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TELEDYNE TECHNOLOGIES INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Teledyne Technologies Incorporated provides enabling technologies for industrial growth markets. We have evolved from a company that was primarily focused on aerospace and defense to one that serves multiple markets that require advanced technology and high reliability. These markets include deepwater oil and gas exploration and production, oceanographic research, air and water quality environmental monitoring, factory automation and medical imaging. Our products include monitoring instrumentation for marine and environmental applications, harsh environment interconnects, electronic test and measurement equipment, digital imaging sensors and cameras, aircraft information management systems, and defense electronic and satellite communication subsystems. We also supply engineered systems for defense, space, environmental and energy applications. We differentiate ourselves from many of our direct competitors by having a customer and company sponsored applied research center that augments our product development expertise. Strategy/Overview Our strategy continues to emphasize growth in our core markets of instrumentation, digital imaging, aerospace and defense electronics and engineered systems. Our core markets are characterized by high barriers to entry and include specialized products and services not likely to be commoditized. We intend to strengthen and expand our core businesses with targeted acquisitions and through product development. We aggressively pursue operational excellence to continually improve our margins and earnings. At Teledyne, operational excellence includes the rapid integration of the businesses we acquire. Using complementary technology across our businesses and internal research and development, we seek to create new products to grow our company and expand our addressable markets. We continue to evaluate our businesses to ensure that they are aligned with our strategy. Consistent with this strategy, we made five acquisitions in 2012 and three acquisitions in 2011, as well as one significant divestiture in 2011. Our largest acquisition in 2012, LeCroy Corporation ("LeCroy"), broadened our portfolio of analytical instrumentation with the addition of electronic test and measurement solutions. We acquired VariSystems Inc. ("VariSystems") to expand our portfolio of rugged interconnect solutions. We acquired BlueView Technologies, Inc. ("BlueView") principally to increase our instrumentation content on AUVs and ROVs used in oil and gas and marine survey applications. Through the acquisition of a majority interest in the parent company of Optech Incorporated ("Optech"), we added 3D imaging capability to our portfolio of visible, X-ray and ultraviolet sensors, cameras, Optech's bathymetric LIDAR systems used for coastal mapping and shallow water profiling also complement our marine survey sensors and systems. The acquisition of the parent company of PDM Neptec Limited ("PDM Neptec") expanded our line of harsh environmental marine connectors. In 2011, we focused on the expansion of our digital imaging capabilities first with the acquisition of DALSA Corporation ("DALSA"), followed by the acquisitions of a majority interest in Nova Sensors, Inc. ("Nova Sensors") and a minority interest investment in Optech. In 26-------------------------------------------------------------------------------- Table of Contents April 2011, we completed the sale of our general aviation piston engine businesses and consequently classified our Aerospace Engines and Components segment as a discontinued operation. Given the strength of our commercial businesses, as well as our strategic acquisitions, we were able to achieve record sales and earnings in 2012. In 2012, sales and net income from continuing operations increased by 9.5% and 13.9%, respectively over 2011 results. Earnings per share from continuing operations in 2012 increased 13.6% over 2011. In 2012, sales totaled $2,127.3 million, compared with sales of $1,941.9 million in 2011. Net income for 2012, excluding our discontinued operations, was $161.8 million or $4.33 per diluted share, compared with $142.1 million or $3.81 per diluted share in 2011. The increase in revenue included incremental sales from acquisitions of $180.7 million. Our 2012 net income including discontinued operations totaled $164.1 million or $4.39 per diluted share, compared to $255.2 million or $6.84 per diluted share in 2011. In addition, each business segment experienced higher operating profit growth except for the Aerospace and Defense Electronics segment. The operating profit decrease for the Aerospace and Defense Electronics segment primarily reflected the impact of lower sales, as well as $1.7 million of severance and relocation costs, within certain electronic manufacturing service products businesses. With the recent acquisition of LeCroy in 2012 and DALSA in 2011, as well as growth in our commercial markets, our business mix has continued to change, and for 2012, Teledyne's sales were approximately 68% to commercial customers and 32% to the U.S. Government. This has changed from about 56% commercial and 44% government in 2010. Our international sales also increased to 39% of total sales in 2012, compared to 29% in 2010. We have worked to transform our product portfolio into that of a high technology industrial company that is less dependent on U.S. Government business. Recent Acquisitions The Company spent $389.2 million, $366.7 million and $67.9 million on acquisitions in 2012, 2011 and 2010, respectively. On August 3, 2012, Teledyne acquired the stock of LeCroy for $301.3 million, net of cash acquired. LeCroy, headquartered in Chestnut Ridge, New York is a leading supplier of oscilloscopes, protocol analyzers and signal integrity test solutions. LeCroy had sales of $178.1 million for its fiscal year ended June 30, 2011 and is part of the Instrumentation segment. Also on August 3, 2012, a subsidiary of Teledyne acquired the parent company of PDM Neptec for $7.4 million in cash, net of cash acquired. PDM Neptec, located in Hampshire, United Kingdom, is part of the Instrumentation segment and operates as Teledyne Impulse-PDM Ltd. PDM Neptec had sales of GBP 5.5 million for its fiscal year ended March 31, 2012. On July 2, 2012, a subsidiary of Teledyne acquired BlueView for $16.3 million in cash, net of cash acquired. BlueView, located in Seattle, Washington, is part of the Instrumentation segment and operates as Teledyne BlueView, Inc. BlueView had sales of $7.1 million for its fiscal year ended December 31, 2011. On April 2, 2012, Teledyne acquired a majority interest in the parent company of Optech for $27.9 million, net of cash acquired. The purchase increased Teledyne's ownership percentage to 51 percent from the original 19 percent interest purchased in the first quarter of 2011. With the April 2012 purchase, we now consolidate Optech's financial results into Teledyne's results with an appropriate adjustment for the minority ownership. Optech had sales of CAD $54.7 million for its fiscal year ended March 30, 2012 and is reported as part of the Digital Imaging segment. On February 25, 2012, Teledyne acquired VariSystems for $34.9 million, net of cash acquired. Teledyne paid a $1.4 million purchase price adjustment in the second quarter of 2012. VariSystems, headquartered in Calgary, Alberta, Canada, is a leading supplier of custom harsh environment interconnects used in energy exploration and production. VariSystems had sales of CAD $27.5 million for its fiscal year ended May 31, 2011 and is part of the Aerospace and Defense Electronics segment. In 2011, the Company acquired the stock of DALSA for an aggregate purchase price of $339.5 million in cash. DALSA designs and manufactures digital imaging products, primarily consisting of high performance sensors, cameras and software for use in industrial, scientific, medical and professional applications products, as well as specialty semiconductors and micro electro mechanical systems ("MEMS"). In addition to the acquisition of DALSA in 2011, the Company completed the acquisition of a majority interest in Nova Sensors for total consideration of $5.1 million in cash and a minority interest in Optech for $18.9 million. Nova Sensors produces compact short-wave and mid-wave infrared cameras and operates within the Digital Imaging segment. Optech is a laser-based survey and digital imaging company. We also bought the remaining minority interest in Energy Systems for $3.2 million in 2011. In 2010, Teledyne acquired Intelek plc ("Intelek") for $43.5 million in cash. Intelek primarily designs and manufactures electronic systems for satellite and microwave communications and aerospace manufacturing. In 2010, Teledyne also acquired Optimum Optical Systems Inc. ("Optimum"), a designer and manufacturer of custom optics and optomechanical assemblies and Hafmynd ehf. ("Gavia"), a designer and manufacturer of the Gavia™ autonomous underwater vehicle. See Note 3 to our Consolidated Financial Statements for additional information about our recent acquisitions. See also Note 17 to our Consolidated Financial Statements for information about our fiscal year 2013 pending acquisition of RESON A/S ("RESON"). 27-------------------------------------------------------------------------------- Table of Contents Our fiscal year is determined based on a 52- or 53-week convention ending on the Sunday nearest to December 31. Fiscal years 2012, 2011 and 2010 each contained 52 weeks. The following is our financial information for 2012, 2011 and 2010 (in millions, except per-share amounts): 2012 2011 2010 Sales $ 2,127.3 $ 1,941.9 $ 1,644.2 Costs and Expenses Cost of sales 1,379.1 1,290.7 1,148.1 Selling, general and administrative expenses 505.1 424.0 317.6 Total costs and expenses 1,884.2 1,714.7 1,465.7 Income before other income and expense and income taxes 243.1 227.2 178.5 Interest and debt expense, net (17.8 ) (16.2 ) (6.5 ) Other income, net 2.9 0.6 1.6 Income from continuing operations before income taxes 228.2 211.6 173.6 Provision for income taxes(a) 65.4 69.5 53.6 Net income from continuing operations including noncontrolling interest 162.8 142.1 120.0 Discontinued operations, net of income taxes 2.3 113.1 0.6 Net income 165.1 255.2 120.6 Less: net income attributable to noncontrolling interest (1.0 ) - (0.1 ) Net income attributable to Teledyne $ 164.1 $ 255.2 $ 120.5 Net income from continuing operations including noncontrolling interest $ 162.8 $ 142.1 $ 120.0 Less: net income attributable to noncontrolling interest (1.0 ) - (0.1 ) Net income from continuing operations 161.8 142.1 119.9 Discontinued operations, net of income taxes 2.3 113.1 0.6 Net income attributable to Teledyne $ 164.1 $ 255.2 $ 120.5 Basic earnings per common share: Continuing operations $ 4.41 $ 3.88 $ 3.31 Discontinued operations 0.06 3.09 0.02 Basic earnings per common share: $ 4.47 $ 6.97 $ 3.33 Diluted earnings per common share: Continuing operations $ 4.33 $ 3.81 $ 3.25 Discontinued operations 0.06 3.03 0.02 Diluted earnings per common share $ 4.39 $ 6.84 $ 3.27 (a) Fiscal years 2012, 2011 and 2010 include net tax benefits of $5.4 million, $2.4 million and $12.5 million, respectively. Our businesses are divided into 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 2012, 2011 and 2010 are summarized in the following table: Percentage of Sales Segment 2012 2011 2010 Instrumentation 35 % 32 % 35 % Digital Imaging 20 18 8 Aerospace and Defense Electronics 31 34 37 Engineered Systems 14 16 20 100 % 100 % 100 % 28-------------------------------------------------------------------------------- Table of Contents Results of Operations 2012 Compared with 2011 % Sales 2012 2011 Change (in millions) Instrumentation $ 749.4 $ 616.6 21.5 % Digital Imaging 415.9 349.9 18.9 % Aerospace and Defense Electronics 660.6 670.8 (1.5 )% Engineered Systems 301.4 304.6 (1.1 )% Total sales $ 2,127.3 $ 1,941.9 9.5 % % Operating profit and other segment income 2012 2011 Change (in millions) Instrumentation $ 136.2 $ 122.8 10.9 % Digital Imaging 24.8 16.1 54.0 % Aerospace and Defense Electronics 90.3 93.9 (3.8 )% Engineered Systems 28.5 28.1 1.4 % Segment operating profit and other segment income 279.8 260.9 7.2 % Corporate expense (36.7 ) (33.7 ) 8.9 % Interest and debt expense, net (17.8 ) (16.2 ) 9.9 % Other income, net 2.9 0.6 * Income from continuing operations before income taxes 228.2 211.6 7.8 % Provision for income taxes(a) 65.4 69.5 (5.9 )% Net income from continuing operations including noncontrolling interest 162.8 142.1 14.6 % Discontinued operations, net of income taxes 2.3 113.1 * Net income 165.1 255.2 (35.3 )% Less: net income attributable to noncontrolling interest (1.0 ) - * Net income attributable to Teledyne $ 164.1 $ 255.2 (35.7 )% * not meaningful (a) Fiscal years 2012 and 2011 include net tax benefits of $5.4 million and $2.4 million, respectively, primarily related to the remeasurement of uncertain tax positions and an expiration of the statute of limitations in the United States. We reported 2012 sales of $2,127.3 million, compared with sales of $1,941.9 million for 2011, an increase of 9.5%. Net income from continuing operations was $161.8 million ($4.33 per diluted share) for 2012, compared with net income from continuing operations of $142.1 million ($3.81 per diluted share) for 2011, an increase of 13.9%. Net income for 2012 and 2011 also included net tax credits of $5.4 million and $2.4 million, respectively. Net income attributable to Teledyne, including discontinued operations, was $164.1 million ($4.39 per diluted share) for 2012, compared with $255.2 million ($6.84 per diluted share) for 2011. On April 19, 2011, Teledyne completed the sale of its piston engines businesses and recorded a gain on the sale of $113.8 million. The increase in sales in 2012, compared with 2011, reflected substantially higher sales in both the Instrumentation and Digital Imaging segments, partially offset by slightly lower sales in both the Engineered Systems and Aerospace and Defense Electronics segments. Sales in the Instrumentation segment reflected $80.8 million from the acquisition of LeCroy, as well as, higher sales of both marine and environmental instrumentation products. Sales of marine products increased by $45.6 million or 12.2% and included incremental sales of $8.0 million from the acquisitions of PDM and BlueView. The increase in the Digital Imaging segment reflected $66.9 million in incremental revenue from recent acquisitions, primarily Optech, Nova Sensors and DALSA. Sales in the Aerospace and Defense Electronics segment reflected lower sales for electronic manufacturing service products partially offset by higher sales of $12.4 million from avionics products and electronic relays, as well as greater sales of $15.3 million from microwave devices and interconnects. Microwave devices and interconnects sales in 2012 included $25.0 million in revenue from the February 2012 acquisition of VariSystems. The decrease in the Engineered Systems segment revenue reflected lower sales of space and defense programs as well as nuclear programs, partially offset by higher sales of energy systems and turbine engines. 29-------------------------------------------------------------------------------- Table of Contents The incremental increase in revenue in 2012 from businesses acquired in 2012 and in 2011 was $180.7 million. The increase in segment operating profit and other segment income for 2012, compared with 2011, reflected improved results in each operating segment except for the Aerospace and Defense Electronics segment. The increase in operating profit primarily reflected the impact of acquisitions. The increase in operating profit also reflected the impact of higher sales for the Instrumentation segment. The decrease in operating profit in the Aerospace and Defense Electronics segment reflected the impact of lower sales, reduced margins, as well as $1.7 million of severance and relocation costs, within certain electronic manufacturing service products businesses. Operating profit included incremental operating profit from acquisitions of $9.4 million, which included acquisition expenses of $7.1 million and intangible amortization of $5.3 million. LIFO income was less than $0.1 million in 2012 compared with LIFO expense of $0.9 million in 2011. The table below presents sales and cost of sales by segment and total company: (Dollars in millions) 2012 2011 Change Instrumentation Sales $ 749.4 $ 616.6 $ 132.8 Cost of sales $ 422.3 $ 354.2 $ 68.1 Cost of sales % of sales 56.4 % 57.4 % Digital Imaging Sales $ 415.9 $ 349.9 $ 66.0 Cost of sales $ 266.9 $ 231.5 $ 35.4 Cost of sales % of sales 64.2 % 66.2 % Aerospace and Defense Electronics Sales $ 660.6 $ 670.8 $ (10.2 ) Cost of sales $ 442.6 $ 458.0 $ (15.4 ) Cost of sales % of sales 67.0 % 68.3 % Engineered Systems Sales $ 301.4 $ 304.6 $ (3.2 ) Cost of sales $ 247.3 $ 247.0 $ 0.3 Cost of sales % of sales 82.1 % 81.1 % Total Company Sales $ 2,127.3 $ 1,941.9 $ 185.4 Cost of sales $ 1,379.1 $ 1,290.7 $ 88.4 Cost of sales % of sales 64.8 % 66.5 % Consolidated cost of sales in total dollars increased by $88.4 million in 2012, compared with 2011, and primarily reflected $94.2 million in cost of sales from recent acquisitions and organic sales increases, partially offset by sales mix differences. Cost of sales from recent acquisitions totaled $37.7 million for the Instrumentation segment, $39.9 million for the Digital Imaging segment and $16.6 million for the Aerospace and Defense Electronics segment. The Instrumentation segment cost of sales increase reflected the impact of higher organic sales. The Aerospace and Defense Electronics segment reflected the impact of lower organic sales. Cost of sales as a percentage of sales for 2012 was 64.8%, compared with 66.5% for 2011. The lower cost of sales percentage reflected the impact of the LeCroy and DALSA cost structure which has a lower cost of sales percentage than the overall Teledyne cost of sales percentage. Excluding the impact of recent acquisitions, cost of sales as a percentage of sales for 2012 would have been 66.7%. Selling, general and administrative expenses, including research and development and bid and proposal expense, in total dollars were higher in 2012 compared with 2011. The increase reflected the impact of higher sales, higher acquired intangible asset amortization of $3.7 million and higher research and development costs of $28.8 million. Corporate administrative expense in 2012 was higher by $3.0 million compared with 2011 and reflected higher employee compensation and professional fee expenses. For 2012, we recorded a total of $8.0 million in stock option expense, of which $2.4 million was recorded as corporate expense and $5.6 million was recorded in segment results. For 2011, we recorded a total of $5.8 million in stock option expense, of which $2.1 million was recorded as corporate expense and $3.7 million was recorded in segment results. Selling, general and administrative expenses for 2012, as a percentage of sales, increased to 23.7%, compared with 21.8% for 2011 and reflected the impact of acquisition related expenses, higher research and development costs and the LeCroy and DALSA cost structures which have a higher selling, general and 30-------------------------------------------------------------------------------- Table of Contents administrative expense percentage than the overall Teledyne selling, general and administrative expense percentage. Included in operating profit in 2012 was domestic pension expense of $6.6 million. In accordance with U.S. Government Cost Accounting Standards ("CAS"), $12.7 million was recoverable from certain government contracts. Included in operating profit in 2011 was domestic pension expense of $6.7 million. In accordance with CAS, $12.6 million was recoverable from certain government contracts. Pension expense determined under CAS can generally be recovered through the pricing of products and services sold to the U.S. Government. The Company's effective tax rate for 2012 was 28.7%, compared with 32.9% for 2011. The decrease reflected a remeasurement of uncertain tax positions in 2012, as well as a change in the proportion of domestic and international income. Fiscal year 2012 included tax benefits of $5.4 million primarily related to the remeasurement of uncertain tax positions and an expiration of the statute of limitations in the United States. Fiscal year 2011 included tax benefits of $2.4 million related to research and development tax credits. Excluding the impact of the $5.4 million for 2012 and $2.4 million for 2011 the effective tax rates would have been 31.0% for 2012, compared with 34.0% for 2011. During the next twelve months, it is reasonably possible that tax audit resolutions and expirations of the statutes of limitations could reduce unrecognized tax benefits by $13.7 million, either because our tax positions are sustained on audit, because the Company agrees to their disallowance, or because of the expiration of the statutes of limitations. Of the $13.7 million, $0.4 million would not impact tax expense as it would be offset by the reversal of deferred tax assets. Sales under contracts with the U.S. Government were approximately 32% of sales in 2012 and 36% of sales in 2011. Sales to international customers represented approximately 39% of sales in 2012 and 36% of sales in 2011. Total interest expense, including credit facility fees and other bank charges, was $18.2 million in 2012 and $16.7 million in 2011. Interest income was $0.4 million in 2012 and $0.5 million in 2011. The increase in interest expense primarily reflected the impact of higher outstanding debt levels partially offset by lower overall average interest rates. Other income and expense in 2012 included foreign currency translation gains of $0.8 million, compared with $2.0 million for 2011 and a $0.6 million gain on the purchase of the majority interest in Optech. Other income and expense in 2011 also included $2.3 million related to the reduction of an environmental reserve determined to be no longer needed and a $4.5 million pretax charge to write off a minority investment in a private company. 31-------------------------------------------------------------------------------- Table of Contents 2011 Compared with 2010 % Sales 2011 2010 Change (in millions) Instrumentation $ 616.6 $ 573.2 7.6 % Digital Imaging 349.9 122.5 185.6 % Aerospace and Defense Electronics 670.8 614.7 9.1 % Engineered Systems 304.6 333.8 (8.7 )% Total sales $ 1,941.9 $ 1,644.2 18.1 % % Operating profit and other segment income 2011 2010 Change (in millions) Instrumentation $ 122.8 $ 113.9 7.8 % Digital Imaging 16.1 5.2 209.6 % Aerospace and Defense Electronics 93.9 57.8 62.5 % Engineered Systems 28.1 30.4 (7.6 )% Segment operating profit and other segment income 260.9 207.3 25.9 % Corporate expense (33.7 ) (28.8 ) 17.0 % Interest and debt expense, net (16.2 ) (6.5 ) 149.2 % Other income, net 0.6 1.6 (62.5 )% Income from continuing operations before income taxes 211.6 173.6 21.9 % Provision for income taxes(a) 69.5 53.6 29.7 % Net income from continuing operations including noncontrolling interest 142.1 120.0 18.4 % Discontinued operations, net of income taxes 113.1 0.6 * Net income 255.2 120.6 111.6 % Less: Net income attributable to noncontrolling interest - (0.1 ) * Net income attributable to Teledyne $ 255.2 $ 120.5 111.8 % * not meaningful (a) Fiscal years 2011 and 2010 include net tax benefits of $2.4 million and $12.5 million, respectively. We reported 2011 sales of $1,941.9 million, compared with sales of $1,644.2 million for 2010, an increase of 18.1%. Net income attributable to Teledyne was $255.2 million ($6.84 per diluted share) for 2011, compared with $120.5 million ($3.27 per diluted share) for 2010, an increase of 111.8%. Net income attributable to Teledyne, excluding discontinued operations, was $142.1 million ($3.81 per diluted share) for 2011, compared with $119.9 million ($3.25 per diluted share) for 2010, an increase of 18.4%. The increase in sales in 2011, compared with 2010, reflected higher sales in each business segment except the Engineered Systems segment. Sales in the Instrumentation segment reflected higher sales of marine and environmental instrumentation products by over 5% and 10%, respectively. Sales of marine products included incremental sales of $3.7 million from the 2010 acquisition of Gavia. Sales in the Aerospace and Defense Electronics segment reflected higher sales of microwave devices and interconnects, as well as, incremental sales of $25.7 million from the 2010 acquisition of Intelek. The increase in the Digital Imaging segment included $214.0 million in revenue from recent acquisitions, primarily the February 2011 acquisition of DALSA, as well as higher organic sales. The decrease in the Engineered Systems segment revenue reflected lower sales of missile defense engineering services, lower sales from NASA programs, lower sales of gas centrifuge service modules and lower sales related to the Joint Air-to-Surface Standoff Missile ("JASSM") turbine engine program partially offset by incremental sales of $6.2 million from a recent acquisition. The incremental increase in revenue in 2011 from businesses acquired in 2011 and in 2010 was $249.6 million. The increase in segment operating profit and other segment income for 2011, compared with 2010, reflected improved results in each operating segment except for the Engineered Systems segment. The increase in operating profit reflected the impact of acquisitions as well as improved margins in each operating segment. The