filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Teledyne Technologies Incorporated provides enabling technologies for industrial growth markets 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, product development and share repurchases. We aggressively pursue operational excellence to continually improve our margins and earnings by emphasizing cost containment and cost reductions in all aspects of our business. 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, e2v provides high reliability semiconductors and board-level solutions for use in aerospace, space and communications applications. No material acquisitions were made in 2018, one other acquisition was made in 2017 and five acquisitions were made in 2016.
On February 5, 2019, we acquired the scientific imaging businesses of Roper for $225.0 million in cash. The scientific imaging businesses include Princeton Instruments, Photometrics and Lumenera, as well as other brands. These businesses provide a range of imaging solutions, primarily for life sciences, academic research and customized OEM industrial imaging solutions. Princeton Instruments and Photometrics manufacture state-of-the-art cameras, spectrographs and optics for advanced research in physical sciences, life sciences research and spectroscopy imaging. Applications and markets include materials analysis, quantum technology and cell biology imaging using fluorescence and chemiluminescence. Lumenera primarily provides rugged USB-based customized cameras for markets such as traffic management, as well as life sciences applications.
In the second quarter of 2018, we realigned the reporting structure for certain of our microwave product groupings. These products, acquired with the acquisition of e2v were formerly reported as part of the Aerospace and Defense Electronics segment and are now reported as part of the Digital Imaging segment. Previously reported segment data has been adjusted to reflect this change. Total sales for these products were $24.2 million for fiscal year 2017.
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 and have taken 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. At December 30, 2018, $2.8 million remains to be paid related to these actions.
The following pre-tax charges were incurred related to severance and facility consolidations (in millions):
| 2018 | 2017 | 2016 | ||||||||||
| Instrumentation | $ | 5.6 | $ | 2.1 | $ | 10.6 | ||||||
| Digital Imaging | 0.7 | — | 2.0 | |||||||||
| Aerospace and Defense Electronics | 1.3 | 2.1 | 4.6 | |||||||||
| Engineered Systems | 0.2 | — | 0.1 | |||||||||
| Total | $ | 7.8 | $ | 4.2 | $ | 17.3 |
| 2018 | 2017 | 2016 | ||||||||||
| Severance | $ | 5.6 | $ | 3.8 | $ | 9.5 | ||||||
| Facility consolidations | 2.2 | 0.4 | 7.8 | |||||||||
| Total | $ | 7.8 | $ | 4.2 | $ | 17.3 |
| 2018 | 2017 | 2016 | ||||||||||
| Cost of sales | $ | 4.9 | $ | 2.8 | $ | 6.8 | ||||||
| Selling, general and administrative expenses | 2.9 | 1.4 | 10.5 | |||||||||
| Total | $ | 7.8 | $ | 4.2 | $ | 17.3 |
Recent Acquisitions
The Company spent $3.1 million, $774.1 million and $93.4 million on acquisitions and other investments in 2018, 2017 and 2016, 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 for fiscal year 2017.
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 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 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.
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 years 2018, 2017 and 2016 each contained 52 weeks. The following are selected financial highlights for 2018, 2017 and 2016 (in millions, except per-share amounts):
| 2018 | 2017 | 2016 | ||||||||||
| Net sales | $ | 2,901.8 | $ | 2,603.8 | $ | 2,149.9 | ||||||
| Costs and Expenses | ||||||||||||
| Cost of sales | 1,791.0 | 1,624.0 | 1,329.5 | |||||||||
| Selling, general and administrative expenses | 694.2 | 658.1 | 579.9 | |||||||||
| Total costs and expenses | 2,485.2 | 2,282.1 | 1,909.4 | |||||||||
| Operating Income | 416.6 | 321.7 | 240.5 | |||||||||
| Interest and debt expense, net | (25.5 | ) | (33.1 | ) | (23.2 | ) | ||||||
| Non-service retirement benefit income | 13.5 | 13.9 | 13.3 | |||||||||
| Other income/(expense), net | (10.7 | ) | (15.5 | ) | 10.7 | |||||||
| Income before income taxes | 393.9 | 287.0 | 241.3 | |||||||||
| Provision for income taxes | 60.1 | 59.8 | 50.4 | |||||||||
| Net income | $ | 333.8 | $ | 227.2 | $ | 190.9 | ||||||
| Basic earnings per common share | $ | 9.32 | $ | 6.45 | $ | 5.52 | ||||||
| Diluted earnings per common share | $ | 9.01 | $ | 6.26 | $ | 5.37 |
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 2018, 2017 and 2016 are summarized in the following table:
| Percentage of Total Sales | |||||||||
| Segment contribution to total sales: | 2018 | 2017 | 2016 | ||||||
| Instrumentation | 35 | % | 36 | % | 41 | % | |||
| Digital Imaging | 31 | % | 28 | % | 18 | % | |||
| Aerospace and Defense Electronics | 24 | % | 25 | % | 29 | % | |||
| Engineered Systems | 10 | % | 11 | % | 12 | % | |||
| 100 | % | 100 | % | 100 | % |
Results of Operations
2018 compared with 2017
| Net sales (dollars in millions) | 2018 | 2017 | % Change | |||||||||
| Instrumentation | $ | 1,021.2 | $ | 953.9 | 7.1 | % | ||||||
| Digital Imaging | 885.2 | 717.7 | 23.3 | % | ||||||||
| Aerospace and Defense Electronics | 696.5 | 646.0 | 7.8 | % | ||||||||
| Engineered Systems | 298.9 | 286.2 | 4.4 | % | ||||||||
| Total net sales | $ | 2,901.8 | $ | 2,603.8 | 11.4 | % | ||||||
| Results of operations (dollars in millions) | 2018 | 2017 | % Change | |||||||||
| Instrumentation | $ | 147.4 | $ | 126.0 | 17.0 | % | ||||||
| Digital Imaging | 157.3 | 110.4 | 42.5 | % | ||||||||
| Aerospace and Defense Electronics | 135.2 | 116.3 | 16.3 | % | ||||||||
| Engineered Systems | 32.7 | 32.0 | 2.2 | % | ||||||||
| Corporate expense | (56.0 | ) | (63.0 | ) | (11.1 | )% | ||||||
| Operating income | 416.6 | 321.7 | 29.5 | % | ||||||||
| Interest and debt expense, net | (25.5 | ) | (33.1 | ) | (23.0 | )% | ||||||
| Non-service retirement benefit income | 13.5 | 13.9 | (2.9 | )% | ||||||||
| Other expense, net | (10.7 | ) | (15.5 | ) | (31.0 | )% | ||||||
| Income before income taxes | 393.9 | 287.0 | 37.2 | % | ||||||||
| Provision for income taxes | 60.1 | 59.8 | 0.5 | % | ||||||||
| Net income | $ | 333.8 | $ | 227.2 | 46.9 | % | ||||||
| * not meaningful |
Sales and cost of sales by segment and total company (dollars in millions):
| 2018 | 2017 | Change | |||||||||
| Instrumentation | |||||||||||
| Net sales | $ | 1,021.2 | $ | 953.9 | $ | 67.3 | |||||
| Cost of sales | $ | 575.2 | $ | 547.2 | $ | 28.0 | |||||
| Cost of sales % of net sales | 56.3 | % | 57.4 | % | |||||||
