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, electronics design and development, oceanographic research, deepwater oil and gas exploration and production, medical imaging and pharmaceutical research. 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. We believe that technological capabilities and innovation and the ability to invest in the development of new and enhanced products are critical to obtaining and maintaining leadership in our markets and the industries in which we compete.
Strategy/Overview
Our strategy continues to emphasize growth in our core markets of instrumentation, digital imaging, aerospace and defense electronics and engineered systems. Our core markets are characterized by high barriers to entry and include specialized products and services not likely to be commoditized. We intend to strengthen and expand our core businesses with targeted acquisitions and through product development. We continue to focus on balanced and disciplined capital deployment among capital expenditures, acquisitions and product development. 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, we made one acquisition in 2020 and three acquisitions in 2019. See the Recent and Pending Acquisitions section for additional information.
COVID-19 and Other Matters
We concluded 2020 with the best operating margin and cash flow in the Company’s history. With regard to the COVID-19 pandemic, our first priority remains the health and safety of our employees and their families. Our manufacturing sites are deemed essential businesses and remain operational, and we are practicing social distancing, enhanced cleaning protocols, usage of personal protective equipment and other preventative measures.
While no company is immune to global economic challenges, Teledyne's business portfolio is well-balanced across end markets and geographies, and includes a high degree of businesses serving critical infrastructure sectors such as the defense industrial base, water and wastewater, and healthcare and public health. However, given the continuing dynamic nature of this situation, the Company may not fully estimate the impacts of COVID-19 on its financial condition, results of operations or cash flows.
As part of a continuing effort to reduce costs and improve operating performance, as well as to respond to the impact of COVID-19, in 2020 the Company took actions to reduce headcount by 9.8% across various businesses, reducing our exposure to weak end markets, such as commercial aerospace. At January 3, 2021, $2.1 million remains to be paid related to these actions.
The following pre-tax charges were incurred related to severance and facility consolidations (in millions):
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Instrumentation | $ | 5.9 | $ | 1.5 | $ | 5.6 | ||||||||||||||
| Digital Imaging | 2.9 | 1.1 | 0.7 | |||||||||||||||||
| Aerospace and Defense Electronics | 11.1 | 0.5 | 1.3 | |||||||||||||||||
| Engineered Systems | 0.5 | 0.1 | 0.2 | |||||||||||||||||
| Corporate | 0.4 | — | — | |||||||||||||||||
| Total | $ | 20.8 | $ | 3.2 | $ | 7.8 |
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Severance | $ | 16.0 | $ | 3.5 | $ | 5.6 | ||||||||||||||
| Facility consolidations (a) | 4.8 | (0.3) | 2.2 | |||||||||||||||||
| Total | $ | 20.8 | $ | 3.2 | $ | 7.8 |
(a) 2019 includes the reversal of certain amounts recorded in 2018 no longer needed.
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Cost of sales | $ | 10.3 | $ | 0.8 | $ | 4.9 | ||||||||||||||
| Selling, general and administrative expenses | 10.5 | 2.4 | 2.9 | |||||||||||||||||
| Total | $ | 20.8 | $ | 3.2 | $ | 7.8 |
Recent and Pending Acquisitions
The Company spent $29.0 million, $484.0 million and $3.1 million on acquisitions and other investments, net of cash acquired in 2020, 2019 and 2018, respectively.
Pending 2021 Acquisition
On January 4, 2021, the first day of our 2021 fiscal year, Teledyne and FLIR Systems, Inc. (“FLIR”) entered into a definitive agreement under which Teledyne will acquire FLIR in a cash and stock transaction valued at approximately $8.0 billion. Under the terms of the agreement, FLIR stockholders will receive $28.00 per share in cash and 0.0718 shares of Teledyne common stock for each FLIR share, which implies a total purchase price of $56.00 per FLIR share based on Teledyne’s 5-day volume weighted average price as of December 31, 2020. The transaction is expected to close in the middle of 2021 subject to the receipt of required regulatory approvals, including expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act, approvals of Teledyne and FLIR stockholders and other customary closing conditions.
FLIR designs, develops, manufactures, markets, and distributes technologies that enhance perception and awareness. FLIR provides innovative sensing solutions through thermal imaging, visible-light imaging, video analytics, measurement and diagnostic, and advanced threat detection systems. FLIR offers a diversified portfolio that serves a number of applications in government and defense, industrial, and commercial markets. FLIR, headquartered in Wilsonville, Oregon, will be part of the Digital Imaging segment.
2020 Acquisition
On January 5, 2020, we acquired OakGate Technology, Inc. (“OakGate”) for $28.5 million in cash, net of cash acquired. Based in Loomis, California, OakGate provides software and hardware designed to test electronic data storage devices from development through manufacturing and end-use applications. The acquired business is part of the Test and Measurement product line within the Instrumentation segment.
2019 Acquisitions
On February 5, 2019, we acquired the scientific imaging businesses of Roper Technologies, Inc. for $224.8 million in cash. The acquired businesses include Princeton Instruments, Photometrics and Lumenera. The acquired 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. Principally located in the United States and Canada, the acquired businesses are part of the Digital Imaging segment.
On August 1, 2019, we acquired the gas and flame detection businesses of 3M Company for $233.5 million in cash. The gas and flame detection businesses includes Oldham, Simtronics, Gas Measurement Instruments, Detcon and select Scott Safety products. The gas and flame detection businesses provides a portfolio of fixed and portable industrial gas and flame detection instruments used in a variety of industries including petrochemical, power generation, oil and gas, food and beverage, mining and waste water treatment. Principally located in France, the United Kingdom and the United States, the acquired businesses are part of the Environmental Instrumentation product line of the Instrumentation segment.
On August 30, 2019, we acquired Micralyne Inc. (“Micralyne”) for $25.7 million in cash. Micralyne provides micro electromechanical systems (“MEMS”) devices. In particular, Micralyne possesses unique microfluidic technology for biotech applications, as well as capabilities in non-silicon-based MEMS (e.g. gold, polymers) often required for human body compatibility. Based in Edmonton, Alberta, Canada, the acquired business is part of the Digital Imaging segment.
See Note 3 of the Notes to Consolidated Financial Statements for additional information about our recent acquisitions and Note 15 of the Notes to Consolidated Financial Statements for additional information about a pending acquisition.
