmanned surface vehicles. Oceanscience had sales of $6.8 million for its fiscal year ended December 31, 2013.
On August 18, 2014, a subsidiary of Teledyne acquired assets Atlas for $5.2 million. On March 31, 2014, a subsidiary of Teledyne acquired Photon for an initial payment of $3.3 million. Teledyne expects to pay an additional $0.7 million in equal installments over the next three years. On July 1, 2014, Teledyne made an investment in Ocean Aero. Based in San Diego, California. Ocean Aero is designing an unmanned surface vehicle that will also have the ability to descend subsea. Teledyne owns a 29.7% interest in Ocean Aero and it is accounted for as an equity investment.
All of the 2014 acquisitions are part of the Instrumentation segment.
On October 22, 2013, a subsidiary of Teledyne acquired CDL for $21.8 million in cash, net of cash acquired. CDL is headquartered in Aberdeen, Scotland, is a leading supplier of subsea inertial navigation systems and motion sensors for a variety of marine applications. CDL had sales of £9.9 million for its fiscal year ended December 31, 2012, and is part of the Instrumentation segment.
On August 30, 2013, a subsidiary of Teledyne acquired CETAC for $26.4 million. Teledyne paid a $0.4 million purchase price adjustment in the fourth quarter. CETAC, headquartered in Omaha, Nebraska, is a designer and manufacturer of automated sample handling and sample introduction equipment for laboratory instrumentation. CETAC had sales of $24.0 million for its fiscal year ended December 31, 2012, and is part of the Instrumentation segment.
On July 8, 2013, a subsidiary of Teledyne purchased the remaining 49% interest in Nova Sensors that it did not already own for $4.9 million. Nova Sensors produces compact short-wave and mid-wave infrared cameras and operates within the Digital Imaging segment.
On May 8, 2013, a subsidiary of Teledyne acquired Axiom, for an initial payment of $4.0 million, net of cash acquired, with an additional $1.3 million expected to be paid in equal installments over three years. Axiom is located in the Netherlands and is a fabless semiconductor company that develops high-performance CMOS mixed-signal integrated circuits and is part of the Digital Imaging segment.
On March 1, 2013, a subsidiary of Teledyne acquired all the outstanding shares of RESON for $69.7 million, net of cash acquired. RESON, headquartered in Slangerup, Denmark, provides multibeam sonar systems and specialty acoustic sensors for hydrography, global marine infrastructure and offshore energy operations. RESON had sales of €50.8 million for its fiscal year ended December 31, 2012, and is part of the Instrumentation segment. Also in 2013, the Company spent $1.4 million on the purchase of a product line.
On August 3, 2012, Teledyne acquired the stock of LeCroy for $301.3 million, net of cash acquired. LeCroy, headquartered in Chestnut Ridge, New York, is a leading supplier of oscilloscopes, protocol analyzers and signal integrity test solutions. LeCroy had sales of $178.1 million for its fiscal year ended June 30, 2011, and is part of the Instrumentation segment.
Also on August 3, 2012, a subsidiary of Teledyne acquired the parent company of PDM Neptec for $7.4 million in cash, net of cash acquired. PDM Neptec, located in Hampshire, United Kingdom, is part of the Instrumentation segment and operates as Teledyne Impulse-PDM Ltd. PDM Neptec had sales of £5.5 million for its fiscal year ended March 31, 2012.
On July 2, 2012, a subsidiary of Teledyne acquired BlueView for $16.3 million in cash, net of cash acquired. BlueView, located in Seattle, Washington, is part of the Instrumentation segment and operates as Teledyne BlueView, Inc. BlueView had sales of $7.1 million for its fiscal year ended December 31, 2011.
On April 2, 2012, Teledyne acquired a majority interest in the parent company of Optech for $27.9 million, net of cash acquired. The purchase increased Teledyne’s ownership percentage to 51% from the original 19% interest purchased in the first quarter of 2011. With the April 2012 purchase, we now consolidate Optech’s financial results into Teledyne’s results with an appropriate adjustment for the minority ownership. At the time of the purchase, the value of Optech’s total equity was based on the same per share price as those shares purchased by Teledyne to obtain the majority interest in 2012 and the value of the non-controlling interest was 49% of Optech’s total equity and was equal to $49.8 million. The minority ownership of Optech was $41.3 million and $47.3 million at December 28, 2014, and December 29, 2013, respectively. Optech had sales of CAD $54.7 million for its fiscal year ended March 30, 2012, and is reported as part of the Digital Imaging segment.
On February 25, 2012, Teledyne acquired VariSystems for $34.9 million, net of cash acquired. Teledyne paid a $1.4 million purchase price adjustment in the second quarter of 2012. VariSystems, headquartered in Calgary, Alberta, Canada, is a leading supplier of custom harsh environment interconnects used in energy exploration and production. VariSystems had sales of CAD $27.5 million for its fiscal year ended May 31, 2011, and is part of the Instrumentation segment.
See Note 3 to our Consolidated Financial Statements for additional information about our recent acquisitions. On February 2, 2015, a subsidiary of Teledyne acquired Bowtech Products Limited for $18.4 million in cash, net of cash acquired and including an estimated working capital adjustment. Based in Aberdeen, Scotland, Bowtech designs and manufactures harsh underwater environment vision systems.
Our fiscal year is determined based on a 52- or 53-week convention ending on the Sunday nearest to December 31. Fiscal years 2014, 2013 and 2012 each contained 52 weeks. The following is our financial information for 2014, 2013 and 2012 (in millions, except per-share amounts):
| 2014 | 2013 | 2012 | ||||||||||
| Sales | $ | 2,394.0 | $ | 2,338.6 | $ | 2,127.3 | ||||||
| Costs and Expenses | ||||||||||||
| Cost of sales | 1,487.1 | 1,500.0 | 1,379.1 | |||||||||
| Selling, general and administrative expenses | 612.4 | 598.3 | 505.1 | |||||||||
| Total costs and expenses | 2,099.5 | 2,098.3 | 1,884.2 | |||||||||
| Operating Income | 294.5 | 240.3 | 243.1 | |||||||||
| Interest and debt expense, net | (19.0 | ) | (20.4 | ) | (17.8 | ) | ||||||
| Other income, net | 6.6 | 4.1 | 2.9 | |||||||||
| Income from continuing operations before income taxes | 282.1 | 224.0 | 228.2 | |||||||||
| Provision for income taxes(a) | 66.5 | 39.5 | 65.4 | |||||||||
| Income from continuing operations including noncontrolling interest | 215.6 | 184.5 | 162.8 | |||||||||
| Discontinued operations, net of income taxes | — | — | 2.3 | |||||||||
| Net income | 215.6 | 184.5 | 165.1 | |||||||||
| Noncontrolling interest | 2.1 | 0.5 | (1.0 | ) | ||||||||
| Net income attributable to Teledyne | $ | 217.7 | $ | 185.0 | $ | 164.1 | ||||||
| Income from continuing operations including noncontrolling interest | $ | 215.6 | $ | 184.5 | $ | 162.8 | ||||||
| Noncontrolling interest | 2.1 | 0.5 | (1.0 | ) | ||||||||
| Net income from continuing operations | 217.7 | 185.0 | 161.8 | |||||||||
| Discontinued operations, net of income taxes | — | — | 2.3 | |||||||||
| Net income attributable to Teledyne | $ | 217.7 | $ | 185.0 | $ | 164.1 | ||||||
| Basic earnings per common share: | ||||||||||||
| Continuing operations | $ | 5.87 | $ | 4.96 | $ | 4.41 | ||||||
| Discontinued operations | — | — | 0.06 | |||||||||
| Basic earnings per common share | $ | 5.87 | $ | 4.96 | $ | 4.47 | ||||||
| Diluted earnings per common share: | ||||||||||||
| Continuing operations | $ | 5.75 | $ | 4.87 | $ | 4.33 | ||||||
| Discontinued operations | — | — | 0.06 | |||||||||
| Diluted earnings per common share | $ | 5.75 | $ | 4.87 | $ | 4.39 | ||||||
| (a) Fiscal years 2014, 2013 and 2012 include net discrete tax benefits of $8.9 million, $21.3 million and $5.4 million, respectively. |
Our businesses are divided into four business segments: Instrumentation, Digital Imaging, Aerospace and Defense Electronics and Engineered Systems. Our four business segments and their respective percentage contributions to our total sales in 2014, 2013 and 2012 are summarized in the following table:
| Percentage of Sales | |||||||||
| Segment | 2014 | 2013 | 2012 | ||||||
| Instrumentation | 47 | % | 44 | % | 38 | % | |||
| Digital Imaging | 17 | % | 18 | % | 20 | % | |||
| Aerospace and Defense Electronics | 25 | % | 26 | % | 28 | % | |||
| Engineered Systems | 11 | % | 12 | % | 14 | % | |||
| 100 | % | 100 | % | 100 | % |
Results of Operations
2014 compared with 2013
| Sales | 2014 | 2013 | % Change | |||||||||
| (in millions) | ||||||||||||
| Instrumentation | $ | 1,115.5 | $ | 1,022.8 | 9.1 | % | ||||||
| Digital Imaging | 403.6 | 414.8 | (2.7 | )% | ||||||||
| Aerospace and Defense Electronics | 603.0 | 625.1 | (3.5 | )% | ||||||||
| Engineered Systems | 271.9 | 275.9 | (1.4 | )% | ||||||||
| Total sales | $ | 2,394.0 | $ | 2,338.6 | 2.4 | % | ||||||
| Operating profit and other segment income | 2014 | 2013 | % Change | |||||||||
| (in millions) | ||||||||||||
| Instrumentation | $ | 181.6 | $ | 162.0 | 12.1 | % | ||||||
| Digital Imaging | 37.1 | 28.2 | 31.6 | % | ||||||||
| Aerospace and Defense Electronics | 88.3 | 65.7 | 34.4 | % | ||||||||
| Engineered Systems | 31.4 | 22.0 | 42.7 | % | ||||||||
| Segment operating profit and other segment income | 338.4 | 277.9 | 21.8 | % | ||||||||
| Corporate expense | (43.9 | ) | (37.6 | ) | 16.8 | % | ||||||
| Interest and debt expense, net | (19.0 | ) | (20.4 | ) | (6.9 | )% | ||||||
| Other income, net | 6.6 | 4.1 | 61.0 | % | ||||||||
| Income before income taxes | 282.1 | 224.0 | 25.9 | % | ||||||||
| Provision for income taxes(a) | 66.5 | 39.5 | 68.4 | % | ||||||||
| Net income | 215.6 | 184.5 | 16.9 | % | ||||||||
| Noncontrolling interest | 2.1 | 0.5 | 320.0 | % | ||||||||
| Net income attributable to Teledyne | $ | 217.7 | $ | 185.0 | 17.7 | % | ||||||
| (a) Fiscal years 2014 and 2013 include net discrete tax benefits of $8.9 million and $21.3 million, respectively, |
The table below presents sales and cost of sales by segment and total company:
| (Dollars in millions) | 2014 | 2013 | Change | ||||||||
| Instrumentation | |||||||||||
| Sales | $ | 1,115.5 | $ | 1,022.8 | $ | 92.7 | |||||
| Cost of sales | $ | 630.0 | $ | 570.9 | $ | 59.1 | |||||
| Cost of sales % of sales | 56.5 | % | 55.8 | % | |||||||
| Digital Imaging | |||||||||||
| Sales | $ | 403.6 | $ | 414.8 | $ | (11.2 | ) | ||||
| Cost of sales | $ | 252.0 | $ | 263.7 | $ | (11.7 | ) | ||||
| Cost of sales % of sales | 62.4 | % | 63.6 | % | |||||||
| Aerospace and Defense Electronics | |||||||||||
| Sales | $ | 603.0 | $ | 625.1 | $ | (22.1 | ) | ||||
| Cost of sales | $ | 386.6 | $ | 434.6 | $ | (48.0 | ) | ||||
| Cost of sales % of sales | 64.2 | % | 69.5 | % | |||||||
| Engineered Systems | |||||||||||
| Sales | $ | 271.9 | $ | 275.9 | $ | (4.0 | ) | ||||
| Cost of sales | $ | 218.5 | $ | 230.8 | $ | (12.3 | ) | ||||
| Cost of sales % of sales | 80.4 | % | 83.6 | % | |||||||
| Total Company | |||||||||||
| Sales | $ | 2,394.0 | $ | 2,338.6 | $ | 55.4 | |||||
| Cost of sales | $ | 1,487.1 | $ | 1,500.0 | $ | (12.9 | ) | ||||
| Cost of sales % of sales | 62.1 | % | 64.1 | % |
We reported 2014 sales of $2,394.0 million, compared with sales of $2,338.6 million for 2013, an increase of 2.4%. Net income attributable to Teledyne was $217.7 million ($5.75 per diluted share) for 2014, compared with net income attributable to Teledyne of $185.0 million ($4.87 per diluted share) for 2013, an increase of 17.7%. Total year 2014 and 2013 reflected pretax charges totaling $4.4 million and $24.0 million, respectively, for severance and facility consolidation expenses. Net income for 2014 and 2013 also included net discrete tax benefits of $8.9 million and $21.3 million, respectively.
