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
September 30, 2017
. 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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•
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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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•
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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 - power generation, oil and gas exploration and wind energy.
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•
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Medical market - enteral clinical nutrition and infusion therapy pumps, ultrasonic sensors and surgical handpieces and CT scanners.
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We operate under three segments, Aircraft Controls, Space and Defense Controls and Industrial Systems. Our principal manufacturing facilities are located in the United States, Philippines, United Kingdom, Germany, Czech Republic, Costa Rica, India, 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 38%, 34% and 33% of our sales in 2017, 2016 and 2015, 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 segment, 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 core foundational strengths, which are our technical experts working collaboratively around the world and the capabilities we deliver for mission-critical solutions. These strengths yield a broad control product portfolio, across a diverse base of customers and end markets.
By focusing on customer intimacy and commitment to solving their most demanding technical problems, we have been able to innovate our control product franchise from one market to another, organically growing from a high-performance components supplier to a high-performance systems supplier. In addition, we continue achieving 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 innovative business models.
Our fundamental strategies to achieve our goals center around talent, lean and innovation and include:
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a strong leadership team that has positioned the company for growth,
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•
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utilizing our global capabilities and strong engineering heritage to innovate,
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•
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maintaining our technological excellence by solving our customers’ most demanding technical problems in applications "When Performance Really Matters
®
,"
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•
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continuing to invest in talent development to strengthen employee performance, and
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•
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maximizing customer value by implementing lean enterprise principles.
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These activities will help us achieve our financial objective of increasing shareholder value with sustainable competitive advantages across our segments. In doing so, we expect to maintain a balanced, diversified portfolio in terms of markets served, product applications, customer base and geographic presence.
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.
Acquisitions, Divestitures and Equity Method Investments
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.
On March 29, 2018, we acquired VUES Brno s.r.o, located in the Czech Republic and Germany, for
$63
million. VUES designs and manufactures customized electric motors, generators and solutions. This operation is included in our Industrial Systems segment.
On October 3, 2017, we, in collaboration with SIA Engineering Company, announced the joint venture company, Moog Aircraft Services Asia ("MASA"), in Singapore, of which we currently hold a
51%
ownership. MASA is intended to provide maintenance, repair and overhaul services for our manufactured flight control systems. As we hold a majority ownership in MASA, but share voting control, we are accounting for this investment using the equity method. At
March 31, 2018
, we have made total contributions of
$4
million to MASA and intend to make
one
additional contribution of
$2 million
during
2018
. This operation is included in our Aircraft Controls segment.
In 2017, we acquired Rotary Transfer Systems, a manufacturer of electromechanical systems, located in Germany and France for $43 million. This acquisition is included in our Industrial Systems segment. We also sold non-core businesses in our Space and Defense Controls segment for $7 million and recorded losses in other expense of $13 million related to the sales.
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 and contract-related loss reserves, reserves for inventory valuation, reviews for impairment of goodwill, reviews for impairment of long-lived assets, pension assumptions and income taxes. See Note 12 of the Consolidated Condensed Financial Statements included in Item 1, Financial Statements of this report for the impact of the enactment of the Tax Cuts and Jobs Act of 2017.
Other than that described below, there have been no material changes in critical accounting policies in the current year from those disclosed in our 2017 Annual Report on Form 10-K.
Reviews for Impairment of Goodwill
Interim Test
Effective October 1, 2017, we changed our segment reporting structure from four to three reporting segments. The former Components reporting segment has been divided and merged into the Space and Defense Controls and Industrial Systems reporting segments. This change also impacted the reporting units we use to review goodwill for impairment. Based on the accounting rules that require aggregation of components with similar economic characteristics, we have changed the number of reporting units from five to four - Aircraft Controls, Space and Defense Controls, Industrial Systems and Medical Devices.
We transferred or allocated the assets and liabilities of the former Components business including the proportionate share of goodwill based on the relative fair value of the business to the new respective reporting units - Space and Defense Controls and Industrial Systems. We then compared the fair values to the carrying values of the reporting units and the resulting fair values exceeded the carrying values, so we determined that goodwill was not impaired.
The fair value of each of these two reporting units exceeded the carrying amounts by over 100%. While any individual assumption could differ from those that we used, we believe the overall fair values of these reporting units are reasonable, as the values are derived from a mix of reasonable assumptions. Had we used discount rates that were 100 basis points higher or a terminal growth rate that was 100 basis points lower than those we assumed, the fair values of each of these reporting units would have continued to exceed their carrying amounts by at least 80%.
