Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report filed on Form 10-K for the fiscal year ended
October 1, 2016
. All references to years in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are to fiscal years and amounts may differ from reported values due to rounding.
OVERVIEW
We are a worldwide designer, manufacturer and systems integrator of high performance precision motion and fluid controls and control systems for a broad range of applications in aerospace and defense and industrial markets.
Within the aerospace and defense market, our products and systems include:
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Defense market - primary and secondary flight controls for military aircraft, stabilization and automatic ammunition loading controls for armored combat vehicles, tactical and strategic missile steering controls and gun aiming controls.
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•
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Commercial aircraft market - primary and secondary flight controls for commercial aircraft.
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•
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Commercial space market - satellite positioning controls and thrust vector controls for space launch vehicles.
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In the industrial market, our products are used in a wide range of applications including:
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Industrial automation market - injection molding, metal forming, heavy industry, material and automotive testing and pilot training simulators.
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•
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Energy market - wind energy, power generation and oil and gas exploration.
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Medical market - enteral clinical nutrition and infusion therapy pumps, CT scanners and ultrasonic sensors and surgical handpieces.
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We operate under four segments, Aircraft Controls, Space and Defense Controls, Industrial Systems and Components. Our principal manufacturing facilities are located in the United States, Philippines, United Kingdom, Germany, India, Costa Rica, China, Japan, Italy, Netherlands, Canada, Ireland and Luxembourg.
We have long-term contracts with some of our customers. These contracts are predominantly within Aircraft Controls and Space and Defense Controls and represent
34%
,
33%
and
34%
of our sales in 2016, 2015 and 2014, respectively. We recognize revenue on these contracts using the percentage of completion, cost-to-cost method of accounting as work progresses toward completion. The remainder of our sales are recognized when the risks and rewards of ownership and title to the product are transferred to the customer, principally as units are delivered or as service obligations are satisfied. This method of revenue recognition is predominantly used within the Industrial Systems and Components segments, as well as with aftermarket activity.
We concentrate on providing our customers with products designed and manufactured to the highest quality standards. Our products are applied in demanding applications, "When Performance Really Matters
®
." We believe we have achieved a leadership position in the high performance, precision controls market, by capitalizing on our strengths, which include:
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superior technical competence in delivering mission-critical solutions,
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a focused customer-intimacy approach,
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•
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a diverse base of customers and end markets served by a broad product portfolio, and
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•
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a well-established international presence serving customers worldwide.
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These strengths afford us the ability to innovate our current solutions into new, complimentary technologies. They also provide us the opportunity to expand our control product franchise from one market to another, organically growing us from a high-performance components supplier to a high-performance systems supplier. In addition, we continually strive to achieve substantial content positions on the platforms on which we currently participate, seeking to be the dominant supplier in the current niche markets we serve. We also look for innovation in all aspects of our business, employing new technologies to improve productivity and to develop new business models.
These activities will help us achieve our financial objectives of increasing our revenue base and improving our long term profitability and cash flow from operations. In doing so, we expect to maintain a balanced, diversified portfolio in terms of markets served, product applications, customer bases and geographic presence. Our fundamental strategies to achieve our goals center around talent, lean and innovation and include:
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maintaining our technological excellence by building upon our systems integration capabilities while solving our customers’ most demanding technical problems in applications "When Performance Really Matters
®
,"
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•
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utilizing our global capabilities and strong engineering heritage to expand our product offerings,
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•
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maximizing customer value by implementing lean enterprise principles, and
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investing in talent development to strengthen our leadership capability and employee performance.
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We focus on improving shareholder value through strategic revenue growth, both acquired and organic, through improving operating efficiencies and manufacturing initiatives and through utilizing low cost manufacturing facilities without compromising quality. Additionally, we take a balanced approach to capital deployment, which may include strategic acquisitions or further share buyback activity in order to maximize shareholder returns over the long-term. We face numerous challenges to improving shareholder value. These include, but are not limited to, adjusting to dynamic global economic conditions that are influenced by governmental, industrial and commercial factors, pricing pressures from customers, strong competition, foreign currency fluctuations and increases in employee benefit costs. We may also engage in restructuring and divesting activities, including reducing overhead, consolidating facilities and exiting some product lines if we deem the operations as non-strategic or underperforming.