increase in operating profit in the Instrumentation segment, Aerospace and Defense Electronics segment and the Digital Imaging segment reflected the impact of higher sales. Operating profit in the Aerospace and Defense Electronics segment in 2010 reflected charges of $8.2 million, primarily to correct inventory valuations incorrectly recorded in previous periods at a business 32-------------------------------------------------------------------------------- Table of Contents unit. The decrease in operating profit in the Engineered Systems segment reflected the impact of lower sales, partially offset by lower pension expense and higher margins. Operating profit included incremental operating profit from acquisitions of $18.6 million, which included acquisition expenses of $2.0 million and intangible amortization of $10.3 million. Segment operating profit in 2011 also reflected LIFO expense of $0.9 million compared with LIFO expense of $0.8 million in 2010. The table below presents sales and cost of sales by segment and total company: (Dollars in millions) 2011 2010 Change Instrumentation Sales $ 616.6 $ 573.2 $ 43.4 Cost of sales $ 354.2 $ 332.4 $ 21.8 Cost of sales % of sales 57.4 % 58.0 % Digital Imaging Sales $ 349.9 $ 122.5 $ 227.4 Cost of sales $ 231.5 $ 91.3 $ 140.2 Cost of sales % of sales 66.2 % 74.5 % Aerospace and Defense Electronics Sales $ 670.8 $ 614.7 $ 56.1 Cost of sales $ 458.0 $ 451.9 $ 6.1 Cost of sales % of sales 68.3 % 73.5 % Engineered Systems Sales $ 304.6 $ 333.8 $ (29.2 ) Cost of sales $ 247.0 $ 272.5 $ (25.5 ) Cost of sales % of sales 81.1 % 81.6 % Total Company Sales $ 1,941.9 $ 1,644.2 $ 297.7 Cost of sales $ 1,290.7 $ 1,148.1 $ 142.6 Cost of sales % of sales 66.5 % 69.8 % Consolidated cost of sales in total dollars increased by $142.6 million in 2011, compared with 2010, and primarily reflected $123.5 million in cost of sales from the DALSA acquisition which is included in the Digital Imaging segment and the impact of higher sales primarily in the Instrumentation and Aerospace and Defense Electronics segments and lower sales in the Engineered Systems segment. Also, cost of sales in 2010 included an $8.2 million inventory write-down in the Aerospace and Defense Electronics segment. Cost of sales as a percentage of sales for 2011 was 66.5%, compared with 69.8% for 2010. The lower cost of sales percentage reflected the impact of the DALSA cost structure which has a lower cost of sales percentage than the overall Teledyne cost of sales percentage and other sales mix changes as well as cost reductions partially offset by the impact of the $8.2 million inventory write-down. Excluding the impact of the DALSA acquisition, cost of sales as a percentage of sales for 2011 would have been 67.3%. The remaining 2.5% decrease in the cost of sales percentage was primarily the result of a lower cost of sales percentage for the Aerospace and Defense Electronics segment due to cost reductions, product mix and lower pension expense. Selling, general and administrative expenses, including research and development and bid and proposal expense, in total dollars were higher in 2011 compared with 2010. The increase reflected the impact of higher sales, higher acquired intangible asset amortization of $9.7 million and higher research and development costs of $41.4 million. Corporate administrative expense in 2011 was higher by $4.9 million compared with 2010 and reflected higher employee compensation and professional fee expenses. For 2011, we recorded a total of $5.8 million in stock option expense, of which $2.1 million was recorded as corporate expense and $3.7 million was recorded in segment results. For 2010, we recorded a total of $4.7 million in stock option expense, of which $1.7 million was recorded as corporate expense and $3.0 million was recorded in segment results. Selling, general and administrative expenses for 2011, as a percentage of sales, increased to 21.8%, compared with 19.3% for 2010 and reflected the impact of acquisition related expenses, higher research and development costs and the DALSA cost structure which has a higher selling, general and administrative expense percentage than the overall Teledyne selling, general and administrative expense percentage. 33-------------------------------------------------------------------------------- Table of Contents Included in operating profit in 2011 was domestic pension expense of $6.7 million. In accordance with CAS, $12.6 million was recoverable from certain government contracts. Included in operating profit in 2010 was domestic pension expense of $4.8 million. In accordance with CAS, $9.6 million was recoverable from certain government contracts. The Company's effective tax rate for 2011 was 32.9%, compared with 30.9% for 2010. Fiscal years 2011 and 2010 included net tax credits of $2.4 million and $12.5 million, respectively, which were primarily research and development tax credits. Excluding the net tax credits, the effective tax rates for 2011 and 2010, would have been 34.0% and 38.1%, respectively. Sales under contracts with the U.S. Government were approximately 36% of sales in 2011 and 44% of sales in 2010. Sales to international customers represented approximately 36% of sales in 2011 and 29% of sales in 2010. Total interest expense, including credit facility fees and other bank charges, was $16.7 million in 2011 and $6.9 million in 2010. Interest income was $0.5 million in 2011 and $0.4 million in 2010. The increase in interest expense primarily reflected the impact of higher outstanding debt levels and higher overall average interest rates from our new credit facility and our senior notes. Other income in 2011 included income of $2.3 million related to the reduction of an environmental reserve determined to be no longer needed and a $4.5 million pretax charge to write off the Company's minority investment in a private company. Other income in 2011 and in 2010 each included an insurance benefit of $1.0 million. Segments The following discussion of our four segments should be read in conjunction with Note 13 to the Notes to Consolidated Financial Statements. Instrumentation (Dollars in millions) 2012 2011 2010 Sales $ 749.4 $ 616.6 $ 573.2 Cost of sales $ 422.3 $ 354.2 $ 332.4 Selling, general and administrative expenses $ 190.9 $ 139.6 $ 126.9 Operating profit $ 136.2 $ 122.8 $ 113.9 Cost of sales % of sales 56.4 % 57.4 % 58.0 % Selling, general and administrative expenses % of sales 25.4 % 22.7 % 22.1 % Operating profit % of sales 18.2 % 19.9 % 19.9 % International sales % of sales 56.0 % 52.4 % 52.3 % Governmental sales % of sales 5.3 % 6.3 % 6.2 % Capital expenditures $ 13.2 $ 8.9 $ 6.4 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. 2012 compared with 2011 Our Instrumentation segment sales were $749.4 million in 2012, compared with sales of $616.6 million in 2011, an increase of 21.5%. Operating profit was $136.2 million in 2012, compared with $122.8 million in 2011, an increase of 10.9%. The 2012 sales change resulted primarily from higher sales of marine instrumentation, test and measurement instrumentation, and environmental instrumentation. The higher sales of $45.6 million for marine instrumentation products reflected increased sales of interconnect systems used in offshore energy production and also included a total of $8.0 million in revenue from the acquisitions of PDM Neptec and BlueView. Increased sales of $80.8 million for test and measurement instrumentation resulted from the acquisition of LeCroy. The increase in sales of $6.4 million for environmental instrumentation primarily reflected higher domestic sales of air quality monitoring instrumentation products. The increase in operating profit reflected the impact of higher sales, greater margins for marine instrumentation, partially offset by $6.4 million in acquisition expenses and $2.8 million in additional intangible asset amortization related to the LeCroy, PDM Neptec and BlueView transactions. The incremental operating profit included in the results for 2012 from recent acquisitions was $1.4 million. Cost of sales in total dollars increased by $68.1 million in 2012, compared with 2011, and reflected the impact of higher sales and product mix differences. The decrease in the cost of sales percentage primarily reflected the impact of the LeCroy acquisition products which carry a lower cost of sales percentage than the average for other products, partially offset by product mix differences. Segment operating profit in 2012 also reflected LIFO income of $0.3 million compared with LIFO expense of $0.5 million in 2011. Selling, general and administrative expenses for 2012, as a percentage of sales, increased to 25.4%, compared with 34-------------------------------------------------------------------------------- Table of Contents 22.6% for 2011 and reflected the impact of acquisition related expenses, higher research and development costs and the LeCroy cost structure which has a higher selling, general and administrative expense percentage than other instrumentation businesses. 2011 compared with 2010 Our Instrumentation segment sales were $616.6 million in 2011, compared with sales of $573.2 million in 2010, an increase of 7.6%. Operating profit was $122.8 million in 2011, compared with $113.9 million in 2010, an increase of 7.8%. The 2011 sales change resulted primarily from $24.0 million in higher sales of environmental instrumentation products and $19.4 million in higher sales of marine instrumentation products. The higher sales for environmental instrumentation reflected improvement for substantially all product offerings. The higher sales for marine instrumentation reflected increased sales of marine interconnect systems, partially offset by reduced sales of geophysical sensors for the energy exploration market. The higher sales for marine instrumentation also included $3.7 million from a recent acquisition. The increase in operating profit reflected the impact of higher sales. Segment operating profit in 2011 also reflected LIFO expense of $0.5 million compared with LIFO expense of $0.2 million in 2010. Cost of sales in total dollars increased by $21.8 million in 2011, compared with 2010, and primarily reflected the increase in sales. Operating profit as a percentage of sales was 19.9% for both 2011 and 2010 and reflected a slightly lower cost of sales percentage due to mix, offset by a slightly higher selling, general and administrative percentage due to increased research and development expenses. Digital Imaging (Dollars in millions) 2012 2011 2010 Sales $ 415.9 $ 349.9 $ 122.5 Cost of sales $ 266.9 $ 231.5 $ 91.3 Selling, general and administrative expenses $ 124.2 $ 102.3 $ 26.0 Operating profit $ 24.8 $ 16.1 $ 5.2 Cost of sales % of sales 64.2 % 66.2 % 74.5 % Selling, general and administrative expenses % of sales 29.8 % 29.2 % 21.3 % Operating profit % of sales 6.0 % 4.6 % 4.2 % International sales % of sales 46.1 % 47.1 % 7.1 % Governmental sales % of sales 31.0 % 31.5 % 76.2 % Capital expenditures $ 23.5 $ 13.8 $ 11.3 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. It also includes our sponsored and centralized research laboratories benefiting government programs and businesses. 2012 compared with 2011 Our Digital Imaging segment sales were $415.9 million in 2012, compared with sales of $349.9 million in 2011, an increase of 18.9%. Operating profit was $24.8 million in 2012, compared with $16.1 million in 2011, an increase of 54.0%. The 2012 sales increase included $66.9 million in incremental revenue from the acquisitions of DALSA, Nova Sensors and Optech. The 2012 sales also reflected increased sales of infrared imaging sensors and optics, offset by lower sales of funded research activities. The increase in operating profit was impacted by the absence of purchase accounting adjustments that were incurred in 2011 for the DALSA acquisition and product mix differences. The incremental operating profit for 2012 from recent acquisitions was $6.2 million. Operating profit in 2011 included $2.6 million of inventory purchase accounting charges resulting from the February 2011 acquisition of DALSA. Cost of sales in total dollars increased by $35.4 million, compared with 2011, and primarily reflected the impact of higher sales, offset by the absence in 2012 of the inventory purchase accounting charges for DALSA made in 2011. The lower cost of sales percentage in 2012 reflected the results of the Optech acquisition, which carries a lower cost of sales percentage, as well as the absence of inventory purchase accounting charges for DALSA in 2011. 