Document


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 FORM 10-K
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended: December 31, 2018
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                      to                      
Commission File Number 1-01520
  Aerojet Rocketdyne Holdings, Inc.
(Exact name of registrant as specified in its charter)
Delaware
 
34-0244000
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
222 N. Pacific Coast Highway, Suite 500
El Segundo, California
 
90245
(Address of Principal Executive Offices)
 
(Zip Code)
Registrant’s telephone number, including area code
(310) 252-8100
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
 
Name of each exchange on which registered
 
Common Stock, $0.10 par value 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 ý   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  ý
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  ý      No  ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes  ý      No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) 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.    ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth 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.
Large accelerated filer ý Accelerated filer ¨ Non-accelerated filer ¨ 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. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)    Yes  ¨      No ý
The aggregate market value of the voting common equity held by nonaffiliates of the registrant as of June 30, 2018, was approximately $2.2 billion.
As of February 12, 2019, there were 78,391,006 outstanding shares of the Company’s common stock, including unvested common shares, $0.10 par value.
Portions of the 2019 Proxy Statement of Aerojet Rocketdyne Holdings, Inc. relating to its annual meeting of stockholders scheduled to be held on May 9, 2019, are incorporated by reference into Part III of this Report.




Aerojet Rocketdyne Holdings, Inc.
Annual Report on Form 10-K
For the Year Ended December 31, 2018
Table of Contents 
Item
Number
 
 
PART I
 
1.
Business
1A.
Risk Factors
1B.
Unresolved Staff Comments
2.
Properties
3.
Legal Proceedings
4.
Mine Safety Disclosures
 
 
 
PART  II
 
5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
6.
Selected Financial Data
7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
7A.
Quantitative and Qualitative Disclosures About Market Risk
8.
Consolidated Financial Statements and Supplementary Data
9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
9A.
Controls and Procedures
9B.
Other Information
 
 
PART  III
 
10.
Directors, Executive Officers and Corporate Governance
11.
Executive Compensation
12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
13.
Certain Relationships and Related Transactions, and Director Independence
14.
Principal Accountant Fees and Services
 
 
PART  IV
 
15.
Exhibits and Financial Statement Schedules
16.
Form 10-K Summary
 
 
 
 
Signatures
 






Part I
Item 1. Business
Unless otherwise indicated or required by the context, as used in this Annual Report on Form 10-K ("Report"), the terms "we," "our," "us," and the "Company" refer to Aerojet Rocketdyne Holdings, Inc. and all of its subsidiaries that are consolidated in conformity with accounting principles generally accepted in the United States of America ("GAAP").
All statements in this Report other than historical information should be considered "forward-looking statements" as defined by Section 21E of the Private Securities Litigation Reform Act of 1995. These statements present (without limitation) the expectations, beliefs, plans, and objectives of management and future financial performance and assumptions underlying, or judgments concerning, the matters discussed in the statements. The words "believe," "estimate," "anticipate," "project," "expect," and "reliable" and similar expressions, are intended to identify forward-looking statements. Forward-looking statements involve certain risks, estimates, assumptions, and uncertainties, including with respect to future sales and activity levels, cash flows, contract performance, the outcome of litigation and contingencies, environmental remediation, availability of capital, and anticipated costs of capital. Important risk factors that could cause actual results or outcomes to differ from those expressed in the forward-looking statements are described in the section "Risk Factors" in Item 1A of this Report. Additional risk factors may be described from time to time in our future filings with the Securities and Exchange Commission ("SEC").
Overview
Our operations are organized into two segments:
Aerospace and Defense — includes the operations of our wholly-owned subsidiary Aerojet Rocketdyne, Inc. ("Aerojet Rocketdyne"), a leading technology-based designer, developer and manufacturer of aerospace and defense products and systems for the United States ("U.S.") government, including the Department of Defense ("DoD"), the National Aeronautics and Space Administration ("NASA"), and major aerospace and defense prime contractors.
Real Estate — includes the activities of our wholly-owned subsidiary Easton Development Company, LLC ("Easton") related to the re-zoning, entitlement, sale, and leasing of our excess real estate assets. We currently are in the process of seeking zoning changes and other governmental approvals on our excess real estate assets to optimize their value.
The year of our subsidiary, Aerojet Rocketdyne, ends on the last Saturday in December. As a result of the 2016 calendar, Aerojet Rocketdyne had 53 weeks of operations in 2016 compared with 52 weeks of operations in 2018 and 2017. The additional week of operations, which occurred in the fourth quarter of 2016, accounted for $32.2 million in additional net sales.
We were incorporated in Ohio in 1915 and reincorporated in the State of Delaware on April 11, 2014. Our principal executive offices are located at 222 N. Pacific Coast Highway, Suite 500, El Segundo, California 90245.
Our Internet website address is www.AerojetRocketdyne.com. We have made available through our Internet website, free of charge, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after such materials were electronically filed with, or furnished to, the SEC. We also make available on our Internet website our corporate governance guidelines and the charters for each of the following committees of our Board of Directors: Audit; Corporate Governance & Nominating; and Organization & Compensation. Copies of the Code of Conduct and the Company’s Corporate Governance Guidelines are available on the Company’s web site at www.AerojetRocketdyne.com (copies are available in print to any stockholder or other interested person who requests them by writing to Secretary, Aerojet Rocketdyne Holdings, Inc., 222 N. Pacific Coast Highway, Suite 500, El Segundo, California 90245).
Aerospace and Defense
Aerojet Rocketdyne is a world-recognized technology-based engineering and manufacturing company that develops and produces specialized propulsion systems, as well as armament systems. We develop and manufacture all four propulsion types (liquid, solid, air-breathing, and electric) for space, defense, civil and commercial applications. Principal customers and end users include the DoD (including the U.S. Air Force, U.S. Army, Missile Defense Agency, and U.S. Navy), NASA, The Boeing Company ("Boeing"), Lockheed Martin Corporation ("Lockheed Martin"), Raytheon Company ("Raytheon"), and United Launch Alliance ("ULA").
For over 70 years, we have demonstrated a legacy of successfully meeting the most challenging missions by producing some of the world’s most technologically advanced propulsion systems that are aligned with our nation's critical needs. We believe Aerojet Rocketdyne maintains a unique competitive position due to a strategic focus on creating and maintaining a broad spectrum of propulsion and energetic products assisted by the growing market demand for its innovative energy management technologies. The highly reliable nature of our revenue comes from the long-term nature of the programs with which we are involved, our attractive contract base and our deep customer relationships. High renewal rates, supported by our market leading technology provide us with a highly stable business base from which to grow. As of December 31, 2018, our remaining performance obligations, also referred to as backlog, totaled $4.1 billion and our funded backlog, which includes only amounts for which funding has been authorized by a customer and a purchase order has been received, totaled $1.9 billion.



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Primary Markets and Programs
The markets and key programs we serve are:
Aerospace. We specialize in the development and production of propulsion and power systems for space applications. Our products include a broad market offering of both electric and chemical propulsion (liquid propellant engines and solid rocket motors) required for launch vehicle and in-space applications supporting defense, civil and commercially based missions.
Our space launch products have a long, successful flight heritage with the DoD and NASA where we continue to project strong support related to National Security Space requirements enabling communications, navigation, intelligence, surveillance, and reconnaissance missions. We provide booster and upper stage propulsion for ULA’s Delta IV launch vehicle and upper stage propulsion for the Atlas V ("Atlas") launch vehicle in support of the Evolved Expendable Launch Vehicle ("EELV") program, as well as a limited number of Delta II vehicles which are supporting commercial customers launching Earth Observation spacecraft. In 2018, we announced contract awards associated with two new rocket development efforts for the U.S. government and commercial customers that assure the continued flight of our RL-10 cryogenic upper stage engine, providing more than 50 years of flight heritage.
During 2018, we continued to make progress in moving toward first launch of NASA’s Space Launch System ("SLS"). An inventory of 16 flight-ready RS-25 main engines are nearly complete and include newly upgraded flight controller to support the first four flights of the heavy-lift rocket. In parallel, we are modernizing our RS-25 components and preparing for production of the next generation of RS-25 engines.
We achieved several successful milestones in 2018 supporting NASA’s scientific programs. Every phase of NASA’s Mars InSight lander’s journey to the red planet was supported by our products. All eight successful landings on Mars have relied on our propulsion. We also provided all 28 rocket engines on OSIRIS-REx, the asteroid sample-return probe that recently arrived at Asteroid Bennu. In addition to powering the launch vehicle’s main and second stages, we are providing critical in-space propulsion. Our thrusters enabled braking maneuvers to support the arrival, and will maneuver the spacecraft during its year of close-proximity science operations, and enable its journey back to Earth’s orbit. Also, NASA’s Parker Solar Probe, launched with our RS-68A and RL-10 engines, is using our propulsion system to enable the probe’s 7-year journey to within 6.2 million kilometers of the Sun’s surface - eight times closer than the previous record.
We continued to mature critical technologies for our nation’s next generation of advanced hydrocarbon engines for future high-performance booster systems with the ability to eliminate the U.S. dependence on Russian-provided booster systems for National Security Space Launches. In February 2016, pursuant to an Other Transaction Agreement ("OTA"), the U.S. Air Force selected Aerojet Rocketdyne and ULA to share in a public-private partnership to develop jointly the AR1 engine under an agreement valued at $804.0 million with the U.S. Air Force investing two-thirds of the funding required to complete development of the AR1 engine by December 2019. In June 2018, the Company and the U.S. Air Force signed a modification to the existing OTA to modify the scope, funding, cost share, and period of performance of the AR1 engine. The modified OTA is valued at $353.8 million with the U.S. Air Force investing five-sixths of the funding required to design, build, and assemble a single AR1 engine prototype by December 2019.
A subset of our key space programs include: RL-10, RS-68, and RS-25 engines/boosters that power EELV launch vehicles, propulsion for the Orion human space capsule and the Starliner Commercial Crew Transportation Capability capsule, AR1, and multiple in-space electric and chemical propulsion systems to provide orbit raising and satellite station positioning.
Defense. We specialize in the development and production of propulsion systems for defense applications including both solid and liquid propellant based systems, along with air-breathing (ramjet) systems for missile applications. The majority of these systems are the primary axial propulsion for missile systems. The breadth of our products includes tactical missiles, missile defense boosters and large solid-propellant boosters for a variety of applications.
We also develop and manufacture liquid and solid divert and attitude control ("DACs") propulsion systems for missile defense applications. These are complex systems that provide multi-directional thrust and variable thrust levels to steer or control an intercept missile. Additionally, we develop and manufacture post-boost propulsion systems for strategic missiles. These systems provide directional control for critical missile defense interceptors and for ground and sea-based strategic missiles.
We also design, develop, and produce warhead/lethality systems for tactical missiles. Our tactical armament products have been successfully fielded on multiple active U.S. and international weapon system platforms.
During 2018, we continued to expand our strong legacy propulsion franchises on the Standard Missile, Patriot Advanced Capability-3 ("PAC-3"), Terminal High Altitude Area Defense ("THAAD") and Guided Multiple Launch Rocket System ("GMLRS") missile propulsion systems. These franchise programs all experienced backlog growth during 2018, and continue to be globally deployed in support of U.S. and allied armed forces.
As part of our continuing Competitive Improvement Program, we built on the 2017 validation of activity to move energetic production of the Standard Missile-3 DACs and THAAD Boost Motor from our Sacramento, California facility to our Orange County, Virginia, and Camden, Arkansas, facilities. In 2018, we completed facility construction of a new Advanced Manufacturing Facility in Huntsville, Alabama, that will produce high-value non-energetic sub-assemblies for Standard Missile and THAAD; completing the transition of defense manufacturing out of the Sacramento facility. These production consolidation activities help to reduce costs and strengthen competitiveness.
In the advanced programs business arena, we initiated a full-scale engineering development of the advanced air-launched ("AAL") propulsion system that will transition to production. In the hypersonic propulsion technology area, we were competitively

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selected for multiple key missile propulsion development programs including: Hypersonic Conventional Strike Weapon ("HCSW") with Lockheed Martin and Operational Fires ("OpFires") with the U.S. Defense Advanced Research Projects Agency ("DARPA"). Both of these systems use conventional solid rocket motors to achieve hypersonic missile velocities. Our work on complementary air-breathing propulsion (ramjet / scramjet) for hypersonic missile continued in 2018 with significant hardware testing and maturation.
Finally, our Aerojet Rocketdyne Coleman Aerospace ("Coleman") business successfully completed development of the medium-range ballistic missile ("MRBM") target that is C-17 aircraft deployed. The initial deployment of an inert MRBM system from a C-17 occurred in early 2019. Coleman also continued to expand its scope on the Missile Defense MRBM missile target program.
A subset of our key defense programs include: Boosters and Solid DACs for the Navy’s Standard Missile family, Booster and Liquid DACs for THAAD, PAC-3, GMLRS, Redesigned Exoatmospheric Kill Vehicle ("RKV") Liquid DACs, Stinger, Javelin, Tactical Tomahawk, Army TACMs, Tube-launched Optically-tracked Wire-guided warhead, and HAWK.
Information concerning the percentage of net sales attributable to our significant programs appears in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations under the caption "Major Customers."
Competition
The competitive dynamics of our multi-faceted marketplace vary by product line and customer, but we experience many of the same influences felt by the broader aerospace and defense industry. The large majority of products we manufacture are highly complex, technically sophisticated and extremely hazardous to build, demanding rigorous manufacturing procedures and highly specialized manufacturing equipment. While historically these factors, posed substantial barriers to entry, modern design tools and manufacturing techniques (such as additive manufacturing) available to new entrants with the ability to self-fund start-up as well as development costs has led to increased competition in aerospace markets. To date, competition from new entrants has been limited to a few participants who tend to be narrowly focused on products that are sub-elements of our overall product portfolio. For example, entrepreneurs such as SpaceX and Blue Origin, who have been or are in the process of developing liquid fuel propulsion capabilities are primarily focused on the development of space propulsion systems for heavy lift launch vehicles and are not pursuing or participating in the missile defense or tactical propulsion products that make up a substantial portion of our overall business. These new entrepreneurs have signaled their intent to compete primarily on price and are therefore bringing pressure to bear on existing cost paradigms and manufacturing methodologies.
The following table lists the primary participants in the propulsion market (in alphabetical order):
Company
Parent
Propulsion Type
Aerojet Rocketdyne
Aerojet Rocketdyne Holdings, Inc.
Solid, liquid, air-breathing, electric
Airbus Defence and Space (formerly Astrium)
Airbus Group
Solid, liquid
Avio
Avio S.p.A
Solid, liquid
Blue Origin LLC
Blue Origin
Liquid
Electron Technologies, Inc.
L-3 Communications Corporation
Electric
General Dynamics OTS
General Dynamics
Solid
Moog Inc.
Moog Inc.
Liquid, electric
Nammo Talley
Nammo Talley
Solid
Northrop Grumman Innovation Systems
Northrop Grumman Corporation ("Northrop")
Solid, liquid, air-breathing
Safran
Safran
Solid, liquid
SpaceX
SpaceX
Liquid
Industry Overview
Our primary aerospace and defense customers include the DoD and its agencies, NASA, and the prime contractors that supply products to these customers. Our backlog depends, in large part, on continued funding by the U.S. government for the programs in which we are involved. These funding levels are not generally correlated with any specific economic cycle, but rather follow the cycle of general public policy and political support for this type of funding. Moreover, although our contracts will be performed over a period of several years, the U.S. Congress must appropriate funds for a given program and the U.S. President must sign into law such appropriations legislation each government fiscal year ("GFY") that may significantly increase, decrease or eliminate, funding for a program. A decrease in DoD and/or NASA expenditures, the elimination or curtailment of a material program in which we are or hope to be involved, or changes in payment patterns of our customers as a result of changes in U.S. government outlays, could have a material adverse effect on our operating results, financial condition, and/or cash flows.
In September 2018, the U.S. President signed into law H.R. 6157, which included two full-year appropriations bills for GFY 2019: (i) the DoD Appropriations Act and (ii) the Labor, Health and Human Services, Education and Related Agencies Appropriations Act. For Defense, the bill, now Public Law 115-245, includes $606.5 billion in base budget funding and $67.9 billion for Overseas Contingency Operations. On February 15, 2019, the U.S. President signed legislation to fund several U.S. government agencies, including NASA. 

