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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 electronics 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 three acquisitions in 2015, four acquisitions in 2014 and four acquisitions in 2013. On June 5, 2015, Teledyne DALSA BV, a Netherlands-based subsidiary, acquired Industrial Control Machines SA (“ICM”) a leading supplier of portable X-ray generators for non-destructive testing applications, as well as complete X-ray imaging systems for on-site security screening. On April 29, 2015, Teledyne DALSA, Inc. acquired the remaining 49% noncontrolling interest in the parent company of Optech Incorporated (“Optech”). On February 2, 2015, Teledyne acquired Bowtech Products Limited (“Bowtech”) through a U.K.-based subsidiary. Bowtech designs and manufactures harsh underwater environment vision systems. In 2015, Teledyne made an additional investment in Ocean Aero, Inc. (“Ocean Aero”) and now owns a 36.9% interest in Ocean Aero which is accounted for under the equity method. Also in 2015, we acquired a product line for $3.0 million of which an initial payment of $2.7 million was made in 2015.
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 initial investment in Ocean Aero, Inc.
During 2013 and continuing into 2014 and 2015, 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. In 2015 and 2014, we incurred $8.4 million and $4.4 million, respectively, primarily for severance related costs. While the 2015 actions and related cash payments were substantially completed by year-end, we continue to seek cost reductions in our businesses.
With our recent acquisitions, 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 2015, Teledyne’s sales were approximately 74% to commercial and international customers and 26% to the U.S. Government compared with about 75% commercial and international customers and 25% U.S. government in 2014. Our international sales have increased to 44% of total sales in 2015, compared with 39% in 2012.
Recent Acquisitions
The Company spent $66.7 million, $195.8 million and $128.2 million on acquisitions and investments in 2015, 2014 and 2013, respectively.
On June 5, 2015, Teledyne DALSA BV, a Netherlands-based subsidiary, acquired Industrial Control Machines SA (“ICM”) for an initial payment of $21.4 million, net of cash acquired. The Company paid a $0.4 million purchase price adjustment in 2015. An additional $2.6 million of the purchase price is subject to an indemnification holdback, all or a portion of which is payable in December 2016. Based in Liège, Belgium, ICM is a leading supplier of portable X-ray generators for non-destructive testing applications, as well as complete X-ray imaging systems for on-site security screening and is part of the Digital Imaging segment.
On April 29, 2015, Teledyne DALSA, Inc. acquired the remaining 49% noncontrolling interest in the parent company of Optech Incorporated (“Optech”) for $22.0 million in cash. As a result of the purchase, the difference between the cash paid and the balance of noncontrolling interest was recorded to additional paid-in capital. The balance of the noncontrolling interest of $41.2 million at December 28, 2014 decreased by $0.3 million for the net loss and $1.3 million in translation adjustments prior to the purchase which eliminated the remaining balance. The balance of the noncontrolling interest of $47.0 million at December 29, 2013 decreased by $2.1 million for the net loss and $3.7 million in translation adjustments, resulting in a balance of $41.2 million at December 28, 2014. Teledyne no longer has any noncontrolling interests. Optech is part of the Digital Imaging segment.
On February 2, 2015, Teledyne acquired Bowtech Products Limited (“Bowtech”) through a U.K.-based subsidiary for $18.9 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 and is part of the Instrumentation segment.
Also in 2015, Teledyne made an additional $1.3 million investment in Ocean Aero, Inc. (“Ocean Aero”) and now owns a 36.9% interest in Ocean Aero which is accounted for under the equity method. Based in Poway, California, Ocean Aero is designing an unmanned surface vehicle that will also have the ability to descend subsea. Also in 2015, we acquired a product line for $3.0 million of which an initial payment of $2.7 million was made in 2015.
Teledyne funded the purchases from borrowings under its credit facility and cash on hand. The ICM, Bowtech and Optech acquisitions were funded with cash held by foreign subsidiaries. The results of the acquisitions have been included in Teledyne’s results since the dates of the respective acquisition.
During 2014, Teledyne made 4 acquisitions, the largest of which was Bolt Technology Corporation (“Bolt”) in November 2014.
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, to enhance our capabilities related to marine sensor platforms and unmanned surface vehicles. On August 18, 2014, a subsidiary of Teledyne acquired assets of Atlas Hydrographic GmbH (“Atlas”) for $5.2 million. We acquired assets of Atlas to add marine sonar systems for mid and deep water applications. On March 31, 2014, a subsidiary of Teledyne acquired Photon Machines, Inc. (“Photon”) for an initial payment of $3.3 million. We acquired Photon to supplement our offerings of laser-based sample introduction equipment for laboratory instrumentation. On July 1, 2014, Teledyne made an initial investment in Ocean Aero.
All of the 2014 acquisitions are part of the Instrumentation segment.
On March 1, 2013, a subsidiary of Teledyne acquired all the outstanding shares of RESON A/S (“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 is part of the Instrumentation segment.
On October 22, 2013, a subsidiary of Teledyne acquired C.D. Limited (“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. We acquired 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. CDL is part of the Instrumentation segment.
On August 30, 2013, a subsidiary of Teledyne acquired SD Acquisition, Inc. d/b/a CETAC Technologies (“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. We acquired CETAC to expand our automated sample handling and sample introduction equipment for laboratory instrumentation capabilities. CETAC is part of the Instrumentation segment.
On July 8, 2013, a subsidiary of Teledyne purchased the remaining 49% interest in Nova Research, Inc. (“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. Also in 2013, the Company spent $1.4 million on the purchase of a product line.
On May 8, 2013, a subsidiary of Teledyne acquired Axiom IC B.V. (“Axiom”), for an initial payment of $4.0 million, net of cash acquired. Axiom, located in the Netherlands, is a fabless semiconductor company that develops high-performance CMOS mixed-signal integrated circuits and is part of the Digital Imaging segment.
See Note 3 to our Consolidated Financial Statements for additional information about our recent acquisitions.
