Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report filed on Form 10-K for the fiscal year ended
October 3, 2015
. All references to years in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are to fiscal years and amounts may differ from reported values due to rounding.
OVERVIEW
We are a worldwide designer, manufacturer and systems integrator of high performance precision motion and fluid controls and control systems for a broad range of applications in aerospace and defense and industrial markets.
Within the aerospace and defense market, our products and systems include:
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•
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Defense market - primary and secondary flight controls for military aircraft, stabilization and automatic ammunition loading controls for armored combat vehicles, tactical and strategic missile steering controls and gun aiming controls.
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•
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Commercial aircraft market - primary and secondary flight controls for commercial aircraft.
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•
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Commercial space market - satellite positioning controls and thrust vector controls for launch vehicles.
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In the industrial market, our products are used in a wide range of applications including:
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•
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Industrial automation market - injection molding, metal forming, heavy industry, material and automotive testing, pilot training simulators and surveillance systems.
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•
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Energy market - oil and gas exploration, wind energy and power generation.
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•
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Medical market - sleep apnea devices, surgical handpieces, CT scanners, as well as enteral clinical nutrition and infusion therapy solutions.
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We operate under five segments, Aircraft Controls, Space and Defense Controls, Industrial Systems, Components and Medical Devices. Our principal manufacturing facilities are located in the United States, United Kingdom, Philippines, Germany, Italy, Netherlands, China, Costa Rica, Japan, Luxembourg, India, Canada and Ireland.
We have long-term contracts with some of our customers. These contracts are predominantly within Aircraft Controls and Space and Defense Controls and represent
33%
,
34%
and
33%
of our sales in 2015, 2014 and 2013, respectively. We recognize revenue on these contracts using the percentage of completion, cost-to-cost method of accounting as work progresses toward completion. The remainder of our sales are recognized when the risks and rewards of ownership and title to the product are transferred to the customer, principally as units are delivered or as service obligations are satisfied. This method of revenue recognition is predominantly used within the Industrial Systems, Components and Medical Devices segments, as well as with aftermarket activity.
We concentrate on providing our customers with products designed and manufactured to the highest quality standards. Our products are applied in demanding applications, "When Performance Really Matters
®
." We believe we have achieved a leadership position in the high performance, precision controls market, by capitalizing on our strengths, which include:
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•
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superior technical competence in delivering mission-critical solutions,
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•
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an innovative customer-intimacy approach,
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•
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a diverse base of customers and end markets served by a broad product portfolio,
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•
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well-established international presence serving customers worldwide, and
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•
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a proven ability to successfully undertake investments designed to enhance our control systems product franchise and drive continued growth.
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These strengths have afforded us the ability to expand our current solutions into new, complimentary technologies, which provide us with the opportunity to develop our product scope supply from one market to another and from component to systems supplier, as well as achieve substantial content positions on the platforms on which we currently participate. As we seek to be the dominant supplier in the current niche markets we serve, we will also look for innovation in all aspects of our business, employing new technologies to improve productivity and to develop progressive business models.
Our financial objectives include increasing our revenue base and improving our long term profitability and cash flow from operations while continuously focusing on internal cost improvement initiatives. In doing so, we expect to maintain a balanced, diversified portfolio in terms of markets served, product applications, customer base and geographic presence. Our fundamental strategies to achieve our objectives include:
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•
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maintaining our technological excellence by building upon our systems integration capabilities while solving our customers’ most demanding technical problems in applications "When Performance Really Matters
®
,"
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•
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utilizing our global capabilities and strong engineering heritage to innovate new solutions,
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•
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maximizing customer value by implementing lean enterprise principles, and
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•
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investing in talent development to accelerate our leadership capability and employee performance.
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We focus on improving shareholder value through strategic revenue growth, both acquired and organic, through improving operating efficiencies and manufacturing initiatives and through utilizing low cost manufacturing facilities without compromising quality. Additionally, we take a balanced approach to capital deployment, which may include strategic acquisitions or further share buyback activity in order to maximize shareholder returns over the long-term. We face numerous challenges to improving shareholder value. These include, but are not limited to, adjusting to dynamic global economic conditions that are influenced by governmental, industrial and commercial factors, pricing pressures from customers, strong competition, foreign currency fluctuations and increases in employee benefit costs. Based on periodic strategy reviews, including the financial outlook of our business, we may also engage in restructuring activities, including reducing overhead, consolidating facilities, exiting some product lines and divesting operations.
Acquisition and Divestiture
All of our acquisitions are accounted for under the purchase method and, accordingly, the operating results for the acquired companies are included in the consolidated statements of earnings from the respective dates of acquisition. Under purchase accounting, we record assets and liabilities at fair value on the consolidated balance sheet. The purchase price described for each acquisition below is net of any cash acquired and includes debt issued or assumed.
In 2016, we acquired a 70% ownership in Linear Mold and Engineering, a Livonia, Michigan-based company specializing in metal additive manufacturing that provides engineering, manufacturing and production consulting services to customers across a wide range of industries, including aerospace, defense, energy and industrial. We acquired Linear Mold and Engineering for $23 million. The acquisition also includes a redeemable noncontrolling interest in the remaining 30%, which is exercisable beginning three years from the date of acquisition. This acquisition is included in of our Aircraft Controls segment.
In 2015, we sold the Rochester, New York and Erie, Pennsylvania life sciences operations of our Medical Devices segment for $3 million.
CRITICAL ACCOUNTING POLICIES
On a regular basis, we evaluate the critical accounting policies used to prepare our consolidated financial statements, including, but not limited to, revenue recognition on long-term contracts, contract loss reserves, reserves for inventory valuation, reviews for impairment of goodwill, purchase price allocations for business combinations, pension assumptions and deferred tax asset valuation allowances.
There have been no material changes in critical accounting policies in the current year from those disclosed in our 2015 Annual Report on Form 10-K. However, we have expanded our disclosure for reviews for impairment of goodwill. The disclosure below includes key assumptions and circumstances that, if changed, could negatively impact our assessment of goodwill in reporting units for which the fair value is not significantly in excess of carrying value.
Reviews for Impairment of Goodwill
We performed an interim test on goodwill for impairment for our Medical Devices reporting unit in the fourth quarter of 2015. This reporting unit had $62 million of goodwill at October 3, 2015. The fair value of the Medical Devices reporting unit exceeded its carrying amount by 18%. Had we used a discount rate that was 100 basis points higher or a terminal growth rate that was 100 basis points lower than those we assumed, the fair value of this reporting unit would have exceeded its carrying amount by 4% and 10%, respectively.