Sales
The increase in sales in 2014, compared with 2013, reflected higher sales in the Instrumentation segment, partially offset by lower sales in the Aerospace and Defense Electronics, Digital Imaging and the Engineered Systems segments. Sales in the Instrumentation segment reflected $53.6 million of incremental sales from recent acquisitions, as well as higher organic sales for marine products. Sales of marine products increased by $74.4 million and included incremental sales of $32.5 million from recent acquisitions. Sales in the Aerospace and Defense Electronics segment primarily reflected increased sales of $17.8 million from avionics products and electronic relays, more than offset by decreased sales of microwave devices, due to the completion of a program with a foreign government. Sales in both the Digital Imaging segment and the Engineered Systems segment decreased slightly. The incremental increase in revenue in 2014 from businesses acquired in 2014 and in 2013 was $53.8 million.
Sales under contracts with the U.S. Government were approximately 25% of sales in 2014 and 27% of sales in 2013. Sales to international customers represented approximately 45% of sales in 2014 and 44% of sales in 2013.
Operating Income
Segment operating profit and other segment income for 2014, compared with 2013, increased by $60.5 million, or 21.8%. Operating income reflected lower costs as a result of the cost reduction actions taken in 2013 and the impact of pension income. Operating income in 2014 included $4.4 million in severance and facility consolidation costs, compared with $24.0 million of similar costs in 2013. The incremental operating income included in the results for 2014 from recent acquisitions was $6.3 million which included $1.2 million in additional intangible asset amortization expense. Operating income in 2014 included pension income of $1.3 million, compared with pension expense of $17.5 million in 2013. The change to pension income in 2014 from pension expense in 2013, primarily reflected the impact of using a 5.4 percent discount rate to determine the benefit obligation for the domestic plan in 2014 compared with a 4.4 percent discount rate used in 2013. Pension expense allocated to contracts pursuant to U.S. Government Cost Accounting Standards (“CAS”) was $13.8 million in 2014, compared with $14.5 million in 2013. Pension expense determined allowable under CAS can generally be recovered through the pricing of products and services sold to the U.S. Government. LIFO income was less than $0.1 million in 2014 and was $0.7 million in 2013.
Cost of Sales
Total company cost of sales decreased by $12.9 million in 2014, compared with 2013, and reflected $16.1 million in lower severance and facility consolidation expense and environmental reserves and lower pension expense, partially offset by higher sales. The Instrumentation segment cost of sales increase of $59.1 million reflected the impact of recent acquisitions, the impact of organic sales increases, as well as increased customer funded research and development. The Aerospace and Defense Electronics segment decrease in cost of sales of $48.0 million reflected the impact of lower sales as well as $14.8 million in lower severance and facility consolidation expense and environmental reserves. The total company cost of sales as a percentage of sales for 2014 was 62.1%, compared with 64.1% for 2013. The lower cost of sales percentage reflected the impact of lower severance and facility consolidation expense and environmental reserves and lower pension expense.
Selling, general and administrative expenses
Selling, general and administrative expenses, including research and development and bid and proposal expense, in total dollars were higher in 2014 compared with 2013. The increase reflected the impact of higher sales and higher corporate administrative expense. Corporate administrative expense in 2014 was $43.9 million, compared with $37.6 million in 2013 an increase of 16.8%. The increase in corporate administrative expense reflected higher compensation and professional fees expense. For 2014, we recorded a total of $14.0 million in stock option expense, of which $4.5 million was recorded as corporate expense and $9.5 million was recorded in the operating segment results. For 2013, we recorded a total of $10.7 million in stock option expense, of which $3.4 million was recorded as corporate expense and $7.3 million was recorded in the operating segment results. Selling, general and administrative expenses for 2014, as a percentage of sales, were 25.6% for both 2014 and 2013.
Pension Income/Expense
Included in operating profit in 2014 was pension income of $1.3 million compared with pension expense of $17.5 million in 2013. In accordance with CAS, $13.8 million in pension costs are recoverable from certain government contracts for 2014, compared with $14.5 million for 2013. The change to pension income in 2014 from pension expense in 2013 primarily reflected the impact of using a 5.4 percent discount rate to determine the benefit obligation for the domestic plan in 2014 compared with a 4.4 percent discount rate used in 2013. For the Company’s domestic pension plan, the discount rate for 2015 will decrease to 4.5% from 5.4% which will increase pension expense for 2015, compared with 2014.
Interest Expense and Other Income and Expense
Total interest expense, including credit facility fees and other bank charges, was $19.0 million in 2014 and $20.9 million in 2013. Interest income was $0.2 million in 2014 and $0.5 million in 2013. Other income and expense in 2014 included a net gain on legal settlements of $6.5 million. Other income and expense in 2013 included $3.6 million from the reversal of reserves no longer needed in connection with a legal settlement.
Income Taxes
The Company’s effective tax rate for 2014 was 23.6%, compared with 17.7% for 2013. The increase primarily reflected lower net discrete tax benefits in 2014. Fiscal year 2014 included net discrete tax benefits of $8.9 million primarily related to the remeasurement of uncertain tax positions, primarily due to an expiration of statute of limitations and the favorable resolution of a tax matter. Total year 2014 also included $5.6 million in research and development tax credits. Fiscal year 2013 included net discrete tax benefits of $21.3 million primarily related to the statute of limitations expirations, favorable tax audit resolutions, research and development credits and the remeasurement of uncertain tax positions. Excluding the impact of the net discrete tax benefits of $8.9 million for 2014 and $21.3 million for 2013, the effective tax rates would have been 26.7% for 2014, compared with 27.1% for 2013.
During the next twelve months, it is reasonably possible that favorable tax audit resolutions and expirations of the statutes of limitations could reduce unrecognized tax benefits by $8.7 million, either because our tax positions are sustained on audit, because the Company agrees to their disallowance, or because of the expiration of the statutes of limitations. Of the $8.7 million, $0.5 million would not impact tax expense as it would be offset by the reversal of deferred tax assets.
2013 Compared with 2012
| Sales | 2013 | 2012 | % Change | |||||||||
| (in millions) | ||||||||||||
| Instrumentation | $ | 1,022.8 | $ | 804.7 | 27.1 | % | ||||||
| Digital Imaging | 414.8 | 415.9 | (0.3 | )% | ||||||||
| Aerospace and Defense Electronics | 625.1 | 605.3 | 3.3 | % | ||||||||
| Engineered Systems | 275.9 | 301.4 | (8.5 | )% | ||||||||
| Total sales | $ | 2,338.6 | $ | 2,127.3 | 9.9 | % | ||||||
| Operating profit and other segment income | 2013 | 2012 | % Change | |||||||||
| (in millions) | ||||||||||||
| Instrumentation | $ | 162.0 | $ | 146.0 | 11.0 | % | ||||||
| Digital Imaging | 28.2 | 24.8 | 13.7 | % | ||||||||
| Aerospace and Defense Electronics | 65.7 | 80.5 | (18.4 | )% | ||||||||
| Engineered Systems | 22.0 | 28.5 | (22.8 | )% | ||||||||
| Segment operating profit and other segment income | 277.9 | 279.8 | (0.7 | )% | ||||||||
| Corporate expense | (37.6 | ) | (36.7 | ) | 2.5 | % | ||||||
| Interest and debt expense, net | (20.4 | ) | (17.8 | ) | 14.6 | % | ||||||
| Other income, net | 4.1 | 2.9 | 41.4 | % | ||||||||
| Income from continuing operations before income taxes | 224.0 | 228.2 | (1.8 | )% | ||||||||
| Provision for income taxes(a) | 39.5 | 65.4 | (39.6 | )% | ||||||||
| Income from continuing operations including noncontrolling interest | 184.5 | 162.8 | 13.3 | % | ||||||||
| Discontinued operations, net of income taxes | — | 2.3 | * | |||||||||
| Net income | 184.5 | 165.1 | 11.8 | % | ||||||||
| Noncontrolling interest | 0.5 | (1.0 | ) | * | ||||||||
| Net income attributable to Teledyne | $ | 185.0 | $ | 164.1 | 12.7 | % | ||||||
| * not meaningful | ||||||||||||
| (a) Fiscal years 2013 and 2012 include net discrete tax benefits of $21.3 million and $5.4 million, respectively. |
The table below presents sales and cost of sales by segment and total company:
| (Dollars in millions) | 2013 | 2012 | Change | ||||||||
| Instrumentation | |||||||||||
| Sales | $ | 1,022.8 | $ | 804.7 | $ | 218.1 | |||||
| Cost of sales | $ | 570.9 | $ | 458.7 | $ | 112.2 | |||||
| Cost of sales % of sales | 55.8 | % | 57.0 | % | |||||||
| Digital Imaging | |||||||||||
| Sales | $ | 414.8 | $ | 415.9 | $ | (1.1 | ) | ||||
| Cost of sales | $ | 263.7 | $ | 266.9 | $ | (3.2 | ) | ||||
| Cost of sales % of sales | 63.6 | % | 64.2 | % | |||||||
| Aerospace and Defense Electronics | |||||||||||
| Sales | $ | 625.1 | $ | 605.3 | $ | 19.8 | |||||
| Cost of sales | $ | 434.6 | $ | 406.2 | $ | 28.4 | |||||
| Cost of sales % of sales | 69.5 | % | 67.1 | % | |||||||
| Engineered Systems | |||||||||||
| Sales | $ | 275.9 | $ | 301.4 | $ | (25.5 | ) | ||||
| Cost of sales | $ | 230.8 | $ | 247.3 | $ | (16.5 | ) | ||||
| Cost of sales % of sales | 83.6 | % | 82.1 | % | |||||||
| Total Company | |||||||||||
| Sales | $ | 2,338.6 | $ | 2,127.3 | $ | 211.3 | |||||
| Cost of sales | $ | 1,500.0 | $ | 1,379.1 | $ | 120.9 | |||||
| Cost of sales % of sales | 64.1 | % | 64.8 | % |
We reported 2013 sales of $2,338.6 million, compared with sales of $2,127.3 million for 2012, an increase of 9.9%. Net income from continuing operations was $185.0 million ($4.87 per diluted share) for 2013, compared with net income from continuing operations of $161.8 million ($4.33 per diluted share) for 2012, an increase of 14.3%. Net income for 2013 and 2012 also included net discrete tax benefits of $21.3 million and $5.4 million, respectively. Net income attributable to Teledyne, including discontinued operations, was $185.0 million ($4.87 per diluted share) for 2013, compared with $164.1 million ($4.39 per diluted share) for 2012.
Sales
The increase in sales in 2013, compared with 2012, reflected higher sales in both the Instrumentation and Aerospace and Defense Electronics segments, partially offset by lower sales in both the Engineered Systems and Digital Imaging segments. Sales in the Instrumentation segment reflected $178.4 million of incremental sales from acquisitions, as well as higher organic sales for marine products. Increased sales of test and measurement instrumentation of $103.6 million reflected the full year contribution from the LeCroy acquisition. Sales of marine products increased by $106.7 million and included incremental sales of $65.3 million from acquisitions. Sales in the Aerospace and Defense Electronics segment primarily reflected increased sales of $19.3 million from avionics products and electronic relays. Sales in the Digital Imaging segment decreased slightly. The decrease in the Engineered Systems segment revenue primarily reflected lower sales of $23.8 million from engineered products and services. The incremental increase in revenue in 2013 from businesses acquired in 2013 and in 2012 was $172.0 million.
Sales under contracts with the U.S. Government were approximately 27% of sales in 2013 and 32% of sales in 2012, principally reflective of our recent acquisitions. Such decline has been consistent with our strategy to be less dependent on U.S. government business. Sales to international customers represented approximately 44% of sales in 2013 and 39% of sales in 2012.
Operating Income
Segment operating profit and other segment income for 2013, compared with 2012, decreased by $1.9 million, or only 0.7%, despite $24.0 million in pretax charges for severance and facility consolidation expense and environmental reserves, compared with $1.7 million of similar charges in 2012. For 2013, the charges impacted each business segment as follows: Aerospace and Defense Electronics, $15.7 million; Digital Imaging, $3.9 million; Instrumentation, $2.5 million; and Engineered Systems, $1.9 million. In 2012, we incurred $1.7 million of similar charges which only impacted the Aerospace and Defense Electronics segment. Segment operating profit and other segment income for 2013 also reflected
the impact of acquisitions as well as the impact of higher organic sales in each segment except the Engineered Systems segment. Operating profit included incremental operating profit from acquisitions of $11.7 million, which included intangible amortization of $5.0 million. LIFO income was $0.7 million in 2013 and was less than $0.1 million in 2012.