Consolidated Operating Results
Our fiscal year is determined based on a 52- or 53-week convention ending on the Sunday nearest to December 31. Fiscal year 2015 contained 53 weeks and fiscal years 2014 and 2013 each contained 52 weeks. The following are selected financial highlights for 2015, 2014 and 2013 (in millions, except per-share amounts):
| 2015 | 2014 | 2013 | ||||||||||
| Sales | $ | 2,298.1 | $ | 2,394.0 | $ | 2,338.6 | ||||||
| Costs and Expenses | ||||||||||||
| Cost of sales | 1,427.8 | 1,487.1 | 1,500.0 | |||||||||
| Selling, general and administrative expenses | 588.6 | 612.4 | 598.3 | |||||||||
| Total costs and expenses | 2,016.4 | 2,099.5 | 2,098.3 | |||||||||
| Operating Income | 281.7 | 294.5 | 240.3 | |||||||||
| Interest and debt expense, net | (23.9 | ) | (19.0 | ) | (20.4 | ) | ||||||
| Other income, net | 0.4 | 6.6 | 4.1 | |||||||||
| Income before income taxes | 258.2 | 282.1 | 224.0 | |||||||||
| Provision for income taxes | 62.7 | 66.5 | 39.5 | |||||||||
| Net income | 195.5 | 215.6 | 184.5 | |||||||||
| Noncontrolling interest | 0.3 | 2.1 | 0.5 | |||||||||
| Net income attributable to Teledyne | $ | 195.8 | $ | 217.7 | $ | 185.0 | ||||||
| Basic earnings per common share | $ | 5.55 | $ | 5.87 | $ | 4.96 | ||||||
| Diluted earnings per common share | $ | 5.44 | $ | 5.75 | $ | 4.87 | ||||||
Our businesses are aligned in 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 2015, 2014 and 2013 are summarized in the following table:
| Percentage of Total Sales | |||||||||
| Segment contribution to total sales: | 2015 | 2014 | 2013 | ||||||
| Instrumentation | 46 | % | 47 | % | 44 | % | |||
| Digital Imaging | 16 | % | 17 | % | 18 | % | |||
| Aerospace and Defense Electronics | 26 | % | 25 | % | 26 | % | |||
| Engineered Systems | 12 | % | 11 | % | 12 | % | |||
| 100 | % | 100 | % | 100 | % |
Results of Operations
2015 compared with 2014
| Sales | 2015 | 2014 | % Change | |||||||||
| (in millions) | ||||||||||||
| Instrumentation | $ | 1,051.1 | $ | 1,115.5 | (5.8 | )% | ||||||
| Digital Imaging | 379.0 | 403.6 | (6.1 | )% | ||||||||
| Aerospace and Defense Electronics | 593.4 | 603.0 | (1.6 | )% | ||||||||
| Engineered Systems | 274.6 | 271.9 | 1.0 | % | ||||||||
| Total sales | $ | 2,298.1 | $ | 2,394.0 | (4.0 | )% | ||||||
| Results of operations | 2015 | 2014 | % Change | |||||||||
| (in millions) | ||||||||||||
| Instrumentation | $ | 171.0 | $ | 181.6 | (5.8 | )% | ||||||
| Digital Imaging | 40.0 | 37.1 | 7.8 | % | ||||||||
| Aerospace and Defense Electronics | 84.8 | 88.3 | (4.0 | )% | ||||||||
| Engineered Systems | 26.1 | 31.4 | (16.9 | )% | ||||||||
| Corporate expense | (40.2 | ) | (43.9 | ) | (8.4 | )% | ||||||
| Operating income | 281.7 | 294.5 | (4.3 | )% | ||||||||
| Interest and debt expense, net | (23.9 | ) | (19.0 | ) | 25.8 | % | ||||||
| Other income, net | 0.4 | 6.6 | (93.9 | )% | ||||||||
| Income before income taxes | 258.2 | 282.1 | (8.5 | )% | ||||||||
| Provision for income taxes | 62.7 | 66.5 | (5.7 | )% | ||||||||
| Net income | 195.5 | 215.6 | (9.3 | )% | ||||||||
| Noncontrolling interest | 0.3 | 2.1 | (85.7 | )% | ||||||||
| Net income attributable to Teledyne | $ | 195.8 | $ | 217.7 | (10.1 | )% | ||||||
Sales and cost of sales by segment and total company:
| 2015 | 2014 | Change | |||||||||
| Instrumentation | (dollars in millions) | ||||||||||
| Sales | $ | 1,051.1 | $ | 1,115.5 | $ | (64.4 | ) | ||||
| Cost of sales | $ | 589.8 | $ | 630.0 | $ | (40.2 | ) | ||||
| Cost of sales % of sales | 56.1 | % | 56.5 | % | |||||||
| Digital Imaging | |||||||||||
| Sales | $ | 379.0 | $ | 403.6 | $ | (24.6 | ) | ||||
| Cost of sales | $ | 228.0 | $ | 252.0 | $ | (24.0 | ) | ||||
| Cost of sales % of sales | 60.1 | % | 62.4 | % | |||||||
| Aerospace and Defense Electronics | |||||||||||
| Sales | $ | 593.4 | $ | 603.0 | $ | (9.6 | ) | ||||
| Cost of sales | $ | 383.8 | $ | 386.6 | $ | (2.8 | ) | ||||
| Cost of sales % of sales | 64.7 | % | 64.2 | % | |||||||
| Engineered Systems | |||||||||||
| Sales | $ | 274.6 | $ | 271.9 | $ | 2.7 | |||||
| Cost of sales | $ | 226.2 | $ | 218.5 | $ | 7.7 | |||||
| Cost of sales % of sales | 82.4 | % | 80.4 | % | |||||||
| Total Company | |||||||||||
| Sales | $ | 2,298.1 | $ | 2,394.0 | $ | (95.9 | ) | ||||
| Cost of sales | $ | 1,427.8 | $ | 1,487.1 | $ | (59.3 | ) | ||||
| Cost of sales % of sales | 62.1 | % | 62.1 | % |
We reported 2015 sales of $2,298.1 million, compared with sales of $2,394.0 million for 2014, a decrease of 4.0%. Net income attributable to Teledyne was $195.8 million ($5.44 per diluted share) for 2015, compared with net income attributable to Teledyne of $217.7 million ($5.75 per diluted share) for 2014, a decrease of 10.1%. Total year 2015 and 2014 reflected pretax charges totaling $8.4 million and $4.2 million, respectively, for severance charges. Net income for 2015 and 2014 also included net discrete tax benefits of $9.8 million and $8.9 million, respectively.