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
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Three Months Ended
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Six Months Ended
|
(dollars and shares in millions, except per share data)
|
March 31, 2018
|
April 1, 2017
|
$ Variance
|
% Variance
|
|
March 31, 2018
|
April 1, 2017
|
$ Variance
|
% Variance
|
Net sales
|
$
|
689
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|
$
|
632
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|
$
|
57
|
|
9
|
%
|
|
$
|
1,317
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|
$
|
1,222
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|
$
|
95
|
|
8
|
%
|
Gross margin
|
28.0
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%
|
29.3
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%
|
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|
28.6
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%
|
29.3
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%
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|
Research and development expenses
|
$
|
34
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$
|
37
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$
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(3
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)
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(8
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%)
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$
|
67
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$
|
72
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|
$
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(5
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)
|
(7
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%)
|
Selling, general and administrative expenses as a percentage of sales
|
14.5
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%
|
13.8
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%
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|
|
|
14.9
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%
|
14.1
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%
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|
Interest expense
|
$
|
9
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|
$
|
9
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|
$
|
—
|
|
5
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%
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|
$
|
18
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|
$
|
17
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|
$
|
1
|
|
4
|
%
|
Restructuring expense
|
$
|
24
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|
$
|
—
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|
$
|
24
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|
n/a
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|
|
$
|
24
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|
$
|
—
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|
$
|
24
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|
n/a
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Other
|
$
|
—
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|
$
|
4
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|
$
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(4
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)
|
(106
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%)
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|
$
|
(1
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)
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$
|
12
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|
$
|
(13
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)
|
(108
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%)
|
Effective tax rate
|
45.6
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%
|
34.3
|
%
|
|
|
|
79.2
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%
|
27.1
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%
|
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|
Net earnings attributable to Moog
|
$
|
14
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|
$
|
32
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|
$
|
(18
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)
|
(56
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%)
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|
$
|
15
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|
$
|
63
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|
$
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(47
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)
|
(76
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%)
|
Diluted earnings per share attributable to Moog
|
$
|
0.39
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|
$
|
0.88
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|
$
|
(0.49
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)
|
(56
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%)
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|
$
|
0.42
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$
|
1.73
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|
$
|
(1.31
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)
|
(76
|
%)
|
Net sales increased across all of our segments in the second quarter and in the first half of 2018 compared to the second quarter and the first half of 2017. S
tronger foreign currencies, primarily the Euro relative to the U.S. Dollar, increased sales $15 million and $23 million, respectively.
Gross margin decreased in the second quarter of 2018 compared to the second quarter of 2017. Gross profit in the second quarter of 2018 includes $7 million of inventory write-down associated with the restructuring expense in Industrial Systems. In addition, Aircraft Controls' gross margin declined as cost growth on fixed-price development programs and lower amounts of high-margin legacy commercial OEM sales offset a favorable sales mix from higher military OEM and commercial aftermarket sales. In the first half of 2018 compared to the first half of 2017, gross margin excluding the second quarter inventory write-down was relatively unchanged. Improved sales mixes in Aircraft Controls and in Industrial Systems were offset by a negative sales mix in Space and Defense Controls, due to the reduced amount of last year's favorable defense controls sales.
Research and development expenses decreased in the second quarter and in the first half of 2018 compared to the same periods of 2017. Within Aircraft Controls, research and development expenses decreased $4 million and $8 million, respectively, as we had lower activity across our major commercial OEM programs. The reduced spend was partially offset by increases in research and development activities across our other two segments.
Selling, general and administrative expenses as a percentage of sales increased in the second quarter and in the first half of 2018 compared to the same periods of 2017. Administrative expense increased $6 million and $9 million, respectively, due to higher planned selling expense in select growth markets, primarily in Industrial Systems, acquisition-related expenses and higher medical claims.
After years of investment in the wind pitch control business, we concluded we no longer have a viable business model, and that our best option is to phase out our participation in this market over the next six months. Therefore, in the second quarter of 2018, we incurred $31 million of restructuring expense in Industrial Systems. Of the total expense, the charges consist of
$7
million of non-cash inventory reserves,
$14
million of non-cash charges, primarily for the impairment of long-lived assets,
$7
million for severance and
$2
million for other costs.
