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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 that require advanced technology and high reliability. These markets include aerospace and defense, factory automation, air and water quality environmental monitoring, oceanographic research, deepwater oil and gas exploration and production, medical imaging and pharmaceutical research. Our products include digital imaging sensors, cameras and systems within the visible, infrared and X-ray spectra, monitoring instrumentation for marine and environmental applications, harsh environment interconnects, electronic test and measurement equipment, 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, in March 2017, we made our largest acquisition to date, e2v technologies plc (“e2v”). e2v provides high performance image sensors and custom camera solutions and application specific standard products for the machine vision market. 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 communications applications. We made one other acquisition in 2017, five acquisitions in 2016 and three acquisitions in 2015.
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. The transition services agreement terminated in 2017. In addition, in 2016 we sold a former operating facility in California and recorded a pretax gain of $17.9 million.
As part of a continuing effort to reduce costs and improve operating performance, we may take 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):
| 2017 | 2016 | 2015 | ||||||||||
| Instrumentation | $ | 2.1 | $ | 10.6 | $ | 3.9 | ||||||
| Digital Imaging | — | 2.0 | 3.2 | |||||||||
| Aerospace and Defense Electronics | 2.1 | 4.6 | 1.2 | |||||||||
| Engineered Systems | — | 0.1 | 0.1 | |||||||||
| Total | $ | 4.2 | $ | 17.3 | $ | 8.4 |
| 2017 | 2016 | 2015 | ||||||||||
| Severance | $ | 3.8 | $ | 9.5 | $ | 8.4 | ||||||
| Facility consolidations | 0.4 | 7.8 | — | |||||||||
| Total | $ | 4.2 | $ | 17.3 | $ | 8.4 |
| 2017 | 2016 | 2015 | ||||||||||
| Cost of sales | $ | 2.8 | $ | 6.8 | $ | 3.7 | ||||||
| Selling, general and administrative expenses | 1.4 | 10.5 | 4.7 | |||||||||
| Total | $ | 4.2 | $ | 17.3 | $ | 8.4 |
At December 31, 2017, $1.5 million remains to be paid related to these actions.
Recent Acquisitions
The Company spent $774.1 million, $93.4 million and $66.7 million on acquisitions and investments in 2017, 2016 and 2015, respectively, net of any cash acquired.
On March 28, 2017, Teledyne completed the acquisition of all of the outstanding common stock of e2v for $770.7 million, including stock options and assumed debt, net of $24.4 million of cash acquired. Most of e2v’s operations are included in the Digital Imaging and Aerospace and Defense Electronics segments. The Instrumentation segment includes a small portion of e2v’s operations. Principally located in Chelmsford, United Kingdom and Grenoble, France, e2v had sales of approximately £236 million for its fiscal year ended March 31, 2016. e2v’s results have been included since the date of the acquisition and include $273.7 million in net sales and operating income of $37.3 million, which included $8.3 million in acquisition-related costs and $11.2 million in additional intangible asset amortization expense.
Fiscal year 2017 includes pretax charges of $27.0 million related to the acquisition of e2v, which included $13.0 million in transaction costs, including stamp duty, advisory, legal and other consulting fees and other costs recorded to selling, general and administrative expenses, $5.7 million in inventory fair value step-up amortization expense recorded to cost of sales, $6.0 million related to a foreign currency option contract expense to hedge the e2v purchase price recorded as other expense and $2.3 million in bank bridge facility commitment expense recorded to interest expense. Of these amounts, $8.3 million impacted segment operating income.
On July 20, 2017 Teledyne Instruments, Inc. completed the acquisition of assets of Scientific Systems, Inc. (“SSI”) for $31.0 million in cash. A subsequent cash payment of $0.3 million related to a purchase price adjustment was made in 2017. Headquartered in State College, Pa., SSI is a manufacturer of precision components and specialized subassemblies used primarily in analytical and diagnostic instrumentation, such as high performance liquid chromatography (HPLC) systems and specific medical devices. SSI designs and manufactures high pressure positive-displacement piston pumps for a wide variety of analytical, clinical, sample prep and fluid-metering applications and is part of the Instrumentation segment.
On November 2, 2016, Teledyne Instruments, Inc. acquired assets of IN USA, Inc. (“IN USA”), headquartered in Norwood, Massachusetts, for $10.2 million in cash. IN USA is a manufacturer of a range of ozone generators, ozone analyzers and other gas monitoring instruments utilizing ultraviolet and infrared based technologies. Teledyne relocated and consolidated 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 Corporation (“Hanson Research”), headquartered in Chatsworth, California, for $25.0 million, net of cash acquired. Hanson Research specializes in analytical instrumentation for the pharmaceutical industry. On May 3, 2016, Teledyne DALSA, Inc., a Canadian-based subsidiary, acquired the assets and business of CARIS, Inc. (“CARIS”), based in Fredericton, New Brunswick, Canada, for $26.2 million, net of cash acquired. CARIS is 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”), based in Elgin, Illinois, for $17.3 million in cash. Quantum Data is a market leader in video protocol analysis test tools. On April 6, 2016, Teledyne LeCroy, Inc. also acquired Frontline Test Equipment, Inc. (“Frontline”), based in Charlottesville, Virginia, for $13.7 million in cash. Frontline is a market leader in wireless protocol analysis test tools.
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.
On April 29, 2015, Teledyne DALSA, Inc. acquired the remaining 49% noncontrolling interest in the parent company of Optech Incorporated (“Optech”). 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. 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.