Sales
The decrease in sales in 2015, compared with 2014, reflected lower sales in each segment except the Engineered Systems segment. Sales in the Instrumentation segment reflected $32.1 million of incremental sales from recent acquisitions while sales in the Digital Imaging segment reflected $6.8 million of incremental sales from a recent acquisition. The incremental increase in revenue in 2015 from businesses acquired in 2015 and in 2014 was $38.9 million.
Sales under contracts with the U.S. Government were approximately 26% of sales in 2015 and 25% of sales in 2014. Sales to international customers represented approximately 44% of sales in 2015 and 45% of sales in 2014.
Cost of Sales
Total company cost of sales decreased by $59.3 million in 2015, compared with 2014, primarily due to lower sales. The total company cost of sales as a percentage of sales for 2015 was 62.1%, for both 2015 and 2014.
Selling, general and administrative expenses
Selling, general and administrative expenses, including company-funded research and development and bid and proposal expense, in total dollars were lower in 2015 compared with 2014. The decrease reflected the impact of lower sales and lower corporate administrative expense. Corporate administrative expense in 2015 was $40.2 million, compared with $43.9 million in 2014, a decrease of 8.4%. The decrease in corporate administrative expense reflected lower compensation and professional fees expense. For 2015, we recorded a total of $12.2 million in stock option expense, of which $3.4 million was recorded as corporate expense and $8.8 million was recorded in the operating segment results. 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. Stock option expense in 2015 was lower than in 2014 primarily due to the absence of stock option grants in 2015. Selling, general and administrative expenses as a percentage of sales, were 25.6% for both 2015 and 2014.
Pension Income/Expense
Included in operating profit in 2015 was pension expense of $3.0 million compared with pension income of $1.3 million in 2014. The change to pension expense in 2015 from pension income in 2014 primarily reflected the impact of using a 4.5 percent discount rate to determine the benefit obligation for the domestic plan in 2015 compared with a 5.4 percent discount rate used in 2014. In the first quarter of 2015, Teledyne froze its non-qualified pension plan for top executives which resulted in a one-time gain of $1.2 million. For 2016, the Company’s domestic pension plan will result in pension income, compared with pension expense in 2015, due to changes to the pension assumptions. Pension expense allocated to contracts pursuant to U.S. Government Cost Accounting Standards (“CAS”) was $13.8 million for both 2015 and 2014. Pension expense determined under CAS can generally be recovered through the pricing of products and services sold to the U.S. Government.
Operating Income
Operating income for 2015 was $281.7 million, compared with $294.5 million for 2014, a decrease of 4.3%. Operating income primarily reflected lower costs as a result of the lower sales. Operating income in 2015 and 2014 included $8.4 million and $4.2 million in severance costs, respectively. The incremental operating loss included in the results for 2015 from recent acquisitions was $3.7 million which included $3.3 million in additional intangible asset amortization expense. Operating income in 2015 included pension expense of $3.0 million compared to pension income of $1.3 million in 2014.
Interest Expense and Other Income and Expense
Total interest expense, including credit facility fees and other bank charges, was $24.0 million in 2015 and $19.2 million in 2014. The increase in interest expense primarily reflected the impact of higher outstanding debt levels, due to recent acquisitions and stock repurchases. Interest income was $0.1 million in 2015 and $0.2 million in 2014. Other income and expense in 2015 and 2014 included net gains on legal settlements of $3.0 million and $6.5 million, respectively.
Income Taxes
The Company’s effective tax rate for 2015 was 24.3%, compared with 23.6% for 2014. Fiscal year 2015 included net discrete tax benefits of $9.8 million primarily related to the remeasurement of uncertain tax positions which were mainly due to the expiration of statute of limitations and the release of valuation allowances. Total year 2015 also included $5.9 million in federal research and development tax credits. Fiscal year 2014 included net discrete tax benefits of $8.9 million primarily related to the remeasurement of uncertain tax positions, which were mainly due to an expiration of statute of limitations and the favorable resolution of a tax matter. Fiscal year 2014 also included $5.6 million in federal research and development tax credits. Excluding the impact of the net discrete tax benefits of $9.8 million for 2015 and $8.9 million for 2014, the effective tax rates would have been 28.1% for 2015, compared with 26.7% for 2014. The Company anticipates the total unrecognized tax benefit may be reduced by $7.0 million due to the resolution of various federal, state and foreign tax issues in the next twelve months.
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 | % | ||||||
| Results of operations | 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 | % | ||||||||
| Corporate expense | (43.9 | ) | (37.6 | ) | 16.8 | % | ||||||
| Operating income | 294.5 | 240.3 | 22.6 | % | ||||||||
| 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 | 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 | % | ||||||
Sales and cost of sales by segment and total company:
| 2014 | 2013 | Change | |||||||||
| Instrumentation | (dollars in millions) | ||||||||||
| 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.
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 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. 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. 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.
Operating Income
Operating income for 2014, compared with 2013, increased by $54.2 million, or 22.6%. 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.
Interest Expense and Other Income and Expense
Total interest expense, including credit facility fees and other bank charges, was $19.2 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 net gains 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, which were mainly 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 federal 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. Fiscal year 2013 also included $4.2 million in federal research and development tax credits. 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.
Segments
The following discussion of our four segments should be read in conjunction with Note 12 to the Notes to Consolidated Financial Statements.
Instrumentation
| (Dollars in millions) | 2015 | 2014 | 2013 | |||||||||
| Sales | $ | 1,051.1 | $ | 1,115.5 | $ | 1,022.8 | ||||||
| Cost of sales | $ | 589.8 | $ | 630.0 | $ | 570.9 | ||||||
| Selling, general and administrative expenses | $ | 290.3 | $ | 303.9 | $ | 289.9 | ||||||
| Operating income | $ | 171.0 | $ | 181.6 | $ | 162.0 | ||||||
| Cost of sales % of sales | 56.1 | % | 56.5 | % | 55.8 | % | ||||||
| Selling, general and administrative expenses % of sales | 27.6 | % | 27.2 | % | 28.4 | % | ||||||
| Operating income % of sales | 16.3 | % | 16.3 | % | 15.8 | % | ||||||
| International sales % of sales | 58.2 | % | 58.1 | % | 56.3 | % | ||||||
| Governmental sales % of sales | 5.8 | % | 3.5 | % | 4.0 | % | ||||||
| Capital expenditures | $ | 20.9 | $ | 17.0 | $ | 22.0 |
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.
