filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Teledyne Technologies Incorporated provides enabling technologies for industrial growth markets. We have evolved from a company that was primarily focused on aerospace and defense to one that serves multiple markets that require advanced technology and high reliability. These markets include deepwater oil and gas exploration and production, oceanographic research, air and water quality environmental monitoring, factory automation and medical imaging. Our products include monitoring instrumentation for marine and environmental applications, harsh environment interconnects, electronic test and measurement equipment, digital imaging sensors and cameras, aircraft information management systems, and defense 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 five acquisitions in 2016, three acquisitions in 2015 and four acquisitions in 2014. On December 6, 2016, Teledyne Instruments, Inc. acquired Hanson Research Corporation (“Hanson Research”) which specializes in analytical instrumentation for the pharmaceutical industry. On November 2, 2016, Teledyne Instruments, Inc. acquired assets of IN USA, Inc. (“IN USA”), a manufacturer of a range of ozone generators, ozone analyzers and other gas monitoring instruments utilizing ultraviolet and infrared based technologies. On May 3, 2016, Teledyne DALSA, Inc., a Canadian-based subsidiary, acquired the assets and business of CARIS, Inc. (“CARIS”) a leading developer of geospatial software designed for the hydrographic and marine community. On April 15, 2016, Teledyne LeCroy, Inc., a U.S.-based subsidiary, acquired assets of Quantum Data, Inc. (“Quantum Data”) a market leader in video protocol analysis test tools. On April 6, 2016, Teledyne LeCroy, Inc. also acquired Frontline Test Equipment, Inc. (“Frontline”) a market leader in wireless protocol analysis test tools.
On June 5, 2015, Teledyne DALSA B.V., 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 we acquired a product line.
On December 12, 2016, Teledyne and e2v technologies plc (“e2v”) reached agreement on the terms of a recommended cash acquisition to be made by Teledyne for the ordinary share capital of e2v by means of a Scheme of Arrangement (the “Offer”). Under the terms of the Offer, e2v’s ordinary shareholders (“e2v Shareholders”) will receive 275 pence in cash for each e2v share valuing the entire issued and to be issued ordinary share capital of e2v at approximately £619.6 million on a fully diluted basis. It is expected that, subject to the satisfaction or waiver of all relevant conditions, the acquisition will be completed in the first half of calendar 2017. At meetings held in January 2017, e2v shareholders voted in favor of the resolution to approve the scheme of arrangement and voted to pass a special resolution to approve the implementation of the scheme. The waiting periods required under both the U.S. Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and in respect of the e2v’s U.S. State Department’s ITAR registration have expired. Clearance or expiration of the waiting period under German merger control laws remains outstanding. After discussions with the German authorities, e2v and Teledyne submitted a revised application for clearance on February 24, 2017 in respect of the acquisition. The German authorities have one month to review such revised submission. Clearance from the French Ministry of Economy and Finance and the French Ministry of Defense in respect of the acquisition also remains outstanding. Teledyne expects to fund the acquisition from cash on hand and its credit facility, as well as the anticipated proceeds from the issuance of senior unsecured notes and term loans.
For the machine vision market, e2v provides high performance image sensors and custom camera solutions and application specific standard products. In addition, e2v provides high performance space qualified imaging sensors and arrays for space science and astronomy. e2v also produces components and subsystems that deliver high reliability radio frequency power generation for healthcare, industrial and defense applications. Finally, the company provides high reliability semiconductors and board-level solutions for use in aerospace, space and radio frequency communications applications. At announcement, the aggregate enterprise value for the transaction is expected to be approximately £627.1 million (or approximately $788.9 million) taking into account e2v stock options and net debt. For its fiscal year ended March 31, 2016, e2v had sales of approximately £236.4 million.
In connection with our strategy, in the third quarter of 2016, Teledyne completed the disposition of the net assets of its Printed Circuit Technology (“PCT”) business for $9.3 million in cash, resulting in no gain or loss. PCT was part of the Aerospace and Defense Electronics segment. In connection with the sale, we entered into a transition services agreement, effective July 8, 2016, to provide certain administrative services to facilitate the orderly transfer of the business operations to the buyer, with the transition services agreement expected to continue through the first half of 2017. In addition, in 2016 we sold a former operating facility in California and recorded a pretax gain of $17.9 million, and incurred pretax charges totaling $7.9 million related to the pending e2v acquisition.
As part of a continuing effort to reduce 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. We continue to seek cost reductions in our businesses. The following pre-tax charges were incurred related to severance and facility consolidations (in millions):
| 2016 | 2015 | 2014 | ||||||||||
| Instrumentation | $ | 10.6 | $ | 3.9 | $ | 1.0 | ||||||
| Digital Imaging | 2.0 | 3.2 | 2.7 | |||||||||
| Aerospace and Defense Electronics | 4.6 | 1.2 | 0.9 | |||||||||
| Engineered Systems | 0.1 | 0.1 | (0.2 | ) | ||||||||
| Total | $ | 17.3 | $ | 8.4 | $ | 4.4 |
| 2016 | 2015 | 2014 | ||||||||||
| Severance | $ | 9.5 | $ | 8.4 | $ | 4.2 | ||||||
| Facility consolidations | 7.8 | — | 0.2 | |||||||||
| Total | $ | 17.3 | $ | 8.4 | $ | 4.4 |
| 2016 | 2015 | 2014 | ||||||||||
| Cost of sales | $ | 6.8 | $ | 3.7 | $ | 1.0 | ||||||
| Selling, general and administrative expenses | 10.5 | 4.7 | 3.4 | |||||||||
| Total | $ | 17.3 | $ | 8.4 | $ | 4.4 |
At January 1, 2017, $3.7 million remains to be paid related to these actions.
Recent Acquisitions
The Company spent $93.4 million, $66.7 million and $195.8 million on acquisitions and investments in 2016, 2015 and 2014, respectively.
