Attached files

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EX-32.2 - SECTION 906 CERTIFICATION BY CHIEF FINANCIAL OFFICER - ROCKWELL COLLINS INCcol_exhibitx322x9302017.htm
EX-32.1 - SECTION 906 CERTIFICATION BY CHIEF EXECUTIVE OFFICER - ROCKWELL COLLINS INCcol_exhibitx321x9302017.htm
EX-31.2 - SECTION 302 CERTIFICATION BY CHIEF FINANCIAL OFFICER - ROCKWELL COLLINS INCcol_exhibitx312x9302017.htm
EX-31.1 - SECTION 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - ROCKWELL COLLINS INCcol_exhibitx311x9302017.htm
EX-24 - POWERS OF ATTORNEY - ROCKWELL COLLINS INCcol_exhibitx24x9302017.htm
EX-23 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - ROCKWELL COLLINS INCcol_exhibitx23x9302017.htm
EX-21 - LIST OF SUBSIDIARIES OF THE COMPANY - ROCKWELL COLLINS INCcol_exhibitx21x9302017.htm
EX-12 - STATEMENT RE: COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - ROCKWELL COLLINS INCcol_exhibitx12x9302017.htm
EX-10.N-2 - SCHEDULE OF EXECUTIVES WHO ARE PARTY TO THE CHANGE OF CONTROL AGREEMENT - ROCKWELL COLLINS INCcol_exhibitx10-nx2x9302017.htm


  
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
 R ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2017
£ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-16445  
 
Rockwell Collins, Inc.
(Exact name of registrant as specified in its charter)
Delaware
52-2314475
(State or other jurisdiction
(I.R.S. Employer
of incorporation or organization)
Identification No.)
 
 
400 Collins Road NE
 
Cedar Rapids, Iowa
52498
(Address of principal executive offices)
(Zip Code)
Registrant's telephone number, including area code: (319) 295-1000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of each class
Name of each exchange on which registered
Common Stock, par value $.01 per share
New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes R No £
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes £ No R
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R No £
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer R
 
Accelerated filer £
Non-accelerated filer  £
(Do not check if a smaller reporting company)
Smaller reporting company £
 
 
Emerging growth company £
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No  R
The aggregate market value of the registrant's voting stock held by non-affiliates of the registrant on March 31, 2017 was approximately $12.71 billion. For purposes of this calculation, the registrant has assumed that its directors and executive officers are affiliates.
162,904,627 shares of the registrant's Common Stock were outstanding on October 31, 2017.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information contained in the Proxy Statement for the Annual Meeting of Shareowners of the registrant to be held on February 1, 2018 is incorporated by reference into Part III.
 



ROCKWELL COLLINS, INC.

Annual Report on Form 10-K

Table of contents

 
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


i



PART I


Item 1.
Business.

General

Rockwell Collins, Inc. (the Company or Rockwell Collins) designs, produces and supports cabin interior, communications and aviation systems and products for commercial and military customers and provides information management services through voice and data communication networks and solutions worldwide. The integrated system solutions and products we provide to our served markets are oriented around a set of core competencies: communications, navigation, automated flight control, displays/surveillance, bespoke interior products, simulation and training, integrated electronics and information management systems. We also provide a wide range of services and support to our customers through a worldwide network of service centers, including equipment repair and overhaul, service parts, field service engineering, training, technical information services and aftermarket used equipment sales. The structure of our business allows us to leverage these core competencies across markets and applications to bring high value solutions to customers. We operate in multiple countries and are headquartered in Cedar Rapids, Iowa.

Our Company's heritage is rooted in the Collins Radio Company, established in 1933. Rockwell Collins, Inc., the parent company, is incorporated in Delaware. As used herein, the terms "we", "us", "our", "Rockwell Collins" or the "Company" include subsidiaries and predecessors unless the context indicates otherwise.

Whenever reference is made in any Item of this Annual Report on Form 10-K to information in our Proxy Statement for the Annual Meeting of Shareowners to be held on February 1, 2018 (2018 Proxy Statement), such information shall be deemed to be incorporated herein by such reference.

All date references contained herein relate to our fiscal year ending on the Friday closest to September 30 unless otherwise stated. For ease of presentation, September 30 is utilized consistently throughout this report to represent the fiscal year end date. Fiscal years 2017, 2016 and 2015 were 52-week fiscal years.

Proposed Acquisition by United Technologies Corporation

On September 4, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with United Technologies Corporation, a Delaware corporation (“UTC”), and Riveter Merger Sub Corp., a Delaware corporation and a wholly owned subsidiary of UTC (“Merger Sub”). Upon the terms and subject to the conditions set forth in the Merger Agreement, at the closing, Merger Sub will merge with and into Rockwell Collins, with Rockwell Collins surviving as a wholly owned subsidiary of UTC (the “UTC Merger”).

Pursuant to the Merger Agreement, at the effective time of the UTC Merger (the “Effective Time”), each share of Rockwell Collins common stock, par value $0.01 per share, issued and outstanding immediately prior to the Effective Time (other than (1) shares held by Rockwell Collins as treasury stock, UTC, or any subsidiaries of Rockwell Collins or UTC and (2) shares held by a holder who has properly exercised and perfected (and not effectively withdrawn or lost) such holder’s demand for appraisal rights under Section 262 of the General Corporation Law of the State of Delaware, which in each case will be treated as described in the Merger Agreement) will be converted into the right to receive (1) $93.33 in cash, without interest, plus (2) a fraction of a share of UTC common stock having a value equal to the quotient obtained by dividing $46.67 by the average of the volume-weighted average prices per share of UTC common stock on the New York Stock Exchange for each of the 20 consecutive trading days ending with the trading day immediately prior to the closing date (the “UTC stock price”), subject to a two-way collar mechanism described below (together, the “Merger Consideration”), less any applicable withholding taxes.

The fraction of a share of UTC common stock into which each such share of Rockwell Collins common stock will be converted is referred to as the exchange ratio. The exchange ratio will depend upon the UTC stock price. If the UTC stock price is greater than $107.01 but less than $124.37, the exchange ratio will be equal to the quotient of (i) $46.67 divided by (ii) the UTC stock price, which, in each case, will result in the stock consideration having a value equal to $46.67. If the UTC stock price is less than or equal to $107.01 or greater than or equal to $124.37, a two-way collar mechanism will apply, pursuant to which (i) if the UTC stock price is greater than or equal to $124.37, the exchange ratio will be fixed at 0.37525 and the value of the stock consideration will be more than $46.67, and (ii) if the UTC stock price is less than or equal to $107.01, the exchange ratio will be fixed at 0.43613 and the value of the stock consideration will be less than $46.67.

The completion of the UTC Merger is subject to customary conditions, including, without limitation, (1) the approval of the UTC Merger by Rockwell Collins shareowners, (2) the expiration or termination of the applicable waiting period under the

1



Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, (3) the receipt of other required regulatory approvals, (4) the absence of any order or law that has the effect of enjoining or otherwise prohibiting the completion of the UTC Merger or resulting in the occurrence of certain conditions specified in the Merger Agreement, (5) the absence of a material adverse effect on Rockwell Collins and UTC and (6) the approval for listing of the shares of common stock of UTC forming part of the Merger Consideration on the New York Stock Exchange and the effectiveness of a registration statement on Form S-4 with respect to such common stock. The completion of the UTC Merger is not subject to the approval of UTC’s shareowners or the receipt of financing by UTC.

The Company and UTC have made customary representations and warranties in the Merger Agreement. The Merger Agreement also contains customary covenants and agreements, including covenants and agreements relating to (a) the conduct of each of the Company’s and UTC’s respective businesses between the date of the signing of the Merger Agreement and the consummation of the UTC Merger, and (b) the efforts of the parties to cause the UTC Merger to be completed.

The Merger Agreement includes termination provisions for both Rockwell Collins and UTC. The Merger Agreement provides that the Company may be required to pay UTC a termination fee equal to $695 million if the Merger Agreement is terminated by the Company under certain circumstances described in the Merger Agreement.

Financial Information About Our Operating Segments

Financial information with respect to our operating segments, including product line disclosures, revenues, operating earnings and total assets, is contained under the caption Segment Financial Results in Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 below and in Note 21 of the Notes to Consolidated Financial Statements in Item 8 below.

Access to the Company's Reports and Governance Information

We maintain an internet website at www.rockwellcollins.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form  10-Q, Current Reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on this site as soon as reasonably practicable after the reports are filed with or furnished to the Securities and Exchange Commission (SEC). All reports we file with the SEC are also available free of charge via EDGAR through the SEC website at www.sec.gov. We also post corporate governance information (including our corporate governance guidelines and Board committee charters) and other information related to our Company on our internet website where it is available free of charge. We will provide, without charge, upon written request, copies of our SEC reports and corporate governance information. Our internet website and the information contained therein or connected thereto are not incorporated into this Annual Report on Form 10-K.

Description of Business by Segment

We serve a worldwide customer base through our Interior Systems, Commercial Systems, Government Systems and Information Management Services operating segments. These four segments are described in detail below.

Interior Systems

On April 13, 2017, we acquired B/E Aerospace and formed the new Interior Systems business segment. Our Interior Systems business manufactures cabin interior products for commercial aircraft and business aviation customers. We sell our products and provide our services directly to virtually all of the world’s major airlines and aerospace manufacturers. We have achieved a leading global market position in each of our major product categories, which include:

commercial aircraft seats, including an extensive line of super first class, first class, business class, economy class and regional aircraft seats

a full line of aircraft food and beverage preparation and storage equipment, including coffee and espresso makers, water boilers, beverage containers, refrigerators, freezers, chillers and a line of microwave, high efficiency convection and steam ovens

modular lavatory systems, wastewater management systems and galley systems

both chemical and gaseous aircraft oxygen storage, distribution and delivery systems, protective breathing equipment and a broad range of lighting products

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business jet and general aviation interior products, including an extensive line of executive aircraft and helicopter seats, direct and indirect overhead lighting systems, exterior lighting systems, passenger and crew oxygen systems, air valve systems and high-end aircraft monuments

Interior Systems sales are categorized by product type into interior products and services and aircraft seating.
Interior products and services includes a portfolio of interior structure products (galley structures, food and beverage preparation equipment, water and waste systems), integrated engineering services, oxygen and passenger service equipment, cabin lighting systems, de-icing equipment and aftermarket services. These products and services are marketed and sold to original equipment manufacturers (OEMs) as well as airliner customers. Additionally, interior products and services manufactures customized fully integrated thermal and power management solutions for participants in the defense industry, OEMs and the airlines.
Aircraft seating includes a portfolio of innovative and bespoke seating products for applications on all classes of commercial, business aviation, executive and helicopter platforms for line fit and retrofit programs. These products are marketed and sold directly to OEMs, airlines and completion centers across the globe.

Commercial Systems

Our Commercial Systems segment supplies aviation electronics systems, products and services to customers located throughout the world. The customer base is comprised of OEMs of commercial air transport, business and regional aircraft, commercial airlines and business aircraft operators. Our systems and products are used in both OEM applications as well as in retrofit and upgrade applications designed to increase the efficiency and enhance the value of existing aircraft.

Our commercial aviation electronics systems, products and services include:

integrated avionics systems, such as Pro Line Fusion®, which provide advanced avionics capabilities to meet the challenges of operating in the next generation global airspace. Pro Line Fusion® capabilities include: touch control primary flight displays, advanced flight and performance management, flight guidance and information management

integrated cabin electronics solutions, including cabin management systems with touch-screen controls, wireless connectivity equipment, high definition video and audio, and entertainment and information content such as Airshow moving maps

communications systems and products, such as data link, high frequency (HF), very high frequency (VHF) and satellite communications systems

navigation systems and products, including landing sensors to enable fully automatic landings, radio navigation and geophysical sensors, as well as flight management systems

situational awareness and surveillance systems and products, such as synthetic and enhanced vision systems, surface surveillance and guidance solutions, head-up guidance systems, weather radar and collision avoidance systems

integrated flight controls including fly-by-wire, advanced flight guidance with auto-land capability, pilot controls, and primary and secondary electro-mechanical actuation

simulation and training systems, including full-flight simulators for crew training, visual system products, training systems and engineering services

maintenance, repair, parts, after-sales support services and aftermarket used equipment

Commercial Systems sales are categorized into air transport aviation electronics and business and regional aviation electronics. Product category sales are delineated based upon the difference in the underlying customer base, size of aircraft and markets served.

Air transport aviation electronics include avionics, cabin systems and flight control systems for large commercial transport aircraft platforms. We design these items as sub-systems and work with OEMs to integrate with other suppliers' products into the flight deck and broader aircraft systems. Our products offered for OEM applications in the air transport category are

3



marketed directly to aircraft OEMs and airline operators, while our products offered for aftermarket applications are primarily marketed to airline operators.

Business and regional aviation electronics include integrated avionics, cabin management and flight control systems for application on regional and business aircraft platforms. We develop integrated avionics, cabin and flight control solutions for business and regional aircraft OEMs and support them with integration into other aircraft systems. Products offered for OEM applications in the business and regional aircraft category are marketed directly to the aircraft OEMs. Products offered for aftermarket applications are primarily marketed through distributors for business aviation and directly to regional airline operators.

Government Systems

Our Government Systems segment provides a broad range of electronic products, systems and services to customers including the U.S. Department of Defense, various ministries of defense, other government agencies and defense contractors around the world. Our defense electronic solutions are designed to meet a wide range of customer requirements, but tend to share certain characteristics including design for rugged environments and use in size, weight and power constrained applications. These applications also typically have stringent product integrity and certification requirements with a high degree of customer oversight. These products, systems and services support airborne, precision weapon, ground and maritime applications on new equipment as well as in retrofit and upgrade applications designed to extend the service life and enhance the capability of existing aircraft, vehicle and weapon platforms.

Our defense-related systems, products and services include:

communications systems and products designed to enable the transmission of information across the communications spectrum

navigation products and systems, including radio navigation products, global positioning system (GPS) equipment and multi-mode receivers

avionics systems for aircraft flight decks, including cockpit display products (multipurpose flat panel head-down displays, wide field of view head-up and helmet-mounted displays), flight controls, information/data processing and communications, navigation, safety and surveillance systems

precision targeting, electronic warfare and range and training systems

simulation and training systems, including visual system products, training systems and services

space wheels for satellite stabilization

maintenance, repair, parts, after-sales support services and aftermarket used equipment

Government Systems sales are categorized into avionics and communication and navigation products. Product category sales are delineated based upon underlying product technologies.

Avionics consists of electronic solutions for a broad range of airborne platforms including fixed wing aircraft and military and civil rotary wing aircraft, unmanned aerial systems (UASs) and the associated aircrew and maintenance training devices and services. We provide complete avionics solutions, including cockpit avionics, mission system applications and system integration, and also provide individual avionics products to platform integrators. We serve various roles within these markets including system and sub-systems integrator as well as provider of various electronic products. For the UAS market we provide cost effective, high performance integrated flight control, navigation, communication and sensor capabilities. Simulation and training solutions are provided for both fixed and rotary wing aircraft.

Communication and navigation products include full spectrum communication solutions for voice and data connectivity for government and military use in the air, on the ground and at sea. These communication products support military user requirements for high availability, highly secure, jam resistant wireless communication. Products include radio communication, data links, electronic warfare and networked communication systems. The navigation products are primarily comprised of global positioning system based products used for precision navigation and targeting applications. These applications include airborne, vehicular, maritime, soldier navigation devices, precision targeting subsystems, precision-guided weapons products, range and training systems and a variety of embedded GPS applications.

4




Information Management Services

Our Information Management Services segment provides communications services, systems integration and security solutions across the aviation, airport, rail and nuclear security markets to customers located around the world. The customer base includes commercial airlines, business aircraft operators, the U.S. Federal Aviation Administration (FAA), airport and critical infrastructure operators and major passenger and freight railroads.
Our information management services include:
voice and data communication services, such as air-to-ground GLOBALinkSM and ground-to-ground AviNet® services, which enable satellite, VHF and HF transmissions between the cockpit, air traffic control, airline operation centers, reservation systems and other third parties ensuring safety and efficiency for commercial airlines and other related entities in the aviation ecosystem
global, high throughput cabin connectivity solutions enabling airlines to provide an enhanced experience for their passengers and improved operational efficiency for crews
robust connectivity management services that ensure interoperability between smart aircraft and legacy airline systems, allowing airlines to increase efficiency, reduce costs and enhance operations
cybersecurity as a service to protect the integrity of our customers’ information systems across a wide variety of domains including aviation, airports, rail and critical infrastructure
around the clock global flight support services for business aircraft operators, under the ARINCDirectSM brand, including flight planning and datalink, international trip support, cabin connectivity solutions and flight operations management software
airport communications and information systems designed to ease congestion and improve airport efficiency via airline agent and self-service check-in, airport operations, baggage management, boarding and access control solutions
train dispatching and information systems including solutions to support positive train control as mandated by the 2008 Railroad Safety Improvement Act
mission critical security command and control systems for nuclear power facilities with functions such as intrusion detection, access control, video and credential management and vehicle identification

Customers, Sales and Marketing

We serve a broad range of customers worldwide, including the U.S. Department of Defense, U.S. Coast Guard, civil agencies, airports, defense contractors, foreign ministries of defense, manufacturers of commercial helicopters, manufacturers of commercial air transport, airframe manufacturers, defense manufacturers, business and regional aircraft, commercial airlines, aerospace OEMs, fractional and other business jet operators, the FAA, critical infrastructure operators and major passenger and freight railroads. We market our systems, products and services directly to our customers through an internal marketing and sales force. In addition, we utilize a worldwide dealer network to distribute our products and international sales representatives to assist with international sales and marketing. In 2017, various branches of the U.S. Government, both directly and indirectly through subcontracts, accounted for 25 percent of our total sales.
 