2015 compared with 2014
Our Instrumentation segment sales were $1,051.1 million in 2015 compared with sales of $1,115.5 million in 2014, a decrease of 5.8%. Operating income was $171.0 million in 2015, compared with $181.6 million in 2014, a decrease of 5.8%. The 2015 sales decrease resulted from lower sales of marine instrumentation and electronic test and measurement instrumentation, while sales for environmental instrumentation increased slightly. Sales for marine instrumentation decreased by $40.8 million and primarily reflected lower sales of geophysical sensors for offshore oil exploration, interconnect systems for land-based energy applications, and other marine sensors and systems, partially offset by $32.1 million in incremental sales from recent acquisitions. Sales of electronic test and measurement instrumentation decreased $23.9 million primarily as a result of lower international sales due in part to the impact of foreign exchange rates. Sales of environmental instrumentation increased $0.3 million. The decrease in operating income primarily reflected the impact of lower sales as well as $2.9 million in higher severance costs compared with 2014. The incremental operating loss from recent acquisitions was $4.6 million, which included $3.0 million in additional intangible asset amortization.
Cost of sales decreased by $40.2 million in 2015, compared with 2014, and primarily reflected the impact of lower sales. The cost of sales percentage decreased slightly to 56.1% from 56.5%. Selling, general and administrative expenses, including research and development and bid and proposal expense, in 2015, decreased by $13.6 million, compared with 2014, and primarily reflected the impact of lower sales. Selling, general and administrative expenses for 2015, as a percentage of sales, increased slightly to 27.6%, compared with 27.2% for 2014.
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 income 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 income reflected the impact of higher sales from both recent acquisitions and organic sales growth. The incremental operating income from recent acquisitions was $6.1 million, which included $1.2 million in additional intangible asset amortization.
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 to 27.2%, compared with 28.4% for 2013.
Digital Imaging
| (Dollars in millions) | 2015 | 2014 | 2013 | |||||||||
| Sales | $ | 379.0 | $ | 403.6 | $ | 414.8 | ||||||
| Cost of sales | $ | 228.0 | $ | 252.0 | $ | 263.7 | ||||||
| Selling, general and administrative expenses | $ | 111.0 | $ | 114.5 | $ | 122.9 | ||||||
| Operating income | $ | 40.0 | $ | 37.1 | $ | 28.2 | ||||||
| Cost of sales % of sales | 60.1 | % | 62.4 | % | 63.6 | % | ||||||
| Selling, general and administrative expenses % of sales | 29.3 | % | 28.4 | % | 29.6 | % | ||||||
| Operating income % of sales | 10.6 | % | 9.2 | % | 6.8 | % | ||||||
| International sales % of sales | 51.0 | % | 50.2 | % | 49.0 | % | ||||||
| Governmental sales % of sales | 20.8 | % | 25.3 | % | 29.0 | % | ||||||
| Capital expenditures | $ | 9.2 | $ | 10.3 | $ | 20.2 |
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.
2015 compared with 2014
Our Digital Imaging segment sales were $379.0 million in 2015, compared with sales of $403.6 million in 2014, a decrease of 6.1%. Operating income was $40.0 million in 2015, compared with $37.1 million in 2014, an increase of 7.8%.
The 2015 sales decrease primarily reflected lower sales from U.S. Government research and development contracts and reduced sales of machine vision cameras for semiconductor and electronics inspection and of infrared imaging systems, partially offset by increased sales of sensors and cameras for life sciences and general industrial applications. Sales in 2015 included $6.8 million in incremental sales from a recent acquisition. The increase in operating income in 2015, compared with 2014, despite lower sales, reflected the impact of improved margins across a number of product categories as a result of ongoing cost reductions and improved contract performance and also included $0.9 million in operating income from a recent acquisition.
Cost of sales for 2015 decreased by $24.0 million, compared with 2014, and primarily reflected the impact of lower costs as a result of ongoing cost reduction actions and product mix differences. The decrease in the cost of sales percentage primarily reflected lower costs as a result of ongoing cost reduction actions and a greater mix of higher gross margin commercial sales. Selling, general and administrative expenses, for 2015, decreased to $111.0 million, compared with $114.5 million in 2014 and primarily reflected lower general and administrative expenses. The selling, general and administrative expense percentage increased to 29.3% in 2015 from 28.4% in 2014 and reflected higher research and development spending.
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 income 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 income
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.
Aerospace and Defense Electronics
| (Dollars in millions) | 2015 | 2014 | 2013 | |||||||||
| Sales | $ | 593.4 | $ | 603.0 | $ | 625.1 | ||||||
| Cost of sales | $ | 383.8 | $ | 386.6 | $ | 434.6 | ||||||
| Selling, general and administrative expenses | $ | 124.8 | $ | 128.1 | $ | 124.8 | ||||||
| Operating income | $ | 84.8 | $ | 88.3 | $ | 65.7 | ||||||
| Cost of sales % of sales | 64.7 | % | 64.2 | % | 69.5 | % | ||||||
| Selling, general and administrative expenses % of sales | 21.0 | % | 21.2 | % | 20.0 | % | ||||||
| Operating income % of sales | 14.3 | % | 14.6 | % | 10.5 | % | ||||||
| International sales % of sales | 31.8 | % | 32.2 | % | 34.0 | % | ||||||
| Governmental sales % of sales | 37.7 | % | 40.7 | % | 41.6 | % | ||||||
| Capital expenditures | $ | 9.1 | $ | 8.8 | $ | 15.3 |
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.
2015 compared with 2014
Our Aerospace and Defense Electronics segment sales were $593.4 million in 2015, compared with sales of $603.0 million in 2014, a decrease of 1.6%. Operating income was $84.8 million in 2015, compared with $88.3 million in 2014, a decrease of 4.0%.