On November 2, 2016, Teledyne Instruments, Inc. acquired assets of IN USA, headquartered in Norwood, Massachusetts, for $10.2 million in cash. Teledyne intends to relocate and consolidate manufacturing into the new, owned facility of Teledyne Advanced Pollution Instrumentation in San Diego, California. On December 6, 2016, Teledyne Instruments, Inc. acquired Hanson Research, headquartered in Chatsworth, California, for $25.0 million, net of cash acquired. On May 3, 2016, Teledyne DALSA, Inc., a Canadian-based subsidiary, acquired the assets and business of CARIS, based in Fredericton, New Brunswick, Canada, for $26.2 million, net of cash acquired. On April 15, 2016, Teledyne LeCroy, Inc., a U.S.-based subsidiary, acquired assets of Quantum Data, based in Elgin, Illinois, for $17.3 million in cash. On April 6, 2016, Teledyne LeCroy, Inc. also acquired Frontline, based in Charlottesville, Virginia, for $13.7 million in cash.
Each of the 2016 acquisitions are part of the Instrumentation segment except for CARIS which is part of the Digital Imaging segment.
On June 5, 2015, Teledyne DALSA B.V., a Netherlands-based subsidiary, acquired Industrial Control Machines SA (“ICM”) for $21.8 million, net of cash acquired. In December 2016, an additional $2.5 million was paid by Teledyne related to an indemnification holdback. 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.
As a result of the purchase of the remaining interest in Optech in 2015, 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.
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.
The 2014 acquisitions included, Bolt Technology Corporation (“Bolt”) which 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 also acquired assets of Atlas Hydrographic GmbH (“Atlas”) to add marine sonar systems for mid and deep water applications and 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.
Teledyne funded the purchases from borrowings under its credit facility and cash on hand. The CARIS, 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.
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. On August 18, 2014, a subsidiary of Teledyne acquired assets of Atlas for $5.2 million. On March 31, 2014, a subsidiary of Teledyne acquired Photon Machines, Inc. (“Photon”) for an initial payment of $3.3 million.
All of the 2014 acquisitions are part of the Instrumentation 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 2016 contained 52 weeks, fiscal year 2015 contained 53 weeks and fiscal year 2014 contained 52 weeks. The following are selected financial highlights for 2016, 2015 and 2014 (in millions, except per-share amounts):
| 2016 | 2015 | 2014 | ||||||||||
| Sales | $ | 2,149.9 | $ | 2,298.1 | $ | 2,394.0 | ||||||
| Costs and Expenses | ||||||||||||
| Cost of sales | 1,318.0 | 1,427.8 | 1,487.1 | |||||||||
| Selling, general and administrative expenses | 578.1 | 588.6 | 612.4 | |||||||||
| Total costs and expenses | 1,896.1 | 2,016.4 | 2,099.5 | |||||||||
| Operating Income | 253.8 | 281.7 | 294.5 | |||||||||
| Interest and debt expense, net | (23.2 | ) | (23.9 | ) | (19.0 | ) | ||||||
| Other income, net | 10.7 | 0.4 | 6.6 | |||||||||
| Income before income taxes | 241.3 | 258.2 | 282.1 | |||||||||
| Provision for income taxes | 50.4 | 62.7 | 66.5 | |||||||||
| Net income | 190.9 | 195.5 | 215.6 | |||||||||
| Noncontrolling interest | — | 0.3 | 2.1 | |||||||||
| Net income attributable to Teledyne | $ | 190.9 | $ | 195.8 | $ | 217.7 | ||||||
| Basic earnings per common share | $ | 5.52 | $ | 5.55 | $ | 5.87 | ||||||
| Diluted earnings per common share | $ | 5.37 | $ | 5.44 | $ | 5.75 |
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 2016, 2015 and 2014 are summarized in the following table:
| Percentage of Total Sales | |||||||||
| Segment contribution to total sales: | 2016 | 2015 | 2014 | ||||||
| Instrumentation | 41 | % | 46 | % | 47 | % | |||
| Digital Imaging | 18 | % | 16 | % | 17 | % | |||
| Aerospace and Defense Electronics | 29 | % | 26 | % | 25 | % | |||
| Engineered Systems | 12 | % | 12 | % | 11 | % | |||
| 100 | % | 100 | % | 100 | % |
Results of Operations
2016 compared with 2015
| Sales | 2016 | 2015 | % Change | |||||||||
| (in millions) | ||||||||||||
| Instrumentation | $ | 876.7 | $ | 1,051.1 | (16.6 | )% | ||||||
| Digital Imaging | 398.7 | 379.0 | 5.2 | % | ||||||||
| Aerospace and Defense Electronics | 615.9 | 593.4 | 3.8 | % | ||||||||
| Engineered Systems | 258.6 | 274.6 | (5.8 | )% | ||||||||
| Total sales | $ | 2,149.9 | $ | 2,298.1 | (6.4 | )% | ||||||
| Results of operations | 2016 | 2015 | % Change | |||||||||
| (in millions) | ||||||||||||
| Instrumentation | $ | 109.8 | $ | 171.0 | (35.8 | )% | ||||||
| Digital Imaging | 45.9 | 40.0 | 14.8 | % | ||||||||
| Aerospace and Defense Electronics | 112.1 | 84.8 | 32.2 | % | ||||||||
| Engineered Systems | 32.1 | 26.1 | 23.0 | % | ||||||||
| Corporate expense | (46.1 | ) | (40.2 | ) | 14.7 | % | ||||||
| Operating income | 253.8 | 281.7 | (9.9 | )% | ||||||||
| Interest and debt expense, net | (23.2 | ) | (23.9 | ) | (2.9 | )% | ||||||
| Other income, net | 10.7 | 0.4 | * | |||||||||
| Income before income taxes | 241.3 | 258.2 | (6.5 | )% | ||||||||
| Provision for income taxes | 50.4 | 62.7 | (19.6 | )% | ||||||||
| Net income | 190.9 | 195.5 | (2.4 | )% | ||||||||
| Noncontrolling interest | — | 0.3 | (100.0 | )% | ||||||||
| Net income attributable to Teledyne | $ | 190.9 | $ | 195.8 | (2.5 | )% | ||||||
- not meaningful
Sales and cost of sales by segment and total company:
| 2016 | 2015 | Change | |||||||||
| Instrumentation | (dollars in millions) | ||||||||||
| Sales | $ | 876.7 | $ | 1,051.1 | $ | (174.4 | ) | ||||
| Cost of sales | $ | 494.6 | $ | 589.8 | $ | (95.2 | ) | ||||
| Cost of sales % of sales | 56.4 | % | 56.1 | % | |||||||
| Digital Imaging | |||||||||||
| Sales | $ | 398.7 | $ | 379.0 | $ | 19.7 | |||||
| Cost of sales | $ | 239.4 | $ | 228.0 | $ | 11.4 | |||||
| Cost of sales % of sales | 60.0 | % | 60.1 | % | |||||||
| Aerospace and Defense Electronics | |||||||||||
| Sales | $ | 615.9 | $ | 593.4 | $ | 22.5 | |||||
| Cost of sales | $ | 377.5 | $ | 383.8 | $ | (6.3 | ) | ||||
| Cost of sales % of sales | 61.3 | % | 64.7 | % | |||||||
| Engineered Systems | |||||||||||
| Sales | $ | 258.6 | $ | 274.6 | $ | (16.0 | ) | ||||
| Cost of sales | $ | 206.5 | $ | 226.2 | $ | (19.7 | ) | ||||
| Cost of sales % of sales | 79.9 | % | 82.4 | % | |||||||
| Total Company | |||||||||||
| Sales | $ | 2,149.9 | $ | 2,298.1 | $ | (148.2 | ) | ||||
| Cost of sales | $ | 1,318.0 | $ | 1,427.8 | $ | (109.8 | ) | ||||
| Cost of sales % of sales | 61.3 | % | 62.1 | % |
We reported 2016 sales of $2,149.9 million, compared with sales of $2,298.1 million for 2015, a decrease of 6.4%. Net income attributable to Teledyne was $190.9 million ($5.37 per diluted share) for 2016, compared with net income attributable to Teledyne of $195.8 million ($5.44 per diluted share) for 2015, a decrease of 2.5%.