Consolidated Operating Results
Our fiscal year is determined based on a 52- or 53-week convention ending on the Sunday nearest to December 31. Fiscal year 2020 contained 53 weeks while fiscal years 2019 and 2018 each contained 52 weeks. The following are selected financial highlights for 2020, 2019 and 2018 (in millions, except per-share amounts):
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Net sales | $ | 3,086.2 | $ | 3,163.6 | $ | 2,901.8 | ||||||||||||||
| Costs and expenses | ||||||||||||||||||||
| Cost of sales | 1,905.3 | 1,920.3 | 1,791.0 | |||||||||||||||||
| Selling, general and administrative expenses | 700.8 | 751.6 | 694.2 | |||||||||||||||||
| Total costs and expenses | 2,606.1 | 2,671.9 | 2,485.2 | |||||||||||||||||
| Operating income | 480.1 | 491.7 | 416.6 | |||||||||||||||||
| Interest and debt expense, net | (15.3) | (21.0) | (25.5) | |||||||||||||||||
| Non-service retirement benefit income | 12.1 | 8.0 | 13.5 | |||||||||||||||||
| Other expense, net | (7.2) | (5.0) | (10.7) | |||||||||||||||||
| Income before income taxes | 469.7 | 473.7 | 393.9 | |||||||||||||||||
| Provision for income taxes | 67.8 | 71.4 | 60.1 | |||||||||||||||||
| Net income | $ | 401.9 | $ | 402.3 | $ | 333.8 | ||||||||||||||
| Basic earnings per common share | $ | 10.95 | $ | 11.08 | $ | 9.32 | ||||||||||||||
| Diluted earnings per common share | $ | 10.62 | $ | 10.73 | $ | 9.01 | ||||||||||||||
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 2020, 2019 and 2018 are summarized in the following table:
| Percentage of Total Net Sales | ||||||||||||||||||||
| Segment contribution to total net sales: | 2020 | 2019 | 2018 | |||||||||||||||||
| Instrumentation | 35 | % | 35 | % | 35 | % | ||||||||||||||
| Digital Imaging | 32 | % | 31 | % | 30 | % | ||||||||||||||
| Aerospace and Defense Electronics | 19 | % | 22 | % | 22 | % | ||||||||||||||
| Engineered Systems | 14 | % | 12 | % | 13 | % | ||||||||||||||
| 100 | % | 100 | % | 100 | % |
Results of Operations
2020 compared with 2019
| Net sales (dollars in millions) | 2020 | 2019 | % Change | ||||||||||||||||||||
| Instrumentation | $ | 1,094.5 | $ | 1,105.1 | (1.0) | % | |||||||||||||||||
| Digital Imaging | 986.0 | 992.9 | (0.7) | % | |||||||||||||||||||
| Aerospace and Defense Electronics | 589.4 | 690.1 | (14.6) | % | |||||||||||||||||||
| Engineered Systems | 416.3 | 375.5 | 10.9 | % | |||||||||||||||||||
| Total net sales | $ | 3,086.2 | $ | 3,163.6 | (2.4) | % | |||||||||||||||||
| Results of operations (dollars in millions) | 2020 | 2019 | % Change | ||||||||||||||||||||
| Instrumentation | $ | 213.2 | $ | 200.4 | 6.4 | % | |||||||||||||||||
| Digital Imaging | 192.8 | 176.5 | 9.2 | % | |||||||||||||||||||
| Aerospace and Defense Electronics | 80.8 | 143.4 | (43.7) | % | |||||||||||||||||||
| Engineered Systems | 50.1 | 36.5 | 37.3 | % | |||||||||||||||||||
| Corporate expense | (56.8) | (65.1) | (12.7) | % | |||||||||||||||||||
| Operating income | 480.1 | 491.7 | (2.4) | % | |||||||||||||||||||
| Interest and debt expense, net | (15.3) | (21.0) | (27.1) | % | |||||||||||||||||||
| Non-service retirement benefit income | 12.1 | 8.0 | 51.3 | % | |||||||||||||||||||
| Other expense, net | (7.2) | (5.0) | 44.0 | % | |||||||||||||||||||
| Income before income taxes | 469.7 | 473.7 | (0.8) | % | |||||||||||||||||||
| Provision for income taxes | 67.8 | 71.4 | (5.0) | % | |||||||||||||||||||
| Net income | $ | 401.9 | $ | 402.3 | (0.1) | % | |||||||||||||||||
Sales and cost of sales by segment and total company (dollars in millions):
| 2020 | 2019 | Change | |||||||||||||||
| Instrumentation | |||||||||||||||||
| Net sales | $ | 1,094.5 | $ | 1,105.1 | $ | (10.6) | |||||||||||
| Cost of sales | $ | 603.4 | $ | 612.8 | $ | (9.4) | |||||||||||
| Cost of sales % of net sales | 55.1 | % | 55.5 | % | |||||||||||||
| Digital Imaging | |||||||||||||||||
| Net sales | $ | 986.0 | $ | 992.9 | $ | (6.9) | |||||||||||
| Cost of sales | $ | 569.2 | $ | 580.6 | $ | (11.4) | |||||||||||
| Cost of sales % of net sales | 57.7 | % | 58.5 | % | |||||||||||||
| Aerospace and Defense Electronics | |||||||||||||||||
| Net sales | $ | 589.4 | $ | 690.1 | $ | (100.7) | |||||||||||
| Cost of sales | $ | 395.1 | $ | 414.7 | $ | (19.6) | |||||||||||
| Cost of sales % of net sales | 67.0 | % | 60.1 | % | |||||||||||||
| Engineered Systems | |||||||||||||||||
| Net sales | $ | 416.3 | $ | 375.5 | $ | 40.8 | |||||||||||
| Cost of sales | $ | 337.6 | $ | 312.2 | $ | 25.4 | |||||||||||
| Cost of sales % of net sales | 81.1 | % | 83.1 | % | |||||||||||||
| Total Company | |||||||||||||||||
| Net sales | $ | 3,086.2 | $ | 3,163.6 | $ | (77.4) | |||||||||||
| Cost of sales | $ | 1,905.3 | $ | 1,920.3 | $ | (15.0) | |||||||||||
| Cost of sales % of net sales | 61.7 | % | 60.7 | % |
We reported net sales of $3,086.2 million in 2020, compared with net sales of $3,163.6 million for 2019, a decrease of 2.4%. Net income was $401.9 million ($10.62 per diluted share) in 2020, compared with net income of $402.3 million ($10.73 per diluted share) in 2019, a decrease of 0.1%.
Total year 2020 and 2019 reflected pretax charges totaling $33.3 million and $8.8 million, respectively, primarily in severance, facility consolidation, acquisition and certain changes in contract cost estimates. Net income for 2020 and 2019 also included net discrete tax benefits of $34.6 million and $26.1 million, respectively.
Net sales
The decrease in net sales in 2020, compared with 2019, reflected lower net sales in each segment except the Engineered Systems segment. Net sales in 2020 included $68.9 million in incremental net sales from recent acquisitions.
Sales under contracts with the U.S. Government were approximately 26% of net sales in 2020 and 24% of net sales in 2019. Sales to international customers represented approximately 45% of net sales in 2020 and 44% of net sales in 2019.
Cost of Sales
Cost of sales decreased by $15.0 million in 2020, compared with 2019, which primarily reflected the impact of lower net sales, partially offset by higher severance and facility consolidation expense. Cost of sales as a percentage of net sales for 2020 was 61.7%, compared with 60.7% for 2019.
Selling, general and administrative expenses
Selling, general and administrative expenses, including research and development expense, were lower in 2020, compared with 2019. The decrease primarily reflected the impact of lower net sales. Corporate administrative expense in 2020 was $56.8 million, compared with $65.1 million in 2019. The lower 2020 amount primarily reflected lower compensation expense. For 2020, we recorded a total of $24.7 million in stock option expense, of which $7.2 million was recorded within corporate expense and $17.5 million was recorded in the operating segment results. For 2019, we recorded a total of $26.1 million in stock option expense, of which $9.7 million was recorded within corporate expense and $16.4 million was recorded in the operating segment results. Selling, general and administrative expenses as a percentage of sales was 22.7% for 2020, compared with 23.8% for 2019.
Pension Service Expense
Pension service expense is included in both cost of sales and selling, general and administrative expense. Pension service expense in 2020 was $10.4 million compared with $9.4 million in 2019.
Operating Income
Operating income for 2020 was $480.1 million, compared with $491.7 million for 2019, a decrease of 2.4%. The decrease in operating income primarily reflected lower operating income in the Aerospace and Defense Electronics segment, partially offset by higher operating income in our other three segments. Operating income in 2020 and 2019 included charges of $33.3 million and $8.8 million, respectively, primarily related to severance, facility consolidation and acquisition expense and certain changes in contract cost estimates. Of these amounts, severance and facility consolidation expense totaled $20.8 million in 2020 and $3.2 million in 2019. The incremental operating income included in the results for 2020 from recent acquisitions was $4.1 million.
Interest Expense, Interest Income, Non-Service Retirement Benefit Income and Other Expense
Interest expense, including credit facility fees and other bank charges, was $15.8 million in 2020 compared with $22.0 million in 2019 and reflected the impact of lower average debt levels in 2020. Interest income was $0.5 million in 2020 and $1.0 million in 2019. Non-service retirement benefit income was $12.1 million in 2020, compared with $8.0 million in 2019. Other expense was $7.2 million for 2020, compared with expense of $5.0 million in 2019 and reflected higher foreign currency expense.