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 2017 contained 52 weeks, fiscal year 2016 contained 52 weeks and fiscal year 2015 contained 53 weeks. The following are selected financial highlights for 2017, 2016 and 2015 (in millions, except per-share amounts):
| 2017 | 2016 | 2015 | ||||||||||
| Net sales | $ | 2,603.8 | $ | 2,149.9 | $ | 2,298.1 | ||||||
| Costs and Expenses | ||||||||||||
| Cost of sales | 1,612.2 | 1,318.0 | 1,427.8 | |||||||||
| Selling, general and administrative expenses | 656.0 | 578.1 | 588.6 | |||||||||
| Total costs and expenses | 2,268.2 | 1,896.1 | 2,016.4 | |||||||||
| Operating Income | 335.6 | 253.8 | 281.7 | |||||||||
| Interest and debt expense, net | (33.1 | ) | (23.2 | ) | (23.9 | ) | ||||||
| Other income/(expense), net | (15.5 | ) | 10.7 | 0.4 | ||||||||
| Income before income taxes | 287.0 | 241.3 | 258.2 | |||||||||
| Provision for income taxes | 59.8 | 50.4 | 62.7 | |||||||||
| Net income | 227.2 | 190.9 | 195.5 | |||||||||
| Noncontrolling interest | — | — | 0.3 | |||||||||
| Net income attributable to Teledyne | $ | 227.2 | $ | 190.9 | $ | 195.8 | ||||||
| Basic earnings per common share | $ | 6.45 | $ | 5.52 | $ | 5.55 | ||||||
| Diluted earnings per common share | $ | 6.26 | $ | 5.37 | $ | 5.44 |
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 2017, 2016 and 2015 are summarized in the following table:
| Percentage of Total Sales | |||||||||
| Segment contribution to total sales: | 2017 | 2016 | 2015 | ||||||
| Instrumentation | 36 | % | 41 | % | 46 | % | |||
| Digital Imaging | 27 | % | 18 | % | 16 | % | |||
| Aerospace and Defense Electronics | 26 | % | 29 | % | 26 | % | |||
| Engineered Systems | 11 | % | 12 | % | 12 | % | |||
| 100 | % | 100 | % | 100 | % |
Results of Operations
2017 compared with 2016
| Net sales (dollars in millions) | 2017 | 2016 | % Change | |||||||||
| Instrumentation | $ | 953.9 | $ | 876.7 | 8.8 | % | ||||||
| Digital Imaging | 693.5 | 398.7 | 73.9 | % | ||||||||
| Aerospace and Defense Electronics | 670.2 | 615.9 | 8.8 | % | ||||||||
| Engineered Systems | 286.2 | 258.6 | 10.7 | % | ||||||||
| Total net sales | $ | 2,603.8 | $ | 2,149.9 | 21.1 | % | ||||||
| Results of operations (dollars in millions) | 2017 | 2016 | % Change | |||||||||
| (in millions) | ||||||||||||
| Instrumentation | $ | 127.4 | $ | 109.8 | 16.0 | % | ||||||
| Digital Imaging | 108.4 | 45.9 | 136.2 | % | ||||||||
| Aerospace and Defense Electronics | 124.9 | 112.1 | 11.4 | % | ||||||||
| Engineered Systems | 37.7 | 32.1 | 17.4 | % | ||||||||
| Corporate expense | (62.8 | ) | (46.1 | ) | 36.2 | % | ||||||
| Operating income | 335.6 | 253.8 | 32.2 | % | ||||||||
| Interest and debt expense, net | (33.1 | ) | (23.2 | ) | 42.7 | % | ||||||
| Other income/(expense), net | (15.5 | ) | 10.7 | * | ||||||||
| Income before income taxes | 287.0 | 241.3 | 18.9 | % | ||||||||
| Provision for income taxes | 59.8 | 50.4 | 18.7 | % | ||||||||
| Net income | $ | 227.2 | $ | 190.9 | 19.0 | % | ||||||
| * not meaningful |
Sales and cost of sales by segment and total company (dollars in millions):
| 2017 | 2016 | Change | |||||||||
| Instrumentation | |||||||||||
| Net sales | $ | 953.9 | $ | 876.7 | $ | 77.2 | |||||
| Cost of sales | $ | 546.0 | $ | 494.6 | $ | 51.4 | |||||
| Cost of sales % of net sales | 57.2 | % | 56.4 | % | |||||||
| Digital Imaging | |||||||||||
| Net sales | $ | 693.5 | $ | 398.7 | $ | 294.8 | |||||
| Cost of sales | $ | 431.1 | $ | 239.4 | $ | 191.7 | |||||
| Cost of sales % of net sales | 62.2 | % | 60.0 | % | |||||||
| Aerospace and Defense Electronics | |||||||||||
| Net sales | $ | 670.2 | $ | 615.9 | $ | 54.3 | |||||
| Cost of sales | $ | 410.1 | $ | 377.5 | $ | 32.6 | |||||
| Cost of sales % of net sales | 61.2 | % | 61.3 | % | |||||||
| Engineered Systems | |||||||||||
| Net sales | $ | 286.2 | $ | 258.6 | $ | 27.6 | |||||
| Cost of sales | $ | 225.0 | $ | 206.5 | $ | 18.5 | |||||
| Cost of sales % of net sales | 78.6 | % | 79.9 | % | |||||||
| Total Company | |||||||||||
| Net sales | $ | 2,603.8 | $ | 2,149.9 | $ | 453.9 | |||||
| Cost of sales | $ | 1,612.2 | $ | 1,318.0 | $ | 294.2 | |||||
| Cost of sales % of net sales | 61.9 | % | 61.3 | % |
We reported net sales of $2,603.8 million in 2017, compared with net sales of $2,149.9 million for 2016, an increase of 21.1%. Net income was $227.2 million ($6.26 per diluted share) for 2017, compared with net income of $190.9 million ($5.37 per diluted share) for 2016, an increase of 19.0%.
Total year 2017 and 2016 reflected pretax charges totaling $4.2 million and $17.3 million, respectively, for severance and facility consolidation charges. Net income for 2017 and 2016 also included net discrete tax benefits of $21.9 million and $10.9 million, respectively. Total year 2017 also includes provisional charges of $4.7 million for the estimated impact of the Tax Cuts and Jobs Act (“Tax Act”). Net income for 2017 and 2016 included pretax charges totaling $27.0 million and $7.9 million, respectively, related to e2v acquisition related expenses. We also recorded a gain in 2016 of $17.9 million on the sale of a former operating facility in California.
Net sales
The increase in net sales in 2017, compared with 2016, reflected higher sales in each segment. Sales in 2017 included revenue growth of $155.9 million plus $298.0 million in incremental net sales from recent acquisitions, primarily e2v, and the PCT divestiture. The incremental sales from the e2v acquisition in 2017 was $273.7 million.
Sales under contracts with the U.S. Government were approximately 24% of sales in 2017 and 27% of sales in 2016. Sales to international customers represented approximately 46% of sales in 2017 and 43% of sales in 2016.
Cost of Sales
Total company cost of sales increased by $294.2 million in 2017, compared with 2016, which primarily reflected the impact of higher net sales. The total company cost of sales as a percentage of sales for 2017 was 61.9%, compared with 61.3% for 2016.
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 higher in 2017, compared with 2016. The increase reflected the impact of higher sales, partially offset by lower severance and facility consolidation expenses of $9.1 million. Corporate administrative expense in 2017 was $62.8 million, compared with $46.1 million in 2016. The increase in corporate administrative expense reflected
higher compensation expense and $10.4 million in acquisition transaction expense related to the e2v acquisition in 2017. Corporate administrative expense in 2016 reflected $1.9 million in acquisition transaction expense related to the e2v acquisition. For 2017, we recorded a total of $14.2 million in stock option expense, of which $4.5 million was recorded as corporate expense and $9.7 million was recorded in the operating segment results. 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. Selling, general and administrative expenses as a percentage of sales was 25.2% for 2017, compared with 26.9% for 2016 and reflected the impact of the e2v acquisition which carried a lower selling, general and administrative expense percentage than the other Teledyne businesses and lower severance and facility consolidation expenses.