Total year 2016 and 2015 reflected pretax charges totaling $17.3 million and $8.4 million, respectively, for severance and facility consolidation charges. Net income for 2016 and 2015 also included net discrete tax benefits of $10.9 million and $9.8 million, respectively. We also recorded a gain in 2016 of $17.9 million on the sale of a former operating facility in California, and incurred pretax charges totaling $7.9 million related to the pending e2v acquisition.
Sales
The decrease in sales in 2016, compared with 2015, reflected lower sales in the Instrumentation and Engineered Systems segments, partially offset by higher sales in the Aerospace and Defense and Electronics and Digital Imaging segments. Sales in the Instrumentation segment reflected $15.6 million of incremental sales from recent acquisitions while sales in the Digital Imaging segment reflected $9.6 million of incremental sales from recent acquisitions. The incremental sales from recent acquisitions in 2016 was $25.2 million.
Sales under contracts with the U.S. Government were approximately 27% of sales in 2016 and 26% of sales in 2015. Sales to international customers represented approximately 43% of sales in 2016 and 44% of sales in 2015.
Cost of Sales
Total company cost of sales decreased by $109.8 million in 2016, compared with 2015, which primarily reflected the impact of lower sales, partially offset by higher severance and facility consolidation expenses of $3.1 million. The total company cost of sales as a percentage of sales for 2016 was 61.3%, compared with 62.1% for 2015.
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 2016, compared with 2015. The decrease reflected the impact of lower sales, partially offset by higher severance and facility consolidation expenses of $5.8 million. Corporate administrative expense in 2016 was $46.1 million, compared with $40.2 million in 2015, an increase of 14.7%. The increase in corporate administrative expense reflected higher professional fees expense, including $1.9 million related to the pending e2v acquisition. For 2016, we recorded a total of $11.6 million in stock option expense, of which $3.2 million was recorded as corporate expense and $8.4 million was recorded in the operating segment results. 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. Selling, general and administrative expenses as a percentage of sales, was 26.9% for 2016, compared with 25.6% for 2015 and reflected the impact of higher research and development and bid and proposal expense, higher severance and facility consolidation expenses and professional fees expense related to the pending e2v acquisition.
Pension Income/Expense
Included in operating income in 2016 was pension income of $2.2 million compared with pension expense of $3.0 million in 2015. The change to pension income in 2016 from pension expense in 2015 primarily reflected the impact of using a 4.91 percent discount rate to determine the benefit obligation for the domestic plan in 2016 compared with a 4.50 percent discount rate used in 2015. Included in the $3.0 million of pension expense in 2015, 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. Pension expense allocated to contracts pursuant to U.S. Government Cost Accounting Standards (“CAS”) was $13.8 million for both 2016 and 2015. 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 2016 was $253.8 million, compared with $281.7 million for 2015, a decrease of 9.9%. The decrease in operating income primarily reflected lower costs as a result of the lower sales. Operating income in 2016 and 2015 included $17.3 million and $8.4 million in severance and facility consolidation costs, respectively. The incremental operating loss included in the results for 2016 from recent acquisitions was $0.6 million which included $1.3 million in additional intangible asset amortization expense. Operating income in 2016 included pension income of $2.2 million compared to pension expense of $3.0 million in 2015.
Interest Expense and Other Income and Expense
Total interest expense, including credit facility fees and other bank charges, was $23.6 million in 2016, including $0.5 million related to the pending e2v acquisition, and $24.0 million in 2015. Interest income was $0.3 million in 2016 and $0.1 million in 2015. Other income for 2016 included a gain of $17.9 million on the sale of a former operating facility in California. Other income and expense in 2016 reflected $5.5 million of expense for a foreign currency hedge contract related to the pending e2v acquisition. Other income and expense in 2015 included net gains on legal settlements of $3.0 million.
Income Taxes
The Company’s effective tax rate for 2016 was 20.9%, compared with 24.3% for 2015. Total year 2016 reflected $10.9 million in net discrete income tax benefits. The net discrete income tax benefits of $10.9 million, includes $6.7 million in income tax expense related to the $17.9 million gain on the sale of the operating facility and a $8.5 million income tax benefit related to the adoption of ASU 2016-09, as well as $9.1 million income tax benefit for the remeasurement of uncertain tax positions due to the expiration of statute of limitations, the release of valuation allowances and a favorable tax ruling in the Netherlands. Total 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 2016 and 2015 also included $4.1 million and $5.9 million in federal research and development tax credits, respectively. Excluding the net discrete income tax benefits in both years, and the gain and related taxes on the operating facility sale in 2016, the effective tax rates would have been 27.4% for 2016 and 28.1% for 2015.