Cost of Sales
Total company cost of sales increased by $120.9 million in 2013, compared with 2012, and reflected $79.4 million in cost of sales from recent acquisitions, $15.4 million in higher severance and facility consolidation expense and environmental reserves, higher pension expense as well as the impact of organic sales increases. The Instrumentation segment cost of sales increase of $112.2 million reflected the impact of recent acquisitions as well as the impact of organic sales increases. The Aerospace and Defense Electronics segment increase in cost of sales of $28.4 million reflected the impact of higher sales as well as $14.0 million in severance and facility consolidation expense and environmental reserves. The total company cost of sales as a percentage of sales for 2013 was 64.1%, compared with 64.8% for 2012. The lower cost of sales percentage reflected the impact of the LeCroy and Optech cost structures which have a lower cost of sales percentage than the overall Teledyne cost of sales percentage, partially offset by severance and facility consolidation expense and environmental reserves. Excluding the impact of recent acquisitions, cost of sales as a percentage of sales for 2013 would have been 66.8%, compared with 64.8% in 2012. The higher percentage in 2013 reflects the impact of severance and facility consolidation expense and environmental reserves, higher pension expense and product mix differences in 2013.
Selling, general and administrative expenses
Selling, general and administrative expenses, including research and development and bid and proposal expense, in total dollars were higher in 2013 compared with 2012. The increase reflected the impact of higher sales, higher acquired intangible asset amortization of $5.0 million and higher research and development costs of $37.8 million. Corporate administrative expense in 2013 was $37.6 million, compared with $36.7 million in 2012 an increase of 2.5%. For 2013, we recorded a total of $10.7 million in stock option expense, of which $3.4 million was recorded as corporate expense and $7.3 million was recorded in segment results. For 2012, we recorded a total of $8.0 million in stock option expense, of which $2.4 million was recorded as corporate expense and $5.6 million was recorded in segment results. Selling, general and administrative expenses for 2013, as a percentage of sales, increased to 25.6%, compared with 23.7% for 2012 and reflected the impact of higher research and development costs and the recently acquired LeCroy and Optech cost structures which have a higher selling, general and administrative expense percentage of sales than the overall Teledyne selling, general and administrative expense percentage of sales.
Pension Income/Expense
Included in operating profit in 2013 was domestic pension expense of $17.5 million. In accordance with CAS, $14.5 million was recoverable from certain government contracts. Included in operating profit in 2012 was domestic pension expense of $6.6 million. In accordance with CAS, $12.7 million was recoverable from certain government contracts. The increase in pension expense primarily reflected the impact of using a 4.4% discount rate to determine the benefit obligation for the domestic plan in 2013 compared with a 5.5% discount rate used in 2012.
Interest Expense and Other Income and Expense
Total interest expense, including credit facility fees and other bank charges, was $20.9 million in 2013 and $18.2 million in 2012. Interest income was $0.5 million in 2013 and $0.4 million in 2012. The increase in interest expense reflected the impact of higher outstanding debt levels, partially offset by lower overall average interest rates.
Other income and expense in 2013 included $3.6 million from the reversal of reserves no longer needed in connection with a legal settlement. Other income in 2012 included foreign currency translation gains of $0.8 million.
Income Taxes
The Company’s effective tax rate for 2013 was 17.7%, compared with 28.7% for 2012. The decrease reflected higher net discrete tax benefits in 2013 as well as a change in the proportion of domestic and international income. Fiscal year 2013 included net discrete tax benefits of $21.3 million primarily related to the statute of limitation expirations, favorable tax audit resolutions, research and development credits and the remeasurement of uncertain tax positions. Fiscal year 2012 included net discrete tax benefits of $5.4 million related to the remeasurement of uncertain tax positions and an expiration of the statute of limitations in the United States. Excluding the impact of the net discrete tax benefits of $21.3 million for 2013 and $5.4 million for 2012, the effective tax rates would have been 27.1% for 2013, compared with 31.0% for 2012, which reflected a change in the proportion of domestic and international income.
Segments
In the second quarter of 2013, the Company changed the reporting structure of two of its interconnect business units. The two interconnect business units were formerly reported as part of the Aerospace and Defense Electronics segment and are now reported as part of the Instrumentation segment. These business units primarily serve energy production markets and are now managed by and integrated with our other interconnect businesses within Teledyne Oil & Gas, which is part of the marine instrumentation product line. Previously reported segment data has been restated to reflect this change. Total sales for the two business units transferred to the Instrumentation segment from the Aerospace and Defense Electronics segment were $55.3 million for fiscal year 2012. The following discussion of our four segments should be read in conjunction with Note 13 to the Notes to Consolidated Financial Statements.
Instrumentation
| (Dollars in millions) | 2014 | 2013 | 2012 | |||||||||
| Sales | $ | 1,115.5 | $ | 1,022.8 | $ | 804.7 | ||||||
| Cost of sales | $ | 630.0 | $ | 570.9 | $ | 458.7 | ||||||
| Selling, general and administrative expenses | $ | 303.9 | $ | 289.9 | $ | 200.0 | ||||||
| Operating profit | $ | 181.6 | $ | 162.0 | $ | 146.0 | ||||||
| Cost of sales % of sales | 56.5 | % | 55.8 | % | 57.0 | % | ||||||
| Selling, general and administrative expenses % of sales | 27.2 | % | 28.4 | % | 24.9 | % | ||||||
| Operating profit % of sales | 16.3 | % | 15.8 | % | 18.1 | % | ||||||
| International sales % of sales | 58.1 | % | 56.3 | % | 53.7 | % | ||||||
| Governmental sales % of sales | 3.5 | % | 4.0 | % | 5.0 | % | ||||||
| Capital expenditures | $ | 17.0 | $ | 22.0 | $ | 14.4 |
Our Instrumentation segment provides monitoring and control instruments for marine, environmental, industrial and other applications, as well as electronic test and measurement equipment. We also provide power and communications connectivity devices for distributed instrumentation systems and sensor networks deployed in mission critical, harsh environments.
2014 compared with 2013
Our Instrumentation segment sales were $1,115.5 million in 2014, compared with sales of $1,022.8 million in 2013, an increase of 9.1%. Operating profit was $181.6 million in 2014, compared with $162.0 million in 2013, an increase of 12.1%. The 2014 sales increase of $92.7 million resulted from higher sales in the marine instrumentation and environmental instrumentation product lines. The higher sales of $74.4 million for marine instrumentation reflected increased sales of marine acoustic sensors and systems, as well as interconnect systems used in offshore energy production, and also included a total of $32.5 million in incremental revenue from recent acquisitions including the November 2014 acquisition of Bolt, the March 2013 acquisition of RESON and the October 2013 acquisition of CDL. Sales for environmental instrumentation increased $19.8 million and included $21.1 million from the August 2013 acquisition of CETAC. Sales for electronic test and measurement instrumentation decreased by $1.5 million. The increase in operating profit reflected the impact of higher sales from both recent acquisitions and organic sales growth. The incremental operating profit from recent acquisitions was $6.1 million, which included $1.2 million in additional intangible asset amortization. In 2015, we expect increased sales of marine instrumentation as a result of acquisitions, as well as greater sales of marine interconnect systems, partially offset by reduced sales of geophysical sensors for oil and gas exploration.
Cost of sales increased by $59.1 million in 2014, compared with 2013, and primarily reflected the impact of higher sales, as well as increased customer funded research and development. The cost of sales percentage increased to 56.5% from 55.8%. Selling, general and administrative expenses, including research and development and bid and proposal expense, in 2014, increased by $14.0 million, compared with 2013, and reflected the impact of higher sales. Selling, general and administrative expenses for 2014, as a percentage of sales, decreased slightly to 27.2%, compared with 28.4% for 2013.
2013 compared with 2012
Our Instrumentation segment sales were $1,022.8 million in 2013, compared with sales of $804.7 million in 2012, an increase of 27.1%. Operating profit was $162.0 million in 2013, compared with $146.0 million in 2012, an increase of 11.0%. The 2013 sales increase of $218.1 million resulted from higher sales of both marine and electronic test and measurement instrumentation. Marine instrumentation had higher sales of $106.7 million which reflected increased sales of marine acoustic sensors and systems, as well as interconnect systems used in offshore energy production, and also included a total of $65.3 million in incremental revenue from recent acquisitions including the March 2013 acquisition of RESON, which contributed $51.4 million in sales. Increased sales of $103.6 million for electronic test and measurement instrumentation resulted from the August 2012 acquisition of LeCroy. Sales for environmental instrumentation increased by $7.8 million, primarily due to the acquisition of CETAC. The increase in operating profit reflected the impact of higher sales from both recent acquisitions and organic sales growth. The incremental operating profit from recent acquisitions was $11.7 million, which included $4.6 million in additional intangible asset amortization.
Cost of sales increased by $112.2 million in 2013, compared with 2012, and reflected the impact of higher sales, product mix differences and $2.5 million in severance and facility consolidation expenses. The decrease in the cost of sales percentage to 55.8% from 57.0% largely reflected the impact of recent acquisitions which carry a lower cost of sales percentage than the average for our other businesses in this segment, partially offset by product mix differences. Selling, general and administrative expenses, including research and development and bid and proposal expense, in 2013, increased by $89.9 million, compared with 2012, and reflected the impact of acquisitions, primarily LeCroy and RESON. The LeCroy and RESON acquisitions represented $77.7 million of the increase in selling, general and administrative expenses which included $27.5 million in incremental research and development expenses. Selling, general and administrative expenses for 2013, as a percentage of sales, increased to 28.4%, compared with 24.9% for 2012 and reflected higher research and development costs and the LeCroy cost structure which has a higher selling, general and administrative expense percentage of sales than other instrumentation businesses.
Digital Imaging
| (Dollars in millions) | 2014 | 2013 | 2012 | |||||||||
| Sales | $ | 403.6 | $ | 414.8 | $ | 415.9 | ||||||
| Cost of sales | $ | 252.0 | $ | 263.7 | $ | 266.9 | ||||||
| Selling, general and administrative expenses | $ | 114.5 | $ | 122.9 | $ | 124.2 | ||||||
| Operating profit | $ | 37.1 | $ | 28.2 | $ | 24.8 | ||||||
| Cost of sales % of sales | 62.4 | % | 63.6 | % | 64.2 | % | ||||||
| Selling, general and administrative expenses % of sales | 28.4 | % | 29.6 | % | 29.8 | % | ||||||
| Operating profit % of sales | 9.2 | % | 6.8 | % | 6.0 | % | ||||||
| International sales % of sales | 50.2 | % | 49.0 | % | 46.1 | % | ||||||
| Governmental sales % of sales | 25.3 | % | 29.0 | % | 31.0 | % | ||||||
| Capital expenditures | $ | 10.3 | $ | 20.2 | $ | 23.5 |
Our Digital Imaging segment includes high performance sensors, cameras and systems, within the visible, infrared and X-ray spectra for use in industrial, government and medical applications, as well as MEMS. It also includes our sponsored and centralized research laboratories benefiting government programs and businesses.
2014 compared with 2013
Our Digital Imaging segment sales were $403.6 million in 2014, compared with sales of $414.8 million in 2013, a decrease of 2.7%. Operating profit was $37.1 million in 2014, compared with $28.2 million in 2013, an increase of 31.6%.
The 2014 sales decrease reflected increased sales of sensors and cameras for commercial machine vision applications, offset by lower sales of specialty imaging sensors, primarily for government applications. The increase in operating profit primarily reflected a greater mix of higher margin commercial sales and lower costs as a result of cost reduction actions taken in 2013, as well as lower research and development expense. Operating profit in 2014 included $2.7 million in severance and related expenses compared $3.9 million in severance and related expenses and a $1.2 million asset impairment charge in 2013.
Cost of sales for 2014 decreased by $11.7 million, compared with 2013, and primarily reflected lower costs as a result of cost reduction actions taken in 2013 and a greater mix of higher gross margin sales of sensors and cameras for commercial machine vision applications. The decrease in the cost of sales percentage primarily reflected lower costs as a result of cost reduction actions taken in 2013 and a greater mix of higher gross margin commercial sales. Selling, general and administrative expenses, for 2014, decreased to $114.5 million, compared with $122.9 million in 2013 and reflected lower research and development expenses. The selling, general and administrative expense percentage decreased to 28.4% in 2014 from 29.6% in 2013 and reflected lower expense in each major category of selling, general and administrative expense.