Acquisition and Divestiture
All of our acquisitions are accounted for under the purchase method and, accordingly, the operating results for the acquired companies are included in the consolidated statements of earnings from the respective dates of acquisition. Under purchase accounting, we record assets and liabilities at fair value and such amounts are reflected in the respective captions on the consolidated balance sheets. The purchase price described for each acquisition below is net of any cash acquired, includes debt issued or assumed and the fair value of contingent consideration.
In 2016, we acquired a 70% ownership in Linear Mold and Engineering ("Linear"), a Livonia, Michigan-based company specializing in metal additive manufacturing that provides engineering, manufacturing and production consulting services to customers across a wide range of industries, including aerospace, defense, energy and industrial. We acquired our share in Linear Mold and Engineering for $23 million. The acquisition also includes a redeemable noncontrolling interest in the remaining 30%. This acquisition is included in our Space and Defense Controls segment. On January 25, 2017, we acquired the remaining 30% redeemable noncontrolling interest for $2 million in cash, which will also be reflected in additional paid-in capital.
In 2017, we recorded losses in other expense of $9 million related to selling the European space businesses of our Space and Defense Controls segment. We received $1 million in cash and reclassified $7 million in other current assets and $3 million in other current liabilities as held for sale. We expect the sale of the held for sale portion of these businesses to be completed during 2017.
CRITICAL ACCOUNTING POLICIES
On a regular basis, we evaluate the critical accounting policies used to prepare our consolidated financial statements, including, but not limited to, revenue recognition on long-term contracts, contract loss reserves, reserves for inventory valuation, reviews for impairment of goodwill, purchase price allocations for business combinations, pension assumptions and deferred tax asset valuation allowances.
There have been no material changes in critical accounting policies in the current year from those disclosed in our 2016 Annual Report on Form 10-K.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1 of the Consolidated Condensed Financial Statements included in Item 1, Financial Statements of this report for further information regarding Financial Accounting Standards Board issued Accounting Standards Updates ("ASU").
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CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK
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Three Months Ended
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(dollars and shares in millions, except per share data)
|
December 31, 2016
|
January 2, 2016
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$ Variance
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% Variance
|
Net sales
|
$
|
590
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|
$
|
568
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|
$
|
21
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|
4
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%
|
Gross margin
|
29.3
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%
|
28.4
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%
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Research and development expenses
|
$
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35
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$
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35
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$
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—
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(1
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%)
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Selling, general and administrative expenses as a percentage of sales
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14.4
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%
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14.6
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%
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Interest expense
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$
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8
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$
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8
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$
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—
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2
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%
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Other
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$
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8
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$
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—
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$
|
8
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|
n/a
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Effective tax rate
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17.6
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%
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26.6
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%
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Net earnings attributable to Moog
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$
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31
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$
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26
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$
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4
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16
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%
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Diluted average common shares outstanding
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36
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37
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(1
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)
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(2
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%)
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Diluted earnings per share attributable to Moog
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$
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0.84
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$
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0.71
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$
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0.13
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18
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%
|
Net sales increased in the first quarter of 2017 compared to the first quarter of 2016. Sales increased in Aircraft Controls, Components and Space and Defense Controls, and decreased in Industrial Systems. Weaker foreign currencies, primarily the British Pound relative to the U.S. Dollar, decreased sales $8 million.
Gross margin increased in the first quarter of 2017 compared to the same period of 2016. We benefited from a favorable sales mix, primarily in Space and Defense Controls and Components, due to higher defense controls and medical program sales, respectively. In addition, the restructuring benefits from actions taken in 2016 increased profitability $1 million from reduced costs.
Research and development expenses were unchanged in the first quarter of 2017 compared to the same period of 2016. Within Aircraft Controls, research and development expenses decreased $2 million, as we had lower activity on the Embraer E-2 and the Airbus A350 programs. The reduced spend was offset by small increases in research and development activities across our remaining three segments.
In the first quarter of 2017 compared to the first quarter of 2016, selling, general and administrative expenses as a percentage of sales decreased slightly. Most of the decline is attributable to our continued focus on expense reduction, primarily in Aircraft Controls. Additionally, we benefited $2 million from our 2016 restructuring activities.
Other expense in the first quarter of 2017 includes $9 million of losses associated with selling our European space businesses.
Our effective tax rates in both 2017 and 2016 are lower than the U.S. statutory tax rate. The effective tax rate in the first quarter of 2017 includes the tax benefits associated with selling our European space businesses. The effective tax rate in the first quarter of 2016 included the benefit from the enactment of legislation reinstating the research and development tax credit in the U.S.