Our largest customers have substantial bargaining power with respect to price and other commercial terms. Although we believe that we generally enjoy good relations with our customers, the loss of all or a substantial portion of our sales to any of our large volume customers for any reason, including the loss of contracts, bankruptcy, reduced or delayed customer requirements, strikes or other work stoppages affecting production by these customers, could have a material adverse effect on our business, financial condition, results of operations and cash flows.


5



Competition

We operate in a highly competitive environment. Principal competitive factors include total cost of ownership, product and system performance, network coverage, quality, service, warranty and indemnification terms, technology, design engineering capabilities, new product innovation and timely delivery. We compete worldwide with a number of U.S. and non-U.S. companies in each of our businesses. Many of these competitors are also our suppliers or customers. Principal competitors include BAE Systems Aerospace, Inc.; CAE Inc.; Diehl Aerosystems Holding GmBH; Elbit Systems Ltd.; Esterline Technologies Corp.; FlightSafety International; Garmin International Inc.; General Dynamics Corporation; General Electric Co.; Groupe Zodiac Aerospace S.A.; Harris Corp.; Honeywell International, Inc.; Jamco America, Inc.; L3 Communications, Inc.; Northrop Grumman Corp.; Raytheon Co.; Recaro Aircraft Seating GmbH & Co. KG; Satcom Direct, Inc.; SITA; Thales S.A.; The Boeing Company; and Thompson Aero Seating Ltd. Several of our competitors are significantly larger than we are in terms of resources and market share and can offer a broader range of products. We believe that our systems, products and services are well positioned to compete in our served markets.

Industry consolidation has from time to time had a major impact on the competitive environment in which we operate. Our competitors periodically undertake mergers, alliances and realignments that contribute to a dynamic competitive landscape. We have contributed to this changing landscape in the past three years by completing a significant acquisition (B/E Aerospace, Inc.), four smaller acquisitions and several strategic alliances to improve our competitive position and expand our market reach.

Raw Materials, Supplies and Working Capital

We believe we have adequate sources for the supply of raw materials and components for our manufacturing and service needs with suppliers located around the world. Electronic components and other raw materials used in the manufacturing of our products are generally available from several suppliers. We continue to work with our supply base for raw materials and components to ensure an adequate source of supply, utilizing strategic alliances, dual sourcing, identification of substitute or alternate parts that meet performance requirements and life-time buys. These life-time buys involve purchases of multiple years of supply in order to meet production and service requirements over the life span of a product. Although historically we have not experienced any significant difficulties in obtaining an adequate supply of raw materials and components necessary for our manufacturing operations or service needs, the loss of a significant supplier or the inability of a supplier to meet performance and quality specifications or delivery schedules could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Our investment in inventory is a significant part of our working capital, and historically we have maintained sufficient inventory to meet our customers' requirements on a timely basis. This investment includes production stock, work-in-process, pre-production engineering costs, finished goods, spare parts and goods on consignment. Our accounts receivable also constitute a significant part of our working capital. Accounts receivable includes unbilled receivables which are primarily related to sales recorded under the percentage-of-completion method of accounting in accordance with applicable contract terms that have not been billed to customers. The critical accounting policies involving pre-production engineering costs and long-term contracts are discussed under the caption Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 below. Additional information relating to accounts receivable and inventory is contained in Notes 2, 5 and 6 of the Notes to Consolidated Financial Statements in Item 8 below.

Backlog

The following table summarizes our backlog:
 
 
September 30
(in billions)
 
2017
 
2016
Interior Systems
 
$
3.8

 
$

Commercial Systems
 
2.2

 
2.2

Government Systems:
 
 
 
 
Funded orders
 
2.5

 
2.5

Unfunded orders
 
0.8

 
0.7

Information Management Services
 
0.3

 
0.3

Total backlog
 
$
9.6

 
$
5.7



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Our backlog represents the aggregate of the sales price of orders received from customers, but not recognized as revenue, and excludes unexercised options. Although we believe that the orders included in backlog are firm, most of our backlog orders can be modified or terminated by the customer. Our backlog at September 30, 2017 includes approximately $4.8 billion of orders that are expected to be filled after 2018.

Joint Ventures

Joint ventures, strategic alliances, strategic investments and other cooperative arrangements are part of our business strategies to broaden the market for our products and develop new technologies.

We have a 50 percent ownership interest in each of the following:

ACCEL (Tianjin) Flight Simulation Co., Ltd, a joint venture with Haite Group, for the joint development and production of commercial flight simulators in China

ADARI Aviation Technology Limited, a joint venture with Aviation Data Communication Corporation Co., LTD, operates remote ground stations around China and develops certain content delivery management software

AVIC Leihua Rockwell Collins Avionics Company, a joint venture with China Leihua Electronic Technology Research Institute, a subsidiary of the Aviation Industry Corporation of China (AVIC), which provides integrated surveillance system products for the C919 aircraft in China

Data Link Solutions LLC, a joint venture with BAE Systems, plc, for joint pursuit of the worldwide military data link market

ESA Vision Systems LLC, a joint venture with Elbit Systems, Ltd., for joint pursuit of helmet-mounted cueing systems for the worldwide military fixed wing aircraft market

Quest Flight Training Limited, a joint venture with Quadrant Group, plc, which provides aircrew training services primarily for the United Kingdom Ministry of Defence

Rockwell Collins CETC Avionics Co., Ltd. a joint venture with CETC Avionics Co., Ltd. to develop and deliver products for the C919 program

Acquisitions and Dispositions

We regularly consider various business opportunities, including strategic acquisitions and alliances, licenses and marketing arrangements. We review the prospects of our existing businesses to determine whether any of them should be modified, sold or otherwise discontinued.

We completed five acquisitions in the past three years to augment our growth plans. These acquisitions were:

in April 2017, we acquired B/E Aerospace, which provides aircraft cabin interior products and services

in December 2016, we acquired Pulse.aero, a company specializing in self-bag drop technologies used by airlines and airports

in February 2016, we acquired the Matrix series projector product line from Christie Digital Systems, a global visual, audio and collaboration solutions company

in August 2015, we acquired International Communications Group, Inc. (ICG), which provides satellite-based global voice and data communication products and services for the aviation industry

in March 2015, we acquired Pacific Avionics Pty. Limited (Pacific Avionics), which provides technologies used for wireless information distribution


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We completed one material divestiture in the past three years as part of our strategy to reshape our business and focus on opportunities in addressed markets for our core products and solutions. In March 2015, we divested our Aerospace Systems Engineering and Support business (ASES), which provided military aircraft integration and modifications, maintenance, logistics and support.

Additional information relating to our acquisitions, dispositions and joint ventures is contained in Notes 3, 4 and 8 of the Notes to Consolidated Financial Statements in Item 8 below.

Research and Development

We have significant research, development, engineering and product design capabilities. At September 30, 2017, we employed approximately 7,700 engineers.

Our research and development (R&D) investment is as follows:
(in millions)
 
2017
 
2016
 
2015
Customer-funded (1)
 
$
746

 
$
621

 
$
578

Company-funded
 
327

 
224

 
272

Total research and development expense
 
1,073

 
845

 
850

Increase in pre-production engineering costs, net
 
35

 
128

 
136

Total research and development investment (2)
 
$
1,108

 
$
973

 
$
986

(1) Customer-funded R&D includes activities relating to the development of new products and the improvement of existing products for which we are reimbursed by our customers. Customer-funded R&D also includes amortization of pre-production engineering costs as disclosed in Note 6 of the Notes to Consolidated Financial Statements in Item 8 below.
(2) Total R&D investment consists of company- and customer-funded R&D expenditures as well as the net increase in pre-production engineering costs capitalized within inventory. As disclosed in Note 6 of the Notes to Consolidated Financial Statements in Item 8 below, pre-production engineering costs capitalized within inventory were $1.175 billion and $1.140 billion at September 30, 2017 and 2016, respectively. A description of the critical accounting policies involving pre-production engineering is included under the caption Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 below.

Intellectual Property

Our intellectual property rights include valuable patents, trademarks, copyrights, trade secrets, inventions and other proprietary rights. We own numerous U.S. and foreign patents and have numerous pending patent applications, including patents and patent applications purchased in our acquisitions. We also license certain patents relating to our manufacturing and other activities. While in the aggregate we consider our patents and licenses important to the operation of our business, we do not consider any individual patent or license to be of such importance that the loss or termination of any one patent or license would materially affect us.

Rockwell Automation, Inc. (Rockwell) owns the "Rockwell" name. In connection with our spin-off from Rockwell in 2001, we were granted the exclusive right to continue to use the Rockwell Collins name for use in our business other than in connection with the Rockwell Automation business or industrial automation products. This exclusive right would terminate following certain change of control events, including the completion of the UTC Merger, as described in our distribution agreement with Rockwell.

Employees

As of September 30, 2017, we had approximately 29,000 employees and approximately 69 percent of them were located in the U.S. Approximately 11 percent of our employees located within the U.S. and 8 percent of our employees located outside of the U.S. are covered by collective bargaining agreements. Many of our employees located outside of the U.S. who are not covered by a collective bargaining agreement are represented by workers' councils or statutory labor unions. The collective bargaining agreements for most of our employees covered by collective bargaining agreements are set to expire in 2018.


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Cyclicality and Seasonality

The markets in which we sell our products are, to varying degrees, cyclical and have experienced periodic upswings and downturns. For example, markets for our commercial aerospace products have experienced downturns during periods of slowdowns in the commercial airline industry and during periods of weak conditions in the economy in general, as demand for new aircraft generally declines during these periods. We believe that we are currently benefiting from robust backlogs in commercial air transportation and increasing content as next generation aircraft enter into service. While we believe our Government Systems business is well positioned, it is also subject to some cyclicality, primarily as a result of U.S. Government defense budget cycles. Additional information related to the defense budget environment can be found under the caption Risk Factors in Item 1A below.

Our business tends to be seasonal with our fourth quarter usually producing relatively higher sales and cash flow and our first quarter usually producing relatively lower sales and cash flow. A large part of this seasonality variance is attributable to our Government Systems business and relates to the U.S. Government procurement cycle.

Regulatory Matters

As a defense contractor, our contract costs are audited and reviewed on a continual basis by the Defense Contract Management Agency and the Defense Contract Audit Agency. Audits and investigations are conducted from time to time to determine if our performance and administration of our U.S. Government contracts are compliant with applicable contractual requirements and procurement regulations and other applicable federal statutes and regulations. Under present U.S. Government procurement regulations, if indicted or adjudged in violation of procurement or other federal civil laws, a contractor, such as us, could be subject to fines, penalties, repayments or other damages. U.S. Government regulations also provide that certain findings against a contractor may lead to suspension or debarment from eligibility for awards of new U.S. Government contracts for up to three years. In addition, we are subject to various non-U.S. governmental contracting requirements.

The sale, installation and operation of our products in commercial aviation applications is subject to continued compliance with applicable regulatory requirements and future changes to those requirements. In the U.S., our commercial aviation products are required to comply with FAA regulations governing production and quality systems, airworthiness and installation approvals, repair procedures and continuing operational safety. Some of our products, such as radio frequency transmitters and receivers, must also comply with Federal Communications Commission (FCC) regulations governing authorization and operational approval of telecommunications equipment. Our communication services offered in the Information Management Services business are also subject to certain FCC regulations.

Internationally, similar requirements exist for communication services, airworthiness, installation and operational approvals. These requirements are administered by the national aviation authorities of each country and, in the case of Europe, coordinated by the European Joint Aviation Authorities. Many countries also impose specific telecommunications equipment requirements, administered through their national aviation authorities or telecommunications authorities. In Europe, approval to import products also requires compliance with European Commission directives, such as those associated with electrical safety, electro-magnetic compatibility, use of metric units of measurement and restrictions on the use of lead.

Products already in service may also become subject to mandatory changes for continued regulatory compliance as a result of any identified safety issue, which can arise from an aircraft accident, incident or service difficulty report.

Our products and technical data are controlled for export and import under various regulatory agencies. Audits and investigations by these agencies are a regular occurrence to ensure compliance with applicable federal statutes and regulations. Violations, including as a successor to an acquired business, can result in fines and penalties assessed against the Company as well as individuals, and the most egregious acts may result in a complete loss of export privileges.

Various anti-bribery and anti-corruption laws, as well as data privacy laws, are applicable to our business operations throughout the world.

Although we do not have any significant regulatory action pending against us, any such action could have a material adverse impact on our business, financial condition, results of operations and cash flows.


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Environmental Matters

Federal, state and local requirements relating to the discharge of substances into the environment, the disposal of hazardous waste and other activities affecting the environment have had and will continue to have an impact on our manufacturing operations. To date, compliance with environmental requirements and resolution of environmental claims have been accomplished without material effect on our liquidity and capital resources, competitive position or financial condition. We believe that our expenditures for environmental capital investment and remediation necessary to comply with present regulations governing environmental protection and other expenditures for the resolution of environmental claims will not have a material adverse effect on our business or financial condition. Additional information on environmental matters is contained in Note 18 of the Notes to Consolidated Financial Statements in Item 8 below.

Geographic Information

Our principal markets outside the U.S. are in France, Canada, China, the United Kingdom, the United Arab Emirates, Germany, Japan, Qatar, Brazil, South Korea, Taiwan, Russia, Singapore, Italy, Australia and Hong Kong. In addition to normal business risks, operations outside the U.S. are subject to other risks, including political, economic and social environments, governmental laws and regulations and currency revaluations and fluctuations.

Selected financial information by major geographic area for each of the three years in the period ended September 30, 2017, 2016 and 2015 is contained in Note 21 of the Notes to Consolidated Financial Statements in Item 8 below.

Item 1A.
Risk Factors.

Risks Related to Our Business/Industry:

Reduction in U.S. Government spending adversely impacts Government Systems sales and profitability.

In 2017, 25 percent of our sales were derived from U.S. Government contracts, both directly and indirectly through subcontracts. Defense funding by the U.S. Government is expected to continue to be under pressure due to the overall economic environment, budget deficits and competing budget priorities. Cost cutting, efficiency initiatives, reprioritization and other affordability analysis by the U.S. Government on defense spending could present some additional opportunities for us, but continued pressure on U.S. Government spending on defense could also adversely impact our Government Systems sales and profitability. 

The U.S. Government has implemented various initiatives to address its fiscal challenges. In August 2011, Congress enacted the Budget Control Act (BCA) of 2011 which imposed spending caps and certain reductions in defense spending over a ten-year period through 2021. These spending caps and reductions, referred to as sequestration, went into effect in March 2013. Through a series of bipartisan agreements, Congress has been able to temporarily lift discretionary spending limits every year through 2017. However, unless a new agreement is enacted, the BCA will again be in force beginning in 2018. The continued uncertainty surrounding the U.S. defense budget could have a material adverse effect on the Company and the defense industry in general.

In years when the U.S. Government does not complete its annual budget and appropriations process prior to the beginning of its fiscal year (October 1), government operations are typically funded through a continuing resolution that authorizes agencies of the U.S. Government to continue to operate in the new year, but generally does not authorize new spending initiatives. During periods covered by a continuing resolution (or until the regular appropriation bills are passed), we may experience delays by the government in the procurement of new or existing products and services which can adversely impact our results of operations and cause variability in the timing of revenue between periods. The government began operations in fiscal year 2018 under a continuing resolution that is set to expire in December 2017.

We offer a diverse range of defense products and services. We believe that this makes it less likely that cuts in any specific contract or program will have a long-term effect on our business; however, delays or termination of multiple or large programs or contracts could adversely affect our business and future financial performance. Potential changes in funding priorities may afford new or additional opportunities for our businesses in terms of existing, follow-on or replacement programs. While we would expect to compete and be well positioned as the incumbent on existing programs, we may not be successful, and any replacement programs may be funded at lower levels.


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We depend to a significant degree on U.S. Government contracts, which are subject to unique risks.

In addition to normal business risks, our supply of systems and products to the U.S. Government is subject to unique risks which are largely beyond our control. These risks include:

dependence on Congressional appropriations and administrative allotment of funds

the ability of the U.S. Government to terminate, without prior notice, partially completed government programs and contracts that were previously authorized (although we may recover certain costs if terminated for convenience)

changes in governmental procurement legislation and regulations and other policies which may reflect military and political developments, including U.S. Government initiatives to gain increased access to intellectual property

significant changes in contract scheduling or program structure, which generally result in delays or reductions in deliveries

intense competition for available U.S. Government business necessitating increases in time and investment for design and development

difficulty of forecasting costs and schedules when bidding on developmental and highly sophisticated technical work

changes over the life of U.S. Government contracts, particularly development contracts, which generally result in adjustments of contract prices

claims based on U.S. Government work and violation of associated compliance and other requirements, which may result in fines, the cancellation or suspension of payments or suspension or debarment proceedings affecting potential further business with the U.S. Government

We are subject to risks arising from changes in the competitive environment in which we operate.