Pension Income/Expense
Included in operating income in 2017 was pension income of $2.7 million compared with pension income of $2.2 million in 2016. Pension expense allocated to contracts pursuant to U.S. Government Cost Accounting Standards (“CAS”) was $13.8 million for both 2017 and 2016. 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 2017 was $335.6 million, compared with $253.8 million for 2016, an increase of 32.2%. The increase in operating income primarily reflected higher operating income in each segment, partially offset by higher corporate expense. Operating income in 2017 and 2016 included $4.2 million and $17.3 million in severance and facility consolidation costs, respectively. The incremental operating income included in the results for 2017 from recent acquisitions was $43.8 million which included $13.0 million in additional intangible asset amortization expense.
Interest Expense and Other Income and Expense
Total interest expense, including credit facility fees and other bank charges, was $35.5 million in 2017 compared with $23.6 million in 2016 and reflected the impact of higher debt levels in 2017 due to the acquisition of e2v. Interest income was $2.4 million in 2017 and $0.3 million in 2016. Other expense in 2017 and 2016 reflected $6.0 million and $5.5 million, respectively, of expense for a foreign currency option contract related to the e2v acquisition. Other income for 2016 included a gain of $17.9 million on the sale of a former operating facility in California.
Income Taxes
On December 22, 2017, the Tax Cuts and Jobs Act was enacted. The Tax Act significantly revised the U.S. corporate income tax by, among other things, lowering corporate income tax rates, implementing the territorial tax system and imposing a tax on deemed repatriation of non-U.S. earnings. As a result of the Tax Act, Teledyne incurred provisional charges of $4.7 million in the fourth quarter of 2017 primarily due to the repatriation tax and the remeasurement of U.S. deferred tax assets and liabilities. In accordance with the Tax Act, the Company will elect to pay the repatriation tax liability over a period of eight years, with the first installment of $3.1 million due in 2018. The remainder of the tax liability is recorded in non-current income tax payable. The repatriation tax resulted in a net tax expense of $26.2 million and the remeasurement of U.S. deferred tax assets and liabilities resulted in a net tax benefit of $21.5 million. The impacts of the Tax Act may differ from this estimate, possibly materially (and the amount of the provisional charge may accordingly be adjusted over the course of 2018), due to changes in interpretations and assumptions Teledyne has made, guidance that may be issued, and actions Teledyne may take as a result of the Tax Act. These adjustments to the provisional charge related to the Tax Act will be recorded quarterly until the computations are complete which is expected no later than the fourth quarter of 2018.
The Company’s effective tax rate for 2017 was 20.8%, compared with 20.9% for 2016. Total year 2017 reflected $21.9 million in net discrete income tax benefits, which included an $8.5 million income tax benefit related to the release of valuation allowance for which the deferred tax assets are now determined more-likely-than-not to be realizable and a $8.5 million income tax benefit as a result of the remeasurement of uncertain tax positions due to expiration of statute of limitation, partially offset by $4.6 million related to adjustments for uncertain tax positions. Total year 2017 also includes $8.8 million in net discrete tax benefits related to share-based accounting.
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 No. 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.
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 26.8% for 2017 and 27.4% for 2016.
2016 Compared with 2015
| Sales (dollars in millions) | 2016 | 2015 | % Change | |||||||||
| 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 (dollars in millions) | 2016 | 2015 | % Change | |||||||||
| 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 (dollars in millions):
| 2016 | 2015 | Change | |||||||||
| Instrumentation | |||||||||||
| Net sales | $ | 876.7 | $ | 1,051.1 | $ | (174.4 | ) | ||||
| Cost of sales | $ | 494.6 | $ | 589.8 | $ | (95.2 | ) | ||||
| Cost of sales % of net sales | 56.4 | % | 56.1 | % | |||||||
| Digital Imaging | |||||||||||
| Net sales | $ | 398.7 | $ | 379.0 | $ | 19.7 | |||||
| Cost of sales | $ | 239.4 | $ | 228.0 | $ | 11.4 | |||||
| Cost of sales % of net sales | 60.0 | % | 60.1 | % | |||||||
| Aerospace and Defense Electronics | |||||||||||
| Net sales | $ | 615.9 | $ | 593.4 | $ | 22.5 | |||||
| Cost of sales | $ | 377.5 | $ | 383.8 | $ | (6.3 | ) | ||||
| Cost of sales % of net sales | 61.3 | % | 64.7 | % | |||||||
| Engineered Systems | |||||||||||
| Net sales | $ | 258.6 | $ | 274.6 | $ | (16.0 | ) | ||||
| Cost of sales | $ | 206.5 | $ | 226.2 | $ | (19.7 | ) | ||||
| Cost of sales % of net sales | 79.9 | % | 82.4 | % | |||||||
| Total Company | |||||||||||
| Net sales | $ | 2,149.9 | $ | 2,298.1 | $ | (148.2 | ) | ||||
| Cost of sales | $ | 1,318.0 | $ | 1,427.8 | $ | (109.8 | ) | ||||
| Cost of sales % of net sales | 61.3 | % | 62.1 | % |
We reported 2016 net sales of $2,149.9 million, compared with net 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 e2v acquisition.
Net Sales
The decrease in net 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.
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. 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 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 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 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 the impact of 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 compared with $24.0 million in 2015. Interest income was $0.3 million in 2016 and $0.1 million in 2015. Other income for 2016 included the 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 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 an $8.5 million income tax benefit related to the adoption of ASU No. 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.
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) | 2017 | 2016 | 2015 | |||||||||
| Net sales | $ | 953.9 | $ | 876.7 | $ | 1,051.1 | ||||||
| Cost of sales | $ | 546.0 | $ | 494.6 | $ | 589.8 | ||||||
| Selling, general and administrative expenses | $ | 280.5 | $ | 272.3 | $ | 290.3 | ||||||
| Operating income | $ | 127.4 | $ | 109.8 | $ | 171.0 | ||||||
| Cost of sales % of net sales | 57.2 | % | 56.4 | % | 56.1 | % | ||||||
| Selling, general and administrative expenses % of net sales | 29.4 | % | 31.1 | % | 27.6 | % | ||||||
| Operating income % of net sales | 13.4 | % | 12.5 | % | 16.3 | % | ||||||
| International sales % of net sales | 53.7 | % | 53.8 | % | 58.2 | % | ||||||
| U.S. Government sales % of net sales | 6.8 | % | 8.5 | % | 5.8 | % |
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.
2017 compared with 2016
Our Instrumentation segment net sales were $953.9 million in 2017 compared with net sales of $876.7 million in 2016, an increase of 8.8%. Operating income was $127.4 million in 2017, compared with $109.8 million in 2016, an increase of 16.0%.