Other expense in the second quarter and in the first half of 2017 included losses associated with selling our non-core businesses in Space and Defense Controls.
The effective tax rate in the second quarter of 2018 was impacted by limited tax benefits associated with the restructuring charges taken in foreign jurisdictions of our Industrial Systems segment. The effective tax rate in the first half of 2018 was also significantly impacted by the enactment of the Tax Cuts and Jobs Act of 2017. Excluding the one-time special impacts due to the Act, the effective tax rate for the first half of 2018 was 29.2%.
Our effective tax rate in the first half of 2017 is lower than the U.S. statutory tax rate as result of earnings taxed in foreign jurisdictions with lower statutory tax rates and includes the tax benefits associated with selling our European space businesses in the first quarter of 2017.
Other comprehensive income in the first half of 2018 includes $31 million of foreign currency translation income, whereas other comprehensive income in the first half of 2017 includes $29 million of foreign currency translation loss. Foreign currency translation adjustments increased $59 million during the first half of 2018 compared to the first half of 2017, primarily attributable to changes in the Euro and the British Pound.
SEGMENT RESULTS OF OPERATIONS
Effective October 1, 2017, we changed our segment reporting structure to three reporting segments. Our former Components segment has been separated and merged into Space and Defense Controls and Industrial Systems. All amounts have been restated to conform to the current presentation.
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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|
|
|
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|
|
Three Months Ended
|
|
Six Months Ended
|
(dollars in millions)
|
March 31, 2018
|
April 1, 2017
|
$ Variance
|
% Variance
|
|
March 31, 2018
|
April 1, 2017
|
$ Variance
|
% Variance
|
Net sales - military aircraft
|
$
|
156
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|
$
|
137
|
|
$
|
19
|
|
14
|
%
|
|
$
|
280
|
|
$
|
264
|
|
$
|
16
|
|
6
|
%
|
Net sales - commercial aircraft
|
156
|
|
153
|
|
3
|
|
2
|
%
|
|
310
|
|
294
|
|
16
|
|
6
|
%
|
|
$
|
311
|
|
$
|
290
|
|
$
|
22
|
|
8
|
%
|
|
$
|
590
|
|
$
|
558
|
|
$
|
32
|
|
6
|
%
|
Operating profit
|
$
|
33
|
|
$
|
31
|
|
$
|
2
|
|
7
|
%
|
|
$
|
64
|
|
$
|
54
|
|
$
|
10
|
|
18
|
%
|
Operating margin
|
10.8
|
%
|
10.8
|
%
|
|
|
|
10.9
|
%
|
9.7
|
%
|
|
|
Backlog
|
|
|
|
|
|
$
|
583
|
|
$
|
594
|
|
$
|
(11
|
)
|
(2
|
%)
|
Aircraft Controls' net sales increased in the second quarter of 2018 compared to the second quarter of 2017, driven primarily by increases in military OEM sales. Aircraft Controls' net sales also increased in the first half of 2018 compared to the first half of 2017, driven by increased military OEM and commercial aftermarket sales.
In the second quarter of 2018 compared to the second quarter of 2017, military OEM sales increased $21 million. Sales for foreign military programs increased $6 million, military navigational aides increased $4 million after an unusually low activity in the prior year's quarter and helicopters increased $4 million. In addition, sales for the F-35 program increased $3 million due to higher orders. Partly offsetting the OEM sales increase was lower aftermarket sales, driven primarily by lower sales volumes on the V-22 program. The total military aircraft sales growth in the second quarter of 2018 contributed to the sales growth in the first half of 2018 after a relatively flat first quarter.
In the second quarter and in the first half of 2018 compared to the same periods of 2017, commercial aftermarket sales increased $11 million and $18 million, respectively. Specifically, aftermarket sales for legacy Boeing programs increased $6 million and $10 million, respectively, as a result of business recapture activities. Also higher initial provisioning orders for the Boeing 787 and Airbus A350 programs increased aftermarket sales $4 million and $8 million.
In the second quarter, lower commercial OEM sales mostly offset the commercial aftermarket sales increase, as legacy Boeing volumes decreased sales $5 million and delays and unfavorable order timing on Airbus programs decreased sales an additional $4 million. In the first half of 2018, commercial OEM sales for Boeing decreased $4 million, as legacy volume declines offset 787 growth.