Average common shares outstanding decreased in the first quarter of 2017 compared to the same period of 2016 due to our share buyback program. Since the Board of Directors amended the program in January 2014, we have repurchased ten million shares, and have three million additional shares available for repurchase under this program.
Other comprehensive loss in the first quarter of 2017 includes $42 million of foreign currency translation loss. In the first quarter of 2016, other comprehensive loss included $23 million of foreign currency translation loss. Foreign currency translation adjustments decreased $18 million during this period, primarily attributable to the changes in the Euro, the British Pound and the Japanese Yen.
2017 Outlook
– We expect sales in 2017 to increase 1% from fiscal 2016 to $2.4 billion, driven primarily by higher OEM sales for the Airbus A350 program in Aircraft Controls. We also expect sales in Components will increase due to higher medical pump sales. Partially offsetting the sales growth is an expected decline in Industrial Systems across our major markets. We expect operating margin will remain flat at 10.0% in 2017 compared with 9.9% in 2016. The absence of the 2016 restructuring expense and goodwill impairment charge, as well as the associated restructuring benefits, will help drive margin expansion. These will be offset by an unfavorable sales mix and the losses associated with selling our European space businesses. We expect net earnings attributable to Moog will remain flat with 2016 at $127 million. Average diluted shares outstanding will decrease 1% to 36 million due to shares already repurchased under our current share buyback program. We expect diluted earnings per share will range between $3.30 and $3.70, with a midpoint of $3.50, an increase of 1% compared to 2016.
SEGMENT RESULTS OF OPERATIONS AND OUTLOOK
During 2016, we made changes to our segment reporting. Components now includes the Medical Devices product lines, which we previously reported as a separate segment. Space and Defense Controls now includes Linear, which we previously included in the Aircraft Controls segment. All amounts have been restated to present Medical Devices within Components, and Linear within Space and Defense Controls.
Operating profit, as presented below, is net sales less cost of sales and other operating expenses, excluding interest expense, equity-based compensation expense and other corporate expenses. Cost of sales and other operating expenses are directly identifiable to the respective segment or allocated on the basis of sales, manpower or profit. Operating profit is reconciled to earnings before income taxes in Note 16 of the Notes to Consolidated Condensed Financial Statements included in this report.
Aircraft Controls
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Three Months Ended
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(dollars in millions)
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December 31, 2016
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January 2, 2016
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$ Variance
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% Variance
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Net sales - military aircraft
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$
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128
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$
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120
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$
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8
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6
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%
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Net sales - commercial aircraft
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141
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134
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7
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5
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%
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$
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268
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$
|
254
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$
|
14
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|
6
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%
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Operating profit
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$
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23
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$
|
18
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$
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5
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|
25
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%
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Operating margin
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8.6
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%
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7.3
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%
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Backlog
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$
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610
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$
|
639
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$
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(29
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)
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(5
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%)
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Aircraft Controls' net sales increased in both military and commercial aircraft programs the first quarter of 2017 compared to the first quarter of 2016. Weaker foreign currencies, primarily the British Pound relative to the U.S. Dollar, decreased sales $5 million.
In the first quarter of 2017 compared to the first quarter of 2016, military OEM sales increased $9 million while military aftermarket sales declined $2 million. Military OEM sales for the F-35 increased $5 million due to higher production volumes. Also, higher levels of military funded development jobs offset lower foreign military sales. The decreased military aftermarket sales was driven primarily by lower B-2 spares purchases. Additionally in the first quarter of 2017, commercial OEM sales increased $8 million while commercial aftermarket sales decreased $1 million. Commercial OEM sales for the Airbus A350 program increased $10 million due to the program's production volume ramp up. The decreased commercial aftermarket sales was due to lower Boeing 787 and A350 initial provisioning sales.
Operating margin increased in the first quarter of 2017 compared to the first quarter of 2016. Research and development expenses decreased $2 million, as we had lower activity on the Embraer E-2 and the Airbus A350 programs. Additionally, operating profit benefited $1 million from the restructuring benefits associated with exiting a product line in the second quarter of 2016, and are in line with our total expected return.
The decrease of twelve-month backlog for Aircraft Controls at December 31, 2016 compared to January 2, 2016 is primarily due to lower orders for legacy commercial OEM programs, but is partially offset by higher orders for the F-35.