2013 compared with 2012
Our Digital Imaging segment sales were $414.8 million in 2013, compared with sales of $415.9 million in 2012, a decrease of 0.3%. Operating profit was $28.2 million in 2013, compared with $24.8 million in 2012, an increase of 13.7%.
The 2013 sales decrease primarily reflected lower sales of imagers for remote sensing applications, LIDAR systems and MEMS products, nearly offset by increased sales of sensors and cameras for commercial machine vision and medical applications. The increase in operating profit reflected improved margins across multiple product lines, partially offset by $3.9 million in severance and related expenses and a $1.2 million asset impairment charge. The incremental operating loss for 2013 from recent acquisitions was $4.3 million which reflected $0.4 million in additional intangible asset amortization and a $1.2 million asset impairment charge.
Cost of sales for 2013 decreased by $3.2 million, compared with 2012, and primarily reflected the impact of product mix differences, partially offset by $2.3 million in severance and related expenses. The decrease in the cost of sales percentage reflected the impact of the Optech acquisition, which carries a lower cost of sales percentage than the average for our other products in this segment. Selling, general and administrative expenses, for 2013, decreased slightly to $122.9 million, compared with $124.2 million in 2012. The selling, general and administrative expense percentage decreased slightly to 29.6% in 2013 from 29.8% in 2012.
Aerospace and Defense Electronics
| (Dollars in millions) | 2014 | 2013 | 2012 | |||||||||
| Sales | $ | 603.0 | $ | 625.1 | $ | 605.3 | ||||||
| Cost of sales | $ | 386.6 | $ | 434.6 | $ | 406.2 | ||||||
| Selling, general and administrative expenses | $ | 128.1 | $ | 124.8 | $ | 118.6 | ||||||
| Operating profit | $ | 88.3 | $ | 65.7 | $ | 80.5 | ||||||
| Cost of sales % of sales | 64.2 | % | 69.5 | % | 67.1 | % | ||||||
| Selling, general and administrative expenses % of sales | 21.2 | % | 20.0 | % | 19.6 | % | ||||||
| Operating profit % of sales | 14.6 | % | 10.5 | % | 13.3 | % | ||||||
| International sales % of sales | 32.2 | % | 34.0 | % | 28.6 | % | ||||||
| Governmental sales % of sales | 40.7 | % | 41.6 | % | 44.6 | % | ||||||
| Capital expenditures | $ | 8.8 | $ | 15.3 | $ | 12.6 |
Our Aerospace and Defense Electronics segment provides sophisticated electronic components and subsystems and communications products, including defense electronics, harsh environment interconnects, data acquisition and communications equipment for aircraft, and components and subsystems for wireless and satellite communications, as well as general aviation batteries.
2014 compared with 2013
Our Aerospace and Defense Electronics segment sales were $603.0 million in 2014, compared with sales of $625.1 million in 2013, a decrease of 3.5%. Operating profit was $88.3 million in 2014, compared with $65.7 million in 2013, an increase of 34.4%.
Sales for 2014 decreased by $22.1 million and reflected lower sales of $37.0 million from microwave and interconnect systems due to the completion of a program with a foreign government, which had sales of $44.3 million in 2013. Sales for 2014 also reflected increased sales of $17.8 million from avionics products and electronic relays and lower sales of $2.9 million from electronic manufacturing services products. Operating profit in 2014 increased by $22.6 million and reflected pension income of $1.2 million compared with $8.0 million of pension expense, and $0.9 million in severance and facility consolidation costs, compared with $15.7 million in severance and facility consolidation and environmental costs in 2013.
Cost of sales for 2014 decreased by $48.0 million, compared with 2013, and reflected the impact of lower sales, lower severance and facility consolidation costs and environmental reserves, as well as lower pension expense. Cost of sales as a percentage of sales for 2014 decreased to 64.2% from 69.5% in 2013 and reflected the impact of lower severance and facility consolidation costs, environmental reserves and lower pension expense. Selling, general and administrative expenses, including research and development and bid and proposal expense, increased to $128.1 million in 2014, compared with $124.8 million in 2013, and reflected $6.7 million in higher research and development and bid and proposal expense. The increase in the selling, general and administrative expense percentage to 21.2% for 2014, compared with 20.0% for 2013 reflected the impact of higher research and development and bid and proposal expense.
2013 compared with 2012
Our Aerospace and Defense Electronics segment sales were $625.1 million in 2013, compared with sales of $605.3 million in 2012, an increase of 3.3%. Operating profit was $65.7 million in 2013, compared with $80.5 million in 2012, a decrease of 18.4%.
Sales for 2013 increased by $19.8 million, compared with 2012, and reflected higher sales of $19.3 million from avionics products and electronic relays and higher sales of $3.1 million from microwave and interconnect systems, partially offset by lower sales of electronic manufacturing service products. Operating profit in 2013 reflected $10.4 million for severance and facility consolidation costs and a $5.3 million charge for estimated environmental liabilities, partially offset by the impact of higher sales. Operating profit in 2012 reflected $1.7 million for severance and facility consolidation costs.
Cost of sales for 2013 increased by $28.4 million, compared with 2012, and reflected the impact of higher sales, $13.6 million for severance and facility consolidation costs and environmental reserves, $3.6 million in higher pension expense and product mix differences. Cost of sales as a percentage of sales for 2013 increased to 69.5% from 67.1% in 2012 and reflected the impact of severance and facility consolidation costs, environmental reserves and product mix differences. Selling, general and administrative expenses, including research and development and bid and proposal expense, increased to $124.8 million in 2013, compared with $118.6 million in 2012, and reflected $2.1 million in severance and facility consolidation costs. The increase in the selling, general and administrative expense percentage to 20.0% for 2013, compared with 19.6% for 2012 reflected the impact of severance and facility consolidation costs.
Engineered Systems
| (Dollars in millions) | 2014 | 2013 | 2012 | |||||||||
| Sales | $ | 271.9 | $ | 275.9 | $ | 301.4 | ||||||
| Cost of sales | $ | 218.5 | $ | 230.8 | $ | 247.3 | ||||||
| Selling, general and administrative expenses | $ | 22.0 | $ | 23.1 | $ | 25.6 | ||||||
| Operating profit | $ | 31.4 | $ | 22.0 | $ | 28.5 | ||||||
| Cost of sales % of sales | 80.4 | % | 83.6 | % | 82.0 | % | ||||||
| Selling, general and administrative expenses % of sales | 8.1 | % | 8.4 | % | 8.5 | % | ||||||
| Operating profit % of sales | 11.5 | % | 8.0 | % | 9.5 | % | ||||||
| International sales % of sales | 9.0 | % | 12.4 | % | 11.6 | % | ||||||
| Governmental sales % of sales | 81.6 | % | 75.8 | % | 81.4 | % | ||||||
| Capital expenditures | $ | 4.3 | $ | 3.6 | $ | 4.2 |
Our Engineered Systems segment provides innovative systems engineering and integration, advanced technology development, and manufacturing solutions for defense, space, environmental and energy applications. This segment also designs and manufactures electrochemical energy systems and small turbine engines.
2014 compared with 2013
Our Engineered Systems segment sales were $271.9 million in 2014, compared with sales of $275.9 million in 2013, a decrease of 1.4%. Operating profit was $31.4 million in 2014, compared with $22.0 million in 2013, an increase of 42.7%.
The 2014 sales decrease of $4.0 million reflected lower sales of $6.1 million from engineered products and services, partially offset by higher sales of energy systems products of $1.6 million and higher turbine engines sales of $0.5 million. The sales decrease from engineered products and services, primarily reflected lower sales from missile defense and nuclear programs. The increase in operating profit in 2014 reflected the impact of pension income, compared with pension expense in 2013, lower severance and facility consolidation expenses, partially offset by the impact of lower sales. Pension income was $1.6 million for 2014, compared with pension expense of $6.7 million for 2013. Pension expense allocated to contracts pursuant to CAS was $8.8 million for 2014, compared with $8.5 million for 2013.
Cost of sales for 2014 decreased by $12.3 million, compared with 2013, and reflected the impact of lower sales and higher pension income. Cost of sales as a percentage of sales for 2014 decreased to 80.4%, compared with 83.6% in 2013 and reflected lower pension expense. Selling, general and administrative expenses, including research and development and bid and proposal expense, decreased to $22.0 million in 2014, compared with $23.1 million in 2013, and reflected the impact of lower sales and lower research and development and bid and proposal expenses of $0.5 million. The selling, general and administrative expense percentage decreased slightly to 8.1% for 2014, compared with 8.4% for 2013.
2013 compared with 2012
Our Engineered Systems segment sales were $275.9 million in 2013, compared with sales of $301.4 million in 2012, a decrease of 8.5%. Operating profit was $22.0 million in 2013, compared with $28.5 million in 2012, a decrease of 22.8%.
The 2013 sales decrease of $25.5 million reflected lower sales of $23.8 million from engineered products and services and lower sales of energy systems of $3.1 million, partially offset by higher turbine engines sales of $1.4 million. The sales decrease from engineered products and services, primarily reflected lower sales of defense and space programs. Operating profit in 2013 primarily reflected the impact of lower sales, $1.9 million in severance and facility consolidation expenses, as well as higher pension expense. Pension expense was $6.7 million for 2013, compared with $2.7 million for 2012. Pension expense allocated to contracts pursuant to CAS was $8.5 million for 2013, compared with $8.4 million for 2012.
Cost of sales for 2013 decreased by $16.5 million, compared with 2012, and reflected the impact of lower sales, partially offset by the severance and facility consolidation expenses and higher pension expense. Cost of sales as a percentage of sales for 2013 increased to 83.6%, compared with 82.0% in 2012 and reflected the severance and facility consolidation expenses and higher pension expense. Selling, general and administrative expenses, including research and development and bid and proposal expense, decreased to $23.1 million in 2013, compared with $25.6 million in 2012, and reflected the impact of lower sales and lower research and development and bid and proposal expenses of $1.6 million. The selling, general and administrative expense percentage decreased slightly to 8.4% for 2013, compared with 8.5% for 2012.
Financial Condition, Liquidity and Capital Resources
Principal Capital Requirements
Our principal capital requirements are to fund working capital needs, capital expenditures, voluntary and required pension contributions, debt service requirements, share repurchases and acquisitions. It is anticipated that operating cash flow, together with available borrowings under the credit facility described below, will be sufficient to meet these requirements and could be used to fund acquisitions in 2015. To support acquisitions, we may need to raise additional capital. Our liquidity is not dependent upon the use of off-balance sheet financial arrangements. We have no off-balance sheet financing arrangements that incorporate the use of special purpose or unconsolidated entities.
Revolving Credit Agreement, Senior Notes and Term Loans
In December 2014, the Company issued $125.0 million of senior unsecured notes which consisted of $30.0 million of 2.61% senior unsecured notes due December 2019, and $95.0 million of 3.09% senior unsecured notes due December 2021.
In March 2013, the Company amended its $550.0 million credit facility to increase the borrowing capacity to $750.0 million and extend the maturity date from February 2016 to March 2018. Excluding interest and fees, no payments are due under the credit facility until it matures. In November 2013, the Company amended its $200.0 million term loan agreements to extend the maturity dates from October 2015 to March 2019 and to lower the applicable interest rate. The credit agreements require the Company to comply with various financial and operating covenants, including maintaining certain consolidated leverage and interest coverage ratios. Borrowings under our credit facility and term loans are at variable rates which are, at our option, tied to a Eurocurrency rate equal to LIBOR (London Interbank Offered Rate) plus an applicable rate or a base rate as defined in our credit agreements. Eurocurrency rate loans may be denominated in U.S. dollars or an alternative currency as defined in the agreement. Eurocurrency or LIBOR based loans under the facility typically have terms of one, two, three or six months and the interest rate for each such loan is subject to change if the loan is continued or converted following the applicable maturity date. The Company has not drawn any loans with a term longer than three months under the credit facility. Base rate loans have interest rates that primarily fluctuate with changes in the prime rate. Interest rates are also subject to change based on our consolidated leverage ratio as defined in the credit agreement. The credit facility also provides for facility fees that vary between 0.125% and 0.30% of the credit line, depending on our consolidated leverage ratio as calculated from time to time.