We operate in a highly competitive environment. Many of our competitors are also our suppliers or customers on our programs and may be significantly larger than us. Among others, risks in the competitive environment include:

original equipment manufacturers' efforts to vertically integrate

customers seeking more rights in intellectual property developed in connection with their program, price concessions, extensive liability protections and other customer favorable contract terms

competitors offering lower prices and new solutions, developing new technologies or otherwise capturing more market share

International conflicts and terrorism may adversely affect our business.

International conflicts and political turmoil in the Middle East and elsewhere and the possibility of future terrorist attacks cause significant uncertainty with respect to business and financial markets and may adversely affect our business. These international conflicts also affect the price of oil, which has a significant impact on the financial health of our commercial customers. Although our Government Systems business may experience greater demand for its products as a result of increased government defense spending, factors arising (directly or indirectly) from international conflicts or terrorism which may adversely affect our commercial business include reduced aircraft build rates, upgrades, maintenance and spending on discretionary products, as well as increases in the cost of property and aviation products insurance and increased restrictions placed on our insurance policies.

Our business is heavily concentrated in the aviation industry.

As a provider of products and services to the aviation industry, we are significantly affected by the overall economic condition of that industry. The aviation industry is historically cyclical.


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Our business, financial condition, results of operations and cash flows may be adversely impacted, among other things, by the following:

reductions in demand for aircraft and delayed aircraft delivery schedules

bankruptcy or other significant financial difficulties of our existing and potential customers

reductions in the need for, or the deferral of, aircraft maintenance and repair services and spare parts support

deferral of discretionary spending by our airline customers for cabin retrofit activities

retirement or storage of older generation aircraft, resulting in fewer retrofits and less demand for services for those aircraft, as well as the increased availability of used or recycled equipment on the market

limited availability of financing for airlines or aircraft

impact on the aviation industry due to the volatility of fuel prices

disruptions to commercial air travel demand
 
A global or regional recession may adversely affect us.

If a recession emerges that impacts where we do business, risks may include:

declines in revenues, profitability and cash flows from reduced orders, payment delays or other factors caused by the economic problems of our customers

adverse impacts on our access to short-term commercial paper borrowings or other credit sources

supply problems associated with any financial constraints faced by our suppliers

We derive a significant portion of our revenues from international sales and are subject to the risks of doing business outside the U.S.

In 2017, 45 percent of our total revenues were from sales of our products and services internationally, including foreign military sales. We expect that international sales will continue to account for a significant portion of our total sales. As a result, we are subject to risks of doing business internationally, including:

laws, regulations and policies of non-U.S. governments relating to investments and operations, as well as U.S. laws affecting the activities of U.S. companies abroad

regulatory requirements and potential changes, including imposition of tariffs or embargoes, export controls and other trade restrictions, anti-bribery, anti-money laundering, antitrust and data privacy requirements

changes in government spending on defense programs

uncertainties and restrictions concerning the availability of funding, credit or guarantees

requirements of certain customers which obligate us to specified levels of in-country purchases, manufacturing or investments, known as offsets, and penalties in the event we fail to perform in accordance with the offset requirements

impacts associated with foreign currency volatility

uncertainties as to local laws and enforcement of contract and intellectual property rights

rapid changes in government, economic and political policies, political or civil unrest or the threat of international boycotts or U.S. anti-boycott legislation


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We have made, and expect to continue to make, strategic acquisitions and partnerships that involve risks and uncertainties.

We completed five acquisitions and several joint ventures and strategic alliances (partnerships) in the past three fiscal years. We will consider making minor acquisitions and partnerships in the future in an effort to enhance shareowner value. Acquisitions and partnerships involve certain risks and uncertainties, such as:

difficulty in integrating newly-acquired businesses and commencing partnership operations in an efficient and cost-effective manner and the risk that we encounter significant unanticipated costs or other problems associated with integration or commencement

challenges in achieving strategic objectives, cost and revenue synergies and other expected benefits

risk that our markets do not evolve as anticipated and the targeted technologies do not prove to be those needed to be successful in those markets

risk that we assume significant liabilities that exceed the limitations of any applicable indemnification provisions or the financial resources of any indemnifying parties

loss of key employees of the acquired businesses or joint venture

risk of diverting the attention of senior management from our existing operations

risk of litigation associated with an acquisition

We enter into fixed-price contracts that could subject us to losses in the event that we have cost overruns.

During 2017, approximately 94 percent of our total sales were, and a significant portion of our anticipated future sales will be, from fixed-price contracts. This allows us to benefit from cost savings, but it carries the burden of potential cost overruns since we assume all of the cost risk. If our initial cost estimates are incorrect, we can incur losses on these contracts. These fixed-price contracts can expose us to potentially large losses because the customer may compel us to complete a project or, in the event of a termination for default, pay the entire incremental cost of its replacement by another provider regardless of the size of any cost overruns that occur over the life of the contract. Because many of these projects involve new technologies and applications and can last for years, unforeseen events such as technological difficulties, fluctuations in the price of raw
materials, problems with subcontractors and cost overruns can result in the contractual price becoming less favorable or even unprofitable to us over time. Furthermore, if we do not meet project deadlines or specifications, we may need to renegotiate contracts on less favorable terms, be forced to pay penalties or liquidated damages or suffer major losses if the customer exercises its right to terminate. In addition, some of our contracts have provisions relating to cost controls and audit rights, and if we fail to meet the terms specified in those contracts we may not realize their full benefits. Our results of operations are dependent on our ability to maximize earnings from our contracts. Lower earnings caused by cost overruns could have an adverse impact on our financial condition, results of operations and cash flows.

We are subject to risks in our integration processes and production systems, including potential issues in meeting stringent performance and reliability standards.

The aerospace and defense business is complex, involving extensive coordination and integration with U.S. and non-U.S. suppliers and customers, highly-skilled labor, stringent regulatory and contractual requirements and performance and reliability standards. As a result, our ability to deliver products and systems on time, satisfy regulatory and customer requirements, and achieve or maintain program profitability is subject to significant risk. Operational delays or defects could result in increased production costs, as well as delayed deliveries and disruption to our customers.

Costs of certain employee and retiree benefits may rise.

Although we have taken action seeking to contain volatility in the costs related to medical and pension benefits, there are risks that our costs for these benefits will increase as a result of:

continued increases in medical costs related to current employees due to increased usage of medical benefits, medical inflation and the impact of U.S. Government health care legislation

continued increases in the average life span of retirees

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material changes in legislation or market dynamics impacting medical or pension matters

the effect declines in the stock and bond markets have on our pension plan assets

reductions in the discount rate used to determine the present value of our retirement benefit obligations

Tax changes could affect our effective tax rate and future profitability.

Our future results could be adversely affected by changes in the effective tax rate as a result of changes in our overall profitability and changes in the mix of earnings in countries with differing statutory tax rates, changes in tax legislation, the results of audits and examination of previously filed tax returns and continuing assessment of our tax exposures.

We depend on critical suppliers and subcontractors.

We do not always have alternate sources of supply readily available for certain goods or services, such as liquid crystal displays. The loss of a significant supplier or subcontractor or their inability to meet performance, quality or delivery requirements due to natural disaster, financial stress, capacity constraints, military conflicts or other causes could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We depend on specialized test equipment.

Some of our specialized test equipment that supports the reliability of our products and systems is the result of significant investment. Back-up test equipment may not be readily available. Damage to our specialized test equipment may result in protracted production recovery and may adversely impact our ability to service our products.

A cybersecurity incident, network failure or other business disruption could have negative impacts.

We face cyber threats, threats to the physical security of our facilities, potential cyber attacks to the integrity of our networks and/or products, and the potential release or theft of our intellectual property, as well as the potential for business disruptions associated with information technology (IT) failures. Possible areas of significant exposure to cyber threats or other disruptions include our enterprise information technology resources, our information management network that provides communication services to customers and our flight deck communication products and solutions. Any of these threats or disruptions may result in a material adverse effect on our business, financial condition, results of operations and cash flows. Risks may include:

adverse effects to future results due to the theft, destruction, loss, corruption or release of personal data, confidential information or intellectual property

operational or business disruptions resulting from the failure of IT or other systems and subsequent mitigation activities

negative publicity resulting in reputation or brand damage with our customers, suppliers, employees, shareowners and others

Risks Related to Our B/E Aerospace Transaction:

We may be unable to successfully integrate B/E Aerospace's business and realize the anticipated benefits of the merger.

The success of the merger will depend, in part, on our ability to successfully combine our business with B/E Aerospace's business and realize the anticipated benefits, including synergies, cost savings, innovation and operational efficiencies, from the combination. If we are unable to achieve these objectives within the anticipated time frame, or at all, the anticipated benefits may not be realized fully, or at all, or may take longer to realize than expected.

The merger involves the integration of B/E Aerospace's business with our existing business, which is a complex, costly and time-consuming process. We have not previously completed a transaction comparable in size or scope to the merger. The integration of the two companies may result in material challenges, including, without limitation:

the diversion of management's attention from ongoing business concerns and performance shortfalls at one or both of the companies as a result of the devotion of management's attention to the integration

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maintaining employee morale and retaining key management and other employees

the possibility of faulty assumptions underlying expectations regarding the integration process

retaining existing business and operational relationships and attracting new business and operational relationships
 
consolidating corporate and administrative infrastructures and eliminating duplicative operations
 
coordinating geographically separate organizations

unanticipated issues in integrating information technology, communications and other systems
 
unforeseen expenses or delays associated with the integration

Many of these factors are outside of our control and any one of them could result in delays, increased costs, decreases in the amount of expected revenues and diversion of management's time and energy, which could materially affect our financial position, results of operations and cash flows.

Between signing of the merger agreement and closing of the merger, we were permitted to conduct only limited planning for the integration of the two companies following the merger. The actual integration may result in additional and unforeseen expenses, and the anticipated benefits of the integration plan may not be realized on a timely basis, if at all.

Our future results may be adversely impacted if we do not effectively manage the expanded operations following the completion of the B/E Aerospace merger.

Following the completion of the merger, our business is significantly larger. Our ability to successfully manage this expanded business depends, in part, upon management's ability to design and implement strategic initiatives that address not only the integration of two discrete companies, but also the increased scale and scope of the combined business with its associated increased costs and complexity. There can be no assurances that we will be successful or that we will realize the expected operating efficiencies, cost savings and other benefits currently anticipated from the merger.

We are incurring substantial expenses related to the merger and the integration of B/E Aerospace.

There are a large number of processes, policies, procedures, operations, technologies and systems that must be integrated, including purchasing, accounting and finance, sales, payroll, pricing, revenue recognition, marketing, employee benefits, legal and compliance, strategic and financial planning, information technology and treasury. The substantial majority of costs for these integration activities will be non-recurring expenses related to the merger (including financing of the merger and the refinancing of certain indebtedness), facilities and systems consolidation costs. We may incur additional costs to maintain employee morale and to retain key employees. We are also incurring transaction fees and costs related to integration plans for the combined business, and the execution of these plans may lead to additional unanticipated costs and time delays. These incremental transaction and merger-related costs may exceed the savings we expect to achieve from the elimination of duplicative costs and the realization of other efficiencies related to the integration of the businesses, particularly in the near term and in the event there are material unanticipated costs.

We are significantly more leveraged.

In connection with the B/E Aerospace merger, we incurred $5.9 billion in additional indebtedness. We have consolidated indebtedness of approximately $7.2 billion, which is greater than what our indebtedness was prior to the merger. The increased indebtedness and higher debt-to-total capitalization ratio may have the effect, among other things, of reducing our flexibility to respond to changing business and economic conditions, requiring us to use substantial amounts of cash flow to repay indebtedness, increasing borrowing costs and placing us at a disadvantage compared to competitors with less leverage.


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The financing arrangements entered into in connection with the merger contain restrictions and limitations that could, under certain circumstances, significantly impact our ability to operate the business.

We incurred significant new indebtedness in connection with the merger. The agreements governing the indebtedness incurred in connection with the merger contain covenants that, among other things, may, under certain circumstances, place limitations on the dollar amounts paid or other actions relating to:

consolidating with or merging into any other corporation or conveying or transferring all or substantially all its properties and assets

incurring secured debt
 
entering into sale and leaseback transactions
 
designating subsidiaries as restricted or unrestricted

Such agreements also require us to maintain a debt-to-capitalization ratio below a specified threshold, which may further limit discretion in the operation of our business following the merger. Such agreements also contain additional restrictive covenants. Various risks, uncertainties and events beyond our control could affect our ability to comply with the covenants contained in our debt agreements. Failure to comply with any of the covenants in our existing or future financing agreements could result in a default under those agreements and under other agreements containing cross-default provisions. A default would permit lenders to accelerate the maturity of the debt under these agreements. Under these circumstances, we might not have sufficient funds or other resources to satisfy all of our obligations. In addition, the limitations imposed by financing agreements on our ability to incur additional debt and to take other actions might significantly impair our ability to obtain other financing.

The merger could result in significant liability to us if the merger causes the KLX spin-off to fail to qualify for the KLX spin-off tax treatment.

In 2014, the Consumables Management Segment of B/E Aerospace, which consisted of its aerospace distribution and energy services businesses, was spun-off to form KLX, Inc., which is referred to as KLX. At the time of the KLX spin-off, B/E Aerospace received an opinion of Shearman & Sterling to the effect that, subject to the limitations and assumptions set forth therein, the KLX spin-off that occurred in December 2014 will qualify for the KLX spin-off tax treatment, which generally means a transaction tax-free to B/E Aerospace and its stockholders under the U.S. federal income tax rules for spin-offs in Section 355 of the Code and related provisions. If, however, the KLX spin-off were to fail to qualify for the KLX spin-off tax treatment, B/E Aerospace would be subject to tax on substantial gain as if B/E Aerospace had sold the KLX common stock in a taxable sale for its fair market value at the time of the KLX spin-off. In addition, if the KLX spin-off failed to qualify for tax-free treatment, each B/E Aerospace stockholder at the time of the KLX spin-off would be treated as if it had received a distribution from B/E Aerospace in an amount equal to the fair market value of the KLX common stock that they received; this distribution generally would be taxed as a dividend to the extent of the stockholder's pro rata share of B/E Aerospace's current and accumulated earnings and profits at the time of the KLX spin-off and then treated as a non-taxable return of capital to the extent of the stockholder's basis in the B/E Aerospace common stock and finally as capital gain from the sale or exchange of B/E Aerospace common stock.

Under current U.S. federal income tax law, the KLX spin-off would fail to qualify for the KLX spin-off tax treatment if the KLX spin-off was determined to have been used by B/E Aerospace principally as a device for the distribution of earnings and profits by, for example, facilitating a taxable sale of the stock of B/E Aerospace or KLX through a planned or intended change-in-control transaction identified prior to the KLX spin-off rather than principally to achieve one or more valid corporate business purposes. Furthermore, even if the KLX spin-off were otherwise to qualify for tax-free treatment under Section 355 and related provisions of the Code, it would be taxable to B/E Aerospace (but not to B/E Aerospace's stockholders) under Section 355(e) of the Code, if the KLX spin-off was determined to be part of a plan (or series of related transactions) pursuant to which one or more persons acquire, directly or indirectly, stock representing a 50% or greater interest in B/E Aerospace or KLX.

If it is determined that the KLX spin-off fails to qualify for the KLX spin-off tax treatment as a result of the merger (for example, if the merger is viewed as part of a plan or series of related transactions that includes the KLX spin-off or the KLX spin-off is found to have been used principally as a device for the distribution of earnings and profits), or because of the failure of the KLX spin-off to initially qualify for the KLX spin-off tax treatment, B/E Aerospace could incur significant tax liabilities. Because B/E Aerospace is our wholly owned subsidiary, any such tax liabilities of B/E Aerospace could also adversely affect us. If the KLX spin-off fails to qualify for the KLX spin-off tax treatment, this may also result in adverse tax consequences to

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stockholders of B/E Aerospace at the time of the KLX spin-off because they would be taxed on the distribution of KLX stock as described above.

In connection with the merger, we received an opinion from our counsel, Skadden, Arps, Slate, Meagher & Flom LLP and Shearman & Sterling to the effect that, subject to the limitations and assumptions set fourth therein, the merger will not cause the KLX spin-off to fail to qualify for the KLX spin-off tax treatment. The tax opinions received in connection with the merger rely on certain representations, assumptions, undertakings and covenants, including representation letters from each of us and B/E Aerospace. These representations relate to, among other items, confirming the accuracy of the representations and warranties originally made with respect to the KLX spin-off, along with compliance with covenants, the actions taken in pursuit of the corporate business purposes of the KLX spin-off, the interaction of the parties, and business developments since the KLX spin-off. If any of the factual representations in any of the representation letters, or any of the assumptions in the tax opinions is untrue or incomplete, an undertaking or covenant is not complied with or the facts upon which a tax opinion is based are materially different from the facts at the time of the merger, the opinions may not be valid. Moreover, opinions of counsel are not binding on the IRS or the courts. As a result, the conclusions expressed in the tax opinions could be challenged by the IRS, and a court may sustain such a challenge. None of Rockwell Collins, B/E Aerospace or KLX has requested a ruling from the IRS regarding the impact of the merger on the qualification of the KLX spin-off for the KLX spin-off tax treatment.