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The SLS appears to remain a top Congressional priority as the CR included a provision to allow NASA the funding flexibility for SLS and deep exploration to remain on track. The SLS program also has enjoyed wide, bipartisan support in both chambers of Congress. We maintain a strong relationship with NASA and our propulsion systems have been powering NASA launch vehicles and spacecraft since the inception of the U.S. space program. Our booster, upper stage and Orion vehicle propulsion systems are currently baselined on the new SLS vehicle and both upper stage and booster engines are in development for future SLS variants. Due to the retirement of the space shuttle fleet, U.S. astronauts have been dependent on Russian Soyuz flights for access to and from the International Space Station ("ISS") for the better part of this decade. NASA has been working to re-establish U.S. manned space capability as soon as possible through development of a new "space taxi" to ferry astronauts and cargo to the ISS. In 2014, Boeing’s CST-100 Starliner capsule, powered by Aerojet Rocketdyne propulsion, was selected by NASA to transport astronauts to and from the ISS. As Boeing’s business partner, Aerojet Rocketdyne will be providing the propulsion system for this new capsule, thereby supplementing its work for NASA on the SLS designed for manned deep space exploration. In both instances, we have significant propulsion content and we look forward to supporting these programs for NASA.
Major Customers
Information concerning major customers appears in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations under the caption "Major Customers."
Contract Types
Research and development contracts are awarded during the early stages of a program’s development. Production contracts provide for the production and delivery of mature products for operational use. Aerojet Rocketdyne’s contracts are largely categorized as either "fixed-price" (largely used by the U.S. government for production-type contracts) or "cost-reimbursable" (largely used by the U.S. government for development-type contracts). During 2018, approximately 63% of our net sales were from fixed-price contracts and 37% from cost-reimbursable contracts.  
Fixed-price contracts are typically (i) firm fixed-price, (ii) fixed-price-incentive fee, or (iii) fixed-price level of effort contracts. For firm fixed-price contracts, Aerojet Rocketdyne performs work for a fixed price and realizes all of the profit or loss resulting from variations in costs during contract performance. For fixed-price-incentive fee contracts, Aerojet Rocketdyne receives increased or decreased fees (or profits) based upon actual performance against established targets or other criteria. For fixed-price level of effort contracts, Aerojet Rocketdyne generally receives a structured fixed price per labor hour, dependent upon the customer’s labor hour needs. All fixed-price contracts present the risk of unreimbursed cost overruns potentially resulting in lower than expected contract profit margin and losses.
Cost-reimbursable contracts are typically (i) cost plus fixed fee, (ii) cost plus incentive fee, or (iii) cost plus award fee contracts. For cost plus fixed fee contracts, Aerojet Rocketdyne typically receives reimbursement of its costs, to the extent the costs are allowable under contractual and regulatory provisions, in addition to receiving a fixed fee. For cost plus incentive fee contracts and cost plus award fee contracts, Aerojet Rocketdyne receives adjustments to the contract fee, within designated limits, based on actual results as compared with contractual targets for factors such as cost, performance, quality, and schedule.
In addition, OTA contracts are becoming more prevalent in the developmental stages of U.S. government procurements. An OTA is a special vehicle used by federal agencies for obtaining or advancing research and development or prototypes. The U.S. government's procurement regulations and certain procurement statutes do not apply to OTAs, and accordingly, other transaction authority gives agencies the flexibility necessary to develop agreements tailored to a particular transaction. Our sales and backlog figures do not include work we have under contracts obligated by the customer under an OTA as our share of the contract costs are recognized as company-funded research and development.
Government Contracts and Regulations
U.S. government contracts generally are subject to Federal Acquisition Regulations ("FAR"), agency-specific regulations that supplement FAR, such as the DoD’s Defense Federal Acquisition Regulations, and other applicable laws and regulations. These regulations impose a broad range of requirements, many of which are unique to U.S. government contracting, including various procurement, import and export, security, contract pricing and cost, contract termination and adjustments, mandatory disclosure, and audit requirements. Our failure to comply with these regulations and requirements could result in reductions of the value of contracts, contract modifications or termination, inability to bill and collect receivables from customers, and the assessment of penalties and fines that could lead to suspension or debarment from U.S. government contracting or subcontracting. In addition, as a U.S. government contractor, we are subject to routine audits, reviews, and investigations by the Defense Contract Audit Agency ("DCAA"), the Defense Contract Management Agency, and other similar U.S. government agencies. Such reviews include but are not limited to our contract performance, compliance with applicable laws, regulations, and standards as well as the review of the adequacy of our accounting systems, purchasing systems, property management systems, estimating systems, earned value management systems, and material management and accounting systems.
The U.S. government’s ability to unilaterally modify or terminate a contract or to discontinue funding for a particular program at any time could have a material adverse effect on our operating results, financial condition, and/or cash flows. The cancellation of a contract, if terminated for cause, could also subject us to liability for the excess costs incurred by the U.S. government in procuring undelivered items from another source. If terminated for convenience, our recovery of costs would be limited to amounts already incurred or committed (including severance costs for terminated employees), and our profit would be limited based on the work completed prior to termination.
Additional information about the risks relating to government contracts and regulations appears in "Risk Factors" in Item 1A of this Report.

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Backlog
Information concerning backlog appears in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations under the caption "Backlog."
Seasonality
Aerojet Rocketdyne’s business is not subject to predictable seasonality. Primary factors affecting the timing of our sales include the timing of U.S. government awards, the availability of U.S. government funding, contractual product delivery requirements, and customer acceptances.
Research and Development ("R&D")
We view R&D efforts as critical to maintaining our leadership position in markets in which we compete. Our R&D is primarily supported by customer funding.
Our company-funded R&D efforts include expenditures for technical activities that are vital to the development of new products, services, processes or techniques, as well as those expenses for significant improvements to existing products or processes.
The following table summarizes our R&D expenditures:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(In millions)
Customer-funded
$
591.6

 
$
561.1

 
$
513.0

Company-funded
46.7

 
44.6

 
43.0

  Total R&D expenditures
$
638.3

 
$
605.7

 
$
556.0

Suppliers and Raw Materials
The national aerospace supply base continues to consolidate due to economic, environmental, and marketplace circumstances beyond our control. The loss of key qualified suppliers of technologies, components, and materials can cause significant disruption to our program performance and cost.
 Availability of raw materials and supplies has been generally sufficient. We sometimes are dependent, for a variety of reasons, upon sole-source or qualified suppliers and have, in some instances in the past, experienced difficulties meeting production and delivery obligations because of delays in delivery or reliance on such suppliers. Further, as a U.S. government contractor, we are often limited to procuring materials from certain suppliers capable of meeting rigorous customer and government specifications.
Additional information about the risks relating to suppliers and raw materials appears in "Risk Factors" in Item 1A of this Report.
Intellectual Property
Where appropriate, Aerojet Rocketdyne obtains patents in the U.S. and other countries for new and useful processes, machines, manufactures or compositions of matter, or any new and useful improvements thereof relating to its products and services. Our patents are maintained through the statutory limit of time, which is typically 20 years from the date of filing of the patent application, where the claimed invention has value in the markets in which we compete. We rely on trade secret protection for financial, technical and personnel information that provides an economic competitive advantage by virtue of not being known by the relevant public and ordinarily require employees to sign confidentiality agreements as a condition to employment. If properly protected, trade secrets can be maintained in perpetuity. Aerojet Rocketdyne takes reasonable steps to prevent disclosure of its trade secrets in order to maintain protection under applicable state and federal laws. As our products and services typically embody complex systems that include many technologies, we do not believe any single existing patent, license, or trade secret is material to our success.
Real Estate
We own 11,394 acres of land adjacent to U.S. Highway 50 between Rancho Cordova and Folsom, California east of Sacramento ("Sacramento Land"). Acquired in the early 1950s and historically used for our aerospace and defense operations, large portions were used solely to provide safe buffer zones around hazardous operations. Modern changes in propulsion technology coupled with the relocation of our propulsion operations led us to determine large portions of the Sacramento Land were no longer needed for operations. Consequently, our plan has been to re-entitle the Sacramento Land for new uses and explore various opportunities to optimize its value.
The Sacramento Land is made up of 5,203 acres used for our aerospace and defense operations, 628 acres available for future entitlement, and 5,563 acres for future development under the brand name "Easton". Easton has 3,904 acres that are fully entitled. The term "entitlement" is generally used to denote the required set of regulatory approvals required to allow land to be zoned for new requested uses. Required regulatory approvals vary with each jurisdiction and each zoning proposal and may include permits, land use master plans, zoning designations, state and federal environmental documentation, and other regulatory approvals unique to the land. The entitlement and development process in California is long and uncertain with

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approvals required from various authorities, including local jurisdictions, and in select projects, permits required by federal agencies such as the U.S. Army Corps of Engineers and the U.S. Department of Interior, Fish and Wildlife Service, and others prior to construction.
As Easton continues to execute re-entitlement and pre-development activities, we are pursuing all monetization options and are exploring how to maximize value from Easton. Value creation and monetization may include outright land sales and/or joint ventures with real estate developers, residential builders, and/or other third parties. We believe the long-term prospect for the Sacramento region represents an attractive and affordable alternative to the San Francisco Bay Area and other large metropolitan areas of California.
The following table summarizes the Sacramento Land (in acres):  
 
 
Environmentally
Unrestricted 
 
Environmentally
Restricted (1)
 
Total
 
Entitled
Glenborough and Easton Place
 
1,043

 
349

 
1,392

 
1,392

Rio del Oro
 
1,818

 
491

 
2,309

 
2,309

Westborough
 
1,387

 
272

 
1,659

 

Hillsborough (2)
 
51

 
97

 
148

 
148

Office Park and Auto Mall
 
47

 
8

 
55

 
55

     Total Easton acreage
 
4,346

 
1,217

 
5,563

 
3,904

Operations land
 
24

 
5,179

 
5,203

 
 

Land available for future entitlement (3)
 
386

 
242

 
628

 
 

      Total Sacramento Land
 
4,756

 
6,638

 
11,394

 
 

_________
(1)
Indicates land subject to restrictions imposed by state and/or federal regulatory agencies because of our historical propulsion system testing and manufacturing activities. We are actively working with the various regulatory agencies to have the restrictions removed as early as practicable, and the solutions to use these lands within Easton have been accounted for in the various land use plans and granted entitlements. See Note 8(c) in the consolidated financial statements in Item 8 of this Report for a discussion of the federal and/or state environmental restrictions affecting portions of the Sacramento Land.
(2) The remaining 148 acres designated in Hillsborough will be transferred, per the completed purchase and sale contract from 2015, when the required environmental remediation work is completed.
(3)
We believe it will be several years before any of this excess Sacramento Land is available for future change in entitlement. Some of this excess land is outside the current Urban Services Boundary established by the County of Sacramento and all of it is far from existing infrastructure, making it uneconomical to pursue entitlement for this land at this time.
Leasing & Other Real Estate
We currently lease approximately 0.5 million square feet of office space in Sacramento to various third parties. These leasing activities generated $6.4 million in revenue in 2018.
We also own approximately 580 acres of land in Chino Hills, California. This property was used for the manufacture and testing of ordnance. With the sale of our ordnance business in the mid-1990s, we closed this facility and commenced clean-up of the site. We continue to work with state regulators and the City of Chino Hills to complete those efforts.
Environmental Matters
Our current and former business operations are subject to, and affected by, federal, state, local, and foreign environmental laws and regulations relating to the discharge, treatment, storage, disposal, investigation, and remediation of certain materials, substances, and wastes. Our policy is to conduct our business with due regard for the preservation and protection of the environment. We continually assess compliance with these regulations, and we believe our current operations are materially in compliance with all applicable environmental laws and regulations.
Under existing U.S. environmental laws, Potentially Responsible Parties ("PRPs"), are jointly and severally liable, and therefore we are potentially liable to the U.S. government or other third parties for the full cost of remediating the contamination at our facilities or former facilities or at third-party sites where we have been designated as a PRP by the Environmental Protection Agency or state environmental agencies. The nature of environmental investigation and cleanup activities requires significant management judgment to determine the timing and amount of any estimated future costs that may be required for remediation measures. Further, environmental standards change from time to time. However, we perform quarterly reviews of these matters and accrue for costs associated with environmental remediation when it becomes probable that a liability has been incurred and the amount of the liability, usually based on proportionate sharing, can be reasonably estimated. These liabilities have not been discounted to their present value as the amounts and timing of cash payments are not fixed or reliably determinable.
On January 12, 1999, we reached a settlement agreement ("Global Settlement") with the U.S. government covering environmental costs associated with our Sacramento site and our former Azusa site. Pursuant to the Global Settlement, we can

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recover up to 88% of our environmental remediation costs through the establishment of prices for Aerojet Rocketdyne's products and services sold to the U.S. government. Additionally, in conjunction with the sale of the Electronics and Information Systems business in 2001, Aerojet Rocketdyne entered into an agreement with Northrop (the "Northrop Agreement") whereby Aerojet Rocketdyne is reimbursed by Northrop for a portion of environmental expenditures eligible for recovery under the Global Settlement, subject to an annual billing limitation of $6.0 million and a cumulative limitation of $189.7 million.
Operation and maintenance costs associated with environmental compliance and management of contaminated sites are a normal, recurring part of operations. Most of our environmental costs are incurred by our Aerospace and Defense segment, and certain of these future costs are allowed to be included in our contracts with the U.S. government.
The inclusion of environmental costs in our contracts with the U.S. government impacts our competitive pricing; however, we believe that this impact is mitigated by driving improvements and efficiencies across our operations as well as our ability to deliver innovative and quality products to our customers.
We did not incur material capital expenditures for environmental control facilities in 2018 nor do we anticipate any material capital expenditures in 2019 and 2020. See Management’s Discussion and Analysis in Part II, Item 7 "Environmental Matters" of this Report for additional information.
Additional information on the risks related to environmental matters can be found under "Risk Factors" in Item 1A of this Report, including the material effects on compliance with environmental regulations that may impact our competitive position and operating results.
Employees
As of December 31, 2018, 12% of our 5,004 employees were covered by collective bargaining agreements. We believe that our relations with our employees and unions are good.
Item 1A. Risk Factors
Reductions, delays or changes in U.S. government spending, including failure to timely appropriate funding, may reduce, delay or cancel certain programs in which we participate and as a result adversely affect our financial results.
Our primary aerospace and defense customers include the DoD and its agencies, NASA, and the prime contractors that supply products to these customers. We rely on particular levels of U.S. government spending on propulsion systems for defense, space and armament systems for precision tactical weapon systems and munitions applications, and our backlog depends, in a large part, on continued funding by the U.S. government for the programs in which we are involved. These spending levels are not generally correlated with any specific economic cycle, but rather follow the cycle of general public policy and political support for this type of spending. Moreover, although our contracts often contemplate that our services will be performed over a period of several years, the U.S. President must propose and Congress must appropriate funds for a given program each GFY and may significantly change, increase, reduce or eliminate, funding for a program. The failure by Congress to approve future budgets on a timely basis could delay procurement of our products and services and cause us to lose future revenues. If a prolonged government shutdown were to occur, it could result in program cancellations, disruptions and/or stop work orders and could limit the U.S. government’s ability to make timely payments, and our ability to perform on our U.S. government contracts.
In addition, a decrease in DoD and/or NASA expenditures, the elimination or curtailment of a material program in which we are involved, or changes in payment patterns of our customers as a result of changes in U.S. government spending, could have a material adverse effect on our operating results, financial condition, and/or cash flows.
The cancellation or material modification of one or more significant contracts could adversely affect our financial results.
Sales, directly and indirectly, to the U.S. government and its agencies accounted for approximately 94% of our total net sales in 2018. Our contracts typically permit the U.S. government to unilaterally modify or terminate a contract or to discontinue funding for a particular program at any time. The cancellation of a contract, if terminated for cause, could also subject us to liability for the excess costs incurred by the U.S. government in procuring undelivered items from another source. If terminated for convenience, our recovery of costs would be limited to amounts already incurred or committed (including severance costs for terminated employees), and our profit would be limited based on the work completed prior to termination.
In addition, termination or suspension of any of our significant commercial contracts could result in the loss of future sales and unreimbursable expenses that could have a material adverse effect on our operating results, financial condition, and/or cash flows. Furthermore, the termination of any such contracts for default could also have a material adverse effect on our reputation and ability to obtain new business in the future.
If we experience cost overruns on our contracts, we would have to absorb the excess costs which could adversely affect our financial results and our ability to win new contracts.
In 2018, approximately 63% of our net sales were from fixed-price contracts, most of which are in mature production mode. Under fixed-price contracts, we agree to perform specified work for a fixed price and realize all of the profit or loss resulting from variations in the costs of performing the contract. As a result, all fixed-price contracts involve the inherent risk of unreimbursed cost overruns. To the extent we incur unanticipated cost overruns on a program or platform subject to a fixed-price contract, our profitability would be adversely affected. Future profitability is subject to risks including the ability of suppliers to