Long-term debt consisted of the following (in millions):
| Balance at | December 28, 2014 | December 29, 2013 | ||||||
| 4.04% Senior Notes due September 2015 | $ | 75.0 | $ | 75.0 | ||||
| 4.74% Senior Notes due September 2017 | 100.0 | 100.0 | ||||||
| 2.61% Senior Notes due December 2019 | 30.0 | — | ||||||
| 5.30% Senior Notes due September 2020 | 75.0 | 75.0 | ||||||
| 3.09% Senior Notes due December 2021 | 95.0 | — | ||||||
| Term Loans due through March 2019, weighted average rate of 1.28% at December 28, 2014, and 1.29% at December 29, 2013 | 200.0 | 200.0 | ||||||
| Other debt at various rates due through 2031 | 14.7 | 16.0 | ||||||
| $750.0 million revolving credit facility, due March 2018, weighted average rate of 1.24% at December 28, 2014, and 1.26% at December 29, 2013 | 105.0 | 74.2 | ||||||
| Total debt | 694.7 | 540.2 | ||||||
| Less: current portion of long-term debt | (84.9 | ) | (2.1 | ) | ||||
| Total long-term debt | $ | 609.8 | $ | 538.1 |
The Company also has $10.4 million in capital leases, of which $1.3 million is current. At December 28, 2014, Teledyne had $16.8 million in outstanding letters of credit.
The credit agreements require the Company to comply with various financial and operating covenants, including maintaining certain consolidated leverage and interest coverage ratios, as well as minimum net worth levels and limits on acquired debt. At December 28, 2014, the Company was in compliance with these covenants and we had a significant amount of margin between required financial covenant ratios and our actual ratios. Currently, we do not believe our ability to undertake additional debt financing, if needed, is reasonably likely to be materially impacted by debt restrictions under our credit agreements subject to our complying with required financial covenants listed in the table below.
At December 28, 2014, the required financial covenant ratios and the actual ratios were as follows:
| $750.0 million Credit Facility expires March 2018 and $200.0 million term loans due March 2019 | |||
| Financial Covenant | Requirement | Actual Measure | |
| Consolidated Leverage Ratio (Net Debt/EBITDA) (a) | No more than 3.25 to 1 | 1.7 to 1 | |
| Consolidated Interest Coverage Ratio (EBITDA/Interest) (b) | No less than 3.0 to 1 | 19.8 to 1 | |
| $250.0 million Private Placement Notes due 2015, 2017 and 2020 and $125.0 million Private Placement Notes due 2019 and 2021 | |||
| Financial Covenant | Requirement | Actual Measure | |
| Consolidated Leverage Ratio (Net Debt/EBITDA) (a) | No more than 3.25 to 1 | 1.7 to 1 | |
| Consolidated Interest Coverage Ratio (EBITDA/Interest) (b) | No less than 3.0 to 1 | 19.8 to 1 |
| (a) | The Consolidated Leverage Ratio is equal to Net Debt/EBITDA as defined in our private placement note purchase agreement and our $750.0 million credit agreement. |
| (b) | The Consolidated Interest Coverage Ratio is equal to EBITDA/Interest as defined in our private placement note purchase agreement and our $750.0 million credit agreement. |
Available borrowing capacity under the $750.0 million credit facility, which is reduced by borrowings and outstanding letters of credit, was $629.7 million at December 28, 2014. The available borrowing capacity does not reflect the payment on February 2, 2015, of $134.9 million in connection with an accelerated share repurchase agreement. Teledyne also has a $5.0 million uncommitted credit line which permits credit extensions up to $5.0 million plus an incremental $2.0 million solely for standby letters of credit. This credit line is utilized, as needed, for periodic cash needs. No amounts are outstanding under this facility at December 28, 2014. The maximum amount that could be borrowed under our $750.0 million credit facility as of December 28, 2014 while still remaining in compliance with our consolidated leverage ratio covenant was $629.7 million.
Permanently Reinvested Earnings
We consider the earnings of material non-U.S. subsidiaries to be indefinitely invested outside the United States on the basis of estimates that future domestic cash generation will be sufficient to meet future domestic cash requirements. At December 28, 2014, the amount of undistributed foreign earnings was $170.4 million. We have not recorded a deferred tax liability of approximately $43.1 million related to the $170.4 million of undistributed foreign earnings. Should we decide to repatriate the foreign earnings, we would need to adjust our income tax provision in the period we determined that the earnings will no longer be indefinitely invested outside the United States.
Contractual Obligations
The following table summarizes our expected cash outflows resulting from financial contracts and commitments at December 28, 2014. We have not included information on our normal recurring purchases of materials for use in our operations. These amounts are generally consistent from year to year, closely reflect our levels of production and are not long-term in nature (in millions):
| Category | 2015 | 2016 | 2017 | 2018 | 2019 | After 2019 | Total | |||||||||||||||||||||
| Long-term debt obligations | $ | 84.9 | $ | 10.6 | $ | 120.3 | $ | 131.4 | $ | 177.5 | $ | 170.0 | $ | 694.7 | ||||||||||||||
| Interest expense(a) | 18.8 | 16.4 | 14.9 | 9.9 | 8.1 | 8.5 | 76.6 | |||||||||||||||||||||
| Operating lease obligations | 21.0 | 16.6 | 12.4 | 8.6 | 6.6 | 18.4 | 83.6 | |||||||||||||||||||||
| Capital lease obligations(b) | 1.6 | 1.6 | 1.4 | 1.4 | 1.4 | 5.3 | 12.7 | |||||||||||||||||||||
| Purchase obligations (c) | 72.5 | 5.0 | 1.2 | 1.1 | 0.8 | 1.1 | 81.7 | |||||||||||||||||||||
| Total | $ | 198.8 | $ | 50.2 | $ | 150.2 | $ | 152.4 | $ | 194.4 | $ | 203.3 | $ | 949.3 |
| (a) | Interest expense related to the credit facility, including facility fees, is assumed to accrue at the rates in effect at year-end 2014 and is assumed to be paid at the end of each quarter with the final payment in March 2019 when the credit facility expires. |
| (b) | Includes imputed interest and short-term portion. |
| (c) | Purchase obligations generally include contractual obligations for the purchase of goods and services. |
Unrecognized tax benefits of $32.3 million are not included in the table above because $1.3 million is offset by deferred tax assets, and the remainder cannot be reasonably estimated to be settled in cash due to a lack of prior settlement history.
At December 28, 2014, we are not required, and are not planning, to make any cash contributions to the domestic qualified pension plan for 2015. In addition, Teledyne does not expect to make any contributions to its foreign-based pension plans in 2015. Our minimum funding requirements after 2015, as set forth by ERISA, are dependent on several factors as discussed under “Accounting for Pension Plans” in the Critical Accounting Policies section of this Management’s Discussion and Analysis of Financial Condition and Results of Operation. Estimates beyond 2015 have not been provided due to the significant uncertainty of these amounts, which are subject to change until the Company’s pension assumptions can be updated at the appropriate times. In addition, certain pension contributions are eligible for future recovery through the pricing of products and services to the U.S. government under certain government contracts, therefore, the amounts noted are not necessarily indicative of the impact these contributions may have on our liquidity. We also have payments due under our other postretirement benefit plans. These plans are not required to be funded in advance, but are pay as you go. See further discussion in Note 12 of the Notes to Consolidated Financial Statements. Teledyne intends to continue to monitor and manage its defined pension benefit plans obligation and may take additional actions in the future.
Operating Activities
In 2014, net cash provided by operating activities was $287.9 million, compared with $203.3 million in 2013 and $189.2 million in 2012. The higher cash provided by operating activities in 2014, compared with 2013, reflected higher net income, the absence of pension contributions in 2014, while in 2013 we made a voluntary $83.0 million pretax cash contribution to the domestic pension plan, partially offset by higher income tax payments. The 2014 amount also reflected the receipt of $10.0 million related to a legal settlement. The higher cash provided by operating activities in 2013, compared with 2012, reflected lower cash contributions to the domestic pension plan and higher net income, partially offset by higher income tax payments. The 2012 net cash provided by operating activities includes $92.8 million in voluntary cash contributions to the domestic pension plan.
Free cash flow (cash provided by operating activities less capital expenditures) was $244.4 million in 2014, compared with $130.7 million in 2013 and $123.9 million in 2012. Adjusted free cash flow eliminates the impact of pension contributions on a net of tax basis and was $244.4 million in 2014, compared with $182.1 million in 2013 and $184.2 million in 2012.
| Free Cash Flow(a) (in millions, brackets indicate use of funds) | 2014 | 2013 | 2012 | ||||||||||
| Cash provided by operating activities | $ | 287.9 | $ | 203.3 | $ | 189.2 | |||||||
| Capital expenditures for property, plant and equipment | (43.5 | ) | (72.6 | ) | (65.3 | ) | |||||||
| Free cash flow | 244.4 | 130.7 | 123.9 | ||||||||||
| Pension contributions, net of tax(b) | — | 51.4 | 60.3 | ||||||||||
| Adjusted free cash flow | $ | 244.4 | $ | 182.1 | $ | 184.2 |
| a) | We define free cash flow as cash provided by operating activities (a measure prescribed by generally accepted accounting principles) less capital expenditures for property, plant and equipment. Adjusted free cash flow eliminates the impact of pension contributions on a net of tax basis. We believe that this supplemental non-GAAP information is useful to assist management and the investment community in analyzing our ability to generate cash flow, including the impact of voluntary and required pension contributions. |
| b) | All domestic pension cash contributions were voluntary. |
Working Capital
Working capital increased to $402.7 million at year-end 2014, compared with $381.0 million at year-end 2013. The increase reflected the impact the Bolt acquisition and higher cash balances, partially offset by an increase in current maturities of long term debt.
Balance Sheet Changes
The changes in the following selected components of Teledyne’s balance sheet are discussed below (in millions):
| 2014 | 2013 | |||||||
| Accounts receivable, net | $ | 400.7 | $ | 378.0 | ||||
| Inventories, net | $ | 311.8 | $ | 294.3 | ||||
| Property, plant and equipment, net | $ | 336.5 | $ | 357.7 | ||||
| Goodwill | $ | 1,150.6 | $ | 1,037.8 | ||||
| Acquired intangible assets, net | $ | 277.6 | $ | 270.9 | ||||
| Prepaid pension assets | $ | 86.3 | $ | 222.0 | ||||
| Long-term debt and capital lease obligations, net of current portion | $ | 618.9 | $ | 549.0 | ||||
| Accumulated other comprehensive loss | $ | 323.2 | $ | 165.5 |
The higher balances in accounts receivable, inventories, goodwill and acquired intangible assets were impacted by the acquisitions made in 2014. The accumulated other comprehensive loss increase reflects the non-cash adjustment of $97.5 million related to the increase in the unfunded pension liability in 2014 and $58.2 million of foreign currency changes. The lower balance in property, plant and equipment also reflected the impact of depreciation, partially offset by capital spending, and acquisitions made in 2014. Long-term debt increased and reflected the impact of funds used for acquisitions in 2014 and the 2011 stock repurchase program.
Investing Activities
Cash flows relating to investing activities consists primarily of cash used for acquisitions and capital expenditures. Net cash used in investing activities was $238.7 million, $195.0 million and $453.4 million for 2014, 2013 and 2012, respectively.
Capital Expenditures
Capital expenditures are presented below (in millions):
| 2014 | 2013 | 2012 | ||||||||||
| Instrumentation | $ | 17.0 | $ | 22.0 | $ | 14.4 | ||||||
| Digital Imaging | 10.3 | 20.2 | 23.5 | |||||||||
| Aerospace and Defense Electronics | 8.8 | 15.3 | 12.6 | |||||||||
| Engineered Systems | 4.3 | 3.6 | 4.2 | |||||||||
| Corporate | 3.1 | 11.5 | 10.6 | |||||||||
| $ | 43.5 | $ | 72.6 | $ | 65.3 |
The decrease in spending in 2014, compared with 2013, reflected the completion of several major projects during 2013, including expanding production capabilities and a resource planning software system. The 2013 amount also reflected expenditures related to facility consolidations. During 2015 we plan to invest approximately $60.0 million in capital expenditures, principally to upgrade capital equipment, reduce manufacturing costs and introduce new products. Commitments at December 28, 2014, for capital expenditures were approximately $5.2 million.
Acquisitions
Investing activities used cash for acquisitions and investments of $195.8 million, $128.2 million and $389.2 million, in fiscal 2014, 2013 and 2012, respectively (see “Recent Acquisitions”).
Teledyne funded the acquisitions primarily from borrowings under its credit facility and cash on hand.
For all acquisitions, the results of operations and cash flows are included in our consolidated financial statements from the date of each respective acquisition. The Axiom acquisition is part of the Digital Imaging segment. All other acquisitions in 2014, 2013 and 2012 are part of the Instrumentation segment.