Risks Related to the Proposed Acquisition of the Company by UTC:

The UTC Merger is subject to conditions, some or all of which may not be satisfied, or completed on a timely basis, if at all. Failure to complete the UTC Merger could have material adverse effects on us.

The completion of the UTC Merger is subject to a number of conditions, including, among other things, receipt of the shareowner approval and receipt of certain regulatory approvals, which make the completion and timing of the completion of the UTC Merger uncertain. The failure to satisfy all of the required conditions could delay the completion of the UTC Merger for a significant period of time or prevent it from occurring at all. There can be no assurance that the conditions to the closing of the UTC Merger will be satisfied or waived or that the UTC Merger will be completed. Also, subject to limited exceptions, either we or UTC may terminate the Merger Agreement if the UTC Merger has not been completed by 5:00 p.m. (Eastern time) on September 4, 2018, subject to extension through March 4, 2019, if all conditions other than certain antitrust-related conditions are or would be satisfied on that date.

If the UTC Merger is not completed, our ongoing business may be materially adversely affected and, without realizing any of the benefits of having completed the UTC Merger, we will be subject to a number of risks, including the following:

the market price of our common stock could decline

we could owe a substantial termination fee to UTC under certain circumstances

if the Merger Agreement is terminated and our board seeks another business combination, our shareowners cannot be certain that we will be able to find a party willing to enter into a transaction on terms equivalent to or more attractive than the terms that UTC has agreed to in the Merger Agreement

time and resources, financial and other, committed by our management to matters relating to the UTC Merger could otherwise have been devoted to pursuing other beneficial opportunities

we may experience negative reactions from the financial markets or from our customers, suppliers or employees

we will be required to pay our costs relating to the UTC Merger, such as legal, accounting, financial advisory and printing fees, whether or not the UTC Merger is completed

In addition, if the UTC Merger is not completed, we could be subject to litigation related to any failure to complete the UTC Merger or related to any enforcement proceeding commenced against us to perform our obligations under the UTC Merger Agreement. Any of these risks could materially and adversely impact our ongoing business, financial condition, financial results and stock price.

Similarly, delays in the completion of the UTC Merger could, among other things, result in additional transaction costs, loss of revenue or other negative effects associated with uncertainty about completion of the UTC Merger and could materially and adversely affect our ongoing business, financial condition, financial results and stock price.


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The Merger Agreement contains provisions that limit our ability to pursue alternatives to the UTC Merger, could discourage a potential competing acquiror of the Company from making a favorable alternative transaction proposal and, in specified circumstances, could require us to pay a substantial termination fee to UTC.

The Merger Agreement contains provisions that make it more difficult for us to be acquired by any company other than UTC. The Merger Agreement contains certain provisions that restrict our ability to, among other things, initiate, seek, solicit, knowingly facilitate, knowingly encourage, knowingly induce or knowingly take any other action reasonably expected to lead to, or engage in negotiations or discussions relating to, or approve or recommend, any third-party acquisition proposal. Further, even if our Board of Directors withdraws or qualifies its recommendation to the shareowners of Rockwell Collins to adopt the Merger Agreement and approve the UTC Merger (the “merger proposal”), unless the Merger Agreement is terminated in accordance with its terms, we will still be required to submit the merger proposal to a vote at the special meeting of our shareowners (the “special meeting”). In addition, following our receipt of any third-party acquisition proposal that constitutes a “superior proposal,” UTC will have an opportunity to offer to modify the terms of the Merger Agreement before our Board of Directors may withdraw or qualify its recommendation with respect to the merger proposal in favor of such superior proposal.

In some circumstances, upon termination of the Merger Agreement, we would be required to pay a termination fee of $695 million to UTC or reimburse certain expenses of UTC in connection with the transactions contemplated by the Merger Agreement.

These provisions could discourage a potential third-party acquiror or merger partner that might have an interest in acquiring all or a significant portion of us or pursuing an alternative transaction from considering or proposing such a transaction, even if it were prepared to pay consideration with a higher per share value than the value proposed to be received in the UTC Merger. In particular, the termination fee, if applicable, would be substantial, and could result in a potential third-party acquiror or merger partner proposing to pay a lower price to our shareowners than it might otherwise have proposed to pay absent such a fee.

If the Merger Agreement is terminated and we determine to seek another business combination, we may not be able to negotiate a transaction with another party on terms comparable to, or better than, the terms of the UTC Merger.

The UTC Merger is subject to the expiration or termination of applicable waiting periods and the receipt of approvals, consents or clearances from several regulatory authorities that may impose conditions that could have an adverse effect on us or, if not obtained, could prevent completion of the UTC Merger.

Before the UTC Merger may be completed, any applicable waiting period (and any extension thereof) under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 relating to the completion of the UTC Merger must have expired or been terminated and any authorization or consent from a governmental authority required to be obtained with respect to the UTC Merger under certain other applicable foreign regulatory laws must have been obtained. In deciding whether to grant the required regulatory authorization or consent, the relevant governmental entities will consider the effect of the UTC Merger within their relevant jurisdiction, including the impact on the parties’ respective customers and suppliers. The terms and conditions of the authorizations and consents that are granted, if any, may impose requirements, limitations or costs or place restrictions on the conduct of the combined company’s business or may materially delay the completion of the UTC Merger.

Under the Merger Agreement, UTC and Rockwell Collins have agreed to use their respective reasonable best efforts to obtain such authorizations and consents and UTC has agreed to take any and all steps necessary to avoid or eliminate impediments under any antitrust or certain other laws that may be asserted by any governmental authority so as to enable the completion of the UTC Merger as promptly as practicable. However, UTC’s obligation to take actions required to obtain authorizations and consents under such laws is subject to limitations, including that UTC will not be required to commit to or effect (1) any sale, divestiture or other transfer if such action would require the sale, divestiture or other transfer of any assets, properties, businesses or product lines representing, in the aggregate, more than $850 million in annual revenues or (2) any other restriction or action if such restriction or action, individually or taken together with all sales, divestitures, transfers or other restrictions or actions in the aggregate, would or would reasonably be expected to have a materially adverse impact on us, UTC or any of their respective subsidiaries (in each case measured on a scale relative to the size of Rockwell Collins and its subsidiaries, taken as a whole) or on the expected benefits to UTC of the UTC Merger.

In addition, at any time before or after the completion of the UTC Merger, and notwithstanding the termination of applicable waiting periods, the applicable U.S. or foreign antitrust authorities or any state attorney general could take such action under the antitrust laws as such party deems necessary or desirable in the public interest. Such action could include, among other things, seeking to enjoin the completion of the UTC Merger or seeking divestiture of substantial assets of the parties. In addition, in some circumstances, a third party could initiate a private action under antitrust laws challenging, seeking to enjoin,

18



or seeking to impose conditions on the UTC Merger. We and UTC may not prevail and we may incur significant costs in defending or settling any such action. There can be no assurance that the conditions to the completion of the UTC Merger set forth in the Merger Agreement relating to applicable regulatory laws will be satisfied.

The value of the stock portion of the Merger Consideration is subject to changes based on fluctuations in the value of UTC common stock, and our shareowners may, in certain circumstances, receive stock consideration with a value that, at the time received, is less than $46.67 per share of our common stock.

The market value of UTC common stock will fluctuate during the period before the date of our special meeting to approve the UTC Merger, during the 20 trading day period that the exchange ratio will be based upon, and the time between the last day of the 20 trading day period and the time our shareowners receive the portion of the Merger Consideration to be issued in the form of UTC common stock, as well as thereafter. Accordingly, at the time of our special meeting, our shareowners will not be able to determine the market value of the stock portion of the per share Merger Consideration they would receive upon completion of the UTC Merger.

Upon completion of the UTC Merger, each issued and outstanding share of Rockwell Collins common stock (other than certain excluded shares) will be converted into the right to receive the Merger Consideration, which is equal to $93.33 in cash, without interest, plus a fraction of a share of UTC common stock having a value equal to the quotient obtained by dividing $46.67 by the average of the volume-weighted average prices per share of UTC common stock on the NYSE on each of the 20 consecutive trading days ending with the trading day immediately prior to the closing date, subject to adjustment based on a two-way collar mechanism as described below. If the UTC stock price is greater than $107.01 but less than $124.37, the exchange ratio will be equal to the quotient of (1) $46.67 divided by (2) the UTC stock price. However, if the UTC stock price is less than or equal to $107.01 or greater than or equal to $124.37, then a two-way collar mechanism will apply, pursuant to which (a) if the UTC stock price is greater than or equal to $124.37, the exchange ratio will be fixed at 0.37525 and result in more than $46.67 in value, and (b) if the UTC stock price is less than or equal to $107.01, the exchange ratio will be fixed at 0.43613 and result in less than $46.67 in value. Accordingly, the actual number of shares and the value of UTC common stock delivered to our shareowners will depend on the UTC stock price, and the value of the shares of UTC common stock delivered for each such share of our common stock may be greater than, less than or equal to $46.67.

It is impossible to accurately predict the market price of UTC common stock at the completion of the UTC Merger or during the period over which the UTC stock price is calculated and, therefore, impossible to accurately predict the number or value of the shares of UTC common stock that our shareowners will receive in the UTC Merger. The market price for UTC common stock may fluctuate both prior to completion of the UTC Merger and thereafter for a variety of reasons, including, among others, general market and economic conditions, the demand for UTC’s or our products and services, changes in laws and regulations, other changes in UTC’s and our respective businesses, operations, prospects and financial results of operations, market assessments of the likelihood that the UTC Merger will be completed, and the expected timing of the UTC Merger. Many of these factors are beyond our control.

We are subject to business uncertainties and contractual restrictions while the UTC Merger is pending, which could adversely affect our business and operations.

In connection with the pendency of the UTC Merger, it is possible that some customers, suppliers and other persons with whom we have a business relationship may delay or defer certain business decisions or might decide to seek to terminate, change or renegotiate their relationships with us as a result of the UTC Merger, which could negatively affect our revenues, earnings and/or cash flows, as well as the market price of our common stock, regardless of whether the UTC Merger is completed.

Under the terms of the Merger Agreement, we are subject to certain restrictions on the conduct of our business prior to completing the UTC Merger which may adversely affect our ability to execute certain of our business strategies, including the ability in certain cases to enter into or amend contracts, acquire or dispose of assets, incur indebtedness or incur capital expenditures. Such limitations could adversely affect our business and operations prior to the completion of the UTC Merger. Each of the risks described above may be exacerbated by delays or other adverse developments with respect to the completion of the UTC Merger.


19



Completion of the UTC Merger will trigger change in control or other provisions in certain customer and other agreements to which we are a party, which may have an adverse impact on our or UTC’s business and results of operations following completion of the UTC Merger.

The completion of the UTC Merger will trigger change in control and other provisions in certain customer and other agreements to which we are a party. If we or UTC are unable to negotiate waivers of those provisions, customers or other counterparties may exercise their rights and remedies under the agreements, potentially terminating the agreements or seeking monetary damages or equitable remedies. Even if we and UTC are able to negotiate consents or waivers, the customers or other counterparties may require a fee for such waivers or seek to renegotiate the agreements on terms less favorable to us or the combined company. Certain of our customers have commented on the potential impact of the UTC Merger, including potential benefits, questions and concerns. Any of the foregoing or similar developments may have an adverse impact on our or UTC’s business and results of operations following completion of the UTC Merger.

Uncertainties associated with the UTC Merger may cause a loss of management personnel and other key employees, which could adversely affect our future business and operations.

We are dependent on the experience and industry knowledge of our officers and other key employees to execute their business plans. Our success will depend in part upon our ability to retain certain key management personnel and employees. Prior to completion of the UTC Merger, current and prospective employees of us and UTC may experience uncertainty about their roles within UTC following the completion of the UTC Merger, which may have an adverse effect on our ability to attract or retain key management and other key personnel. In addition, no assurance can be given that UTC, after the completion of the UTC Merger, will be able to attract or retain key management personnel and other key employees to the same extent that we and UTC have previously been able to attract or retain their own employees.

The UTC common stock to be received by our shareowners upon completion of the UTC Merger will have different rights from shares of Rockwell Collins common stock.

Upon completion of the UTC Merger, our shareowners will no longer be shareowners of Rockwell Collins, but will instead become shareowners of UTC and their rights as UTC shareowners will be governed by the terms of UTC’s certificate of incorporation and by-laws. The terms of UTC’s certificate of incorporation and by-laws are in some respects materially different than the terms of our certificate of incorporation and by-laws, which currently govern the rights of our shareowners.

Litigation filed or that may be filed against the Company, UTC, Merger Sub and the members of the Board of Directors could prevent or delay the consummation of the UTC Merger.

In connection with the UTC Merger, several lawsuits have been filed by purported Rockwell Collins shareowners. The lawsuits seek an injunction barring the UTC Merger, rescission of the UTC Merger in the event it has been consummated, recovery of damages and other relief. The outcome of these lawsuits or any other lawsuit that may be filed challenging the UTC Merger is uncertain. One of the conditions to the closing of the UTC Merger is that no governmental authority has issued or entered any order after the date of the UTC Merger Agreement having the effect of enjoining or otherwise prohibiting the consummation of the UTC Merger, and these lawsuits seek and potential other lawsuits may seek an order enjoining consummation of the UTC Merger. Accordingly, if these lawsuits or any future lawsuit is successful in obtaining an order enjoining consummation of the UTC Merger, then such order may prevent the UTC Merger from being completed, or from being completed within the expected time frame, and could result in substantial costs to Rockwell Collins including, but not limited to, costs associated with the indemnification of directors and officers. Any such injunction or delay in the UTC Merger being completed may adversely affect Rockwell Collins’ business, financial condition, results of operations and cash flows.


20



Cautionary Statement

This Annual Report on Form 10-K, and documents that are incorporated by reference in this Annual Report on Form 10-K, contains statements, including statements regarding the proposed acquisition of Rockwell Collins by UTC, that are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected as a result of certain risks and uncertainties, including but not limited to those disclosed in Risk Factors in Item 1A above and otherwise detailed herein, as well as other risks and uncertainties, including but not limited to those detailed from time to time in our SEC filings and, with respect to the proposed acquisition of Rockwell Collins, UTC’s filings with the SEC. With respect to the business and operations of Rockwell Collins, these risks include but are not limited to: the financial condition of our customers and suppliers, including bankruptcies; the health of the global economy, including potential deterioration in economic and financial market conditions; adjustments to the commercial OEM production rates and the aftermarket; the impacts of natural disasters and pandemics, including operational disruption, potential supply shortages and other economic impacts; cybersecurity threats, including the potential misappropriation of assets or sensitive information, corruption of data or operational disruption; delays related to the award of domestic and international contracts; delays in customer programs, including new aircraft programs entering service later than anticipated; the continued support for military transformation and modernization programs; potential impact of volatility in oil prices, currency exchange rates or interest rates on the commercial aerospace industry or our business; the impact of terrorist events, regional conflicts or governmental sanctions on other nations on the commercial aerospace industry; changes in domestic and foreign government spending, budgetary, procurement and trade policies adverse to our businesses; market acceptance of our new and existing technologies, products and services; reliability of and customer satisfaction with our products and services; potential unavailability of our mission-critical data and voice communication networks; unfavorable outcomes on or potential cancellation or restructuring of contracts, orders or program priorities by our customers; recruitment and retention of qualified personnel; regulatory restrictions on air travel due to environmental concerns; effective negotiation of collective bargaining agreements by us, our customers, and our suppliers; performance of our customers and subcontractors; risks inherent in development and fixed-price contracts, particularly the risk of cost overruns; risk of significant reduction to air travel or aircraft capacity beyond our forecasts; our ability to execute to internal performance plans such as restructuring activities, productivity and quality improvements and cost reduction initiatives; achievement of B/E Aerospace integration and synergy plans; continuing to maintain our planned effective tax rates; our ability to develop contract compliant systems and products on schedule and within anticipated cost estimates; risk of fines and penalties related to noncompliance with laws and regulations including compliance requirements associated with U.S. Government work, export control and environmental regulations; risk of asset impairments; our ability to win new business and convert those orders to sales within the fiscal year in accordance with our annual operating plan; the uncertainties of the outcome of lawsuits, claims and legal proceedings. With respect to the proposed acquisition, these risks include but are not limited to: the ability of Rockwell Collins and UTC to receive the required regulatory approvals for the proposed acquisition of Rockwell Collins by UTC (and the risk that such approvals may result in the imposition of conditions that could adversely affect the combined company or the expected benefits of the transaction) and approval of Rockwell Collins’ shareowners and to satisfy the other conditions to the closing of the transaction on a timely basis or at all; the occurrence of events that may give rise to a right of one or both of the parties to terminate the merger agreement; negative effects of the announcement or the consummation of the transaction on the market price of UTC and/or Rockwell Collins common stock and/or on their respective businesses, financial conditions, results of operations and financial performance; risks relating to the value of UTC’s shares to be issued in the transaction, significant transaction costs and/or unknown liabilities; the possibility that the anticipated benefits from the proposed transaction cannot be realized in full or at all or may take longer to realize than expected; risks associated with third party contracts containing consent and/or other provisions that may be triggered by the proposed transaction; risks associated with transaction-related litigation; the possibility that costs or difficulties related to the integration of Rockwell Collins’ operations with those of UTC will be greater than expected; the outcome of legally required consultation with employees, their works councils or other employee representatives; and the ability of Rockwell Collins and the combined company to retain and hire key personnel. There can be no assurance that the proposed acquisition will in fact be consummated in the manner described or at all. These risks, as well as other risks associated with the proposed merger, are more fully discussed in the preliminary proxy statement/prospectus included in the Registration Statement on Form S-4 that UTC filed with the SEC on October 10, 2017, in connection with the proposed merger. Readers are cautioned not to place undue reliance on these forward-looking statements. These forward-looking statements are made only as of the date hereof and Rockwell Collins assumes no obligation to update any forward-looking statement, except as otherwise required by law.