The primary factor causing the fair value of this reporting unit to not be substantially greater than the carrying value is that the Medical Devices segment was created through a series of acquisitions between 2006 and 2009. The creation of this reporting unit resulted in recording substantial goodwill, which increased the carrying value. The key assumptions that drive the estimated fair value are the projected revenue and operating margins, which are used to project future cash flows. Our expectation for this reporting unit is for revenue growth over the five year projection period to be driven by the overall market growth of the home healthcare segment of the infusion therapy market and by capturing market share due to new product offerings. Additionally, our expectation is that operating margins improve throughout the five year projection period, driven by improved sales, as well as continued cost containment activities. If cash flows generated by our Medical Devices reporting unit were to decline in the future, or if there were adverse revisions to key assumptions, we may be required to record impairment charges. There are specific circumstances that would pose risk to the fair value of this reporting unit. Lower than projected growth rates of the home healthcare segment of the infusion therapy market, changes in provider capital purchase cycles, changes in healthcare legislation, changes in private insurance plans, as well as changes in treatment therapies may negatively affect the fair value of this reporting unit. Also, our projected market share capture rates may be lower due to delayed or unsuccessful new product offerings, which would negatively affect the fair value of this reporting unit. In addition, the fair value of this reporting unit may be negatively impacted based on the results of strategic reviews and courses of action that we may decide to pursue.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” which supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. This ASU requires revenue recognition to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also requires additional disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and assets recognized from costs incurred to obtain or fulfill a contract. This ASU can be adopted using either a full retrospective or modified retrospective approach. In March 2016, the FASB issued ASU No. 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal Versus Agent Considerations." This ASU clarifies implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing." This ASU clarifies implementation guidance on licensing arrangements as well as the process of identifying performance obligations. The provisions of each ASU are effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, pursuant to the issuance of ASU No. 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of Effective Date,” in August 2015. These amendments are applicable to us beginning in the first quarter of 2019. We are currently evaluating the adoption of these standards on our financial statements.
In August 2014, the FASB issued ASU No. 2014-13, “Consolidation (Topic 810): Measuring the Financial Assets and Financial Liabilities of a Consolidated Collateralized Financing Entity.” This ASU allows a reporting entity to elect to measure the financial assets and the financial liabilities of a consolidated collateralized financing entity using either the measurement alternative included in the ASU or Topic 820. The provisions of this ASU are effective for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. Early adoption is permitted as of the beginning of an annual period. This amendment is applicable to us beginning in the first quarter of 2017. The adoption of this standard is not expected to have a material impact on our financial statements.
In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosures of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” This ASU requires management to evaluate whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued or are available to be issued. This ASU also requires management to disclose certain information depending on the results of the going concern evaluation. The provisions of this ASU are effective for fiscal years ending after December 15, 2016 and for interim periods within those fiscal years thereafter. Early adoption is permitted. This amendment is applicable to us beginning in the first quarter of 2017. The adoption of this standard is not expected to have a material impact on our financial statements.
In January 2015, the FASB issued ASU No. 2015-01, "Income Statement - Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items." This ASU eliminates from GAAP the concept of extraordinary items. The ASU retains and expands the existing presentation and disclosure guidance for items that are unusual in nature or occur infrequently to also include items that are both unusual in nature and infrequently occurring. The provisions of this ASU are effective for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. Early adoption is permitted, provided that presentation applied to the beginning of the fiscal year of adoption. This amendment is applicable to us beginning in the first quarter of 2017. The adoption of this standard is not expected to have a material impact on our financial statements.
In April 2015, the FASB issued ASU No. 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” This ASU requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In August 2015, the FASB issued ASU No. 2015-15, “Interest - Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements.” This ASU provides additional guidance on ASU No. 2015-03, specific to debt issuance costs arising from line-of-credit arrangements. This ASU provides an option to either apply the provisions of ASU No. 2015-03 to line-of-credit arrangements or to defer and instead present debt issuance costs as an asset and subsequently amortize the deferred debt issuance costs ratably over the term of the line-of-credit arrangement. The provisions of each ASU are effective for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. Early adoption is permitted, and retrospective application is required. These amendments are applicable to us beginning in the first quarter of 2017. The adoption of these standards are not expected to have a material impact on our financial statements.
In May 2015, the FASB issued ASU No. 2015-07, “Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities that Calculate Net Asset Value per Share (or Its Equivalent).” This ASU removes the requirement to make certain disclosures as well as categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The provisions of this ASU are effective for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. Early adoption is permitted, and retrospective application is required. This amendment is applicable to us beginning in the first quarter of 2017. Other than requiring a change to our disclosures, the adoption of this standard is not expected to have a material impact on our financial statements.
In July 2015, the FASB issued ASU No. 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory.” This ASU requires inventory to be measured at the lower of cost or net realizable value. The provisions of this ASU are effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. Early adoption is permitted, and the amendment is required to be applied prospectively. This amendment is applicable to us beginning in the first quarter of 2018. The adoption of this standard is not expected to have a material impact on our financial statements.
In September 2015, the FASB issued ASU No. 2015-16, “Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments.” This ASU eliminates the requirement to retrospectively account for changes to provisional amounts initially recorded in a business acquisition opening balance sheet. The provisions of this ASU are effective for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. Early adoption is permitted as of the effective date for financial statements that have not yet been made available for issuance. This amendment is applicable to us beginning in the first quarter of 2017. The adoption of this standard is not expected to have a material impact on our financial statements.
In November 2015, the FASB issued ASU No. 2015-17, "Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes." This ASU amends existing guidance to require presentation of deferred tax assets and liabilities as noncurrent within the balance sheet. The provisions of the ASU are effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. Early adoption is permitted, and may be applied either prospectively or retrospectively. This amendment is applicable to us beginning in the first quarter of 2018. We are currently evaluating the adoption of this standard on our financial statements.
In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." This ASU requires most equity investments be measured at fair value, with subsequent changes in fair value recognized in net income. The amendment also impacts the measurement of financial liabilities under the fair value option as well as certain presentation and disclosure requirements for financial instruments. The provisions of this ASU are effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. Early adoption is permitted for some, but not all, provisions. The amendment requires certain provisions to be applied prospectively and others to be applied by means of a cumulative-effect adjustment. This amendment is applicable to us beginning in the first quarter of 2019. We are currently evaluating the adoption of this standard on our financial statements.