The following table shows the purchase price (net of cash acquired), goodwill acquired and intangible assets acquired for the acquisitions and other investments made in fiscal 2014 and 2013 (in millions):
| 2014 | ||||||||||||||
| Acquisition | Acquisition Date | Purchase Price | Goodwill Acquired | Acquired Intangible Assets | ||||||||||
| Photon | March 30, 2014 | $ | 2.9 | $ | 1.4 | $ | 1.5 | |||||||
| Atlas | August 17, 2014 | 5.2 | 3.6 | 0.8 | ||||||||||
| Bolt | November 18, 2014 | 171.0 | 128.8 | 41.5 | ||||||||||
| Oceanscience | October 22, 2014 | 14.7 | 9.0 | 4.4 | ||||||||||
| Other investments | 2.0 | — | — | |||||||||||
| $ | 195.8 | $ | 142.8 | $ | 48.2 | |||||||||
| 2013 | ||||||||||||||
| Acquisition | Acquisition Date | Purchase Price | Goodwill Acquired | Acquired Intangible Assets | ||||||||||
| RESON | March 1, 2013 | $ | 69.7 | $ | 35.1 | $ | 25.5 | |||||||
| Axiom | May 8, 2013 | 4.0 | 3.4 | 0.3 | ||||||||||
| CETAC | August 30, 2013 | 26.4 | 11.1 | 6.7 | ||||||||||
| CDL | October 22, 2013 | 21.8 | 11.9 | 7.8 | ||||||||||
| Purchase of remaining interest of Nova Sensors | July 8, 2013 | 4.9 | — | — | ||||||||||
| Other investments | 1.4 | 1.0 | 0.3 | |||||||||||
| $ | 128.2 | $ | 62.5 | $ | 40.6 | |||||||||
Except for the CETAC, Atlas and Oceanscience acquisitions, goodwill resulting from the acquisitions made in fiscal 2014 and 2013 will not be deductible for tax purposes.
The following is a summary, at the acquisition date, of the estimated fair values of the assets acquired and liabilities assumed for the acquisitions and other investments made in fiscal 2014 and 2013 (in millions):
| 2014 | 2013 | |||||||
| Current assets, excluding cash acquired | $ | 34.0 | $ | 40.1 | ||||
| Property, plant and equipment | 8.7 | 8.3 | ||||||
| Goodwill | 142.8 | 62.5 | ||||||
| Intangible assets | 48.2 | 40.6 | ||||||
| Other long-term assets | 5.3 | — | ||||||
| Total assets acquired | 239.0 | 151.5 | ||||||
| Current liabilities, including short-term debt | (26.0 | ) | (21.4 | ) | ||||
| Other long-term liabilities | (17.2 | ) | (6.8 | ) | ||||
| Total liabilities assumed | (43.2 | ) | (28.2 | ) | ||||
| Noncontrolling interests (a) | — | 4.9 | ||||||
| Purchase price, net of cash acquired | $ | 195.8 | $ | 128.2 | ||||
| (a) Purchase of the remaining interest in Nova Sensors. |
Financing Activities
Cash provided by financing activities for 2014 reflected net proceeds from borrowings on long-term debt of $29.5 million, compared with net payments on long-term debt of $5.0 million for 2013 and net proceeds from borrowings of $229.2 million for 2012. In addition, in December 2014, the Company issued $125.0 million of senior unsecured notes, which consisted of $30.0 million of 2.61% senior unsecured notes due December 2019, and $95.0 million of 3.09% senior unsecured notes due December 2021. Fiscal years 2014, 2013 and 2012 reflect proceeds from the exercise of stock options of $18.3 million, $12.1 million and $19.9 million, respectively. Fiscal years 2014, 2013 and 2012 included $6.2 million, $5.4 million and $8.4 million, respectively, in excess tax benefits related to stock-based compensation. Cash provided by financing activities for 2014 also reflected the repurchase of common stock for $146.6 million.
Total debt at December 28, 2014, includes $375.0 million outstanding in senior notes, $200.0 million in term loans, $105.0 million outstanding under the $750.0 million credit facility and $14.7 million in other debt. The Company also has $10.4 million outstanding under capital leases, of which $1.3 million is current.
In October 2011, our Board of Directors approved a stock repurchase program (“2011 repurchase program”) authorizing the Company to repurchase up to 2,500,000 shares of its common stock. Shares may be repurchased from time to time in open market transactions at prevailing market prices or in privately negotiated transactions. In 2011, Teledyne repurchased 658,562 shares of Teledyne common stock for $34.9 million under the 2011 repurchase program. No repurchases were made in 2013 or 2012. As part of the 2011 repurchase program, in September 2014, the Company entered into a $101.6 million accelerated share repurchase (“ASR”) agreement with a financial institution (“ASR counterparty”) in a privately negotiated transaction for 1,030,000 shares of the Company’s common stock at an initial price of $98.62 per share. Pursuant to the ASR agreement, in September 2014, the Company advanced $101.6 million to the ASR counterparty and received 927,000 shares of common stock, which used $91.4 million of the $101.6 million advanced, representing 90% of the estimated shares to be repurchased under the ASR agreement. The up-front payment was accounted for as a reduction to stockholders’ equity in the Company’s Condensed Consolidated Balance Sheet in the period the payment was made. The total number of shares of common stock that the Company will repurchase under the ASR will be based on the average of the daily volume-weighted average prices of the common stock during the term of the ASR, less a discount. At settlement, the ASR Counterparty may be required to deliver additional shares of the Company’s common stock to the Company or, under certain circumstances, the Company may be required to deliver shares of its common stock or make a cash payment to the ASR Counterparty. Final settlement of the ASR agreement is expected to occur in June 2015, although the settlement may be accelerated at the ASR Counterparty’s option. The Company has treated the ASR as a treasury share repurchase of common stock in the period the shares are delivered for purposes of calculating earnings per share and as a forward contract indexed to its own common stock. The ASR meets all of the applicable criteria for equity classification, and, therefore, is not accounted for as a derivative instrument.
In 2014, the Company spent $146.6 million, which includes $101.6 million advanced under the ASR agreement, to repurchase a total of 1,396,290 shares of its common stock at an average price $97.70 per share common stock. Teledyne issues shares for share-based compensation plans from treasury stock. Teledyne had 1,042,281 shares of treasury stock at December 28, 2014. At December 28, 2014, 342,148 shares remain available for repurchase under the 2011 repurchase program.
On January 27, 2015, Teledyne’s Board of Directors approved an additional stock repurchase program authorizing the Company to repurchase up to an additional 2,500,000 shares of its common stock (“2015 repurchase program”), noting that 342,148 shares remain available for repurchase under the 2011 repurchase program. As part of the 2015 repurchase program, on February 2, 2015, the Company entered into a $142.0 million ASR agreement with a financial institution in a privately negotiated transaction for 1,500,000 shares of the Company's common stock at an initial price of $94.68 per share. Pursuant to the ASR agreement, in February 2015, the Company advanced $142.0 million to the ASR counterparty and received 1,425,000 shares of common stock, which used $134.9 million of the $142.0 million advanced, representing 95% of the estimated shares to be repurchased under the ASR agreement. The ASR was funded by cash on hand and floating rate borrowings of $120.0 million under the $750 million credit facility. The 2011 and 2015 repurchase programs are expected to remain open continuously, and the number of shares purchased will depend on a variety of factors, such as share price, levels of cash and borrowing capacity available, alternative investment opportunities available immediately or longer-term, and other regulatory, market or economic conditions. Future repurchases would be funded with cash on hand and borrowings under the Company’s credit facility.
Pension Plans
Teledyne has a domestic defined benefit pension plan covering substantially all U.S. employees hired before January 1, 2004, or approximately 18% of Teledyne’s active employees. As of January 1, 2004, new hires participate in a defined contribution plan. In 2014, Teledyne’s domestic pension plan was over 100% funded, thus no cash contribution was made. In 2013, Teledyne made a voluntary pretax contribution to its domestic qualified pension plan of $83.0 million, before recovery from the U.S. Government. In 2012, Teledyne made pretax cash contributions of approximately $92.8 million to its domestic pension plan before recovery from the U.S. Government. In connection with recent acquisitions the Company assumed
responsibility for a several defined benefit pension plans based in the United Kingdom, Switzerland and the Netherlands covering approximately 520 participants in total. For the company’s domestic pension plan, the discount rate for 2015 will decrease to 4.5% from 5.4% in 2014.
Other Matters
Income Taxes
Our income tax expense, deferred tax assets and liabilities, and reserves for unrecognized tax benefits reflect management’s best assessment of estimated current and future taxes to be paid. We are subject to income taxes in both the United States and numerous foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax expense.
The Company’s effective tax rate for 2014 was 23.6%, compared with 17.7% for 2013 and 28.7% for 2012. Fiscal years 2014, 2013 and 2012 included net discrete tax benefits of $8.9 million, $21.3 million and $5.4 million, respectively. These relate primarily to the remeasurement of uncertain tax positions, including expirations of the statute of limitations and the favorable resolution of a tax matter. Excluding these items the Company’s effective tax rates for fiscal years 2014, 2013 and 2012 would have been 26.7%, 27.1% and 31.0%, respectively. Total year 2014 also included $5.6 million in federal research and development tax credits. The lower 2013 effective tax rate, compared with the 2012 effective tax rate, excluding the net discrete tax benefits, primarily reflected increased federal tax credits for research and development, a lower state effective tax rate and a change in the portion of foreign and domestic income. Based on the Company’s history of operating earnings, expectations of future operating earnings and potential tax planning strategies, management believes that it is possible that some portion of deferred taxes will not be realized as a future tax benefit and therefore has recorded a valuation allowance. Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amount in the financial statements, which will result in taxable or deductible amounts in the future. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. In projecting future taxable income, we begin with historical results adjusted for the results of discontinued operations and incorporate assumptions about the amount of future state, federal and foreign pretax operating income adjusted for items that do not have tax consequences. The assumptions about future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative operating income.
We file income tax returns in the United States federal jurisdiction and in various states and foreign jurisdictions. The Company has substantially concluded on all U.S. federal income tax matters for all years through 2010, California income tax matters for all years through 2009 and Canadian income tax matters for all years through 2006. The Company does not believe that the resolution of any of the audits will have a material adverse effect on the Company’s results of operations. An appeal filed with a state tax authority for the 2011 tax year, if resolved favorably, could reduce income tax expense up to $1.0 million. Substantially all other material state, local and foreign income tax matters have been concluded for years through 2009.
Costs and Pricing
Inflationary trends in recent years have been moderate. Current inventory costs, the increasing costs of equipment and other costs are considered in establishing sales pricing policies. The Company emphasizes cost containment in all aspects of its business.
Hedging Activities; Market Risk Disclosures
Teledyne transacts business in various foreign currencies and has international sales and expenses denominated in foreign currencies, subjecting the Company to foreign currency risk. The Company’s primary objective is to protect the United States dollar value of future cash flows and minimize the volatility of reported earnings. Following the acquisition of DALSA, the Company began to utilize foreign currency forward contracts to reduce the volatility of cash flows primarily related to forecasted revenue and expenses denominated in Canadian dollars. These contracts are designated and qualify as cash flow hedges.
The effectiveness of the cash flow hedge contracts, excluding time value, is assessed prospectively and retrospectively on a monthly basis using regression analysis, as well as using other timing and probability criteria. To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedges and must be highly effective in offsetting changes to future cash flows on hedged transactions. The effective portion of the cash flow hedge contracts’ gains or losses resulting from changes in the fair value of these hedges is initially reported, net of tax, as a component of accumulated other comprehensive income (“AOCI”) in stockholders’ equity until the underlying hedged item is reflected in our consolidated statements of income, at which time the effective amount in accumulated other comprehensive income is reclassified to cost of sales in our consolidated statements of income. The Company expects to reclassify a loss of
approximately $2.9 million, net of tax, over the next 12 months based on the year-end 2014 exchange rate.
In the event that the gains or losses in AOCI are deemed to be ineffective, the ineffective portion of gains or losses resulting from changes in fair value, if any, is reclassified to other income and expense. In the event that the underlying forecasted transactions do not occur, or it becomes remote that they will occur, within the defined hedge period, the gains or losses on the related cash flow hedges will be reclassified from AOCI to other income and expense. During the current reporting period, all forecasted transactions occurred and, therefore, there were no such gains or losses reclassified to other income and expense. As of December 28, 2014, Teledyne had foreign currency forward contracts designated as cash flow hedges to buy Canadian dollars and to sell U.S. dollars totaling $76.3 million and these contracts had a negative fair value of $3.9 million. These foreign currency forward contracts have maturities ranging from March 2015 to June 2016.