35-------------------------------------------------------------------------------- Table of Contents 2011 compared with 2010 Our Digital Imaging segment sales were $349.9 million in 2011, compared with sales of $122.5 million in 2010, an increase of 185.6%. Operating profit was $16.1 million in 2011, compared with $5.2 million in 2010, an increase of 209.6%. The 2011 sales increase included $214.0 million in revenue from recent acquisitions, primarily the February 2011, acquisition of DALSA, as well as higher organic sales. The increase in operating profit reflected the impact of higher sales, partially offset by increased intangible asset amortization of $9.9 million and $25.9 million in higher research and development and bid and proposal spending, primarily from recent acquisitions. The incremental operating profit from recent acquisitions was $10.7 million. Operating profit as a percentage of sales was 4.6% for 2011 and 4.2% for 2010. Cost of sales in total dollars increased by $140.2 million in 2011, compared with 2010, and reflected $123.5 million in cost of sales from the DALSA acquisition, as well as cost of sales on increased organic sales. The cost structure for this segment was significantly impacted by the acquisition of DALSA. Excluding the impact of the DALSA acquisition, cost of sales as a percentage of sales for 2011 would have been 76.0% which reflects a slightly less profitable mix of contracts versus 2010. Excluding the impact of the DALSA acquisition, selling, general and administrative expense as a percentage of sales for 2011 would have been 19.1% versus 21.2% in 2010 which reflected leveraging fixed costs over higher sales. Aerospace and Defense Electronics (Dollars in millions) 2012 2011 2010 Sales $ 660.6 $ 670.8 $ 614.7 Cost of sales $ 442.6 $ 458.0 $ 451.9 Selling, general and administrative expenses $ 127.7 $ 118.9 $ 105.0 Operating profit $ 90.3 $ 93.9 $ 57.8 Cost of sales % of sales 67.0 % 68.3 % 73.5 % Selling, general and administrative expenses % of sales 19.3 % 17.7 % 17.1 % Operating profit % of sales 13.7 % 14.0 % 9.4 % International sales % of sales 28.1 % 25.1 % 22.3 % Governmental sales % of sales 40.9 % 45.3 % 49.2 % Capital expenditures $ 13.8 $ 13.1 $ 9.7 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. 2012 compared with 2011 Our Aerospace and Defense Electronics segment sales were $660.6 million in 2012, compared with sales of $670.8 million in 2011, a decrease of 1.5%. Operating profit was $90.3 million in 2012, compared with $93.9 million in 2010, a decrease of 3.8%. Sales for 2012 decreased by $10.2 million, which resulted from lower sales of $37.9 million for electronic manufacturing service products, partially offset by $12.4 million of higher sales from avionics products and electronic relays and $15.3 million from microwave devices and interconnects. Microwave devices and interconnects sales in 2012 included $25.0 million from the 2012 acquisition of VariSystems. Operating profit in 2012 decreased due to the decrease in sales, $1.1 million in amortization of acquisition related intangible assets and $0.4 million in other acquisition expenses related to the VariSystems acquisition. Operating profit in 2012 also reflected reduced margins, as well as $1.7 million of severance and relocation costs within certain electronic manufacturing service products businesses. The incremental operating profit for 2012 from recent acquisitions was $1.8 million. Cost of sales for 2012 in total dollars decreased by $15.4 million, compared with 2011, and reflected the impact of lower sales and product mix differences. Cost of sales as a percentage of sales for 2012 decreased to 67.0% from 68.3% in 2011 and reflected increased sales of higher gross margin avionics products, decreased sales of lower gross margin electronic manufacturing service products, as well as the impact of higher gross margin products from VariSystems. Operating profit included pension expense of $2.7 million for 2012, compared with $3.9 million for 2011. Pension expense allocated to contracts pursuant to CAS was $4.3 million for 2012, compared with $3.9 million for 2011. In the first half of 2013, we expect additional severance and relocation costs of approximately $4.0 million associated with certain electronic manufacturing services businesses. 36-------------------------------------------------------------------------------- Table of Contents 2011 compared with 2010 Our Aerospace and Defense Electronics segment sales were $670.8 million in 2011, compared with sales of $614.7 million in 2010, an increase of 9.1%. Operating profit was $93.9 million in 2011, compared with $57.8 million in 2010, an increase of 62.5%. The 2011 sales increase resulted from $46.1 million of higher sales of microwave devices and interconnects, as well as increased sales of $24.1 million from avionics products and electronic relays, partially offset by a reduction of $14.1 million in sales of electronic manufacturing services products. The increased sales of microwave devices and interconnects included sales of $25.7 million from acquisitions as well as higher organic sales. The increase in operating profit reflected the impact of higher sales and product mix differences and the absence of the $8.2 million inventory write-down. The incremental operating profit from recent acquisitions was $5.9 million. Segment operating profit in 2011 also reflected LIFO expense of $0.3 million compared with LIFO expense of $0.4 million in 2010. Operating profit included pension expense of $3.9 million for 2011, compared with $1.7 million for 2010. Pension expense allocated to contracts pursuant to CAS was $3.9 million for 2011, compared with $2.5 million for 2010. Cost of sales in total dollars increased by $6.1 million in 2011, compared with 2010, and reflected the increase in sales, higher pension expense and product mix differences. The cost of sales percentage improved due to the sales mix which had higher sales from our more profitable avionics and interconnects products as well the absence of the $8.2 million inventory write-down in 2010. Engineered Systems (Dollars in millions) 2012 2011 2010 Sales $ 301.4 $ 304.6 $ 333.8 Cost of sales $ 247.3 $ 247.0 $ 272.5 Selling, general and administrative expenses $ 25.6 $ 29.5 $ 30.9 Operating profit $ 28.5 $ 28.1 $ 30.4 Cost of sales % of sales 82.1 % 81.1 % 81.6 % Selling, general and administrative expenses % of sales 8.5 % 9.7 % 9.3 % Operating profit % of sales 9.5 % 9.2 % 9.1 % International sales % of sales 11.6 % 11.1 % 7.6 % Governmental sales % of sales 81.4 % 79.4 % 88.7 % Capital expenditures $ 4.2 $ 5.9 $ 3.6 Our Engineered Systems segment provides innovative systems engineering and integration, advanced technology development, and manufacturing solutions for defense, space, environmental and energy applications. This segment also designs and manufactures electrochemical energy systems and small turbine engines. 2012 compared with 2011 Our Engineered Systems segment sales were $301.4 million in 2012, compared with sales of $304.6 million in 2011, a decrease of 1.1%. Operating profit was $28.5 million in 2012, compared with $28.1 million in 2011, an increase of 1.4%. The 2012 sales decrease of $3.2 million reflected lower sales of $4.9 million from engineered products and services, partially offset by higher sales of $0.9 million for energy systems and $0.8 million for turbine engines. The sales decrease from engineered products and services primarily reflected lower sales of space and defense programs as well as nuclear programs. Operating profit in 2012 improved slightly despite the small decrease in sales. Cost of sales in total dollars for 2012 increased by $0.3 million, compared with 2011, and reflected product mix differences. Cost of sales as a percentage of sales for 2012 increased to 82.1%, compared with 81.1% in 2011 and reflected product mix differences. Operating profit included pension expense of $2.7 million for 2012, compared with $2.4 million for 2011. Pension expense allocated to contracts pursuant to CAS was $8.4 million for 2012, compared with $8.7 million for 2011. 2011 compared with 2010 Our Engineered Systems segment sales were $304.6 million in 2011, compared with sales of $333.8 million in 2010, a decrease of 8.7%. Operating profit was $28.1 million in 2011, compared with $30.4 million in 2010, a decrease of 7.6%. Sales for 2011 reflected lower sales of $33.7 million from engineered products and services and lower energy systems sales of $2.3 million, partially offset by higher sales of $6.8 million of turbine engines resulting from increased sales for the JASSM program. The sales decrease from engineered products and services, primarily reflected lower sales of space and defense programs, partially offset by higher sales of $9.0 million for environmental systems and $6.2 million in sales from acquisitions. The lower operating profit in 2011 primarily reflected the impact of lower sales, partially offset by the impact of higher margins for turbine engines. Operating profit included pension expense of $2.4 million for 2011, compared with $1.6 million for 2010. Pension expense allocated to contracts pursuant to CAS was $8.7 million for 2011, compared with $7.1 million for 2010. Cost of sales in total dollars decreased by $25.5 million in 2011, compared with 2010, and primarily reflected 37-------------------------------------------------------------------------------- Table of Contents the decrease in sales. Both cost of sales as a percentage of sales and selling, general and administrative expense as a percentage of sales were comparable from year to year. Financial Condition, Liquidity and Capital Resources Principal Capital Requirements Our principal capital requirements are to fund working capital needs, capital expenditures, voluntary and required pension contributions, debt service requirements and acquisitions including the pending acquisition of RESON A/S. It is anticipated that operating cash flow, together with available borrowings under the credit facility described below, will be sufficient to meet these requirements and could be used to fund some acquisitions in 2013. 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 entities or unconsolidated entities. Revolving Credit Agreement and Senior Notes On February 25, 2011, Teledyne refinanced the then existing $590.0 million credit facility by terminating the facility and entering into a new facility that has lender commitments totaling $550.0 million that has a termination date of February 25, 2016. Excluding interest and fees, no payments are due under the facility until it matures. Borrowings under our credit facility are at variable rates which are, at our option, tied to a Eurocurrency rate equal to LIBOR (London Interbank Offered Rate) plus an applicable rate or a base rate as defined in our credit agreement. Eurocurrency rate loans may be denominated in U.S. dollars or an alternative currency as defined in the agreement. Eurocurrency or LIBOR based loans under the facility typically have terms of one, two, three or six months and the interest rate for each such loan is subject to change if the loan is continued or converted following the applicable maturity date. Base rate loans have interest rates that primarily fluctuate with changes in the prime rate. Interest rates are also subject to change based on our consolidated leverage ratio as defined in the credit agreement. The credit agreement also provides for facility fees that vary between 0.20% and 0.45% of the credit line, depending on our consolidated leverage ratio as calculated from time to time. On October 22, 2012, Teledyne entered into $200.0 million of term loans that mature in October 2015. The proceeds were applied against the $550.0 million revolving credit facility. On September 15, 2010, the Company issued $250.0 million in aggregate principal amount of private placement Senior Notes at par. The Company used the proceeds of the private placement Senior Notes to pay down amounts outstanding under the Company's then existing $590.0 million credit facility. Long-term debt consisted of the following (in millions): Balance at December 30, 2012 January 1, 2012 4.04% Senior Notes due September 2015 $ 75.0 $ 75.0 4.74% Senior Notes due September 2017 100.0 100.0 5.30% Senior Notes due September 2020 75.0 75.0 Term Loans due October 2015, weighted average rate of 1.59% 200.0 - Other debt at various rates due through 2018 14.3 - $550.0 million revolving credit facility, weighted average rate of 2.19% at December 30, 2012 and 2.48% at January 1, 2012 79.0 48.0 Total long-term debt $ 543.3 $ 298.0 The Company also has $14.3 million in capital leases, of which $1.5 million is current. At December 30, 2012, Teledyne had $13.6 million in outstanding letters of credit. 