In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)." This ASU requires most lease arrangements to be recognized in the balance sheet as lease assets and lease liabilities. The ASU also requires additional disclosures about the leasing arrangements. The provisions of this ASU are effective for fiscal years beginning after December 15, 2018 and interim periods within those years. Early adoption is permitted. This amendment is applicable to us beginning in the first quarter of 2020. We are currently evaluating the adoption of this standard on our financial statements.
In March 2016, the FASB issued ASU No. 2019-09, "Compensation - Stock Compensation (Topic 718): Improvements to Employee Share Based Payment Accounting." This ASU simplifies several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards and classification on the statement of cash flows. The provisions of this ASU are effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted. This amendment is applicable to us beginning in the first quarter of 2018. We are currently evaluating the adoption of this standard on our financial statements.
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CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK
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Three Months Ended
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Six Months Ended
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(dollars and shares in millions, except per share data)
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April 2, 2016
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April 4, 2015
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$ Variance
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% Variance
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|
April 2, 2016
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April 4, 2015
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$ Variance
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% Variance
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Net sales
|
$
|
611
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$
|
637
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$
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(26
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)
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(4
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%)
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|
$
|
1,180
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|
$
|
1,268
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$
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(88
|
)
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(7
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%)
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Gross margin
|
29.3
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%
|
27.2
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%
|
|
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|
28.9
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%
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28.2
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%
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Research and development expenses
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$
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40
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$
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31
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$
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8
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|
27
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%
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|
$
|
75
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|
$
|
63
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$
|
12
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|
19
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%
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Selling, general and administrative expenses as a percentage of sales
|
13.5
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%
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14.5
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%
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14.1
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%
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15.0
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%
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Interest expense
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$
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9
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|
$
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8
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$
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1
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|
17
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%
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|
$
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17
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|
$
|
13
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$
|
4
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|
32
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%
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Restructuring expense
|
$
|
8
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|
$
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—
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|
$
|
8
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|
n/a
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|
$
|
8
|
|
$
|
—
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|
$
|
8
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|
n/a
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Effective tax rate
|
23.9
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%
|
22.5
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%
|
|
|
|
25.2
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%
|
25.8
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%
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|
Net earnings attributable to common shareholders
|
$
|
31
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|
$
|
32
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$
|
(1
|
)
|
(3
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%)
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|
$
|
57
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|
$
|
67
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$
|
(10
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)
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(15
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%)
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Diluted average common shares outstanding
|
37
|
|
40
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|
(3
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)
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(8
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%)
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37
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41
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|
(4
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)
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(9
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%)
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Diluted earnings per share attributable to common shareholders
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$
|
0.85
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$
|
0.80
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$
|
0.05
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6
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%
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|
$
|
1.55
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|
$
|
1.66
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|
$
|
(0.11
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)
|
(7
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%)
|
Net sales decreased in the second quarter of 2016 compared to the second quarter of 2015 driven by a $21 million decline in our Components segment. Weaker foreign currencies, in particular the British Pound, the Brazilian Real and the Euro relative to the U.S. dollar, contributed 29% of the sales decline in the second quarter of 2016.
Net sales decreased in the first half of 2016 compared to the first half of 2015. Our Components and Space and Defense segments contributed 80% of the sales decline. Weaker foreign currencies, in particular the Euro and the British Pound relative to the U.S. dollar, contributed 27% of the sales decline in the first half of 2016.
Gross margin increased in the second quarter of 2016 compared to the second quarter of 2015. In the second quarter of 2016, we benefited from the absence of last year's $7 million correction of an out-of-period accounting error in our Space and Defense Controls segment. Additionally, we had an improved sales mix from higher amounts of foreign military sales in Aircraft Controls and from higher sales volumes in Medical Devices. The improvements were partly offset by an adverse sales mix in both Components and in Industrial Systems due to lower energy related sales.
Research and development expenses increased in the second quarter and the first half of 2016 compared to the same periods of 2015. Within Aircraft Controls, research and development expenses increased $9 million and $14 million, respectively. In both the second quarter and first half of 2016, we had higher activity on the Embraer E-2 and the Airbus A350 programs.
Selling, general and administrative expenses as a percentage of sales decreased in the second quarter and in the first half of 2016 compared to the same periods of 2015. Most of the decline is attributable to an on-going focus on expense reduction across our segments. Additionally, we benefited from our 2015 restructuring activities.
In 2015, we incurred $15 million of restructuring expenses, primarily in Industrial Systems, Space and Defense Controls and Aircraft Controls. Through the first half of 2016, the total savings were $10 million, or 46% of our projected benefits for the year, and were primarily in selling, general and administrative expenses. In the second quarter of 2016, we incurred $8 million of restructuring expenses, primarily related to exiting a product line in Aircraft Controls. We expect the restructuring activities from the second quarter of 2016 will result in $11 million of cost savings over the next four quarters.
In the first half of 2016 compared to the first half of 2015, interest expense increased $2 million due to higher interest rates following the issuance of our $300 million senior notes. Additionally, interest expense increased $2 million due to higher levels of debt attributable to the funding of our share repurchase program.
In comparison to the U.S. statutory tax rate, our effective tax rates in 2016 and 2015 differ as a result of earnings being taxed in foreign jurisdictions with lower statutory tax rates. Additionally, our effective tax rates reflect the reversal of accruals for certain tax exposures outside of the U.S. whose statutes of limitations have expired, as well as the timing of enactment of the U.S. research and development tax credit.
Average common shares outstanding decreased in the second quarter and in the first half of 2016 compared to the same periods of 2015 due to our share buyback program. Since the Board of Directors amended the program in January 2014, we have repurchased nine million shares, and have four million additional shares available for repurchase under this program.
Other comprehensive income increased in the second quarter and in the first half of 2016 compared to same periods of 2015 due to foreign currency translation adjustments. In total, other comprehensive income related to the translation of the Euro and the Canadian Dollar increased $50 million in the second quarter and $58 million in the first half of 2016 compared to the same periods a year ago.
