Teledyne Technologies (TDY) 10-Q2021 Q1 Quarterly report

The accompanying unaudited condensed consolidated financial statements have been prepared by Teledyne Technologies Incorporated (“Teledyne” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in notes to consolidated financial statements have been condensed or omitted pursuant to such rules and regulations, but resultant disclosures are in accordance with generally accepted accounting principles in the United States (“GAAP”) as they apply to interim reporting. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the related notes in Teledyne’s Annual Report on Form 10-K for the fiscal year ended January 3, 2021 (“2020 Form 10-K”).

On January 5, 2020, we acquired OakGate Technology, Inc. (“OakGate”) for $28.5 million in cash, net of cash acquired. Based in Loomis, California, OakGate provides software and hardware designed to test electronic data storage devices from development through manufacturing and end-use applications. OakGate is part of the Test and Measurement product line of the Instrumentation segment. Teledyne funded the acquisition with cash on hand. The results of the OakGate acquisition have been included in Teledyne’s results since the date of the acquisition. Goodwill resulting from the acquisition of OakGate is not deductible for tax purposes.

The effectiveness of the cash flow hedge forward contracts, is assessed prospectively and retrospectively 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 hedges must be highly effective in offsetting changes to future cash flows on hedged transactions. The effective portion of the cash flow hedge forward contracts’ gains or losses resulting from changes in the fair value of these hedges is initially reported, net of tax, as a component of AOCI in stockholders’ equity until the underlying hedged item is reflected in our consolidated statements of income, at which time the effective amount in AOCI is reclassified to revenue in our consolidated statements of income. Net deferred gains recorded in AOCI, net of tax, for the forward contracts that will mature in the next twelve months total $4.8 million. These gains are expected to be offset by anticipated losses in the value of the forecasted underlying hedged item. Amounts related to the cross currency swaps and interest rate swap expected to be reclassified from AOCI into income in the next twelve months total $1.4 million.

The effect of derivative instruments designated as cash flow hedges in the condensed consolidated financial statements for the first quarter ended April 4, 2021 and March 29, 2020 was as follows (in millions):

The preceding table includes non-designated hedges derived from terms contained in triggered or previously designated cash flow hedges. The gains and losses on these derivatives which are not designated as hedging instruments are intended to, at a minimum, partially offset the transaction gains and losses recognized in earnings. Teledyne does not use foreign currency forward contracts for speculative or trading purposes.

The Company has elected to use the income approach to value the derivatives, using observable Level 2 market expectations at measurement date and standard valuation techniques to convert future amounts to a single present amount. Level 2 inputs for the valuations are limited to quoted prices for similar assets or liabilities in active markets (specifically futures contracts on LIBOR and EURIBOR) and inputs other than quoted prices that are observable for the asset or liability (specifically LIBOR and EURIBOR cash and swap rates, foreign currency forward rates and cross currency basis spreads). Mid-market pricing is used as a practical expedient for fair value measurements. The fair value measurement of an asset or liability must reflect the nonperformance risk of the entity and the counterparty. Therefore, the impact of the counterparty’s creditworthiness when in an asset position and the Company’s creditworthiness when in a liability position has also been factored into the fair value measurement of the derivative instruments and did not have a material impact on the fair value of these derivative instruments. Both the counterparty and the Company are expected to continue to perform under the contractual terms of the instruments.

The fair values of the Company’s derivative financial instruments are presented below. All fair values for these derivatives were measured using Level 2 information as defined by the accounting standard hierarchy (in millions):

Teledyne has long-term incentive plans pursuant to which it has granted non-qualified stock options, restricted stock and performance shares to certain employees. The Company also has non-employee Board of Director stock compensation plans, pursuant to which common stock, stock options and restricted stock units have been issued to its directors.

For over time contracts using the cost-to-cost method, we have an Estimate at Completion (“EAC”) process in which management reviews the progress and execution of our performance obligations. This EAC process requires management judgment relative to assessing risks, estimating contract revenue and cost, and making assumptions for schedule and technical issues. Since certain contracts extend over multiple reporting periods, the impact of revisions in cost and revenue estimates during the progress of work may adjust the current period earnings through a cumulative catch-up basis. This method recognizes, in the current period, the cumulative effect of the changes on current and prior quarters. Additionally, if the current contract estimate indicates a loss, a provision is made for the total anticipated loss in the period that it becomes evident. Contract cost and revenue estimates for significant contracts are reviewed and reassessed quarterly. The majority of revenue recognized over time uses an EAC process. The net aggregate effects of changes in estimates on contracts accounted for under the cost-to-cost method in the first three months of 2021 was approximately $7.7 million of favorable operating income, primarily related to favorable changes in estimates that impacted revenue within the Digital Imaging segment. The net aggregate effects of changes in estimates on contracts accounted for under the cost-to-cost method in the first three months of 2020 was approximately $4.4 million of favorable operating income, primarily related to favorable changes in estimates that impacted revenue, and, to a lesser degree, cost of sales. None of the effects of changes in estimates on any individual contract were material to the condensed consolidated statements of income for any period presented.