In addition, the Company utilizes foreign currency forward contracts to mitigate foreign exchange rate risk associated with foreign currency denominated monetary assets and liabilities, including intercompany receivables and payables. As of December 28, 2014, Teledyne had foreign currency contracts of this type in the following currency pairs (in millions):
| Contracts to Buy | Contracts to Sell | |||||||
| Currency | Amount | Currency | Amount | |||||
| Canadian Dollar | C$ | 44.2 | U.S. Dollars | US$ | 39.5 | |||
| Euros | € | 1.0 | Canadian Dollar | C$ | 1.4 | |||
| Euros | € | 11.0 | U.S. Dollars | US$ | 14.0 | |||
| Great Britain Pounds | £ | 1.0 | Australian Dollars | A$ | 1.8 | |||
| Great Britain Pounds | £ | 20.9 | U.S. Dollars | US$ | 34.0 | |||
| U.S. Dollars | US$ | 16.3 | Euros | € | 13.0 | |||
| U.S. Dollars | US$ | 12.0 | Great Britain Pounds | £ | 7.7 | |||
| U.S. Dollars | US$ | 2.7 | Japanese Yen | ¥ | 305.0 | |||
| Singapore Dollar | S$ | 1.0 | U.S. Dollar | US$ | 0.8 |
These contracts had a negative fair value of $4.5 million at December 28, 2014. The gains and losses on these derivatives which are not designated as hedging instruments under ASC 815, Derivatives and Hedging, are intended to, at a minimum, partially offset the transaction gains and losses recognized in earnings. All derivatives are recorded on the balance sheet at fair value. As discussed below, the accounting for gains and losses resulting from changes in fair value depends on the use of the derivative and whether it is designated and qualifies for hedge accounting. Teledyne does not use foreign currency forward contracts for speculative or trading purposes.
Notwithstanding our efforts to mitigate portions of our foreign currency exchange rate risks, there can be no assurance that our hedging activities will adequately protect us against the risks associated with foreign currency fluctuations. A hypothetical 10% appreciation of the U.S. dollar from its value at December 28, 2014, would decrease the fair value of our foreign currency forward contracts associated with our cash flow hedging activities by $7.6 million. A hypothetical 10% depreciation of the U.S. dollar from its value at December 28, 2014, would increase the fair value of our foreign currency forward contracts associated with our cash flow hedging activities by $7.6 million.
Borrowings under our credit facility are at fixed rates that vary with the term and timing of each loan under the facility. Loans under the facility typically have terms of one, two, three or six months and the interest rate for each such loan is subject to change if the loan is continued or converted following the applicable maturity date. Interest rates are also subject to change based on our debt to earnings before interest, taxes, depreciation and amortization ratio. As of December 28, 2014, we had $105.0 million outstanding indebtedness under our $750.0 million credit facility. Any borrowings under the Company’s revolving credit line are based on a fluctuating market interest rate and, consequently, the fair value of any outstanding debt should not be affected materially by changes in market interest rates. A 100 basis point increase in interest rates would result in an increase in annual interest expense of approximately $1.1 million, assuming the $105.0 million in debt was outstanding for the full year.
We believe that adequate controls are in place to monitor any hedging activities. Our primary exposure to market risk relates to changes in interest rates and foreign currency exchange rates. We periodically evaluate these risks and have taken measures to mitigate these risks. We own assets and operate facilities in countries that have been politically stable.
Related Party Transactions
Dr. von Schack is a director of The Bank of New York Mellon Corporation. Dr. Mehrabian was also a director of The Bank of New York Mellon Corporation until his retirement on April 12, 2011. From May 2010 to July 2014, Ms. Sherburne served as Senior Executive Vice President, General Counsel and Corporate Secretary of The Bank of New York Mellon Corporation. The Bank of New York Mellon Corporation is the successor to Mellon Financial Corporation following its merger with The Bank of New York in 2007. Mr. Cahouet had served as Chairman, President and Chief Executive Officer of Mellon Financial Corporation and Mellon Bank, N.A., having retired on December 31, 1998. Mr. Cahouet ceased being a director of Mellon Financial Corporation on April 18, 2000. We maintain various arms-length banking relationships with The Bank of New York Mellon Corporation. On March 1, 2013, we entered into a $750.0 million credit facility under which The Bank of New York Mellon Corporation is one of 13 lenders, having committed to lend up to $60.0 million. The Bank of New York Mellon Corporation also provides cash management services, serves as trustee for the Teledyne Technologies Incorporated Pension Plan and, through its subsidiaries and affiliates, provides asset management and transition management services for the Pension Plan. Notwithstanding these relationships, our Board of Directors has determined that Ms. Sherburne, Mr. Cahouet and Dr. von Schack are “independent,” within the meaning of the rules of the New York Stock Exchange, and are able to serve on the Audit Committee and the Nominating and Governance Committee of Teledyne’s Board of Directors, in the case of Mr. Cahouet, on the Personnel and Compensation Committee and the Nominating and Governance Committee of Teledyne’s Board of Directors, in the case of Dr. von Schack and on the Personnel and Compensation Committee and the Audit Committee, in the case of Ms. Sherburne.
Environmental
We are subject to various federal, state, local and international environmental laws and regulations which require that we investigate and remediate the effects of the release or disposal of materials at sites associated with past and present operations. These include sites at which Teledyne has been identified as a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and comparable state laws. We are currently involved in the investigation and remediation of a number of sites. Reserves for environmental investigation and remediation totaled $9.7 million at December 28, 2014, and $9.1 million at December 29, 2013. As investigation and remediation of these sites proceed and new information is received, the Company expects that accruals will be adjusted to reflect new information. Based on current information, we do not believe that future environmental costs, in excess of those already accrued, will materially and adversely affect our financial condition or liquidity. However, resolution of one or more of these environmental matters or future accrual adjustments in any one reporting period could have a material adverse effect on our results of operations for that period. See also our environmental risk factor disclosure beginning at page 22.
For additional discussion of environmental matters, see Notes 2 and 15 to the Notes to Consolidated Financial Statements.
Government Contracts
We perform work on a number of contracts with the U.S. Department of Defense and other agencies and departments of the U.S. Government including sub-contracts with government prime contractors. Sales under these contracts with the U.S. Government, which included contracts with the U.S. Department of Defense, were approximately 25% of total sales in 2014, 27% of total sales in 2013 and 32% of total sales in 2012. For a summary of sales to the U.S. Government by segment, see Note 13 to the Notes to Consolidated Financial Statements. Sales to the U.S. Department of Defense represented approximately 20%, 21% and 26% of total sales for 2014, 2013 and 2012, respectively. See also our government contracts risks factor disclosure beginning at page 16.
Performance under government contracts has certain inherent risks that could have a material adverse effect on the Company’s business, results of operations and financial condition. Government contracts are conditioned upon the continuing availability of Congressional appropriations, which usually occurs on a fiscal year basis even though contract performance may take more than one year.
For information on accounts receivable from the U.S. Government, see Note 5 to the Notes to Consolidated Financial Statements.
Estimates and Reserves
Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an ongoing basis, we evaluate our estimates, including those related to product returns and replacements, allowance for doubtful accounts, inventories, intangible assets, income taxes, warranty obligations, pension and other postretirement benefits, long-term contracts, environmental, workers’ compensation and general liability, employee dental and medical benefits and other contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances at the time, the results of which form the basis for making our judgments. Actual results may differ materially from these estimates under different assumptions or conditions. In some cases, such differences may be material. See “Other Matters - Critical Accounting Policies.”
The following table reflects significant reserves and valuation accounts, which are estimates and based on judgments as described above, at December 28, 2014, and December 29, 2013 (in millions):
Reserves and Valuation Accounts (a)
| 2014 | 2013 | |||||||
| Allowance for doubtful accounts | $ | 7.8 | $ | 5.2 | ||||
| LIFO inventory reserves | $ | 16.5 | $ | 16.6 | ||||
| Other inventory reserves | $ | 55.3 | $ | 44.8 | ||||
| Workers’ compensation and general liability reserves(b) | $ | 8.9 | $ | 9.1 | ||||
| Warranty reserves(b) | $ | 18.5 | $ | 17.3 | ||||
| Environmental reserves(b) | $ | 9.7 | $ | 9.1 | ||||
| Other accrued liability reserves(b) | $ | 31.5 | $ | 28.6 |
(a) This table should be read in conjunction with the Notes to Consolidated Financial Statements.
(b) Includes both long-term and short-term reserves.
Some of the Company’s products are subject to specified warranties and the Company provides for the estimated cost of product warranties. We regularly assess the adequacy of our pre-existing warranty liabilities and adjust amounts as necessary based on a review of historic warranty experience with respect to the applicable business or products, as well as the length and actual terms of the warranties, which are typically one year. The product warranty reserve is included in current accrued liabilities and other long-term liabilities on the balance sheet. Changes in the Company’s product warranty reserve are as follows (in millions):
| 2014 | 2013 | 2012 | ||||||||||
| Balance at beginning of year | $ | 17.3 | $ | 17.8 | $ | 13.3 | ||||||
| Accruals for product warranties charged to expense | 6.6 | 4.4 | 9.6 | |||||||||
| Cost of product warranty claims | (5.9 | ) | (5.2 | ) | (6.9 | ) | ||||||
| Acquisitions | 0.5 | 0.3 | 1.8 | |||||||||
| Balance at year-end | $ | 18.5 | $ | 17.3 | $ | 17.8 |
Critical Accounting Policies
The preparation of our consolidated financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the notes to the financial statements. Some of those judgments can be subjective and complex, and therefore, actual results could differ materially from those estimates under different assumptions or conditions. Our critical accounting policies are those that are reflective of significant judgment, complexity and uncertainty, and may potentially result in materially different results under different assumptions and conditions. We have identified the following as critical accounting policies: revenue recognition; accounting for pension plans; accounting for business combinations, goodwill and other long-lived assets; and accounting for income taxes. For additional discussion of the application of these and other accounting policies, see Note 2 of the Notes to Consolidated Financial Statements.
Revenue Recognition
Revenue is recognized when the earnings process is substantially complete and all of the following criteria are met: 1) persuasive evidence of an arrangement exists; 2) delivery has occurred or services have been rendered; 3) our price to our customer is fixed or determinable; and 4) collectability is reasonably assured.
We determine the appropriate method by which we recognize revenue by analyzing the terms and conditions of our contracts or arrangements entered into with our customers. The majority of our revenue is recognized on certain product sales upon shipment to the customer, at fixed or determinable prices and with a reasonable assurance of collection, passage of title to the customer and fulfillment of all significant obligations. Revenue is recognized net of estimated sales returns and other allowances. The remaining revenue is generally associated with long-term contracts to design, develop and manufacture highly engineered products used in commercial or defense applications. Such contracts are generally accounted for using contract accounting, percentage-of-completion (“POC”) method.
The Company’s standard terms of sale are FOB shipping point. For a small percentage of sales where title and risk of loss passes at destination point, and assuming all other criteria for revenue recognition are met, the Company recognizes revenue after delivery to the customer. If any significant obligation to the customer with respect to a sales transaction remains following shipment, revenue recognition is deferred until such obligations have been fulfilled. In general, our revenue arrangements do not involve acceptance provisions based on customer specified acceptance criteria. In those circumstances when customer specified acceptance criteria exist, and if we cannot demonstrate that the system meets those specifications prior to the shipment, then revenue is deferred until customer acceptance is obtained. The Company does not offer substantial sales incentives and credits to customers.
We have a few contracts that require the Company to warehouse certain goods, for which revenue is recognized when all risks of loss is borne by the customer and all other criteria for revenue recognition are met.
We also have a small number of multiple elements arrangements (i.e., free product, training, installation, additional parts, etc.). If contract accounting does not apply, we allocate the contract price among the deliverables based on vendor-specific objective evidence of fair value to each element in the arrangement. If objective and reliable evidence of fair value of any element is not available, we use our best estimate of selling price for purposes of allocating the total arrangement consideration among the elements. Also, extended or non-customary warranties do not represent a significant portion of our revenue; however when our revenue arrangements include an extended or non-customary warranty provision the revenue is deferred and recognized ratably over the extended warranty period.
Contracts that require substantial performance over a long time period (generally one or more years), revenues are recorded under the POC method. We record net revenue and an estimated profit as work on our contracts progresses. The POC method for these contracts is dependent on the nature of the contract or products provided. Depending on the contract, we may measure the extent of progress toward completion using the units-of-delivery method, cost-to-cost method or upon attainment of scheduled performance contract milestones which could be time, event or expense driven. For example, for cost-reimbursable contracts we use the cost-to-cost method to measure progress toward completion. Under the cost-to-cost method of accounting, we recognize revenue and an estimated profit as allowable costs are incurred based on the proportion that the incurred costs bear to total estimated costs. Another example, for contracts that require us to provide a substantial number of similar items, we record revenue and an estimated profit on a POC basis using units-of-delivery as the basis to measure progress toward completing the contract. Occasionally, it is appropriate to combine individual customer orders and treat them as one arrangement when the underlying agreement was reached with the customer for a single large project.
The percentage of Company revenue recognized using the POC method was 28.7% in 2014, 32.1% in 2013 and 36.7% in 2012.