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deliver components of acceptable quality on schedule and the successful implementation of automated tooling in production processes.
In 2018, approximately 37% of our net sales were from cost reimbursable contracts. Under cost reimbursable contracts, we agree to be reimbursed for allowable costs and paid a fee. If our costs are in excess of the final target cost, fees and our margin may be adversely affected. If our costs exceed authorized contract funding or do not qualify as allowable costs under applicable regulations, those costs are expensed, and we will not be reimbursed for those costs. Cost overruns may adversely affect our financial performance and our ability to win new contracts.
Also, certain costs such as those related to charitable contributions, advertising, interest expense, and public relations are generally not allowable, and therefore not recoverable through U.S. government contracts. Unexpected variances in unallowable costs may adversely affect our financial performance.
If our subcontractors or suppliers fail to perform their contractual obligations, our contract performance and our ability to win new contracts may be adversely affected.
We rely on subcontractors to perform a portion of the services we agree to provide our customers, and on suppliers to provide raw materials and component parts for our contract performance. A failure by one or more of our subcontractors or suppliers to satisfactorily provide on a timely basis the agreed-upon services or supplies may affect our ability to perform our contractual obligations. Deficiencies in the performance of our subcontractors and/or suppliers could result in liquidated damages or our customer terminating our contract for default. A termination for default could expose us to liability and adversely affect our financial performance and our ability to win new contracts.
Our success and growth in our Aerospace and Defense segment depends on our ability to execute long-standing programs and periodically secure new contracts in a competitive environment.
Aerojet Rocketdyne’s revenue is primarily derived from long-standing contracts (often sole source) where Aerojet Rocketdyne is the long-term incumbent. The challenge for Aerojet Rocketdyne is to successfully utilize its technical, engineering, manufacturing, and management skills to execute these programs for the customer, to continue to innovate and refine its solutions, and to offer the customer increasing affordability in an era of fiscal restraint. If Aerojet Rocketdyne is unable to successfully execute these long-standing programs, our ability to retain existing customers and attract new customers may be impaired.
In addition, in sectors where there is competition, it can be intense. For example, we face increasing competition from entrepreneurs such as SpaceX and Blue Origin, who have been or are in the process of developing liquid fuel propulsion capabilities which are primarily focused on the development of space propulsion systems for heavy lift launch vehicles. These new entrepreneurs have signaled their intent to compete primarily on price and are therefore bringing pressure to bear on existing cost paradigms and our manufacturing methodologies. The U.S. government also has its own manufacturing capabilities in some areas. We may be unable to compete successfully with our competitors and our inability to do so could result in a decrease in sales, profits, and cash flows that we historically have generated from certain contracts. Further, the U.S. government may open to competition programs on which we are currently the sole supplier, which could have a material adverse effect on our operating results, financial condition, and/or cash flows.
Our Aerospace and Defense segment is subject to procurement and other related laws and regulations inherent in contracting with the U.S. government, and non-compliance could adversely affect our financial results.
In the performance of contracts with the U.S. government, we operate in a highly regulated environment and are routinely audited and reviewed by the U.S. government and its agencies, such as the DCAA. These agencies review performance under our contracts, our cost structure and our compliance with applicable laws, regulations and standards, as well as the adequacy of, and our compliance with, our internal control systems and policies. Systems that are subject to review include, but are not limited to, our accounting systems, purchasing systems, property management systems, estimating systems, earned value management systems, and material management and accounting system. Any costs ultimately found to be unallowable or improperly allocated to a specific contract will not be reimbursed or must be refunded if already reimbursed. If an audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties, sanctions or suspension or debarment from doing business with the U.S. government. Whether or not illegal activities are alleged, the U.S. government also has the ability to decrease or withhold certain payments when it deems systems subject to its review to be inadequate. In addition, we could suffer serious reputational harm if allegations of impropriety were made against us. If such actions were to result in suspension or debarment, this could have a material adverse effect on our business.
These laws and regulations provide for ongoing audits and reviews of incurred costs as well as contract procurement, performance and administration. The U.S. government may, if it deems appropriate, conduct an investigation into possible illegal or unethical activity in connection with these contracts. Investigations of this nature are common in the aerospace and defense industry, and lawsuits may result. In addition, the U.S. government and its principal prime contractors periodically investigate the financial viability of their contractors and subcontractors as part of its risk assessment process associated with the award of new contracts. If the U.S. government or one or more prime contractors were to determine that we were not financially viable, our ability to continue to act as a U.S. government contractor or subcontractor would be impaired.  
The release, unplanned ignition, explosion, or improper handling of dangerous materials used in our business could disrupt our operations and adversely affect our financial results.
Our business operations involve the handling, production, and disposition of potentially explosive and ignitable energetic materials and other dangerous chemicals, including motors and other materials used in rocket propulsion. The handling,

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production, transport, and disposition of hazardous materials could result in incidents that temporarily shut down or otherwise disrupt our manufacturing operations and could cause production delays. It is possible that a release of these chemicals or an unplanned ignition or explosion could result in death or significant injuries to employees and others. Material property damage to us and third parties could also occur. The use of these products in applications by our customers could also result in liability if an explosion, unplanned ignition or fire were to occur. Extensive regulations apply to the handling of explosive and energetic materials, including but not limited to, regulations governing hazardous substances and hazardous waste. The failure to properly store and ultimately dispose of such materials could create significant liability and/or result in regulatory sanctions. Any release, unplanned ignition or explosion could expose us to adverse publicity or liability for damages or cause production delays, any of which could have a material adverse effect on our operating results, financial condition, and/or cash flows.
Our Competitive Improvement Program ("CIP") may not be successful in aligning our operations to current market conditions.
During 2015, we initiated the first phase ("Phase I") of our CIP comprised of activities and initiatives aimed at reducing costs in order for us to continue to compete successfully. Phase I is comprised of three major components: (i) facilities optimization and footprint reduction; (ii) product affordability; and (iii) reduced administrative and overhead costs. On April 6, 2017, the Board of Directors approved the second phase ("Phase II") of our previously announced CIP. Pursuant to Phase II, we expanded CIP and further consolidated our Sacramento, California, and Gainesville, Virginia sites, while centralizing and expanding our existing presence in Huntsville, Alabama. We have incurred and will continue to incur significant expenditures to implement the CIP. The CIP may not be successful in achieving anticipated future cost savings and other benefits within the expected timeframes, may be insufficient to successfully restructure our operations through, among other ways, the relocation of programs or the inability to transition institutional program knowledge, to conform with the changes affecting our industry, may disrupt our operations, or may be more costly than currently anticipated. See additional information in Note 11 in the consolidated financial statements in Item 8 of this Report.
Our pension plans are currently underfunded and we expect to be required to make cash contributions in future periods, which may reduce the cash available for our businesses.
As of the last measurement date at December 31, 2018, the pension assets, projected benefit obligations, and unfunded pension obligation were $894.8 million, $1,288.7 million, and $393.9 million, respectively. We expect to make cash contributions of approximately $37.0 million to our tax-qualified defined benefit pension plan in 2019. During 2018, we made cash contributions of $36.7 million to our tax-qualified defined benefit pension plan of which $36.1 million was recoverable from our U.S. government contracts in 2018 with the remaining $0.6 million expected to be recoverable from our U.S. government contracts in the future. We generally are able to recover cash contributions related to our tax-qualified defined benefit pension plan as allowable costs on our U.S. government contracts, but there can be differences between when we contribute cash to our tax-qualified defined benefit pension plan under pension funding rules and recover it under Cost Accounting Standards ("CAS").
The funded status of our pension plans may be adversely affected by the investment experience of the plans' assets, by any changes in U.S. law and by changes in the statutory interest rates used by tax-qualified pension plans in the U.S. to calculate funding requirements. Accordingly, if the performance of our plans' assets does not meet our assumptions, if there are changes to the Internal Revenue Service ("IRS") regulations or other applicable law or if other actuarial assumptions are modified, our future contributions to our underfunded pension plans could be higher than we expect.
Additionally, the level of returns on retirement benefit assets, changes in interest rates, increases in Pension Benefit Guaranty Corporations premiums, changes in regulations, changes in mortality rate assumptions, and other factors affect our financial results. The timing of recognition of retirement benefit expense or income in our financial statements differs from the timing of the required funding under the Pension Protection Act or the amount of funding that can be recorded in our overhead rates through our U.S. government contracting business. Significant cash contributions in future periods could materially adversely affect our business, operating results, financial condition, and/or cash flows.
The level of returns on retirement benefit assets, changes in interest rates, changes in legislation, and other factors affect our financial results.
Our earnings are positively or negatively impacted by the amount of expense or income we record for our employee retirement benefit plans. We calculate the expense for the plans based on actuarial valuations. These valuations are based on assumptions that we make relating to financial market and other economic conditions. Changes in key economic indicators result in changes in the assumptions we use. The key assumptions used to estimate retirement benefit expense for the following year are the discount rate and expected long-term rate of return on assets. Our pension expense or income can also be affected by legislation and other government regulatory actions.

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We may expand our operations through acquisitions, which may divert management’s attention and expose us to unanticipated liabilities and costs. Also, acquisitions may increase our non-reimbursable costs. We may experience difficulties integrating any acquired operations, and we may incur costs relating to acquisitions that are never consummated.
Our business strategy may lead us to expand our Aerospace and Defense segment through acquisitions. However, our ability to consummate any future acquisitions on terms that are favorable to us may be limited by U.S. government regulations, the number of attractive acquisition targets, internal demands on our resources, and our ability to obtain financing. Our success in integrating newly acquired businesses will depend upon our ability to retain key personnel, avoid diversion of management’s attention from operational matters, implement internal controls, integrate general and administrative services and key information processing systems and, where necessary, re-qualify our customer programs. In addition, future acquisitions could result in the incurrence of additional debt, costs, and/or contingent liabilities. We may also incur costs and divert management attention to acquisitions that are never consummated. Integration of acquired operations may take longer, or be more costly or disruptive to our business, than originally anticipated.
Although we undertake a due diligence investigation of each business that we have acquired or may acquire, there may be liabilities of the acquired companies that we fail to, or were unable to, discover during the due diligence investigation and for which we, as a successor owner, may be responsible. Our efforts to minimize the impact of these types of potential liabilities through indemnities and warranties from sellers in connection with acquisitions may not fully cover the liabilities due to limitations in scope, amount or duration, financial limitations of the indemnitor or warrantor, or other reasons.
Cyber security incidents could disrupt business operations, result in the loss of critical and confidential information, and adversely impact our reputation and results of operations.
We routinely experience cyber security threats, threats to our information technology infrastructure and unauthorized attempts to gain access to our sensitive information, as do our customers, suppliers, subcontractors, and other partners. We may experience similar security threats at customer sites that we operate and manage as a contractual requirement. The threats we face vary from attacks common to most industries to more advanced and persistent, highly organized adversaries who target us and other defense and aerospace companies because we protect national security information. If we are unable to protect sensitive information, our customers or governmental authorities could question the adequacy of our threat mitigation and detection processes and procedures. The costs related to cyber or other security threats or disruptions may not be fully insured or indemnified by other means. The occurrence of any of these events could adversely affect our internal operations, the services we provide to our customers, our future financial results, our reputation or our stock price, or such events could result in the loss of competitive advantages derived from our research and development efforts or other intellectual property, early obsolescence of our products and services, or contractual penalties.
Due to the evolving nature of these security threats, the impact of any future incident cannot be predicted. Cyber security assessment analyses undertaken by us to identify and prioritize steps to enhance our cyber security safeguards, and our steps to implement such recommendations can be no assurance that we will adequately protect our information or that we will not experience any future successful attacks. Moreover, we may be required to expend significant additional resources to modify our cyber security protective measures, to investigate and remediate vulnerabilities or other exposures or to make required notifications, and we may be subject to litigation and financial losses.
Our business and operations could be adversely impacted in the event of a failure of our information technology infrastructure or failure to perform by our third party service providers.
We are dependent on various critical information technologies, including cyber security functions, administered and supported by third party service providers. The use of third party service providers can cause unexpected security vulnerabilities, loss of control and additional costs in the delivery of information services and data storage. Any disruption of our information technology infrastructure may cause operational stoppages, fines, penalties, diminished competitive advantages through reputational damages and increased operational costs. Additionally, we may incur additional costs to comply with our customers', including the U.S. government's, increased cyber security protections and standards in our products.
 We may experience warranty claims for product failures, schedule delays or other problems with existing or new products and systems.
Many of the products we develop and manufacture are technologically advanced systems that must function under demanding operating conditions. Even though we believe that we employ sophisticated and rigorous design, manufacturing and testing processes and practices, we may not be able to successfully launch or manufacture our products on schedule or our products may not perform as intended.
If our products fail to perform adequately, some of our contracts require us to forfeit a portion of our expected profit, receive reduced payments, provide a replacement product or service or reduce the price of subsequent sales to the same customer. Performance penalties may also be imposed if we fail to meet delivery schedules or other measures of contract performance. We do not generally insure against potential costs resulting from any required remedial actions or costs or loss of sales due to postponement or cancellation of scheduled operations or product deliveries.
Disruptions in the supply of key raw materials, difficulties in the supplier qualification process or increases in prices of raw materials could adversely affect our financial results.
We use a significant quantity of raw materials that are subject to market fluctuations and government regulations. Further, as a U.S. government contractor, we are often required to procure materials from suppliers capable of meeting rigorous