Sales for 2015, compared with 2014, decreased by $9.6 million and reflected lower sales of $19.8 million from microwave and interconnect systems and lower sales of $13.3 million from electronic manufacturing services products, partially offset by increased sales of $23.5 million from avionics products and electronic relays. Operating income in 2015 decreased by $3.5 million and reflected the impact of lower sales, as well as lower margins for most defense electronics products. Operating income in 2015 reflected higher pension expense of $1.9 million and the reversal of facility and consolidation reserves of $1.7 million no longer needed.
Cost of sales for 2015 decreased by $2.8 million, compared with 2014, and reflected the impact of lower sales, partially offset by higher pension expense. Cost of sales as a percentage of sales for 2015 increased slightly to 64.7% from 64.2% in 2014 and reflected the impact of higher pension expense. Selling, general and administrative expenses, including research and development and bid and proposal expense, decreased to $124.8 million in 2015, compared with $128.1 million in 2014, and reflected the impact of lower sales. The selling, general and administrative expense percentage in 2015 decreased slightly to 21.0% from 21.2% for 2014.
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.
Engineered Systems
| (Dollars in millions) | 2015 | 2014 | 2013 | |||||||||
| Sales | $ | 274.6 | $ | 271.9 | $ | 275.9 | ||||||
| Cost of sales | $ | 226.2 | $ | 218.5 | $ | 230.8 | ||||||
| Selling, general and administrative expenses | $ | 22.3 | $ | 22.0 | $ | 23.1 | ||||||
| Operating income | $ | 26.1 | $ | 31.4 | $ | 22.0 | ||||||
| Cost of sales % of sales | 82.4 | % | 80.4 | % | 83.6 | % | ||||||
| Selling, general and administrative expenses % of sales | 8.1 | % | 8.1 | % | 8.4 | % | ||||||
| Operating income % of sales | 9.5 | % | 11.5 | % | 8.0 | % | ||||||
| International sales % of sales | 9.9 | % | 9.0 | % | 12.4 | % | ||||||
| Governmental sales % of sales | 85.4 | % | 81.6 | % | 75.8 | % | ||||||
| Capital expenditures | $ | 5.7 | $ | 4.3 | $ | 3.6 |
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.
2015 compared with 2014
Our Engineered Systems segment sales were $274.6 million in 2015, compared with sales of $271.9 million in 2014, an increase of 1.0%. Operating income was $26.1 million in 2015, compared with $31.4 million in 2014, a decrease of 16.9%.
The 2015 sales increase of $2.7 million reflected higher sales of energy systems products of $6.5 million and engineered products and services of $4.0 million. The higher energy systems sales primarily reflected increased sales for government energy systems. Turbine engine sales were lower by $7.8 million and reflected decreased sales for the Joint Air-to-Surface Standoff Missile program. Operating income in 2015 reflected the impact of higher sales more than offset by the impact of lower sales of higher margin turbine engines and higher pension expense of $2.0 million.
Cost of sales for 2015 increased by $7.7 million, compared with 2014, and reflected the higher sales and higher pension expense. Cost of sales as a percentage of sales for 2015 increased to 82.4%, compared with 80.4% in 2014 and reflected the impact of higher pension expense and lower sales of higher margin turbine engines. Selling, general and administrative expenses, including research and development and bid and proposal expense, increased to $22.3 million in 2015, compared with $22.0 million in 2014, and reflected the impact of higher sales. The selling, general and administrative expense percentage remained at 8.1% for 2015, compared with 2014.
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 income 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 income 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.
Financial Condition, Liquidity and Capital Resources
Principal Capital Requirements
Our principal cash and capital requirements are to fund working capital needs, capital expenditures, income tax payments, pension contributions and debt service requirements, as well as acquisitions. The Company may also deploy cash for the stock repurchase program. 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 2016. 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.
Credit Facility, Senior Notes and Term Loans
In November 2015, the Company issued $125.0 million in aggregate principal amount of senior unsecured notes. The notes consisted of $25.0 million of 2.81% senior unsecured notes due in November 2020, and $100.0 million of 3.28% senior unsecured notes due in November 2022. Also in December 2015, the Company amended the $750.0 million credit facility to extend the maturity from March 2018 to December 2020. Excluding interest and fees, no payments are due under the credit facility until it matures. 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 0.12% and 0.25% of the credit line, depending on our consolidated leverage ratio as calculated from time to time.
| Long-term debt (in millions): | January 3, 2016 | December 28, 2014 | ||||||
| $750.0 million credit facility, due December 2020, weighted average rate of 1.67% at January 3, 2016, and 1.24% at December 28, 2014 | $ | 150.5 | $ | 105.0 | ||||
| Term Loans due through March 2019, weighted average rate of 1.55% at January 3, 2016, and 1.28% at December 28, 2014 | 190.0 | 200.0 | ||||||
| 4.04% Senior Notes due September 2015 | — | 75.0 | ||||||
| 4.74% Senior Notes due September 2017 | 100.0 | 100.0 | ||||||
| 2.61% Senior Notes due December 2019 | 30.0 | 30.0 | ||||||
| 5.30% Senior Notes due September 2020 | 75.0 | 75.0 | ||||||
| 2.81% Senior Notes due November 2020 | 25.0 | — | ||||||
| 3.09% Senior Notes due December 2021 | 95.0 | 95.0 | ||||||
| 3.28% Senior Notes due November 2022 | 100.0 | — | ||||||
| Other debt | — | 14.7 | ||||||
| Total long-term debt | 765.5 | 694.7 | ||||||
| Current portion of long-term debt | (10.0 | ) | (84.9 | ) | ||||
| Total long-term debt, net of current portion | $ | 755.5 | $ | 609.8 |
The Company also has $8.6 million in capital leases, of which $1.2 million is current. At January 3, 2016, Teledyne had $12.8 million in outstanding letters of credit.
Our credit facility, senior notes and term loans 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 January 3, 2016, 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.