Accounting for contracts using the POC method requires management judgment relative to assessing risks, estimating contract revenue and cost, and making assumptions for schedule and technical issues. Contract revenue may include estimated amounts not contractually agreed to by the customer, including price redetermination, cost or performance incentives (such as award and incentives fees), un-priced change orders, claims and requests for equitable adjustment. The POC method requires management’s judgment to make reasonably dependable cost estimates generally over a long time period. Since certain contracts extend over a long period of time, the impact of revisions in cost and revenue estimates during the progress of work may adjust the current period earnings on a cumulative catch-up basis. This method recognizes, in the current period, the cumulative effect of the changes on current and prior quarters. Additionally, if the current contract estimate indicates a loss, a provision is made for the total anticipated loss in the period that it becomes evident. Contract cost and revenue estimates for significant contracts are generally reviewed and reassessed at least quarterly.
The net effect of the favorable and unfavorable changes in estimates were expense of $3.0 million in 2014, $1.8 million in 2013 and $1.2 million in 2012. The gross aggregate effects of these favorable and unfavorable changes in estimates in 2014, 2013 and 2012 were $22.9 million, $21.4 million and $18.0 million of favorable operating income and $25.9 million, $23.2 million and $19.2 million of unfavorable operating income, respectively. We do not believe that any discrete event or
adjustment to an individual contract within the aggregate changes in contract estimates for 2014, 2013 or 2012 was material to the consolidated statements of income for such annual periods.
Accounting for Pension Plans
Teledyne has a defined benefit pension plan covering substantially all U.S. employees hired before January 1, 2004, or approximately 18% of Teledyne’s active employees. As of January 1, 2004, new hires participate in a defined contribution plan. In connection with recent acquisitions, the Company assumed responsibility for several smaller foreign-based benefit pension plans. At December 28, 2014, the benefit obligation for the domestic defined benefit pension plan totaled $878.4 million and the fair value of the net plan assets were $957.4 million. At December 28, 2014, the benefit obligation for the foreign-based pension plans totaled $61.0 million and the fair value of the net plan assets were $47.7 million. The Company’s accounting for its defined benefit pension plan requires that amounts recognized in financial statements be determined on an actuarial basis, rather than as contributions are made to the plan. In consultation with our actuaries, we determine the appropriate assumptions for use in determining the liability for future pension benefits. Significant assumptions used in determining the Company’s pension income or expense is the expected long-term rate of return on plan assets, participant mortality estimates, expected rates of increase in future compensation levels, employee turnover, as well as the assumed discount rate on pension obligations. The Company has assumed, based upon the types of securities the plan assets are invested in and the long-term historical returns of these investments, that the long-term expected return on pension assets will be 8.25% in 2015 for its domestic pension plan and the assumed discount rate will be 4.5% in 2015 for its domestic pension plan. The Company’s long-term expected return on pension assets used in 2014 was 8.25% for its domestic pension plans and the assumed discount rate used in 2014 was 5.4%. The actual rate of return on pension assets was 5.4% in 2014 and 19.6% in 2013 for its domestic pension plan. If the actual rate of return on pension assets is below the projection, the Company may be required to make additional contributions to the pension trust. At December 28, 2014, the domestic plan is over-funded and contributions are not required. The Company did not make any cash contributions to its domestic pension benefit plan in 2014 and made a voluntary pretax cash contribution of $83.0 million in 2013, before recovery from the U.S. Government. Recently, the Society of Actuaries released revised mortality tables, which update life expectancy assumptions. In consideration of these tables, we modified the mortality assumptions used in determining our pension and post-retirement benefit obligations as of December 28, 2014. The impact of these new mortality assumptions has resulted in an increase to our pension obligation and an increase in future pension expense. Our plan remains over-funded after the impact of the new mortality assumptions, as well as from changes to other relevant assumptions. At year-end 2014 the Company has a $229.3 million non-cash reduction to stockholders’ equity and a long-term additional liability of $365.4 million related to its pension plans. At year-end 2013, the Company had a $133.2 million non-cash reduction to stockholders’ equity and a long-term additional liability of $214.0 million related to its pension plans. See Note 12 of the Notes to Consolidated Financial Statements for additional pension disclosures.
Differences in the discount rate and expected long-term rate of return on assets within the indicated range would have had the following impact on 2014 pension expense (in millions):
| 0.25 Percentage Point Increase | 0.25 Percentage Point Decrease | |||||||
| Increase (decrease) to pension expense resulting from: | ||||||||
| Change in discount rate | $ | (2.0 | ) | $ | 2.0 | |||
| Change in long-term rate of return on plan assets | $ | (2.3 | ) | $ | 2.3 |
See Note 12 of the Notes to Consolidated Financial Statements for additional pension disclosures.
Accounting for Business Combinations, Goodwill, Acquired Intangible Assets and Other Long-Lived Assets
The results for all acquisitions are included in the Company’s consolidated financial statements from the date of each respective acquisition. Business acquisitions are accounted for under the purchase method by assigning the purchase price to tangible and intangible assets acquired and liabilities assumed. Assets acquired and liabilities assumed are recorded at their fair values and the excess of the purchase price over the amounts assigned is recorded as goodwill. We determine the fair value of such assets and liabilities, generally in consultation with third-party valuation advisors. Purchased intangible assets with finite lives are amortized over their estimated useful lives. Adjustments to fair value assessments are recorded to goodwill over the purchase price allocation period.
Goodwill and acquired intangible assets with indefinite lives are not amortized. We review goodwill and acquired indefinite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. The Company also performs an annual impairment test in the fourth quarter of each year. We would test goodwill and acquired indefinite-lived intangible assets for impairment between annual tests if events occur or circumstances change that would more likely than not reduce our enterprise fair value below its book value. These events or circumstances could include a significant change in the business climate, including a significant sustained decline in an entity’s market value, legal factors, operating performance indicators, competition, sale or disposition of a significant
portion of the business, or other factors. Based on a quarterly impairment test completed in 2014, the Company recorded a $0.7 million impairment to acquired intangible assets. Based on the annual impairment test completed in the fourth quarter of 2013, the Company recorded a $1.2 million impairment to acquired intangible assets. No impairment of goodwill was indicated in 2014 or 2013, based on the annual impairment test completed in the fourth quarter of each year.
For goodwill impairment testing, the Company estimates the fair value of the reporting units, using a discounted cash flow model based on our best estimate of amounts and timing of future revenues and cash flows and our most recent business and strategic plans, and compares the estimated fair value to the carrying value of the reporting unit, including goodwill. The discounted cash flow model requires judgmental assumptions about projected revenue growth, future operating margins, discount rates and terminal values over a multi-year period. There are inherent uncertainties related to these assumptions and management's judgment in applying them to the analysis of goodwill impairment. While the Company believes it has made reasonable estimates and assumptions to calculate the fair value of its reporting units, it is possible a material change could occur. If actual results are not consistent with management’s estimates and assumptions, goodwill may be overstated and a charge would need to be taken against net earnings.
As of December 28, 2014, the Company had 26 reporting units for goodwill impairment testing. The carrying value of goodwill included in the Company’s individual reporting units ranges from $0.9 million to $275.1 million. The Company’s analysis in 2014 indicated that in all instances, the fair value of the Company’s reporting units exceeded their carrying values and consequently did not result in an impairment charge. The excess of the estimated fair value over the carrying value (expressed as a percentage of carrying value of the respective reporting unit) for each of the Company’s reporting units as of the fourth quarter of 2014, the annual testing date, ranged from approximately 57% to 5,670%.
Changes in these projections could affect the estimated fair value of certain of the Company’s reporting units and could result in a goodwill impairment charge in a future period. In order to evaluate the sensitivity of the fair value calculations used in the goodwill impairment test, the Company applied a hypothetical 10% decrease to the fair values of each reporting unit and compared those values to the reporting unit carrying values. Based on this sensitivity analysis, the Company did not identify any goodwill impairment. Due to the many variables inherent in the estimation of a reporting unit’s fair value and the relative size of our recorded goodwill, differences in assumptions may have a material effect on the results of our impairment analysis.
The impairment test for indefinite-lived intangibles other than goodwill (primarily trademarks and trade names) consists of a comparison of the fair value of the indefinite-lived intangible asset to the carrying value of the asset as of the impairment testing date. The Company estimates the fair value of its indefinite-lived intangibles using a discounted cash flow model based on our best estimate of amounts and timing of future revenues and cash flows and our most recent business and strategic plans, and compares the estimated fair value to the carrying value of the asset. The estimated fair values exceed the carrying value for each of the Company’s indefinite-lived intangible assets as of the fourth quarter of 2014, the annual testing date.
Accounting for Income Taxes
Income tax expense and deferred tax assets and liabilities reflect management’s assessment of actual future taxes to be paid on items reflected in the financial statements. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. Uncertainty exists regarding tax positions taken in previously filed tax returns still under examination and positions expected to be taken in the current year and future returns. Deferred tax assets and liabilities arise due to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax carryforwards. Although we believe our income tax expense and deferred tax assets and liabilities are reasonable, no assurance can be given that the final tax outcome will not be different from that which is reflected in our historical income tax provisions and accruals. To the extent that the final tax outcome is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of uncertain tax benefits that are considered appropriate, as well as the related net interest.
Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence including past operating results, estimates of future taxable income and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.
We record uncertain tax benefits on the basis of a two-step process whereby (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the “more-likely-than-not” recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.
An increase of 1% in our nominal tax rate would have resulted in additional income tax provision from continuing operations for the fiscal year ended December 28, 2014, of $2.8 million. For a description of the Company’s tax accounting policies, refer to Note 2 and Note 11 to the Company’s Consolidated Financial Statements.
Recent Accounting Pronouncements
Effective December 30, 2013, the first day of our 2014 fiscal year, the Company adopted accounting guidance related to the presentation of an unrecognized tax benefit when a net operating loss carryforward (“NOL”), a similar tax loss or a tax credit carryforward exists. Under the guidance, an entity will be required to present an unrecognized tax benefit as a reduction of a deferred tax asset for a NOL or tax credit carryforward whenever the NOL or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. The Company's adoption of the guidance did not have a material impact on its consolidated financial statements.
In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, which provides a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will supersede most current revenue recognition guidance. This new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and can be adopted either retrospectively to each prior reporting period presented or as a cumulative-effect adjustment as of the date of adoption, with early application not permitted. The Company is currently in the process of determining its implementation approach and assessing the impact on the consolidated financial statements and footnote disclosures.
Safe Harbor Cautionary Statement Regarding Forward-Looking Information
This Management’s Discussion and Analysis of Financial Condition and Results of Operation contains forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, directly and indirectly relating to earnings, growth opportunities, product sales, capital expenditures, pension matters, stock option compensation expense, the credit facility, interest expense, severance and relocation costs, environmental remediation cost, stock repurchases, taxes, exchange rates and strategic plans. All statements made in this Management’s Discussion and Analysis of Financial Condition and Results of Operation that are not historical in nature should be considered forward-looking. Actual results could differ materially from these forward-looking statements.
Many factors could change the anticipated results, including: disruptions in the global economy; changes in demand for products sold to the defense electronics, instrumentation, digital imaging, energy exploration and production, commercial aviation, semiconductor and communications markets; funding, continuation and award of government programs; and cuts to defense spending resulting from existing and future deficit reduction measures; threats to the security of our confidential and proprietary information, including cyber security threats. Lower oil and natural gas prices, as well as instability in the Middle East or other oil producing regions, and new regulations or restrictions relating to energy production, including with respect to hydraulic fracturing could negatively affect our businesses that supply the oil and gas industry. Increasing fuel costs could negatively affect the markets of our commercial aviation businesses. In addition, financial market fluctuations affect the value of our pension assets. Changes in the policies of U.S. and foreign governments could result, over time, in reductions or realignment in defense or other government spending and further changes in programs in which the Company participates.
While Teledyne’s growth strategy includes possible acquisitions, we cannot provide any assurance as to when, if or on what terms any acquisitions will be made. Acquisitions involve various inherent risks, such as, among others, our ability to integrate acquired businesses, retain customers and achieve identified financial and operating synergies. There are additional risks associated with acquiring, owning and operating businesses outside of the United States, including those arising from U.S. and foreign government policy changes or actions and exchange rate fluctuations.
We continue to take action to assure compliance with the internal controls, disclosure controls and other requirements of the Sarbanes-Oxley Act of 2012. While we believe our control systems are effective, there are inherent limitations in all control systems, and misstatements due to error or fraud may occur and may not be detected.
Additional information concerning factors that could cause actual results to differ materially from those projected in the forward-looking statements is contained beginning on page 13 of this Form 10-K under the caption “Risk Factors; Cautionary Statement as to Forward-Looking Statements.” Forward-looking statements are generally accompanied by words such as “estimate”, “project”, “predict”, “believes” or “expect”, that convey the uncertainty of future events or outcomes. We assume no obligation to publicly update or revise any forward-looking statements, whether as a result of new information or otherwise.
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