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customer and government specifications. As market conditions change for these companies, they often discontinue materials with low sales volumes or profit margins. We are often forced to either qualify new materials or pay higher prices to maintain the supply. We may be unable to establish replacement materials and secure customer funding to address specific qualification needs of the programs.
The supply of ammonium perchlorate, a principal raw material used in solid propellant, for many years, has been limited to a domestic independent single source that supplies the majority of the domestic solid propellant industry and actual pricing is based on the total industry demand. The completion of the Space Shuttle Program reduced demand, resulting in significant unit price increases. Although many of our contracts and proposals incorporate abnormal escalation pricing language, we may not be successful in passing the entire price increase on to the customer or may have a reduced profit margin as a result of any such price increase.
We are also impacted, as is the rest of the industry, by fluctuations in the sustained availability, prices and lead-times of raw materials used in production on various fixed-price contracts, particularly on multi-year programs. We continue to experience volatility in the price and lead-times of certain commodity metals, electronic components, and constituent chemicals. Additionally, we may not be able to continue to negotiate with our customers for economic and/or price adjustment clauses tied to obsolete materials and commodity indices to reduce program impact. The DoD also continues to rigorously enforce the provisions of the "Berry Amendment" which imposes a requirement to procure certain strategic materials critical to national security only from U.S. sources. Cost remains a concern as this industry continues to quote "price in effect" at time of shipment terms, increasing the cost risk to our programs. An emerging challenge to the extended supply chain is U.S. government contracting regulations to comply with stringent cyber security regulations that may influence the cost of material and services on U.S. government contracts. Further, a relatively recent Missile Defense Agency ("MDA") requirement to pre-approve supplier background screening processes of personnel that will have access to "controlled unclassified information" and separately approve any supplier personnel with dual citizenship has been challenging due to delays at MDA in approving requests which will potentially impact the award of subcontracts while approval is pending. Cyber security requirements will prove to be a continuing challenge as some small key/critical suppliers do not have the capability or infrastructure to support the requirements.
We are monitoring for significant changes across our supply chain due to increased tariffs on materials imported directly, or significant effects on domestic materials indirectly, we are monitoring for increases in anticipation.
Prolonged disruptions in the supply of any of our key raw materials, difficulty qualifying new sources of supply, implementing use of replacement materials or new sources of supply, and/or a continuing volatility in the prices of raw materials could have a material adverse effect on our operating results, financial condition, and/or cash flows.
Our operations and properties are currently the subject of significant environmental liabilities, and the numerous environmental and other government requirements to which we are subject may become more stringent in the future.
We are subject to federal, state, local, and foreign environmental laws and regulations that, among other things, require us to obtain permits to operate and install pollution control equipment and regulate the generation, storage, handling, transportation, treatment, and disposal of hazardous and solid wastes. These requirements may become more stringent in the future. Additional regulations dictate how and to what level we remediate contaminated soils and the level to which we are required to clean contaminated groundwater. These requirements may also become more stringent in the future. We may also be subject to fines and penalties relating to the operation of our existing and formerly owned businesses. We have been and are subject to toxic tort and asbestos lawsuits as well as other third-party lawsuits, due to either our past or present use of hazardous substances or the alleged on-site or off-site contamination of the environment through past or present operations. We may incur material costs in defending these claims and lawsuits and any similar claims and lawsuits that may arise in the future. Contamination at our current and former properties is subject to investigation and remediation requirements under federal, state and local laws and regulations, and the full extent of the required remediation has not yet been determined. Any adverse judgment or cash outlay could have a significant adverse effect on our operating results, financial condition, and/or cash flows.
Although some of our environmental expenditures may be recoverable and we have established reserves, given the many uncertainties involved in assessing liability for environmental claims, our reserves may not be sufficient, which could adversely affect our financial results and cash flows.
As of December 31, 2018, the aggregate range of our estimated future environmental obligations was $327.9 million to $472.1 million and the accrued amount was $327.9 million. In many cases the nature and extent of the required remediation has not yet been determined. Given the many uncertainties involved in assessing liability for environmental claims, our reserves may prove to be insufficient. For example, in 2016, we reached a decision with the U.S. government on the treatment of certain utility costs related to the Sacramento site resulting in a reserve increase of $59.4 million. The reserves are based only on known sites and the known contamination at those sites. It is possible that additional sites needing remediation may be identified or that unknown contamination at previously identified sites may be discovered. It is also possible that the regulatory agencies may change clean-up standards for chemicals of concern such as ammonium perchlorate and trichloroethylene. This could lead to additional expenditures for environmental remediation in the future and, given the uncertainties involved in assessing liability for environmental claims, our reserves may prove to be insufficient.
Most of our environmental costs are incurred by our Aerospace and Defense segment, and certain of these future costs are allowable to be included in our contracts with the U.S. government. We currently estimate approximately 12% of our Aerospace and Defense segment environmental costs will not likely be reimbursable.

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Our environmental expenses related to non-Aerojet Rocketdyne sites are generally not recoverable and a significant increase in these estimated environmental expenses could have a significant adverse effect on our operating results, financial condition, and/or cash flows.
We face certain significant risk exposures and potential liabilities that may not be adequately covered by indemnity or insurance.
A significant portion of our business relates to developing and manufacturing propulsion systems for defense and space applications, armament systems for precision tactical weapon systems, and munitions applications. New technologies may be untested or unproven. In addition, we may incur significant liabilities that are unique to our products and services. In some, but not all, circumstances, we may receive indemnification from the U.S. government but there is no guarantee such indemnification will sufficiently cover our liability. While we maintain insurance for certain risks, the amount of our insurance coverage may not be adequate to cover all claims or liabilities, and it is not possible to obtain insurance to protect against all operational risks and liabilities. Accordingly, we may be forced to bear substantial costs resulting from risks and uncertainties of our business, which could have a material adverse effect on our operating results, financial condition, and/or cash flows.
Our inability to protect our trade secrets, patents and proprietary rights could adversely affect our businesses’ prospects and competitive positions.
We seek to protect proprietary technology and inventions through patents and other proprietary-right protection. If we are unable to obtain or maintain these protections, we may not be able to prevent third parties from using our proprietary rights. In addition, we may incur significant expense in protecting our intellectual property.
We also rely on trade secrets, proprietary know-how and continuing technological innovation to remain competitive. We have taken measures to protect our trade secrets and know-how, including the use of confidentiality agreements with our employees, consultants and advisors. These agreements may be breached and remedies for a breach may not be sufficient to compensate us for damages incurred. We generally control and limit access to our product documentation and other proprietary information. Other parties may independently develop our know-how or otherwise obtain access to our technology.
Business disruptions could seriously affect us.
Our business may be affected by disruptions including, but not limited to: threats to physical security of our facilities and employees, including senior executives; terrorist acts; information technology attacks or failures; damaging weather or other acts of nature; and pandemics or other public health crises. The costs related to these events may not be fully mitigated by insurance or other means. Disruptions could affect our internal operations or services provided to customers, which could have a material adverse effect on our operating results, financial condition, and/or cash flows.
If our operating subsidiaries do not generate sufficient cash flow or if they are not able to pay dividends or otherwise distribute their cash to us, or if we have insufficient funds on hand, we may not be able to service our debt.
All of the operations of our Aerospace and Defense and Real Estate segments are conducted through subsidiaries. Consequently, our cash flow and ability to service our debt obligations will be largely dependent upon the earnings and cash flows of our operating subsidiaries and the distribution of those earnings to us, or upon loans, advances or other payments made by these subsidiaries to us. The ability of our subsidiaries to pay dividends or make other payments or advances to us will depend upon their operating results and cash flows and will be subject to applicable laws and any contractual restrictions contained in the agreements governing their debt, if any.
 We have a substantial amount of debt. Our ability to operate is limited by the agreements governing our debt.
We have a substantial amount of debt for which we are required to make interest and principal payments. Interest on long-term financing is not a recoverable cost under our U.S. government contracts. As of December 31, 2018, we had $672.8 million of debt principal. Subject to the limits contained in some of the agreements governing our outstanding debt, we may incur additional debt in the future. Our maintenance of higher levels of indebtedness could have adverse consequences including impairing our ability to obtain additional financing in the future.
Our level of debt places significant demands on our cash resources, which could:
make it more difficult to satisfy our outstanding debt obligations;
require us to dedicate a substantial portion of our cash for payments related to our debt, reducing the amount of cash flow available for working capital, capital expenditures, entitlement of our real estate assets, contributions to our tax-qualified pension plan, and other general corporate purposes;
limit our flexibility in planning for, or reacting to, changes in the industries in which we compete;
place us at a competitive disadvantage with respect to our competitors, some of which have lower debt service obligations and greater financial resources than we do;
limit our ability to borrow additional funds;
limit our ability to expand our operations through acquisitions; and
increase our vulnerability to general adverse economic and industry conditions.
If we are unable to generate sufficient cash flow to service our debt and fund our operating costs, our liquidity may be adversely affected.

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We are obligated to comply with financial and other covenants outlined in our debt indentures and agreements that could restrict our operating activities. A failure to comply could result in a default which would, if not waived by the lenders, likely would come with substantial cost and accelerate the payment of our debt.
Our debt instruments generally contain various restrictive covenants which include, among others, provisions which may restrict our ability to:
access the full amount of our revolving credit facility and/or incur additional debt;
enter into certain leases;
make certain distributions, investments, and other restricted payments;
cause our restricted subsidiaries to make payments to us;
enter into transactions with affiliates;
create certain liens;
purchase assets or businesses;
sell assets and, if sold, retain excess cash flow from these sales; and
consolidate, merge or sell all or substantially all of our assets.
Our secured debt also contains other customary covenants, including, among others, provisions restricting our ability to pledge assets or create other liens. In addition, certain covenants in our bank facility require that we maintain certain financial ratios.
Based on our existing debt agreements, we were in compliance with our financial and non-financial covenants as of December 31, 2018. Any of the covenants described in this risk factor may restrict our operations and our ability to pursue potentially advantageous business opportunities. Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in the acceleration of our amended and restated senior credit facility entered into on September 20, 2018, (the "Senior Credit Facility") with the lenders identified therein and Bank of America, N.A., as administrative agent and the 2.25% Convertible Senior Notes ("2¼% Notes"). In addition, our failure to pay principal and interest when due is a default under the Senior Credit Facility, and in certain cases, would cause cross defaults on the 2¼% Notes.
The real estate market involves significant risk, which could adversely affect our financial results.
Our real estate activities involve significant risks, which could adversely affect our financial results. We are subject to various risks, including the following:
we may be unable to obtain, or suffer delays in obtaining, necessary re-zoning, land use, building, occupancy, and other required governmental permits and authorizations, which could result in increased costs or our abandonment of these projects;
we may be unable to complete environmental remediation or to have state and federal environmental restrictions on our property lifted, which could cause a delay or abandonment of these projects;
we may be unable to obtain sufficient water sources to service our projects, which may prevent us from executing our plans;
our real estate activities may require significant expenditures and we may not be able to obtain financing on favorable terms, which may render us unable to proceed with our plans;
economic and political uncertainties could have an adverse effect on consumer buying habits, construction costs, availability of labor and materials and other factors affecting us and the real estate industry in general;
our property is subject to federal, state, and local regulations and restrictions that may impose significant limitations on our plans;
much of our property is raw land that includes the natural habitats of various endangered or protected wildlife species requiring mitigation;
if our land use plans are approved by the appropriate governmental authorities, we may face lawsuits from those who oppose such plans (such lawsuits and the costs associated with such opposition could be material and have an adverse effect on our ability to sell property or realize income from our projects); and
the time frame required for approval of our plans means that we will have to wait years for a significant cash return.
Substantially all of our excess real estate, that we are in the process of entitling for new opportunities, is located in Sacramento County, California, making us vulnerable to changes in economic and other conditions in that particular market.
As a result of the geographic concentration of our properties, our long-term real estate performance and the value of our properties will depend upon conditions in the Sacramento region, including:
the sustainability and growth of industries located in the Sacramento region;
the financial strength and spending of the State of California;

13




local real estate market conditions;
changes in neighborhood characteristics;
changes in interest rates; and
real estate tax rates.
If unfavorable economic or other conditions continue in the region, our plans and business strategy could be adversely affected.
We may incur additional costs related to past or future divestitures, which could adversely affect our financial results.
In connection with our divestitures in prior periods, we have incurred and may incur additional costs. As part of our divestitures, we have provided customary indemnification to the purchasers for such matters as claims arising from the operation of the businesses prior to disposition, including income tax matters and the liability to investigate and remediate certain environmental contamination existing prior to disposition. These additional costs and the indemnification of the purchasers of our former or current businesses may require additional cash expenditures, which could have a material adverse effect on our operating results, financial condition, and/or cash flows.
In order to be successful, we must attract and retain key employees.
Our business has a continuing need to attract large numbers of skilled personnel, including personnel holding security clearances, to support the growth of the enterprise and to replace individuals who have terminated employment due to retirement or for other reasons. To the extent that the demand for qualified personnel exceeds supply, we could experience higher labor, recruiting, or training costs in order to attract and retain such employees, or could experience difficulties in performing under our contracts if our needs for such employees were unmet. In addition, our inability to appropriately plan for the transfer or replacement of appropriate intellectual capital and skill sets critical to us could result in business disruptions and impair our ability to achieve business objectives.
A strike or other work stoppage, or our inability to renew collective bargaining agreements on favorable terms, could adversely affect our financial results.
As of December 31, 2018, 12% of our 5,004 employees were covered by collective bargaining agreements. In the future, if we are unable to negotiate acceptable new agreements with the unions, upon expiration of the existing contracts, we could experience a strike or work stoppage. Even if we are successful in negotiating new agreements, the new agreements could call for higher wages or benefits paid to union members, which would increase our operating costs and could adversely affect our profitability. If our unionized workers were to engage in a strike or other work stoppage, or other non-unionized operations were to become unionized, we could experience a significant disruption of operations at our facilities or higher ongoing labor costs. A strike or other work stoppage in the facilities of any of our major customers or suppliers could also have similar effects on us.
Due to the nature of our business, our sales levels may fluctuate causing our quarterly operating results to fluctuate.
Our quarterly and annual sales are affected by a variety of factors that may lead to significant variability in our operating results. In our Aerospace and Defense segment, sales earned under long-term contracts are recognized either on a cost basis, when deliveries are made, or when contractually defined performance milestones are achieved. The timing of deliveries or milestones may fluctuate from quarter to quarter. In our Real Estate segment, sales of land may be made from time to time, which may result in variability in our operating results and cash flows.
 Failure to maintain effective internal controls in accordance with the Sarbanes-Oxley Act could negatively impact the market price of our common stock.
Effective internal controls are necessary for us to provide reliable financial reports and to effectively prevent fraud. We rely on numerous manual processes to manage our business, which increases our risk of having an internal control failure. The SEC, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include a report by management on the effectiveness of our internal control over financial reporting in our Annual Reports on Form 10-K. In addition, our independent registered public accounting firm must report on the effectiveness of the internal control over financial reporting. Although we review our internal control over financial reporting in order to ensure compliance with the Section 404 requirements, if we or our independent registered public accounting firm is not satisfied with our internal control over financial reporting or the level at which these controls are documented, designed, operated or reviewed, or if our independent registered public accounting firm interprets the requirements, rules and/or regulations differently from our interpretation, then they may issue a report that is qualified. This could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which ultimately could negatively impact our stock price.
In addition, we have in the past recorded, and may in the future record, revisions or out of period adjustments to our consolidated financial statements. In making such adjustments, we apply the analytical framework of SEC Staff Accounting Bulletin ("SAB") No. 99, "Materiality" ("SAB 99") and SEC SAB No. 108 "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements", to determine whether the effect of any adjustment to our consolidated financial statements is material and whether such adjustments, individually or in the aggregate, would require us to restate our consolidated financial statements for previous periods. Under SAB 99, companies are required to apply quantitative and qualitative factors to determine the "materiality" of particular adjustments. In the future, we may identify further errors impacting our interim or annual consolidated financial statements. Depending upon the complete qualitative and quantitative analysis, this could result in us restating previously issued consolidated financial statements.