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 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 income 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. Pension expense allocated to contracts pursuant to CAS was $13.8 million for both 2015 and 2014.
Operating Income
Operating income for 2015 was $281.7 million, compared with $294.5 million for 2014, a decrease of 4.3%. Operating income reflected the impact of 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. Total 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. Total 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. 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.
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) | 2016 | 2015 | 2014 | |||||||||
| Sales | $ | 876.7 | $ | 1,051.1 | $ | 1,115.5 | ||||||
| Cost of sales | $ | 494.6 | $ | 589.8 | $ | 630.0 | ||||||
| Selling, general and administrative expenses | $ | 272.3 | $ | 290.3 | $ | 303.9 | ||||||
| Operating income | $ | 109.8 | $ | 171.0 | $ | 181.6 | ||||||
| Cost of sales % of sales | 56.4 | % | 56.1 | % | 56.5 | % | ||||||
| Selling, general and administrative expenses % of sales | 31.1 | % | 27.6 | % | 27.2 | % | ||||||
| Operating income % of sales | 12.5 | % | 16.3 | % | 16.3 | % | ||||||
| International sales % of sales | 53.8 | % | 58.2 | % | 58.1 | % | ||||||
| U.S. Government sales % of sales | 8.5 | % | 5.8 | % | 3.5 | % | ||||||
| Capital expenditures | $ | 50.9 | $ | 20.9 | $ | 17.0 |
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.
2016 compared with 2015
Our Instrumentation segment sales were $876.7 million in 2016 compared with sales of $1,051.1 million in 2015, a decrease of 16.6%. Operating income was $109.8 million in 2016, compared with $171.0 million in 2015, a decrease of 35.8%. The 2016 sales decrease primarily resulted from lower sales of marine instrumentation partially offset by increased sales of test and measurement instrumentation. Sales for marine instrumentation decreased $195.3 million and primarily reflected lower sales of interconnect systems and other marine sensors for energy exploration and production, as a result of weak energy markets, partially offset by higher sales of interconnects and marine systems for U.S. Government applications. Sales of test and measurement instrumentation increased $19.5 million and included $15.4 million in incremental sales from recent acquisitions. Sales of environmental instrumentation increased $1.4 million. The decrease in operating income primarily reflected the impact of lower sales and also reflected $6.8 million in higher severance and facility consolidation costs compared with 2015. The incremental operating profit from recent acquisitions was $0.9 million, which included $0.8 million in additional intangible asset amortization.
Cost of sales decreased by $95.2 million in 2016, compared with 2015, and primarily reflected the impact of lower sales, partially offset by higher severance and facility consolidation expenses. The cost of sales percentage increased slightly to 56.4% in 2016 from 56.1% in 2015. Selling, general and administrative expenses, including research and development and bid and proposal expense, in 2016, decreased by $18.0 million, compared with 2015, and primarily reflected the impact of lower sales. Selling, general and administrative expenses for 2016, as a percentage of sales, increased to 31.1%, compared with 27.6% for 2015 and reflected the impact of lower sales while certain fixed costs decreased slightly.
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.
Digital Imaging
| (Dollars in millions) | 2016 | 2015 | 2014 | |||||||||
| Sales | $ | 398.7 | $ | 379.0 | $ | 403.6 | ||||||
| Cost of sales | $ | 239.4 | $ | 228.0 | $ | 252.0 | ||||||
| Selling, general and administrative expenses | $ | 113.4 | $ | 111.0 | $ | 114.5 | ||||||
| Operating income | $ | 45.9 | $ | 40.0 | $ | 37.1 | ||||||
| Cost of sales % of sales | 60.0 | % | 60.1 | % | 62.4 | % | ||||||
| Selling, general and administrative expenses % of sales | 28.5 | % | 29.3 | % | 28.4 | % | ||||||
| Operating income % of sales | 11.5 | % | 10.6 | % | 9.2 | % | ||||||
| International sales % of sales | 54.7 | % | 51.0 | % | 50.2 | % | ||||||
| U.S. Government sales % of sales | 18.3 | % | 20.8 | % | 25.3 | % | ||||||
| Capital expenditures | $ | 12.5 | $ | 9.2 | $ | 10.3 |
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 micro electro-mechanical systems (“MEMS”). It also includes our sponsored and centralized research laboratories which benefit government programs and commercial businesses.
2016 compared with 2015
Our Digital Imaging segment sales were $398.7 million in 2016, compared with sales of $379.0 million in 2015, an increase of 5.2%. Operating income was $45.9 million in 2016, compared with $40.0 million in 2015, an increase of 14.8%.
The 2016 sales increase primarily reflected higher sales of sensors and systems for life sciences and industrial X-ray applications, MEMS and geospatial software. Sales in 2016 included $9.6 million in incremental sales from recent acquisitions. The increase in operating income in 2016, compared with 2015, reflected the impact of higher sales and favorable product mix. The incremental operating loss included in the results for 2016 from recent acquisitions was $1.5 million, which included $0.5 million in additional intangible asset amortization expense.
Cost of sales for 2016 increased by $11.4 million, compared with 2015, and primarily reflected the impact of higher sales. The cost of sales percentage in 2016 decreased slightly. Selling, general and administrative expenses, for 2016, increased to $113.4 million, compared with $111.0 million in 2015 and primarily reflected higher research and development expense and the impact of higher sales, partially offset by lower general and administrative costs. The selling, general and administrative expense percentage decreased to 28.5% in 2016 from 29.3% in 2015.
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. Operating income in 2015 increased, compared with 2014, despite lower sales, and 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.