The 2017 net sales increase primarily resulted from higher sales of environmental instrumentation, test and measurement instrumentation and marine instrumentation, as well as the contribution from recent acquisitions. Sales of environmental instrumentation increased $44.2 million and primarily reflected higher sales of air monitoring instruments and $23.4 million in incremental sales from recent acquisitions. Sales of test and measurement instrumentation increased $21.0 million and included $9.7 million in incremental sales from recent acquisitions. Sales of marine instrumentation increased by $12.0 million and primarily reflected higher sales of sensors for energy exploration and autonomous subsea vehicles, partially offset by reduced sales of interconnect systems. The increase in operating income was primarily due to greater sales and improved margins for environmental and test and measurement instrumentation and lower severance, facility consolidation expenses. Total year 2017 included $8.5 million in lower severance and facility consolidation costs. The incremental operating income from recent acquisitions was $3.7 million, which included $1.9 million in additional intangible asset amortization.
Cost of sales increased by $51.4 million in 2017, compared with 2016, and primarily reflected the impact of higher net sales, partially offset by lower severance and facility consolidation expenses. The cost of sales percentage increased to 57.2% in 2017 from 56.4% in 2016. Selling, general and administrative expenses, including research and development and bid and proposal expense, in 2017, increased by $8.2 million, compared with 2016, and primarily reflected the impact of higher net sales. Selling, general and administrative expenses for 2017, as a percentage of sales, decreased to 29.4%, compared with 31.1% for 2016 and reflected the impact of lower severance and facility consolidation expenses.
2016 compared with 2015
Our Instrumentation segment net 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 income 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 net sales, partially offset by higher severance and facility consolidation expenses. The cost of sales percentage increased slightly to 56.4% from 56.1%. 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 net sales. Selling, general and administrative expenses for 2016, as a percentage of net sales, increased to 31.1%, compared with 27.6% for 2015 and reflected the impact of lower sales while certain fixed costs decreased slightly.
Digital Imaging
| (Dollars in millions) | 2017 | 2016 | 2015 | |||||||||
| Net sales | $ | 693.5 | $ | 398.7 | $ | 379.0 | ||||||
| Cost of sales | $ | 431.1 | $ | 239.4 | $ | 228.0 | ||||||
| Selling, general and administrative expenses | $ | 154.0 | $ | 113.4 | $ | 111.0 | ||||||
| Operating income | $ | 108.4 | $ | 45.9 | $ | 40.0 | ||||||
| Cost of sales % of net sales | 62.2 | % | 60.0 | % | 60.1 | % | ||||||
| Selling, general and administrative expenses % of net sales | 22.2 | % | 28.5 | % | 29.3 | % | ||||||
| Operating income % of net sales | 15.6 | % | 11.5 | % | 10.6 | % | ||||||
| International sales % of net sales | 63.7 | % | 54.7 | % | 51.0 | % | ||||||
| U.S. Government sales % of net sales | 12.4 | % | 18.3 | % | 20.8 | % |
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”) and high-performance, high-reliability semiconductors including analog-to-digital and digital-to-analog converters. It also includes our sponsored and centralized research laboratories which benefit government programs and commercial businesses.
2017 compared with 2016
Our Digital Imaging segment net sales were $693.5 million in 2017, compared with net sales of $398.7 million in 2016, an increase of 73.9%. Operating income was $108.4 million in 2017, compared with $45.9 million in 2016, an increase of 136.2%.
The 2017 net sales increase reflected $228.1 million in incremental sales from recent acquisitions, primarily e2v. Total year 2017 also reflected higher sales of machine vision cameras for industrial applications, MEMS, geospatial hardware and software and X-ray detectors for life sciences applications. The increase in operating income in 2017, compared with 2016, reflected the impact of higher net sales, favorable product mix and incremental operating profit from e2v, partially offset by acquisition-related charges of $8.0 million. The incremental operating income included in the results for 2017 from recent acquisitions was $32.1 million, which included $9.6 million in additional intangible asset amortization expense.
Cost of sales for 2017 increased by $191.7 million, compared with 2016, and reflected the impact of higher sales. The cost of sales percentage in 2017 increased to 62.2% compared with 60.0% in 2016 and reflected the impact of the e2v acquisition which carried a higher cost of sales percentage than the other digital imaging businesses collectively. Selling, general and administrative expenses for 2017 increased to $154.0 million, compared with $113.4 million in 2016 and reflected the impact of higher net sales. The selling, general and administrative expense percentage decreased to 22.2% in 2017 from 28.5% in 2016 and reflected the impact of the e2v acquisition which carried a lower selling, general and administrative expense percentage than the other digital imaging businesses collectively and lower research and development expense.
2016 compared with 2015
Our Digital Imaging segment net sales were $398.7 million in 2016, compared with net 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 net sales. The cost of sales percentage in 2016 decreased slightly. Selling, general and administrative expenses for 2016, increased slightly 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.
Aerospace and Defense Electronics
| (Dollars in millions) | 2017 | 2016 | 2015 | |||||||||
| Net sales | $ | 670.2 | $ | 615.9 | $ | 593.4 | ||||||
| Cost of sales | $ | 410.1 | $ | 377.5 | $ | 383.8 | ||||||
| Selling, general and administrative expenses | $ | 135.2 | $ | 126.3 | $ | 124.8 | ||||||
| Operating income | $ | 124.9 | $ | 112.1 | $ | 84.8 | ||||||
| Cost of sales % of net sales | 61.2 | % | 61.3 | % | 64.7 | % | ||||||
| Selling, general and administrative expenses % of net sales | 20.2 | % | 20.5 | % | 21.0 | % | ||||||
| Operating income % of net sales | 18.6 | % | 18.2 | % | 14.3 | % | ||||||
| International sales % of net sales | 33.7 | % | 32.6 | % | 31.8 | % | ||||||
| U.S. Government sales % of net sales | 33.6 | % | 34.2 | % | 37.7 | % |
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 and $16.6 million for 2016 and 2015, respectively. For 2016, PCT reported a pretax loss of $3.1 million, compared with a pretax loss of $3.9 million in 2015.
2017 compared with 2016
Our Aerospace and Defense Electronics segment sales were $670.2 million in 2017, compared with sales of $615.9 million in 2016, an increase of 8.8%. Operating income was $124.9 million in 2017, compared with $112.1 million in 2016, an increase of 11.4%.
The 2017 sales increase reflected $52.3 million of higher sales of microwave and interconnect systems and higher sales of $14.3 million of avionics products and electronic relays, partially offset by $12.3 million of lower sales for electronic manufacturing services products. The higher sales of microwave and interconnect systems included $46.7 million in sales from e2v. The lower sales from electronic manufacturing services products reflected $10.1 million in lower sales from the PCT business sold in July 2016. Operating income in 2017 reflected the impact of higher sales, overall improved margins and favorable product mix. The incremental operating income included in the results for 2017 from e2v was $8.0 million, which included $1.5 million in additional intangible asset amortization expense.