Financial covenant ratios and the actual ratios at January 3, 2016:
| $750.0 million Credit Facility expires December 2020 and $190.0 million term loans due through March 2019 (issued in October 2012) | |||
| Financial Covenant | Requirement | Actual Measure | |
| Consolidated Leverage Ratio (Net Debt/EBITDA) (a) | No more than 3.25 to 1 | 2.1 to 1 | |
| Consolidated Interest Coverage Ratio (EBITDA/Interest) (b) | No less than 3.0 to 1 | 15.9 to 1 | |
| $425.0 million Private Placement Senior Notes due from 2017 to 2022 | |||
| Financial Covenant | Requirement | Actual Measure | |
| Consolidated Leverage Ratio (Net Debt/EBITDA) (a) | No more than 3.25 to 1 | 2.1 to 1 | |
| Consolidated Interest Coverage Ratio (EBITDA/Interest) (b) | No less than 3.0 to 1 | 15.9 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 $588.2 million at January 3, 2016. 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 were outstanding under this facility at January 3, 2016 or December 28, 2014.
Permanently Reinvested Earnings
We intend to indefinitely reinvest the earnings of our material foreign subsidiaries in our operations outside of the United States. The cash that the Company's foreign subsidiaries hold for indefinite reinvestment is generally used to finance foreign operations and investments, including acquisitions. We estimate that future domestic cash generation will be sufficient to meet future domestic cash requirements. At January 3, 2016, the amount of undistributed foreign earnings was $193.3 million, of which we have not recorded a deferred tax liability of approximately $49.7 million. 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 January 3, 2016. 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:
| Contractual obligations (in millions): | 2016 | 2017 | 2018 | 2019 | 2020 | After 2020 | Total | |||||||||||||||||||||
| Debt obligations | $ | 10.0 | $ | 115.0 | $ | 170.5 | $ | 175.0 | $ | 100.0 | $ | 195.0 | $ | 765.5 | ||||||||||||||
| Interest expense(a) | 22.0 | 20.5 | 14.5 | 12.1 | 8.3 | 7.1 | 84.5 | |||||||||||||||||||||
| Operating lease obligations | 22.2 | 19.9 | 16.9 | 15.2 | 14.6 | 77.1 | 165.9 | |||||||||||||||||||||
| Capital lease obligations(b) | 1.5 | 1.3 | 1.4 | 1.3 | 1.1 | 4.0 | 10.6 | |||||||||||||||||||||
| Purchase obligations (c) | 67.8 | 2.9 | 1.8 | 1.1 | 0.7 | 1.6 | 75.9 | |||||||||||||||||||||
| Total | $ | 123.5 | $ | 159.6 | $ | 205.1 | $ | 204.7 | $ | 124.7 | $ | 284.8 | $ | 1,102.4 |
| (a) | Interest expense related to the credit facility, including facility fees, is assumed to accrue at the rates in effect at year-end 2015 and is assumed to be paid at the end of each quarter with the final payment in December 2020 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 $28.8 million are not included in the table above because $9.3 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 January 3, 2016, we were not required, and accordingly are not planning, to make any cash contributions to the domestic qualified pension plan for 2016. Our minimum funding requirements after 2016, 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 2016 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 11 of the Notes to our Consolidated Financial Statements. Teledyne intends to continue to monitor and manage its defined benefit pension plans obligation and may take additional actions to manage risk in the future.
Operating Activities
In 2015, net cash provided by operating activities was $210.2 million, compared with $287.9 million in 2014 and $203.3 million in 2013. The lower cash provided by operating activities in 2015, compared with 2014, reflected lower net income, lower customer deposits and advanced payments and higher income tax payments. The 2015 amounts reflected the receipt of $3.0 million related to a legal settlement while the 2014 amount reflected the receipt of $10.0 million related to a legal settlement. 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.
Free cash flow (cash provided by operating activities less capital expenditures) was $163.2 million in 2015, compared with $244.4 million in 2014 and $130.7 million in 2013. Adjusted free cash flow eliminates the impact of pension contributions on a net of tax basis and was $163.2 million in 2015, compared with $244.4 million in 2014 and $182.1 million in 2013.
| Free Cash Flow(a) (in millions, brackets indicate use of funds) | 2015 | 2014 | 2013 | ||||||||||
| Cash provided by operating activities | $ | 210.2 | $ | 287.9 | $ | 203.3 | |||||||
| Capital expenditures for property, plant and equipment | (47.0 | ) | (43.5 | ) | (72.6 | ) | |||||||
| Free cash flow | 163.2 | 244.4 | 130.7 | ||||||||||
| Pension contributions, net of tax(b) | — | — | 51.4 | ||||||||||
| Adjusted free cash flow | $ | 163.2 | $ | 244.4 | $ | 182.1 |
| 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 $434.6 million at year-end 2015, compared with $402.7 million at year-end 2014. The increase reflected the repayment of $75.0 million in senior notes classified as short term partially offset by lower foreign cash balances due to the use of cash for recent acquisitions. The senior notes were repaid with funds drawn under the credit facility which is classified as long-term.
| Selected balance sheet changes (in millions): | 2015 | 2014 | ||||||
| Cash | $ | 85.1 | $ | 141.4 | ||||
| Current portion of long-term debt, capital leases and other debt | $ | 19.1 | $ | 86.2 | ||||
| Long-term debt and capital lease obligations, net of current portion | $ | 762.9 | $ | 618.9 | ||||
| Treasury stock | $ | 309.9 | $ | 102.1 | ||||
| Accumulated other comprehensive loss | $ | 413.2 | $ | 323.2 |
The decrease in cash primarily reflects the use of cash by foreign subsidiaries to fund the ICM, Bowtech and Optech acquisitions. The decrease in the current portion of long-term debt primarily reflects the repayment of $75.0 million in senior notes. The increase in long-term debt and in treasury stock reflects the impact of the stock repurchase program. The increase in accumulated other comprehensive loss primarily reflects the impact of foreign currency adjustments.