Income Taxes
The Company’s effective tax rate for 2020 was 14.4%, compared with 15.1% for 2019. For 2020 net discrete income tax benefits were $34.6 million, which included a $20.9 million income tax benefit related to share-based accounting, $9.8 million primarily related to U.S. export sales, U.S. research credits and other items. For 2019 net discrete income tax benefits were $26.1 million, which included a $15.4 million income tax benefit related to share-based accounting, $13.1 million in income tax benefit as a result of the remeasurement of uncertain tax positions due to expiration of statute of limitations, a favorable tax settlement and a tax benefit related to U.S. export sales. Excluding the net discrete income tax benefits in both years, the effective tax rates would have been 21.8% for 2020 and 20.6% for 2019.
2019 compared with 2018
| Sales (dollars in millions) | 2019 | 2018 | % Change | ||||||||||||||||||||
| Instrumentation | $ | 1,105.1 | $ | 1,021.2 | 8.2 | % | |||||||||||||||||
| Digital Imaging | 992.9 | 875.3 | 13.4 | % | |||||||||||||||||||
| Aerospace and Defense Electronics | 690.1 | 640.2 | 7.8 | % | |||||||||||||||||||
| Engineered Systems | 375.5 | 365.1 | 2.8 | % | |||||||||||||||||||
| Total sales | $ | 3,163.6 | $ | 2,901.8 | 9.0 | % | |||||||||||||||||
| Results of operations (dollars in millions) | 2019 | 2018 | % Change | ||||||||||||||||||||
| Instrumentation | $ | 200.4 | $ | 147.4 | 36.0 | % | |||||||||||||||||
| Digital Imaging | 176.5 | 155.5 | 13.5 | % | |||||||||||||||||||
| Aerospace and Defense Electronics | 143.4 | 131.8 | 8.8 | % | |||||||||||||||||||
| Engineered Systems | 36.5 | 37.9 | (3.7) | % | |||||||||||||||||||
| Corporate expense | (65.1) | (56.0) | 16.3 | % | |||||||||||||||||||
| Operating income | 491.7 | 416.6 | 18.0 | % | |||||||||||||||||||
| Interest and debt expense, net | (21.0) | (25.5) | (17.6) | % | |||||||||||||||||||
| Non-service retirement benefit income | 8.0 | 13.5 | (40.7) | % | |||||||||||||||||||
| Other expense, net | (5.0) | (10.7) | (53.3) | % | |||||||||||||||||||
| Income before income taxes | 473.7 | 393.9 | 20.3 | % | |||||||||||||||||||
| Provision for income taxes | 71.4 | 60.1 | 18.8 | % | |||||||||||||||||||
| Net income | $ | 402.3 | $ | 333.8 | 20.5 | % | |||||||||||||||||
Sales and cost of sales by segment and total company (dollars in millions):
| 2019 | 2018 | Change | |||||||||||||||
| Instrumentation | |||||||||||||||||
| Net sales | $ | 1,105.1 | $ | 1,021.2 | $ | 83.9 | |||||||||||
| Cost of sales | $ | 612.8 | $ | 575.2 | $ | 37.6 | |||||||||||
| Cost of sales % of net sales | 55.5 | % | 56.3 | % | |||||||||||||
| Digital Imaging | |||||||||||||||||
| Net sales | $ | 992.9 | $ | 875.3 | $ | 117.6 | |||||||||||
| Cost of sales | $ | 580.6 | $ | 529.4 | $ | 51.2 | |||||||||||
| Cost of sales % of net sales | 58.5 | % | 60.5 | % | |||||||||||||
| Aerospace and Defense Electronics | |||||||||||||||||
| Net sales | $ | 690.1 | $ | 640.2 | $ | 49.9 | |||||||||||
| Cost of sales | $ | 414.7 | $ | 385.9 | $ | 28.8 | |||||||||||
| Cost of sales % of net sales | 60.1 | % | 60.3 | % | |||||||||||||
| Engineered Systems | |||||||||||||||||
| Net sales | $ | 375.5 | $ | 365.1 | $ | 10.4 | |||||||||||
| Cost of sales | $ | 312.2 | $ | 300.5 | $ | 11.7 | |||||||||||
| Cost of sales % of net sales | 83.1 | % | 82.3 | % | |||||||||||||
| Total Company | |||||||||||||||||
| Net sales | $ | 3,163.6 | $ | 2,901.8 | $ | 261.8 | |||||||||||
| Cost of sales | $ | 1,920.3 | $ | 1,791.0 | $ | 129.3 | |||||||||||
| Cost of sales % of net sales | 60.7 | % | 61.7 | % |
We reported net sales of $3,163.6 million in 2019, compared with net sales of $2,901.8 million for 2018, an increase of
9.0%. Net income was $402.3 million ($10.73 per diluted share) in 2019, compared with net income of $333.8 million ($9.01
per diluted share) in 2018, an increase of 20.5%.
Total year 2019 and 2018 reflected pretax charges totaling $3.2 million and $7.8 million, respectively, for severance and
facility consolidation charges. Net income for 2019 and 2018 also included net discrete tax benefits of $26.1 million and $23.8
million, respectively.
Net sales
The increase in net sales in 2019, compared with 2018, reflected higher net sales in each segment. Net sales in 2019
included revenue growth of $128.7 million plus $133.1 million in incremental net sales from recent acquisitions.
Sales under contracts with the U.S. Government were approximately 24% of net sales in 2019 and 23% of net sales in
- Sales to international customers represented approximately 44% of net sales in 2019 and 47% of net sales in 2018.
Cost of Sales
Cost of sales increased by $129.3 million in 2019, compared with 2018, which primarily reflected the impact of higher net sales. Cost of sales as a percentage of sales for 2019 was 60.7%, compared with 61.7% for 2018.
Selling, general and administrative expenses
Selling, general and administrative expenses, including research and development expense, were
higher in 2019, compared with 2018. The increase primarily reflected the impact of higher sales and higher research and
development expense. Corporate administrative expense in 2019 was $65.1 million, compared with $56.0
million in 2018. The higher 2019 amount reflected higher compensation expense including higher stock option expense. For
2019, we recorded a total of $26.1 million in stock option expense, of which $9.7 million was recorded within corporate
expense and $16.4 million was recorded in the operating segment results. 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. Selling, general and administrative expenses as a percentage of sales was 23.8% for 2019, compared
with 23.9% for 2018.
Pension Service Expense
Pension service expense is included in both cost of sales and selling, general and administrative expense. Pension service expense in 2019 was $9.4 million compared with pension service expense of $10.7 million in 2018.
Operating Income
Operating income for 2019 was $491.7 million, compared with $416.6 million for 2018, an increase of 18.0%. The
increase in operating income primarily reflected higher operating income in each segment, except the Engineered Systems
segment. Operating income in 2019 and 2018 reflected $3.2 million and $7.8 million in severance and facility consolidation
costs, respectively. The incremental operating income included in the results for 2019 from recent acquisitions was $16.2
million.
Interest Expense, Interest Income, Non-Service Retirement Benefit Income and Other Expense
Interest expense, including credit facility fees and other bank charges, was $22.0 million in 2019 compared with
$29.2 million in 2018 and reflected the impact of lower average debt levels in 2019. Interest income was $1.0 million in 2019
and $3.7 million in 2018. Non-service retirement benefit income was $8.0 million in 2019, compared with $13.5 million in
- Other expense was $5.0 million for 2019, compared with expense of $10.7 million in 2018 and reflected lower foreign currency expense in 2019.
Income Taxes
The Company’s effective tax rate for 2019 was 15.1%, compared with 15.3% for 2018. For 2019 net discrete income tax
benefits were $26.1 million, which included a $15.4 million income tax benefit related to share-based accounting, $13.1 million
in income tax benefit as a result of the remeasurement of uncertain tax positions due to expiration of statute of limitations, a
favorable tax settlement and a tax benefit related to U.S. export sales. 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. Excluding the net discrete income tax benefits in both years, the effective tax rates would have been
20.6% for 2019 and 21.3% for 2018.
Segments
The following discussion of our four segments should be read in conjunction with Note 12 of the Notes to Consolidated Financial Statements.