| Digital Imaging | |||||||||||
| Net sales | $ | 885.2 | $ | 717.7 | $ | 167.5 | |||||
| Cost of sales | $ | 536.0 | $ | 448.6 | $ | 87.4 | |||||
| Cost of sales % of net sales | 60.6 | % | 62.5 | % | |||||||
| Aerospace and Defense Electronics | |||||||||||
| Net sales | $ | 696.5 | $ | 646.0 | $ | 50.5 | |||||
| Cost of sales | $ | 437.3 | $ | 398.3 | $ | 39.0 | |||||
| Cost of sales % of net sales | 62.8 | % | 61.7 | % | |||||||
| Engineered Systems | |||||||||||
| Net sales | $ | 298.9 | $ | 286.2 | $ | 12.7 | |||||
| Cost of sales | $ | 242.5 | $ | 229.9 | $ | 12.6 | |||||
| Cost of sales % of net sales | 81.2 | % | 80.3 | % | |||||||
| Total Company | |||||||||||
| Net sales | $ | 2,901.8 | $ | 2,603.8 | $ | 298.0 | |||||
| Cost of sales | $ | 1,791.0 | $ | 1,624.0 | $ | 167.0 | |||||
| Cost of sales % of net sales | 61.7 | % | 62.4 | % |
We reported net sales of $2,901.8 million in 2018, compared with net sales of $2,603.8 million for 2017, an increase of 11.4%. Net income was $333.8 million ($9.01 per diluted share) in 2018, compared with net income of $227.2 million ($6.26 per diluted share) in 2017, an increase of 46.9%.
Total year 2018 and 2017 reflected pretax charges totaling $7.8 million and $4.2 million, respectively, for severance and facility consolidation charges. Net income for 2018 and 2017 also included net discrete tax benefits of $23.8 million and $17.2 million, respectively. The total year 2017 amount included provisional charges of $4.7 million for the estimated impact of the Tax Cuts and Jobs Act (“Tax Act”). The Company finalized the assessment of the Tax Act in 2018, resulting in a decrease of $0.8 million to the provisional charge. Net income for 2017 included pretax charges totaling $27.0 million related to e2v acquisition related expenses, of which, $5.7 million was recorded to cost of sales, $13.0 million was recorded to selling, general and administrative expenses, $2.3 million was recorded to interest expense and $6.0 million was recorded as other expense. The amount recorded to cost of sales related to the inventory fair value step-up amortization expense. The amount recorded to selling, general and administrative expenses related to transaction costs, including stamp duty, advisory, legal and other consulting fees and other costs. The amount recorded to interest expense related to funds-certain bank bridge facility commitment expense. The amount recorded to other expense related to a foreign currency option contract.
Net sales
The increase in net sales in 2018, compared with 2017, reflected higher net sales in each segment. Net sales in 2018 included revenue growth of $182.9 million plus $115.1 million in incremental net sales from recent acquisitions, primarily e2v. The incremental net sales from the March 2017 e2v acquisition in 2018 was $103.0 million.
Sales under contracts with the U.S. Government were approximately 23% of net sales in 2018 and 24% of net sales in 2017. Sales to international customers represented approximately 47% of net sales in 2018 and 46% of net sales in 2017.
Cost of Sales
Total company cost of sales increased by $167.0 million in 2018, compared with 2017, which primarily reflected the impact of higher net sales. The total company cost of sales as a percentage of sales for 2018 was 61.7%, compared with 62.4% for 2017.
Selling, general and administrative expenses
Selling, general and administrative expenses, including Company-funded research and development and bid and proposal expense, were higher in 2018, compared with 2017. The increase primarily reflected the impact of higher sales and higher research and development and bid and proposal expense. The 2017 amount included $13.0 million in acquisition related expenses for the e2v acquisition. Corporate administrative expense in 2018 was $56.0 million, compared with $63.0 million in 2017. The 2017 amount included $10.4 million in acquisition related expenses for the e2v acquisition. For 2018, we recorded a total of $19.8 million in stock option expense, of which $6.3 million was recorded within corporate expense and $13.5 million was recorded in the operating segment results. For 2017, we recorded a total of $14.2 million in stock option expense, of which $4.5 million was recorded within corporate expense and $9.7 million was recorded in the operating segment results. Selling, general and administrative expenses as a percentage of sales was 23.9% for 2018, compared with 25.3% for 2017. The higher percentage in 2017 reflected the impact of acquisition related expenses for the e2v acquisition.
Pension Service Expense
Pension service expense is included in both cost of sales and selling general and administrative expense. Pension service expense in 2018 was $10.8 million compared with pension service expense of $11.2 million in 2017.
Operating Income
Operating income for 2018 was $416.6 million, compared with $321.7 million for 2017, an increase of 29.5%. The increase in operating income primarily reflected higher operating income in each segment, as well as lower corporate expense. Operating income in 2018 and 2017 reflected $7.8 million and $4.2 million in severance and facility consolidation costs, respectively. The incremental operating income included in the results for 2018 from recent acquisitions was $43.3 million.
Interest Expense, Interest Income, Non-Service Retirement Benefit Income and Other Expense
Total interest expense, including credit facility fees and other bank charges, was $29.2 million in 2018 compared with $35.5 million in 2017 and reflected the impact of lower debt levels in 2018. Interest expense in 2017 included $2.3 million in fees related to the terminated bridge facility in connection with the acquisition of e2v. Interest income was $3.7 million in 2018 and $2.4 million in 2017. Non-service retirement benefit income was $13.5 million in 2018, compared with $13.9 million in 2017. Other expense was $10.7 million for 2018, compared with expense of $15.5 million. Other expense in 2017 included $6.0 million of expense for a foreign currency option contract related to the e2v acquisition.
Income Taxes
On December 22, 2017, the Tax Act was enacted, which 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. 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, for a net provisional charge of $4.7 million recorded in the fourth quarter of 2017. The Company finalized its assessment of the Tax Act during the fourth quarter of 2018, resulting in a decrease of $0.8 million to the provisional charge and the repatriation tax. At December 30, 2018, $12.0 million of the repatriation tax remained to be paid. In February 2019, the remaining balance of $12.0 million was paid.