38-------------------------------------------------------------------------------- Table of Contents The credit agreements require the Company to comply with various financial and operating covenants, including maintaining certain consolidated leverage and interest coverage ratios, as well as minimum net worth levels and limits on acquired debt. At December 30, 2012, 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. At December 30, 2012, the required financial covenant ratios and the actual ratios were as follows: $550.0 million Credit Facility expires February 2016 and $200.0 million term loans due October 2015 Financial Covenant Requirement Actual MeasureConsolidated Leverage Ratio (Net Debt/EBITDA) No more than (a) 3.25 to 1 1.7 to 1 Consolidated Interest Coverage Ratio No less than 3.0 (EBITDA/Interest) (b) to 1 15.7 to 1 $250.0 million Private Placement Notes due 2015, 2017 and 2020 Financial Covenant Requirement Actual Measure Consolidated Leverage Ratio (Net Debt/EBITDA) No more than (a) 3.25 to 1 1.6 to 1 Consolidated Interest Coverage Ratio No less than 3.0 (EBITDA/Interest) (b) to 1 15.7 to 1 (a) The Consolidated Leverage Ratio is equal to Net Debt/EBITDA as defined in our private placement note purchase agreement and our $550.0 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 $550.0 million credit agreement. Available borrowing capacity under the $550.0 million credit facility, which is reduced by borrowings and outstanding letters of credit, was $458.6 million at December 30, 2012. Teledyne also has a $5.0 million uncommitted credit line which permits credit extensions up to $5.0 million plus an incremental $2.0 million solely for standby letters of credit. This credit line is utilized, as needed, for periodic cash needs. No amounts are outstanding under this facility at December 30, 2012. The maximum amount that could be borrowed under our $550.0 million credit facility as of December 30, 2012 while still remaining in compliance with our consolidated leverage ratio covenant was $458.6 million. The Company may amend the $550.0 million credit facility in the first quarter of 2013 to extend the termination date and increase the amount of the facility. Permanently Reinvested Earnings We consider the earnings of non-U.S. subsidiaries to be indefinitely invested outside the United States on the basis of estimates that future domestic cash generation will be sufficient to meet future domestic cash requirements. At December 30, 2012, the amount of undistributed foreign earnings was $87.5 million. We have not recorded a deferred tax liability of approximately $19.6 million related to the $87.5 million of undistributed foreign earnings. Should we decide to repatriate the foreign earnings, we would need to adjust our income tax provision in the period we determined that the earnings will no longer be indefinitely invested outside the United States. 39-------------------------------------------------------------------------------- Table of Contents Contractual Obligations The following table summarizes our expected cash outflows resulting from financial contracts and commitments at December 30, 2012. We have not included information on our normal recurring purchases of materials for use in our operations. These amounts are generally consistent from year to year, closely reflect our levels of production and are not long-term in nature (in millions): 2018 and Category 2013 2014 2015 2016 2017 beyond Total Long-term debt obligations $ - $ 0.6 $ 275.5 $ 79.6 $ 100.5 $ 87.1 $ 543.3 Interest expense(a) 17.5 17.4 16.0 9.8 7.9 16.8 85.4 Operating lease obligations 22.3 17.2 14.9 10.9 7.7 14.6 87.6 Capital lease obligations(b) 2.1 1.8 1.7 1.7 1.7 9.1 18.1 Purchase obligations(c) 58.6 6.2 2.9 2.5 0.8 1.7 72.7 Total $ 100.5 $ 43.2 $ 311.0 $ 104.5 $ 118.6 $ 129.3 $ 807.1 (a) Interest expense related to the credit facility, including facility fees, is assumed to accrue at the rates in effect at year-end 2012 and is assumed to be paid at the end of each quarter with the final payment in February 2016 when the credit facility expires. (b) Includes imputed interest and short-term portion. (c) Purchase obligations generally include long-term contractual obligations for the purchase of goods and services. Unrecognized tax benefits of $42.6 million are not included in the table above because $9.7 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. At December 30, 2012, we are not required to make any cash contributions to the domestic qualified pension plan for 2012. Teledyne made a voluntary pretax contribution to its domestic qualified pension plan of $83.0 million on January 7, 2013. Teledyne has no required or scheduled contributions to its foreign pension plans for 2013. Our minimum funding requirements after 2012, 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 2013 have not been provided due to the significant uncertainty of these amounts, which are subject to change until the Company's pension assumptions can be updated at the appropriate times. In addition, certain pension contributions are eligible for future recovery through the pricing of products and services to the U.S. government under certain government contracts, therefore, the amounts noted are not necessarily indicative of the impact these contributions may have on our liquidity. We also have payments due under our other postretirement benefit plans. These plans are not required to be funded in advance, but are pay as you go. See further discussion in Note 12 of the Notes to Consolidated Financial Statements. In addition, for covered active salaried employees in the domestic pension plan, in 2011 the Company approved a plan amendment to change the rate at which pension benefits will accrue after February 29, 2012. The pension benefit formula was changed from a "final average pay" calculation to a "career average pay" approach. This amendment reduced the pension benefit obligation by $43.3 million in 2011. Teledyne intends to continue to monitor and manage its defined pension benefit plans obligation and may take additional actions in the future. Operating Activities In 2012, net cash provided by operating activities from continuing operations was $189.5 million, compared with $219.5 million in 2011 and $127.1 million in 2010. The lower cash provided by operating activities from continuing operations in 2012 reflected the impact of the timing of accounts receivable collections and higher cash contributions to the domestic pension plan, partially offset by lower income tax payments. The 2012 net cash provided by operating activities from continuing operations amount includes voluntary cash contributions of $92.8 million to the domestic pension plan, compared with $69.0 million in voluntary cash contributions to the domestic pension plan for 2011. The higher net cash provided by operating activities from continuing operations for 2011, compared with 2010, reflected the impact of higher net income, lower income tax payments of $33.5 million and lower deferred accounts receivable, partially offset by higher pretax pension contributions of $24.2 million. Free cash flow (cash from operating activities from continuing operations less capital expenditures) was $124.2 million in 2012, compared with $177.8 million in 2011 and $96.1 million in 2010. Adjusted free cash flow eliminates the impact of pension contributions on a net of tax basis and was $184.5 million, compared with $221.8 million in 2011 and $124.2 million in 2010. 40-------------------------------------------------------------------------------- Table of Contents Free Cash Flow(a) (in millions, brackets indicate use of funds) 2012 2011 2010 Cash provided by operating activities, continuing operations $ 189.5 $ 219.5 $ 127.1 Capital expenditures for property, plant and equipment (65.3 ) (41.7 ) (31.0 ) Free cash flow 124.2 177.8 96.1 Pension contributions, net of tax(b) 60.3 44.0 28.1 Adjusted free cash flow $ 184.5 $ 221.8 $ 124.2 a) We define free cash flow as cash provided by operating activities from continuing operations (a measure prescribed by generally accepted accounting principles) less capital expenditures for property, plant and equipment. Adjusted free cash flow eliminates the impact of pension contributions on a net of tax basis. We believe that this supplemental non-GAAP information is useful to assist management and the investment community in analyzing our ability to generate cash flow, including the impact of voluntary and required pension contributions. b) All domestic pension cash contributions were voluntary. Working Capital Working capital increased to $337.5 million at year-end 2012, compared with $268.5 million at year-end 2011. The increase primarily reflected working capital from recent acquisitions as well as higher accounts receivable due to higher sales late in 2012 compared with the same period of 2011. Balance Sheet Changes The changes in the following selected components of Teledyne's balance sheet are discussed below (in millions): 2012 2011 Accounts receivable, net $ 350.3 $ 270.0 Inventories, net $ 281.2 $ 219.4 Properly, plant and equipment, net $ 349.5 $ 254.6 Goodwill $ 990.2 $ 717.8 Acquired intangible assets, net $ 265.7 $ 181.4 Accounts payable $ 148.6 $ 102.0 Long-term debt and capital lease obligations, net of current portion $ 556.2 $ 311.4 Other long-term liabilities $ 169.7 $ 117.2 Accumulated other comprehensive loss $ 273.4 $ 241.1 Noncontrolling interest $ 55.6 $ 4.8 The higher balances in accounts receivable, inventories, goodwill, acquired intangible assets, accounts payable and other long-term liabilities were impacted by the acquisitions made in 2012. The higher balances in property, plant and equipment also reflected the impact of 2012 acquisitions, as well as capital spending, partially offset by depreciation. The higher balance in account receivable also reflected the impact of higher sales late in 2012 compared with the same period of 2011. Long-term debt increased and reflected the impact of funds used for acquisitions in 2012 and pension contributions. The accumulated other comprehensive loss increase primarily reflects the non-cash adjustment of $49.4 million related to the increase in the unfunded pension liability in 2012, partially offset by $14.3 million of foreign currency changes. The increase in noncontrolling interest primarily reflects the noncontrolling interest related to the Optech purchase. Investing Activities Net cash used in investing activities included capital expenditures as presented below (in millions): Capital Expenditures 2012 2011 2010 Instrumentation $ 13.2 $ 8.9 $ 6.4 Digital Imaging 23.5 13.8 11.3 Aerospace and Defense Electronics 13.8 13.1 9.7 Engineered Systems 4.2 5.9 3.6 Corporate 10.6 - - $ 65.3 $ 41.7 $ 31.0 During 2013 we plan to invest approximately $90.0 million in capital expenditures, principally to upgrade capital equipment, reduce manufacturing costs, to implement an enterprise resource planning software system and introduce new 41-------------------------------------------------------------------------------- Table of Contents products. Commitments at December 30, 2012, for capital expenditures were approximately $17.1 million. Investing activities from continuing operations used cash for acquisitions of $389.2 million, $366.7 million and $67.9 million, in fiscal 2012, 2011 and 2010, respectively (see "Recent Acquisitions"). The 2011 amount includes $18.9 million for the minority interest in Optech and $3.2 million for the purchase of the remaining minority interest in Energy Systems. Teledyne funded the acquisitions primarily from borrowings under its credit facility and cash on hand. In all acquisitions, the results of operations and cash flows are included in our consolidated financial statements from the date of each respective acquisition. The DALSA, Nova Sensors and Optech acquisitions are part of the Digital Imaging segment. The LeCroy, BlueView, and PDM acquisitions are part of the Instrumentation segment and VariSystems is part of the Aerospace and Defense Electronics segment. The following table shows the purchase price (net of cash acquired), goodwill acquired and intangible assets acquired for the acquisitions made in fiscal 2012 and 2011 (in millions): Fiscal year 2012 Acquired Purchase Goodwill Intangible Acquisition Acquisition Date Price(a) Acquired Assets VariSystems February 25, 2012 $ 36.3 $ 14.2 $ 11.9 Optech April 2, 2012 27.9 62.4 23.4 BlueView July 2, 2012 16.3 10.8 4.8 LeCroy August 3, 2012 301.3 174.4 67.6 PDM Neptec August 3, 2012 7.4 3.3 1.3 $ 389.2 $ 265.1 $ 109.0 Fiscal year 2011 Acquired Acquisition Purchase Goodwill Intangible Acquisition Date Price(a) Acquired Assets February 11, DALSA 2011 $ 339.5 $ 166.9 $ 91.5 March 17, Nova Sensors 2011 5.1 8.3 2.0 $ 344.6 $ 175.2 $ 93.5 (a) includes transaction costs that are expensed under current accounting guidance. Goodwill resulting from the acquisitions made in fiscal 2012 and 2011 will not be deductible for tax purposes. The following is a summary, at the acquisition date, of the estimated fair values of the assets acquired and liabilities assumed for the acquisitions made in fiscal 2012 and 2011 (in millions): 2012 2011 Current assets, excluding cash acquired $ 116.2 $ 98.7 Property, plant and equipment 79.1 53.3 Goodwill 265.1 175.2 Intangible assets 109.0 93.5 Other long-term assets 5.3 - Total assets acquired 574.7 420.7 Current liabilities, including short-term debt (61.8 ) (37.7 ) Other long-term liabilities (123.7 ) (38.4 ) Total liabilities assumed (185.5 ) (76.1 ) Purchase price, net of cash acquired $ 389.2 $ 344.6 Investing activities in 2011 also included the net of tax proceeds of $136.6 million received from the sale of our general aviation piston engine businesses. 