2016 Outlook
– We expect sales in 2016 to decrease 2% from fiscal 2015 to $2.47 billion. We expect sales declines in Components and Industrial Systems, as they are negatively impacted by global macro-economic conditions, particularly in our energy market and in our industrial market. Partly offsetting the declines is growth in Aircraft Controls as the Airbus A350 program continues to ramp up. We expect operating margin to decrease slightly to 9.6%. The benefits of our 2015 and 2016 cost containment strategies will drive margin expansion; however, the improvement will be offset by unfavorable sales mix in Aircraft Controls and Components. We expect net earnings attributable to common shareholders will decrease 7% to $123 million. Average diluted shares outstanding will decrease 6% to 37 million due to shares already repurchased under our current share buyback program. We expect diluted earnings per share will range between $3.20 and $3.50, with a midpoint of $3.35, which would be unchanged from 2015.
SEGMENT RESULTS OF OPERATIONS AND OUTLOOK
During 2015, we made a change to our segment reporting. Our Components segment now includes our sensors and handpieces product line, which we previously included in the Medical Devices segment. This product line consists of manufactured ultrasonic and optical sensors as well as surgical handpieces distributed to medical OEMs. Since the customer base is different from the sale of medical pumps directly to end users, the chief operating decision maker is now reviewing performance and assessing the allocation of resources of this product line as part of the Components segment. Sales of sensors and handpieces were $25 million in 2015. All amounts have been restated to present sensors and handpieces within Components.
Operating profit, as presented below, is net sales less cost of sales and other operating expenses, excluding interest expense, equity-based compensation expense and other corporate expenses. Cost of sales and other operating expenses are directly identifiable to the respective segment or allocated on the basis of sales, number of employees or profit. Operating profit is reconciled to earnings before income taxes in Note 16 of the Notes to Consolidated Condensed Financial Statements included in this report.
Aircraft Controls
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Three Months Ended
|
|
Six Months Ended
|
(dollars in millions)
|
April 2, 2016
|
April 4, 2015
|
$ Variance
|
% Variance
|
|
April 2, 2016
|
April 4, 2015
|
$ Variance
|
% Variance
|
Net sales - military aircraft
|
$
|
132
|
|
$
|
134
|
|
$
|
(3
|
)
|
(2
|
%)
|
|
$
|
252
|
|
$
|
260
|
|
$
|
(8
|
)
|
(3
|
%)
|
Net sales - commercial aircraft
|
144
|
|
140
|
|
4
|
|
3
|
%
|
|
279
|
|
281
|
|
$
|
(2
|
)
|
(1
|
%)
|
|
$
|
276
|
|
$
|
274
|
|
$
|
1
|
|
1
|
%
|
|
$
|
531
|
|
$
|
541
|
|
$
|
(10
|
)
|
(2
|
%)
|
Operating profit
|
$
|
19
|
|
$
|
22
|
|
$
|
(3
|
)
|
(15
|
%)
|
|
37
|
|
47
|
|
$
|
(10
|
)
|
(21
|
%)
|
Operating margin
|
6.9
|
%
|
8.1
|
%
|
|
|
|
7.0
|
%
|
8.7
|
%
|
|
|
Backlog
|
|
|
|
|
|
|
|
|
|
$
|
625
|
|
$
|
691
|
|
$
|
(66
|
)
|
(9
|
%)
|
Aircraft Controls' net sales were comparable in the second quarters of 2016 and 2015; however, net sales decreased in the first half of 2016 compared to the first half of 2015.
In the second quarter of 2016 compared to the second quarter of 2015, commercial OEM sales to Airbus increased $8 million, due to the ramp up of the A350 program. This increase was partially offset by $3 million of lower sales to Boeing and $3 million of lower business jet sales. Also, sales in military aircraft decreased. Sales decreased $5 million due to lower volumes for the V-22 program and decreased $3 million due to slowdowns in various aftermarket programs. However, sales for foreign military aircraft increased $6 million compared to the prior year's quarter.
In the first half of 2016 compared to the first half of 2015, military aircraft sales decreased. The V-22 program decreased $10 million and various aftermarket programs decreased, in aggregate, $5 million. These declines were partially offset by $4 million of higher sales for foreign military aircraft. Additionally, sales in our commercial market decreased as Boeing and business jet programs each decreased $5 million. However, sales to Airbus increased $10 million, driven by higher A350 program sales.
Operating margin for the second quarter and for the first half of 2016 declined compared to the second quarter and the first half of 2015. Research and development expenses increased $9 million and $14 million, respectively, largely associated with the ramp up of the Embraer E-2 and Airbus A350 programs. Additionally, we incurred $6 million of restructuring charges related to exiting a product line in the second quarter of 2016. We expect these actions will provide an aggregate benefit of $5 million over the next four quarters. However, an improved sales mix due to higher amounts of foreign military sales and lower operating costs partially offset the margin pressures. The operating profit in the first half of 2016 also included $2 million of benefits from restructuring activities in 2015. The year-to-date savings of last year's restructuring activities are approximately half of our total expected annual benefits. Our expected annual benefits are approximately 80% of our original annual expected benefits as we have revised our workforce planning.
The decrease of twelve-month backlog for Aircraft Controls at April 2, 2016 compared to April 4, 2015 is primarily due to the timing of certain commercial orders as well as work completed on military programs.
2016 Outlook for Aircraft Controls
–
We expect sales in Aircraft Controls to increase 4% to $1.13 billion in 2016. Commercial OEM aircraft sales are expected to increase 11%, due primarily to the continued ramp up of the Airbus A350 program. We expect that commercial aftermarket sales will continue to decline due to the lower levels of Boeing 787 initial provisioning sales. We expect military sales will decline 2% in 2016, as lower V-22 and military aftermarket sales offset higher F-35 production sales. We expect our operating margin will decrease to 8.5% in 2016 from 9.2% in 2015. Our operating margin will be negatively affected by our second quarter restructuring expenses, as well as continued unfavorable sales mix associated with lower amounts of military and commercial aftermarket sales. Additionally, our research and development costs will increase due to the continued spend on the A350 and the Embraer E-2 programs. However, we expect that lower costs, including the benefits from both of our recent restructuring actions, will offset some of the margin pressures.
Space and Defense Controls
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Six Months Ended
|
(dollars in millions)
|
April 2, 2016
|
April 4, 2015
|
$ Variance
|
% Variance
|
|
April 2, 2016
|
April 4, 2015
|
$ Variance
|
% Variance
|
Net sales
|
$
|
89
|
|
$
|
93
|
|
$
|
(4
|
)
|
(4
|
%)
|
|
$
|
172
|
|
$
|
193
|
|
$
|
(21
|
)
|
(11
|
%)
|
Operating profit
|
$
|
13
|
|
$
|
5
|
|
$
|
8
|
|
172
|
%
|
|
$
|
25
|
|
$
|
14
|
|
$
|
12
|
|
85
|
%
|
Operating margin
|
15.0
|
%
|
5.3
|
%
|
|
|
|
14.7
|
%
|
7.1
|
%
|
|
|
Backlog
|
|
|
|
|
|
|
|
|
|
$
|
254
|
|
$
|
238
|
|
$
|
16
|
|
7
|
%
|
Space and Defense Controls' net sales decreased in the second quarter and in the first half of 2016 compared to the same periods of 2015 due to declines in our space market.