The Company recognized revenue of $52.6 million during the three months ended April 4, 2021 from contract liabilities that existed at the beginning of year. The Company recognizes the incremental costs of obtaining or fulfilling a contract as expense when incurred if the amortization period of the asset is one year or less. Incremental costs to obtain or fulfill contracts with an amortization period greater than one year were not material.

Remaining performance obligations represent the transaction price of firm orders for which work has not been performed as of the period end date and excludes unexercised contract options and potential orders under ordering-type contracts (e.g., indefinite-delivery, indefinite-quantity). As of April 4, 2021, the aggregate amount of the transaction price allocated to remaining performance obligations was $1,987.4 million. The Company expects approximately 78% of remaining performance obligations to be recognized into revenue within the next twelve months, with the remaining 22% recognized thereafter.

In the first quarter of 2021, Teledyne completed various financing activities related to the pending acquisition of FLIR and incurred related interest and debt expense totaling $33.1 million. These activities included entering into a $4.5 billion short term stand-by bridge facility on January 4, 2021, as required by the definitive agreement, resulting in debt expense of $17.2 million. In addition, on March 17, 2021 Teledyne called $493.3 million of existing fixed rate senior notes and incurred debt extinguishment expenses of $13.4 million, which is included in interest and debt expense, net. On March 22, 2021, Teledyne completed all permanent financing for the pending acquisition of FLIR. The permanent financing consists of $3.0 billion investment-grade bonds (the “Notes”), including $300.0 million aggregate principal amount of 0.65% Notes due 2023, $450.0 million aggregate principal amount of 0.95% Notes due 2024, $450.0 million aggregate principal amount of 1.60% Notes due 2026, $700.0 million aggregate principal amount of 2.25% Notes due 2028 and $1.1 billion aggregate principal amount of 2.75% Notes due 2031. We may redeem the $450.0 million of 0.95% Notes due 2024 at any time or from time to time, in whole or in part, at the Company’s option, from and after April 1, 2022, at a redemption price equal to 100% of the principal amount of the Notes redeemed. Given the permanent financing, together with certain continuing debt, Teledyne expects its weighted average borrowing cost to be less than 2 percent upon closing the acquisition. The interest expense incurred in the quarter associated with the $3.0 billion Notes offering related to the pending FLIR acquisition totaled $2.5 million. Previously on March 4, 2021, Teledyne entered into a $1.0 billion Term Loan Credit Agreement and Amended and Restated Credit Agreement with capacity of $1.15 billion both maturing on March 4, 2026. The terms of the $1.0 billion

Term Loan Credit Agreement allow for prepayments, at the Company’s option, at any time or from time to time, in whole or in part without premium or penalty. As a result of the completion of the permanent debt financing, on March 22, 2021 Teledyne terminated the $4.5 billion stand-by bridge facility. Teledyne intends to use the proceeds from the Notes together with the proceeds from the $1.0 billion Term Loan Credit Agreement, expected to be drawn at the closing of the acquisition, and cash on hand to pay the cash portion of the consideration for the FLIR acquisition and refinance certain existing debt.

Available borrowing capacity under the $750.0 million credit facility, which is reduced by borrowings and certain outstanding letters of credit, was $616.0 million at April 4, 2021. The credit agreements require the Company to comply with various financial and operating covenants and at April 4, 2021, the Company was in compliance with these covenants. At April 4, 2021, Teledyne had $26.5 million in outstanding letters of credit.

Teledyne estimates the fair value of its long-term debt based on debt of similar type, rating and maturity and at comparable interest rates. The Company’s long-term debt is considered a level 2 fair value hierarchy and is valued based on observable market data. The estimated fair value of Teledyne’s long-term debt at April 4, 2021 and January 3, 2021, approximated the carrying value.