Item 1B.
Unresolved Staff Comments.

None.


21


Item 2.
Properties.

As of September 30, 2017, we operated various manufacturing and engineering facilities, sales offices, warehouses and service locations throughout the U.S. and around the world. These facilities have aggregate floor space of approximately 10.5 million square feet. Of this floor space, 45 percent is owned and 55 percent is leased. There are no major encumbrances on any of our plants or equipment. In the opinion of management, our properties have been well maintained, are in sound operating condition and contain all equipment and facilities necessary to operate at present levels. A summary of floor space of these facilities at September 30, 2017 is as follows:
Location (in thousands of square feet)
 
Owned
Facilities
 
Leased
Facilities
 
Total
Interior Systems
 
 
 
 
 
 
U.S. 
 
394

 
2,087

 
2,481

Europe / Africa / Middle East
 
277

 
256

 
533

Asia-Pacific
 
286

 
142

 
428

Americas, excluding U.S.
 

 
267

 
267

Total
 
957

 
2,752

 
3,709

 
 
 
 
 
 
 
Commercial and Government Systems









U.S. 

3,357


1,691


5,048

Europe / Africa / Middle East

330


226


556

Asia-Pacific



369


369

Americas, excluding U.S.



148


148

Total

3,687


2,434


6,121

 
 
 
 
 
 
 
Information Management Services
 
 
 
 
 
 
U.S. 
 
39

 
555

 
594

Europe / Africa / Middle East
 

 
43

 
43

Asia-Pacific
 

 
26

 
26

Americas, excluding U.S.
 

 
1

 
1

Total
 
39

 
625

 
664

Combined Total
 
4,683

 
5,811

 
10,494

 
 
 
 
 
 
 
Type of Facility (in thousands of square feet)
 
Owned
Facilities
 
Leased
Facilities
 
Total
Interior Systems
 
 
 
 
 
 
Manufacturing and service
 
939

 
2,432

 
3,371

Sales, engineering and general office space
 
18

 
320

 
338

 
 
 
 
 
 
 
Commercial and Government Systems
 
 
 
 
 
 
Manufacturing and service
 
1,267

 
989

 
2,256

Sales, engineering and general office space
 
2,420

 
1,445

 
3,865

 
 








Information Management Services
 
 
 
 
 
 
Manufacturing and service
 
39

 
30

 
69

Sales, engineering and general office space
 

 
595

 
595

Combined Total
 
4,683

 
5,811

 
10,494


We have facilities with a total of at least 200,000 square feet (in rounded thousands) in the following cities: Cedar Rapids, Iowa (2,910,000 square feet), Winston-Salem, North Carolina (660,000 square feet), Melbourne, Florida (390,000 square feet), Annapolis, Maryland (370,000 square feet), Tanauan City, Philippines (350,000 square feet), Richardson, Texas (280,000 square feet), Everett, Washington (240,000 square feet), Heidelberg, Germany (240,000 square feet), Nogales, Mexico (230,000 square feet), Irvine, California (210,000 square feet) and Coralville, Iowa (200,000 square feet). Most of our facilities for our

22


Commercial Systems and Government Systems businesses are shared and have therefore been presented together in the tables above. We have excluded from the tables above hundreds of leased locations wherein our Information Management Services business has radio frequency equipment in various locations throughout the world.

We purchase property insurance covering physical damage to our facilities and resulting business interruption from perils including fire, windstorm, flood and earthquake. This insurance generally provides replacement cost coverage subject to a $10 million deductible with certain exceptions. For example, certain of our facilities, including those located in California and Mexico, are located near major earthquake fault lines. For those facilities we maintain earthquake insurance with limits that may be less than full replacement cost. These exceptions are largely driven by the availability and cost of catastrophe coverage from the insurance markets.

Item 3.
Legal Proceedings.

Various lawsuits, claims and proceedings have been or may be instituted or asserted against us relating to the conduct of our business, including those pertaining to product liability, intellectual property, environmental, safety and health, exporting or importing, contract, employment and regulatory matters. Although the outcome of litigation cannot be predicted with certainty and some lawsuits, claims or proceedings may be disposed of unfavorably to us, management believes there are no material pending legal proceedings.

Item 4.
Mine Safety Disclosures.

Not applicable.


23


Item 4A.
Executive Officers of the Company.

The name, age, office, position held with us and principal occupations and employment during the past five years of each of our executive officers as of November 14, 2017 are as follows:
Name, Office and Position, and Principal Occupations and Employment
 
Age
Robert K. Ortberg—Chairman of the Board of Directors since November 2015; Chief Executive Officer and a Director since August 2013; President since September 2012; Executive Vice President and Chief Operating Officer, Government Systems prior thereto
 
57

Patrick E. Allen—Senior Vice President and Chief Financial Officer since January 2005
 
53

Tatum J. Buse—Vice President, Finance and Corporate Controller since September 2013; Vice President Cost Optimization prior thereto
 
43

Philip J. Jasper—Executive Vice President and Chief Operating Officer, Government Systems since September 2012
 
49

Bruce M. King—Senior Vice President, Operations since May 2011
 
56

Werner Lieberherr—Executive Vice President and Chief Operating Officer, Interior Systems since April 2017; President and Chief Executive Officer of B/E Aerospace, Inc. from December 2014 to April 2017; President and Co-Chief Executive Officer of B/E Aerospace, Inc. from January 2014 to December 2014; President and Chief Operating Officer of B/E Aerospace, Inc. prior thereto
 
58

Jeffrey D. MacLauchlan—Senior Vice President, Corporate Development since September 2014; Vice President, Corporate Development of Lockheed Martin Corporation prior thereto
 
58

Colin R. Mahoney—Senior Vice President, International and Service Solutions since February 2013; Vice President of Commercial Systems Sales, Marketing and Customer Support prior thereto
 
52

Nan Mattai—Senior Vice President, Engineering and Information Technology since August 2015; Senior Vice President, Engineering and Technology prior thereto
 
65

David J. Nieuwsma—Senior Vice President, Information Management Services since April 2016; Vice President, Strategy and Business Development from December 2012 to April 2016; Vice President and General Manager of Airborne Solutions prior thereto
 
53

Robert J. Perna—Senior Vice President, General Counsel and Secretary since February 2014; Senior Vice President, General Counsel from January 2014 to February 2014; Vice President, General Counsel and Secretary for AM Castle & Co. prior thereto
 
53

Jeffrey A. Standerski—Senior Vice President, Human Resources since April 2016; Senior Vice President, Information Management Services from December 2013 to April 2016; Vice President and General Manager, Business and Regional Systems from July 2013 to December 2013; Vice President and General Manager, Air Transport Systems prior thereto
 
51

Kent L. Statler—Executive Vice President and Chief Operating Officer, Commercial Systems since February 2010
 
52

Douglas E. Stenske—Vice President, Treasurer and Risk Management since September 2013; Vice President, Treasurer and Financial Planning prior thereto
 
51

Robert A. Sturgell—Senior Vice President, Washington Operations since April 2009
 
58


There are no family relationships, as defined, between any of the above executive officers and any other executive officer or any director. No officer was selected pursuant to any arrangement or understanding between the officer and any person other than us. All executive officers are elected annually.

24



PART II


Item 5.
Market for the Company's Common Equity, Related Stockholder Matters and Company Purchases of Equity Securities.

Market Information

Our common stock, par value $.01 per share, is listed on the New York Stock Exchange and trades under the symbol COL. On October 31, 2017, there were 16,304 shareowners of record of our common stock.

The following table sets forth the high and low sales price of our common stock on the New York Stock Exchange—Composite Transactions reporting system during each quarter of our years ended September 30, 2017 and 2016:
 
 
2017
 
2016
Fiscal Quarters
 
High
 
Low
 
High
 
Low
First
 
$
96.55

 
$
78.54

 
$
95.11

 
$
82.26

Second
 
99.85

 
88.80

 
93.20

 
76.03

Third
 
109.30

 
96.13

 
94.98

 
81.04

Fourth
 
135.31

 
104.91

 
87.11

 
80.92


Dividends

The following table sets forth the cash dividends per share paid by us during each quarter of our years ended September 30, 2017 and 2016:
Fiscal Quarters
 
2017
 
2016
First
 
$
0.33

 
$
0.33

Second
 
0.33

 
0.33

Third
 
0.33

 
0.33

Fourth
 
0.33

 
0.33


Based on our current dividend policy, we have been paying quarterly cash dividends which, on an annual basis, equal $1.32 per share. The declaration and payment of dividends, however, will be at the sole discretion of our Board of Directors and there can be no assurance that we will continue to pay dividends at our current levels.

Repurchases

Our Board of Directors has authorized certain repurchases of our common stock. During 2017, we repurchased approximately 0.4 million shares of our common stock at a total cost of $39 million and a weighted average cost of $104.32 per share. As described in the table below, there were no repurchases during the three months ended September 30, 2017. During 2016, we repurchased approximately 2.9 million shares of our common stock at a total cost of $255 million, at a weighted average cost of $87.30 per share.

The following table provides information with respect to purchases made by or on behalf of us or any "affiliated purchaser" (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934) of shares of our common stock during the three months ended September 30, 2017:
Period
 
Total
Number of
Shares
Purchased
 
Average Price
Paid per Share
 
Total Number of
Shares Purchased as
Part of Publicly
Announced
Plans or Programs
 
Maximum Number
(or Approximate
Dollar Value) of
Shares that May Yet
Be Purchased Under the
Plans or Programs(1)
July 1, 2017 through July 31, 2017
 

 
$

 

 
$
285 million
August 1, 2017 through August 31, 2017
 

 

 

 
 
285 million
September 1, 2017 through September 30, 2017
 

 

 

 
 
285 million
Total / Average
 

 

 

 
 
 
(1) On July 7, 2017, we announced that our Board authorized the repurchase of an additional $200 million of our common stock. The authorization has no stated expiration.

25


Item 6.
Selected Financial Data.

The following selected financial data should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8 below. The Statement of Operations, Statement of Financial Position and other data have been derived from our audited financial statements. The Company operates on a 52/53 week fiscal year ending on the Friday closest to September 30. Fiscal years 2017, 2016, 2015 and 2013 were 52-week fiscal years while fiscal year 2014 was a 53-week fiscal year. Certain prior data has been reclassified to conform to the current year presentation and to reflect the adoption of new guidance in 2017 requiring debt issuance costs to be presented as a deduction from the carrying amount of the related debt (see Note 2 in Notes to Consolidated Financial Statements in Item 8 below).
 
 
Years Ended September 30
(dollars in millions, except per share amounts)
 
2017(a)
 
2016(b)
 
2015(c)
 
2014(d)
 
2013(e)
Statement of Operations Data:
 
 
 
 
 
 
 
 
 
 
Sales
 
$
6,822

 
$
5,259

 
$
5,244

 
$
4,979

 
$
4,474

Cost of sales
 
4,868

 
3,642

 
3,630

 
3,469

 
3,103

Selling, general and administrative expenses
 
732

 
638

 
606

 
594

 
495

Income from continuing operations
 
705

 
727

 
694

 
618

 
630

Income (loss) from discontinued operations, net of taxes
 

 
1

 
(8
)
 
(14
)
 
2

Net income
 
705

 
728

 
686

 
604

 
632

Net income as a percent of sales
 
10.3
%
 
13.8
%

13.1
%

12.1
%

14.1
%
Diluted earnings per share from continuing operations
 
4.79

 
5.50

 
5.19

 
4.52

 
4.56

Statement of Financial Position Data:
 
 
 
 
 
 
 
 
 
 
Working capital(f)
 
$
1,691

 
$
1,144

 
$
1,164

 
$
1,054

 
$
1,096

Property
 
1,398

 
1,035

 
964

 
919

 
773

Goodwill and intangible assets
 
11,287

 
2,586

 
2,607

 
2,551

 
1,067

Total assets
 
17,997

 
7,699

 
7,294

 
6,994

 
5,394

Short-term debt
 
479

 
740

 
448

 
504

 
436

Long-term debt, net
 
6,676

 
1,374

 
1,670

 
1,652

 
560

Shareowners' equity
 
6,043

 
2,078

 
1,875

 
1,884

 
1,618

Other Data:
 
 
 
 
 
 
 
 
 
 
Capital expenditures
 
$
240

 
$
193

 
$
210

 
$
163

 
$
120

Depreciation and amortization
 
399

 
253

 
252

 
225

 
177

Dividends per share
 
1.32

 
1.32

 
1.26

 
1.20

 
1.20

Stock Price:
 
 
 
 
 
 
 
 
 
 
High
 
$
135.31

 
$
95.11

 
$
99.37

 
$
84.06

 
$
75.25

Low
 
78.54

 
76.03

 
72.35

 
65.76

 
52.24

(a)
On April 13, 2017, we completed the acquisition of B/E Aerospace for $6.5 billion in cash and stock, plus the assumption of $2.0 billion of debt, net of cash acquired. To finance the acquisition and repay assumed debt, we issued 31.2 million shares of common stock, issued $4.35 billion of senior unsecured notes and borrowed $1.5 billion under a new senior unsecured syndicated term loan facility. Income from continuing operations includes $86 million of transaction, integration and financing costs associated with the acquisition of B/E Aerospace ($125 million before income taxes) and $15 million of transaction costs associated with the pending acquisition of the Company by UTC ($24 million before income taxes).
(b)
Income from continuing operations includes a $24 million income tax benefit from the retroactive reinstatement of the previously expired Federal Research and Development Tax Credit and a $41 million income tax benefit due to the release of a valuation allowance for a U.S. capital loss carryforward. In addition, income from continuing operations includes $28 million of restructuring and asset impairment charges ($45 million before income taxes) primarily related to employee severance costs. Approximately $33 million of the pre-tax expense was recorded within cost of sales and $12 million was included within selling, general and administrative expenses.
(c)
Income from continuing operations includes a $22 million income tax benefit from the retroactive reinstatement of the previously expired Federal Research and Development Tax Credit and a $16 million income tax benefit related to the remeasurement of certain prior year tax positions.
(d)
Income from continuing operations includes $18 million of restructuring, pension settlement and ARINC transaction costs ($25 million before income taxes). Approximately $18 million of the pre-tax expense was recorded in selling, general and administrative expenses, $4 million was included within cost of sales, and $3 million was classified as interest expense. Income from continuing operations also includes a $9 million gain ($10 million before income taxes) resulting from the

26


sale of the KOSI business. On December 23, 2013, we acquired ARINC for $1.405 billion. This acquisition was funded through a combination of new long-term debt and short-term commercial paper borrowings.
(e)
Net income includes a $19 million income tax benefit related to the retroactive reinstatement of the previously expired Federal Research and Development Tax Credit. Short-term debt includes commercial paper borrowings incurred to fund a portion of our share repurchase program and also includes $200 million related to debt that matured in December 2013.
(f)
Working capital consists of all current assets and liabilities, including cash and short-term debt.

Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto in Item 8 below. The following discussion and analysis contains forward-looking statements and estimates that involve risks and uncertainties. Actual results could differ materially from these estimates. Factors that could cause or contribute to differences from estimates include those discussed under Cautionary Statement and Risk Factors contained in Item 1A above.

We operate on a 52/53 week fiscal year ending on the Friday closest to September 30. For ease of presentation, September 30 is utilized consistently throughout Management's Discussion and Analysis of Financial Condition and Results of Operations to represent the fiscal year end date. Fiscal years 2017, 2016 and 2015 were 52-week fiscal years. All date references contained herein relate to our fiscal year unless otherwise stated.

As discussed in Note 4 of the Notes to Consolidated Financial Statements in Item 8 below, on March 10, 2015, the Company divested the ASES business. As a result of the divestiture, the operating results of ASES have been accounted for as discontinued operations for all periods presented.

OVERVIEW AND OUTLOOK

On September 4, 2017, we entered into the Merger Agreement providing for the acquisition of the Company by UTC. If the UTC Merger is consummated, we will become a wholly owned subsidiary of UTC. The agreement includes covenants and agreements relating to the conduct of our business between the date of signing the Merger Agreement and the consummation of the UTC Merger. In light of the announced transaction with UTC, we will not be issuing guidance for fiscal year 2018. During 2017, we incurred $24 million of transaction costs associated with the pending UTC Merger.

On April 13, 2017, we completed our acquisition of B/E Aerospace for $6.5 billion in cash and stock, plus the assumption of $2.0 billion of debt, net of cash acquired. To finance the acquisition and repay assumed debt, we issued 31.2 million shares of common stock, issued $4.35 billion of senior unsecured notes and borrowed $1.5 billion under a new senior unsecured syndicated term loan facility. The results of operations of the acquired business are reported in a newly formed Interior Systems business segment.