Operating margin in the second quarter of 2018 remained unchanged compared to the second quarter of 2017. Operating profit benefited $4 million on lower research and development expenses, as we had lower activity on our major commercial OEM programs. However, cost growth on fixed-price funded military development programs and lower amounts of high-margin legacy commercial OEM sales more than offset a favorable sales mix from higher military OEM and commercial aftermarket sales. Operating margin in the first half of 2018 increased compared to the operating margin in the first half of 2017. Research and development expenses decreased $8 million due to lower activity on our major commercial OEM programs. Additionally, operating profit benefited from higher amounts of foreign military sales.
The decrease of twelve-month backlog for Aircraft Controls at March 31, 2018 compared to April 1, 2017 is primarily due to the timing of orders for the F-35, partly offset by increasing orders for major commercial OEM programs.
Space and Defense Controls
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Six Months Ended
|
(dollars in millions)
|
March 31, 2018
|
April 1, 2017
|
$ Variance
|
% Variance
|
|
March 31, 2018
|
April 1, 2017
|
$ Variance
|
% Variance
|
Net sales
|
$
|
144
|
|
$
|
139
|
|
$
|
5
|
|
3
|
%
|
|
$
|
277
|
|
$
|
261
|
|
$
|
15
|
|
6
|
%
|
Operating profit
|
$
|
17
|
|
$
|
11
|
|
$
|
5
|
|
48
|
%
|
|
$
|
33
|
|
$
|
20
|
|
$
|
13
|
|
62
|
%
|
Operating margin
|
11.7
|
%
|
8.2
|
%
|
|
|
|
12.0
|
%
|
7.8
|
%
|
|
|
Backlog
|
|
|
|
|
|
$
|
410
|
|
$
|
371
|
|
$
|
39
|
|
11
|
%
|
Space and Defense Controls' net sales increased in our space market but declined in our defense market in the second quarter of 2018 compared to the second quarter of 2017. In the first half of 2018 compared to the first half of 2017, sales increased in both our space and defense markets. Partially offsetting the sales growth in our space market were declines of $5 million in the quarter and $11 million in the first half due to lost sales associated the 2017 divestitures of non-core businesses.
In the second quarter of 2018 compared to the second quarter of 2017, sales in our space market increased $9 million. Specifically, new satellite avionics programs increased sales $7 million and production ramp ups on launch vehicle programs increased sales $7 million. These sales increases were partially offset by the lost sales associated with the divestitures. Also in the second quarter of 2018 compared to the second quarter of 2017, sales in our defense market decreased $4 million. Specifically, sales decreased $7 million in total for both domestic and foreign defense vehicles due to production wind downs and timing delays. Additionally, we had lower spares sales and order push outs for our naval products, which decreased sales $3 million. Partly offsetting these declines was $4 million of higher defense components sales.
Sales also increased in the first half of 2018 compared to the first half of 2017. Sales increased $11 million in our space market driven by the strong avionics and launch vehicle sales, including the impact of the lost sales associated with last year's divestitures. Sales also increased $4 million in our defense market in the first half of 2018 compared to the first half of 2017. Higher orders for defense components increased sales $7 million, but were partially offset by the second quarter naval sales decline.
Operating margin increased in the second quarter and in the first half of 2018 compared to the same periods of 2017 due to the absence of last year's losses associated with selling our non-core businesses. Operating margin excluding the losses would have been 11.4% and 13.0%, respectively in 2017. The decline in operating margin in the first half of 2018 compared to the adjusted first half of 2017 is due to a negative sales mix, as the prior year's defense production programs have since wound down.
Twelve-month backlog for Space and Defense Controls at March 31, 2018 compared to April 1, 2017 increased as growth in orders for components and security programs was partially offset by program completions for satellite avionics.
Industrial Systems
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Six Months Ended
|
(dollars in millions)
|
March 31, 2018
|
April 1, 2017
|
$ Variance
|
% Variance
|
|
March 31, 2018
|
April 1, 2017
|
$ Variance
|
% Variance
|
Net sales
|
$
|
234
|
|
$
|
204
|
|
$
|
30
|
|
15
|
%
|
|
$
|
450
|
|
$
|
403
|
|
$
|
47
|
|
12
|
%
|
Operating profit (loss)
|
$
|
(6
|
)
|
$
|
22
|
|
$
|
(28
|
)
|
(127
|
%)
|
|
$
|
13
|
|
$
|
42
|
|
$
|
(29
|
)
|
(69
|
%)
|
Operating margin
|
(2.6
|
%)
|
10.9
|
%
|
|
|
|
2.9
|
%
|
10.5
|
%
|
|
|
Backlog
|
|
|
|
|
|
$
|
287
|
|
$
|
236
|
|
$
|
51
|
|
22
|
%
|
Industrial Systems' net sales increased across our four markets in the second quarter and in the first half of 2018 compared to the same periods of 2017. Also, stronger foreign currencies, primarily the Euro relative to the U.S. Dollar, increased sales $11 million and $17 million, respectively. Additionally, the recent acquisition of Rotary Transfer Systems increased sales $6 million and $12 million, respectively, primarily in our industrial automation market.