Sales in our space market decreased $6 million in the second quarter of 2016 compared to the second quarter of 2015, due primarily to the completion of prior year satellite contracts. Higher sales for military vehicles increased our defense market sales $2 million.
For the first half of 2016 compared to the first half of 2015, sales in our space market decreased $19 million, due primarily to satellite and launch vehicle contracts winding down. Within our defense market, sales decreased $3 million due to lower sales volumes on missile systems and security products, partially offset by higher defense controls sales for military vehicles.
Operating margin increased in the second quarter of 2016 compared to the second quarter of 2015. Contributing to the increase was the absence of an $8 million out-of-period adjustment to correct an accounting error in the second quarter of 2015. Additionally, operating margin increased as we had lower operating expenses in 2016 due to various cost containment activities. Partly offsetting the increases was a decline in operating margin due to the lower sales volumes.
Operating margin increased in the first half of 2016 compared to the first half of 2015, primarily due to the absence of last year's out-of-period adjustment as well as the absence of an inventory obsolescence charge. Additionally, we benefited from an improved sales mix in 2016. The operating profit in the first half of 2016 also included $3 million of benefits from restructuring activities in 2015. These year-to-date savings are approximately 60% of our original total expected annual benefits and are in line with our expectations.
The higher level of twelve-month backlog for Space and Defense Controls at April 2, 2016 compared to April 4, 2015 is due to higher orders in launch vehicles and naval programs.
2016 Outlook for Space and Defense Controls
–
We expect sales in Space and Defense Controls to decrease 2% to $375 million in 2016. We expect sales declines in our space market as sales for satellite programs are lower. Partially offsetting the declines are expected increases in our defense market, driven by increased naval sales. We expect our operating margin will increase to 12.7% in 2016 from 8.7% in 2015 as the 2015 accounting correction does not repeat and as we benefit from our 2015 restructuring actions.
Industrial Systems
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Six Months Ended
|
(dollars in millions)
|
April 2, 2016
|
April 4, 2015
|
$ Variance
|
% Variance
|
|
April 2, 2016
|
April 4, 2015
|
$ Variance
|
% Variance
|
Net sales
|
$
|
128
|
|
$
|
129
|
|
$
|
(1
|
)
|
(1
|
%)
|
|
$
|
253
|
|
$
|
263
|
|
$
|
(9
|
)
|
(3
|
%)
|
Operating profit
|
$
|
13
|
|
$
|
13
|
|
$
|
1
|
|
5
|
%
|
|
$
|
27
|
|
$
|
26
|
|
$
|
1
|
|
4
|
%
|
Operating margin
|
10.3
|
%
|
9.8
|
%
|
|
|
|
10.6
|
%
|
9.9
|
%
|
|
|
Backlog
|
|
|
|
|
|
|
|
|
|
$
|
175
|
|
$
|
185
|
|
$
|
(10
|
)
|
(5
|
%)
|
Industrial Systems' net sales decreased slightly in the second quarter of 2016 compared to the second quarter of 2015. Weaker foreign currencies, in particular the Brazilian Real relative to the U.S. dollar, resulted in $3 million of the sales decline. Excluding the currency effects, sales increased $3 million due to higher sales volumes to flight simulation customers.
Industrial Systems' net sales decreased in the first half of 2016 compared to the first half of 2015. Weaker foreign currencies, in particular the Euro and the Brazilian Real relative to the U.S. dollar, resulted in a $14 million sales decline. Excluding the currency effects, Industrial Systems' sales increased $5 million, as simulation programs increased $10 million, but were partially offset by $3 million of lower energy sales and $2 million of lower industrial automation sales. Simulation programs increased due to higher sales volumes to flight simulation customers. Sales in our energy market decreased due to the continued unfavorable macro-economic conditions related to the significant decline in the price of crude oil. Additionally, sales decreased in our industrial automation market due to the continuing economic weakness in our markets resulting in lower demand for our products.
Operating margin increased in both the second quarter and the first half of 2016 compared to the same periods of 2015. Operating profit included $2 million and $3 million, respectively, of benefits from our 2015 restructuring activities. These year-to-date savings are approximately 45% of our original total expected annual benefits and are in line with our expectations. Partly offsetting the operating margin improvements was an unfavorable sales mix in our energy and industrial automation markets in the first half of 2016 compared to the first half of 2015. We also incurred $1 million of additional restructuring expense in the second quarter of 2016.
The lower level of twelve-month backlog in Industrial Systems at April 2, 2016 compared to April 4, 2015 is due the completion of simulation orders as well as lower energy orders related to the decline in the energy market.
2016 Outlook for Industrial Systems
–
We expect sales in Industrial Systems to decrease 5% to $495 million in 2016. We expect that the impacts of the weaker foreign currencies relative to the U.S. dollar, as well as the evolving global economic conditions, will continue to reduce our sales. We expect our operating margin will increase to 9.2% in 2016 from 8.6% in 2015, as we benefit from both our recent restructuring actions and our cost containment actions.
Components
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Six Months Ended
|
(dollars in millions)
|
April 2, 2016
|
April 4, 2015
|
$ Variance
|
% Variance
|
|
April 2, 2016
|
April 4, 2015
|
$ Variance
|
% Variance
|
Net sales
|
$
|
94
|
|
$
|
115
|
|
$
|
(21
|
)
|
(18
|
%)
|
|
$
|
173
|
|
$
|
223
|
|
$
|
(49
|
)
|
(22
|
%)
|
Operating profit
|
$
|
8
|
|
$
|
16
|
|
$
|
(8
|
)
|
(47
|
%)
|
|
$
|
13
|
|
$
|
33
|
|
$
|
(20
|
)
|
(60
|
%)
|
Operating margin
|
8.9
|
%
|
13.8
|
%
|
|
|
|
7.5
|
%
|
14.8
|
%
|
|
|
Backlog
|
|
|
|
|
|
|
|
|
|
$
|
165
|
|
$
|
175
|
|
$
|
(10
|
)
|
(6
|
%)
|
Components' net sales decreased across all of our markets in the second quarter and in the first half of 2016 compared to the same periods of 2015.