The B/E Aerospace acquisition expands our reach and broadens our portfolio of aircraft content with the addition of a wide range of cabin interior products for commercial aircraft and business jets including seating, food and beverage preparation and storage equipment, lighting and oxygen systems and modular galley and lavatory systems. The Company's portfolio of aircraft content now spans the aircraft from cockpit to cabin, communications to connectivity. The acquisition also further diversifies our geographic presence and customer mix as Interior Systems products and services are sold to airlines and original equipment manufacturers across the globe. In addition, the acquisition enhances our diversified and balanced business, serving both commercial and government markets. During 2017, we incurred $125 million of transaction, integration and financing costs associated with the acquisition of B/E Aerospace.

Our Commercial Systems business supplies aviation electronics systems, products and services to customers located throughout the world. The Commercial Systems customer base is comprised of commercial air transport and business and regional aircraft OEMs, commercial airlines and business aircraft operators. The Government Systems business provides communication and navigation products and avionics to the U.S. Department of Defense, state and local governments, other government agencies, civil agencies, defense contractors and foreign ministries of defense around the world. These systems, products and services support airborne (fixed and rotary wing), ground and shipboard applications. Our Information Management Services business enables mission-critical data and voice communications throughout the world to customers including the U.S. Federal Aviation Administration, commercial airlines, business aircraft operators, airport and critical infrastructure operators and major passenger and freight railroads. These communications are enabled by our high-performance, high-quality and high-assurance proprietary radio and terrestrial networks, enhancing customer efficiency, safety and connectivity.


27


Total sales increased $1.563 billion, or 30 percent, in 2017 compared to 2016, primarily due to the B/E Aerospace acquisition, which contributed $1.406 billion of revenue. Sales excluding the B/E Aerospace acquisition (organic sales) increased $157 million, or 3 percent, compared to 2016, due to revenue growth across all of our legacy businesses.(1) Information Management Services sales grew 9 percent, Government Systems grew 3 percent and Commercial Systems grew 1 percent.

Total segment operating earnings(2) increased $211 million to $1.326 billion in 2017 compared to 2016. The Interior Systems business contributed $174 million of operating earnings, while Information Management Services increased $30 million and Government Systems increased $19 million, offsetting a $12 million decrease in Commercial Systems operating earnings.

Our 2017 effective tax rate increased over 2016, primarily due to the retroactive reinstatement of the Federal R&D Tax Credit and the release of a $41 million valuation allowance related to a U.S. capital loss carryforward in 2016, both of which favorably impacted the 2016 effective income tax rate, partially offset by favorable 2017 benefits associated with the jurisdictional mix of income as a result of the B/E Aerospace acquisition.

We generated operating cash flows of $1.264 billion during 2017, representing a 75 percent increase over 2016, and generated free cash flow(3) of $1.024 billion in 2017, a 93 percent increase over 2016. The increase in cash provided by operating activities was primarily due to operating cash flow from the acquisition of B/E Aerospace, as well as higher cash collections from customers in the Company's other segments, partially offset by higher income tax payments and payments for B/E Aerospace acquisition-related expenses. Excluding the acquisition of B/E Aerospace, cash provided by operating activities increased $286 million, or 40 percent, from fiscal year 2016. We continued to deploy cash for the benefit of our shareowners in 2017 by paying aggregate dividends of $194 million and repurchasing 0.4 million shares of common stock for $39 million. In addition, we repaid $630 million of debt incurred to finance a portion of the B/E Aerospace acquisition.

Fiscal year 2017 results are as follows:
(in billions, except per share amounts)
 
FY17 Results
Total sales
 
$6.822
Diluted earnings per share from continuing operations
 
$4.79
Operating cash flow from continuing operations
 
$1.264
Capital expenditures
 
$0.240
Total research and development investment(4)
 
$1.108
(1) Organic sales, organic growth, and similar measures excluding the effects of the B/E Aerospace acquisition are non-GAAP measures which measure the applicable item (e.g., sales or sales growth) without giving effect to the contribution for such item as a result of the B/E Aerospace acquisition. Such non-GAAP measures are believed to be important indicators of our operations for purposes of period-to-period comparisons of the underlying businesses. The Company does not intend for any of the non-GAAP information to be considered in isolation or as a substitute for the related GAAP measures.
(2) Total segment operating earnings is a non-GAAP measure and is reconciled to the related GAAP measure, Income from continuing operations before income taxes, in Note 21 of the Notes to Consolidated Financial Statements. Total segment operating earnings is calculated as the total of segment operating earnings of our four segments. The non-GAAP total segment operating earnings information included in this disclosure is believed to be useful to investors in comparing our operating performance from period to period by isolating the effects of some items that vary from period to period without any correlation to core operating performance.
(3) Free cash flow is a non-GAAP measure and is reconciled to the related GAAP measure, Cash Provided by Operating Activities from Continuing Operations below. The non-GAAP free cash flow information included in this disclosure is believed to be useful to investors' understanding of cash generated from operations that is available for investment opportunities, such as acquisitions, dividend payments, debt repayment and share repurchases.
 
Year Ended September 30
(in millions)
2017
 
2016
 
2015
Cash Provided by Operating Activities from Continuing Operations
$
1,264

 
$
723

 
$
749

Less: Property Additions
(240
)
 
(193
)
 
(210
)
Free Cash Flow
$
1,024

 
$
530

 
$
539


(4) Total research and development (R&D) investment is comprised of company- and customer-funded R&D expenditures and the net increase in pre-production engineering costs capitalized within Inventory.


28


Our long-term strategies are focused on the following:

accelerate sales growth

expand operating margins and improve cash flow conversion

deploy capital with priorities on growth and shareowner return

Accelerate sales growth

Accelerating our business growth is a fundamental objective of our management team. For the past decade we have been in a period of significant investment in research and development for our company to support market share gains throughout our businesses. Our record of success in migrating technologies across the enterprise is a core strength and enables us to realize the benefits of investment even if market conditions change. We are realizing the benefits of completing investments in these programs as new platforms enter service. Our focus on developing solutions aimed at making Rockwell Collins the supplier of choice is evidenced by our significant investment in research and development. Over the past 5 years, we invested approximately $4.9 billion in research and development, which has allowed us to develop new systems, products and software solutions for our customers and capture strategically important positions on a variety of air transport, business aviation and military aircraft.

Highlights of our strategy to accelerate top-line sales growth are as follows:

Strong positions will fuel growth
Our Interior Systems segment was created in April 2017 with the acquisition of B/E Aerospace. The Interior Systems current backlog of $3.8 billion increased $247 million since the acquisition date. Increased aircraft production rates at commercial air transport and business jet OEMs fuel opportunities to expand our product offering. Backlog growth results from favorable trends in airline selectable equipment, including seating, lighting systems and food preparation and storage, as well as increased production of aircraft with standard Interior Systems equipment. Additionally, the large installed base provides a robust flow of aftermarket retrofit and spares opportunities to support long-term growth.

Within Commercial Systems, over the past several years we have captured key positions and market share gains on platforms such as the Boeing 737 MAX and 777X, as well as the Bombardier CSeries. We successfully completed numerous milestones on these and other aircraft development programs throughout the year, and we achieved top customer support ratings from our largest customers. We believe these accomplishments have positioned us to continue to grow our market share. We recently announced that Airbus has selected our flight operations and maintenance exchanger solution, called FOMAX, as standard on their A320 family. Under this agreement, we will supply each A320 aircraft with a secure router to wirelessly send aircraft performance and maintenance data to ground-based operations.

Within Government Systems, we increased our backlog by $171 million during 2017. Defense budgets have been improving not only in the United States, but also throughout the world. During 2017, we were selected as one of two companies on the HMS Manpack program, which has the potential to be a significant program. We also were selected by the U.S. Navy to supply our encrypted, next-generation tactical training system for the Tactical Combat Training System Increment II program. This program will increase war-fighter readiness at a reduced training cost, enabling interaction between a number of participants in live, virtual and constructive training.

We are capitalizing on aviation’s information age
In today’s information-enabled world, the industry continues to trend away from hardware-based solutions to more software-based applications and the needs for connectivity are increasing for airlines, airports and passengers. Through organic innovations and acquisitions, our Information Management Services portfolio positions us as a leader in aviation information management, delivering efficiency and safety to our customers and their passengers.

As traffic on our air-to-ground network increases, we’re taking steps to enhance its capacity and usefulness. In the cockpit, more robust data streams and sophisticated applications are enhancing operational efficiencies, safety and on-time flight performance. In the cabin, broadband connectivity is enabling passengers to stay connected throughout their flight, and it also provides new ways to enhance the passenger experience. In 2017, we were awarded a contract by Norwegian Air Shuttle to provide a nose-to-tail integrated digital aircraft solution for their fleet of Boeing 737 MAX and 787 aircraft. This solution combines our avionics, cockpit communication, cabin connectivity and information management solutions to deliver enhanced operational efficiency for the airline and high-bandwidth wireless in-flight connectivity for passengers. Our cabin connectivity

29


solution for passengers is underpinned by Inmarsat's Global Xpress satellite network, allowing passengers a range of connectivity options including e-mail, internet access, video streaming and electronic commerce.
We will continue to grow globally
Market opportunities outside the United States continue to evolve, driven in part by expanding populations and emerging economies. Security needs are on the rise in places around the globe, as countries seek to establish indigenous capabilities to protect their borders, infrastructure and resources. At the same time, global commercial air travel is expected to increase as we see a growing middle class in developing countries, generating higher traffic and demand for new aircraft. We believe we are positioned to grow by capturing new programs at emerging international OEMs, strategically positioning service centers around the globe and by launching joint ventures.

Expand operating margins and improve cash flow conversion

Operational excellence is a fundamental objective at our Company. We have extended Lean concepts beyond the factory floor to virtually every aspect of our business. We focus on streamlining processes, reducing costs and increasing quality while enhancing our ability to respond quickly to customer needs. In addition, our shared service model uses a centralized organizational structure to leverage resources across the business. This is evidenced by our product and technology centers of excellence, through which we apply our core competencies to solutions across our segments. By applying common tools and systems across our businesses, we can better manage our cost structure and maximize our R&D investments.

We believe our Company has a proven ability to both react quickly to changing business conditions and to execute business plans. For example, as we faced challenging conditions in business aviation and the defense environment in the past several years, we took actions to manage our cost structure, while focusing on our customers, continuing our commitment to operational excellence and maintaining our balanced business model. We will also distinguish ourselves through strong customer relationships, high returns on invested capital and continued investment in market differentiating technologies and programs. As we grow our Company, our goal is to generate long-term double-digit cash flow growth. In 2017, our operating cash flow grew 75 percent (40 percent organically) as we wound down some of our major program investments.

Deploy capital with priorities on growth and shareowner return

We plan to allocate capital across our Company to prioritize debt repayment and to fund growth through investments in R&D, capital expenditures and minor acquisitions. On April 13, 2017, the Company completed the acquisition of B/E Aerospace for $6.5 billion in cash and stock, plus the assumption of $2.0 billion in net debt. The transaction combines our capabilities in flight deck avionics, cabin electronics, mission communications, simulation and training, and information management systems with B/E Aerospace's range of cabin interior products, which include seating, food and beverage preparation and storage equipment, lighting and oxygen systems, and modular galley and lavatory systems for commercial airliners and business jets. The acquisition significantly increases our scale and diversifies our product portfolio, customer mix and geographic presence.

See the following sections for further discussion of our results of operations. For additional disclosure on segment operating earnings see Note 21 of the Notes to Consolidated Financial Statements in Item 8 below. Please also see our Risk Factors and Cautionary Statement in Item 1A of this Form 10-K.

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RESULTS OF OPERATIONS

The following management discussion and analysis of results of operations is based on reported financial results for 2015 through 2017 and should be read in conjunction with our consolidated financial statements and the notes thereto in Item 8 below.


Consolidated Financial Results

Sales
(in millions)
 
2017
 
2016
 
2015
U.S.(1) (2)
 
$
3,873

 
$
3,292

 
$
3,174

Non-U.S.(1)
 
2,949

 
1,967

 
2,070

Total
 
$
6,822

 
$
5,259

 
$
5,244

Percent increase
 
30
%
 
%
 
 

(1) Sales are attributed to geographic region based on the location of our customers.
(2) For the years ended September 30, 2017, 2016 and 2015, U.S. sales include revenue from foreign military sales of $139 million, $171 million and $171 million, respectively.

Sales for 2017 compared to 2016

Total sales increased $1.563 billion, or 30 percent, for the year ended September 30, 2017, compared to the prior year. B/E Aerospace, which was acquired on April 13, 2017, contributed $1.406 billion of the overall revenue growth. Sales excluding the B/E Aerospace acquisition (organic sales) increased $157 million, or 3 percent, compared to the prior year, driven by a $74 million increase within Government Systems, a $60 million increase within Information Management Services and a $23 million increase within Commercial Systems. Refer to the Interior Systems, Commercial Systems, Government Systems and Information Management Services sections of the Segment Financial Results below for a detailed discussion of sales by segment in 2017 and 2016.

U.S. sales increased $581 million, or 18 percent, primarily due to $567 million of sales from the B/E Aerospace acquisition. The remaining increase results primarily from higher Government Systems sales to the U.S. Government.

Non-U.S. sales increased $982 million, or 50 percent, primarily due to $839 million of sales from the B/E Aerospace acquisition. The remaining variance is primarily driven by higher Airbus A350 production rates, a favorable mix of international airline selectable equipment sales and higher customer-funded development program revenues in Commercial Systems and increased international usage of connectivity services at Information Management Services.

Sales for 2016 compared to 2015

Total sales increased $15 million primarily due to a $35 million increase in Information Management Services sales and a $19 million increase in Government Systems, partially offset by a $39 million reduction in Commercial Systems. Refer to the Commercial Systems, Government Systems and Information Management Services sections of the Segment Financial Results below for a detailed discussion of sales by segment in 2016 and 2015.

U.S. sales increased $118 million, or 4 percent, with Government Systems contributing $76 million of the increase driven primarily by higher sales to the U.S. Government. Commercial Systems sales contributed $44 million of the increase driven by higher Boeing 787 production rates, higher flight deck retrofit and mandate activity, as well as inorganic sales growth from the acquisition of International Communications Group (ICG).

Non-U.S. sales decreased $103 million, or 5 percent, with Commercial Systems sales decreasing $83 million driven primarily by lower business aircraft OEM production rates. Additionally, non-U.S. sales for Government Systems decreased $57 million due to lower international deliveries of targeting systems and the wind-down of an international electronic warfare program. Information Management Services increased $37 million primarily due to higher international aviation-related sales.


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Cost of Sales
(in millions)
 
2017
 
2016
 
2015
Total cost of sales
 
$
4,868

 
$
3,642

 
$
3,630

Percent of total sales
 
71.4
%
 
69.3
%
 
69.2
%

Cost of sales consists of all costs incurred to design and manufacture our products and provide our services and includes R&D, raw material, labor, facility, product warranty, depreciation, amortization, service and support and other related expenses.

Cost of sales for 2017 compared to 2016

Total cost of sales increased $1.226 billion primarily due to the following:

$1.140 billion of cost of sales from the recently acquired B/E Aerospace business

an $83 million increase from higher organic sales, which was favorably impacted by benefits from cost savings initiatives

a $40 million increase in employee incentive compensation costs

partially offset by $33 million of asset and restructuring charges recorded in 2016

further offset by a $9 million decrease in company-funded R&D expense in Government Systems and Information Management Services, as detailed in the Research and Development Expense section below

The increase in cost of sales as a percent of revenues was primarily due to the recently acquired B/E Aerospace business.

Cost of sales for 2016 compared to 2015

Total cost of sales increased $12 million primarily due to the following:

a $45 million increase from higher sales volume, which was negatively impacted by less favorable program sales mix

$33 million of asset and restructuring charges recorded in 2016

partially offset by a $48 million reduction in company-funded R&D expense, as detailed in the Research and Development Expense section below

in addition, pension costs decreased $16 million


32



Research and Development Expense

R&D expense is included as a component of cost of sales and is summarized as follows:
(in millions)
 
2017
 
2016
 
2015
Customer-funded:
 
 
 
 
 
 
Interior Systems
 
$
54

 
$

 
$

Commercial Systems
 
262

 
231

 
187

Government Systems
 
421

 
381

 
382

Information Management Services
 
9

 
9

 
9

Total customer-funded
 
746


621


578

Company-funded:
 
 

 
 

 
 
Interior Systems
 
112

 

 

Commercial Systems
 
143

 
143

 
182

Government Systems
 
72

 
79

 
88

Information Management Services (1)
 

 
2

 
2

Total company-funded
 
327

 
224

 
272

Total research and development expense
 
$
1,073

 
$
845

 
$
850

Percent of total sales
 
15.7
%
 
16.1
%
 
16.2
%
(1) R&D expenses for the Information Management Services segment do not include costs of internally developed software and other costs associated with the expansion and construction of network-related assets. These costs are capitalized as Property on the Consolidated Statement of Financial Position.
We make significant investments in research and development to allow our customers to benefit from the latest technological advancements. Total R&D expense is comprised of both company-funded and customer-funded expenditures. In addition to the R&D expenditures shown in the table above, we capitalize in inventory the cost of certain pre-production engineering effort incurred during the development phase of programs when the customer has provided us a long-term supply arrangement and a contractual guarantee for reimbursement. Pre-production engineering costs are then amortized over their useful lives. This amortization cost is included within customer-funded R&D expense and totaled $59 million, $49 million and $47 million for 2017, 2016 and 2015, respectively. Refer to the Research and Development section found in Item 1 and the Critical Accounting Policies section found in Item 7 below for further discussion of our incremental investments in pre-production engineering effort.