Excluding the currency effects on sales in the second quarter and in the first half of 2018 compared to the same periods of 2017, sales increased in our industrial automation market $8 million and $13 million, respectively. The increases were primarily driven by the Rotary Transfer Systems acquisition, as well as the stronger macro economic growth. Sales also increased $4 million and $7 million, respectively, in our medical market driven by higher orders for our components. In addition, sales increased $4 million and $6 million, respectively, in our energy market driven by increased shipments for energy generation and exploration products. Finally, sales increased $2 million and $5 million, respectively, in our simulation and test market due to the timing of shipments for aerospace and auto test applications.
After years of investment in the wind pitch control business, we concluded we no longer have a viable business model, and that our best option is to phase out our participation in this market over the next six months. Therefore, in the second quarter of 2018, we incurred $31 million of restructuring expense in Industrial Systems. The total expense includes
$7
million for inventory reserves,
$14
million of non-cash charges, primarily for the impairment of long-lived assets,
$7
million for severance and
$2
million for other costs.
Operating margin decreased in the second quarter of 2018 compared to the second quarter of 2017 due to the restructuring expense. Excluding the effect of this expense, operating margin in the second quarter of 2018 was relatively unchanged from operating margin in the second quarter of 2017. Incremental margin from the higher sales volume offset higher operating expenses, including increased investments in research and development and selling. Operating margin excluding the effect of the restructuring expense in the first half of 2018 was lower compared to the same period of 2017. Through the first half of 2018, higher operating expenses more than offset the incremental margin from higher sales volumes.
The higher level of twelve-month backlog in Industrial Systems at March 31, 2018 compared to April 1, 2017 is mostly due to higher orders in our industrial automation market and for our energy generation and exploration products.
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|
|
|
|
|
|
|
|
|
|
|
|
|
CONSOLIDATED AND SEGMENT OUTLOOK
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018 vs. 2017
|
(dollars in millions)
|
2018
|
|
2017
|
|
$ Variance
|
|
% Variance
|
Net sales:
|
|
|
|
|
|
|
|
Aircraft Controls
|
$
|
1,195
|
|
|
$
|
1,125
|
|
|
$
|
70
|
|
|
6
|
%
|
Space and Defense Controls
|
557
|
|
|
529
|
|
|
28
|
|
|
5
|
%
|
Industrial Systems
|
934
|
|
|
843
|
|
|
91
|
|
|
11
|
%
|
|
$
|
2,687
|
|
|
$
|
2,498
|
|
|
$
|
189
|
|
|
8
|
%
|
Operating profit:
|
|
|
|
|
|
|
|
Aircraft Controls
|
$
|
128
|
|
|
$
|
114
|
|
|
$
|
14
|
|
|
12
|
%
|
Space and Defense Controls
|
65
|
|
|
49
|
|
|
16
|
|
|
34
|
%
|
Industrial Systems
|
69
|
|
|
88
|
|
|
(19
|
)
|
|
(22
|
%)
|
|
$
|
261
|
|
|
$
|
250
|
|
|
$
|
11
|
|
|
4
|
%
|
Operating margin:
|
|
|
|
|
|
|
|
Aircraft Controls
|
10.7
|
%
|
|
10.1
|
%
|
|
|
|
|
Space and Defense Controls
|
11.7
|
%
|
|
9.2
|
%
|
|
|
|
|
Industrial Systems
|
7.4
|
%
|
|
10.4
|
%
|
|
|
|
|
|
9.7
|
%
|
|
10.0
|
%
|
|
|
|
|
2018
Outlook
– We expect that all three segments will contribute to higher sales in 2018, driven primarily by military OEM sales in Aircraft Controls and industrial automation sales in Industrial Systems. We expect 2018 operating margin will decrease due to the second quarter's restructuring expense in Industrial Systems. Operating margin excluding the effect of this expense will be 10.9%, as margin expansion will be driven by the absence of 2017's losses associated with divesting non-core businesses, as well as incremental margin from higher sales. We expect that the impact of the Tax Cuts and Jobs Act will result in an unusually high effective tax rate of 48% in 2018. This will result in a 31% decrease in net earnings attributable to common shareholders to $97 million, and diluted earnings per share will range between $2.47 and $2.87 with a midpoint of $2.67. Excluding the impacts from the restructuring charge and the special impacts from the Tax Act, we expect an effective tax rate of 26.7%, net earnings attributable to common shareholders of $159 million and diluted earnings per share will range between $4.20 and $4.60, with a midpoint of $4.40, an increase of 13% compared to 2017.