Within our non-aerospace and defense market, sales decreased $15 million in the second quarter of 2016 and $36 million in the first half of 2016 compared to the same periods of 2015. Sales in our energy market declined $10 million and $20 million, respectively, due to the macro-economic conditions centered around the significant decline in the price of crude oil and the resulting lower demand for our marine products. Additionally, sales declined $3 million and $9 million, respectively, in our medical market due in part to a lower price point for a key customer's next generation sleep apnea product that we will continue to support. Also, sales declined $3 million and $7 million, respectively, in our industrial market due to unfavorable macro-economic industrial conditions. Within our aerospace and defense market, sales decreased $6 million and $13 million, respectively, due primarily to lower amounts of aftermarket sales.
Operating margin declined in the second quarter and in the first half of 2016 compared to the same periods of 2015. The decreases are due, in part, to lower demand for our marine energy products resulting from the significant decline in the price of crude oil. Operating margin in the first half of 2016 was also negatively affected by lower sales in our medical market and unfavorable timing of sales in our military market. Additionally, we incurred $1 million of restructuring expense in the second quarter of 2016.
The twelve-month backlog at April 2, 2016 declined compared to the level at April 4, 2015 due to reduced orders for our aircraft, marine energy and industrial products.
2016 Outlook for Components –
We expect sales to decrease 17% to $365 million in 2016 due to continued declines in our energy, medical and industrial markets. Partially offsetting these declines is expected growth in our space and defense market, driven by improved defense vehicle sales. We expect our operating margin will decrease to 10.0% in 2016 from 13.4% in 2015. We will continue to be negatively impacted by macro-economic conditions reducing the demand for products in our energy and industrial markets in 2016.
Medical Devices
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Six Months Ended
|
(dollars in millions)
|
April 2, 2016
|
April 4, 2015
|
$ Variance
|
% Variance
|
|
April 2, 2016
|
April 4, 2015
|
$ Variance
|
% Variance
|
Net sales
|
$
|
24
|
|
$
|
25
|
|
$
|
(1
|
)
|
(5
|
%)
|
|
$
|
50
|
|
$
|
49
|
|
$
|
2
|
|
4
|
%
|
Operating profit
|
$
|
3
|
|
$
|
1
|
|
$
|
2
|
|
257
|
%
|
|
$
|
6
|
|
$
|
3
|
|
$
|
3
|
|
91
|
%
|
Operating margin
|
10.6
|
%
|
2.8
|
%
|
|
|
|
11.6
|
%
|
6.3
|
%
|
|
|
Backlog
|
|
|
|
|
|
|
|
|
|
$
|
8
|
|
$
|
7
|
|
$
|
—
|
|
5
|
%
|
Medical Devices' net sales in the second quarter and first half of 2016 were negatively affected by lost sales from operations sold in 2015. These operations contributed $2 million of sales in the second quarter of 2015 and $3 million of sales in the first half of 2015.
In the first half of 2016 compared to the first half of 2015, sales for IV products increased $3 million, due to higher shipments of IV pumps, as we continued the replacement of competitors' older products in the U.S. home healthcare market. Enteral sales also increased $2 million, due to higher sales volumes of enteral pumps.
Operating margin in the second quarter and in the first half of 2016 increased compared to the second quarter and the first half of 2015 due to the absence of last year's $1 million loss on the sale of two small operations. In addition, we benefited from higher sales volumes, primarily for our IV products, a more favorable sales mix across both of our IV and enteral products and lower material costs.
Twelve-month backlog for Medical Devices is not as substantial relative to sales as compared to our other segments, reflecting the shorter order-to-shipment cycle for this line of business.
2016 Outlook for Medical Devices –
We expect sales to increase slightly to $102 million in 2016. We expect that sales will increase due to improved enteral and IV product sales. However, this growth will be offset by a reduction related to the operations we sold in 2015. We expect our operating margin will increase to 11.4% in 2016 from 8.7% in 2015 as we continue to benefit from an improved cost structure and incremental margin contribution from higher sales volumes.
FINANCIAL CONDITION AND LIQUIDITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
(dollars in millions)
|
April 2,
2016
|
|
April 4,
2015
|
|
$ Variance
|
|
% Variance
|
Net cash provided (used) by:
|
|
|
|
|
|
|
|
Operating activities
|
$
|
78
|
|
|
$
|
132
|
|
|
$
|
(53
|
)
|
|
(40
|
%)
|
Investing activities
|
(38
|
)
|
|
(34
|
)
|
|
(3
|
)
|
|
10
|
%
|
Financing activities
|
(5
|
)
|
|
(46
|
)
|
|
41
|
|
|
(89
|
%)
|
Our available borrowing capacity and our cash flow from operations provide us with the financial resources needed to run our operations, reinvest in our business and make strategic acquisitions.
At
April 2, 2016
, our cash balance was $348 million, which is primarily held outside of the U.S. Cash flow from our U.S. operations, together with borrowings on our credit facility, fund on-going activities, debt service requirements and future growth investments. We reinvest the cash generated from foreign operations locally and such international balances are not available to pay down debt in the U.S. unless we decide to repatriate such amounts. If we determined repatriation of foreign funds was necessary, we would then be required to pay U.S. income taxes on those funds.
Operating activities
Net cash provided by operating activities decreased in the first half of 2016 compared to the same period of 2015. Unfavorable timing of payments and collections across our segments used $58 million more of cash compared to a year ago. Additionally, we made $8 million more in pension contributions. Partially offsetting the increases in these uses of cash was $14 million more of cash provided by customer advances, primarily in Aircraft Controls.
Investing activities
Net cash used by investing activities in the first half of 2016 included $28 million for capital expenditures and $11 million as partial payment for the Linear acquisition. Net cash used by investing activities in the first half of 2015 included $38 million for capital expenditures.
We expect our 2016 capital expenditures to be approximately $80 million, as we support major program-related tooling and test equipment expenditures, primarily in commercial aircraft.
Financing activities
In the six months ending April 2, 2016, we repurchased 0.5 million shares through our stock repurchase program for $22 million, which was funded by our credit facility.
In the first six months ending April 4, 2015, we repurchased 2.6 million shares through our stock repurchase program for $186 million, which was funded by our credit facility as well as cash from operations.