2017 Outlook for Aircraft Controls
–
We expect sales in Aircraft Controls to increase 4% from 2016 driven primarily by the continued ramp up of the Airbus A350 program. Partially offsetting the growth is expected lower commercial aftermarket sales on lower initial provisioning for the Boeing 787 program. We expect military sales will increase marginally, as higher F-35 sales are mostly offset by lower sales in other military programs. We expect operating margin will increase to 9.5% in 2017 from 9.3% in 2016. We expect that research and development costs will decrease $10 million, our restructuring expenses will not repeat and we will continue to realize the benefits of cost saving activities. However, partially offsetting these positive effects on operating margin is an expected negative sales mix. Sales from our newer military cost plus development jobs and higher sales on newer, lower margin commercial OEM platforms are replacing sales from higher-margin foreign military programs, and we expect lower commercial aftermarket sales.
Space and Defense Controls
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Three Months Ended
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(dollars in millions)
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December 31, 2016
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January 2, 2016
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$ Variance
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% Variance
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Net sales
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$
|
93
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$
|
84
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$
|
9
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|
11
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%
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Operating profit
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$
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7
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$
|
12
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$
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(4
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)
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(38
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%)
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Operating margin
|
7.6
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%
|
13.8
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%
|
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Backlog
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$
|
278
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$
|
238
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$
|
41
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|
17
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%
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Space and Defense Controls' net sales increased in our space and our defense markets in the first quarter of 2017 compared to the same period of 2016.
Sales in our space market increased $5 million in the first quarter of 2017 compared to the first quarter of 2016, due in part to new satellite propulsion customers. Within our defense market, sales increased $4 million in the first quarter of 2017, driven by higher LAV turret upgrade program sales in defense controls and by higher naval program sales.
Operating margin decreased in the first quarter of 2017 compared to the first quarter of 2016, due to losses associated with selling our European space businesses. Operating margin excluding the losses would have been 17.3% in the first quarter of 2017, reflecting a favorable sales mix in our defense markets.
The higher level of twelve-month backlog for Space and Defense Controls at December 31, 2016 compared to January 2, 2016 is due to higher orders for defense controls programs and satellites programs.
2017 Outlook for Space and Defense Controls
–
We expect sales in Space and Defense Controls to remain flat from fiscal 2016. We expect sales in our space market will remain flat as higher satellite component sales are offset by slightly lower launch vehicle sales. Additionally, we expect sales in our defense market will remain flat as higher sales for products on U.S. defense vehicles are offset by lower missile sales. We expect operating margin will decrease to 10.7% in 2017 from 11.3% in 2016, due to the impact of losses associated with selling our European space businesses. Excluding these losses, we expect operating margin to increase to 13.2% in 2017. This increase is driven by the lack of the prior year's goodwill impairment charge and by the continued realized savings from our cost containment actions.
Industrial Systems
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Three Months Ended
|
(dollars in millions)
|
December 31, 2016
|
January 2, 2016
|
$ Variance
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% Variance
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Net sales
|
$
|
112
|
|
$
|
125
|
|
$
|
(13
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)
|
(10
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%)
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Operating profit
|
$
|
11
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|
$
|
14
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$
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(3
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)
|
(22
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%)
|
Operating margin
|
9.5
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%
|
10.9
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%
|
|
|
Backlog
|
$
|
134
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$
|
166
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|
$
|
(31
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)
|
(19
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%)
|
Industrial Systems' net sales decreased across our three markets in the first quarter of 2017 compared to the first quarter of 2016.
In our industrial automation market, sales decreased $6 million in the first quarter of 2017 compared to the first quarter of 2016. The decrease is due to lower U.S. sales, primarily related to lower levels of aftermarket support activity, as well as the absence of prior year's orders. Also, sales in our test and simulation market decreased $5 million, due to the absence of last year's large sales volumes in material testing and simulation programs. Additionally, sales in our energy market decreased $2 million, mainly as a result of lost sales to a key customer in Brazil who was acquired.
Operating margin decreased in the first quarter of 2017 compared to the first quarter of 2016, due in part to lower sales volumes across our three markets. Also, operating expenses, including research and development and selling, general and administrative, increased $1 million. Partly offsetting these impacts was $1 million of benefits from our 2016 restructuring activities, which are in line with our total expected return.
The lower level of twelve-month backlog in Industrial Systems at December 31, 2016 compared to January 2, 2016 is due to lower energy orders related to the decline in that market and the completion of simulation orders.