2018
Outlook for Aircraft Controls
–
We expect 2018 sales in Aircraft Controls will increase primarily due to higher military OEM sales, driven by the continued ramp up of the F-35 program and by higher sales volumes on various other legacy programs. Partially offsetting the increases is an expected sales decline of legacy Boeing OEM programs. We expect 2018 operating margin will increase compared to 2017. We expect that research and development costs will decrease $11 million and that we will continue to realize the benefits of cost saving activities. However, we expect a negative sales mix, as sales on our mature commercial programs are replaced with sales growth on newer commercial programs.
2018
Outlook for Space and Defense Controls –
We expect 2018 sales in Space and Defense Controls will increase due to sales growth from launch vehicles and satellite programs. Also, within our defense market, we expect higher missile systems and security sales will offset a decline in defense controls sales. We expect 2018 operating margin will increase, as the losses associated with divesting non-core businesses do not repeat.
2018
Outlook for Industrial Systems –
We expect 2018 sales in Industrial Systems to increase across all of our major markets, lead primarily by growth in our industrial automation products. Also, we expect favorable currency adjustments and the recent acquisition of VUES Brno s.r.o to contribute to the sales growth. We expect 2018 operating margin will decrease due to the second quarter's restructuring expense. Operating margin excluding this expense will increase as we benefit from incremental margin on higher sales volumes.
FINANCIAL CONDITION AND LIQUIDITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
(dollars in millions)
|
March 31,
2018
|
April 1,
2017
|
$ Variance
|
% Variance
|
Net cash provided (used) by:
|
|
|
|
|
Operating activities
|
$
|
45
|
|
$
|
122
|
|
$
|
(76
|
)
|
(63
|
%)
|
Investing activities
|
(90
|
)
|
(31
|
)
|
(59
|
)
|
188
|
%
|
Financing activities
|
(79
|
)
|
(62
|
)
|
(17
|
)
|
28
|
%
|
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
March 31, 2018
, our cash balances were
$256 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. Due to provisions in the Tax Cuts and Jobs Act, we plan to repatriate substantial amounts of our existing offshore cash and future earnings back to the U.S. Through the first half of 2018, we have repatriated $91 million.
Operating activities
Net cash provided by operating activities decreased in the first half of 2018 compared to the same period of 2017. Cash used by net pension and retirement liabilities increased $61 million, primarily due to an incremental pension contribution in the second quarter of 2018. Also, cash provided by inventory decreased $35 million, primarily in Aircraft Controls.
Investing activities
Net cash used by investing activities in the first half of 2018 included $44 million for capital expenditures and $42 million for the acquisition in our Industrial Systems segment, while net cash used by investing activities in 2017 included $30 million for capital expenditures.
We expect our
2018
capital expenditures to be approximately $95 million, due to facilities investments supporting the increased production of the F-35 program, as well as engine propulsion testing.
Financing activities
Net cash used by financing activities in the first half of both 2018 and 2017 include net payments on our credit facility. Also, we expect to pay approximately $18 million of cash dividends in 2018.
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 2017 Annual Report on Form 10-K, with the exception of tax payments required as a result of the Tax Cuts and Jobs Act of 2017 and accelerated pension contributions into our 2017 pension plan year. See Notes 10 and 12 of the Consolidated Condensed Financial Statements included in Item 1, Financial Statements of this report for the impact.
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
$480 million
at
March 31, 2018
. The weighted-average interest rate on all of the outstanding credit facility borrowings was
3.19%
and is based on LIBOR plus the applicable margin, which was
1.38%
at
March 31, 2018
and will increase to 1.63% during the third quarter of 2018. 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
March 31, 2018
, we had
$586 million
of unused capacity, including
$573 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
$466 million
as of
March 31, 2018
.