Instrumentation
| (Dollars in millions) | 2020 | 2019 | 2018 | |||||||||||||||||
| Net sales | $ | 1,094.5 | $ | 1,105.1 | $ | 1,021.2 | ||||||||||||||
| Cost of sales | $ | 603.4 | $ | 612.8 | $ | 575.2 | ||||||||||||||
| Selling, general and administrative expenses | $ | 277.9 | $ | 291.9 | $ | 298.6 | ||||||||||||||
| Operating income | $ | 213.2 | $ | 200.4 | $ | 147.4 | ||||||||||||||
| Cost of sales % of net sales | 55.1 | % | 55.5 | % | 56.3 | % | ||||||||||||||
| Selling, general and administrative expenses % of net sales | 25.4 | % | 26.4 | % | 29.3 | % | ||||||||||||||
| Operating income % of net sales | 19.5 | % | 18.1 | % | 14.4 | % | ||||||||||||||
| International sales % of net sales | 57.0 | % | 54.8 | % | 51.0 | % | ||||||||||||||
| U.S. Government sales % of net sales | 7.4 | % | 7.3 | % | 6.7 | % | ||||||||||||||
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.
2020 compared with 2019
Our Instrumentation segment net sales for 2020 decreased 1.0%, compared with 2019. Operating income for 2020 increased 6.4%, compared with 2019.
The 2020 net sales decrease primarily resulted from lower sales of marine instrumentation and test and measurement instrumentation, partially offset by higher sales of environmental instrumentation. Sales of environmental instrumentation increased $19.9 million and included $51.8 million in incremental sales from the gas and flame detection business acquisition. Sales of marine instrumentation decreased by $23.9 million. Sales of test and measurement instrumentation decreased $6.6 million and included $14.8 million in incremental sales from the acquisition of OakGate. The increase in operating income reflected the impact of improved product line margins and lower severance, facility consolidation and acquisition expense. The incremental operating income included in the results for 2020 from recent acquisitions was $4.1 million, including $3.4 million in incremental intangible asset amortization expense. Operating income in 2020 included $7.6 million in severance, facility consolidation and acquisition expense compared with $2.9 million in similar costs for 2019.
Cost of sales decreased by $9.4 million in 2020, compared with 2019, and primarily reflected the impact of lower net sales. The cost of sales percentage decreased slightly to 55.1% in 2020 from 55.5% in 2019. Selling, general and administrative expenses, including research and development expense, in 2020, decreased by $14.0 million, compared with 2019, and reflected the impact of lower sales, $3.0 million in lower research and development expense, partially offset by higher severance, facility consolidation and acquisition expense. Selling, general and administrative expenses for 2020, as a percentage of sales, decreased to 25.4%, compared with 26.4% for 2019, and reflected the impact of $3.0 million in lower research and development expense, partially offset by the impact of higher severance and facility consolidation and acquisition expense.
2019 compared with 2018
Our Instrumentation segment net sales for 2019 increased 8.2%, compared with 2018. Operating income increased 36.0%, compared with 2018.
The 2019 net sales increase primarily resulted from higher sales of environmental instrumentation, marine instrumentation
and test and measurement instrumentation, as well as the contribution from the gas and flame detection business acquisition.
Sales of environmental instrumentation increased $51.8 million and included $45.3 million in incremental sales from the gas
and flame detection business acquisition. Sales of marine instrumentation increased by $17.2 million. Sales of test and
measurement instrumentation increased $14.9 million. The increase in operating income reflected the impact of higher sales
and higher margins across most product lines. The incremental operating income included in the results for 2019 from the gas
and flame detection business acquisition was $4.1 million. Operating income in 2019 included $1.5 million in severance and
facility consolidation costs compared with $5.6 million in severance and facility consolidation costs for 2018.
Cost of sales increased by $37.6 million in 2019, compared with 2018, and primarily reflected the impact of higher net sales. The cost of sales percentage decreased slightly to 55.5% in 2019 from 56.3% in 2018. Selling, general and administrative expenses, including research and development expense, in 2019, decreased by $6.7 million, compared with 2018, and reflected the impact of cost control efforts, lower severance and facility consolidation costs and lower research and development expense of $3.2 million. Selling, general and administrative expenses for 2019, as a percentage of sales, decreased to 26.4%, compared with 29.3% for 2018, and reflected the impact of cost control efforts, lower severance and facility consolidation costs and lower research and development expense.
Digital Imaging
| (Dollars in millions) | 2020 | 2019 | 2018 | |||||||||||||||||
| Net sales | $ | 986.0 | $ | 992.9 | $ | 875.3 | ||||||||||||||
| Cost of sales | $ | 569.2 | $ | 580.6 | $ | 529.4 | ||||||||||||||
| Selling, general and administrative expenses | $ | 224.0 | $ | 235.8 | $ | 190.4 | ||||||||||||||
| Operating income | $ | 192.8 | $ | 176.5 | $ | 155.5 | ||||||||||||||
| Cost of sales % of net sales | 57.7 | % | 58.5 | % | 60.5 | % | ||||||||||||||
| Selling, general and administrative expenses % of net sales | 22.7 | % | 23.7 | % | 21.7 | % | ||||||||||||||
| Operating income % of net sales | 19.6 | % | 17.8 | % | 17.8 | % | ||||||||||||||
| International sales % of net sales | 60.8 | % | 59.7 | % | 66.0 | % | ||||||||||||||
| U.S. Government sales % of net sales | 12.3 | % | 10.8 | % | 10.3 | % | ||||||||||||||
Our Digital Imaging segment includes high-performance sensors, cameras and systems, within the visible, infrared and X-ray spectra for use in industrial, government and medical applications, as well as 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.
2020 compared with 2019
Our Digital Imaging segment net sales for 2020 decreased 0.7%, compared with 2019. Operating income for 2020 increased 9.2%, compared with 2019.
Total year 2020 net sales primarily reflected lower sales of X-ray products for dental and medical applications, due in part to deferred patient treatments, partially offset by greater sales of infrared detectors for defense and space applications, MEMS products, and $2.3 million in incremental sales from recent acquisitions. The increase in operating income for 2020 reflected the impact of favorable product mix.
Cost of sales for 2020 decreased by $11.4 million, compared with 2019, and reflected the impact of lower net sales. The cost of sales percentage in 2020 decreased to 57.7% compared with 58.5% in 2019. Selling, general and administrative expenses for 2020 decreased to $224.0 million, compared with $235.8 million in 2019 and reflected the impact of lower net sales and lower research and development expense. The selling, general and administrative expense percentage decreased to 22.7% in 2020 from 23.7% in 2019 and reflected the impact of lower selling and research and development expense.
2019 compared with 2018
Our Digital Imaging segment net sales for 2019 increased 13.4%, compared with 2018. Operating income for 2019 increased 13.5%, compared with 2018.
Total year 2019 net sales primarily reflected higher sales of X-ray detectors for life sciences applications and aerospace, defense and MEMS products, as well as $87.8 million in sales from recent acquisitions, partially offset by lower sales of industrial machine vision products. The increase in operating income for 2019 reflected the impact of higher sales and incremental operating profit from recent acquisitions. The incremental operating income reflected in the results for 2019 from recent acquisitions was $12.1 million which included $4.7 million in additional intangible asset amortization expense.
Cost of sales for 2019 increased by $51.2 million, compared with 2018, and reflected the impact of higher net sales. The cost of sales percentage in 2019 decreased to 58.5% compared with 60.5% in 2018 and reflected product mix differences. Selling, general and administrative expenses for 2019 increased to $235.8 million, compared with $190.4 million in 2018 and reflected the impact of higher net sales, higher research and development expense and intangible amortization expense from recent acquisitions. The selling, general and administrative expense percentage increased to 23.7% in 2019 from 21.7% in 2018 and reflected the impact of higher research and development expense and intangible amortization expense from recent acquisitions.