Aerospace and Defense Electronics
| (Dollars in millions) | 2016 | 2015 | 2014 | |||||||||
| Sales | $ | 615.9 | $ | 593.4 | $ | 603.0 | ||||||
| Cost of sales | $ | 377.5 | $ | 383.8 | $ | 386.6 | ||||||
| Selling, general and administrative expenses | $ | 126.3 | $ | 124.8 | $ | 128.1 | ||||||
| Operating income | $ | 112.1 | $ | 84.8 | $ | 88.3 | ||||||
| Cost of sales % of sales | 61.3 | % | 64.7 | % | 64.2 | % | ||||||
| Selling, general and administrative expenses % of sales | 20.5 | % | 21.0 | % | 21.2 | % | ||||||
| Operating income % of sales | 18.2 | % | 14.3 | % | 14.6 | % | ||||||
| International sales % of sales | 32.6 | % | 31.8 | % | 32.2 | % | ||||||
| U.S. Government sales % of sales | 34.2 | % | 37.7 | % | 40.7 | % | ||||||
| Capital expenditures | $ | 12.6 | $ | 9.1 | $ | 8.8 |
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. In the third quarter of 2016, Teledyne completed the disposition of the net assets of its PCT business. Sales for this business totaled $10.1 million, $16.6 million and $18.8 million for 2016, 2015 and 2014, respectively. For 2016, PCT reported a pretax loss of $3.1 million, compared with a pretax loss of $3.9 million in 2015 and pretax income of $1.1 million in 2014.
2016 compared with 2015
Our Aerospace and Defense Electronics segment sales were $615.9 million in 2016, compared with sales of $593.4 million in 2015, an increase of 3.8%. Operating income was $112.1 million in 2016, compared with $84.8 million in 2015, an increase of 32.2%.
Sales for 2016, compared with 2015, increased by $22.5 million and reflected higher sales of $26.3 million from avionics products and electronic relays partially offset by lower sales of $3.7 million from electronic manufacturing services products. The lower sales from electronic manufacturing services products reflected $6.5 million in lower sales from the PCT business, sold in July 2016. Operating income in 2016 increased by $27.3 million and reflected the impact of higher sales, as well as overall improved margins, partially offset by $3.4 million in higher severance and facility and consolidation costs. Operating income in 2016 reflected higher pension income of $2.4 million and 2015 included the reversal of facility and consolidation reserves of $1.7 million no longer needed.
Cost of sales for 2016 decreased by $6.3 million, compared with 2015, and reflected the impact of favorable product mix and higher pension income and higher pension income. Cost of sales as a percentage of sales for 2016 decreased to 61.3% from 64.7% in 2015 and reflected favorable product mix and the impact of higher pension income. Selling, general and administrative expenses, including research and development and bid and proposal expense, increased to $126.3 million in 2016, compared with $124.8 million in 2015. The selling, general and administrative expense percentage in 2016 decreased to 20.5% from 21.0% for 2015.
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 reflects 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. 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.
Engineered Systems
| (Dollars in millions) | 2016 | 2015 | 2014 | |||||||||
| Sales | $ | 258.6 | $ | 274.6 | $ | 271.9 | ||||||
| Cost of sales | $ | 206.5 | $ | 226.2 | $ | 218.5 | ||||||
| Selling, general and administrative expenses | $ | 20.0 | $ | 22.3 | $ | 22.0 | ||||||
| Operating income | $ | 32.1 | $ | 26.1 | $ | 31.4 | ||||||
| Cost of sales % of sales | 79.9 | % | 82.4 | % | 80.4 | % | ||||||
| Selling, general and administrative expenses % of sales | 7.7 | % | 8.1 | % | 8.1 | % | ||||||
| Operating income % of sales | 12.4 | % | 9.5 | % | 11.5 | % | ||||||
| International sales % of sales | 11.2 | % | 9.9 | % | 9.0 | % | ||||||
| U.S. Government sales % of sales | 85.0 | % | 85.4 | % | 81.6 | % | ||||||
| Capital expenditures | $ | 5.9 | $ | 5.7 | $ | 4.3 |
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.
2016 compared with 2015
Our Engineered Systems segment sales were $258.6 million in 2016, compared with sales of $274.6 million in 2015, a decrease of 5.8%. Operating income was $32.1 million in 2016, compared with $26.1 million in 2015, an increase of 23.0%.
The 2016 sales decrease of $16.0 million reflected lower sales of engineered products and services of $12.7 million and lower energy system products of $4.8 million, partially offset by higher sales of turbine engine sales of $1.5 million. The lower sales of engineered products and services primarily resulted from decreased sales of space and missile defense programs. The lower energy systems sales reflected lower sales of commercial hydrogen generators, as well as government energy systems. Operating income in 2016 reflected improved margins for engineered products and services and higher pension income of $2.5 million, partially offset by the impact of lower sales.
Cost of sales for 2016 decreased by $19.7 million, compared with 2015, and reflected the impact of lower sales and higher pension income. Cost of sales as a percentage of sales for 2016 decreased to 79.9%, compared with 82.4% in 2015 reflected the lower margin space and marine manufacturing programs ending in 2015 and also reflected the impact of higher pension income. Selling, general and administrative expenses, including research and development and bid and proposal expense, decreased to $20.0 million in 2016, compared with $22.3 million in 2015, and reflected the impact of lower sales. The selling, general and administrative expense percentage decreased to 7.7% for 2016, compared with 8.1% in 2015.
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.
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 and the pending e2v acquisition. We 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 2017. 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 December 2016, the Company entered into an amendment relating to unsecured term loans of $182.5 million in aggregate principal amount (the “Term Loans”) to extend the maturity date of the Term Loans from March 1, 2019 to January 31, 2022 and extending the date on which amortization of principal begins; and generally lowering the applicable rate for base rate and Eurocurrency loans. The other material terms of the Term Loans, including covenants, remain unchanged. In November 2015, the Company issued $125.0 million in aggregate principal amount of senior unsecured notes (“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 unsecured credit facility (“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.
In connection with the agreement to acquire e2v, Teledyne, together with certain of its subsidiaries as guarantors, has entered into a Credit Agreement (the “Bridge Facility”) dated December 11, 2016. The lenders under the Bridge Facility are committed to lend up to £345.0 million to fund the acquisition, and Teledyne has committed to have remain available for borrowing up to $410.0 million under its $750.0 million credit facility to fund the acquisition. No amounts have been drawn against the Bridge Facility to date.