The Company’s effective tax rate for 2018 was 15.3%, compared with 20.8% for 2017. For 2018 net discrete income tax benefits were $23.8 million, which included a $12.9 million income tax benefit related to share-based accounting, $5.1 million in income tax benefit as a result of the remeasurement of uncertain tax positions due to expiration of statute of limitations and a $4.8 million income tax benefit related to the release of a valuation allowance for which the deferred tax assets are now determined more-likely-than-not to be realizable. For 2017, net discrete income tax benefits were $17.2 million, 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, $8.5 million income tax benefit as a result of the remeasurement of uncertain tax positions due to expiration of statute of limitation, and $8.8 million in net discrete tax benefits related to share-based accounting, partially offset by $4.6 million related to adjustments for uncertain tax positions and the $4.7 million provisional charge, related to the Tax Act.
Excluding the net discrete income tax benefits in both years, the effective tax rates would have been 21.3% for 2018 and 26.8% for 2017. The decrease in the effective tax rate in 2018, primarily reflects the lower corporate income tax rates as part of the Tax Act.
2017 compared with 2016
| Sales (dollars in millions) | 2017 | 2016 | % Change | |||||||||
| Instrumentation | $ | 953.9 | $ | 876.7 | 8.8 | % | ||||||
| Digital Imaging | 717.7 | 398.7 | 80.0 | % | ||||||||
| Aerospace and Defense Electronics | 646.0 | 615.9 | 4.9 | % | ||||||||
| Engineered Systems | 286.2 | 258.6 | 10.7 | % | ||||||||
| Total sales | $ | 2,603.8 | $ | 2,149.9 | 21.1 | % | ||||||
| Results of operations (dollars in millions) | 2017 | 2016 | % Change | |||||||||
| Instrumentation | $ | 126.0 | $ | 109.4 | 15.2 | % | ||||||
| Digital Imaging | 110.4 | 44.1 | 150.3 | % | ||||||||
| Aerospace and Defense Electronics | 116.3 | 106.7 | 9.0 | % | ||||||||
| Engineered Systems | 32.0 | 26.5 | 20.8 | % | ||||||||
| Corporate expense | (63.0 | ) | (46.2 | ) | 36.4 | % | ||||||
| Operating income | 321.7 | 240.5 | 33.8 | % | ||||||||
| Interest and debt expense, net | (33.1 | ) | (23.2 | ) | 42.7 | % | ||||||
| Non-service retirement benefit income | 13.9 | 13.3 | 4.5 | % | ||||||||
| 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 | $ | 547.2 | $ | 494.9 | $ | 52.3 | |||||
| Cost of sales % of net sales | 57.4 | % | 56.5 | % | |||||||
| Digital Imaging | |||||||||||
| Net sales | $ | 717.7 | $ | 398.7 | $ | 319.0 | |||||
| Cost of sales | $ | 448.6 | $ | 240.9 | $ | 207.7 | |||||
| Cost of sales % of net sales | 62.5 | % | 60.4 | % | |||||||
| Aerospace and Defense Electronics | |||||||||||
| Net sales | $ | 646.0 | $ | 615.9 | $ | 30.1 | |||||
| Cost of sales | $ | 398.3 | $ | 382.3 | $ | 16.0 | |||||
| Cost of sales % of net sales | 61.7 | % | 62.1 | % | |||||||
| Engineered Systems | |||||||||||
| Net sales | $ | 286.2 | $ | 258.6 | $ | 27.6 | |||||
| Cost of sales | $ | 229.9 | $ | 211.4 | $ | 18.5 | |||||
| Cost of sales % of net sales | 80.3 | % | 81.8 | % | |||||||
| Total Company | |||||||||||
| Net sales | $ | 2,603.8 | $ | 2,149.9 | $ | 453.9 | |||||
| Cost of sales | $ | 1,624.0 | $ | 1,329.5 | $ | 294.5 | |||||
| Cost of sales % of net sales | 62.4 | % | 61.8 | % |
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) in 2017, compared with net income of $190.9 million ($5.37 per diluted share) in 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 included provisional charges of $4.7 million for the estimated impact of the 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 organic revenue growth of $155.9 million plus $298.0 million in incremental net sales from recent acquisitions, primarily e2v. 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 net sales in 2017 and 27% of net sales in 2016. Sales to international customers represented approximately 46% of sales in net 2017 and 43% of net sales in 2016.
Cost of Sales
Total company cost of sales increased by $294.5 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 62.4%, compared with 61.8% 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 $63.0 million, compared with $46.2 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 within 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 within corporate expense and $8.4 million was recorded in the operating segment results. Selling, general and administrative expenses as a percentage of sales was 25.3% for 2017, compared with 27.0% 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 Service Expense
Pension service expense is included in both cost of sales and selling general and administrative expense. Pension service expense was $11.2 million for both 2017 and 2016.
Operating Income
Operating income for 2017 was $321.7 million, compared with $240.5 million for 2016, an increase of 33.8%. 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 reflected $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 reflected $13.0 million in additional intangible asset amortization expense.
Interest Expense, Interest Income, Non-Service Retirement Benefit Income 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 expense in 2017 included $2.3 million in fees related to the terminated bridge facility in connection with the acquisition of e2v. Interest income was $2.4 million in 2017 and $0.3 million in 2016. Non-service retirement benefit income was $13.9 million in 2017, compared with $13.3 million in 2016. Other income and 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 and expense for 2016 included a gain of $17.9 million on the sale of a former operating facility in California.
Income Taxes
The Company’s effective tax rate for 2017 was 20.8%, compared with 20.9% for 2016. Total year 2017 reflected $17.2 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, $8.5 million income tax benefit as a result of the remeasurement of uncertain tax positions due to expiration of statute of limitation, $8.8 million in net discrete tax benefits related to share-based accounting partially offset by $4.6 million related to adjustments for uncertain tax positions and the $4.7 million provisional charge, related to the Tax Act. 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.
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) | 2018 | 2017 | 2016 | |||||||||
| Net sales | $ | 1,021.2 | $ | 953.9 | $ | 876.7 | ||||||
| Cost of sales | $ | 575.2 | $ | 547.2 | $ | 494.9 | ||||||
| Selling, general and administrative expenses | $ | 298.6 | $ | 280.7 | $ | 272.4 | ||||||
| Operating income | $ | 147.4 | $ | 126.0 | $ | 109.4 | ||||||
| Cost of sales % of net sales | 56.3 | % | 57.4 | % | 56.5 | % | ||||||
| Selling, general and administrative expenses % of net sales | 29.3 | % | 29.4 | % | 31.0 | % | ||||||
| Operating income % of net sales | 14.4 | % | 13.2 | % | 12.5 | % | ||||||
| International sales % of net sales | 51.0 | % | 53.7 | % | 53.8 | % | ||||||
| U.S. Government sales % of net sales | 6.7 | % | 6.8 | % | 8.5 | % |
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.