Aerospace and Defense Electronics
| (Dollars in millions) | 2020 | 2019 | 2018 | |||||||||||||||||
| Net sales | $ | 589.4 | $ | 690.1 | $ | 640.2 | ||||||||||||||
| Cost of sales | $ | 395.1 | $ | 414.7 | $ | 385.9 | ||||||||||||||
| Selling, general and administrative expenses | $ | 113.5 | $ | 132.0 | $ | 122.5 | ||||||||||||||
| Operating income | $ | 80.8 | $ | 143.4 | $ | 131.8 | ||||||||||||||
| Cost of sales % of net sales | 67.0 | % | 60.1 | % | 60.3 | % | ||||||||||||||
| Selling, general and administrative expenses % of net sales | 19.3 | % | 19.1 | % | 19.1 | % | ||||||||||||||
| Operating income % of net sales | 13.7 | % | 20.8 | % | 20.6 | % | ||||||||||||||
| International sales % of net sales | 27.1 | % | 27.4 | % | 34.1 | % | ||||||||||||||
| U.S. Government sales % of net sales | 39.0 | % | 32.6 | % | 27.7 | % | ||||||||||||||
Our Aerospace and Defense Electronics segment provides sophisticated electronic components and subsystems and communications products, including defense electronics, harsh environment interconnects, data acquisition and communications equipment for aircraft, and components and subsystems for wireless and satellite communications, as well as general aviation batteries.
2020 compared with 2019
Our Aerospace and Defense Electronics segment net sales for 2020 decreased 14.6%, compared with 2019. Operating income for 2020 decreased 43.7%, compared with 2019.
The 2020 net sales decrease reflected $94.8 million of lower sales of aerospace electronics and lower sales of $5.9 million of defense electronics. The continued weakness in the commercial aerospace industry, due to COVID-19, has negatively affected sales of aerospace electronics. The decrease in operating income in 2020 primarily reflected the impact of lower sales and $18.3 million of higher severance, facility consolidation expense and certain unfavorable changes in contract cost estimates.
Cost of sales for 2020 decreased by $19.6 million, compared with 2019, and reflected the impact of lower net sales. Cost of sales as a percentage of net sales for 2020 increased to 67.0% from 60.1% in 2019 and reflected the impact of higher severance, facility consolidation expense and certain unfavorable changes in contract cost estimates. Selling, general and administrative expenses, including research and development expense, decreased to $113.5 million in 2020, from $132.0 million in 2019 and reflected the impact of lower net sales, partially offset by higher severance and facility consolidation expense. The selling, general and administrative expense percentage was 19.3% in 2020 compared to 19.1% in 2019.
2019 compared with 2018
Our Aerospace and Defense Electronics segment net sales for 2019 increased 7.8%, compared with 2018. Operating income for 2019 increased 8.8%, compared with 2018.
The 2019 net sales increase reflected $57.9 million of higher sales of defense electronics, partially offset by $8.0 million
of lower sales of aerospace electronics. The higher sales of defense electronics reflected greater sales in most product
categories. Operating income in 2019 reflected the impact of higher net sales.
Cost of sales for 2019 increased by $28.8 million, compared with 2018, and reflected the impact of higher net sales. Cost
of sales as a percentage of net sales for 2019 decreased slightly to 60.1% from 60.3% in 2018. Selling, general and administrative expenses, including research and development expense, increased to $132.0 million in 2019, from $122.5 million in 2018 and reflected higher research and development expense of $10.5 million. The selling, general and administrative expense percentage was 19.1% for both 2019 and 2018.
Engineered Systems
| (Dollars in millions) | 2020 | 2019 | 2018 | |||||||||||||||||
| Net sales | $ | 416.3 | $ | 375.5 | $ | 365.1 | ||||||||||||||
| Cost of sales | $ | 337.6 | $ | 312.2 | $ | 300.5 | ||||||||||||||
| Selling, general and administrative expenses | $ | 28.6 | $ | 26.8 | $ | 26.7 | ||||||||||||||
| Operating income | $ | 50.1 | $ | 36.5 | $ | 37.9 | ||||||||||||||
| Cost of sales % of net sales | 81.1 | % | 83.1 | % | 82.3 | % | ||||||||||||||
| Selling, general and administrative expenses % of net sales | 6.9 | % | 7.2 | % | 7.3 | % | ||||||||||||||
| Operating income % of net sales | 12.0 | % | 9.7 | % | 10.4 | % | ||||||||||||||
| International sales % of net sales | 0.7 | % | 1.1 | % | 2.9 | % | ||||||||||||||
| U.S. Government sales % of net sales | 92.9 | % | 92.3 | % | 87.5 | % | ||||||||||||||
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.
2020 compared with 2019
Our Engineered Systems segment net sales for 2020 increased 10.9%, compared with 2019. Operating income for 2020 increased 37.3%, compared with 2019.
The 2020 sales increase reflected higher sales of $35.2 million of engineered products and services and $8.4 million of turbine engines, partially offset by lower sales of $2.8 million of energy systems products. The higher sales of engineered products and services primarily reflected increased sales from marine, space, nuclear and other manufacturing programs, as well as electronic manufacturing services products, partially offset by lower sales related to missile defense. The higher sales of turbine engines reflected increased sales for the Harpoon missile program. Operating income in 2020 reflected the impact of higher sales and a greater mix of higher margin fixed-price manufacturing programs.
Cost of sales for 2020 increased by $25.4 million, compared with 2019, and primarily reflected the impact of higher net sales. Cost of sales as a percentage of net sales for 2020 decreased to 81.1%, compared with 83.1% in 2019. Selling, general and administrative expenses, including research and development and bid and proposal expense, increased to $28.6 million in 2020, compared with $26.8 million in 2019. The selling, general and administrative expense percentage decreased slightly to 6.9% for 2020, compared with 7.2% in 2019.
2019 compared with 2018
Our Engineered Systems segment net sales for 2019 increased 2.8%, compared with 2018. Operating income for 2019 decreased 3.7%, compared with 2018.
The 2019 sales increase of $10.4 million reflected higher sales of $14.3 million of engineered products and services, partially offset by lower sales of $2.6 million of energy systems products and $1.3 million of turbine engines. The higher sales of engineered products and services primarily reflected increased sales for nuclear manufacturing and space programs. Operating income in 2019 decreased due to product mix differences.
Cost of sales for 2019 increased by $11.7 million, compared with 2018, and primarily reflected the impact of higher net sales. Cost of sales as a percentage of net sales for 2019 increased slightly 83.1%, compared with 82.3% in 2018. Selling, general and administrative expenses, including research and development and bid and proposal expense, increased slightly to $26.8 million in 2019, compared with $26.7 million in 2018. The selling, general and administrative expense percentage decreased slightly to 7.2% for 2019, compared with 7.3% in 2018.
Financial Condition, Liquidity and Capital Resources
Principal Cash and 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. It is anticipated that operating cash flow, together with available borrowings under the credit facility and the debt financing arrangement described below will be sufficient to meet these requirements and to fund the FLIR acquisition. 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.
As part of the pending acquisition of FLIR, Teledyne has arranged a $4.5 billion 364-day credit commitment to support funding of the transaction. Teledyne expects to fund the acquisition with a combination of equity, cash on hand and permanent debt financing, including a combination of senior notes and bank term loans.
Credit Facility, Senior Notes and Term Loan
| Long-term debt (dollars in millions): | January 3, 2021 | December 29, 2019 | ||||||||||||
| $750.0 million credit facility, due March 2024, weighted average rate of 1.05% at January 3, 2021 and 2.80% at December 29, 2019 | $ | 125.0 | $ | 125.0 | ||||||||||
| Term loan due October 2024, variable rate of 1.15% at January 3, 2021 and 2.702% at December 29, 2019, swapped to a Euro fixed rate of 0.612% | 150.0 | 150.0 | ||||||||||||
| 5.30% Fixed Rate Senior Notes repaid September 2020 | — | 75.0 | ||||||||||||
| 2.81% Fixed Rate Senior Notes repaid November 2020 | — | 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 | 61.1 | 56.0 | ||||||||||||
| 0.92% €100 Million Fixed Rate Senior Notes due April 2023 | 122.1 | 111.9 | ||||||||||||
| 1.09% €100 Million Fixed Rate Senior Notes due April 2024 | 122.1 | 111.9 | ||||||||||||
| Other debt | 4.0 | 2.0 | ||||||||||||
| Debt issuance costs | (0.8) | (1.2) | ||||||||||||
| Total long-term debt | 778.5 | 850.6 | ||||||||||||
| Current portion of long-term debt | (97.6) | (100.6) | ||||||||||||
| Total long-term debt, net of current portion | $ | 680.9 | $ | 750.0 |
At January 3, 2021, we had $27.7 million in outstanding letters of credit.