14




Item 1B. Unresolved Staff Comments
None.
Item  2. Properties
Significant operating, manufacturing, research, design, and/or marketing locations are set forth below.
Facilities
Corporate Headquarters
Aerojet Rocketdyne Holdings, Inc.
222 N. Pacific Coast Highway, Suite 500
El Segundo, California 90245
Operating/Manufacturing/Research/Design/Marketing Locations
 
Aerospace and Defense
El Segundo, California*
Operating/Design/Manufacturing Facilities:  Camden, Arkansas (owned and leased); Carlstadt, New Jersey*; Chatsworth, California (owned and leased); Hancock County, Mississippi*; Huntsville, Alabama*; Jonesborough, Tennessee**; Orange, Virginia; Orlando, Florida*; Rancho Cordova, California; Redmond, Washington; West Palm Beach, Florida*
Marketing/Sales Offices: Arlington, Virginia*
Real Estate
 
 
Rancho Cordova, California
 
 
_____
  *
Indicates a leased property.
**
Owned and operated by Aerojet Ordnance Tennessee, Inc., a 100% owned subsidiary of Aerojet Rocketdyne.
We believe each of the facilities is suitable and adequate for the business conducted at that facility taking into account current and planned future needs.
Item 3. Legal Proceedings
The Company and its subsidiaries are subject to legal proceedings, including litigation in U.S. federal and state courts, which arise out of, and are incidental to, the ordinary course of the Company’s on-going and historical businesses. The Company is also subject from time to time to suits under the federal False Claims Act, known as "qui tam" actions, and to governmental investigations by federal and state agencies. The Company cannot predict the outcome of such proceedings with any degree of certainty. Loss contingency provisions are recorded for probable losses at management’s best estimate of a loss. When only a range of amounts can be reasonably estimated and no amount within the range is more likely than another, the low end of the range is recorded. These estimates are often initially developed substantially earlier than when the ultimate loss is known, and are refined each quarterly reporting period as additional information becomes available.
Asbestos Litigation
The Company has been, and continues to be, named as a defendant in lawsuits alleging personal injury or death due to exposure to asbestos in building materials, products, or in manufacturing operations. The majority of cases are pending in Illinois state courts. There were 60 asbestos cases pending as of December 31, 2018.
Given the lack of any significant consistency to claims (i.e., as to product, operational site, or other relevant assertions) filed against the Company, the Company is generally unable to make a reasonable estimate of the future costs of pending claims or unasserted claims. As of December 31, 2018, the Company has accrued an immaterial amount related to pending claims.
The aggregate settlement costs and legal and administrative fees associated with asbestos cases were immaterial for 2018, 2017, and 2016.
United States ex. rel. Markus vs. Aerojet Rocketdyne Holdings
The Company responded to a civil investigative demand issued by the Department of Justice ("DOJ") in the three months ended March 31, 2017, requesting information relating to allegations under the False Claims Act that the Company may have previously made false representations to the U.S. government regarding the Company’s compliance with certain regulatory cybersecurity requirements. In the three months ended June 30, 2018, the DOJ completed its review and declined to intervene in a case filed against the Company and Aerojet Rocketdyne in the U.S. District Court, Eastern District of California, originally filed under seal on September 13, 2017. The case is captioned United States ex. rel. Markus vs. Aerojet Rocketdyne Holdings, Inc. et al., Case No. 2:15-CV-02245-WBS-AC. The complaint alleges causes of action based on false claims, retaliation, and wrongful termination of employment and seeks injunctive relief, civil penalties, and compensatory and punitive damages. The relator has continued to pursue the claim and the Company continues to vigorously contest the complaint’s allegations. The Company has not recorded any liability for this matter as of December 31, 2018.
Item 4. Mine Safety Disclosures
None.




PART II
Item  5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
As of February 12, 2019, there were 5,820 holders of record of our common stock. Our common stock is listed on the New York Stock Exchange under the trading symbol "AJRD." On February 12, 2019, the last reported sale price of our common stock on the New York Stock Exchange was $40.28 per share.
Information concerning long-term debt appears in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations under the caption "Liquidity and Capital Resources" and in Part II, Item 8. Consolidated Financial Statements and Supplementary Data at Note 6 in the consolidated financial statements. Our Senior Credit Facility restricts the payment of dividends, and we do not anticipate paying cash dividends in the foreseeable future.
Information concerning securities authorized for issuance under our equity compensation plans appears in Part III, Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters under the caption "Equity Compensation Plan Information."
The following graph compares the cumulative total stockholder returns, calculated on a dividend reinvested basis, on $100 invested in our common stock in November 2013 with the cumulative total return of (i) the Standard & Poor’s 500 Composite Stock Price Index ("S&P 500 Index"), and (ii) the Standard & Poor’s 500 Aerospace & Defense Index. The stock price performance shown on the graph is not necessarily indicative of future performance.

Comparison of Cumulative Total Stockholder Return Among
Aerojet Rocketdyne, S&P 500 Index, and the S&P 500 Aerospace & Defense Index,
November 2013 through December 2018
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12720237&doc=16

Company/Index
 
Base
Year
2013
 
Year Ended
 
November 30,
 
November 30,
 
December 31,
 
December 31,
 
December 31,
 
2014
 
2015
 
2016
 
2017
 
2018
 
Aerojet Rocketdyne Holdings, Inc.
 
$
100.00

 
$
91.06

 
$
95.64

 
$
97.87

 
$
170.12

 
$
192.09

S&P 500 Index
 
100.00

 
116.86

 
120.07

 
132.31

 
161.20

 
154.13

S&P 500 Aerospace & Defense
 
100.00

 
114.50

 
122.08

 
144.02

 
203.61

 
187.18



16




Item 6. Selected Financial Data
The following selected financial data is qualified by reference to and should be read in conjunction with the consolidated financial statements, including the notes thereto in Item 8. Consolidated Financial Statements and Supplementary Data and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Year Ended
 
One Month Ended
 
December 31,
 
December 31,
 
December 31,
 
November 30,
 
November 30,
 
December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
2015
 
(In millions, except per share amounts)
 
 
Net sales
$
1,895.9

 
$
1,877.2

 
$
1,761.3

 
$
1,708.3

 
$
1,602.2

 
$
96.3

Net income (loss)
137.3

 
(9.2
)
 
18.0

 
(16.2
)
 
(50.0
)
 
7.0

Basic income (loss) per share of common stock
1.80

 
(0.13
)
 
0.27

 
(0.27
)
 
(0.86
)
 
0.11

Diluted income (loss) per share of common stock
1.75

 
(0.13
)
 
0.27

 
(0.27
)
 
(0.86
)
 
0.10

Supplemental statement of operations information:
 
 
 
 
 
 
 
 
 

 
 
Net income (loss)
$
137.3

 
$
(9.2
)
 
$
18.0

 
$
(16.2
)
 
$
(50.0
)
 
$
7.0

Interest expense
34.4

 
30.9

 
32.5

 
50.4

 
52.7

 
3.8

Interest income
(10.0
)
 
(3.5
)
 
(0.6
)
 
(0.3
)
 
(0.1
)
 

Income tax provision (benefit)
51.3

 
96.1

 
11.2

 
0.3

 
16.3

 
2.0

Depreciation and amortization
72.3

 
72.6

 
64.9

 
65.1

 
63.7

 
5.1

GAAP retirement benefits expense
57.6

 
73.2

 
68.9

 
67.6

 
36.5

 
5.6

CAS recoverable retirement benefits expense
(38.2
)
 
(36.2
)
 
(29.5
)
 
(17.9
)
 
(5.2
)
 
(2.6
)
Unusual items
0.2

 
(1.0
)
 
34.5

 
51.9

 
61.7

 
0.4

Adjusted EBITDAP (Non-GAAP measure)*
$
304.9

 
$
222.9

 
$
199.9

 
$
200.9

 
$
175.6

 
$
21.3

Adjusted EBITDAP (Non-GAAP measure) as a percentage of net sales
16.1
%
 
11.9
 %
 
11.3
%
 
11.8
 %
 
11.0
 %
 
22.1
%
Net income (loss) as percentage of net sales
7.2
%
 
(0.5
)%
 
1.0
%
 
(0.9
)%
 
(3.1
)%
 
7.3
%
Stock-based compensation expense (benefit)
$
20.5

 
$
22.0

 
$
12.9

 
$
8.6

 
$
5.7

 
$
(0.4
)
Environmental remediation provision adjustments
(36.9
)
 
8.2

 
18.3

 
17.3

 
10.8

 
(0.1
)
Cash flow information:
 
 
 
 
 
 
 
 
 

 
 
   Cash flow provided by operating activities
$
252.7

 
$
212.8

 
$
158.7

 
$
67.6

 
$
151.9

 
$
0.1

   Capital Expenditures
(43.2
)
 
(29.4
)
 
(47.6
)
 
(36.8
)
 
(43.4
)
 
(1.2
)
   Free Cash Flow*
$
209.5

 
$
183.4

 
$
111.1

 
$
30.8

 
$
108.5

 
$
(1.1
)
Balance Sheet information:
 
 
 
 
 
 
 
 
 

 
 
   Total assets
$
2,490.1

 
$
2,258.7

 
$
2,249.5

 
$
2,034.9

 
$
1,918.6

 
$
2,023.3

   Total debt principal
672.8

 
670.9

 
725.6

 
652.0

 
782.2

 
650.6

_________
* We provide Non-GAAP measures as a supplement to financial results presented in accordance with GAAP. A reconciliation of the Non-GAAP measures to the most directly comparable GAAP measures is presented later in the Management’s Discussion and Analysis under the heading "Use of Non-GAAP Financial Measures."


17




 Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the other sections of this Report, including the consolidated financial statements and notes thereto appearing in Item 8 of this Report, the risk factors appearing in Item 1A of this Report, and the disclaimer regarding forward-looking statements appearing at the beginning of Item 1 of this Report.
Overview
A summary of the significant financial highlights for 2018, which management uses to evaluate our operating performance and financial condition, is presented below. 
Net sales for 2018 totaled $1,895.9 million compared with $1,877.2 million for 2017.
Net income for 2018 was $137.3 million, or $1.75 diluted income per share ("EPS"), compared with net loss of $(9.2) million, or $(0.13) diluted EPS for 2017.
Adjusted Net Income (Non-GAAP measure*) for 2018 was $151.5 million, or $1.93 Adjusted EPS (Non-GAAP measure*), compared with $76.0 million, or $1.02 Adjusted EPS for 2017.
Adjusted EBITDAP (Non-GAAP measure*) for 2018 was $304.9 million compared with $222.9 million for 2017.
Segment performance before environmental remediation provision adjustments, retirement benefits, net, and unusual items (Non-GAAP measure*) was $236.2 million for 2018, compared with $202.9 million for 2017.
Cash provided by operating activities in 2018 totaled $252.7 million compared with $212.8 million in 2017.
Free cash flow (Non-GAAP measure*) in 2018 totaled $209.5 million compared with $183.4 million in 2017.
Effective January 1, 2018, we adopted the new revenue recognition guidance. Consistent with the standard, net assets increased by $37.6 million and $578.0 million of net sales were recognized in the cumulative effect at January 1, 2018, with a corresponding reduction to backlog.
Total backlog as of December 31, 2018, was $4.1 billion compared with $4.6 billion as of December 31, 2017.
_________
* We provide Non-GAAP measures as a supplement to financial results presented in accordance with GAAP. A reconciliation of the Non-GAAP measures to the most directly comparable GAAP measures is presented later in the Management’s Discussion and Analysis under the heading "Operating Segment Information" and "Use of Non-GAAP Financial Measures."
In May 2014, the Financial Accounting Standards Board ("FASB") amended the existing accounting standards for revenue recognition. The amendments are based on the principle that revenue should be recognized to depict the transfer of promised 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. We adopted the guidance effective January 1, 2018, using the modified retrospective method, with the cumulative effect recognized as of January 1, 2018. All applicable amounts and disclosures for 2018 reflect the impact of adoption. As we elected to use the modified retrospective method, prior periods presented have not been restated to reflect the impact of adoption. Reclassifications have been made where noted for conforming presentation only (see Notes 1(p) and 14 in the consolidated financial statements in Item 8 of this Report).
Our business outlook is affected by both increasing complexity in the global security environment and continuing worldwide economic pressures. A significant component of our strategy in this environment is to focus on delivering excellent performance to our customers, driving improvements and efficiencies across our operations, and creating value through the enhancement and expansion of our business.
Some of the significant challenges we face are as follows: dependence upon U.S. government programs and contracts, future reductions or changes in U.S. government spending in our markets, successful implementation of our cost reduction plans, environmental matters, capital structure, underfunded retirement benefit plans, and information technology and cyber security.
Major Customers
The principal end user customers of our products and technology are primarily agencies of the U.S. government. Since a majority of our sales are, directly or indirectly, to the U.S. government, funding for the purchase of our products and services generally follows trends in U.S. aerospace and defense spending. However, individual U.S. government agencies, which include the military services, NASA, the Missile Defense Agency, and the prime contractors that serve these agencies, exercise independent purchasing power within "budget top-line" limits. Therefore, sales to the U.S. government are not regarded as sales to one customer, but rather each contracting agency is viewed as a separate customer.

18




The following table summarizes net sales to the U.S. government and its agencies, including net sales to significant customers disclosed below:
Year Ended December 31,
Percentage of Net
Sales
2018
94
%
2017
92
%
2016
91
%
The following table summarizes net sales by principal end user in 2018:
NASA
25
%
U.S. Air Force
18

U.S. Army
15

Missile Defense Agency
24

U.S. Navy
7

Other U.S. government
5

Total U.S. government customers
94

Other customers
6

Total
100
%
The following table summarizes the percentages of net sales for significant programs, all of which are included in the U.S. government sales and are comprised of multiple contracts:
 
Year Ended December 31,
 
2018
 
2017
 
2016
RS-25 program
14
%
 
14
%
 
12
%
Standard Missile program
13

 
9

 
12

THAAD program
11

 
9

 
13

The following table summarizes customers that represented more than 10% of net sales, each of which involves sales of several product lines and programs:
 
Year Ended December 31,
 
2018
 
2017
 
2016
Lockheed Martin
30
%
 
24
%
 
27
%
Raytheon
19

 
17

 
20

NASA
18

 
17

 
13

ULA
17

 
22

 
21

Industry Update
Information concerning our industry appears in Part I, Item 1. Business under the caption "Industry Overview."
Competitive Improvement Program
During 2015, we initiated Phase I of our CIP comprised of activities and initiatives aimed at reducing costs in order for us to continue to compete successfully. Phase I is comprised of three major components: (i) facilities optimization and footprint reduction; (ii) product affordability; and (iii) reduced administrative and overhead costs. On April 6, 2017, the Board of Directors approved Phase II of our previously announced CIP. Pursuant to Phase II, we expanded CIP and further consolidated our Sacramento, California, and Gainesville, Virginia sites, while centralizing and expanding our existing presence in Huntsville, Alabama. When fully implemented, we anticipate that the CIP will result in annual costs that are $230 million below levels anticipated prior to CIP.
We currently estimate that we will incur restructuring and related costs of the Phase I and II programs of approximately $210.0 million (including approximately $60.5 million of capital expenditures). Our current estimate is down from the initial estimate of $235.0 million primarily due to efficiencies in program transitions and lower than expected employee costs. We have incurred $131.4 million of such costs through December 31, 2018, including $48.1 million in capital expenditures.