2018 compared with 2017
Our Instrumentation segment net sales for 2018 increased 7.1%, compared with 2017. Operating income for 2018 increased 17.0%, compared with 2017.
The 2018 net sales increase primarily resulted from higher sales of test and measurement instrumentation, environmental instrumentation and marine instrumentation, as well as the contribution from the SSI acquisition. Sales of test and measurement instrumentation increased $39.7 million. Sales of environmental instrumentation increased $25.3 million and included $12.1 million in incremental sales from the SSI acquisition. Sales of marine instrumentation increased by $2.3 million. The increase in operating income was primarily due to higher sales and improved margins for test and measurement instrumentation. Operating income in 2017 included a $2.6 million reversal of a previously reserved receivable that was collected during 2017. The incremental operating income included in the results for 2018 from recent acquisitions was $3.5 million.
Cost of sales increased by $28.0 million in 2018, compared with 2017, and primarily reflected the impact of higher net sales. The cost of sales percentage decreased to 56.3% in 2018 from 57.4% in 2017. Selling, general and administrative expenses, including research and development and bid and proposal expense, in 2018, increased by $17.9 million, compared with 2017, and primarily reflected the impact of higher net sales. Selling, general and administrative expenses for 2018, as a percentage of sales, decreased slightly to 29.3%, compared with 29.4% for 2017.
2017 compared with 2016
Our Instrumentation segment net sales for 2017 increased 8.8%, compared with 2016. Operating income increased 15.2%, compared with 2016.
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 and facility consolidation expenses. Total year 2017 included $8.5 million in lower severance and facility consolidation costs. Operating income in 2017 reflected a $2.6 million reversal of a previously reserved receivable that was collected during 2017. The incremental operating income in 2017 from recent acquisitions was $3.7 million, which reflected $1.9 million in additional intangible asset amortization.
Cost of sales increased by $52.3 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 57.4% in 2017 from 56.5% in 2016. Selling, general and administrative expenses, including research and development and bid and proposal expense, in 2017, increased by $8.3 million, compared with 2016, and primarily reflected the impact of higher net sales. Selling, general and administrative expenses for 2017, as a percentage of net sales, decreased to 29.4%, compared with 31.0% for 2016.
Digital Imaging
| (Dollars in millions) | 2018 | 2017 | 2016 | |||||||||
| Net sales | $ | 885.2 | $ | 717.7 | $ | 398.7 | ||||||
| Cost of sales | $ | 536.0 | $ | 448.6 | $ | 240.9 | ||||||
| Selling, general and administrative expenses | $ | 191.9 | $ | 158.7 | $ | 113.7 | ||||||
| Operating income | $ | 157.3 | $ | 110.4 | $ | 44.1 | ||||||
| Cost of sales % of net sales | 60.6 | % | 62.5 | % | 60.4 | % | ||||||
| Selling, general and administrative expenses % of net sales | 21.6 | % | 22.1 | % | 28.5 | % | ||||||
| Operating income % of net sales | 17.8 | % | 15.4 | % | 11.1 | % | ||||||
| International sales % of net sales | 66.3 | % | 64.5 | % | 54.7 | % | ||||||
| U.S. Government sales % of net sales | 10.2 | % | 11.9 | % | 18.3 | % |
Our Digital Imaging segment includes high-performance sensors, cameras and systems, within the visible, infrared and X-ray spectra for use in industrial, government and medical applications, as well as micro electro-mechanical systems (“MEMS”) 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. In the second quarter of 2018, we realigned the reporting structure for certain of our microwave product groupings. These products, acquired with the 2017 acquisition of e2v were formerly reported as part of the Aerospace and Defense Electronics segment and are now reported as part of the Digital Imaging segment. Previously reported segment data has been adjusted to reflect this change. Total sales for these products were $24.2 million for fiscal year 2017.
2018 compared with 2017
Our Digital Imaging segment net sales for 2018, increased 23.3%, compared with 2017. Operating income for 2018, increased 42.5%, compared with 2017.
The 2018 net sales included organic growth of $77.4 million and $90.1 million in incremental net sales from the e2v acquisition. Total year 2018 also reflected higher sales of X-ray detectors for life sciences applications, machine vision cameras for industrial applications, infrared detectors, geospatial hardware and software and MEMS products. The increase in operating income for 2018 reflected the impact of higher sales, favorable product mix and incremental operating profit from e2v. Operating income in 2017 reflected $8.0 million in acquisition-related costs related to the e2v acquisition. The incremental operating income reflected in the results for 2018 from the e2v acquisition was $32.9 million which included $1.1 million in additional intangible asset amortization expense.
Cost of sales for 2018 increased by $87.4 million, compared with 2017, and reflected the impact of higher net sales. The cost of sales percentage in 2018 decreased to 60.6% compared with 62.5% in 2017 and reflected product mix differences, as well as the inclusion in 2017 of $5.4 million of inventory fair value step-up amortization expense related to the e2v acquisition. Selling, general and administrative expenses for 2018 increased to $191.9 million, compared with $158.7 million in 2017 and reflected the impact of higher net sales. The selling, general and administrative expense percentage decreased slightly to 21.6% in 2018 from 22.1% in 2017.
2017 compared with 2016
Our Digital Imaging segment net sales for 2017 increased 80.0%, compared with 2016. Operating income for 2017 increased 150.3%, compared with 2016.
The 2017 net sales increase reflected $252.3 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 $34.9 million, which included $10.5 million in additional intangible asset amortization expense.
Cost of sales for 2017 increased by $207.7 million, compared with 2016, and reflected the impact of higher net sales. The cost of sales percentage in 2017 increased to 62.5% compared with 60.4% 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 $158.7 million, from $113.7 million in 2016 and reflected the impact of higher net sales. The selling, general and administrative expense percentage decreased to 22.1% 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.