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 $109.9 million, $238.7 million and $195.0 million for 2015, 2014 and 2013, respectively.
| Capital expenditures (in millions): | 2015 | 2014 | 2013 | |||||||||
| Instrumentation | $ | 20.9 | $ | 17.0 | $ | 22.0 | ||||||
| Digital Imaging | 9.2 | 10.3 | 20.2 | |||||||||
| Aerospace and Defense Electronics | 9.1 | 8.8 | 15.3 | |||||||||
| Engineered Systems | 5.7 | 4.3 | 3.6 | |||||||||
| Corporate | 2.1 | 3.1 | 11.5 | |||||||||
| $ | 47.0 | $ | 43.5 | $ | 72.6 |
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 2016 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 January 3, 2016, for capital expenditures were approximately $8.0 million.
Acquisitions
Investing activities used cash for acquisitions and investments of $66.7 million, $195.8 million and $128.2 million, in fiscal 2015, 2014 and 2013, 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 ICM and Axiom acquisitions are part of the Digital Imaging segment. All other acquisitions in 2015, 2014 and 2013 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 2015 and 2014 (in millions):
| 2015 | ||||||||||||||
| Acquisition | Acquisition Date | Cash Paid (a) | Goodwill Acquired | Acquired Intangible Assets | ||||||||||
| Bowtech | February 2, 2015 | $ | 18.9 | $ | 7.0 | $ | 4.3 | |||||||
| ICM | June 5, 2015 | 21.8 | 19.2 | 5.8 | ||||||||||
| Purchase of remaining interest of Optech | April 29, 2015 | 22.0 | — | — | ||||||||||
| Other Investments | 4.0 | 1.4 | 0.9 | |||||||||||
| $ | 66.7 | $ | 27.6 | $ | 11.0 | |||||||||
| (a) net of any cash acquired. | ||||||||||||||
| 2014 | ||||||||||||||
| Acquisition | Acquisition Date | Cash Paid (a) | 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 | |||||||||
| (a) net of any cash acquired. |
Except for the Atlas and Oceanscience acquisitions, goodwill resulting from the acquisitions made in fiscal 2015 and 2014 will not be deductible for tax purposes.
| Estimated fair values of the assets acquired and liabilities assumed (in millions): | 2015 | 2014 | ||||||
| Current assets, excluding cash acquired | $ | 8.5 | $ | 34.0 | ||||
| Property, plant and equipment | 9.8 | 8.7 | ||||||
| Goodwill | 27.6 | 142.8 | ||||||
| Intangible assets | 11.0 | 48.2 | ||||||
| Other long-term assets | 1.9 | 5.3 | ||||||
| Total assets acquired | 58.8 | 239.0 | ||||||
| Current liabilities, including short-term debt | (5.1 | ) | (26.0 | ) | ||||
| Other long-term liabilities | (9.0 | ) | (17.2 | ) | ||||
| Total liabilities assumed | (14.1 | ) | (43.2 | ) | ||||
| Noncontrolling interests (a) | 22.0 | — | ||||||
| Cash paid, net of cash acquired | $ | 66.7 | $ | 195.8 | ||||
| (a) Purchase of the remaining interest in Optech. |
Financing Activities
Financing activities for 2015 reflected net payments on long-term debt of $47.6 million, compared with net proceeds from long-term debt of $29.5 million for 2014 and net payments on long-term debt of $5.0 million for 2013. In addition, in both 2015 and 2014, the Company issued $125.0 million of senior unsecured notes.
Fiscal years 2015, 2014 and 2013 reflect proceeds from the exercise of stock options of $19.0 million, $18.3 million and $12.1 million, respectively. Fiscal years 2015, 2014 and 2013 included $4.3 million, $6.2 million and $5.4 million, respectively, in excess tax benefits related to stock-based compensation. Financing activities for 2015 and 2014 also reflected the repurchase of common stock for $243.8 million and $146.6 million, respectively. Share repurchases totaled 2,561,815 shares in 2015 and 1,396,290 shares in 2014. See Note 8 to our Consolidated Financial Statements for additional information about our stock repurchase program.
Other Matters
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 2015 and 2014, Teledyne’s domestic pension plan was over 100% funded, thus no cash contributions were made. For the Company’s domestic pension plan, the discount rate for 2016 will increase to 4.9% from 4.5% in 2015. 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. The Company also has several foreign-based defined benefit pension plans.
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.
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. 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.
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 2011, California income tax matters for all years through 2010 and Canadian income tax matters for all years through 2007.
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. The Company utilizes foreign currency forward contracts to reduce the volatility of cash flows primarily related to forecasted revenue and expenses denominated in Canadian dollars for our Canadian companies, including DALSA. 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 $4.0 million, net of tax, over the next 12 months based on the year-end 2015 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 January 3, 2016, Teledyne had foreign currency forward contracts designated as cash flow hedges to buy Canadian dollars and to sell U.S. dollars totaling $79.4 million and these contracts had a negative fair value of $5.9 million. These foreign currency forward contracts have maturities ranging from March 2016 to February 2018.
In addition, the Company utilizes foreign currency forward contracts to mitigate foreign exchange rate risk associated with foreign currency denominated monetary assets and liabilities, including intercompany receivables and payables. As of January 3, 2016, Teledyne had foreign currency contracts of this type in the following currency pairs (in millions):
| Contracts to Buy | Contracts to Sell | |||||||
| Currency | Amount | Currency | Amount | |||||
| Canadian Dollars | C$ | 64.9 | U.S. Dollars | US$ | 51.3 | |||
| Euros | € | 11.9 | U.S. Dollars | US$ | 13.1 | |||
| Great Britain Pounds | £ | 0.9 | Australian Dollars | A$ | 1.9 | |||
| Great Britain Pounds | £ | 21.0 | U.S. Dollars | US$ | 32.0 | |||
| Euros | € | 7.4 | Canadian Dollars | C$ | 4.9 | |||
| U.S. Dollars | US$ | 2.1 | Japanese Yen | ¥ | 250.0 | |||
| Singapore Dollars | S$ | 1.7 | U.S. Dollars | US$ | 1.2 |
These contracts had a negative fair value of $5.7 million at January 3, 2016. 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 January 3, 2016, would decrease the fair value of our foreign currency forward contracts associated with our cash flow hedging activities by $7.9 million. A hypothetical 10% depreciation of the U.S. dollar from its value at January 3, 2016, would increase the fair value of our foreign currency forward contracts associated with our cash flow hedging activities by $7.9 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 January 3, 2016, we had $150.5 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 $1.5 million, assuming the $150.5 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.