42-------------------------------------------------------------------------------- Table of Contents Financing Activities Cash provided by financing activities for 2012 reflected net proceeds of borrowings of $229.2 million. Cash provided by financing activities for 2011 reflected net proceeds of borrowings of $46.6 million. Cash provided by financing activities for 2010 reflected the $250.0 million proceeds from the issuance of Senior Notes and the net repayment of borrowings under our revolving credit agreement of $246.4 million. Fiscal years 2012, 2011 and 2010 reflect proceeds from the exercise of stock options of $19.9 million, $14.8 million and $3.9 million, respectively. Fiscal years 2012, 2011 and 2010 included $8.4 million, $7.2 million and $1.5 million, respectively, in excess tax benefits related to stock-based compensation. Cash provided by financing activities for 2011 also reflected the repurchase of common stock for $34.9 million. On October 22, 2012, Teledyne entered into $200.0 million of term loans that mature in October 2015. The proceeds were applied against the $550.0 million revolving credit facility. On February 25, 2011, Teledyne refinanced the then existing $590.0 million credit facility by terminating the facility and entering into a new facility that has lender commitments totaling $550.0 million. At year-end 2012, we had $458.6 million of available committed credit under the $550.0 million credit facility, which can be utilized, as needed, for daily operating and periodic cash needs, including acquisitions. Excluding interest and fees, no payments are due under the amended and restated credit facility until it matures in February 2016. As of February 22, 2013, we had $149.0 million outstanding under the credit facility. This reflects cash flow used in operations, which includes the impact of the $83.0 million pension contribution made in January 2013. On September 15, 2010, the Company issued $250.0 million in aggregate principal amount of private placement Senior Notes at par. The Company used the proceeds of the private placement Senior Notes to pay down amounts outstanding under the Company's then existing $590.0 million credit facility. Teledyne also has a $5.0 million uncommitted credit line which permits credit extensions up to $5.0 million plus an incremental $2.0 million solely for standby letters of credit. This credit line is utilized, as needed, for periodic cash needs. There were no outstanding funding advances under the uncommitted credit line at December 30, 2012. Total debt at year-end 2012 includes $250.0 million outstanding in Senior Notes, $200.0 million in term loans, $79.0 million outstanding under the $550.0 million credit facility and $14.3 million in other debt. The Company also has $14.3 million outstanding under capital leases, of which $1.5 million is current. At year-end 2012, Teledyne had $13.6 million in outstanding letters of credit. In October 2011, our Board of Directors approved a stock repurchase program authorizing the Company to repurchase up to 2,500,000 shares of its common stock. Shares may be repurchased from time to time in open market transactions at prevailing market prices or in privately negotiated transactions. Shares could be repurchased in a plan pursuant to Rule 10b5-1 of the Securities Exchange Act of 1934. The repurchase program is expected to remain open continuously, and the number of shares purchased will depend on a variety of factors, such as share price, levels of cash available, alternative investment opportunities available immediately or longer-term, and other regulatory, market or economic conditions. Repurchases would be funded with cash on hand and borrowings under the company's credit facility. In 2011, Teledyne repurchased 658,562 shares of Teledyne common stock for $34.9 million under the program. No repurchases were made in 2012. Pension Plans Teledyne has a domestic defined benefit pension plan covering substantially all U.S. employees hired before January 1, 2004, or approximately 22% of Teledyne's active employees. As of January 1, 2004, new hires participate in a defined contribution plan. Teledyne made a voluntary pretax contribution to its domestic qualified pension plan of $83.0 million on January 7, 2013. In 2012, Teledyne made pretax cash contributions of approximately $92.8 million to its domestic pension plan before recovery from the U.S. Government. In connection with the 2010 acquisition of Intelek, the Company assumed responsibility for a frozen defined benefit pension plan based in the United Kingdom covering certain employees of Intelek. In 2010, Teledyne made pretax cash contributions of approximately $8.1 million to the Intelek pension plan. The plan was closed to new members in January 2000 and ceased further service accruals to members in September 2002. In connection with the 2012 acquisition of LeCroy, the Company assumed the responsibility for a defined benefit plan based in Switzerland covering certain employees of LeCroy. Other Matters 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. 43-------------------------------------------------------------------------------- Table of Contents The Company's effective tax rate for 2012 was 28.7%, compared with 32.9% for 2011 and 30.9% for 2010. Fiscal years 2012, 2011 and 2010 included net tax credits of $5.4 million, $2.4 million and $12.5 million, respectively. These relate primarily to research and development tax credits and expiration of statute of limitations on unrecognized tax benefits. Excluding these items the company's effective tax rates for fiscal years 2012, 2011 and 2010 would have been 31.0%, 34.0% and 38.1%, respectively. The lower 2012 effective tax rate, compared with the 2011 effective tax rate, excluding tax credits, primarily reflected a change in the proportion of domestic and international income and foreign research and development tax credits. Based on the Company's history of operating earnings, expectations of future operating earnings and potential tax planning strategies, it is more likely than not that the deferred income tax assets at December 30, 2012 will be realized. 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. Changes in tax laws and rates may affect the recorded deferred tax assets and liabilities and our effective tax rate. The American Taxpayer Relief Act of 2012 (the "Act") was signed into law on January 2, 2013. Because a change in tax law is accounted for in the period of enactment, certain provisions of the Act benefiting the Company's 2012 U.S. federal taxes, including the research and development credit and the Subpart F controlled foreign corporation look through exception cannot be recognized in the Company's 2012 financial results and instead will be reflected in the Company's 2013 financial results. We estimate that a benefit of approximately $2.9 million will be accounted for as a discrete item in our tax provision for the first quarter of 2013. In addition, we expect the Act's extension for these provisions through the end of 2013 will favorably affect our estimated annual effective tax rate for 2013 by approximately 1.2 percentage points as compared with 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 in all aspects of its business. Hedging Activities; Market Risk Disclosures Teledyne transacts business in various foreign currencies and has international sales and expenses denominated in foreign currencies, subjecting the Company to foreign currency risk. The Company's primary objective is to protect the United States dollar value of future cash flows and minimize the volatility of reported earnings. Due to the February 2011 acquisition of DALSA, the Company began to utilize foreign currency forward contracts to reduce the volatility of cash flows primarily related to forecasted revenue and expenses denominated in Canadian dollars. These contracts are designated and qualify as cash flow hedges. The effectiveness of the cash flow hedge contracts, excluding time value, is assessed prospectively and retrospectively on a monthly basis using regression analysis, as well as using other timing and probability criteria. To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedges and must be highly effective in offsetting changes to future cash flows on hedged transactions. The effective portion of the cash flow hedge contracts' gains or losses resulting from changes in the fair value of these hedges is initially reported, net of tax, as a component of accumulated other comprehensive income ("AOCI") in stockholders' equity until the underlying hedged item is reflected in our consolidated statements of income, at which time the effective amount in accumulated other comprehensive income is reclassified to cost of sales in our consolidated statements of income. The Company expects to reclassify a gain of approximately $0.5 million over the next 12 months based on the year end 2012 exchange rate. In the event that the gains or losses in AOCI are deemed to be ineffective, the ineffective portion of gains or losses resulting from changes in fair value, if any, is reclassified to other income and expense. In the event that the underlying forecasted transactions do not occur, or it becomes remote that they will occur, within the defined hedge period, the gains or losses on the related cash flow hedges will be reclassified from AOCI to other income and expense. During the current reporting period, all forecasted transactions occurred and, therefore, there were no such gains or losses reclassified to other income and expense. As of December 30, 2012, Teledyne had foreign currency forward contracts designated as cash flow hedges to buy Canadian dollars and to sell U.S. dollars totaling $51.7 million and these contracts had a fair value of $0.8 million. These foreign currency forward contracts have maturities ranging from March 2013 to February 2014. 44-------------------------------------------------------------------------------- Table of Contents In addition, the Company utilizes foreign currency forward contracts to mitigate foreign exchange rate risk associated with foreign-currency-denominated monetary assets and liabilities, including intercompany receivables and payables and as of December 30, 2012, Teledyne had foreign currency contracts of this type in the following currency pairs: Contracts to Buy Contracts to Sell Currency Amount Currency Amount Canadian Dollars C$ 2.6 Euros € (2.0 ) Canadian Dollars C$ 26.3 U.S. Dollars $ (26.3 ) Great Britain Pounds £ 5.5 U.S. Dollars $ (8.9 ) U.S. Dollars $ 8.9 Euros € (6.8 ) U.S. Dollars $ 2.6 Japanese Yen ¥ (218.0 ) U.S. Dollars $ 1.0 Korean Won (1,126.0 ) These contracts had a fair value of $0.1 million at December 30, 2012. The gains and losses on these derivatives which are not designated as hedging instruments under ASC 815, Derivatives and Hedging ("ASC 815"), are intended to, at a minimum, partially offset the transaction gains and losses recognized in earnings. Under ASC 815, 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 appreciation of the U.S. dollar from its value at December 30, 2012 would decrease the fair value of our foreign currency forward contracts associated with our cash flow hedging activities by $5.2 million. A hypothetical 10 percent depreciation of the U.S. dollar from its value at December 30, 2012 would increase the fair value of our foreign currency forward contracts associated with our cash flow hedging activities by $5.2 million. Borrowings under our credit facility are at fixed rates that vary with the term and timing of each loan under the facility. Loans under the facility typically have terms of one, two, three or six months and the interest rate for each such loan is subject to change if the loan is continued or converted following the applicable maturity date. Interest rates are also subject to change based on our debt to earnings before interest, taxes, depreciation and amortization ratio. As of December 30, 2012, we had $79.0 million outstanding indebtedness under our $550.0 million credit facility. Any borrowings under the Company's revolving credit line are based on a fluctuating market interest rate and, consequently, the fair value of any outstanding debt should not be affected materially by changes in