2017 Outlook for Industrial Systems
–
We expect sales in Industrial Systems to decline 9% from 2016 across all of our major markets. Approximately half of the decline is due to lower demand. Specifically, we expect that wind energy sales will decrease as a result of lost sales to a key customer who was acquired. Also, we expect that simulation and test sales will decrease from the high level of sales in 2016. Additionally, we expect lower industrial automation sales as the global economic conditions continue to negatively impact our sales. The other half of the expected sales decline is due to the strengthening U.S. Dollar relative to our other currencies. We expect operating margin will increase to 10.4% in 2017 from 9.4% in 2016, as we will benefit from both our restructuring actions in 2016 and our continued cost containment actions.
Components
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Three Months Ended
|
(dollars in millions)
|
December 31, 2016
|
January 2, 2016
|
$ Variance
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% Variance
|
Net sales
|
$
|
116
|
|
$
|
106
|
|
$
|
10
|
|
10
|
%
|
Operating profit
|
$
|
11
|
|
$
|
8
|
|
$
|
3
|
|
44
|
%
|
Operating margin
|
9.9
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%
|
7.5
|
%
|
|
|
Backlog
|
$
|
168
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|
$
|
171
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|
$
|
(3
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)
|
(2
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%)
|
Components' net sales increased across all of our markets in the first quarter of 2017 compared to the first quarter of 2016.
Sales in our medical market increased $5 million in the first quarter of 2017 compared to the same period of 2016, as we had higher sales on medical pumps, sets and sensors and handpieces. Also, sales increased $4 million in our aerospace and defense market, primarily related to higher shipments on the Guardian program.
Operating margin increased in the first quarter of 2017 compared to the same period of 2016. In the first quarter of 2017, we benefited from an improved sales mix, primarily in our medical market. Additionally, we had $1 million of restructuring benefits associated with the 2016 restructuring activities, which are in line with our total expected return.
The twelve-month backlog at December 31, 2016 is comparable to the level at January 2, 2016, as lower orders for our defense and marine energy products are offset by higher orders for our medical and industrial products.
2017 Outlook for Components –
We expect sales in Components to increase 2% from 2016. We expect that our medical market will contribute all of the growth due to higher sales volumes of pumps and sets. We expect that our aerospace and defense sales and our industrial sales will remain flat. We expect operating margin will decrease to 10.4% in 2017 from 10.7% in 2016, as we continue to be affected by the negative sales mix in our industrial and our aerospace and defense markets.
FINANCIAL CONDITION AND LIQUIDITY
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Three Months Ended
|
(dollars in millions)
|
December 31,
2016
|
January 2,
2016
|
$ Variance
|
% Variance
|
Net cash provided (used) by:
|
|
|
|
|
Operating activities
|
$
|
51
|
|
$
|
—
|
|
$
|
51
|
|
n/a
|
|
Investing activities
|
(16
|
)
|
(22
|
)
|
6
|
|
(29
|
%)
|
Financing activities
|
(13
|
)
|
44
|
|
(57
|
)
|
(129
|
%)
|
Our available borrowing capacity and our cash flow from operations provide us with the financial resources needed to run our operations, reinvest in our business and make strategic acquisitions.
At
December 31, 2016
, our cash balance was
$332 million
, which is primarily held outside of the U.S. Cash flow from our U.S. operations, together with borrowings on our credit facility, fund on-going activities, debt service requirements and future growth investments. We reinvest the cash generated from foreign operations locally and such international balances are not available to pay down debt in the U.S. unless we decide to repatriate such amounts. During 2016, we repatriated $91 million of earnings from various foreign subsidiaries and used the funds to pay down our U.S. revolving credit facility. If we determine further repatriation of foreign funds is necessary, we would then be required to pay U.S. income taxes on those funds.
Operating activities
Net cash provided by operating activities increased in the first quarter of 2017 compared to the same period of 2016. Cash provided by accounts payable increased $29 million due to favorable timing across all of our segments. Also, cash provided by inventory increased $18 million, primarily in Aircraft Controls across a variety of programs. In addition, cash increased $9 million due to higher net earnings adjusted for non-cash losses.
Investing activities
Net cash used by investing activities in the first quarter of 2017 included $15 million for capital expenditures. Net cash used by investing activities in the first quarter of 2016 included $12 million for capital expenditures and $11 million as partial payment for the Linear acquisition.
We expect our
2017
capital expenditures to be approximately $80 million, as we support the increased production of commercial aircraft.