Off Balance Sheet Arrangements
We do not have any material off balance sheet arrangements that have or are reasonably likely to have a material future effect on our results of operations or financial condition.
Contractual Obligations and Commercial Commitments
Our contractual obligations and commercial commitments have not changed materially from the disclosures in our 2015 Annual Report on Form 10-K.
CAPITAL STRUCTURE AND RESOURCES
We maintain bank credit facilities to fund our short and long-term capital requirements, including for acquisitions. From time to time, we also sell debt and equity securities to fund acquisitions or take advantage of favorable market conditions.
On
November 21, 2014
, we completed the sale of
$300 million
aggregate principal amount of
5.25%
senior notes due
December 1, 2022
at par with interest paid semiannually on
June 1
and
December 1
of each year. The senior notes are unsecured obligations, guaranteed on a senior unsecured basis by certain subsidiaries and contain normal incurrence-based covenants and limitations such as the ability to incur additional indebtedness, pay dividends, make other restricted payments and investments, create liens and certain corporate acts such as mergers and consolidations. The aggregate net proceeds of
$294 million
were used to repay indebtedness under our U.S. bank credit facility, thereby increasing the unused portion of our U.S. revolving credit facility.
Our U.S. revolving credit facility has a capacity of
$1,100 million
and matures on
May 22, 2019
. It also provides an expansion option, which permits us to request an increase of up to
$200 million
to the credit facility upon satisfaction of certain conditions. The U.S. revolving credit facility had an outstanding balance of
$703 million
at
April 2, 2016
. Interest on the outstanding credit facility borrowings is principally based on LIBOR plus the applicable margin, which was
1.88%
at
April 2, 2016
and will decrease to 1.63% during the third quarter of 2016. The credit facility is secured by substantially all of our U.S. assets.
The U.S. revolving credit facility contains various covenants. The covenant for minimum interest coverage ratio, defined as the ratio of EBITDA to interest expense for the most recent four quarters, is 3.0. The covenant for the maximum leverage ratio, defined as the ratio of net debt, including letters of credit, to EBITDA for the most recent four quarters, is 3.5. The covenant for maximum capital expenditures is $185 million for
2016
and increases by $10 million each year thereafter. We are in compliance with all covenants. EBITDA is defined in the loan agreement as (i) the sum of net income, interest expense, income taxes, depreciation expense, amortization expense, other non-cash items reducing consolidated net income and non-cash equity-based compensation expenses minus (ii) other non-cash items increasing consolidated net income.
We are generally not required to obtain the consent of lenders of the U.S. revolving credit facility before raising significant additional debt financing; however, certain limitations and conditions may apply that would require consent to be obtained. In recent years, we have demonstrated our ability to secure consents to access debt markets. We have also been successful in accessing equity markets from time to time. We believe that we will be able to obtain additional debt or equity financing as needed.
At
April 2, 2016
, we had
$391 million
of unused capacity, including
$379 million
from the U.S. revolving credit facility after considering standby letters of credit. However, our leverage ratio covenant limits our borrowing capacity to
$324 million
as of
April 2, 2016
.
We have a trade receivables securitization facility (the "Securitization Program"), which terminates on
April 13, 2018
. Under the Securitization Program, we sell certain trade receivables and related rights to an affiliate, which in turn sells an undivided variable percentage ownership interest in the trade receivables to a financial institution, while maintaining a subordinated interest in a portion of the pool of trade receivables. The Securitization Program effectively increases our borrowing capacity by up to $120 million and lowers our cost to borrow funds as compared to the U.S. revolving credit facility. We had an outstanding balance of
$100 million
at
April 2, 2016
. The Securitization Program has a minimum borrowing requirement, which was $80 million at
April 2, 2016
. Interest on the secured borrowings under the Securitization Program was
1.19%
at
April 2, 2016
and is based on 30-day LIBOR plus an applicable margin.
Net debt to capitalization was
42%
at
April 2, 2016
and 44% at
October 3, 2015
. The decrease in net debt to capitalization is primarily due to our net earnings and positive cash flow.
We believe that our cash on hand, cash flows from operations and available borrowings under short and long-term arrangements will continue to be sufficient to meet our operating needs.
The Board of Directors authorized a share repurchase program beginning in January 2014 that includes both Class A and Class B common shares, and allows us to buy up to an aggregate 13.0 million common shares. Under this program, we have purchased approximately 9.3 million shares for $633 million as of
April 2, 2016
.
ECONOMIC CONDITIONS AND MARKET TRENDS
We operate within the aerospace and defense and industrial markets. Our aerospace and defense markets are affected by market conditions and program funding levels, while our industrial markets are influenced by general capital investment trends and economic conditions. A common factor throughout our markets is the continuing demand for technologically advanced products.
Aerospace and Defense
Approximately 64% of our 2015 sales were generated in aerospace and defense markets. Within aerospace and defense, we serve three end markets: defense, commercial aircraft and space.
The defense market is dependent on military spending for development and production programs. Aircraft production programs are typically long-term in nature, offering predictability as to capacity needs and future revenues. We maintain positions on numerous high priority programs, including the Lockheed Martin F-35 Joint Strike Fighter, FA-18E/F Super Hornet and V-22 Osprey. The large installed base of our products leads to attractive aftermarket sales and service opportunities. The tactical and strategic missile, missile defense and defense controls markets are dependent on many of the same market conditions as military aircraft, including overall military spending and program funding levels. Our security and surveillance product line is dependent on government funding at federal and local levels, as well as private sector demand.
Reductions in the U.S. Department of Defense's mandatory and discretionary budgeted spending, which became effective on March 1, 2013, resulting from the Budget Control Act of 2011, will have ongoing ramifications for the domestic aerospace and defense market for the near future. The automatic spending limitations (which is generally referred to as sequestration) of approximately $500 billion through the Federal Government's 2021 fiscal year will present challenges over the next decade, as uncertainty remains with respect to the levels of defense spending. We believe that lower U.S. defense spending is affecting our military sales. Currently, we expect approximately $670 million of U.S. defense sales in 2016.
The commercial aircraft market is dependent on a number of factors, including global demand for air travel, which generally follows underlying economic growth. As such, the commercial aircraft market has historically exhibited cyclical swings which tend to track the overall economy. In recent years, the development of new, more fuel-efficient commercial air transports has helped drive increased demand in the commercial aircraft market, as airlines replace older, less fuel-efficient aircraft with newer models in an effort to reduce operating costs. The aftermarket is driven by usage of the existing aircraft fleet and the age of the installed fleet, and is impacted by fleet re-sizing programs for passenger and cargo aircraft. Changes in aircraft utilization rates affect the need for maintenance and spare parts and impact aftermarket sales. Boeing and Airbus have historically adjusted production in line with air traffic volume. Demand for our commercial aircraft products is in large part dependent on new aircraft production, which is increasing as Boeing and Airbus work to fulfill large backlogs of unfilled orders.