| Long-term debt (in millions): | January 1, 2017 | January 3, 2016 | ||||||
| $750.0 million credit facility, due December 2020, weighted average rate of 1.67% at January 3, 2016 | $ | — | $ | 150.5 | ||||
| Term Loans due through January 2022, weighted average rate of 1.90% at January 1, 2017, and 1.55% at January 3, 2016 | 182.5 | 190.0 | ||||||
| 4.74% Fixed Rate Senior Notes due September 2017 | 100.0 | 100.0 | ||||||
| 2.61% Fixed Rate Senior Notes due December 2019 | 30.0 | 30.0 | ||||||
| 5.30% Fixed Rate Senior Notes due September 2020 | 75.0 | 75.0 | ||||||
| 2.81% Fixed Rate Senior Notes due November 2020 | 25.0 | 25.0 | ||||||
| 3.09% Fixed Rate Senior Notes due December 2021 | 95.0 | 95.0 | ||||||
| 3.28% Fixed Rate Senior Notes due November 2022 | 100.0 | 100.0 | ||||||
| Other debt | 4.2 | — | ||||||
| Total long-term debt | 611.7 | 765.5 | ||||||
| Current portion of long-term debt and debt issue costs | (102.0 | ) | (11.4 | ) | ||||
| Total long-term debt, net of current portion | $ | 509.7 | $ | 754.1 |
At January 1, 2017, we had $7.4 million in capital leases, of which $1.3 million is current and had $15.5 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 1, 2017, 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 1, 2017:
| $750.0 million Credit Facility expires December 2020 and $182.5 million term loans due through January 2022 (issued in October 2012) | |||
| Financial Covenant | Requirement | Actual Measure | |
| Consolidated Leverage Ratio (Net Debt/EBITDA) (a) | No more than 3.25 to 1 | 1.7 to 1 | |
| Consolidated Interest Coverage Ratio (EBITDA/Interest) (b) | No less than 3.0 to 1 | 16.0 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 | 1.7 to 1 | |
| Consolidated Interest Coverage Ratio (EBITDA/Interest) (b) | No less than 3.0 to 1 | 16.0 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. |
In the event of an acquisition, our debt instruments permit us, at our option, to exceed the Consolidated Leverage Ratio of 3.25 to 1 for up to four quarters following the fiscal quarter in which the acquisition event occurs, provided that the Consolidated Leverage Ratio does not exceed 3.5 to 1. If the pending acquisition of e2v closes, we expect to remain in compliance with this financial ratio as a result.
Available borrowing capacity under the $750.0 million credit facility, which is reduced by borrowings and outstanding letters of credit, was $735.5 million at January 1, 2017; noting, however, that Teledyne has committed to have remain available for borrowing up to $410.0 million under this facility to fund the pending e2v acquisition.
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. At January 1, 2017, $3.5 million was outstanding under the uncommitted credit line. No amounts were outstanding under this credit line at January 3, 2016.
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 expect to fund a portion of the cost of the e2v acquisition with cash held by our foreign subsidiaries. We estimate that future domestic cash generation will be sufficient to meet future domestic cash requirements. At January 1, 2017, the amount of undistributed foreign earnings was $226.6 million, of which we have not recorded a deferred tax liability of approximately $59.0 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 1, 2017. We have not included information on our normal recurring purchases of materials for use in our operations. We have also not included any amounts that may be required related to our pending acquisition of e2v.
The amounts in the following table are generally consistent from year to year, closely reflect our levels of production and are not long-term in nature:
| Contractual obligations (in millions): | 2017 | 2018 | 2019 | 2020 | 2021 | After 2021 | Total | |||||||||||||||||||||
| Debt obligations | $ | 100.7 | $ | 1.1 | $ | 34.6 | $ | 108.6 | $ | 102.4 | $ | 264.3 | $ | 611.7 | ||||||||||||||
| Interest expense(a) | 19.6 | 15.5 | 15.3 | 11.9 | 9.2 | 1.4 | 72.9 | |||||||||||||||||||||
| Operating lease obligations | 18.1 | 17.1 | 14.6 | 13.4 | 12.3 | 55.9 | 131.4 | |||||||||||||||||||||
| Capital lease obligations(b) | 1.3 | 1.3 | 1.4 | 1.1 | 1.1 | 2.2 | 8.4 | |||||||||||||||||||||
| Purchase obligations (c) | 74.4 | 3.7 | 2.0 | 1.7 | 0.7 | 1.9 | 84.4 | |||||||||||||||||||||
| Total | $ | 214.1 | $ | 38.7 | $ | 67.9 | $ | 136.7 | $ | 125.7 | $ | 325.7 | $ | 908.8 |
| (a) | Interest expense related to the credit facility, including facility fees, is assumed to accrue at the rates in effect at year-end 2016 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 $24.5 million are not included in the table above because $7.1 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 1, 2017, we were not required, and accordingly are not planning, to make any cash contributions to the domestic qualified pension plan for 2017. Our minimum funding requirements after 2017, 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 2017 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 2016, net cash provided by operating activities was $317.0 million, compared with $210.2 million in 2015 and $287.9 million in 2014. The higher cash provided by operating activities in 2016, compared with 2015, reflected $61.9 million in lower income tax payments, lower annual bonus and regular payroll payments and higher customer advanced payments, partially offset by higher payments for severance, facility closure and relocation costs and lower operating income. 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 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.
Free cash flow (cash provided by operating activities less capital expenditures) was $229.4 million in 2016, compared with $163.2 million in 2015 and $244.4 million in 2014. Adjusted free cash flow reflects utilization of restricted cash from the sale of a former operating facility which funded, in part, the facility purchase pursuant to a 1031 like-kind exchange and was $248.9 million in 2016, compared with $163.2 million in 2015 and $244.4 million in 2014.
| Free Cash Flow(a) (in millions, brackets indicate use of funds) | 2016 | 2015 | 2014 | ||||||||||
| Cash provided by operating activities | $ | 317.0 | $ | 210.2 | $ | 287.9 | |||||||
| Capital expenditures for property, plant and equipment, excluding facility purchase | (61.6 | ) | (47.0 | ) | (43.5 | ) | |||||||
| Facility purchase pursuant to 1031 like-kind exchange | (26.0 | ) | — | — | |||||||||
| Total capital expenditures | (87.6 | ) | (47.0 | ) | (43.5 | ) | |||||||
| Free cash flow | 229.4 | 163.2 | 244.4 | ||||||||||
| Restricted cash utilized for 1031 like-kind exchange facility purchase | 19.5 | — | — | ||||||||||
| Adjusted free cash flow | $ | 248.9 | $ | 163.2 | $ | 244.4 |
| 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 reflects utilization of restricted cash from the sale of a former operating facility which funded, in part, the facility purchase pursuant to a 1031 like-kind exchange. The company believes that this supplemental non-GAAP information is useful to assist management and the investment community in analyzing the company’s ability to generate cash flow. |
| Selected balance sheet changes (in millions): | 2016 | 2015 | ||||||
| Cash | $ | 98.6 | $ | 85.1 | ||||
| Current portion of long-term debt, capital leases and other debt | $ | 102.0 | $ | 19.1 | ||||
| Long-term debt and capital lease obligations, net of current portion | $ | 515.8 | $ | 761.5 | ||||
| Treasury stock | $ | 242.9 | $ | 309.9 | ||||
| Accumulated other comprehensive loss | $ | 451.2 | $ | 413.2 |
The increase in the current portion of long-term debt primarily reflects the expected repayment in 2017 of $100.0 million in term loans. The increase in accumulated other comprehensive loss reflects the impact of foreign currency adjustments and the non-cash reduction to stockholders’ equity for the pension and postretirement plans.