Our credit facility, senior notes and term loan agreement require the Company to comply with various financial and operating covenants, including maintaining certain consolidated leverage and interest coverage ratios, as well as minimum net worth levels and limits on acquired debt. At January 3, 2021, the Company was in compliance with these covenants and we had a significant amount of margin between required financial covenant ratios and our actual ratios. Currently, we do not believe our ability to undertake additional debt financing, if needed, is reasonably likely to be materially impacted by debt restrictions under our credit agreements subject to our complying with required financial covenants listed in the table below.
Financial covenant ratios and the actual ratios at January 3, 2021:
| $750.0 million Credit Facility expires March 2024 and $150.0 million term loan due October 2024 (issued October 2019) | |||||||||||
| Financial Covenant | Requirement | Actual Measure | |||||||||
| Consolidated Leverage Ratio (Net Debt/EBITDA) (a) | No more than 3.25 to 1 | 1.338 to 1 | |||||||||
| Consolidated Interest Coverage Ratio (EBITDA/Interest) (b) | No less than 3.0 to 1 | 40.1 to 1 | |||||||||
| $500.3 million Private Placement Senior Notes due from 2021 to 2024 | |||||||||||
| Financial Covenant | Requirement | Actual Measure | |||||||||
| Consolidated Leverage Ratio (Net Debt/EBITDA) (a) | No more than 3.25 to 1 | 1.338 to 1 | |||||||||
| Consolidated Interest Coverage Ratio (EBITDA/Interest) (b) | No less than 3.0 to 1 | 40.1 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 credit agreements 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 $615.5 million at January 3, 2021. See Note 9, Long-Term Debt to these Consolidated Financial Statements for additional information regarding our credit facility and term loan.
Contractual Obligations
The following table summarizes our expected cash outflows resulting from financial contracts and commitments at January 3, 2021:
| Contractual obligations (in millions): | 2021 | 2022 | 2023 | 2024 | 2025 | After 2025 | Total | |||||||||||||||||||||||||||||||||||||
| Debt obligations | $ | 97.1 | $ | 161.1 | $ | 122.1 | $ | 397.1 | $ | 0.8 | $ | 1.1 | $ | 779.3 | ||||||||||||||||||||||||||||||
| Interest expense(a) | 12.9 | 9.2 | 5.6 | 2.2 | — | — | 29.9 | |||||||||||||||||||||||||||||||||||||
| Operating lease obligations (b) | 23.8 | 22.4 | 19.2 | 17.0 | 15.5 | 66.0 | 163.9 | |||||||||||||||||||||||||||||||||||||
| Purchase obligations (c) | 203.7 | 11.8 | 1.9 | 2.7 | 1.0 | 0.7 | 221.8 | |||||||||||||||||||||||||||||||||||||
| Total | $ | 337.5 | $ | 204.5 | $ | 148.8 | $ | 419.0 | $ | 17.3 | $ | 67.8 | $ | 1,194.9 |
(a) Interest expense related to the credit facility, including facility fees, is assumed to accrue at the rates in effect at year-end 2020 and is assumed to be paid at the end of each quarter with the final payment in March 2024 when the credit facility expires.
(b) Includes imputed interest and the short-term portion of 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 $32.3 million are not included in the table above because $14.7 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 January 3, 2021, we were not required, and accordingly are not planning, to make any cash contributions to the domestic qualified pension plans for 2021. Our minimum funding requirements after 2020 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 2021 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 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 2020, net cash provided by operating activities was $618.9 million, compared with $482.1 million in 2019 and $446.9 million in 2018. The higher cash provided by operating activities in 2020, compared with 2019, was driven by timing of accounts receivable collections, cash flow from recent acquisitions and $35.6 million of lower income tax payments. The higher cash provided by operating activities in 2019, compared with 2018, was driven by higher operating income, partially offset by $45.4 million of higher income tax payments.
Free cash flow (cash provided by operating activities less capital expenditures) was $547.5 million in 2020, compared with $393.7 million in 2019 and $360.1 million in 2018.
| Free Cash Flow(a) (in millions, brackets indicate use of funds) | 2020 | 2019 | 2018 | ||||||||||||||||||||
| Cash provided by operating activities | $ | 618.9 | $ | 482.1 | $ | 446.9 | |||||||||||||||||
| Capital expenditures for property, plant and equipment | (71.4) | (88.4) | (86.8) | ||||||||||||||||||||
| Free cash flow | $ | 547.5 | $ | 393.7 | $ | 360.1 |
a) We define free cash flow as cash provided by operating activities (a measure prescribed by generally accepted accounting principles) less capital expenditures for property, plant and equipment. We believe that this supplemental non-GAAP information is useful to assist management and the investment community in analyzing our ability to generate cash flow.
Investing Activities
Net cash used in investing activities was $99.4 million, $571.9 million and $88.6 million for 2020, 2019 and 2018, respectively. Cash flows relating to investing activities consists primarily of cash used for acquisitions and other investments and capital expenditures.
| Capital expenditures (in millions): | 2020 | 2019 | 2018 | |||||||||||||||||
| Instrumentation | $ | 18.0 | $ | 18.9 | $ | 14.8 | ||||||||||||||
| Digital Imaging | 33.4 | 45.2 | 35.8 | |||||||||||||||||
| Aerospace and Defense Electronics | 10.4 | 19.0 | 18.7 | |||||||||||||||||
| Engineered Systems | 7.5 | 3.6 | 13.6 | |||||||||||||||||
| Corporate | 2.1 | 1.7 | 3.9 | |||||||||||||||||
| $ | 71.4 | $ | 88.4 | $ | 86.8 |
During 2021, we plan to invest approximately $80.0 million in capital expenditures, principally to upgrade facilities and manufacturing equipment.
Acquisitions
Investing activities used cash for acquisitions and other investments of $29.0 million, $484.0 million and $3.1 million, in 2020, 2019 and 2018, 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 January 5, 2020, we acquired OakGate Technology, Inc. for $28.5 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 2020 and 2019 (in millions):
| 2020 | ||||||||||||||||||||||||||
| Acquisition | Acquisition date | Cash Paid (a) | Goodwill Acquired | Acquired Intangible Assets | ||||||||||||||||||||||
| OakGate Technology, Inc. | January 5, 2020 | $ | 28.5 | $ | 16.9 | $ | 7.0 | |||||||||||||||||||
| Purchase price adjustment - Micralyne Inc. | 0.5 | — | — | |||||||||||||||||||||||
| Total | $ | 29.0 | $ | 16.9 | $ | 7.0 | ||||||||||||||||||||
| (a) Net of cash acquired . | ||||||||||||||||||||||||||
Goodwill resulting from the OakGate acquisition will not be deductible for tax purposes.
| 2019 | ||||||||||||||||||||||||||
| Acquisition | Acquisition date | Cash Paid (a) | Goodwill Acquired | Acquired Intangible Assets | ||||||||||||||||||||||
| Scientific imaging business | February 5, 2019 | $ | 224.8 | $ | 149.9 | $ | 52.4 | |||||||||||||||||||
| Gas and flame detection business | August 1, 2019 | 233.5 | 147.7 | 69.0 | ||||||||||||||||||||||
| Micralyne Inc. | August 30, 2019 | 25.7 | 7.3 | 0.9 | ||||||||||||||||||||||
| Total | $ | 484.0 | $ | 304.9 | $ | 122.3 | ||||||||||||||||||||
| (a) Net of any cash acquired and any purchase price adjustments. |
The majority of the goodwill resulting from the acquisition of the scientific imaging businesses will be deductible for tax purposes. Goodwill resulting from the acquisition of the gas and flame detection business and Micralyne will not be deductible for tax purposes.