Aerospace and Defense Electronics
| (Dollars in millions) | 2018 | 2017 | 2016 | |||||||||
| Net sales | $ | 696.5 | $ | 646.0 | $ | 615.9 | ||||||
| Cost of sales | $ | 437.3 | $ | 398.3 | $ | 382.3 | ||||||
| Selling, general and administrative expenses | $ | 124.0 | $ | 131.4 | $ | 126.9 | ||||||
| Operating income | $ | 135.2 | $ | 116.3 | $ | 106.7 | ||||||
| Cost of sales % of net sales | 62.8 | % | 61.7 | % | 62.1 | % | ||||||
| Selling, general and administrative expenses % of net sales | 17.8 | % | 20.3 | % | 20.6 | % | ||||||
| Operating income % of net sales | 19.4 | % | 18.0 | % | 17.3 | % | ||||||
| International sales % of net sales | 28.7 | % | 31.7 | % | 32.6 | % | ||||||
| U.S. Government sales % of net sales | 36.3 | % | 34.8 | % | 34.2 | % |
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 second quarter of 2018, we realigned the reporting structure for certain of our microwave product groupings. These products, acquired with the 2017 acquisition of e2v were formerly reported as part of the Aerospace and Defense Electronics segment and are now reported as part of the Digital Imaging segment. Previously reported segment data has been adjusted to reflect this change. Total sales for these products were $24.2 million for fiscal year 2017.
2018 compared with 2017
Our Aerospace and Defense Electronics segment net sales for 2018, increased 7.8% compared with 2017. Operating income for 2018, increased of 16.3%, compared with 2017.
The 2018 net sales increase reflected $61.0 million of higher sales of defense electronics, partially offset by $10.5 million of lower sales of aerospace electronics. The higher sales of defense electronics reflected higher sales in most product categories and included $12.3 million in incremental sales from the e2v acquisition. Operating income in 2018 reflected the impact of higher net sales, overall improved margins and favorable product mix. The incremental operating income included in the results for 2018 from the e2v acquisition was $6.9 million.
Cost of sales for 2018 increased by $39.0 million, compared with 2017, and reflected the impact of higher net sales. Cost of sales as a percentage of net sales for 2018 increased to 62.8% from 61.7% in 2017. Selling, general and administrative expenses, including research and development and bid and proposal expense, decreased to $124.0 million in 2018, from $131.4 million in 2017 and reflected lower research and development and bid and proposal expense of $10.5 million. The selling, general and administrative expense percentage in 2018 decreased to 17.8% from 20.3% for 2017 and reflected the impact of lower research and development and bid and proposal expense.
2017 compared with 2016
Our Aerospace and Defense Electronics segment net sales for 2017 increased 4.9%, compared with 2016. Operating income for 2017 increased 9.0%, compared with 2016.
The 2017 net sales increase reflected $18.4 million of higher sales of aerospace electronics and higher sales of $11.7 million of defense electronics. The higher sales of defense electronics included $22.5 million in net sales from e2v, partially offset by $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 the e2v acquisition was $5.1 million.
Cost of sales for 2017 increased by $16.0 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 61.7% from 62.1% in 2016. Selling, general and administrative expenses, including research and development and bid and proposal expense, increased to $131.4 million in 2017, compared with $126.9 million in 2016 and reflected the impact of higher net sales. The selling, general and administrative expense percentage in 2017 decreased slightly to 20.3% from 20.6% for 2016.
Engineered Systems
| (Dollars in millions) | 2018 | 2017 | 2016 | |||||||||
| Net sales | $ | 298.9 | $ | 286.2 | $ | 258.6 | ||||||
| Cost of sales | $ | 242.5 | $ | 229.9 | $ | 211.4 | ||||||
| Selling, general and administrative expenses | $ | 23.7 | $ | 24.3 | $ | 20.7 | ||||||
| Operating income | $ | 32.7 | $ | 32.0 | $ | 26.5 | ||||||
| Cost of sales % of net sales | 81.2 | % | 80.3 | % | 81.8 | % | ||||||
| Selling, general and administrative expenses % of net sales | 7.9 | % | 8.5 | % | 8.0 | % | ||||||
| Operating income % of net sales | 10.9 | % | 11.2 | % | 10.2 | % | ||||||
| International sales % of net sales | 15.2 | % | 10.0 | % | 11.2 | % | ||||||
| U.S. Government sales % of net sales | 81.6 | % | 85.2 | % | 85.0 | % |
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.
2018 compared with 2017
Our Engineered Systems segment net sales for 2018, increased 4.4%, compared with 2017. Operating income for 2018 increased 2.2%, compared with 2017.
The 2018 sales increase of $12.7 million reflected higher sales of $24.7 million of engineered products and services, partially offset by lower sales of $12.0 million of turbine engines. The higher sales of engineered products and services, primarily reflected increased nuclear and aviation manufacturing programs and increased sales related to missile defense. Sales of turbine engines reflected lower sales of cruise missile engines. Operating income in 2018 increased due to higher sales of engineered products and services, partially offset by lower sales of turbine engines.
Cost of sales for 2018 increased by $12.6 million, compared with 2017, and reflected the impact of higher net sales. Cost of sales as a percentage of net sales for 2018 increased to 81.2%, compared with 80.3% in 2017. Selling, general and administrative expenses, including research and development and bid and proposal expense, decreased to $23.7 million in 2018, compared with $24.3 million in 2017, and reflected the impact of lower research and development and bid and proposal expense of $1.7 million. The selling, general and administrative expense percentage decreased to 7.9% for 2018, compared with 8.5% in 2017, and reflected the impact of lower research and development and bid and proposal expense.
2017 compared with 2016
Our Engineered Systems segment net sales for 2017 increased 10.7%, compared with 2016. Operating income for 2017 increased 20.8%, compared with 2016.
The 2017 net 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 80.3%, compared with 81.8% in 2016. Selling, general and administrative expenses, including research and development and bid and proposal expense, increased to $24.3 million in 2017, compared with $20.7 million in 2016, and reflected the impact of higher sales and higher research and development and bid and proposal expense of $2.0 million. The selling, general and administrative expense percentage increased to 8.5% for 2017, compared with 8.0% in 2016 and reflected the impact higher research and development and bid and proposal expense.
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 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 2019. 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. In April 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.
The Company has a $750.0 million unsecured credit facility (“credit facility”) that matures in 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. The Company expects to amend the credit facility in the first quarter of 2019 in order to extend the maturity date from December 2020 to March 2024. In anticipation of the expected elimination of LIBOR in 2021, this credit facility amendment will include the procedure to switch to LIBOR alternative replacement rates in the future.