Financing activities
Cash used by financing activities in the first quarter of 2017 includes net payments on our credit facility, while c
ash provided by financing activities in the first quarter of 2016 includes net proceeds from our credit facility.
Off Balance Sheet Arrangements
We do not have any material off balance sheet arrangements that have or are reasonably likely to have a material future effect on our results of operations or financial condition.
Contractual Obligations and Commercial Commitments
Our contractual obligations and commercial commitments have not changed materially from the disclosures in our 2016 Annual Report on Form 10-K.
CAPITAL STRUCTURE AND RESOURCES
We maintain bank credit facilities to fund our short and long-term capital requirements, including for acquisitions. From time to time, we also sell debt and equity securities to fund acquisitions or take advantage of favorable market conditions.
Our U.S. revolving credit facility matures on
June 28, 2021
. The U.S. revolving credit facility has a capacity of
$1.1 billion
and also provides an expansion option, which permits us to request an increase of up to
$200 million
to the credit facility upon satisfaction of certain conditions. The U.S. revolving credit facility had an outstanding balance of
$585 million
at
December 31, 2016
. Interest on the outstanding credit facility borrowings is based on LIBOR plus the applicable margin, which was
1.63%
at
December 31, 2016
. The credit facility is secured by substantially all of our U.S. assets.
The U.S. revolving credit facility contains various covenants. The covenant for minimum interest coverage ratio, defined as the ratio of EBITDA to interest expense for the most recent four quarters, is 3.0. The covenant for the maximum leverage ratio, defined as the ratio of net debt, including letters of credit, to EBITDA for the most recent four quarters, is 3.5. We are in compliance with all covenants. EBITDA is defined in the loan agreement as (i) the sum of net income, interest expense, income taxes, depreciation expense, amortization expense, other non-cash items reducing consolidated net income and non-cash equity-based compensation expenses minus (ii) other non-cash items increasing consolidated net income.
We are generally not required to obtain the consent of lenders of the U.S. revolving credit facility before raising significant additional debt financing; however, certain limitations and conditions may apply that would require consent to be obtained. In recent years, we have demonstrated our ability to secure consents to access debt markets. We have also been successful in accessing equity markets from time to time. We believe that we will be able to obtain additional debt or equity financing as needed.
At
December 31, 2016
, we had
$506 million
of unused capacity, including
$495 million
from the U.S. revolving credit facility after considering standby letters of credit. However, our leverage ratio covenant limits our total borrowing capacity to
$459 million
as of
December 31, 2016
.
We have
$300 million
aggregate principal amount of
5.25%
senior notes due
December 1, 2022
with interest paid semiannually on
June 1
and
December 1
of each year. The senior notes are unsecured obligations, guaranteed on a senior unsecured basis by certain subsidiaries and contain normal incurrence-based covenants and limitations such as the ability to incur additional indebtedness, pay dividends, make other restricted payments and investments, create liens and certain corporate acts such as mergers and consolidations.
We have a trade receivables securitization facility (the "Securitization Program"), which terminates on
April 13, 2018
. Under the Securitization Program, we sell certain trade receivables and related rights to an affiliate, which in turn sells an undivided variable percentage ownership interest in the trade receivables to a financial institution, while maintaining a subordinated interest in a portion of the pool of trade receivables. The Securitization Program effectively increases our borrowing capacity by up to $120 million and lowers our cost to borrow funds as compared to the U.S. revolving credit facility. We had an outstanding balance of
$120 million
at
December 31, 2016
. The Securitization Program has a minimum borrowing requirement, which was $96 million at
December 31, 2016
. Interest on the secured borrowings under the Securitization Program was
1.65%
at
December 31, 2016
and is based on 30-day LIBOR plus an applicable margin.
Net debt to capitalization was
41%
at both
December 31, 2016
and
October 1, 2016
.
We believe that our cash on hand, cash flows from operations and available borrowings under short and long-term arrangements will continue to be sufficient to meet our operating needs.
The Board of Directors has authorized a share repurchase program. This program has been amended from time to time to authorize additional repurchases that includes both Class A and Class B common shares, and allows us to buy up to an aggregate 13 million common shares. Under this program, we have purchased approximately 9.6 million shares for $650 million as of
December 31, 2016
.
ECONOMIC CONDITIONS AND MARKET TRENDS
We operate within the aerospace and defense and industrial markets. Our aerospace and defense markets are affected by market conditions and program funding levels, while our industrial markets are influenced by general capital investment trends and economic conditions. A common factor throughout our markets is the continuing demand for technologically advanced products.