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 $8.7 million at January 3, 2016, and $9.7 million at December 28, 2014. 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. See also our environmental risk factor disclosure beginning on page 23 and Notes 2 and 14 to our 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 26% of total sales in 2015, 25% of total sales in 2014 and 27% of total sales in 2013. For a summary of sales to the U.S. Government by segment, see Note 12 to our Notes to Consolidated Financial Statements. Sales to the U.S. Department of Defense represented approximately 19%, 20% and 21% of total sales for 2015, 2014 and 2013, respectively. See also our government contracts risks factor disclosure beginning on page 17.
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 our 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 also Critical Accounting Policies.
The following table reflects significant reserves and valuation accounts, which are estimates and based on judgments as described above, at January 3, 2016, and December 28, 2014 (in millions):
| Reserves and Valuation Accounts: (a) | 2015 | 2014 | ||||||
| Allowance for doubtful accounts | $ | 6.3 | $ | 7.8 | ||||
| Reduction to LIFO cost basis | $ | 15.3 | $ | 16.5 | ||||
| Other inventory reserves | $ | 58.8 | $ | 55.3 | ||||
| Workers’ compensation and general liability reserves(b) | $ | 8.3 | $ | 8.9 | ||||
| Warranty reserves(b) | $ | 17.1 | $ | 18.5 | ||||
| Environmental reserves(b) | $ | 8.7 | $ | 9.7 | ||||
| Other accrued liability reserves(b) | $ | 33.9 | $ | 31.5 |
(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.
| Warranty Reserve (in millions): | 2015 | 2014 | 2013 | |||||||||
| Balance at beginning of year | $ | 18.5 | $ | 17.3 | $ | 17.8 | ||||||
| Accruals for product warranties charged to expense | 6.1 | 6.6 | 4.4 | |||||||||
| Cost of product warranty claims | (7.7 | ) | (5.9 | ) | (5.2 | ) | ||||||
| Acquisitions | 0.2 | 0.5 | 0.3 | |||||||||
| Balance at year-end | $ | 17.1 | $ | 18.5 | $ | 17.3 |
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 our 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 relates to product sales and is recognized 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 Company does not offer substantial sales incentives and credits to customers. 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.
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.
For contracts that require substantial performance over a long time period (generally one or more years), revenue is 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 31.2% in 2015, 28.7% in 2014 and 32.1% in 2013.
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 $3.1 million in 2015, $3.0 million in 2014 and $1.8 million in 2013. The gross aggregate effects of these favorable and unfavorable changes in estimates in 2015, 2014 and 2013 were $38.6 million, $22.9 million and $21.4 million of favorable operating income and $35.5 million, $25.9 million and $23.2 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 2015, 2014 or 2013 was material to the consolidated statements of income for such annual periods.
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 only. The Company also has several smaller foreign-based defined benefit pension plans. At January 3, 2016, the benefit obligation for the domestic defined benefit pension plan totaled $820.4 million and the fair value of the net qualified plan assets totaled $890.4 million. At January 3, 2016, the benefit obligation for the foreign-based pension plans totaled $56.6 million and the fair value of the net plan assets totaled $43.8 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. Net actuarial gains or losses are amortized to expense on a plan-by-plan basis when they exceed the accounting corridor. The accounting corridor is a defined range within which amortization of net gains and losses is not required and is equal to 10 percent of the greater of the market related value of assets or benefit obligations. Gains or losses outside of the corridor are subject to amortization over our average employee future service period of approximately nine years. 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 8.0% in 2016 for its domestic qualified pension plan and the assumed discount rate will be 4.91% in 2016 for its domestic pension plan. The Company’s long-term expected return on pension assets used in 2015 was 8.25% for its domestic qualified pension plans and the assumed discount rate used in 2015 was 4.5%. The actual rate of return on pension assets was a negative return of 1.1% in 2015 and 5.4% in 2014 for its domestic qualified pension plan. If the actual rate of return on pension assets is below the expected rate of return, the Company may be required to make additional contributions to the pension trust. At January 3, 2016, 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 2015 or in 2014 and made a voluntary pretax cash contribution of $83.0 million in 2013, before recovery from the U.S. Government. In 2014, the Society of Actuaries released revised mortality tables, which updated life expectancy assumptions. In consideration of these tables, we modified the mortality assumptions used in determining our pension obligations. 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 2015 the Company has a $232.3 million non-cash reduction to stockholders’ equity and a long-term additional liability of $370.4 million related to its pension plans. At year-end 2014, the Company had 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.
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 2015 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 11 of our Notes to Consolidated Financial Statements for additional pension disclosures.
Business Combinations, Goodwill and Acquired Intangible 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 acquisition 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. Acquired 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 an annual impairment test completed in 2015, the Company recorded a $0.5 million impairment to acquired intangible assets. Based on a quarterly impairment test completed in 2014, the Company recorded a $0.7 million impairment to acquired intangible assets. No impairment of goodwill was indicated in 2015 or 2014, 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 January 3, 2016, 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 $0.7 million to $189.7 million. The Company’s analysis in 2015 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 2015, the annual testing date, ranged from approximately 65% to 7,199%.
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 from our most recent business and strategic plans, and compares the estimated fair value to the carrying value of the asset. With the exception of the indefinite-lived intangible assets from a single business unit, the estimated fair values exceed the carrying value for each of the Company’s indefinite-lived intangible
assets as of the fourth quarter of 2015, the annual testing date. An impairment was recognized for the indefinite-lived intangible assets of a single business unit for $0.5 million, an amount for which its carrying value exceeded its estimated fair value.
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 positions 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 for the fiscal year ended January 3, 2016, of $2.6 million. For a description of the Company’s tax accounting policies, refer to Note 2 and Note 10 of our Notes to the Consolidated Financial Statements.
New Accounting Standards
For a discussion of new accounting standards see Note 2 of our Notes to the Consolidated Financial Statements.
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 further 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 2002. 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.
| Item 7A. Quantitative and Qualitative Disclosures About Market Risk |
The information required by this item is included in this Report on page 47 under the caption “Other Matters - Hedging Activities; Market Risk Disclosures” of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.”
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