| Long-term debt (in millions): | December 30, 2018 | December 31, 2017 | ||||||
| $750.0 million credit facility, due December 2020, weighted average rate of 5.50% at December 30, 2018 and 2.72% at December 31, 2017 | $ | 29.0 | $ | 165.0 | ||||
| Term Loans, weighted average rate of 2.94% at December 31, 2017 | — | 175.5 | ||||||
| Term loan due October 2019, variable rate of 3.63% at December 30, 2018 and 2.80% at December 31, 2017, swapped to a Euro fixed rate of 0.7055% | 100.0 | 100.0 | ||||||
| 2.61% Fixed Rate Senior Notes due December 2019 | 30.0 | 30.0 | ||||||
| 5.30% Fixed Rate Senior Notes due September 2020 | 75.0 | 75.0 | ||||||
| 2.81% Fixed Rate Senior Notes due November 2020 | 25.0 | 25.0 | ||||||
| 3.09% Fixed Rate Senior Notes due December 2021 | 95.0 | 95.0 | ||||||
| 3.28% Fixed Rate Senior Notes due November 2022 | 100.0 | 100.0 | ||||||
| 0.70% €50 Million Fixed Rate Senior Notes due April 2022 | 57.2 | 60.0 | ||||||
| 0.92% €100 Million Fixed Rate Senior Notes due April 2023 | 114.4 | 120.0 | ||||||
| 1.09% €100 Million Fixed Rate Senior Notes due April 2024 | 114.4 | 120.0 | ||||||
| Other debt | 8.8 | 2.7 | ||||||
| Total long-term debt | 748.8 | 1,068.2 | ||||||
| Current portion of long-term debt and debt issue costs | (138.7 | ) | (4.3 | ) | ||||
| Total long-term debt, net of current portion | $ | 610.1 | $ | 1,063.9 |
At December 30, 2018, we had $3.1 million in capital leases, of which $0.9 million is current. At December 30, 2018, we had $41.3 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 30, 2018, 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 30, 2018:
| $750.0 million Credit Facility expires December 2020 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 | 1.5 to 1 | |
| Consolidated Interest Coverage Ratio (EBITDA/Interest) (b) | No less than 3.0 to 1 | 21.1 to 1 | |
| $611.0 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 | 1.5 to 1 | |
| Consolidated Interest Coverage Ratio (EBITDA/Interest) (b) | No less than 3.0 to 1 | 21.1 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 $686.3 million at December 30, 2018.
Contractual Obligations
The following table summarizes our expected cash outflows resulting from financial contracts and commitments at December 30, 2018.
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): | 2019 | 2020 | 2021 | 2022 | 2023 | After 2023 | Total | |||||||||||||||||||||
| Debt obligations | $ | 137.4 | $ | 129.5 | $ | 95.0 | $ | 157.1 | $ | 114.3 | $ | 115.5 | $ | 748.8 | ||||||||||||||
| Interest expense(a) | 18.8 | 12 | 9.2 | 5.3 | 1.6 | 0.5 | 47.4 | |||||||||||||||||||||
| Operating lease obligations | 23.0 | 20.4 | 18.2 | 18.3 | 11.8 | 48.2 | 139.9 | |||||||||||||||||||||
| Capital lease obligations(b) | 1.0 | 0.5 | 0.6 | 0.6 | 0.5 | 0.3 | 3.5 | |||||||||||||||||||||
| Purchase obligations (c) | 141.9 | 21.5 | 7.2 | 5.8 | 0.7 | 0.9 | 178.0 | |||||||||||||||||||||
| Total | $ | 322.1 | $ | 183.9 | $ | 130.2 | $ | 187.1 | $ | 128.9 | $ | 165.4 | $ | 1,117.6 |
| (a) | Interest expense related to the credit facility, including facility fees, is assumed to accrue at the rates in effect at year-end 2018 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 that are enforceable and legally binding on us and that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum, or variable price provisions; and the approximate timing of the transaction. |
Unrecognized tax benefits of $25.0 million are not included in the table above because $9.2 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 30, 2018, we were not required, and accordingly are not planning, to make any cash contributions to the domestic qualified pension plan for 2019. Our minimum funding requirements after 2019, 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 2019 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, future cash contributions 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 2018, net cash provided by operating activities was $446.9 million, compared with $374.7 million in 2017 and $317.0 million in 2016. The higher cash provided by operating activities in 2018, compared with 2017, was driven by higher operating income, partially offset by higher income tax payments of $28.0 million. 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 and the impact of transaction related payments for the e2v acquisition.
Free cash flow (cash provided by operating activities less capital expenditures) was $360.1 million in 2018, compared with $316.2 million in 2017 and $229.4 million in 2016. Adjusted free cash flow reflects the 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 $360.1 million in 2018, compared with $316.2 million in 2017 and $248.9 million in 2016.
| Free Cash Flow(a) (in millions, brackets indicate use of funds) | 2018 | 2017 | 2016 | ||||||||||
| Cash provided by operating activities | $ | 446.9 | $ | 374.7 | $ | 317.0 | |||||||
| Capital expenditures for property, plant and equipment, excluding facility purchase | (86.8 | ) | (58.5 | ) | (61.6 | ) | |||||||
| Facility purchase pursuant to 1031 like-kind exchange | — | — | (26.0 | ) | |||||||||
| Total capital expenditures | (86.8 | ) | (58.5 | ) | (87.6 | ) | |||||||
| Free cash flow | 360.1 | 316.2 | 229.4 | ||||||||||
| Restricted cash utilized for 1031 like-kind exchange facility purchase | — | — | 19.5 | ||||||||||
| Adjusted free cash flow | $ | 360.1 | $ | 316.2 | $ | 248.9 |
| 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 $88.6 million, $831.2 million and $151.0 million for 2018, 2017 and 2016, respectively. Cash flows relating to investing activities consists primarily of cash used for acquisitions and other investments 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): | 2018 | 2017 | 2016 | |||||||||
| Instrumentation | $ | 14.8 | $ | 13.7 | $ | 50.9 | ||||||
| Digital Imaging | 36.3 | 23.6 | 12.5 | |||||||||
| Aerospace and Defense Electronics | 19.6 | 10.7 | 12.6 | |||||||||
| Engineered Systems | 12.2 | 5.8 | 5.9 | |||||||||
| Corporate | 3.9 | 4.7 | 5.7 | |||||||||
| $ | 86.8 | $ | 58.5 | $ | 87.6 |
The increase in capital spending in 2018 compared with 2017, primarily reflects facility upgrades and expansions. The 2016 capital spending amount reflected the purchase of an operating facility for $26.0 million in the Instrumentation segment. During 2019, we plan to invest approximately $90.0 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 other investments of $3.1 million, $774.1 million and $93.4 million, in 2018, 2017 and 2016, 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. On February 5, 2019, we acquired the scientific imaging businesses of Roper Technologies, Inc. for $225.0 million in cash.
For all acquisitions, the results of operations and cash flows are included in our consolidated financial statements from the date of each respective acquisition.