Cost of sales for 2017 increased by $32.6 million, compared with 2016, and reflected the impact of higher net sales. Cost of sales as a percentage of sales for 2017 decreased slightly to 61.2% from 61.3% in 2016. Selling, general and administrative expenses, including research and development and bid and proposal expense, increased to $135.2 million in 2017, compared with $126.3 million in 2016 and reflected the impact of higher net sales. The selling, general and administrative expense percentage in 2017 decreased slightly to 20.2% from 20.5% for 2016.
2016 compared with 2015
Our Aerospace and Defense Electronics segment net sales were $615.9 million in 2016, compared with net 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 product mix changes 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 product mix differences and the impact of higher pension income. Selling, general and administrative expenses, including research and development and bid and proposal expense, increased slightly 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.
Engineered Systems
| (Dollars in millions) | 2017 | 2016 | 2015 | |||||||||
| Net sales | $ | 286.2 | $ | 258.6 | $ | 274.6 | ||||||
| Cost of sales | $ | 225.0 | $ | 206.5 | $ | 226.2 | ||||||
| Selling, general and administrative expenses | $ | 23.5 | $ | 20.0 | $ | 22.3 | ||||||
| Operating income | $ | 37.7 | $ | 32.1 | $ | 26.1 | ||||||
| Cost of sales % of net sales | 78.6 | % | 79.9 | % | 82.4 | % | ||||||
| Selling, general and administrative expenses % of net sales | 8.2 | % | 7.7 | % | 8.1 | % | ||||||
| Operating income % of net sales | 13.2 | % | 12.4 | % | 9.5 | % | ||||||
| International sales % of net sales | 10.0 | % | 11.2 | % | 9.9 | % | ||||||
| U.S. Government sales % of net sales | 85.2 | % | 85.0 | % | 85.4 | % |
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.
2017 compared with 2016
Our Engineered Systems segment net sales were $286.2 million in 2017, compared with net sales of $258.6 million in 2016, an increase of 10.7%. Operating income was $37.7 million in 2017, compared with $32.1 million in 2016, an increase of 17.4%.
The 2017 sales increase of $27.6 million reflected higher sales of $20.1 million of engineered products and services and $9.0 million of turbine engines, partially offset by lower sales of $1.5 million of energy systems products. The higher sales of engineered products and services primarily reflected greater sales from missile defense, space and marine manufacturing programs. The higher sales of turbine engines reflected greater sales for the JASSM missile program. Operating income in 2017 reflected the impact of higher net sales and a greater proportion of higher margin manufacturing programs.
Cost of sales for 2017 increased by $18.5 million, compared with 2016, and reflected the impact of higher net sales. Cost of sales as a percentage of sales for 2017 decreased to 78.6%, compared with 79.9% in 2016. Selling, general and administrative expenses, including research and development and bid and proposal expense, increased to $23.5 million in 2017, compared with $20.0 million in 2016, and reflected the impact of higher sales. The selling, general and administrative expense percentage increased to 8.2% for 2017, compared with 7.7% in 2016.
2016 compared with 2015
Our Engineered Systems segment net sales were $258.6 million in 2016, compared with net 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 net 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.
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 and debt service requirements, as well as acquisitions. 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 2018. 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 March 2017, Teledyne entered into a $100.0 million term loan with a maturity date of October 30, 2019. Subsequently, in March 2017, Teledyne entered into a cross currency swap to effectively convert the $100.0 million term loan to a €93.0 million denominated instrument with a fixed euro interest rate of 0.7055%. The proceeds from the term loan were used in connection with the acquisition of e2v. On April 18, 2017, Teledyne entered into a note purchase agreement for a private placement of €250.0 million of senior unsecured notes due through April 2024. Teledyne used the proceeds of this private placement note issuance, among other things, to repay indebtedness and for general corporate purposes. In September 2017, Teledyne repaid the $100.0 million 4.74% fixed rate senior notes at their maturity.
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 2019 to January 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.
| Long-term debt (in millions): | December 31, 2017 | January 1, 2017 | ||||||
| $750.0 million credit facility, due December 2020, weighted average rate of 2.72% at December 31, 2017 | $ | 165.0 | $ | — | ||||
| Term Loans due through January 2022, weighted average rate of 2.94% at December 31, 2017, and 1.90% at January 1, 2017 | 175.5 | 182.5 | ||||||
| Term loan due October 2019, variable rate of 2.80% swapped to a Euro fixed rate of 0.7055% at December 31, 2017 | 100.0 | — | ||||||
| 4.74% Fixed Rate Senior Notes due and repaid September 2017 | — | 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 | ||||||
| 0.70% €50 Million Fixed Rate Senior Notes due April 2022 | 60.0 | — | ||||||
| 0.92% €100 Million Fixed Rate Senior Notes due April 2023 | 120.0 | — | ||||||
| 1.09% €100 Million Fixed Rate Senior Notes due April 2024 | 120.0 | — | ||||||
| Other debt | 2.7 | 4.2 | ||||||
| Total long-term debt | 1,068.2 | 611.7 | ||||||
| Current portion of long-term debt and debt issue costs | (4.3 | ) | (102.0 | ) | ||||
| Total long-term debt, net of current portion | $ | 1,063.9 | $ | 509.7 |
At December 31, 2017, we had $6.7 million in capital leases, of which $1.3 million is current and had $29.6 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 December 31, 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 December 31, 2017:
| $750.0 million Credit Facility expires December 2020 and $175.5 million term loans due through January 2022 (issued in October 2012) and $100.0 million term loan due October 2019 (issued March 2017) | |||
| Financial Covenant | Requirement | Actual Measure | |
| Consolidated Leverage Ratio (Net Debt/EBITDA) (a) | No more than 3.25 to 1 | 2.3 to 1 | |
| Consolidated Interest Coverage Ratio (EBITDA/Interest) (b) | No less than 3.0 to 1 | 12.0 to 1 | |
| $625.0 million Private Placement Senior Notes due from 2019 to 2024 | |||
| Financial Covenant | Requirement | Actual Measure | |
| Consolidated Leverage Ratio (Net Debt/EBITDA) (a) | No more than 3.25 to 1 | 2.3 to 1 | |
| Consolidated Interest Coverage Ratio (EBITDA/Interest) (b) | No less than 3.0 to 1 | 12.0 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.
Available borrowing capacity under the $750.0 million credit facility, which is reduced by borrowings and outstanding letters of credit, was $558.7 million at December 31, 2017.
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 December 31, 2017, no amounts were outstanding under this credit line. At January 1, 2017, $3.5 million was outstanding under the credit line.
Contractual Obligations
The following table summarizes our expected cash outflows resulting from financial contracts and commitments at December 31, 2017. We have not included information on our normal recurring purchases of materials for use in our operations.