See Note 15, Subsequent Events, to these Consolidated Financial Statements for information about the pending acquisition of FLIR.
Financing Activities
Financing activities for 2020 reflected net payments on debt of $98.1 million, compared with net proceeds from debt of $108.8 million in 2019 and net payments on debt of $306.5 million for 2018. Fiscal years 2020, 2019 and 2018 reflect proceeds from the exercise of stock options of $36.3 million, $34.6 million and $37.2 million, respectively.
Other Matters
Pension Plans
Effective January 1, 2020, Teledyne restructured its domestic qualified defined benefit pension plan. The restructuring involved dividing our domestic qualified defined pension plan into two separate plans, one comprised primarily of inactive participants (the “inactive plan”) and the other comprised primarily of active participants (the “active plan”). The reorganization was made to facilitate a targeted investment strategy over time and to provide additional flexibility in evaluating opportunities to reduce risk and volatility. Actuarial gains and losses associated with the active plan will continue to be amortized over the average remaining service period of the active participants, which is approximately nine years, while the actuarial gains and losses associated with the inactive plan will be amortized over the average remaining life expectancy of the inactive participants, which is approximately 17 years. These plans cover substantially all U.S. employees hired before January 1, 2004, or approximately 10% of Teledyne’s active employees as of January 3, 2021. As of January 1, 2004, new U.S. hires participate in a domestic defined contribution plan. In 2020, 2019 and 2018, Teledyne was not required, and did not make any cash contributions to the domestic pension plans. For the Company’s qualified defined benefit pension plans, the discount rate for 2021 will decrease to an average of 2.64% from 3.41% in 2020. 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 foreign 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 January 3, 2021, the amount of undistributed foreign earnings was $326.8 million, for which we have not recorded a deferred tax liability of approximately $1.4 million for 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 2016, United Kingdom income tax matters for all years through 2019, France income tax matters for all years through 2016 and Canadian income tax matters for all years through 2012.
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, and in British pounds for our U.K. companies. These contracts are designated and qualify as cash flow hedges. The Company has converted U.S. dollar denominated, variable rate and fixed rate debt obligations of a European subsidiary, into euro fixed rate obligations using a receive float, pay fixed cross currency swap, and a received fixed pay, fixed cross currency swap. These cross currency swaps are designated as cash flow hedges. In addition, the Company has converted domestic U.S. variable rate debt to fixed rate debt using a receive variable, pay fixed interest rate swap. The interest rate swap is also designated as a cash flow hedge.
The effectiveness of the cash flow hedge forward contracts, the cross currency swap hedges, and the interest rate swap cash flow hedge 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 forward 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 revenue in our consolidated statements of income. For the cross currency swap and interest rate cash flow hedges, effective amounts are recorded in AOCI, and reclassified into interest expense in the consolidated statements of income. In addition, for the cross currency swaps an amount is reclassified from AOCI to other income and expense each reporting period, to offset the earnings impact of the remeasurement of the hedged liabilities. Net deferred gains recorded in AOCI, net of tax, for forward contracts that will mature in the next 12 months total $5.4 million. These gains are expected to be offset by anticipated losses in the value of the forecasted underlying hedged item. Amounts related to the cross currency swaps and interest rate swap expected to be reclassified from AOCI into income in the coming 12 months total $1.2 million.
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, due to missed forecasts.
As of January 3, 2021, Teledyne had foreign currency forward contracts designated as cash flow hedges to buy Canadian dollars and to sell U.S. dollars totaling $127.5 million. These foreign currency forward contracts have maturities ranging from March 2020 to February 2021.
The cross currency swaps have notional amounts of €113.0 million and $125.0 million, and €135.0 million and $150.0 million, and mature in March 2023 and October 2024, respectively. The interest rate swap has a notional amount of $125.0 million and matures in March 2023.
In addition, the Company utilizes foreign currency forward contracts to mitigate foreign exchange rate risk associated with foreign currency denominated monetary assets and liabilities, including intercompany receivables and payables. As of January 3, 2021, Teledyne primarily 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 | $ | 78.0 | U.S. Dollars | US$ | 59.7 | |||||||||
| Euros | € | 36.2 | U.S. Dollars | US$ | 43.3 | |||||||||
| Great Britain Pounds | £ | 88.9 | U.S. Dollars | US$ | 119.1 | |||||||||
| Canadian Dollars | $ | 22.3 | Euros | € | 14.4 | |||||||||
| Danish Krone | Kr. | 302.3 | U.S. Dollars | US$ | 49.0 | |||||||||
These contracts had a positive fair value of $5.6 million at January 3, 2021. 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 January 3, 2021, 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 $12.7 million. A hypothetical 10 percent price change in the U.S. dollar from its value at January 3, 2021 would result in a decrease or increase in the fair value of our Euro/U.S. Dollar cross currency swaps designated as cash flow hedges by approximately $31.3 million. A hypothetical 100 basis point increase in U.S. interest rates at January 3, 2021 would result in an increase in the fair value of our U.S. Dollar interest rate swap designated as a cash flow hedge by approximately $2.6 million, while a 100 basis point decrease would result in a decrease in its fair value of $0.5 million.
Borrowings under our credit facility are at fixed rates that vary with the term and timing of each loan under the facility. Loans under the facility typically have terms of one, two, three or six months and the interest rate for each such loan is subject to change if the loan is continued or converted following the applicable maturity date. Interest rates are also subject to change based on our debt to earnings before interest, taxes, depreciation and amortization ratio. As of January 3, 2021, we had $125.0 million outstanding under our $750.0 million credit facility. Any borrowings under the Company’s credit facility 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.
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 $6.5 million and $6.0 million as of January 3, 2021 and December 29, 2019, respectively. 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 15 and Notes 2 and 14 of the Notes to Consolidated Financial Statements.
Government Contracts
We perform work on a number of contracts with the U.S. Department of Defense and other agencies and departments of the U.S. Government including sub-contracts with government prime contractors. Sales under these contracts with the U.S. Government, which included contracts with the U.S. Department of Defense, were approximately 26% of total net sales in 2020, 24% of total net sales in 2019 and 23% of total sales in 2018. For a summary of sales to the U.S. Government by segment, see Note 12 of the Notes to Consolidated Financial Statements. Sales to the U.S. Department of Defense represented approximately 19%, 17% and 17% of total net sales for 2020, 2019 and 2018, 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 11.
For information on accounts receivable from the U.S. Government, see Note 5 of the Notes to Consolidated Financial Statements.
Estimates and Reserves
Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an ongoing basis, we evaluate our estimates, including those related to product returns and replacements, allowance for doubtful accounts, inventories, intangible assets, income taxes, warranty obligations, pension and other postretirement benefits, long-term contracts, environmental, workers’ compensation and general liability, employee benefits and other contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances at the time, the results of which form the basis for making our judgments. Actual results may differ materially from these estimates under different assumptions or conditions. In some cases, such differences may be material. See also Critical Accounting Policies.