At April 4, 2021, Teledyne has right-of-use assets of $119.4 million and a total lease liability for operating leases of $133.3 million of which $111.9 million is included in long-term lease liabilities and $21.4 million is included in current accrued liabilities. Operating lease expense was $6.4 million for the first quarter of 2021. Operating lease expense was $6.1 million for the first quarter of 2020.

For a further description of the Company’s commitments and contingencies, reference is made to Note 14 of the Company’s financial statements as of and for the fiscal year ended January 3, 2021, included in the 2020 Form 10-K.

At April 4, 2021, the Company’s reserves for environmental remediation obligations totaled $6.4 million, of which $1.5 million is included in current accrued liabilities. At January 3, 2021, the Company’s reserves for environmental remediation obligations totaled $6.5 million. The Company evaluates whether it may be able to recover a portion of future costs for environmental liabilities from its insurance carriers and from third parties. The timing of expenditures depends on a number of factors that vary by site, including the nature and extent of contamination, the number of potentially responsible parties, the timing of regulatory approvals, the complexity of the investigation and remediation, and the standards for remediation. The Company expects that it will expend present accruals over many years and will complete remediation of all sites with which it has been identified in up to 30 years.

A number of other lawsuits, claims and proceedings have been or may be asserted against the Company, including those pertaining to product liability, acquisitions, patent infringement, contracts, environmental, employment and employee benefits matters. While the outcome of litigation cannot be predicted with certainty, and some of these lawsuits, claims or proceedings may be determined adversely to the Company, management does not believe that the disposition of any such pending matters is likely to have a material adverse effect on the Company’s financial statements.

For the domestic qualified pension plans, the weighted-average discount rate decreased to 2.64% in 2021, compared with 3.41% for 2020. Teledyne has not made any cash pension contributions to its domestic qualified pension plans since 2013 and 0 cash pension contributions are planned for 2021.

Segment results includes net sales and operating income by segment but excludes non-service retirement benefit income, equity income or loss, unusual non-recurring legal matter settlements, interest income and expense, gains and losses on the disposition of assets, sublease rental income and non-revenue licensing and royalty income, domestic and foreign income taxes and corporate office expenses. Corporate expense includes various administrative expenses relating to the corporate office and certain non-operating expenses, including certain acquisition-related transaction costs, not allocated to our segments.

As part of a continuing effort to reduce costs and improve operating performance, as well as to respond to the impact of COVID-19, beginning in 2020, the Company took actions to reduce headcount across various businesses, reducing our exposure to weak end markets, such as commercial aerospace. Teledyne incurred $1.0 million in expense related to these actions, including facility consolidation expense, for the first quarter of 2021, compared with $3.7 million for the first quarter of 2020. At April 4, 2021, Teledyne had a liability of $1.3 million included in other current liabilities related to these actions.

The following table presents Teledyne’s segment disclosures (dollars in millions):

Teledyne Technologies Incorporated (“Teledyne” or the “Company”) provides enabling technologies for industrial growth markets that require advanced technology and high reliability. These markets include aerospace and defense, factory automation, air and water quality environmental monitoring, electronics design and development, oceanographic research, deepwater oil and gas exploration and production, medical imaging and pharmaceutical research. Our products include digital imaging sensors, cameras and systems within the visible, infrared and X-ray spectra, monitoring and control instrumentation for marine and environmental applications, harsh environment interconnects, electronic test and measurement equipment, aircraft information management systems, and defense electronics and satellite communication subsystems. We also supply engineered systems for defense, space, environmental and energy applications. We differentiate ourselves from many of our direct competitors by having a customer and Company-sponsored applied research center that augments our product development expertise. We believe that technological capabilities and innovation and the ability to invest in the development of new and enhanced products are critical to obtaining and maintaining leadership in our markets and the industries in which we compete.

Our strategy continues to emphasize growth in our core markets of instrumentation, digital imaging, aerospace and defense electronics and engineered systems. Our core markets are characterized by high barriers to entry and include specialized products and services not likely to be commoditized. We intend to strengthen and expand our core businesses with targeted acquisitions and through product development. We continue to focus on balanced and disciplined capital deployment among capital expenditures, acquisitions and product development. We aggressively pursue operational excellence to continually improve our margins and earnings by emphasizing cost containment and cost reductions in all aspects of our business. At Teledyne, operational excellence includes the rapid integration of the businesses we acquire. Using complementary technology across our businesses and internal research and development, we seek to create new products to grow our Company and expand our addressable markets. We continue to evaluate our businesses to ensure that they are aligned with our strategy.