Aerospace and Defense
Approximately 65% of our 2016 sales were generated in aerospace and defense markets. Within aerospace and defense, we serve three end markets: defense, commercial aircraft and space.
The defense market is dependent on military spending for development and production programs. Aircraft production programs are typically long-term in nature, offering predictability as to capacity needs and future revenues. We maintain positions on numerous high priority programs, including the Lockheed Martin F-35 Joint Strike Fighter, FA-18E/F Super Hornet and V-22 Osprey. The large installed base of our products leads to attractive aftermarket sales and service opportunities. The tactical and strategic missile, missile defense and defense controls markets are dependent on many of the same market conditions as military aircraft, including overall military spending and program funding levels. Our security and surveillance product line is dependent on government funding at federal and local levels, as well as private sector demand.
Reductions in the U.S. Department of Defense's mandatory and discretionary budgeted spending, which became effective on March 1, 2013, resulting from the Budget Control Act of 2011, has had and will continue to have ongoing ramifications for the domestic aerospace and defense market for the near future. As originally passed, the Budget Control Act provided that, in addition to an initial significant reduction in future domestic defense spending, further automatic cuts to defense spending authorization (which is generally referred to as sequestration) of approximately $500 billion through the Federal Government's 2021 fiscal year would be triggered by the failure of Congress to produce a deficit reduction bill. The sequestration spending cuts were intended to be uniform by category for programs, projects and activities within accounts. The Bipartisan Budget Act of 2013 and the Bipartisan Budget Act of 2015 provided stability and modest growth in the Department of Defense spending through 2017. However, future budgets beyond 2017 are uncertain with respect to the overall levels of defense spending. As a result of this uncertainty, we expect we will continue to face significant challenges over the next decade. We believe that our military sales remain likely to be most affected due to lower defense spending. Currently, we expect approximately $670 million of U.S. defense sales in 2017.
The commercial aircraft market is dependent on a number of factors, including global demand for air travel, which generally follows underlying economic growth. As such, the commercial aircraft market has historically exhibited cyclical swings which tend to track the overall economy. In recent years, the development of new, more fuel-efficient commercial air transports has helped drive increased demand in the commercial aircraft market, as airlines replace older, less fuel-efficient aircraft with newer models in an effort to reduce operating costs. The aftermarket is driven by usage of the existing aircraft fleet and the age of the installed fleet, and is impacted by fleet re-sizing programs for passenger and cargo aircraft. Changes in aircraft utilization rates affect the need for maintenance and spare parts and impact aftermarket sales. Boeing and Airbus have historically adjusted production in line with air traffic volume. Demand for our commercial aircraft products is in large part dependent on new aircraft production, which is increasing as Boeing and Airbus work to fulfill large backlogs of unfilled orders.
The commercial space market is comprised of large satellite customers, traditionally communications companies. Trends for this market, as well as for commercial launch vehicles, follow demand for increased capacity. This, in turn tends to track with underlying demand for increased consumption of telecommunication services, satellite replacement and global navigation needs. The space market is also partially dependent on the governmental-authorized levels of funding for satellite communications, as well as investment for commercial and exploration activities.
Industrial
Approximately 35% of our 2016 sales were generated in industrial markets. Within industrial, we serve three end markets: industrial automation, energy and medical.
The industrial automation market we serve is influenced by several factors including capital investment, product innovation, economic growth, cost-reduction efforts and technology upgrades. We experience challenges from the need to react to the demands of our customers, who are in large part sensitive to international and domestic economic conditions.
The energy market we serve is affected by changing oil and natural gas prices, global urbanization, the resulting change in supply and demand for global energy and the political climate and corresponding public support for investments in renewable energy generation capacity. Historically, drivers for global growth include investments in power generation infrastructure, including renewable energy, and exploration in search of new oil and gas resources. However, the significant decline in the price of crude oil has reduced investment in exploration activities. This reduced investment has directly affected our energy business in Components and in Industrial Systems. Currently, we expect approximately $33 million of oil exploration-related sales in 2017, down from approximately $100 million in 2014.
The medical market we serve is influenced by economic conditions, regulatory environments, hospital and outpatient clinic spending on equipment, population demographics, medical advances, patient demands and the need for precision control components and systems. Advances in medical technology and medical treatments have had the effect of extending the average life spans, in turn resulting in greater need for medical services. These same technology and treatment advances also drive increased demand from the general population as a means to improve quality of life. Access to medical insurance, whether through government funded health care plans or private insurance, also affects the demand for medical services.