19




Environmental Matters
Our current and former business operations are subject to, and affected by, federal, state, local, and foreign environmental laws and regulations relating to the discharge, treatment, storage, disposal, investigation, and remediation of certain materials, substances, and wastes. See Notes 8(c) and 8(d) in the consolidated financial statements in Item 8 of this Report and "Environmental Matters" below for summary of our environmental reserve activity.
Capital Structure
We have a substantial amount of debt for which we are required to make interest and principal payments. Interest on long-term financing is not a recoverable cost under our U.S. government contracts. As of December 31, 2018, we had $625.4 million of debt outstanding. In 2018, we entered into an industrial bond transaction with a subsidiary to realize property tax savings.
Retirement Benefits
As of the last measurement date at December 31, 2018, the pension assets, projected benefit obligations, and unfunded pension obligation were $894.8 million, $1,288.7 million, and $393.9 million, respectively. We estimate that 82% of our unfunded pension obligation as of December 31, 2018, is related to our U.S. government contracting business, Aerojet Rocketdyne.
On September 10, 2018, we made a discretionary contribution of 2.7 million treasury stock, or $95.0 million, of our common stock to our tax-qualified defined benefit pension plan. This voluntary contribution will help address the current underfunding of the tax-qualified defined benefit pension plan. This contribution was tax deductible in the current period and will be used as a pre-funding credit.
We expect to make cash contributions of approximately $37.0 million to our tax-qualified defined benefit pension plan in 2019. We generally are able to recover cash contributions related to our tax-qualified defined benefit pension plan as allowable costs on our U.S. government contracts, but there can be differences between when we contribute cash to our tax-qualified defined benefit pension plan under pension funding rules and recover it under CAS.
Information Technology and Cyber Security
We routinely experience cyber security threats, threats to our information technology infrastructure and unauthorized attempts to gain access to our sensitive information, as do our customers, suppliers, subcontractors, and other partners. In 2017, we outsourced certain information technology and cyber security functions to third-party contractors in order to take advantage of advanced cyber security technologies. The visibility provided by the additional cyber security technologies identified vulnerabilities and resulted in additional costs to remediate throughout 2018. The transition to the outsourced provider impacted our level of control over the performance and delivery of such service to the business.
We continue to assess our information technology systems and are engaged in cooperative efforts with our customers, suppliers, and subcontractors to seek to minimize the impact of cyber threats, other security threats or business disruptions.
Results of Operations:
Net Sales:
 
Year Ended December 31,
 
 
 
Year Ended December 31,
 
 
 
2018
 
2017
 
Change*
 
2017
 
2016
 
Change**
 
(In millions)
Net sales:
$
1,895.9

 
$
1,877.2

 
$
18.7

 
$
1,877.2

 
$
1,761.3

 
$
115.9

* Primary reason for change. Net sales were impacted by the adoption of new revenue recognition guidance effective January 1, 2018, using the modified retrospective method. The primary impact of the new guidance was a change in the timing of revenue recognition on certain long-term contracts. Under this new guidance, we discontinued the use of the unit-of-delivery method on certain customer contracts and re-measured the performance obligations using the cost-to-cost method. Net sales in 2018 would have been $1,910.0 million under the previous revenue recognition guidance which is $32.8 million higher than net sales reported in 2017, resulting from an increase of $126.0 million in defense programs primarily driven by increased deliveries on the Standard Missile and PAC-3 programs. The increase in net sales was partially offset by a decrease of $94.6 million in space programs primarily driven by cost growth and performance issues on the Commercial Crew Development program and lower deliveries on the Atlas V program as this program winds down. The Atlas V program contributed sales of $42.6 million under the new revenue recognition guidance in 2018, and sales of $89.1 million under the previous revenue recognition guidance in 2018.
 ** Primary reason for change. The increase in net sales was primarily due to an increase of $158.0 million in space programs primarily driven by the following (i) the RS-25 program development and integration effort in support of the SLS development program; (ii) increased development effort and volume on the Commercial Crew Development program; and (iii) increased deliveries on the Atlas V program. The increase in net sales was partially offset by a decrease of $36.5 million in defense programs primarily driven by the timing of deliveries on the THAAD and Standard Missile programs partially offset by the net sales generated from the Coleman Aerospace acquisition. Further, as a result of the 2016 calendar, Aerojet Rocketdyne had 53 weeks of operations in 2016 compared with 52 weeks of operations in 2017. The additional week of operations, which occurred in the fourth quarter of 2016 and accounted for $32.2 million in additional net sales, is included in the above discussion of program changes.

20




Cost of Sales (exclusive of items shown separately below):
 
Year Ended December 31,
 
 
 
Year Ended December 31,
 
 
 
2018
 
2017
 
Change*
 
2017
 
2016
 
Change**
 
(In millions, except percentage amounts)
Cost of sales (exclusive of items shown separately below)
$
1,549.4

 
$
1,562.2

 
$
(12.8
)
 
$
1,562.2

 
$
1,477.4

 
$
84.8

Percentage of net sales
81.7
%
 
83.2
%
 
 
 
83.2
%
 
83.9
%
 
 
* Primary reason for change. The decrease in cost of sales as a percentage of net sales was primarily due to the following: (i) risk retirements on the RS-68 program, (ii) favorable overhead rate performance, and (iii) cost growth and manufacturing inefficiencies in 2017 on electric propulsion contracts. These factors were partially offset by cost growth and performance issues in the current period on the Commercial Crew Development program and favorable contract performance on the THAAD program in 2017 as a result of risk retirements and cost reductions. The same factors drove the decrease in cost of sales as a percentage of net sales under the previous revenue recognition guidance.
** Primary reason for change. The decrease in cost of sales as a percentage of net sales was primarily due to favorable contract performance on numerous programs as a result of overhead cost reductions and reduced program risks, most notably on the THAAD program, partially offset by cost growth and manufacturing inefficiencies in 2017 on electric propulsion contracts.
Selling, General and Administrative Expense ("SG&A"):
 
Year Ended December 31,
 
 
 
Year Ended December 31,
 
 
 
2018
 
2017
 
Change*
 
2017
 
2016
 
Change**
 
(In millions, except percentage amounts)
Components of SG&A:
 
 
 
 
 
 
 
 
 
 
 
SG&A excluding stock-based compensation
$
23.3

 
$
25.0

 
$
(1.7
)
 
$
25.0

 
$
21.8

 
$
3.2

Stock-based compensation
20.5

 
22.0

 
(1.5
)
 
22.0

 
12.9

 
9.1

SG&A
$
43.8

 
$
47.0

 
$
(3.2
)
 
$
47.0

 
$
34.7

 
$
12.3

Percentage of net sales
2.3
%
 
2.5
%
 
 
 
2.5
%
 
2.0
%
 
 
Percentage of net sales excluding stock-based compensation
1.2
%
 
1.3
%
 
 
 
1.3
%
 
1.2
%
 
 
 * Primary reason for change. The decrease in SG&A expense was primarily driven by (i) a decrease of $1.5 million in stock-based compensation primarily as a result of decreases in the fair value of the stock appreciation rights in the current period and accelerated vesting of stock awards to a former executive officer in 2017 and (ii) a decrease in legal and professional services expenses.
** Primary reason for change. The increase in SG&A expense was primarily driven by an increase of $9.1 million in stock-based compensation primarily as a result of increases in the fair value of stock appreciation rights, the accelerated vesting of stock awards to a former executive officer, and the August 2016 stock award granted to the Executive Chairman that vested according to the attainment of share prices ranging from $22 per share to $27 per share of our common stock.
Depreciation and Amortization:
 
Year Ended December 31,
 
 
 
Year Ended December 31,
 
 
 
2018
 
2017
 
Change*
 
2017
 
2016
 
Change**
 
(In millions)
Components of depreciation and amortization:
 
 
 
 
 
 
 
 
 
 
 
Depreciation
$
56.1

 
$
56.7

 
$
(0.6
)
 
$
56.7

 
$
49.6

 
$
7.1

Amortization
13.7

 
13.7

 

 
13.7

 
13.3

 
0.4

Accretion
2.5

 
2.2

 
0.3

 
2.2

 
2.0

 
0.2

Depreciation and amortization
$
72.3

 
$
72.6

 
$
(0.3
)
 
$
72.6

 
$
64.9

 
$
7.7

 * Primary reason for change. Depreciation and amortization expense did not change significantly in 2018 compared with 2017.
** Primary reason for change. The increase in depreciation expense was primarily the result of increased accelerated depreciation associated with changes in the estimated useful lives of long-lived assets and capital projects being placed in service to support the cost saving initiatives of the CIP.

21




Other (Income) Expense, Net and Loss On Debt:
 
Year Ended December 31,
 
 
 
Year Ended December 31,
 
 
 
2018
 
2017
 
Change*
 
2017
 
2016
 
Change**
 
(In millions)
Other (income) expense, net and loss on debt:
$
(40.2
)
 
$
7.9

 
$
(48.1
)
 
$
7.9

 
$
54.3

 
$
(46.4
)
* Primary reason for change. The increase in other income, net was primarily due to a one-time benefit of $43.0 million in environmental remediation provision adjustments as a result of reaching a determination with the U.S. government that certain environmental expenditures are reimbursable under the Global Settlement (see discussion of "Environmental Matters" below).
** Primary reason for change. The decrease in other expense, net was primarily due to a decrease of $35.5 million in unusual items (discussed below) and a decrease of $10.1 in environmental remediation expenses (see discussion of "Environmental Matters" below).
The following table summarizes unusual items, comprised of a component of other (income) expense, net and loss on debt in the consolidated statements of operations:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(In millions)
Aerospace and Defense:
 
 
 
 
 
        Gain on legal matters (1)
$

 
$
(2.0
)
 
$

        Aerospace and defense unusual items

 
(2.0
)
 

Corporate:
 
 
 
 
 
        Loss on debt repurchased (2)

 

 
34.4

        Acquisition costs (1)

 
1.0

 

        Loss on bank amendment (1)
0.2

 

 
0.1

        Corporate unusual items
0.2

 
1.0

 
34.5

            Total unusual items
$
0.2

 
$
(1.0
)
 
$
34.5

________
(1) Operating expense (income)
(2) Non-operating expense
2018 Activity:
We recorded a charge of $0.2 million associated with an amendment to the Senior Credit Facility.
2017 Activity:
We recorded $2.0 million of realized gains, net of interest associated with the failure to register with the SEC the issuance of certain of our common shares under the defined contribution 401(k) employee benefit plan. On May 30, 2017, we made a registered rescission offer to buy back unregistered shares from eligible Plan participants at the original purchase price plus interest, or to reimburse eligible Plan participants for losses they may have incurred if their shares had been sold. The actual cost of the registered rescission offer was less than the previously estimated costs. The registered rescission offer expired on June 30, 2017, and settlement payments of $3.5 million under the offer were completed in the third quarter of 2017.
We recorded $1.0 million of costs related to the acquisition of Coleman Aerospace from L3 Technologies, Inc.
2016 Activity:
On July 18, 2016, we redeemed $460.0 million principal amount of our 7.125% Second-Priority Senior Secured Notes ("7 1/8% Notes"), representing all of the outstanding 7 1/8% Notes, at a redemption price equal to 105.344% of the principal amount, plus accrued and unpaid interest. We incurred a pre-tax charge of $34.1 million in 2016 associated with the extinguishment of the 7 1/8% Notes. The $34.1 million pre-tax charge was the result of the $24.6 million paid in excess of the par value and $9.5 million associated with the write-off of unamortized deferred financing costs.
We retired $13.0 million principal amount of our delayed draw term loan resulting in a loss of $0.3 million.
We recorded a charge of $0.1 million associated with an amendment to the Senior Credit Facility.

22




Interest Income:
 
Year Ended December 31,
 
 
 
Year Ended December 31,
 
 
 
2018
 
2017
 
Change*
 
2017
 
2016
 
Change*
 
(In millions)
Interest income:
$
10.0

 
$
3.5

 
$
6.5

 
$
3.5

 
$
0.6

 
$
2.9

 * Primary reason for change. The increase in interest income was primarily due to higher average cash balances and interest rates for both period comparisons.
Interest Expense:
 
Year Ended December 31,
 
 
 
Year Ended December 31,
 
 
 
2018
 
2017
 
Change*
 
2017
 
2016
 
Change**
 
(In millions)
Components of interest expense:
 
 
 
 
 
 
 
 
 
 
 
Contractual interest and other
$
25.5

 
$
22.4

 
$
3.1

 
$
22.4

 
$
30.2

 
$
(7.8
)
Amortization of debt discount and deferred financing costs
8.9

 
8.5

 
0.4

 
8.5

 
2.3

 
6.2

Interest expense
$
34.4

 
$
30.9

 
$
3.5

 
$
30.9

 
$
32.5

 
$
(1.6
)
* Primary reason for change. The increase in interest expense was primarily due to a higher variable interest rate on our Senior Credit Facility partially offset by a lower principal balance on the Senior Credit Facility. The Senior Credit Facility variable interest rate was 4.52% as of December 31, 2018, compared with 3.82% as of December 31, 2017.
**  Primary reason for change. The decrease in interest expense was primarily due to the retirement of the principal amount of our delayed draw term loan in the first quarter of 2016, the redemption of the 7 1/8% Notes in the third quarter of 2016, and the conversion of 41/16% Convertible Subordinated Debentures to common shares. The decrease was partially offset by interest expense on the debt incurred on the Senior Credit Facility at a variable interest rate of 3.82% as of December 31, 2017, and the issuance of the 2¼% Notes in December 2016 at an effective interest rate of 5.8%.
Income Tax Provision:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(In millions)
Income tax provision
$
51.3

 
$
96.1

 
$
11.2

In 2018, our effective tax rate was 27.2%. Our effective tax rate differed from the 21% statutory federal income tax rate primarily due to an increase from state income taxes and unfavorable adjustments to uncertain tax positions partially offset by R&D credits.
In 2017, our effective tax rate was 110.6%. Our effective tax rate differed from the 35.0% statutory federal income tax rate primarily due to the change in the federal statutory tax rate from 35% to 21% under Tax Cuts and Jobs Act ("Tax Act"). The one time reduction to deferred tax assets due to the Tax Act was $64.6 million or a 74.4% increase to the effective tax rate. Before applying the effects of the Tax Act, the effective tax rate was 36.2%. This rate differs from the 35% federal income tax rate due to an increase from state income taxes partially offset by R&D credits and favorable adjustments to uncertain tax positions.
In 2016, the income tax provision recorded differs from the expected tax that would be calculated by applying the federal statutory rate to our income before income taxes primarily due to the impacts from state income taxes, and certain expenditures which are permanently not deductible for tax purposes, partially offset by the impact of R&D credits.
We recorded an initial estimate of our current tax payable of $127.7 million during the first quarter ended March 31, 2018, based on our best estimate of the impact of the adoption of new revenue recognition guidance and the enactment of certain provisions of tax reform under the Tax Act, both effective on January 1, 2018. Subsequently, guidance was issued by federal taxing authorities providing clarification on provisions within the Tax Act. This new clarification allows us to spread the impact of adoption of the new revenue recognition guidance over a four-year period, reducing the single-year impact in 2018. The current tax payable of $19.8 million as of December 31, 2018, reflects this reduction as well as other refinements to the estimated impacts from both the new revenue recognition guidance and the Tax Act.
As of December 31, 2018, the liability for uncertain income tax positions was $5.9 million. Due to the uncertainty regarding the timing of potential future cash flows associated with these liabilities, we are unable to make a reasonably reliable estimate of the amount and period in which these liabilities might be paid.