market interest rates. A 100 basis point increase in interest rates would result in an increase in annual interest expense of approximately $0.8 million, assuming the $79.0 million in debt was outstanding for the full year. We believe that adequate controls are in place to monitor any hedging activities. Our primary exposure to market risk relates to changes in interest rates and foreign currency exchange rates. We periodically evaluate these risks and have taken measures to mitigate these risks. We own assets and operate facilities in countries that have been politically stable. Related Party Transactions Dr. von Schack and Ms. Bruch are directors of The Bank of New York Mellon Corporation. Dr. Mehrabian was also a director of The Bank of New York Mellon Corporation until his retirement on April 12, 2011. The Bank of New York Mellon Corporation is the successor to Mellon Financial Corporation following its merger with The Bank of New York in 2007. Mr. Cahouet had served as Chairman, President and Chief Executive Officer of Mellon Financial Corporation and Mellon Bank, N.A., having retired on December 31, 1998. Mr. Cahouet ceased being a director of Mellon Financial Corporation on April 18, 2000. We maintain various arms-length banking relationships with The Bank of New York Mellon Corporation. On February 25, 2011, we entered into a $550.0 million credit facility under which The Bank of New York Mellon Corporation is one of 12 lenders, having committed to lend up to $45.0 million. The Bank of New York Mellon Corporation also provides cash management services, serves as trustee for the Teledyne Technologies Incorporated Pension Plan and, through its subsidiaries and affiliates, provides asset management and transition management services for the Pension Plan. Notwithstanding these relationships, our Board of Directors has determined that Ms. Bruch, Mr. Cahouet and Dr. von Schack are "independent," within the meaning of the rules of the New York Stock Exchange, and are able to serve on Audit Committee and Nominating and Governance Committee of Teledyne's Board of Directors, in the case of Mr. Cahouet, and on Personnel and Compensation Committee and Nominating and Governance Committee of Teledyne's Board of Directors, in the case of Dr. von Schack and Ms. Bruch. 45-------------------------------------------------------------------------------- Table of Contents 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 $3.2 million at December 30, 2012 and $3.2 million at January 1, 2012. As investigation and remediation of these sites proceed and new information is received, the Company expects that accruals will be adjusted to reflect new information. Based on current information, we do not believe that future environmental costs, in excess of those already accrued, will materially and adversely affect our financial condition or liquidity. However, resolution of one or more of these environmental matters or future accrual adjustments in any one reporting period could have a material adverse effect on our results of operations for that period. See also our environmental risk factor disclosure beginning at page 21. For additional discussion of environmental matters, see Notes 2 and 15 to the Notes to Consolidated Financial Statements. Government Contracts We perform work on a number of contracts with the 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 Department of Defense, were approximately 32% of total sales in 2012, 36% of total sales in 2011 and 44% of total sales in 2010. For a summary of sales to the U.S. Government by segment, see Note 13 to the Notes to Consolidated Financial Statements. Sales to the Department of Defense represented approximately 26%, 29% and 34% of total sales for 2012, 2011 and 2010, respectively. See also our government contracts risks factor disclosure beginning at page 13. Performance under government contracts has certain inherent risks that could have a material adverse effect on the Company's business, results of operations and financial condition. Government contracts are conditioned upon the continuing availability of Congressional appropriations, which usually occurs on a fiscal year basis even though contract performance may take more than one year. For information on accounts receivable from the U.S. Government, see Note 5 to 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 dental and medical benefits and other contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances at the time, the results of which form the basis for making our judgments. Actual results may differ materially from these estimates under different assumptions or conditions. In some cases, such differences may be material. See "Other Matters - Critical Accounting Policies". 46-------------------------------------------------------------------------------- Table of Contents The following table reflects significant reserves and valuation accounts, which are estimates and based on judgments as described above, at December 30, 2012 and January 1, 2012 (in millions): Reserves and Valuation Accounts (a) 2012 2011 Allowance for doubtful accounts $ 4.7 $ 3.8 LIFO inventory reserves $ 17.3 $ 17.4 Other inventory reserves $ 42.0 $ 42.0 Workers' compensation and general liability reserves(b) $ 9.5 $ 10.4 Warranty reserves(b) $ 17.8 $ 13.3 Environmental reserves(b) $ 3.2 $ 3.2 Other accrued liability reserves(b) $ 24.0 $ 12.5 (a) This table should be read in conjunction with the Notes to Consolidated Financial Statements. (b) Includes both long-term and short-term reserves. Some of the Company's products are subject to specified warranties and the Company provides for the estimated cost of product warranties. We regularly assess the adequacy of our pre-existing warranty liabilities and adjust amounts as necessary based on a review of historic warranty experience with respect to the applicable business or products, as well as the length and actual terms of the warranties, which are typically one year. The product warranty reserve is included in current accrued liabilities and other long-term liabilities on the balance sheet. Changes in the Company's product warranty reserve are as follows (in millions): 2012 2011 2010 Balance at beginning of year $ 13.3 $ 13.0 $ 13.6 Accruals for product warranties charged to expense 9.6 5.1 4.0 Cost of product warranty claims (6.9 ) (5.9 ) (4.8 ) Acquisitions 1.8 1.1 0.2 Balance at year-end $ 17.8 $ 13.3 $ 13.0 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 other long-lived assets; and accounting for income taxes. For additional discussion of the application of these and other accounting policies, see Note 2 of the Notes to Consolidated Financial Statements. Revenue Recognition Commercial sales and sales from U.S. Government fixed-price type contracts are generally recorded as shipments are made or as services are rendered. Revenue related to a product or service is recognized when products are shipped to the customer or services have been rendered in accordance with terms of an agreement of sale, under which title and risk of loss have been transferred, collectability is reasonably assured and pricing is fixed or determinable. The Company's typical terms of sale are FOB shipping point and, as such, the Company primarily records revenue for product sales upon shipment. For the very small percentage of sales where title and risk of loss passes at point of delivery, the Company recognizes revenue upon delivery to the customer, assuming all other criteria for revenue recognition are met. For contracts that require the Company to warehouse certain goods, revenue is recognized when all risks of loss is borne by the customer and all other criteria for revenue recognition are met. If any significant obligation to the customer with respect to a sales transaction remains to be fulfilled following shipment, typically involving acceptance by the buyer, revenue recognition is deferred until such obligations have been fulfilled following shipment. The Company does not offer substantial sales incentives and credits to customers. Accruals for sales returns and other allowances are provided at the time revenue is recognized based upon past experience. For certain fixed-price type contracts that require substantial performance over a long time period (generally one or more 47-------------------------------------------------------------------------------- Table of Contents years), revenues are recorded under the percentage-of-completion method ("POC"). We measure the extent of progress toward completion using the units-of-delivery method, cost-to-cost method or upon attainment of scheduled performance milestones which could be time, event or expense driven. Occasionally, invoices are submitted to and paid by the customer under a contractual agreement which has a different time schedule than the related revenue recognition. Sales under cost-reimbursement contracts, usually from the U.S. Government, are recorded as allowable costs are incurred and fees are earned. The percentage of Company sales recognized using the POC method has been decreasing and was 36.7% in 2012, 39.4% in 2011 and 50.0% in 2010, due to the increase in our commercial business which does not typically utilize the POC method. The development of cost of sales percentages used to record costs under certain fixed-price type contracts and fees under certain cost-reimbursement type contracts accounted for under the POC method of accounting requires management's judgment to make reasonably dependable cost estimates for the design, manufacture and delivery of products and services, generally over a long time period. Since certain fixed-price and cost-reimbursement type contracts extend over a long period of time, the impact of revisions in cost and revenue estimates during the progress of work may adjust the current period earnings on a cumulative catch-up basis. This method recognizes, in the current period, the cumulative effect of the changes on current and prior quarters. For fixed-price contracts, 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. These types of contracts and estimates are most frequently related to our sales to the U.S. Government or sales to other defense contractors for ultimate sale to the U.S. Government. Changes in estimates related to contracts accounted for under the POC method are recorded using the cumulative catch-up method of accounting. The net effect of these favorable and unfavorable changes in estimates were expense of $1.2 million in 2012 and $0.3 million of income in both 2011 and 2010. The aggregate effects of these favorable and unfavorable changes in estimates in 2012, 2011 and 2010 were $18.0 million, $4.7 million and $3.5 million of favorable operating income and $19.2 million, $4.4 million and $3.2 million of unfavorable operating income, respectively. We do not believe that any discrete event or adjustments to an individual contract within the aggregate changes in contract estimates for 2012, 2011 or 2010 was material to the consolidated statements of income for such annual periods. Accounting for Pension Plans The Company's accounting for its defined benefit pension plan requires that amounts recognized in financial statements be determined on an actuarial basis, rather than as contributions are made to the plan. A significant element in determining the Company's pension income or expense is the expected return on plan assets, as well as the assumed discount rate on pension liabilities. The Company has assumed, based upon the types of securities the plan assets are invested in and the long-term historical returns of these investments, that the long-term expected return on pension assets will be 8.25% in 2013 for its domestic pension plan, 6.4% for its United Kingdom based pension plan and 3.0% for its Swiss based pension plan, which was part of the LeCroy acquisition. The assumed discount rate will be 4.4% in 2013 for its domestic pension plan, 4.2% for its United Kingdom based pension plan and 1.8% for its Swiss based pension plan. The Company's long-term expected return on pension assets used in 2012 was 8.25% for its domestic pension plans and the assumed discount rate used in 2012 was 6.6%. For its United Kingdom based pension plan, the Company's long-term expected return on pension assets used in 2012 was 6.4% and the assumed discount rate used in 2012 was 4.7%. For its Swiss based pension plan, the Company's long-term expected return on pension assets used in 2012 was 3.0% and the assumed discount rate used in 2012 was 2.0%. The actual rate of return on pension assets was 13.9% in 2012 and a negative 0.4% in 2011 for its domestic pension plans. The actual rate of return on pension assets was 7.0% in 2012 and a negative 2.7% in 2011 for its United Kingdom based pension plan. If the actual rate of return on pension assets is above the projection, the Company may be able to reduce its contributions to the pension trust. If the actual rate of return on pension assets is below the projection, the Company may be required to make additional contributions to the pension trust. The Company made voluntary pretax cash contributions of $92.8 million to its domestic pension benefit plan in 2012 and made a voluntary pretax cash contribution of $83.0 million on January 7, 2013, before recovery from the U.S. Government. The assumed long-term rate of return on assets is applied to the market-related value of plan assets at the end of the previous year. The market-related value of plan assets is a smoothed value, where investment gains and losses have been smoothed over five years. This produces the expected return on plan assets that is included in the annual pension income or expense calculation for the current year. The cumulative difference between this expected return and the actual return on plan assets is deferred and amortized into pension income or expense over future periods. At year-end 2012 the Company has a $257.1 million non-cash reduction to stockholders' equity and a long-term additional liability of $418.6 million related to its pension plans. At year-end 2011, the Company had a $208.2 million non-cash reduction to stockholders' equity and a long-term additional liability of $339.9 million related to its pension plans. See Note 12 of the Notes to Consolidated Financial Statements for additional pension disclosures. 