The following table reflects significant reserves and valuation accounts, which are estimates and based on judgments as described above, at January 3, 2021, and December 29, 2019:
| Reserves and Valuation Accounts (in millions): (a) | 2020 | 2019 | ||||||||||||
| Allowance for doubtful accounts | $ | 12.3 | $ | 10.2 | ||||||||||
| Reduction to LIFO cost basis | $ | 6.7 | $ | 7.8 | ||||||||||
| Workers’ compensation and general liability reserves (b) | $ | 6.2 | $ | 6.5 | ||||||||||
| Environmental reserves (b) | $ | 6.5 | $ | 6.0 | ||||||||||
| Other accrued liability reserves (b) | $ | 12.9 | $ | 16.0 |
(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): | 2020 | 2019 | 2018 | |||||||||||||||||
| Balance at beginning of year | $ | 24.8 | $ | 21.0 | $ | 21.1 | ||||||||||||||
| Product warranty expense | 3.3 | 13.1 | 10.0 | |||||||||||||||||
| Deductions | (8.2) | (14.2) | (10.1) | |||||||||||||||||
| Acquisitions | 2.5 | 4.9 | — | |||||||||||||||||
| Balance at year-end | $ | 22.4 | $ | 24.8 | $ | 21.0 |
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 acquired intangible assets; and accounting for income taxes. For additional discussion of the application of these and other accounting policies, see Note 2 of the Notes to Consolidated Financial Statements.
Revenue Recognition
Approximately 40% of our revenue is recognized over time with the remaining 60% of our revenue recognized at a point in time.
Revenue recognized over time relates primarily to contracts to design, develop and/or manufacture highly engineered products used in both defense and commercial applications. 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. 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.
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, determining reasonably dependable cost estimates, and making assumptions for schedule and technical issues. 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.
We do not believe that any discrete event or adjustment to an individual contract within the aggregate changes in contract estimates for 2020, 2019 or 2018 was material to the consolidated statements of income for such annual periods.
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. See Note 2 of the Notes to Consolidated Financial Statements for additional revenue recognition disclosures.
Pension Plans
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. For our plan which covers mostly inactive participants, gains and losses subject to amortization are amortized over the average participants future life expectancy which is approximately 17 years. This plan represents the majority of the pension obligations. For our other plan, gains and losses subject to amortization are amortized over the average employee future service period which is 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.
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 2020 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 | $ | (0.3) | $ | 0.3 | ||||||||||
| Change in long-term rate of return on plan assets | $ | (2.1) | $ | 2.1 |
See Note 11 of the 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, often 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.
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 a quantitative test for each reporting unit at least once every three years.
For goodwill impairment testing using the quantitative approach, the Company estimates the fair value of the selected reporting units primarily through the use of 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.
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.
As of January 3, 2021, the Company had nine reporting units for goodwill impairment testing. The carrying value of goodwill included in the Company’s individual reporting units ranged from $20.4 million to $885.0 million on the quantitative test date. The Company’s analysis in 2020 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 the Company’s reporting units subject to a quantitative test as of the fourth quarter of 2020, the annual testing date, exceeded at least 116%.
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.
An increase of 100 basis points in our nominal tax rate would have resulted in additional income tax provision for the fiscal year ended January 3, 2021, of $4.7 million. For a description of the Company’s tax accounting policies, refer to Note 2 and Note 10 of the Notes to Consolidated Financial Statements.
Recent Accounting Standards
For a discussion of recent accounting standards see Note 2 of the 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. Forward-looking statements involve risks and uncertainties, are based on the current expectations of the management of Teledyne and are subject to uncertainty and changes in circumstances. The forward-looking statements contained herein may include statements about the expected effects on Teledyne of the proposed acquisition of FLIR, the anticipated timing and scope of the proposed transaction, anticipated
earnings enhancements, estimated cost savings and other synergies related to the proposed transaction, costs to be incurred in achieving synergies, anticipated capital expenditures and product developments, and other strategic options. 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: ongoing challenges and uncertainties posed by the COVID-19 pandemic for businesses and governments around the world; the occurrence of any event, change or other circumstances that could give rise to the right of Teledyne or FLIR or both to terminate the merger agreement; the outcome of any legal proceedings that may be instituted against Teledyne or FLIR in connection with the merger agreement; the failure to obtain necessary regulatory approvals (and the risk that such approvals may result in the imposition of conditions that could adversely affect the combined company or the expected benefits of the transaction) or stockholder approvals or to satisfy any of the other conditions to the proposed transaction on a timely basis or at all; the failure to obtain the debt portion of the financing for the proposed transaction; the inability to complete the acquisition and integration of FLIR successfully, to retain customers and key employees and to achieve operating synergies, including the possibility that the anticipated benefits of the proposed transaction are not realized when expected or at all, including as a result of the impact of, or problems arising from, the integration of the two companies or as a result of the strength of the economy and competitive factors in the areas where Teledyne and FLIR do business; the possibility that the proposed transaction may be more expensive to complete than anticipated, including as a result of unexpected factors or events; the parties’ ability to meet expectations regarding the timing, completion and accounting and tax treatments of the proposed transaction; changes in relevant tax and other laws; the inability to develop and market new competitive products; inherent uncertainties involved in the estimates and judgments used in the preparation of financial statements and the providing of estimates of financial measures, in accordance with U.S. GAAP and related standards; operating results of FLIR being lower than anticipated; disruptions in the global economy; the spread of the COVID-19 virus resulting in production, supply, contractual and other disruptions, including facility closures and furloughs and travel restrictions; customer and supplier bankruptcies; 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 or changes to U.S. and foreign government spending and budget priorities triggered by the COVID-19 pandemic; impacts from the United Kingdom’s exit from the European Union; uncertainties related to the policies of the new U.S. Presidential Administration; the imposition and expansion of, and responses to, trade sanctions and tariffs; escalating economic and diplomatic tension between China and the United States; 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. Disruptions from the production delay of Boeing’s 737 Max aircraft and continued weakness in the commercial aerospace industry will negatively affect the markets of our commercial aviation businesses. In addition, financial market fluctuations affect the value of the Company's 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 5 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.
Additional Information and Where to Find It
In connection with the proposed transaction between Teledyne and FLIR, Teledyne will file with the SEC a Registration Statement on Form S-4 that will include a joint proxy statement of Teledyne and FLIR and a prospectus of Teledyne, as well as other relevant documents concerning the proposed transaction. The proposed transaction involving Teledyne and FLIR will be submitted to Teledyne’s stockholders and FLIR’s stockholders for their consideration. Stockholders of Teledyne and stockholders of FLIR are urged to read the registration statement and the joint proxy statement/prospectus regarding the
transaction when they become available and any other relevant documents filed with the SEC, as well as any amendments or supplements to those documents, because they will contain important information.
Stockholders will be able to obtain a free copy of the definitive joint proxy statement/prospectus, as well as other filings containing information about Teledyne and FLIR, without charge, at the SEC’s website (http://www.sec.gov). Copies of the joint proxy statement/prospectus and the filings with the SEC that will be incorporated by reference in the joint proxy statement/prospectus can also be obtained, without charge, by directing a request to Teledyne, Attn: Investor Relations, 1049 Camino Dos Rios, Thousand Oaks, California 91360, or to FLIR, Attn: Corporate Secretary, 1201 S Joyce St, Arlington, Virginia 22202.
Participants in the Solicitation
Teledyne, FLIR and certain of their respective directors, executive officers and employees may be deemed to be participants in the solicitation of proxies in connection with the proposed transaction. Information regarding Teledyne’s directors and executive officers will be available in its definitive proxy statement for its 2021 Annual Meeting, which is expected to be filed with the SEC on or about March 8, 2021, and this Annual Report on Form 10-K. Information regarding FLIR’s directors and executive officers is available in its Annual Report on Form 10-K for the year ended December 31, 2020, which was filed on February 25, 2021. Other information regarding the participants in the proxy solicitation and a description of their direct and indirect interests, by security holdings or otherwise, will be contained in the joint proxy statement/prospectus and other relevant materials filed with the SEC. Free copies of this document may be obtained as described in the preceding paragraph.
No Offer or Solicitation
This communication shall not constitute an offer to sell or the solicitation of an offer to sell or an offer to buy any securities, nor shall there be any sale of securities in any jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such jurisdiction. No offer of securities shall be made except by means of a prospectus meeting the requirements of Section 10 of the Securities Act of 1933.
| Item 7A. Quantitative and Qualitative Disclosures About Market Risk |
The information required by this item is included in this Report on page 34 under the caption “Other Matters - Hedging Activities; Market Risk Disclosures” of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.”
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