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): | 2018 | 2019 | 2020 | 2021 | 2022 | After 2022 | Total | |||||||||||||||||||||
| Debt obligations | $ | 2.3 | $ | 136.0 | $ | 105.1 | $ | 102.4 | $ | 482.0 | $ | 240.4 | $ | 1,068.2 | ||||||||||||||
| Interest expense(a) | 29.9 | 22.8 | 21.0 | 18.5 | 12.2 | 3.3 | 107.7 | |||||||||||||||||||||
| Operating lease obligations | 22.4 | 18.7 | 17.6 | 15.6 | 12.4 | 51.4 | 138.1 | |||||||||||||||||||||
| Capital lease obligations(b) | 1.3 | 1.2 | 1.3 | 1.2 | 1.2 | 1.5 | 7.7 | |||||||||||||||||||||
| Purchase obligations (c) | 129.9 | 2.6 | 1.9 | 0.9 | 0.9 | 1.9 | 138.1 | |||||||||||||||||||||
| Total | $ | 185.8 | $ | 181.3 | $ | 146.9 | $ | 138.6 | $ | 508.7 | $ | 298.5 | $ | 1,459.8 |
| (a) | Interest expense related to the credit facility, including facility fees, is assumed to accrue at the rates in effect at year-end 2017 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 the short-term portion of capital lease obligations. |
| (c) | Purchase obligations generally include contractual obligations for the purchase of goods and services and capital commitments. |
Unrecognized tax benefits of $26.0 million are not included in the table above because $8.0 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 and offsetting credits.
At December 31, 2017, we were not required, and accordingly are not planning, to make any cash contributions to the domestic qualified pension plan for 2018. Our minimum funding requirements after 2018, 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 2018 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 2017, net cash provided by operating activities was $374.7 million, compared with $317.0 million in 2016 and $210.2 million in 2015. The higher cash provided by operating activities in 2017, compared with 2016, reflected cash flow from e2v and the impact of higher operating income, partially offset by $12.1 million in higher income tax payments. 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.
Free cash flow (cash provided by operating activities less capital expenditures) was $316.2 million in 2017, compared with $229.4 million in 2016 and $163.2 million in 2015. 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 $316.2 million in 2017, compared with $248.9 million in 2016 and $163.2 million in 2015.
| Free Cash Flow(a) (in millions, brackets indicate use of funds) | 2017 | 2016 | 2015 | ||||||||||
| Cash provided by operating activities | $ | 374.7 | $ | 317.0 | $ | 210.2 | |||||||
| Capital expenditures for property, plant and equipment, excluding facility purchase | (58.5 | ) | (61.6 | ) | (47.0 | ) | |||||||
| Facility purchase pursuant to 1031 like-kind exchange | — | (26.0 | ) | — | |||||||||
| Total capital expenditures | (58.5 | ) | (87.6 | ) | (47.0 | ) | |||||||
| Free cash flow | 316.2 | 229.4 | 163.2 | ||||||||||
| Restricted cash utilized for 1031 like-kind exchange facility purchase | — | 19.5 | — | ||||||||||
| Adjusted free cash flow | $ | 316.2 | $ | 248.9 | $ | 163.2 |
| a) | We define free cash flow as cash provided by operating activities (a measure prescribed by generally accepted accounting principles) less capital expenditures for property, plant and equipment. Adjusted free cash flow 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. |
Investing Activities
Net cash used in investing activities was $831.2 million, $151.0 million and $109.9 million for 2017, 2016 and 2015, 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): | 2017 | 2016 | 2015 | |||||||||
| Instrumentation | $ | 13.7 | $ | 50.9 | $ | 20.9 | ||||||
| Digital Imaging | 23.3 | 12.5 | 9.2 | |||||||||
| Aerospace and Defense Electronics | 11.0 | 12.6 | 9.1 | |||||||||
| Engineered Systems | 5.8 | 5.9 | 5.7 | |||||||||
| Corporate | 4.7 | 5.7 | 2.1 | |||||||||
| $ | 58.5 | $ | 87.6 | $ | 47.0 |
The higher capital spending amount in 2016, primarily reflected the purchase of an operating facility for $26.0 million. During 2018 we plan to invest approximately $80.0 million in capital expenditures, principally to upgrade facilities and capital equipment, reduce manufacturing costs and introduce new products.
Acquisitions
Investing activities used cash for acquisitions and investments of $774.1 million, $93.4 million and $66.7 million, in 2017, 2016 and 2015, respectively (see “Recent Acquisitions”). Teledyne funded the acquisitions primarily from borrowings under its credit facilities, issuance of senior notes and term loans 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. Most of e2v’s operations are included in the Digital Imaging and Aerospace and Defense Electronics segments. The Instrumentation segment includes a small portion of e2v’s operations. The CARIS and ICM acquisitions are part of the Digital Imaging segment. All other acquisitions in 2017, 2016 and 2015 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 2017 and 2016 (in millions):
| 2017 | ||||||||||||||
| Acquisition | Acquisition Date | Cash Paid | Goodwill Acquired | Acquired Intangible Assets | ||||||||||
| e2v | March 28, 2017 | $ | 740.6 | $ | 490.4 | $ | 172.3 | |||||||
| SSI | July 20, 2017 | 31.3 | 13.8 | 9.3 | ||||||||||
| Other investments | 2.2 | 0.6 | 0.4 | |||||||||||
| $ | 774.1 | $ | 504.8 | $ | 182.0 | |||||||||
| 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. |
Goodwill resulting from the acquisitions of SSI, Frontline, Quantum Data, IN USA and CARIS will be deductible for tax purposes. Goodwill resulting from the acquisitions of e2v and Hanson Research will not be deductible for tax purposes.
Financing Activities
Financing activities for 2017 reflected net proceeds from debt of $393.7 million, compared with net payments on debt of $163.1 million in 2016 and net proceeds from debt of $77.4 million for 2015. Financing activities for 2017 reflected net borrowings from the $750.0 million credit facility of $165.0 million and the proceeds from a $100.0 million term loan and the proceeds from the private placement of €250.0 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 e2v acquisition. In 2015, the Company issued $125.0 million of senior unsecured notes.
Fiscal years 2017, 2016 and 2015 reflect proceeds from the exercise of stock options of $24.9 million, $36.1 million and $19.0 million, respectively. Financing activities for 2015 also reflected the repurchase of common stock of $243.8 million. Share repurchases totaled 2,561,815 shares in 2015. No repurchases were made in 2017 or in 2016. 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 13% of Teledyne’s active employees as of December 31, 2017. As of January 1, 2004, new U.S. hires participate in a domestic defined contribution plan. In 2017, 2016 and 2015, 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 2018 will decrease to 4.02% from 4.54% in 2017. 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.