The 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 (in millions):
| 2017 | ||||||||||||||
| Acquisition | Acquisition Date | Cash Paid (a) | Goodwill Acquired | Acquired Intangible Assets | ||||||||||
| e2v | March 28, 2017 | $ | 740.6 | $ | 494.3 | $ | 172.3 | |||||||
| SSI | July 20, 2017 | 31.3 | 18.6 | 4.8 | ||||||||||
| Other investments | 2.2 | 0.6 | 0.4 | |||||||||||
| $ | 774.1 | $ | 513.5 | $ | 177.5 | |||||||||
| (a) Net of any cash acquired and any purchase price adjustments. |
Goodwill resulting from the SSI acquisition will be deductible for tax purposes. Goodwill resulting from the e2v acquisition will not be deductible for tax purposes.
Financing Activities
Financing activities for 2018 reflected net payments on debt of $306.5 million, compared with net proceeds from debt of $393.7 million in 2017 and net payments on debt of $163.1 million for 2016. Financing activities for 2017 reflected net borrowings from the $750.0 million credit facility of $165.0 million, 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. Fiscal years 2018, 2017 and 2016 reflect proceeds from the exercise of stock options of $37.2 million, $24.9 million and $36.1 million, respectively.
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 12% of Teledyne’s active employees as of December 30, 2018. As of January 1, 2004, new U.S. hires participate in a domestic defined contribution plan. In 2018, 2017 and 2016, 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 2019 will increase to 4.59% from 4.02% in 2018. The company also has several small non-qualified 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.
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 30, 2018, the amount of undistributed foreign earnings was $381.1 million, for which we have not recorded a deferred tax liability of approximately $2.1 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 2014, United Kingdom and France income tax matters for all years through 2014 and Canadian income tax matters for all years through 2010.
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 and cost reductions 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 Teledyne Digital Imaging and in British pounds for our U.K. companies, including e2v. These contracts are designated and qualify as cash flow hedges. The Company has converted a U.S. 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 losses recorded in AOCI, net of tax, for forward contracts that will mature in the next 12 months total $2.8 million. These losses are expected to be offset by anticipated gains 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 $0.1 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 30, 2018, Teledyne had foreign currency forward contracts designated as cash flow hedges to buy Canadian dollars and to sell U.S. dollars totaling $81.6 million. These foreign currency forward contracts have maturities ranging from March 2019 to February 2020. e2v had foreign currency forward contracts designated as cash flow hedges to buy British pounds and to sell U.S. dollars totaling $17.2 million. These foreign currency forward contracts have maturities ranging from March 2019 to February 2020. Together these contracts had a negative fair value of $4.2 million. The cross currency swap has notional amounts of $93.0 million euros equivalent to $100.0 million, and matures in October 2019.
In addition, the Company utilizes foreign currency forward contracts to mitigate foreign exchange rate risk associated with foreign currency denominated monetary assets and liabilities, including intercompany receivables and payables. As of December 30, 2018, Teledyne had foreign currency contracts of this type in the following currency pairs (in millions):
| Contracts to Buy | Contracts to Sell | |||||||
| Currency | Amount | Currency | Amount | |||||
| Canadian Dollars | C$ | 77.0 | U.S. Dollars | US$ | 57.1 | |||
| Euros | € | 28.5 | U.S. Dollars | US$ | 32.7 | |||
| Great Britain Pounds | £ | 1.2 | Australian Dollars | A$ | 2.1 | |||
| Great Britain Pounds | £ | 35.4 | U.S. Dollars | US$ | 44.9 | |||
| Canadian Dollars | C$ | 23.7 | Euros | € | 15.2 | |||
| U.S. Dollars | US$ | 0.9 | Japanese Yen | ¥ | 100.0 | |||
| Singapore Dollars | S$ | 2.3 | U.S. Dollars | US$ | 1.7 | |||
| Danish Krone | Kr. | 65.0 | U.S. Dollars | US$ | 10.0 | |||
| Great Britain Pounds | € | 9.0 | Euros | £ | 10.0 |
These contracts had a negative fair value of $0.6 million at December 30, 2018. 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 30, 2018, 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 $13.9 million. A hypothetical 10 percent price change in the U.S. dollar from its value at December 30, 2018 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 $10.7 million.
Borrowings under our credit facility are at fixed rates that vary with the term and timing of each loan under the facility. Loans under the facility typically have terms of one, two, three or six months and the interest rate for each such loan is subject to change if the loan is continued or converted following the applicable maturity date. Interest rates are also subject to change based on our debt to earnings before interest, taxes, depreciation and amortization ratio. As of December 30, 2018, we had$29.0 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 $6.0 million at December 30, 2018, and $5.1 million at December 31, 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 24 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 23% of total net sales in 2018, 24% of total net sales in 2017 and 27% of total sales in 2016. 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 17%, 18% and 21% of total net sales for 2018, 2017 and 2016, 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 30, 2018, and December 31, 2017:
| Reserves and Valuation Accounts (in millions): (a) | 2018 | 2017 | ||||||
| Allowance for doubtful accounts | $ | 6.8 | $ | 10.3 | ||||
| Reduction to LIFO cost basis | $ | 9.4 | $ | 10.6 | ||||
| Workers’ compensation and general liability reserves(b) | $ | 8.9 | $ | 9.7 | ||||
| Environmental reserves(b) | $ | 6.0 | $ | 5.1 | ||||
| Other accrued liability reserves(b) | $ | 26.5 | $ | 28.3 |
(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): | 2018 | 2017 | 2016 | |||||||||
| Balance at beginning of year | $ | 21.1 | $ | 18.4 | $ | 17.1 | ||||||
| Accruals for product warranties charged to expense | 10.0 | 6.0 | 7.4 | |||||||||
| Cost of product warranty claims | (10.1 | ) | (6.4 | ) | (6.7 | ) | ||||||
| Acquisitions | — | 3.1 | 0.6 | |||||||||
| Balance at year-end | $ | 21.0 | $ | 21.1 | $ | 18.4 |
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
We determine the appropriate method by which we recognize revenue by analyzing the nature of the products or services being provided as well as the terms and conditions of contracts or arrangements entered into with our customers. We account for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable. A contract’s transaction price is allocated to each distinct good or service (i.e., performance obligation) identified in the contract, and each performance obligation is valued based on its estimated relative standalone selling price. For standard products or services, list prices generally represent the standalone selling price. For performance obligations where list price is not available, we typically use the expected cost plus a margin approach to estimate the standalone selling price for that performance obligation. Approximately 60% of our revenue is recognized at a point in time, with the remaining 40% recognized over time.
Revenue recognized at a point in time relates primarily to the sale of standard or minimally customized products, with control transferring to the customer generally upon the transfer of title. This type of revenue arrangement is typical for our commercial contracts within the Instrumentation, Digital Imaging, and Aerospace and Defense Electronics segments, and to a lesser extent for certain commercial contracts within the Engineered Systems segment relating to the sale of standard hydrogen/oxygen gas generators. In limited circumstances, customer specified acceptance criteria exist. If we cannot objectively demonstrate that the product meets those specifications prior to the shipment, the revenue is deferred until customer acceptance is obtained. Performance obligations recognized at a point in time can include variable consideration, such as product returns and sales allowances. The estimation of this variable consideration and determination of whether to include estimated amounts as a reduction in the transaction price is based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available to us.