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 was extended on October 23, 2017 and now matures on
October 23, 2019
. The Securitization Program provides up to
$130 million
of borrowing capacity and lowers our cost to borrow funds as compared to the U.S. revolving credit facility. 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. We had an outstanding balance of
$130 million
at
March 31, 2018
. The Securitization Program has a minimum borrowing requirement, which was
$104 million
at
March 31, 2018
. Interest on the secured borrowings under the Securitization Program was
2.71%
at
March 31, 2018
and is based on 30-day LIBOR plus an applicable margin.
Net debt to capitalization was
34%
at
March 31, 2018
and 33% at
September 30, 2017
.
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.
During the second quarter of 2018, the Board of Directors declared a
$0.25
per share quarterly dividend payable on issued and outstanding shares of our Class A and Class B common stock on June 1, 2018 to shareholders of record at the close of business on May 15, 2018.
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 stock, and allows us to buy up to an aggregate 13 million common shares. Under this program, we have purchased approximately 9.7 million shares for $650 million as of
March 31, 2018
.
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 two-thirds of our 2017 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 ramifications for the domestic aerospace and defense market. 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 Department of Defense spending through 2017. However, future budgets beyond 2017 are uncertain with respect to the overall levels of defense spending. Currently, we expect approximately $740 million of U.S. defense sales in 2018.
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 impacting 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 one-third of our 2017 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. Currently, we expect approximately $34 million of oil exploration-related sales in 2018, 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 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 Aircraft Controls and Industrial Systems. About one-quarter of our 2017 sales were denominated in foreign currencies. During the first six months of 2018, average foreign currency rates generally strengthened against the U.S. dollar compared to 2017. The translation of the results of our foreign subsidiaries into U.S. dollars increased sales by $23 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:
|
|
•
|
the markets we serve are cyclical and sensitive to domestic and foreign economic conditions and events, which may cause our operating results to fluctuate;
|
|
|
•
|
we operate in highly competitive markets with competitors who may have greater resources than we possess;
|
|
|
•
|
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;
|
|
|
•
|
we make estimates in accounting for long-term contracts, and changes in these estimates may have significant impacts on our earnings;
|
|
|
•
|
we enter into fixed-price contracts, which could subject us to losses if we have cost overruns;
|
|
|
•
|
we may not realize the full amounts reflected in our backlog as revenue, which could adversely affect our future revenue and growth prospects;
|
|
|
•
|
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;
|
|
|
•
|
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;
|
|
|
•
|
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;
|
|
|
•
|
our new product research and development efforts may not be successful which could reduce our sales and earnings;
|
|
|
•
|
our inability to adequately enforce and protect our intellectual property or defend against assertions of infringement could prevent or restrict our ability to compete;
|
|
|
•
|
our business operations may be adversely affected by information systems interruptions, intrusions or new software implementations;
|
|
|
•
|
our indebtedness and restrictive covenants under our credit facilities could limit our operational and financial flexibility;
|
|
|
•
|
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;
|
|
|
•
|
a write-off of all or part of our goodwill or other intangible assets could adversely affect our operating results and net worth;
|
|
|
•
|
our sales and earnings may be affected if we cannot identify, acquire or integrate strategic acquisitions, or if we engage in divesting activities;
|
|
|
•
|
our operations in foreign countries expose us to political and currency risks and adverse changes in local legal and regulatory environments;
|
|
|
•
|
unforeseen exposure to additional income tax liabilities may affect our operating results;
|
|
|
•
|
government regulations could limit our ability to sell our products outside the United States and otherwise adversely affect our business;
|
|
|
•
|
governmental regulations and customer demands related to conflict minerals may adversely impact our operating results;
|
|
|
•
|
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;
|
|
|
•
|
future terror attacks, war, natural disasters or other catastrophic events beyond our control could negatively impact our business;
|
|
|
•
|
our operations are subject to environmental laws, and complying with those laws may cause us to incur significant costs; and
|
|
|
•
|
we are involved in various legal proceedings, the outcome of which may be unfavorable to us.
|
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
September 30, 2017
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.
|
|
(a)
|
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.
|
|
|
(b)
|
Changes in Internal Control over Financial Reporting. There have been no changes during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
|