On a provisional basis, we intend to reinvest indefinitely the earnings of our material foreign subsidiaries in our operations outside of the United States. The cash that the Company's foreign subsidiaries hold for indefinite reinvestment is generally used to finance foreign operations and investments, including acquisitions. We estimate that future domestic cash generation will be sufficient to meet future domestic cash requirements. Due to the Tax Act, U.S. federal and applicable state income taxes have been accrued for the deemed repatriation. At December 31, 2017, the amount of undistributed foreign
earnings was $324.3 million, for which we have not recorded a deferred tax liability of approximately $1.4 million for state corporate income taxes which would be due if reinvested foreign earnings were repatriated. Should we decide to repatriate the foreign earnings, we would need to adjust our income tax provision in the period we determined that we would no longer indefinitely reinvest the earnings outside the United States.
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 2013, United Kingdom and France income tax matters for all years through 2014 and Canadian income tax matters for all years through 2009.
Costs and Pricing
Inflationary trends in recent years have been moderate. Current inventory costs, the increasing costs of equipment and other costs are considered in establishing sales pricing policies. The Company emphasizes cost containment in all aspects of its business.
Hedging Activities 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 and in British pounds for our UK companies, including e2v. These contracts are designated and qualify as cash flow hedges. The Company has converted a US dollar denominated, variable rate debt obligation into a euro fixed rate obligation using a receive-float, pay fixed cross currency swap. This cross currency swap is designated as a cash flow hedge.
The effectiveness of the cash flow hedge forward 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 AOCI is reclassified to cost of sales in our consolidated statements of income. Net deferred gains recorded in AOCI, net of tax, for forward contracts that will mature in the next 12 months total $3.2 million. These gains are expected to be offset by anticipated losses in the value of the forecasted underlying hedged item. Amounts related to the cross currency swap expected to be reclassified from AOCI into income in the coming 12 months total $2.2 million.
In the event that the gains or losses in AOCI are deemed to be ineffective, the ineffective portion of gains or losses resulting from changes in fair value, if any, is reclassified to other income and expense. In the event that the underlying forecasted transactions do not occur, or it becomes remote that they will occur, within the defined hedge period, the gains or losses on the related cash flow hedges will be reclassified from AOCI to other income and expense. During the current reporting period, all forecasted transactions occurred and, therefore, there were no such gains or losses reclassified to other income and expense. As of December 31, 2017, Teledyne had foreign currency forward contracts designated as cash flow hedges to buy Canadian dollars and to sell U.S. dollars totaling $80.6 million. These foreign currency forward contracts have maturities ranging from March 2018 to February 2019. e2v had foreign currency forward contracts designated as cash flow hedges to buy British pounds and to sell U.S. dollars totaling $0.6 million. These foreign currency forward contracts have maturities ranging from March 2018 to April 2018. Together these contracts had a fair value of $3.8 million. The cross currency swap has notional amounts of $93.0 million euros equivalent to $100.0 million, and matures in October 2019.
In addition, the Company utilizes foreign currency forward contracts to mitigate foreign exchange rate risk associated with foreign currency denominated monetary assets and liabilities, including intercompany receivables and payables. As of December 31, 2017, Teledyne had foreign currency contracts of this type in the following currency pairs (in millions):
| Contracts to Buy | Contracts to Sell | |||||||
| Currency | Amount | Currency | Amount | |||||
| Canadian Dollars | C$ | 165.7 | U.S. Dollars | US$ | 128.4 | |||
| Euros | € | 20.7 | U.S. Dollars | US$ | 24.8 | |||
| Great Britain Pounds | £ | 1.5 | Australian Dollars | A$ | 2.7 | |||
| Great Britain Pounds | £ | 70.3 | U.S. Dollars | US$ | 94.6 | |||
| Canadian Dollars | C$ | 7.6 | Euros | € | 5.0 | |||
| U.S. Dollars | US$ | 0.9 | Japanese Yen | ¥ | 100.0 | |||
| Singapore Dollars | S$ | 2.0 | U.S. Dollars | US$ | 1.5 | |||
| Danish Krone | Kr. | 44.8 | U.S. Dollars | US$ | 7.2 | |||
| Swedish Krone | kr | 16.5 | Great Britain Pounds | £ | 1.4 | |||
| Swiss Franc | Fr. | 1.8 | U.S. Dollars | US$ | 1.8 | |||
| Euros | € | 29.9 | Great Britain Pounds | £ | 26.3 |
These contracts had a fair value of $3.8 million at December 31, 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 percent price change of the U.S. dollar from its value at December 31, 2017, would result in a decrease or increase in the fair value of our foreign currency forward contracts designated as cash flow hedges to buy Canadian dollars and to sell U.S. dollars by approximately $8.1 million. A hypothetical 10 percent price change in the U.S. dollar from its value at December 31, 2017 would result in a decrease or increase in the fair value of our Euro/U.S. Dollar cross currency swap designated as a cash flow hedge by approximately $10.2 million.
Borrowings under our credit facility are at fixed rates that vary with the term and timing of each loan under the facility. Loans under the facility typically have terms of one, two, three or six months and the interest rate for each such loan is subject to change if the loan is continued or converted following the applicable maturity date. Interest rates are also subject to change based on our debt to earnings before interest, taxes, depreciation and amortization ratio. As of December 31, 2017, we had$165.0 million 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 $5.1 million at December 31, 2017, and $7.0 million at January 1, 2017. 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 24% of total sales in 2017, 27% of total sales in 2016 and 26% of total sales in 2015. 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 18%, 21% and 19% of total sales for 2017, 2016 and 2015, 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 18.
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 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 December 31, 2017, and January 1, 2017:
| Reserves and Valuation Accounts (in millions): (a) | 2017 | 2016 | ||||||
| Allowance for doubtful accounts | $ | 10.3 | $ | 5.2 | ||||
| Reduction to LIFO cost basis | $ | 10.6 | $ | 13.5 | ||||
| Workers’ compensation and general liability reserves(b) | $ | 9.7 | $ | 9.3 | ||||
| Environmental reserves(b) | $ | 5.1 | $ | 7.0 | ||||
| Other accrued liability reserves(b) | $ | 28.3 | $ | 37.5 |
(a) This table should be read in conjunction with the Notes to Consolidated Financial Statements.
(b) Includes both long-term and short-term reserves.
Some of the Company’s products are subject to 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): | 2017 | 2016 | 2015 | |||||||||
| Balance at beginning of year | $ | 18.4 | $ | 17.1 | $ | 18.5 | ||||||
| Accruals for product warranties charged to expense | 6.0 | 7.4 | 6.1 | |||||||||
| Cost of product warranty claims | (6.4 | ) | (6.7 | ) | (7.7 | ) | ||||||
| Acquisitions | 3.1 | 0.6 | 0.2 | |||||||||
| Balance at year-end | $ | 21.1 | $ | 18.4 | $ | 17.1 |
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. The percentage of Teledyne revenue recognized using any POC method was 28.6 % in 2017, 30.5% in 2016, and 31.2% in 2015. The net aggregate effects of changes in estimates on contracts accounted for under the POC accounting method for 2017 and 2016, were $7.5 million and $1.9 million of unfavorable operating income, respectively, and $3.1 million of favorable operating income for 2015.