48-------------------------------------------------------------------------------- Table of Contents 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 2012 pension expense (in millions): 0.25 Percentage 0.25 Percentage Point Increase Point Decrease Increase (decrease) to pension expense resulting from: Change in discount rate $ (2.0 ) $ 2.1 Change in long-term rate of return on plan assets $ (2.1 ) $ 2.1 See Note 12 of the Notes to Consolidated Financial Statements for additional pension disclosures. Accounting for Business Combinations, Goodwill, Acquired Intangible Assets and Other Long-Lived Assets The Company accounts for goodwill and purchased intangible assets under ASC 80. In all acquisitions, the results are included in the Company's consolidated financial statements from the date of each respective acquisition. Business acquisitions are accounted for under the purchase 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. Purchased intangible assets with finite lives are amortized over their estimated useful lives. Adjustments to fair value assessments are recorded to goodwill over the purchase price allocation period. Goodwill and acquired intangible assets with indefinite lives are not amortized. We review goodwill and acquired indefinite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. The Company also performs an annual impairment test in the fourth quarter of each year. We would test goodwill for impairment between annual tests if events occur or circumstances change that would more likely than not reduce our enterprise fair value below its book value. These events or circumstances could include a significant change in the business climate, including a significant sustained decline in an entity's market value, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of the business, or other factors. Based on the annual impairment test completed in the fourth quarter of 2012, no impairment of goodwill or intangible assets with indefinite lives was indicated. For goodwill impairment testing, the Company estimates the fair value of the reporting units, using a discounted cash flow model based on our best estimate of amounts and timing of future revenues and cash flows and our most recent business and strategic plans, and compares the estimated fair value to the carrying value of the reporting unit, including goodwill. The discounted cash flow model requires judgmental assumptions about projected revenue growth, future operating margins, discount rates and terminal values. There are inherent uncertainties related to these assumptions and management's judgment in applying them to the analysis of goodwill impairment. While the Company believes it has made reasonable estimates and assumptions to calculate the fair value of its reporting units, it is possible a material change could occur. If actual results are not consistent with management's estimates and assumptions, goodwill may be overstated and a charge would need to be taken against net earnings. As of December 30, 2012, the Company had 35 reporting units for goodwill impairment testing. The carrying value of goodwill included in the Company's individual reporting units ranges from $0.5 million to $235.4 million. The Company's analysis in 2012 indicated that in all instances, the fair value of the Company's reporting units exceeded their carrying values and consequently did not result in an impairment charge. The excess of the estimated fair value over the carrying value (expressed as a percentage of carrying value of the respective reporting unit) for each of the Company's reporting units as of the fourth quarter of 2012, the annual testing date, ranged from approximately 38% to 2,756%. Changes in these projections could affect the estimated fair value of certain of the Company's reporting units and could result in a goodwill impairment charge in a future period. In order to evaluate the sensitivity of the fair value calculations used in the goodwill impairment test, the Company applied a hypothetical 10% decrease to the fair values of each reporting unit and compared those values to the reporting unit carrying values. Based on this sensitivity analysis, the Company did not identify any goodwill impairment charges. The impairment test for indefinite-lived intangibles other than goodwill (primarily trademarks and trade names) consists of a comparison of the fair value of the indefinite-lived intangible asset to the carrying value of the asset as of the impairment testing date. The Company estimates the fair value of its indefinite-lived intangibles using a discounted cash flow model based on our best estimate of amounts and timing of future revenues and cash flows and our most recent business and strategic plans, and compares the estimated fair value to the carrying value of the asset. The estimated fair values significantly exceed the carrying value for each of the Company's indefinite-lived intangible assets as of the fourth quarter of 2012, the annual testing date. 49-------------------------------------------------------------------------------- Table of Contents Accounting for 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. Our effective tax rates differ from the statutory rate primarily due to the tax impact of tax credits, including prior year research and development tax credits, state taxes, tax audit settlements and non U.S. subsidiaries taxed at rates less than 35%. The effective tax rate was 28.7%, 32.9% and 30.9% in 2012, 2011 and 2010, respectively. We record uncertain tax positions on the basis of a two-step process whereby (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. The following presents a rollforward of our unrecognized tax benefits (in millions): 2012 2011 2010 Beginning of year $ 25.8 $ 10.1 $ 25.2 Increase (decrease) in prior year tax positions (a) 18.1 18.7 (3.5 ) Increase for tax positions taken during the current period 1.5 0.7 0.6 Reduction related to settlements with taxing authorities - - (9.2 ) Reduction related to lapse of the statute of limitations (2.9 ) (3.5 ) (3.0 ) Impact of exchange rate changes 0.1 (0.2 ) - End of year $ 42.6 $ 25.8 $ 10.1 a) Includes the impact of acquisitions in 2012 and 2011. We recognized interest related to unrecognized tax benefits of $2.7 million and $1.7 million within the provision for income taxes in our statements of operations for fiscal year 2012 and 2011, respectively. As of December 30, 2012, we estimated that $32.9 million of unrecognized tax benefits, if resolved in our favor, would positively impact the effective tax rate and, therefore be recognized as additional tax benefits in our income statement. Of the $42.6 million of unrecognized tax benefits, $9.7 million would be offset by deferred tax assets. 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 2009, California income tax matters for all years through 2006 and Canadian income tax matters for all years through 2003. The Company is currently under audit in Canada for tax periods 2006 through 2011 and in California for tax years 2007 through 2009. The Company does not believe that the resolution of any of the audits will have a material adverse effect on the Company's results of operations. Substantially all other material state, local and foreign income tax matters have been concluded for years through 2006. The Company anticipates the total unrecognized tax benefit for various federal and state tax items may be reduced by $13.7 million due to the expiration of statutes of limitation and settlements with tax authorities for various federal, state and Canadian tax issues in the next 12 months. 50-------------------------------------------------------------------------------- Table of Contents Recent Accounting Pronouncements In July 2012, the Financial Accounting Standards Board ("FASB") issued new accounting guidance on the testing of indefinite-lived intangible assets for impairment. The guidance allows entities to first perform a qualitative assessment to determine the likelihood of an impairment for an indefinite-lived intangible asset and whether it is necessary to perform the quantitative impairment assessment currently required. This guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on Teledyne's financial position, results of operations or cash flows. In 2011, the FASB issued new disclosure guidance related to the presentation of the Statement of Comprehensive Income. The new disclosure guidance requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Teledyne adopted the new presentation requirement effective January 2, 2012. Teledyne elected the two-statement approach presenting other comprehensive income in a separate statement immediately following the condensed consolidated statements of income. In 2011, the FASB issued new accounting guidance that amends some fair value measurement principles and disclosure requirements. The new guidance provides a consistent definition and measurement of fair value, as well as similar disclosure requirements between U.S. GAAP and International Financial Reporting Standards. It also changes certain fair value measurement principles, clarifies the application of existing fair value measurement and expands the disclosure requirements, particularly for Level 3 fair value measurements. Teledyne's adoption of these new provisions, effective January 2, 2012, did not have an impact on our financial position or results of operations. Safe Harbor Cautionary Statement Regarding Forward-Looking Information This Management's Discussion and Analysis of Financial Condition and Results of Operation contains forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, directly and indirectly relating to earnings, growth opportunities, product sales, capital expenditures, pension matters, stock option compensation expense, the credit facility, interest expense, severance and relocation costs, taxes and strategic plans. All statements made in this Management's Discussion and Analysis of Financial Condition and Results of Operation that are not historical in nature should be considered forward-looking. Actual results could differ materially from these forward-looking statements. Many factors could change the anticipated results, including: disruptions in the global economy; changes in demand for products sold to the defense electronics, instrumentation, digital imaging, energy exploration and production, commercial aviation, semiconductor and communications markets; funding, continuation and award of government programs; and cuts to defense spending resulting from future deficit reduction measures, including potential automatic cuts to defense spending that have been triggered by the Budget Control Act of 2011. Increasing fuel costs could negatively affect the markets of our commercial aviation businesses. 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 negatively affect our businesses that supply the oil and gas industry. In addition, financial market fluctuations affect the value of our pension assets. Changes in the policies of U.S. and foreign governments could result, over time, in reductions and 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. 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 12 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. 51-------------------------------------------------------------------------------- Table of Contents |