Foreign Currencies
We are affected by the movement of foreign currencies compared to the U.S. dollar, particularly in Industrial Systems. About one-quarter of our 2016 sales were denominated in foreign currencies. During the first three months of 2017, average foreign currency rates generally weakened against the U.S. dollar compared to 2016. The translation of the results of our foreign subsidiaries into U.S. dollars decreased sales by $8 million compared to the same period one year ago.
Cautionary Statement
Information included or incorporated by reference in this report that does not consist of historical facts, including statements accompanied by or containing words such as “may,” “will,” “should,” “believes,” “expects,” “expected,” “intends,” “plans,” “projects,” “approximate,” “estimates,” “predicts,” “potential,” “outlook,” “forecast,” “anticipates,” “presume” and “assume,” are forward-looking statements. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and are subject to several factors, risks and uncertainties, the impact or occurrence of which could cause actual results to differ materially from the expected results described in the forward-looking statements. These important factors, risks and uncertainties include:
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the markets we serve are cyclical and sensitive to domestic and foreign economic conditions and events, which may cause our operating results to fluctuate;
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we operate in highly competitive markets with competitors who may have greater resources than we possess;
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we depend heavily on government contracts that may not be fully funded or may be terminated, and the failure to receive funding or the termination of one or more of these contracts could reduce our sales and increase our costs;
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we make estimates in accounting for long-term contracts, and changes in these estimates may have significant impacts on our earnings;
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we enter into fixed-price contracts, which could subject us to losses if we have cost overruns;
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we may not realize the full amounts reflected in our backlog as revenue, which could adversely affect our future revenue and growth prospects;
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if our subcontractors or suppliers fail to perform their contractual obligations, our prime contract performance and our ability to obtain future business could be materially and adversely impacted;
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contracting on government programs is subject to significant regulation, including rules related to bidding, billing and accounting kickbacks and false claims, and any non-compliance could subject us to fines and penalties or possible debarment;
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the loss of The Boeing Company as a customer or a significant reduction in sales to The Boeing Company could adversely impact our operating results;
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our new product research and development efforts may not be successful which could reduce our sales and earnings;
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our inability to adequately enforce and protect our intellectual property or defend against assertions of infringement could prevent or restrict our ability to compete;
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our business operations may be adversely affected by information systems interruptions, intrusions or new software implementations;
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our indebtedness and restrictive covenants under our credit facilities could limit our operational and financial flexibility;
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significant changes in discount rates, rates of return on pension assets, mortality tables and other factors could adversely affect our earnings and equity and increase our pension funding requirements;
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a write-off of all or part of our goodwill or other intangible assets could adversely affect our operating results and net worth;
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our sales and earnings may be affected if we cannot identify, acquire or integrate strategic acquisitions, or if we engage in divesting activities;
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our operations in foreign countries expose us to political and currency risks and adverse changes in local legal and regulatory environments;
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unforeseen exposure to additional income tax liabilities may affect our operating results;
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government regulations could limit our ability to sell our products outside the United States and otherwise adversely affect our business;
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governmental regulations and customer demands related to conflict minerals may adversely impact our operating results;
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the failure or misuse of our products may damage our reputation, necessitate a product recall or result in claims against us that exceed our insurance coverage, thereby requiring us to pay significant damages;
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future terror attacks, war, natural disasters or other catastrophic events beyond our control could negatively impact our business;
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our operations are subject to environmental laws, and complying with those laws may cause us to incur significant costs; and
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we are involved in various legal proceedings, the outcome of which may be unfavorable to us.
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These factors are not exhaustive. New factors, risks and uncertainties may emerge from time to time that may affect the forward-looking statements made herein. Given these factors, risks and uncertainties, investors should not place undue reliance on forward-looking statements as predictive of future results. We disclaim any obligation to update the forward-looking statements made in this report.
Item 3.
Quantitative and Qualitative Disclosures about Market Risk.
Refer to the Company’s Annual Report on Form 10-K for the year ended
October 1, 2016
for a complete discussion of our market risk. There have been no material changes in the current year regarding this market risk information.
Item 4.
Controls and Procedures.
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(a)
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Disclosure Controls and Procedures. We carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures are effective as of the end of the period covered by this report, to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
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(b)
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Changes in Internal Control over Financial Reporting. There have been no changes in our internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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