Teledyne and FLIR Systems, Inc. (“FLIR”) have entered into a definitive agreement under which Teledyne will acquire FLIR in a cash and stock transaction valued at approximately $8.0 billion. Under the terms of the agreement, FLIR stockholders will receive $28.00 per share in cash and 0.0718 shares of Teledyne common stock for each FLIR share, which implied a total purchase price of $56.00 per FLIR share based on Teledyne’s 5-day volume weighted average price as of December 31, 2020. The transaction is expected to close on May 14, 2021, subject to the receipt of required regulatory approvals, including approvals of Teledyne and FLIR stockholders and other customary closing conditions. Teledyne has received antitrust clearance for the pending acquisition from regulatory authorities in the United States, Canada, China, Germany, Poland and South Korea. In the first quarter of 2021, Teledyne completed various financing activities related to the pending acquisition of FLIR and incurred related interest and debt expense totaling $33.1 million. These activities included entering into a $4.5 billion short term stand-by bridge facility on January 4, 2021, as required by the definitive agreement, resulting in debt expense of $17.2 million. In addition, on March 17, 2021 Teledyne called $493.3 million of existing fixed rate senior notes and incurred debt extinguishment expenses of $13.4 million, which is included in interest and debt expense, net. On March 22, 2021, Teledyne completed all permanent financing for the pending acquisition of FLIR. The permanent financing consists of $3.0 billion investment-grade bonds (the “Notes”), including $300.0 million aggregate principal amount of 0.65% Notes due 2023, $450.0 million aggregate principal amount of 0.95% Notes due 2024, $450.0 million aggregate principal amount of 1.60% Notes due 2026, $700.0 million aggregate principal amount of 2.25% Notes due 2028 and $1.1 billion aggregate principal amount of 2.75% Notes due 2031. Teledyne may redeem the $450.0 million of 0.95% Notes due 2024 at any time or from time to time, in whole or in part, at the Company’s option, from and after April 1, 2022, at a redemption price equal to 100% of the principal amount of the Notes redeemed. Given the permanent financing, together with certain continuing debt, Teledyne expects its weighted average borrowing cost to be less than two percent upon closing the acquisition. The interest expense incurred in the quarter associated with the $3.0 billion Notes offering related to the pending FLIR acquisition totaled $2.5 million. Previously on March 4, 2021, Teledyne entered into a $1.0 billion Term Loan Credit Agreement and Amended and Restated Credit Agreement with capacity of $1.15 billion both maturing on March 4, 2026. The terms of the $1.0 billion Term Loan Credit Agreement allow for prepayments, at the Company’s option, at any time or from time to time, in whole or in part without premium or penalty. As a result of the completion of the permanent debt financing, on March 22, 2021 Teledyne terminated the $4.5 billion stand-by bridge facility. Teledyne intends to use the proceeds from the Notes together with the proceeds from the $1.0 billion Term Loan Credit Agreement, expected to be drawn at the closing of the acquisition, and cash on hand to pay the cash portion of the consideration for the FLIR acquisition and refinance certain existing debt.

At April 4, 2021, total debt was $3,243.3 million, compared with total debt of $778.5 million at January 3, 2021. The debt balance at April 4, 2021, includes the debt incurred to fund the cash portion of the consideration for the FLIR acquisition. At April 4, 2021, $125.0 million was outstanding under the $750.0 million credit facility with available borrowing capacity under the facility, which is reduced by borrowings and certain outstanding letters of credit, of $616.0 million.

With regard to the COVID-19 pandemic, our first priority remains the health and safety of our employees and their families. Our manufacturing sites are deemed essential businesses and remain operational, and we are practicing social distancing, enhanced cleaning protocols, usage of personal protective equipment and other preventative measures. We are providing certain incentives to employees to promote vaccinations.

While no company is immune to global economic challenges, Teledyne's business portfolio is well-balanced across end markets and geographies, and includes a high degree of businesses serving critical infrastructure sectors such as the defense industrial base, water and wastewater, and healthcare and public health. However, given the continuing dynamic nature of this situation, the Company may not fully estimate the impacts of COVID-19 on its financial condition, results of operations or cash flows.

As part of a continuing effort to reduce costs and improve operating performance, as well as to respond to the impact of COVID-19, beginning in 2020, the Company took actions to reduce headcount across various businesses, reducing our exposure to weak end markets, such as commercial aerospace.