Investing Activities
Net cash used in investing activities was $151.0 million, $109.9 million and $238.7 million for 2016, 2015 and 2014, respectively. Cash flows relating to investing activities consists primarily of cash used for acquisitions and capital expenditures, except 2016 also includes $9.3 million of cash received from the sale of a business and cash received of $19.5 million from the sale of a former operating facility.
| Capital expenditures (in millions): | 2016 | 2015 | 2014 | |||||||||
| Instrumentation | $ | 50.9 | $ | 20.9 | $ | 17.0 | ||||||
| Digital Imaging | 12.5 | 9.2 | 10.3 | |||||||||
| Aerospace and Defense Electronics | 12.6 | 9.1 | 8.8 | |||||||||
| Engineered Systems | 5.9 | 5.7 | 4.3 | |||||||||
| Corporate | 5.7 | 2.1 | 3.1 | |||||||||
| $ | 87.6 | $ | 47.0 | $ | 43.5 |
The increase in capital spending in 2016, compared with 2015, primarily reflected the purchase of an operating facility. During 2017 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 1, 2017, for capital expenditures were approximately $9.5 million.
Acquisitions
Investing activities used cash for acquisitions and investments of $93.4 million, $66.7 million and $195.8 million, in 2016, 2015 and 2014, 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 CARIS, ICM and Axiom acquisitions are part of the Digital Imaging segment. All other acquisitions in 2016, 2015 and 2014 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 2016 and 2015 (in millions):
| 2016 | ||||||||||||||
| Acquisition | Acquisition Date | Cash Paid (a) | Goodwill Acquired | Acquired Intangible Assets | ||||||||||
| Frontline | April 6, 2016 | $ | 13.7 | $ | 11.3 | $ | 2.3 | |||||||
| Quantum Data | April 15, 2016 | 17.3 | 10.7 | 5.4 | ||||||||||
| CARIS | May 3, 2016 | 26.2 | 22.2 | 3.6 | ||||||||||
| IN USA | November 2, 2016 | 10.2 | 6.3 | 3.0 | ||||||||||
| Hanson Research | December 6, 2016 | 25.0 | 13.5 | 8.4 | ||||||||||
| Other investments | 1.0 | — | — | |||||||||||
| $ | 93.4 | $ | 64.0 | $ | 22.7 | |||||||||
| (a) net of any cash acquired and any purchase price adjustments. | ||||||||||||||
| 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. |
Goodwill resulting from the acquisitions of Frontline, Quantum Data, IN USA and CARIS made in 2016 will be deductible for tax purposes. Goodwill resulting from the 2016 acquisition of Hanson Research and the 2015 acquisitions of Bowtech and ICM will not be deductible for tax purposes.
Financing Activities
Financing activities for 2016 reflected net payments on debt of $163.1 million, compared with net payments on debt of $47.6 million in 2015 and net proceeds from debt of $29.5 million for 2014. In addition, in both 2015 and 2014, the Company issued $125.0 million of senior unsecured notes. Financing activities in 2016 also included the payment of $11.6 million for an option contract in connection with the pending e2v acquisition.
Fiscal years 2016, 2015 and 2014 reflect proceeds from the exercise of stock options of $36.1 million, $19.0 million and $18.3 million, respectively. Financing activities for 2015 and 2014 also reflected the repurchase of common stock of $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 qualified defined benefit pension plan covering substantially all U.S. employees hired before January 1, 2004, or approximately 16% of Teledyne’s active employees. As of January 1, 2004, new U.S. hires participate in a domestic defined contribution plan. In 2016, 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 2017 will decrease to 4.54% from 4.91% in 2016. The Company also has several smaller domestic and 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 2012, California income tax matters for all years through 2011 and Canadian income tax matters for all years through 2008.
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 and 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/(loss) (“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 $0.8 million, net of tax, over the next 12 months based on the year-end 2016 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 1, 2017, Teledyne had foreign currency forward contracts designated as cash flow hedges to buy Canadian dollars and to sell U.S. dollars totaling $56.8 million and these contracts had a negative fair value of $1.1 million. These foreign currency forward contracts have maturities ranging from March 2017 to February 2018.
In addition, the Company utilizes foreign currency forward contracts to mitigate foreign exchange rate risk associated with foreign currency denominated monetary assets and liabilities, including intercompany receivables and payables. As of January 1, 2017, Teledyne had foreign currency contracts of this type in the following currency pairs (in millions):
| Contracts to Buy | Contracts to Sell | |||||||
| Currency | Amount | Currency | Amount | |||||
| Canadian Dollars | C$ | 32.1 | U.S. Dollars | US$ | 24.2 | |||
| Euros | € | 10.4 | U.S. Dollars | US$ | 11.1 | |||
| Great Britain Pounds | £ | 1.4 | Australian Dollars | A$ | 2.4 | |||
| Great Britain Pounds | £ | 41.3 | U.S. Dollars | US$ | 52.0 | |||
| Canadian Dollars | C$ | 15.9 | Euros | € | 10.6 | |||
| U.S. Dollars | US$ | 0.9 | Japanese Yen | ¥ | 110.0 | |||
| Singapore Dollars | S$ | 1.8 | U.S. Dollars | US$ | 1.3 |
These contracts had a fair value of $5.4 million at January 1, 2017. The gains and losses on these derivatives which are not designated as hedging instruments, 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 1, 2017, would decrease the fair value of our foreign currency forward contracts associated with our cash flow hedging activities by $5.7 million. A hypothetical 10% depreciation of the U.S. dollar from its value at January 1, 2017, would increase the fair value of our foreign currency forward contracts associated with our cash flow hedging activities by $5.7 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 1, 2017, we had no amounts outstanding 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.