Customer-funded R&D expenditures are incurred pursuant to contractual arrangements and are typically accounted for as contract costs within cost of sales, with the reimbursement accounted for as a sale in accordance with the percentage-of-completion method of accounting.

Company-funded R&D expenditures relate to the development of new products and the improvement of existing products and are expensed as incurred and included in cost of sales, as disclosed in Note 2 of the Notes to Consolidated Financial Statements. Company-funded R&D expense consists primarily of payroll-related expenses of employees engaged in R&D activities, engineering-related product materials and equipment and subcontracting costs.

Total R&D expense increased $228 million from 2016 to 2017. The customer-funded portion of R&D increased $125 million from 2016 to 2017, primarily due to $54 million of customer-funded expenditure from the recently acquired B/E Aerospace business. In addition, customer-funded expenditures for Government Systems increased $40 million due to fixed wing programs and Commercial Systems increased $31 million due to international regional jet programs and higher amortization of pre-production engineering costs. Company-funded R&D expenditures increased $103 million from 2016 to 2017, primarily due to $112 million of company-funded expenditure from the recently acquired B/E Aerospace business.

Total R&D expense decreased $5 million from 2015 to 2016. The customer-funded portion of R&D increased $43 million from 2015 to 2016, primarily due to development expenditures in Commercial Systems for international regional jet programs. Company-funded R&D expenditures decreased $48 million from 2015 to 2016 primarily due to lower business jet development costs in Commercial Systems as well as lower development costs for software-defined radio programs in Government Systems.

In addition to the R&D expenses above, development expenditures incurred on the Bombardier Global 7000/8000 and CSeries programs, the Boeing 737 MAX platform, and certain military transport programs in 2017 resulted in a net $35 million increase to our investments in pre-production engineering programs capitalized within inventory. The net increase of $35 million for 2017 was $93 million less than the $128 million net increase in pre-production engineering costs capitalized within inventory

33



during 2016, primarily due to lower costs incurred for the Boeing 737 MAX platform and a $10 million increase in amortization.

Development expenditures incurred on the Boeing 737 MAX platform, the Bombardier CSeries and Global 7000/8000 programs and certain military transport program in 2016 resulted in a net $128 million increase to our investments in pre-production engineering programs capitalized within inventory. The net increase of $128 million for 2016 was $8 million less than the $136 million net increase in pre-production engineering costs capitalized within inventory during 2015, primarily due to lower costs incurred for the Bombardier CSeries program, partially offset by higher costs incurred for certain military transport programs in Government Systems and the Bombardier Global 7000/8000 program. 

Refer to Note 6 of the Notes to Consolidated Financial Statements for further discussion of our incremental investments in pre-production engineering effort.

Selling, General and Administrative Expenses
(in millions)
 
2017
 
2016
 
2015
Selling, general and administrative expenses
 
$
732

 
$
638

 
$
606

Percent of total sales
 
10.7
%
 
12.1
%
 
11.6
%

Selling, general and administrative (SG&A) expenses consist primarily of personnel, facility and other expenses related to employees not directly engaged in manufacturing or R&D activities. These activities include marketing and business development, finance, legal, information technology and other administrative and management functions.

Total SG&A expenses increased $94 million, or 15 percent, in 2017 compared to 2016, primarily due to the following:

$99 million of SG&A costs from the recently acquired B/E Aerospace business

international customer bankruptcy and employee severance charges in 2017

a $3 million increase in employee incentive compensation costs

partially offset by $12 million of restructuring and asset impairment charges recorded in 2016 and the benefits of cost savings initiatives

Total SG&A expenses increased $32 million, or 5 percent, in 2016 compared to 2015, primarily due to the following:

$12 million of restructuring and asset impairment charges recorded in 2016

higher costs from further expansion in international emerging markets

incremental costs associated with the acquisitions of ICG and Pacific Avionics

Interest Expense
(in millions)
 
2017
 
2016
 
2015
Interest expense
 
$
187

 
$
64

 
$
61

Interest expense increased by $123 million in 2017 compared to 2016, primarily due to the following:

$92 million of incremental interest on the new debt issued to fund the B/E Aerospace acquisition

$29 million of fees incurred in 2017 associated with the bridge credit agreement entered into in December 2016 pursuant to the acquisition of B/E Aerospace

Interest expense increased by $3 million in 2016 compared to 2015, primarily due to higher interest rates on commercial paper borrowings in 2016.
 
See Note 9 of the Notes to Consolidated Financial Statements in Item 8 below for more detail regarding outstanding debt.

34



 
Other Income, Net
(in millions)
 
2017
 
2016
 
2015
Other income, net
 
$
16

 
$
20

 
$
15

Other income, net decreased by $4 million in 2017 compared to 2016, primarily due to the absence of a favorable settlement of a contractual matter with a customer of the ASES business. See Note 4 of the Notes to Consolidated Financial Statements in Item 8 below for more detail regarding this settlement.

Other income, net increased by $5 million in 2016 compared to 2015, primarily due to lower pension costs in 2016.

Income Tax Expense from Continuing Operations
(in millions)
 
2017
 
2016
 
2015
Income tax expense
 
$
226

 
$
208

 
$
268

Effective income tax rate
 
24.3
%
 
22.2
%
 
27.9
%

The difference between our effective income tax rate in 2017 and the statutory tax rate is primarily due to the benefit derived from the Federal Research and Development Tax Credit (Federal R&D Tax Credit), which provides a tax benefit on certain incremental R&D expenditures, the jurisdictional mix of income being taxed outside of the U.S. at lower tax rates and the Domestic Manufacturing Deduction, which provides a tax benefit on U.S.-based manufacturing.

The effective income tax rate in 2017 increased from 2016 primarily due to the retroactive reinstatement of the Federal R&D Tax Credit and the release of a $41 million valuation allowance related to a U.S. capital loss carryforward in the prior year. The current year effective income tax rate was favorably impacted by the jurisdictional mix of income as a result of the B/E Aerospace acquisition.
 
The effective income tax rate in 2016 decreased from 2015 primarily due to the permanent extension of the Federal R&D Tax Credit and the release of a $41 million valuation allowance related to a U.S. capital loss carryforward. The valuation allowance release resulted from the creation of a tax planning strategy in the third quarter of 2016. These tax benefits were partially offset by favorable adjustments in the prior year related to the remeasurement of certain tax positions.

Net Income and Diluted Earnings Per Share
(in millions, except per share amounts)
 
2017
 
2016
 
2015
Income from continuing operations
 
$
705

 
$
727

 
$
694

Percent of sales
 
10.3
%
 
13.8
%
 
13.2
%
 
 
 
 
 
 
 
Income (loss) from discontinued operations, net of taxes
 

 
1

 
(8
)
Net income
 
$
705

 
$
728

 
$
686

 
 
 
 
 
 
 
Diluted earnings per share from continuing operations
 
$
4.79

 
$
5.50

 
$
5.19

Diluted earnings (loss) per share from discontinued operations
 

 
0.01

 
(0.06
)
Diluted earnings per share
 
$
4.79

 
$
5.51

 
$
5.13

 
 
 
 
 
 
 
Weighted average diluted common shares
 
147.2

 
132.1

 
133.7


Income from continuing operations, net of taxes, for 2017 was $705 million, down 3 percent, or $22 million, from the $727 million in income from continuing operations, net of taxes, reported for 2016. Diluted earnings per share from continuing operations decreased 13 percent to $4.79 during this same time period. The rate of decrease in diluted earnings per share from continuing operations was more than the rate of decrease in income from continuing operations, net of taxes, due to the 31.2 million shares of common stock issued to finance the B/E Aerospace acquisition.


35



Income from continuing operations, net of taxes, and diluted earnings per share from continuing operations in 2017 decreased primarily due to:

$125 million of pre-tax transaction, integration and financing costs associated with the acquisition of B/E Aerospace

$92 million of incremental interest expense on the new debt issued to fund the B/E Aerospace acquisition

$24 million of pre-tax transaction costs associated with the pending acquisition of Rockwell Collins by UTC

an $18 million increase in income tax expense as detailed in the Income Tax Expense from Continuing Operations section above

partially offset by a $174 million increase in operating earnings from the recently acquired Interior Systems business, a $30 million increase in Information Management Services operating earnings and a $19 million increase in Government Systems operating earnings, net of a $12 million decrease in Commercial Systems operating earnings

also offset by the absence of $45 million of pre-tax restructuring and asset impairment charges recorded in 2016

Income from continuing operations, net of taxes, for 2016 was $727 million, up 5 percent, or $33 million, from the $694 million in income from continuing operations, net of taxes, reported for 2015. Diluted earnings per share from continuing operations increased 6 percent to $5.50 during this same time period. The rate of increase in diluted earnings per share from continuing operations was more than the rate of increase in income from continuing operations, net of taxes, because of the favorable impacts from our share repurchase program.

Income from continuing operations, net of taxes, and diluted earnings per share from continuing operations in 2016 increased primarily due to:

a $60 million decrease in income tax expense primarily due to the release of a valuation allowance for a U.S. capital loss carryforward, the retroactive reinstatement of the Federal R&D Tax Credit and lower pre-tax income from continuing operations

a total segment operating earnings increase of $9 million as operating earnings increased $20 million in Government Systems and $12 million in Information Management Services, partially offset by a $23 million decrease in Commercial Systems

partially offset by $45 million of pre-tax restructuring and asset impairment charges recorded in 2016

Segment Financial Results

One of the key metrics we use to describe year-over-year changes in operating income for each segment is the incremental (or reduced) earnings derived from higher (or lower) sales volumes. Similarly, the gross margin derived from these incremental (or reduced) earnings is often used to describe changes in segment operating margins. The incremental (or reduced) margin realized on the sales volume change tends to be disproportionately higher than the overall operating margin reported for the segment. This is because the overall operating margin for the segment contemplates more elements of our cost structure, such as company-funded R&D expense, depreciation, amortization and selling, general and administrative expenses.

Interior Systems

Overview

On April 13, 2017, we acquired B/E Aerospace and formed the new Interior Systems business segment, in which the sales and earnings of the acquired business are reported. See Note 3 of the Notes to Consolidated Financial Statements for more information regarding the acquisition.

The Interior Systems business manufactures cabin interior products for the commercial aircraft and business aviation markets. We sell our products and provide our services directly to virtually all of the world’s major airlines and aerospace manufacturers. We have achieved a leading global market position in each of our major product categories, which include:


36



commercial aircraft seats, including an extensive line of super first class, first class, business class, economy class and regional aircraft seats

a full line of aircraft food and beverage preparation and storage equipment, including coffee and espresso makers, water boilers, beverage containers, refrigerators, freezers, chillers and a line of microwave, high efficiency convection and steam ovens

modular lavatory systems, wastewater management systems and galley systems

both chemical and gaseous aircraft oxygen storage, distribution and delivery systems, protective breathing equipment and a broad range of lighting products

business jet and general aviation interior products, including an extensive line of executive aircraft and helicopter seats, direct and indirect overhead lighting systems, exterior lighting systems, passenger and crew oxygen systems, air valve systems and high-end aircraft monuments

For risks to the Interior Systems segment, see Risk Factors in Item 1A above. For additional disclosure on Interior Systems segment results see Note 21 of the Notes to Consolidated Financial Statements in Item 8 below.

Interior Systems Sales

The following table presents Interior Systems sales by product category:
(in millions)
 
2017
 
2016
 
2015
Interior products and services
 
$
821

 
$

 
$

Aircraft seating
 
585

 

 

Total
 
$
1,406

 
$

 
$


The results above reflect sales by the Interior Systems segment from April 13, 2017 through September 30, 2017.

Interior Systems Pro Forma Sales

Note 3 of the Notes to Consolidated Financial Statements presents supplemental pro forma financial data as if the acquisition of B/E Aerospace had been completed as of the beginning of our prior fiscal year, or on October 1, 2015. The pro forma data included in Note 3 combines the Company's consolidated results with the stand-alone results of B/E Aerospace for the pre-acquisition periods. The supplemental pro forma data is not necessarily indicative of results that actually would have occurred had the acquisition been consummated on October 1, 2015.

On a pro forma basis, sales for the Interior Systems segment would be $2.960 billion and $2.862 billion for the twelve months ended September 30, 2017 and 2016, respectively. The $98 million, or 3 percent, increase in the pro forma sales was primarily due to the following:

a $210 million increase in interior products and services sales, primarily due to increased original equipment deliveries of Airbus A350 galleys, Boeing 737 advanced lavatories and oxygen generators across multiple platforms

a $112 million decrease in aircraft seating, primarily due to the completion of certain super first class and retrofit programs

Refer to Note 3 of the Notes to Consolidated Financial Statements for additional pro forma disclosures.

Interior Systems Segment Operating Earnings
(in millions)
 
2017
 
2016
 
2015
Segment operating earnings
 
$
174

 
$

 
$

Percent of sales
 
12.4
%
 
%
 
%


37



The results above reflect operating earnings of the Interior Systems segment from April 13, 2017 through September 30, 2017. Operating earnings include $106 million of intangible asset amortization expense and $74 million of inventory fair value adjustment amortization that unfavorably impacted operating earnings, partially offset by $69 million of favorable acquired contract liability amortization.

Commercial Systems

Overview

Our Commercial Systems business supplies aviation electronics systems, products and services to customers located throughout the world. The customer base is comprised of OEMs of commercial air transport, business and regional aircraft, commercial airlines and business aircraft operators. The near and long-term performance of our Commercial Systems business is impacted by general worldwide economic health, commercial airline flight hours, corporate profits and the financial condition of airlines worldwide.

For risks to the Commercial Systems segment, see Risk Factors in Item 1A above. For additional disclosure on Commercial Systems segment results see Note 21 of the Notes to Consolidated Financial Statements in Item 8 below.

Commercial Systems Sales

The following table presents Commercial Systems sales by product category:
(in millions)
 
2017
 
2016
 
2015
Air transport aviation electronics:
 
 
 
 
 
 
Original equipment
 
$
910

 
$
850

 
$
806

Aftermarket
 
541

 
542

 
522

Wide-body in-flight entertainment
 
19

 
38

 
57

Total air transport aviation electronics
 
1,470

 
1,430

 
1,385

Business and regional aviation electronics:
 
 
 
 

 
 

Original equipment
 
477

 
534

 
640

Aftermarket
 
471

 
431

 
409

Total business and regional aviation electronics
 
948

 
965

 
1,049

Total
 
$
2,418

 
$
2,395

 
$
2,434

Percent increase (decrease)
 
1%

 
(2)%

 
 


Commercial Systems Sales for 2017 compared to 2016

Total air transport aviation electronics sales increased $40 million, or 3 percent, primarily due to the following:

original equipment sales increased $60 million, or 7 percent, primarily due to higher Boeing 737 and Airbus A350 production rates, partially offset by lower legacy wide-body production rates

aftermarket sales decreased $1 million, primarily due to lower retrofit and service and support sales, partially offset by higher regulatory mandate upgrade activity and higher used aircraft equipment sales

wide-body IFE sales decreased $19 million, or 50 percent, as airlines decommissioned their legacy IFE systems

Total business and regional aviation electronics sales decreased $17 million, or 2 percent, primarily due to the following:

original equipment sales decreased $57 million, or 11 percent, primarily due to lower business and regional aircraft OEM production rates, partially offset by higher product deliveries for the Bombardier CSeries and Global 7000 programs and higher customer-funded development program revenues

aftermarket sales increased $40 million, or 9 percent, primarily due to higher regulatory mandate upgrade and flight deck retrofit activity


38



Commercial Systems Sales for 2016 compared to 2015

Total air transport aviation electronics sales increased $45 million, or 3 percent, primarily due to the following:

original equipment sales increased $44 million, or 5 percent, primarily due to higher Airbus A350 and Boeing 787 production rates and higher customer-funded development program revenues, partially offset by lower Airbus A330 production rates and unfavorable customer timing for airline selectable equipment

aftermarket sales increased $20 million, or 4 percent, primarily due to inorganic sales growth from ICG and Pacific Avionics, partially offset by lower service and support activity and the absence of a large used aircraft equipment sale that occurred in the prior year

wide-body IFE sales decreased $19 million, or 33 percent, as airlines decommissioned their legacy IFE systems

Total business and regional aviation electronics sales decreased $84 million, or 8 percent, primarily due to the following:

original equipment sales decreased $106 million, or 17 percent, primarily due to certain lower business aircraft OEM production rates, partially offset by higher product deliveries for the Bombardier CSeries and Embraer Legacy business jet programs and higher customer-funded development program revenues

aftermarket sales increased $22 million, or 5 percent, primarily due to higher regulatory mandate upgrade and flight deck retrofit activity, as well as higher simulation hardware deliveries, partially offset by lower cabin retrofit activity

Commercial Systems Segment Operating Earnings
(in millions)
 
2017
 
2016
 
2015
Segment operating earnings
 
$
519

 
$
531

 
$
554

Percent of sales
 
21.5
%
 
22.2
%
 
22.8
%

Commercial Systems Operating Earnings for 2017 compared to 2016

Commercial Systems operating earnings decreased $12 million, or 2 percent, primarily due to the following:

a $19 million increase in employee incentive compensation costs

a $12 million increase in international customer bankruptcy and employee severance charges in 2017

partially offset by benefits from cost savings initiatives

in addition, the benefits of a $23 million increase in sales were unfavorably impacted by sales mix, as lower margin customer-funded development revenues increased and higher margin business jet OEM sales decreased

The decrease in Commercial Systems operating earnings as a percent of sales was primarily due to increased employee incentive compensation costs, international customer bankruptcy and employee severance charges, and unfavorable sales mix, partially offset by the benefits of cost savings initiatives.