The commercial space market is comprised of large satellite customers, traditionally communications companies. Trends for this market, as well as for commercial launch vehicles, follow demand for increased capacity. This in turn, tends to track with underlying demand for increased consumption of telecommunication services, satellite replacement and global navigation needs. The space market is also partially dependent on the governmental-authorized levels of funding for satellite communications, as well as investment for commercial and exploration activities.
Industrial
Approximately 36% of our 2015 sales were generated in industrial markets. Within industrial, we serve three end markets: industrial automation, energy and medical.
The industrial automation market we serve is influenced by several factors including capital investment, product innovation, economic growth, cost-reduction efforts and technology upgrades. We experience challenges from the need to react to the demands of our customers, who are in large part sensitive to international and domestic economic conditions.
The energy market we serve is affected by changing oil and natural gas prices, global urbanization, the resulting change in supply and demand for global energy and the political climate and corresponding public support for investments in renewable energy generation capacity. Historically, drivers for global growth include investments in power generation infrastructure, including renewable energy, and exploration in search of new oil and gas resources. However, the recent significant decline in the price of crude oil has reduced investment in exploration activities. This reduced investment has directly affected our energy business in Components and in Industrial Systems. Currently, we expect approximately $40 million of oil exploration-related sales in 2016, down from approximately $100 million in 2014.
The medical market we serve is influenced by economic conditions, regulatory environments, hospital and outpatient clinic spending on equipment, population demographics, medical advances, patient demands and the need for precision control components and systems. Advances in medical technology and medical treatments have had the effect of extending the average life spans, in turn resulting in greater need for medical services. These same technology and treatment advances also drive increased demand from the general population as a means to improve quality of life. Access to medical insurance, whether through government funded health care plans or private insurance, also affects the demand for medical services.
Foreign Currencies
We are affected by the movement of foreign currencies compared to the U.S. dollar, particularly in Industrial Systems. About one-quarter of our 2015 sales were denominated in foreign currencies. During the first six months of 2016, average foreign currency rates generally weakened against the U.S. dollar compared to 2015. The translation of the results of our foreign subsidiaries into U.S. dollars decreased sales by $24 million compared to the same period one year ago.
Cautionary Statement
Information included or incorporated by reference in this report that does not consist of historical facts, including statements accompanied by or containing words such as “may,” “will,” “should,” “believes,” “expects,” “expected,” “intends,” “plans,” “projects,” “approximate,” “estimates,” “predicts,” “potential,” “outlook,” “forecast,” “anticipates,” “presume” and “assume,” are forward-looking statements. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and are subject to several factors, risks and uncertainties, the impact or occurrence of which could cause actual results to differ materially from the expected results described in the forward-looking statements. These important factors, risks and uncertainties include:
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the markets we serve are cyclical and sensitive to domestic and foreign economic conditions and events, which may cause our operating results to fluctuate;
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we operate in highly competitive markets with competitors who may have greater resources than we possess;
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we depend heavily on government contracts that may not be fully funded or may be terminated, and the failure to receive funding or the termination of one or more of these contracts could reduce our sales and increase our costs;
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we make estimates in accounting for long-term contracts, and changes in these estimates may have significant impacts on our earnings;
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we enter into fixed-price contracts, which could subject us to losses if we have cost overruns;
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we may not realize the full amounts reflected in our backlog as revenue, which could adversely affect our future revenue and growth prospects;
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if our subcontractors or suppliers fail to perform their contractual obligations, our prime contract performance and our ability to obtain future business could be materially and adversely impacted;
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contracting on government programs is subject to significant regulation, including rules related to bidding, billing and accounting kickbacks and false claims, and any non-compliance could subject us to fines and penalties or possible debarment;
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the loss of The Boeing Company as a customer or a significant reduction in sales to The Boeing Company could adversely impact our operating results;
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our new product research and development efforts may not be successful which could reduce our sales and earnings;
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our inability to adequately enforce and protect our intellectual property or defend against assertions of infringement could prevent or restrict our ability to compete;
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our business operations may be adversely affected by information systems interruptions, intrusions or new software implementations;
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our indebtedness and restrictive covenants under our credit facilities could limit our operational and financial flexibility;
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significant changes in discount rates, rates of return on pension assets, mortality tables and other factors could adversely affect our earnings and equity and increase our pension funding requirements;
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a write-off of all or part of our goodwill or other intangible assets could adversely affect our operating results and net worth;
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our sales and earnings may be affected if we cannot identify, acquire or integrate strategic acquisitions, or if we engage in divesting activities;
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our operations in foreign countries expose us to political and currency risks and adverse changes in local legal and regulatory environments;
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unforeseen exposure to additional income tax liabilities may affect our operating results;
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government regulations could limit our ability to sell our products outside the United States and otherwise adversely affect our business;
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governmental regulations and customer demands related to conflict minerals may adversely impact our operating results;
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the failure or misuse of our products may damage our reputation, necessitate a product recall or result in claims against us that exceed our insurance coverage, thereby requiring us to pay significant damages;
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future terror attacks, war, natural disasters or other catastrophic events beyond our control could negatively impact our business;
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our operations are subject to environmental laws, and complying with those laws may cause us to incur significant costs; and
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we are involved in various legal proceedings, the outcome of which may be unfavorable to us.
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These factors are not exhaustive. New factors, risks and uncertainties may emerge from time to time that may affect the forward-looking statements made herein. Given these factors, risks and uncertainties, investors should not place undue reliance on forward-looking statements as predictive of future results. We disclaim any obligation to update the forward-looking statements made in this report.
Item 3.
Quantitative and Qualitative Disclosures about Market Risk.
Refer to the Company’s Annual Report on Form 10-K for the year ended
October 3, 2015
for a complete discussion of our market risk. There have been no material changes in the current year regarding this market risk information.
Item 4.
Controls and Procedures.
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(a)
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Disclosure Controls and Procedures. We carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures are effective as of the end of the period covered by this report, to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
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(b)
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Changes in Internal Control over Financial Reporting. There have been no changes in our internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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