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 $7.0 million at January 1, 2017, and $8.7 million at January 3, 2016. As investigation and remediation of these sites proceed and new information is received, the Company will adjust accruals 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 25 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 27% of total sales in 2016, 26% of total sales in 2015 and 25% of total sales in 2014. 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 21%, 19% and 20% of total sales for 2016, 2015 and 2014, respectively.
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. See also our government contracts risks factor disclosure beginning on page 19.
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 1, 2017, and January 3, 2016 (in millions):
| Reserves and Valuation Accounts: (a) | 2016 | 2015 | ||||||
| Allowance for doubtful accounts | $ | 5.2 | $ | 6.3 | ||||
| Reduction to LIFO cost basis | $ | 13.5 | $ | 15.3 | ||||
| Other inventory reserves | $ | 59.4 | $ | 58.8 | ||||
| Workers’ compensation and general liability reserves(b) | $ | 9.3 | $ | 8.3 | ||||
| Warranty reserves(b) | $ | 18.4 | $ | 17.1 | ||||
| Environmental reserves(b) | $ | 7.0 | $ | 8.7 | ||||
| Other accrued liability reserves(b) | $ | 37.5 | $ | 33.9 |
(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 standard 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): | 2016 | 2015 | 2014 | |||||||||
| Balance at beginning of year | $ | 17.1 | $ | 18.5 | $ | 17.3 | ||||||
| Accruals for product warranties charged to expense | 7.4 | 6.1 | 6.6 | |||||||||
| Cost of product warranty claims | (6.7 | ) | (7.7 | ) | (5.9 | ) | ||||||
| Acquisitions | 0.6 | 0.2 | 0.5 | |||||||||
| Balance at year-end | $ | 18.4 | $ | 17.1 | $ | 18.5 |
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 upon 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.
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.
| (dollars in millions) | 2016 | 2015 | 2014 | |||||||||
| Percent of revenue - POC Method | 30.5 | % | 31.2 | % | 28.7 | % | ||||||
| Favorable changes in estimate | $ | 27.7 | $ | 38.6 | $ | 22.9 | ||||||
| Unfavorable changes in estimate | (29.6 | ) | (35.5 | ) | (25.9 | ) | ||||||
| Net change - income/(expense) | $ | (1.9 | ) | $ | 3.1 | $ | (3.0 | ) |
We do not believe that any discrete event or adjustment to an individual contract within the aggregate changes in contract estimates for 2016, 2015 or 2014 was material to the consolidated statements of income for such annual periods.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which provides a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will supersede most current revenue recognition guidance. For a discussion of this new accounting standard see Note 2 of our Notes to the Consolidated Financial Statements.
Pension Plans
Teledyne has a domestic qualified defined benefit pension plan covering substantially all U.S. employees hired before January 1, 2004, or approximately 16% of Teledyne’s active employees. As of January 1, 2004, new U.S. hires participate in a defined contribution plan only. The Company also has several smaller domestic and foreign-based defined benefit pension plans. At January 1, 2017, the benefit obligation for the domestic defined benefit pension plans totaled $810.9 million and the fair value of the net qualified plan assets totaled $857.1 million. At January 1, 2017, the benefit obligation for the foreign-based pension plans totaled $51.4 million and the fair value of the net plan assets totaled $42.1 million. The Company’s accounting for its defined benefit pension plans 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 domestic qualified pension plan assets are invested in and the long-term historical returns of these investments, that the long-term expected return on the domestic qualified pension plan assets will be 8.0% in 2017 and the assumed discount rate for determining benefit obligations will be 4.54% in 2017. The Company’s long-term expected return on the domestic qualified pension assets used in 2016 was 8.0% and the assumed discount rate used in 2016 was 4.91%. The actual rate of return on the domestic qualified pension plan assets was 7.09% in 2016 and a negative return of 1.1% in 2015 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 1, 2017, the domestic qualified pension plan is over-funded and contributions are not required. The Company did not make any cash contributions to its domestic qualified pension plan since 2013 when it made a voluntary pretax cash contribution of $83.0 million, before recovery from the U.S. Government. Each year beginning with 2014, the Society of Actuaries released revised mortality tables, which updated life expectancy assumptions. In consideration of these tables, we updated the mortality assumptions used in determining our pension obligations. The net 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 2016, the Company has a $249.6 million non-cash reduction to stockholders’ equity and a long-term additional liability of $396.9 million related to its pension plans. At year-end 2015, the Company had 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.
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 2016 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 | $ | (1.4 | ) | $ | 1.5 | |||
| 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 2016, there was no impairment to acquired intangible assets. Based on a quarterly impairment test completed in 2016, the Company recorded a $1.0 million impairment to acquired intangible assets. Based on a quarterly impairment test completed in 2015, the Company recorded a $0.5 million impairment to acquired intangible assets. No impairment of goodwill was indicated in 2016 or 2015, 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 1, 2017, the Company had 17 reporting units for goodwill impairment testing. The carrying value of goodwill included in the Company’s individual reporting units ranges from $1.0 million to $422.5 million. The Company’s analysis in 2016 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 2016, the annual testing date, ranged from approximately 19% to 4873%.
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. Without exception, the estimated fair values exceed the carrying value for each of the Company’s indefinite-lived intangible assets as of the fourth quarter of 2016, the annual testing date.
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 100 basis point increase in our nominal tax rate would have resulted in additional income tax provision for the fiscal year ended January 1, 2017, of $2.4 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.
Recent Accounting Standards
For a discussion of recent 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, acquisitions and divestitures, 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 rate fluctuations 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; risks associated with our pending acquisition of e2v, including the failure to satisfy closing conditions and the failure to successfully integrate the business; impacts from the United Kingdom’s decision to exit the European Union; uncertainties related to the policies of the new U.S. Presidential administration; and threats to the security of our confidential and proprietary information, including cyber security threats. Continued 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, including the pending e2v transaction, 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 50 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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