We do not believe that any discrete event or adjustment to an individual contract within the aggregate changes in contract estimates for 2017, 2016 or 2015 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. We adopted the new guidance effective January 1, 2018. For a discussion of this new accounting standard see Note 2 of our Notes to 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 13% 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 December 31, 2017, the benefit obligation for the domestic defined benefit pension plans totaled $812.3 million and the fair value of the net qualified plan assets totaled $896.0 million. At December 31, 2017, the benefit obligation for the foreign-based pension plans totaled $57.8 million and the fair value of the net plan assets totaled $46.7 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 2018 and the assumed discount rate for determining benefit obligations will be 4.02% in 2018. The Company’s long-term expected return on the domestic qualified pension assets used in 2017 was 8.0% and the assumed discount rate used in 2017 was 4.54%. The actual rate of return on the domestic qualified pension plan assets was 15.7% in 2017 and 7.1% in 2016 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 December 31, 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 has 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. 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 2017, the Company has a $229.5 million non-cash reduction to stockholders’ equity and a long-term additional liability of $366.3 million related to its pension plans. At year-end 2016, the Company had a $249.6 million non-cash reduction to stockholders’ equity and a long-term additional liability of $369.6 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 2017 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 | ) | $ | 1.4 | |||
| 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 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 impairment tests completed in 2017, 2016 and 2015, the Company recorded $0.2 million, $1.0 million and $0.5 million impairment to acquired intangible assets, respectively. No impairment of goodwill was indicated in 2017, 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 mainly through using a discounted cash flow model based on our best estimate of amounts and timing of future revenues and cash flows and our most recent business and strategic plans, and compares the estimated fair value to the carrying value of the reporting unit, including goodwill. The discounted cash flow model requires judgmental assumptions about projected revenue growth, future operating margins, discount rates and terminal values over a multi-year period. There are inherent uncertainties related to these assumptions and management’s judgment in applying them to the analysis of goodwill impairment. While the Company believes it has made reasonable estimates and assumptions to calculate the fair value of its reporting units, it is possible a material change could occur. If actual results are not consistent with management’s estimates and assumptions, goodwill may be overstated and a charge would need to be taken against net earnings.
As of December 31, 2017, the Company had 12 reporting units for goodwill impairment testing. The carrying value of goodwill included in the Company’s individual reporting units ranges from $1.2 million to $687.6 million. The Company’s analysis in 2017 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 2017, the annual testing date, ranged from approximately 29% to 2,124%.
Changes in our projections used in the discounted cash flow model 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.
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.
On December 22, 2017, the Tax Cuts and Jobs Act was enacted. The Tax Act significantly revised the U.S. corporate income tax by, among other things, lowering corporate income tax rates, implementing the territorial tax system and imposing a tax on deemed repatriation of non-U.S. earnings. As a result of the Tax Act, Teledyne incurred provisional charges of $4.7 million in the fourth quarter of 2017 primarily due to the repatriation tax and the remeasurement of U.S. deferred tax assets and liabilities. In accordance with the Tax Act, the Company will elect to pay the repatriation tax liability over a period of eight years, with the first installment of $3.1 million due in 2018. The remainder of the tax liability is recorded in non-current income tax payable. The repatriation tax resulted in a net tax expense of $26.2 million and the remeasurement of U.S. deferred tax assets and liabilities resulted in a net tax benefit of $21.5 million. The impacts of the Tax Act may differ from this estimate, possibly materially (and the amount of the provisional charge may accordingly be adjusted over the course of 2018), due to changes in interpretations and assumptions Teledyne has made, guidance that may be issued, and actions Teledyne may take as a result of the Tax Act. These adjustments to the provisional charge related to the Tax Act will be recorded quarterly until the computations are complete which is expected no later than the fourth quarter of 2018.
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 December 31, 2017, of $2.9 million. For a description of the Company’s tax accounting policies, refer to Note 2 and Note 10 of our Notes to Consolidated Financial Statements.
Recent Accounting Standards
For a discussion of recent accounting standards see Note 2 of our Notes to 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; changes in the estimated impact of the Tax Act; and cuts to defense spending resulting from existing and future deficit reduction measures; impacts from the United Kingdom’s planned exit from the European Union; uncertainties related to the policies of the U.S. Presidential administration; and threats to the security of our confidential and proprietary information, including cyber security threats. Lower oil and natural gas prices, as well as instability in the Middle East or other oil producing regions, and new regulations or restrictions relating to energy production, including with respect to hydraulic fracturing could further negatively affect our businesses that supply the oil and gas industry. Increasing fuel costs could negatively affect the markets of our commercial aviation businesses. In addition, financial market fluctuations affect the value of our pension assets.
Information regarding the impact of the Tax Act consists of preliminary estimates which are forward-looking statements and are subject to change, possibly materially, as the company completes its financial statements. Information regarding the impact of the Tax Act is based on our current calculations, as well as our current interpretations, assumptions and expectations relating to the Tax Act, which are subject to change.
Changes in the policies of U.S. and foreign governments could result, over time, in reductions or realignment in defense or other government spending and further changes in programs in which the Company participates.
While Teledyne’s growth strategy includes possible acquisitions, we cannot provide any assurance as to when, if or on what terms any acquisitions will be made. Acquisitions involve various inherent risks, such as, among others, our ability to integrate acquired businesses, retain customers and achieve identified financial and operating synergies. There are additional risks associated with acquiring, owning and operating businesses outside of the United States, including those arising from U.S. and foreign government policy changes or actions and exchange rate fluctuations.
We continue to take action to assure compliance with the internal controls, disclosure controls and other requirements of the Sarbanes-Oxley Act of 2002. While we believe our control systems are effective, there are inherent limitations in all control systems, and misstatements due to error or fraud may occur and may not be detected.
Additional information concerning factors that could cause actual results to differ materially from those projected in the forward-looking statements is contained beginning on page 13 of this Form 10-K under the caption “Risk Factors; Cautionary Statement as to Forward-Looking Statements.” Forward-looking statements are generally accompanied by words such as “estimate”, “project”, “predict”, “believes” or “expect”, that convey the uncertainty of future events or outcomes. We assume no obligation to publicly update or revise any forward-looking statements, whether as a result of new information or otherwise.
| Item 7A. Quantitative and Qualitative Disclosures About Market Risk |
The information required by this item is included in this Report on page 47 under the caption “Other Matters - Hedging Activities; Market Risk Disclosures” of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.”
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