Commercial Systems Operating Earnings for 2016 compared to 2015

Commercial Systems operating earnings decreased $23 million, or 4 percent, primarily due to the following:

operating earnings were negatively impacted by a $39 million decrease in sales and sales mix, as lower margin customer-funded development revenues increased and higher margin business jet OEM sales decreased in 2016

a $15 million increase in the amortization of pre-production engineering costs and intangible assets

a $10 million increase in SG&A costs primarily due to the acquisition and integration of Pacific Avionics and ICG


39



partially offset by a $39 million decrease in company-funded R&D expense and the favorable impact of benefits from cost savings initiatives from previously announced restructuring plans

The decrease in Commercial Systems operating earnings as a percent of sales was primarily due to lower sales volume and unfavorable sales mix, partially offset by lower company-funded R&D expense.

Government Systems

Overview

The Government Systems business provides communication and navigation products and avionics to the U.S. Department of Defense, state and local governments, other government agencies, civil agencies, defense contractors and foreign ministries of defense around the world. These systems, products and services support airborne (fixed and rotary wing), ground and shipboard applications. The short- and long-term performance of our Government Systems business is affected by a number of factors, including the amount and prioritization of defense spending by the U.S. and non-U.S. governments, which is generally based on the security environment and underlying political landscape.

For risks to the Government Systems segment, see Risk Factors in Item 1A above. For additional disclosure on Government Systems segment results see Note 21 of the Notes to Consolidated Financial Statements in Item 8 below.

Government Systems Sales

The following table presents Government Systems sales by product category:
(in millions)
 
2017
 
2016
 
2015
Avionics
 
$
1,472

 
$
1,483

 
$
1,436

Communication and navigation
 
808

 
723

 
751

Total
 
$
2,280

 
$
2,206

 
$
2,187

Percent increase
 
3
%
 
1
%
 
 


Government Systems Sales for 2017 compared to 2016

Avionics sales decreased $11 million, or 1 percent, primarily due to the following:

a $25 million decrease from lower fixed wing sales, primarily due to the wind-down of legacy tanker hardware deliveries and lower deliveries for various fighter platforms as a result of production issues, net of higher development program sales

partially offset by a $14 million increase from higher simulation and training sales

Communication and navigation sales increased $85 million, or 12 percent, primarily due to the following:

a $23 million increase from higher data links sales

a $22 million increase from higher deliveries of GPS-related products

$40 million in other net increases to revenue, primarily due to higher test and training range sales and higher legacy communication sales

40




Government Systems Sales for 2016 compared to 2015

Avionics sales increased $47 million, or 3 percent, primarily due to the following:

an $80 million increase from higher deliveries and service revenue on various fixed wing platforms

an $8 million increase from higher simulation and training sales

partially offset by $41 million in other net decreases to revenue, including lower deliveries on various rotary wing platforms

Communication and navigation product sales decreased $28 million, or 4 percent, primarily due to the following:

a $32 million decrease due to lower international deliveries of targeting systems

a $28 million decrease due to the wind-down of an international electronic warfare program

partially offset by $32 million in other net increases to revenue, including increases in data link and ARC-210 radio sales

Government Systems Segment Operating Earnings
(in millions)
 
2017
 
2016
 
2015
Segment operating earnings
 
$
496

 
$
477

 
$
457

Percent of sales
 
21.8
%
 
21.6
%
 
20.9
%

Government Systems Operating Earnings for 2017 compared to 2016

Government Systems operating earnings increased $19 million, or 4 percent, primarily due to the following:

the $74 million increase in sales volume discussed in the Government Systems sales section above, which resulted in a $43 million increase in cost and incremental earnings of $31 million, or 42 percent of the higher sales volume. The margins on the sales increase were favorably impacted by benefits from cost savings initiatives

a $7 million decrease in company-funded R&D expense

partially offset by a $19 million increase in employee incentive compensation costs

The increase in Government Systems operating earnings as a percent of sales was primarily due to earnings from the higher sales volume, the benefits of cost savings initiatives and decreased company-funded R&D expense, partially offset by increased employee incentive compensation costs.


41



Government Systems Operating Earnings for 2016 compared to 2015

Government Systems operating earnings increased $20 million, or 4 percent, primarily due to the following:

the $19 million increase in sales volume discussed in the Government Systems sales section above, which resulted in a $9 million increase in cost and incremental earnings of $10 million, or 53 percent of the higher sales volume. The margins on the sales increase were favorably impacted by benefits from cost savings initiatives from previously announced restructuring plans and unfavorably impacted by the absence of certain favorable development program adjustments that occurred in the prior year

a $9 million decrease in company-funded R&D expense

an $8 million decrease in pension costs

partially offset by a $6 million unfavorable warranty adjustment

The increase in Government Systems operating earnings as a percent of sales was primarily driven by earnings from the higher sales volume, including the favorable impact of cost savings initiatives, decreased company-funded R&D expense and lower pension costs, partially offset by an unfavorable warranty adjustment and the absence of certain favorable development program adjustments that occurred in the prior year.

Information Management Services

Overview

Our Information Management Services business enables mission-critical data and voice communications throughout the world to customers including the FAA, commercial airlines, business aircraft operators, airport and critical infrastructure operators and major passenger and freight railroads. These communications are enabled by our high-performance, high-quality and high-assurance proprietary radio and terrestrial networks, enhancing customer efficiency, safety and connectivity.

For risks to the Information Management Services segment, see Risk Factors in Item 1A above. For additional disclosure on Information Management Services segment results see Note 21 of the Notes to Consolidated Financial Statements in Item 8 below.

Information Management Services Sales

The following table presents Information Management Services sales:
(in millions)
 
2017
 
2016
 
2015
Sales
 
$
718

 
$
658

 
$
623

Percent increase
 
9
%
 
6
%
 
 


Information Management Services Sales for 2017 compared to 2016

Total Information Management Services sales increased $60 million, or 9 percent. Aviation-related sales grew 11 percent primarily due to increased usage of connectivity services and increased connectivity related equipment deliveries. Non-aviation sales grew 6 percent primarily due to nuclear security mandate revenue.

Information Management Services Sales for 2016 compared to 2015

Total Information Management Services sales increased $35 million, or 6 percent, primarily due to 6 percent growth in aviation-related sales, and 4 percent growth in non-aviation related sales for airport and rail programs. Aviation-related sales growth was offset by the absence of certain favorable adjustments recorded in 2015.

42




Information Management Services Segment Operating Earnings
(in millions)
 
2017
 
2016
 
2015
Segment operating earnings
 
$
137

 
$
107

 
$
95

Percent of sales
 
19.1
%
 
16.3
%
 
15.2
%

Information Management Services Operating Earnings for 2017 compared to 2016

Information Management Services operating earnings increased $30 million, primarily due to:

a $60 million increase in sales volume discussed in the Information Management Services sales section above, which resulted in a $33 million increase in cost and an increase in earnings of $27 million, or 45 percent of the higher sales volume. The margins on the sales increase were favorably impacted by benefits from cost savings initiatives

operating earnings were positively impacted in 2017 by the favorable resolution of certain prior year claims associated with international business jet support services, in excess of the 2016 benefit associated with similar claims

The increase in operating earnings as a percent of sales for 2017 compared to the prior year was primarily due to higher sales volume and the above mentioned favorable resolution of prior year claims.

Information Management Services Operating Earnings for 2016 compared to 2015

Information Management Services operating earnings increased $12 million, primarily due to:

a $35 million increase in sales volume discussed in the Information Management Services sales section above, which resulted in a $25 million increase in cost and an increase in earnings of $10 million, or 29 percent of the higher sales volume. The margins on the sales increase were unfavorably impacted by the increase in lower margin non-aviation related sales

operating earnings were positively impacted in 2016 by the favorable resolution of certain prior year claims associated with international business jet support services

The increase in operating earnings as a percent of sales for 2016 compared to the prior year was primarily due to higher sales volume and the above mentioned favorable resolution of prior year claims.

General Corporate, Net
 
General corporate expenses that are not allocated to our operating segments are included in General corporate, net. These costs are included within Cost of sales, SG&A and Other income, net on the Consolidated Statement of Operations. General corporate, net is summarized as follows:
(in millions)
 
2017
 
2016
 
2015
General corporate, net
 
$
57

 
$
44

 
$
59


General corporate, net expense increased $13 million during 2017 as compared to 2016, primarily due to costs of the recently acquired B/E Aerospace business and higher employee incentive compensation costs.

General corporate, net expense decreased $15 million during 2016 as compared to 2015, primarily due to a decrease in employee incentive compensation and pension costs.


43



Retirement Plans

Net benefit expense (income) for pension benefits and other retirement benefits are as follows:
(in millions)
2017
 
2016
 
2015
Pension benefits
$
(25
)
 
$
(24
)
 
$
(6
)
Other retirement benefits
14

 
14

 
11

Net benefit (income) expense
$
(11
)
 
$
(10
)
 
$
5


Pension Benefits

In 2003, we amended our U.S. qualified and non-qualified pension plans covering all salary and hourly employees not covered by collective bargaining agreements to discontinue benefit accruals for salary increases and services rendered after September 30, 2006. Concurrently, we replaced this benefit by supplementing our existing defined contribution savings plan to include an additional Company contribution effective October 1, 2006. Our total contributions made in cash to our defined contribution savings plans were $54 million, $46 million and $47 million for 2017, 2016 and 2015, respectively.

In October 2014, the Society of Actuaries published a new set of mortality tables (RP-2014) and a new mortality improvement scale (MP-2014), which updated life expectancy assumptions. For our 2016 year-end pension liability valuation, we used the RP-2014 tables with an adjustment for plan experience and the MP-2014 mortality improvement scale adjusted to reflect convergence to an ultimate annual rate of mortality improvement of 0.75 percent by 2022. For our 2017 year-end pension liability valuation, we continued to use the RP-2014 tables with an adjustment for plan experience, but utilized the MP-2016 mortality improvement scale adjusted to reflect convergence to an ultimate annual rate of mortality improvement of 0.75 percent by 2032. The MP-2016 mortality improvement scale indicates that U.S. mortality continues to improve, but at a slower average rate. See additional details in the Critical Accounting Policies section in Item 7A below.

In 2015 and prior, we used a single-weighted average discount rate to calculate pension interest and service cost. Since 2016, a "spot rate approach" has been used to calculate pension interest and service cost. The spot rate approach applies separate discount rates for each projected benefit payment in the calculation of pension interest and service cost. This calculation change was considered a change in accounting estimate and was applied prospectively beginning in 2016. The use of the spot rate approach had a favorable impact to pension income of $28 million and $35 million in 2017 and 2016, respectively. See additional details in the Critical Accounting Policies section in Item 7A below.

Defined benefit pension income for the years ended September 30, 2017, 2016 and 2015 was $25 million, $24 million and $6 million, respectively.

The increase in pension income in 2017 compared to 2016 was primarily due to a change in the discount rate, impacting interest costs and amortization of net actuarial losses. The increase in pension income in 2016 compared to 2015 was primarily due to the calculation change of the discount rate for interest and service cost as discussed above, partially offset by the impact of the new mortality assumptions.

During 2017, the funded status of our pension plans went from a deficit of $1.453 billion at September 30, 2016 to a deficit of $1.016 billion at September 30, 2017. The increase in funded status was primarily due to the favorable impact from an increase in the discount rate used to measure our U.S. pension obligations from 3.22 percent at September 30, 2016 to 3.53 percent at September 30, 2017, and an increase in plan assets due to favorable market returns during 2017. We also contributed $68 million to our pension plans during the year ended September 30, 2017.

Our objective with respect to the funding of our pension plans is to provide adequate assets for the payment of future benefits. Pursuant to this objective, we will fund our pension plans as required by governmental regulations and may consider discretionary contributions as conditions warrant. We believe our strong financial position continues to provide us the opportunity to make contributions to our pension funds without inhibiting our ability to pursue strategic investments.

In October 2017, subsequent to our 2017 fiscal year end, we made a $55 million voluntary contribution to our U.S. qualified pension plan. There is no minimum statutory funding requirement for 2018. Any additional future contributions necessary to satisfy minimum statutory funding requirements are dependent upon actual plan asset returns, interest rates and other actuarial assumptions.


44



Other Retirement Benefits

Other retirement benefits expense for the years ended September 30, 2017, 2016 and 2015 was $14 million, $14 million and $11 million, respectively.


FINANCIAL CONDITION AND LIQUIDITY

Cash Flow Summary

Our ability to generate significant cash flow from operating activities coupled with our expected ability to access the credit markets enables us to execute our growth strategies and return value to our shareowners. The timing of our cash inflows is historically heavily weighted towards the second half of our fiscal year, particularly our fourth quarter. We expect this trend to continue in the future.

Operating Activities
 
(in millions)
 
2017
 
2016
 
2015
Cash provided by operating activities from continuing operations
 
$
1,264

 
$
723

 
$
749


The $541 million increase in cash provided by operating activities in 2017 compared to 2016 was primarily due to the following:
    
higher cash receipts from customers, which increased by $1.867 billion to $6.947 billion in 2017 compared to $5.080 billion in 2016, primarily due to cash receipts of the recently acquired B/E Aerospace business. The increase in cash receipts from customers was more than the sales volume increase of $1.563 billion due to the timing of sales relative to the collection of receivables from customers

partially offset by higher payments for production inventory and other operating costs, which increased by $1.135 billion to $5.152 billion in 2017, compared to $4.017 billion in 2016, primarily due to cash payments of the recently acquired B/E Aerospace business

also offset by cash payments for income taxes, which increased $100 million to $230 million in 2017, compared to $130 million in 2016. The increase in cash used for income tax payments was primarily due to the retroactive reinstatement of the Federal R&D tax credit as a result of the Protecting Americans from Tax Hikes Act in 2016, as well as pre-tax income associated with the recently acquired B/E Aerospace business

further offset by payments for transaction costs associated with the B/E Aerospace acquisition of $114 million in 2017

The $26 million decrease in cash provided by operating activities in 2016 compared to 2015 was primarily due to the following:

cash receipts from customers decreased by $135 million to $5.080 billion in 2016 compared to $5.215 billion in 2015. Cash receipts from customers decreased despite sales volume growth of $15 million due to the timing of sales relative to advanced payments and the collection of receivables from customers

payments for employee incentive pay increased $23 million. Incentive pay is expensed in the year incurred and then paid in the first fiscal quarter of the following year. In 2016, $137 million was paid for employee incentive pay costs expensed during 2015. This compares to $114 million paid in 2015 for employee incentive costs expensed during 2014

the above items were partially offset by lower payments for production inventory and other operating costs which decreased $85 million to $4.017 billion in 2016 compared to $4.102 billion in 2015. Cash payments for operating costs decreased despite growth in cost of sales due to the timing of payments to suppliers

cash payments for income taxes decreased $52 million to $130 million in 2016, compared to $182 million in 2015. The decrease in income tax payments was primarily from the retroactive reinstatement of the Federal R&D tax

45



credit as a result of the Protecting Americans from Tax Hikes Act, as well as lower pre-tax income from continuing operations

Investing Activities
 
(in millions)
 
2017
 
2016
 
2015
Cash used for investing activities from continuing operations
 
$
(3,674
)
 
$
(209
)
 
$
(294
)

The $3.465 billion increase in cash used for investing activities in 2017 compared to 2016 was primarily due to the following:

$3.417 billion in cash consideration paid, net of cash acquired, related to the April 2017 acquisition of B/E Aerospace

a $47 million increase in cash payments for property additions to $240 million in 2017, primarily driven by the B/E Aerospace acquisition

The $85 million reduction in cash used for investing activities in 2016 compared to 2015 was primarily due to the following:

we paid $50 million and $24 million in 2015 for the acquisitions of ICG and Pacific Avionics, respectively

a $17 million decrease in cash payments for property additions to $193 million in 2016

the above items were partially offset by $17 million paid for the Matrix series projector product line acquisition in 2016

Financing Activities

(in millions)
 
2017
 
2016
 
2015
Cash provided by (used for) financing activities from continuing operations
 
$
2,759

 
$
(422
)
 
$
(492
)

The $3.181 billion increase in cash provided by financing activities in 2017 compared to 2016 was primarily due to the following:

$3.980 billion related to financing of the April 2017 B/E Aerospace acquisition. $6.099 b