Revenue recognized over time relates primarily to contracts to design, develop and/or manufacture highly engineered products used in both defense and commercial applications. This type of revenue arrangement is typical of our U.S. government contracts and to a lesser extent for certain commercial contracts, with both contract types occurring across all segments. The customer typically controls the work in process as evidenced either by contractual termination clauses or by our right to payment for costs incurred to date plus a reasonable profit for products or services that do not have an alternative use. As control transfers continuously over time on these contracts, revenue is recognized based on the extent of progress towards completion of the performance obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. We generally use the cost-to-cost measure of progress as this measure best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. Under the cost-to-cost method, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. The transaction price in these arrangements may include estimated amounts of variable consideration, including award fees, incentive fees, contract amounts not yet funded, or other provisions that can either increase or decrease the transaction price. We estimate variable consideration at the amount to which we expect to be entitled, and we include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the estimation uncertainty is resolved. The estimation of this variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available to us.
The majority of our over time contracts have a single performance obligation as the promise to transfer the individual goods or services is not separately identifiable from other promises in the contracts and, therefore, not distinct. Over time contracts are often modified to account for changes in contract specifications and requirements. We consider contract modifications to exist when the modification either creates new or changes the existing enforceable rights and obligations. Most of our contract modifications on over time contracts are for goods or services that are not distinct from the existing contract due to the significant integration service provided in the context of the contract and are accounted for as if they were part of that existing contract. The effect of a contract modification on the transaction price and our measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.
For over time contracts using cost-to-cost, we have an Estimate at Completion (“EAC”) process in which management reviews the progress and execution of our performance obligations. This EAC process requires management judgment relative to assessing risks, estimating contract revenue and cost, and making assumptions for schedule and technical issues. This EAC process requires management’s judgment to make reasonably dependable cost estimates. Since certain contracts extend over a longer period of time, the impact of revisions in cost and revenue estimates during the progress of work may adjust the current period earnings through 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 quarterly. The majority of revenue recognized over time uses an EAC process.
While extended or non-customary warranties do not represent a significant portion of our revenue, we recognize warranty services as a separate performance obligations when it is material to the contract. When extended or non-customary warranties represents a separate performance obligation, the revenue is deferred and recognized ratably over the extended warranty period.
The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets), and customer advances and deposits (contract liabilities, which are included in accrued liabilities and other long-term liabilities) on the Consolidated Balance Sheet. Under the typical payment terms of our over time contracts, the customer pays us either performance-based payments or progress payments. Amounts billed and due from our customers are classified as receivables on the Consolidated Balance Sheet. We may receive interim payments as work progresses, although for some contracts, we may be entitled to receive an advance payment. We recognize a liability for these interim and advance payments in excess of revenue recognized and present it as a contract liability which is included within accrued liabilities and other long-term liabilities on the Consolidated Balance Sheet.
We do not believe that any discrete event or adjustment to an individual contract within the aggregate changes in contract estimates for 2018, 2017 or 2016 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 12% 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 small domestic non-qualified and foreign-based defined benefit pension plans. At December 30, 2018, the benefit obligation for the domestic defined benefit pension plans totaled $731.7 million and the fair value of the net qualified plan assets totaled $780.3 million. At December 30, 2018, the benefit obligation for the foreign-based pension plans totaled $52.3 million and the fair value of the net plan assets totaled $43.4 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 7.8% in 2019 and the assumed discount rate for determining benefit obligations will be 4.59% in 2019. The Company’s long-term expected return on the domestic qualified pension assets used in 2018 was 8.0% and the assumed discount rate used in 2018 was 4.02%. The actual rate of return on the domestic qualified pension plan assets was a negative 4.4% in 2018 and a positive return of 15.7% in 2017 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 30, 2018, 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. 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. At year-end 2018, the Company has a $308.7 million non-cash reduction to stockholders’ equity and a long-term additional liability of $406.2 million related to its pension plans. At year-end 2017, the Company had 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.
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 2018 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 | $ | (1.3 | ) | $ | 1.3 | |||
| Change in long-term rate of return on plan assets | $ | (2.2 | ) | $ | 2.2 |
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. Recorded impairment charges to acquired intangibles assets were not material in 2018, 2017 or
- The results of our annual impairment tests of goodwill indicated that no impairment existed in 2018, 2017 or 2016.
We may use either a qualitative or quantitative approach when testing a reporting unit’s goodwill for impairment. For selected reporting units where we use the qualitative approach, we perform a qualitative evaluation of events and circumstances impacting the reporting unit to determine the likelihood of goodwill impairment. Based on that qualitative evaluation, if we determine it is more likely than not that the fair value of a reporting unit exceeds its carrying amount, no further evaluation is necessary. Otherwise we perform a quantitative impairment test. We perform quantitative tests for most reporting units at least once every three years. However, for certain reporting units we may perform a quantitative impairment test every year.
For goodwill impairment testing using the quantitative test, the Company estimates the fair value of the selected 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 30, 2018, 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 $719.4 million. The Company’s analysis in 2018 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 subject to a quantitative analysis as of the fourth quarter of 2018, the annual testing date, ranged from approximately 29% to 140%.
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 quantitative goodwill impairment test, the Company applied a hypothetical 10% decrease to the fair values of each reporting unit subject to a quantitative impairment test 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 Act was enacted, which 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. 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, for a net provisional charge of $4.7 million recorded in the fourth quarter of 2017. The Company finalized its assessment of the Tax Act during the fourth quarter of 2018, resulting in a decrease of $0.8 million to the provisional charge and the repatriation tax. At December 30, 2018, $12.0 million of the repatriation tax remained to be paid. In February 2019, the remaining balance of $12.0 million was paid.
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 30, 2018, of $3.9 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; cuts to defense spending resulting from existing and future deficit reduction measures; impacts from the United Kingdom’s pending exit from the European Union; uncertainties related to the policies of the U.S. Presidential administration; the imposition and expansion of, and responses to, trade sanctions and tariffs; 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.
Changes in the policies of U.S. and foreign governments, including economic sanctions, 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 14 of this Form 10-K under the caption “Risk Factors; Cautionary Statement as to Forward-Looking Statements.” Forward-looking statements are generally accompanied by words such as “estimate”, “project”, “predict”, “believes” or “expect”, that convey the uncertainty of future events or outcomes. We assume no obligation to publicly update or revise any forward-looking statements, whether as a result of new information or otherwise.
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