23




Retirement Benefit Expense:
 
Year Ended December 31,
 
 
 
Year Ended December 31,
 
 
 
2018
 
2017
 
Change*
 
2017
 
2016
 
Change
 
(In millions)
Components of retirement benefits expense:
 
 
 
 
 
 
 
 
 
 
 
Interest cost on benefit obligation
$
50.9

 
$
59.1

 
$
(8.2
)
 
$
59.1

 
$
66.0

 
$
(6.9
)
Assumed return on assets
(60.1
)
 
(49.5
)
 
(10.6
)
 
(49.5
)
 
(56.1
)
 
6.6

Amortization of prior service credits
(0.1
)
 
(0.1
)
 

 
(0.1
)
 
(1.1
)
 
1.0

Amortization of net losses
66.9

 
63.7

 
3.2

 
63.7

 
60.1

 
3.6

Retirement benefits expense
$
57.6

 
$
73.2

 
$
(15.6
)
 
$
73.2

 
$
68.9

 
$
4.3

 * Primary reason for change. The decrease in retirement benefits expense was primarily due to better than expected investment returns on our pension plan assets and lower interest costs on the benefit obligation.
We estimate that our retirement benefits expense will be approximately $26 million in 2019.
See "Critical Accounting Policies - Retirement Benefit Plans" for more information about our accounting practices with respect to retirement benefits.
Operating Segment Information:
We evaluate our operating segments based on several factors, of which the primary financial measure is segment performance. Segment performance represents net sales less applicable costs, expenses and provisions for unusual items relating to the segment. Excluded from segment performance are: corporate income and expenses, interest expense, interest income, income taxes, legacy income or expenses, and unusual items not related to the segment. We believe that segment performance provides information useful to investors in understanding our underlying operational performance. In addition, we provide the Non-GAAP financial measure of our operational performance called segment performance before environmental remediation provision adjustments, retirement benefits, and segment unusual items. We believe the exclusion of the items listed above permits an evaluation and a comparison of results for ongoing business operations, and it is on this basis that management internally assesses operational performance.
Aerospace and Defense Segment
 
Year Ended December 31,
 
 
 
Year Ended December 31,
 
 
 
2018
 
2017
 
Change*
 
2017
 
2016
 
Change**
 
(In millions, except percentage amounts)
Net sales
$
1,888.1

 
$
1,870.8

 
$
17.3

 
$
1,870.8

 
$
1,753.9

 
$
116.9

Segment performance
264.6

 
177.9

 
86.7

 
177.9

 
143.3

 
34.6

Segment margin
14.0
%
 
9.5
%
 
 
 
9.5
%
 
8.2
%
 
 
Segment margin before environmental remediation provision adjustments, retirement benefits, net, and unusual items (Non-GAAP measure)
12.4
%
 
10.7
%
 
 
 
10.7
%
 
10.4
%
 
 
Components of segment performance:
 
 
 
 
 
 
 
 
 
 
 
Aerospace and Defense before environmental remediation provision adjustments, retirement benefits, net, and unusual items (Non-GAAP measure)
$
233.4

 
$
200.4

 
$
33.0

 
$
200.4

 
$
182.1

 
$
18.3

Environmental remediation provision adjustments
37.2

 
(7.5
)
 
44.7

 
(7.5
)
 
(18.3
)
 
10.8

GAAP/CAS retirement benefits expense difference
(6.0
)
 
(17.0
)
 
11.0

 
(17.0
)
 
(20.5
)
 
3.5

Unusual items

 
2.0

 
(2.0
)
 
2.0

 

 
2.0

Aerospace and Defense total
$
264.6

 
$
177.9

 
$
86.7

 
$
177.9

 
$
143.3

 
$
34.6

Net sales were impacted by the adoption of new revenue recognition guidance effective January 1, 2018, using the modified retrospective method. The primary impact of the new guidance was a change in the timing of revenue recognition on certain long-term contracts. Under this new guidance, we discontinued the use of the unit-of-delivery method on certain customer contracts and re-measured the performance obligations using the cost-to-cost method.

24




Segment performance during 2018 was significantly impacted by a one-time benefit of $43.0 million as a result of reaching a determination with the U.S. government that certain environmental expenditures are reimbursable under the Global Settlement. See Note 8(d) in the consolidated financial statements in Item 8 of this Report for additional information.
* Primary reason for change. Net sales in 2018 would have been $1,902.2 million under the previous revenue recognition guidance which is $31.4 million higher than net sales reported in 2017, resulting from an increase of $126.0 million in defense programs primarily driven by increased deliveries on the Standard Missile and PAC-3 programs. The increase in net sales was partially offset by a decrease of $94.6 million in space programs primarily driven by cost growth and performance issues on the Commercial Crew Development program and lower deliveries on the Atlas V program as this program winds down. The Atlas V program contributed sales of $42.6 million under the new revenue recognition guidance in 2018, and sales of $89.1 million under the previous revenue recognition guidance in 2018.
The increase in the segment margin before environmental remediation provision adjustments, retirement benefits, net and unusual items was primarily due to the following: (i) risk retirements on the RS-68 program, (ii) favorable overhead rate performance, and (iii) cost growth and manufacturing inefficiencies in 2017 on electric propulsion contracts. These factors were partially offset by cost growth and performance issues in the current period on the Commercial Crew Development program and favorable contract performance on the THAAD program in 2017 as a result of risk retirements and cost reductions.
During 2018, we had $59.1 million of favorable changes in contract estimates on operating results before income taxes compared with favorable changes of $37.2 million during 2017.
** Primary reason for change. The increase in net sales was primarily due to an increase of $158.0 million in space programs primarily driven by the following (i) the RS-25 program development and integration effort in support of the SLS development program; (ii) increased development effort and volume on the Commercial Crew Development program; and (iii) increased deliveries on the Atlas V program. The increase in net sales was partially offset by a decrease of $36.5 million in defense programs primarily driven by the timing of deliveries on the THAAD and Standard Missile programs partially offset by the net sales generated from the Coleman Aerospace acquisition. Further, as a result of the 2016 calendar, Aerojet Rocketdyne had 53 weeks of operations in 2016 compared with 52 weeks of operations in 2017. The additional week of operations, which occurred in the fourth quarter of 2016 and accounted for $32.2 million in additional net sales, is included in the above discussion of program changes.
Segment margin before environmental remediation provision adjustments, retirement benefits, net, and unusual items in 2017 compared with 2016 was up 30 basis points. Items that had a significant impact were favorable contract performance on numerous programs as a result of overhead cost reductions and reduced program risks, most notably on the THAAD program, partially offset by cost growth and manufacturing inefficiencies in 2017 on electric propulsion contracts.
Real Estate Segment
 
Year Ended December 31,
 
 
 
Year Ended December 31,
 
 
 
2018
 
2017
 
Change
 
2017
 
2016
 
Change
 
(In millions)
Net sales
$
7.8

 
$
6.4

 
$
1.4

 
$
6.4

 
$
7.4

 
$
(1.0
)
Segment performance
2.8

 
2.5

 
0.3

 
2.5

 
4.3

 
(1.8
)
In 2018, we recognized net sales of $1.4 million from a land sale of 57 acres of the Sacramento Land. During 2017 and 2016, net sales and segment performance consisted primarily of rental property operations.
Backlog:
As of December 31, 2018, our total remaining performance obligations, also referred to as backlog, totaled $4.1 billion. We expect to recognize approximately 45%, or $1.8 billion, of the remaining performance obligations as sales over the next twelve months, an additional 29% the following twelve months, and 26% thereafter. The following table summarizes backlog:
 
As of December 31,
 
2018
 
2017
 
(In billions)
Funded backlog
$
1.9

 
$
2.1

Unfunded backlog
2.2

 
2.5

Total backlog
$
4.1

 
$
4.6

Our adoption of the new revenue recognition guidance accelerated the timing of revenue recognition on some of our contracts which resulted in a $0.6 billion reduction in our backlog as of December 31, 2017. Total backlog includes both funded backlog (unfilled orders for which funding is authorized, appropriated and contractually obligated by the customer) and unfunded backlog (firm orders for which funding has not been appropriated). Indefinite delivery and quantity contracts and unexercised options are not reported in total backlog. Backlog is subject to funding delays or program restructurings/cancellations which are beyond our control.

25




Use of Non-GAAP Financial Measures:
In addition to segment performance (discussed above), we provide the Non-GAAP financial measures of our performance called Adjusted EBITDAP, Adjusted Net Income, and Adjusted EPS. We use these metrics to measure our operating and total Company performance. We believe that for management and investors to effectively compare core performance from period to period, the metrics should exclude items that are not indicative of, or are unrelated to, results from our ongoing business operations such as retirement benefits (pension and postretirement benefits), significant non-cash expenses, the impacts of financing decisions on earnings, and items incurred outside the ordinary, on-going and customary course of our business. Accordingly, we define Adjusted EBITDAP as GAAP net income (loss) adjusted to exclude interest expense, interest income, income taxes, depreciation and amortization, retirement benefits net of amounts that are recoverable under our U.S. government contracts, and unusual items which we do not believe are reflective of such ordinary, on-going and customary activities. Adjusted Net Income and Adjusted EPS exclude retirement benefits net of amounts that are recoverable under our U.S. government contracts and unusual items which we do not believe are reflective of such ordinary, on-going and customary activities. Adjusted Net Income and Adjusted EPS do not represent, and should not be considered an alternative to, net income (loss) or diluted EPS as determined in accordance with GAAP.
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(In millions, except per share and percentage amounts)
Net income (loss)
$
137.3

 
$
(9.2
)
 
$
18.0

Interest expense
34.4

 
30.9

 
32.5

Interest income
(10.0
)
 
(3.5
)
 
(0.6
)
Income tax provision
51.3

 
96.1

 
11.2

Depreciation and amortization
72.3

 
72.6

 
64.9

GAAP retirement benefits expense
57.6

 
73.2

 
68.9

CAS recoverable retirement benefits expense
(38.2
)
 
(36.2
)
 
(29.5
)
Unusual items
0.2

 
(1.0
)
 
34.5

Adjusted EBITDAP
$
304.9

 
$
222.9

 
$
199.9

Adjusted EBITDAP as a percentage of net sales
16.1
%
 
11.9
 %
 
11.3
%
Net income (loss) as a percentage of net sales
7.2
%
 
(0.5
)%
 
1.0
%
 
 
 
 
 
 
Net income (loss)
$
137.3

 
$
(9.2
)
 
$
18.0

GAAP retirement benefits expense
57.6

 
73.2

 
68.9

CAS recoverable retirement benefits expense
(38.2
)
 
(36.2
)
 
(29.5
)
Unusual items
0.2

 
(1.0
)
 
34.5

Income tax impact of adjustments (1)
(5.4
)
 
(15.4
)
 
(34.0
)
One-time reduction in deferred tax assets due to the Tax Act

 
64.6

 

Adjusted Net Income
$
151.5

 
$
76.0

 
$
57.9

 
 
 
 
 
 
Diluted EPS
$
1.75

 
$
(0.13
)
 
$
0.27

Adjustments
0.18

 
1.15

 
0.54

Adjusted EPS
$
1.93

 
$
1.02

 
$
0.81

 
 
 
 
 
 
Diluted weighted average shares, as reported
76.8

 
73.0

 
65.7

Adjustments

 
0.1

 
7.1

Diluted weighted average shares, as adjusted
76.8

 
73.1

 
72.8

_________
(1) The income tax impact is calculated using the federal and state statutory rates in the corresponding year.
We also provide the Non-GAAP financial measure of Free Cash Flow. Free Cash Flow, a Non-GAAP financial measure, is defined as cash flow from operating activities less capital expenditures. Free Cash Flow should not be considered in isolation, as a measure of residual cash flow available for discretionary purposes, or as an alternative to cash flows from operations presented in accordance with GAAP. We use Free Cash Flow, both in presenting our results to stakeholders and the investment community, and in our internal evaluation and management of the business. Management believes that this financial measure is useful because it provides supplemental information to assist investors in viewing the business using the same tools that management uses to evaluate progress in achieving our goals (including under our annual cash and long-term compensation

26




incentive plans). The following table summarizes Free Cash Flow:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(In millions)
Net cash provided by operating activities
$
252.7

 
$
212.8

 
$
158.7

Capital expenditures
(43.2
)
 
(29.4
)
 
(47.6
)
Free cash flow(1)
$
209.5

 
$
183.4

 
$
111.1

 _________
(1) Free Cash Flow, a Non-GAAP financial measure, is defined as cash flow from operating activities less capital expenditures.
Because our method for calculating these Non-GAAP measures may differ from other companies’ methods, the Non-GAAP measures presented above may not be comparable to similarly titled measures reported by other companies. These measures are not recognized in accordance with GAAP, and we do not intend for this information to be considered in isolation or as a substitute for GAAP measures.
Environmental Matters:
Our policy is to conduct our businesses with due regard for the preservation and protection of the environment. We devote a significant amount of resources and management attention to environmental matters and actively manage our ongoing processes to comply with environmental laws and regulations. We are involved in the remediation of environmental conditions that resulted from generally accepted manufacturing and disposal practices at certain plants in the 1950s and 1960s. In addition, we have been designated a PRP with other companies at third party sites undergoing investigation and remediation.
Estimating environmental remediation costs is difficult due to the significant uncertainties inherent in these activities, including the extent of remediation required, changing governmental regulations and legal standards regarding liability, evolving technologies and the long period of time over which most remediation efforts take place. We:
accrue for costs associated with the remediation of environmental pollution when it becomes probable that a liability has been incurred and when our proportionate share of the costs can be reasonably estimated; and
record related estimated recoveries when such recoveries are deemed probable.
In addition to the costs associated with environmental remediation discussed above, we incur expenditures for recurring costs associated with managing hazardous substances or pollutants in ongoing operations which were immaterial for 2018, 2017, and 2016.
The following table summarizes our recoverable amounts, environmental reserves, and range of liability, as of December 31, 2018:
 
Recoverable
Amount (1)
 
Reserve
 
Estimated Range
of Liability
 
(In millions)
Aerojet Rocketdyne - Sacramento
$
182.5

 
$
207.4

 
$207.4 - $311.7
Aerojet Rocketdyne - Baldwin Park Operable Unit ("BPOU")
91.3

 
103.8

 
103.8 - 132.6
Other Aerojet Rocketdyne sites
11.1

 
12.4

 
12.4 - 22.0
Other sites
0.7

 
4.3

 
4.3 - 5.8
Total
$
285.6

 
$
327.9

 
$327.9 - $472.1
_____
(1)
Excludes the receivable from Northrop of $58.5 million as of December 31, 2018, related to environmental costs already paid (and therefore not reserved) by us in prior years and reimbursable under our agreement with Northrop.
Environmental Reserves
We review on a quarterly basis estimated future remediation costs and have an established practice of estimating environmental remediation costs over a fifteen year period, except for those environmental remediation costs with a specific contractual term. Environmental liabilities at the BPOU site are currently estimated through the term of the new project agreement, which expires in May 2027. As the period for which estimated environmental remediation costs lengthens, the reliability of such estimates decreases. These estimates consider the investigative work and analysis of engineers, outside environmental consultants, and the advice of legal staff regarding the status and anticipated results of various administrative and legal proceedings. In most cases, only a range of reasonably possible costs can be estimated. In establishing our reserves, the most probable estimate is used when determinable; otherwise, the minimum amount is used when no single amount in the range is more probable. Accordingly, such estimates can change as we periodically evaluate these estimates when new information becomes available. We cannot predict whether new information gained as projects progress will affect the estimated liability accrued. The timing of payment for estimated future environmental costs is influenced by a number of factors, such as the regulatory approval process and the time required designing, constructing, and implementing the remedy.
The following tables summarizes our environmental reserve activity:

27




 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(In millions)
Balance at beginning of year
$
341.4

 
$
349.7

 
$
302.3

Additions
23.3

 
31.3

 
87.4

Expenditures
(36.8
)
 
(39.6
)
 
(40.0
)
Balance at end of year
$
327.9

 
$
341.4

 
$
349.7

The $23.3 million of environmental reserve additions in 2018 was primarily due to the following items: (i) $8.8 million of additional operations and maintenance for treatment facilities; (ii) $4.6 million of regulatory oversight costs and fees; (iii) $3.8 million of remediation related to operable treatment units; (iv) $2.2 million of sampling analysis costs; and (v) $3.9 million related to other environmental clean-up matters.
The $31.3 million of environmental reserve additions in 2017 was primarily due to the following items: (i) $13.4 million of additional operations and maintenance for treatment facilities; (ii) $6.7 million of additional estimated costs related to the Camden, Arkansas site; (iii) $2.3 million associated with water replacement; and (iv) $8.9 million related to other environmental clean-up matters.
The $87.4 million of environmental reserve additions in 2016 was primarily due to the following items: (i) in 2016, we reached a decision with the U.S. government on the treatment of certain utility costs related to the Sacramento site resulting in a reserve increase of $59.4 million for the estimated impact over the current period and a fifteen year reserve period; (ii) $10.4 million of additional operations and maintenance for treatment facilities; (iii) $5.9 million of remediation related to inactive test sites and landfill clean-up; (iv) $2.7 million of remediation related to operable treatment units; and (v) $9.0 million related to other environmental clean-up matters.
The effect of the final resolution of environmental matters and our obligations for environmental remediation and compliance cannot be accurately predicted due to the uncertainty concerning both the amount and timing of future expenditures and due to regulatory or technological changes. We continue our efforts to mitigate past and future costs through pursuit of claims for recoveries from our insurance carriers and other PRPs and continued investigation of new and more cost effective remediation alternatives and associated technologies.
Estimated Recoveries
Environmental remediation costs are primarily incurred by our Aerospace and Defense segment, and certain of these costs are recoverable from our contracts with the U.S. government. We currently estimate approximately 12% of our future Aerospace and Defense segment environmental remediation costs will not likely be reimbursable and are expensed.
Allowable environmental remediation costs are charged to our contracts as the costs are incurred. Because these costs are recovered through forward-pricing arrangements, the ability of Aerojet Rocketdyne to continue recovering these costs from the U.S. government depends on Aerojet Rocketdyne’s sustained business volume from U.S. government contracts and programs.
While we are currently seeking an arrangement with the U.S. government to recover environmental expenditures in excess of the reimbursement ceiling identified in the Global Settlement, there can be no assurances that such a recovery will be obtained, or if not obtained, that such unreimbursed environmental expenditures will not have a materially adverse effect on our operating results, financial condition, and/or cash flows.
The following table summarizes the activity in the current and non-current recoverable amounts from the U.S. government and Northrop:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(In millions)
Balance at beginning of year
$
321.2

 
$
333.0

 
$
300.4

Additions
18.2

 
21.4

 
67.3

Reimbursements
(28.1
)
 
(31.5
)
 
(35.1
)
Other adjustments (1)
32.8

 
(1.7
)
 
0.4

Balance at end of year
$
344.1

 
$
321.2

 
$
333.0

_____
(1) The adjustment in 2018 was primarily a result of reaching a determination with the U.S. government that certain environmental expenditures are reimbursable under the Global Settlement. See Note 8(d) in the consolidated financial statements in Item 8 of this Report for additional information.
The activity for recoveries is commensurate with the activity associated with the environmental reserve activity.

28




Environmental reserves and recoveries impact on the consolidated statements of operations
The expenses associated with adjustments to the environmental reserves are recorded as a component of other (income) expense, net in the consolidated statements of operations. The following table summarizes the impact of environmental reserves and recoveries to the consolidated statements of operations:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(In millions)
(Benefit) expense to consolidated statement of operations
$
(36.9
)
 
$
8.2

 
$
18.3

Recently Adopted Accounting Pronouncements:
See Note 1(v) in the consolidated financial statements in Item 8 of this Report for information relating to our discussion of the effects of recent accounting pronouncements.
Liquidity and Capital Resources:
Net Cash Provided By (Used In) Operating, Investing, and Financing Activities
The following table summarizes the change in cash, cash equivalents and restricted cash: 
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(In millions)
Net Cash Provided by Operating Activities
$
252.7

 
$
212.8

 
$
158.7

Net Cash Used in Investing Activities
(20.9
)
 
(66.4
)
 
(47.1
)
Net Cash (Used in) Provided by Financing Activities
(26.5
)
 
(21.7
)
 
90.2

Net Increase in Cash, Cash Equivalents and Restricted Cash
$
205.3

 
$
124.7

 
$
201.8

Net Cash Provided by Operating Activities
The $39.9 million increase in cash provided by operating activities in 2018 compared with 2017 was primarily driven by improved operating results and a reduction of $39.7 million in retirement benefit cash funding partially offset by cash usage from working capital. The increased cash usage from working capital was primarily due to (i) an increase of $47.3 million in accounts receivable primarily due to the timing of cash receipts; (ii) an increase of $38.7 million in net income tax payments; and (iii) a decrease of $39.4 million in accounts payable due to vendor payment schedules. These factors were partially offset by improved cash flow from contracts of $39.7 million primarily due to the timing of contract performance payments.
The $54.1 million increase in cash provided by operating activities in 2017 compared with 2016 was primarily driven by improved operating results and cash generation from working capital partially offset by $43.0 million of increased retirement benefit funding. The improved cash generation from working capital was primarily due to (i) a decrease in inventories on the Atlas V and PAC-3 contracts and (ii) an increase in customer advances partially offset by an increase in accounts receivables due to the timing of sales and milestone billings on a space program contract.
Net Cash Used in Investing Activities
During 2018, 2017, and 2016, we had capital expenditures of $43.2 million, $29.4 million, and $47.6 million. The higher capital expenditures in 2016 compared with 2018 and 2017 was primarily related to construction projects associated with supporting our CIP.
During the 2018, we received insurance proceeds of $1.9 million and received net proceeds of $20.4 million in marketable securities.
During 2017, we purchased Coleman Aerospace for $17.0 million and we made a net cash investment of $20.0 million in marketable securities.
Net Cash (Used in) Provided by Financing Activities
During 2018, we had debt cash payments of $25.3 million. During 2017, we had debt cash payments of $20.0 million. During 2016, we had $700.6 million in debt cash payments and borrowings of $800.0 million.

29




Debt Activity
The following table summarizes our debt principal activity:
 
December 31, 2017
 
Cash
Payments
 
Non-cash Activity
 
December 31, 2018
 
(In millions)
Term loan
$
370.0

 
$
(24.4
)
 
$

 
$
345.6

2 1/4% Notes
300.0

 

 

 
300.0

Capital lease obligations
0.9

 
(0.9
)
 
27.2

 
27.2

Total Debt Activity
$
670.9

 
$
(25.3
)
 
$
27.2

 
$
672.8

On September 20, 2018, we amended our Senior Credit Facility to a $1.0 billion commitment (see Note 6 in the consolidated financial statements in Item 8 of this Report).
Outlook
Short-term liquidity requirements consist primarily of recurring operating expenses, including but not limited to costs related to our capital and environmental expenditures, company-funded R&D expenditures, debt service requirements, and retirement benefit plans. We believe that our existing cash and cash equivalents and availability under the Senior Credit Facility coupled with cash generated from our future operations will provide sufficient funds to meet our operating plan for the next twelve months. The operating plan for this period provides for full operation of our businesses, including interest and debt payments. As of December 31, 2018, we had $735.3 million of cash and cash equivalents as well as $620.6 million of available borrowings under our Senior Credit Facility. Based on our existing debt agreements, we were in compliance with our financial and non-financial covenants as of December 31, 2018. Our failure to comply with these covenants could result in an event of default that, if not cured or waived by the lenders, could result in the acceleration of the Senior Credit Facility and 2¼% Notes. In addition, our failure to pay principal and interest when due is a default under the Senior Credit Facility, and in certain cases, would cause a cross default on the 2¼% Notes.
We are committed to a cash management strategy that maintains liquidity to adequately support the operation of the business, our growth strategy and to withstand unanticipated business volatility. Our cash management strategy includes maintaining the flexibility to pay down debt and/or repurchase shares depending on economic and other conditions. In connection with the implementation of our cash management strategy, our management may seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise if we believe that it is in our best interests. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.
Potential future acquisitions depend, in part, on the availability of financial resources at an acceptable cost of capital. We expect to utilize cash on hand and cash generated by operations, as well as cash available under our Senior Credit Facility, which may involve renegotiation of credit limits to finance any future acquisitions. Other sources of capital could include the issuance of common and/or preferred stock, and the placement of debt. We periodically evaluate capital markets and may access such markets when circumstances appear favorable. We believe that sufficient capital resources will be available from one or several of these sources to finance any future acquisitions. However, no assurances can be made that acceptable financing will be available, or that acceptable acquisition candidates will be identified, or that any such acquisitions will be accretive to earnings.
As disclosed in Notes 8(b) and 8(c) in the consolidated financial statements in Item 8 of this Report, we have exposure for certain legal and environmental matters. We believe that it is currently not possible to estimate the impact, if any, that the ultimate resolution of certain of these matters will have on our financial position, results of operations, or cash flows.
Major factors that could adversely impact our forecasted operating cash flows and our financial condition are described in Part I, Item 1A. Risk Factors. In addition, our liquidity and financial condition will continue to be affected by changes in prevailing interest rates on the portion of debt that bears interest at variable interest rates.

30




 Contractual Obligations:
We have contractual obligations and commitments in the form of debt obligations, operating leases, certain other liabilities, and other commitments. The following table summarizes our contractual obligations as of December 31, 2018:
 
Payments due by period
 
Total 
 
Less than
1 year
 
1-3
years
 
3-5
years
 
After
5 years
 
(In millions)
  Long-term debt:
 
 
 
 
 
 
 
 
 
    Senior debt
$
345.6

 
$
17.5

 
$
46.0

 
$
282.1

 
$

    Convertible senior notes (1)
300.0

 
300.0

 

 

 

    Capital lease obligations
27.2

 
0.8

 
1.9

 
1.4

 
23.1

  Interest on long-term debt (2)
93.4

 
23.9

 
31.4

 
23.8

 
14.3

  Huntsville building commitments (3)
32.2

 
1.6

 
3.2

 
3.2

 
24.2

  Postretirement medical and life insurance benefits (4)
29.4

 
4.4

 
7.8

 
6.4

 
10.8

  Operating leases
79.4

 
15.9

 
29.6

 
19.5

 
14.4

Purchase obligations (5)
927.7

 
600.1

 
326.3

 
1.2

 
0.1

  Conditional asset retirement obligations (6)
46.0

 

 
4.3

 
17.6

 
24.1

         Total
$
1,880.9

 
$
964.2

 
$
450.5

 
$
355.2

 
$
111.0

________
(1)
Holders may convert their 2¼% Notes at their option from January 1, 2019, through March 31, 2019, because our closing stock price exceeded $33.80 for at least 20 days in the 30 day period prior to December 31, 2018. We have a stated intention to cash settle the principal amount of the 2¼% Notes with the conversion premium to be settled in common shares. Accordingly, the 2¼% Notes are classified as a current liability as of December 31, 2018. The classification of the 2¼% Notes as current or noncurrent on the balance sheet is evaluated at each reporting date and may change depending on whether the sale price contingency has been met. See Note 6 in the consolidated financial statements in Item 8 of this Report for additional information.
(2)
Includes interest on variable debt calculated based on interest rates at December 31, 2018.
(3) See Note 6(c) in the consolidated financial statements in Item 8 of this Report for additional information.
(4)
The payments presented above are expected payments for the next 10 years. The payments for postretirement medical and life insurance benefits reflect the estimated benefit payments of the plans using the provisions currently in effect. The obligation related to postretirement medical and life insurance benefits is actuarially determined on an annual basis. A substantial portion of these amounts are recoverable through our contracts with the U.S. government.
(5) Purchase obligations represent open purchase orders and other commitments to suppliers, subcontractors, and other outsourcing partners for equipment, materials, and supplies in the normal course of business. These amounts are based on volumes consistent with anticipated requirements to fulfill purchase orders or contracts for product deliveries received, or expected to be received, from customers. A substantial portion of these amounts are recoverable through our contracts with the U.S. government.
(6)
The conditional asset retirement obligations presented are related to our Aerospace and Defense segment and are allowable costs under our contracts with the U.S. government.
We expect to make cash contributions of approximately $37.0 million to our tax-qualified defined benefit pension plan in 2019. We generally are able to recover cash contributions related to our tax-qualified defined benefit pension plan as allowable costs on our U.S. government contracts, but there can be differences between when we contribute cash to our tax-qualified defined benefit pension plan under pension funding rules and recover it under CAS.
Arrangements with Off-Balance Sheet Risk:
See Note 8(e) in the consolidated financial statements in Item 8 of this Report for information relating to our off-balance sheet risk.
Critical Accounting Policies:
Our financial statements are prepared in accordance with GAAP that offer acceptable alternative methods for accounting for certain items affecting our financial results, such as determining inventory cost, depreciating long-lived assets, and recognizing revenues.
The preparation of financial statements requires the use of estimates, assumptions, judgments, and interpretations that can affect the reported amounts of assets, liabilities, revenues, and expenses, the disclosure of contingent assets and liabilities and other supplemental disclosures. The development of accounting estimates is the responsibility of our management. Although we believe that the positions we have taken with regard to uncertainties are reasonable, others might reach different

31




conclusions and our positions can change over time as more information becomes available. If an accounting estimate changes, its effects are accounted for prospectively and, if significant, disclosed in notes of the consolidated financial statements.
The areas most affected by our accounting policies and estimates are revenue recognition, other contract considerations, goodwill, retirement benefit plans, litigation, environmental remediation costs and recoveries, and income taxes. Except for income taxes, which are not allocated to our operating segments, these areas affect the financial results of our business segments.
For a discussion of all of our accounting policies, including the accounting policies discussed below, see Note 1 in the consolidated financial statements in Item 8 of this Report.
Revenue Recognition
In our Aerospace and Defense segment, the majority of our revenue is earned from long-term contracts to design, develop, and manufacture aerospace and defense products, and provide related services, for our customers, including the U.S. government, major aerospace and defense prime contractors, and the commercial sector. Each customer contract defines our distinct performance obligations and the associated transaction price for each obligation. A contract may contain one or multiple performance obligations. In certain circumstances, multiple contracts with a customer are required to be combined in determining the distinct performance obligation. For contracts with multiple performance obligations, we allocate the contracted transaction price to each performance obligation based upon the relative standalone selling price, which represents the price at which we would sell the promised good or service separately to the customer. We determine the standalone selling price based upon the facts and circumstances of each obligated good or service. The majority of our contracts have no observable standalone selling price since the associated products and services are customized to customer specifications. As such, the standalone selling price generally reflects our forecast of the total cost to satisfy the performance obligation plus an appropriate profit margin.
Contract modifications are routine in the performance of our long-term contracts. Contracts are often modified to account for changes in contract specifications or requirements. In most instances, contract modifications are for goods or services that are not distinct, and, therefore, are accounted for as part of the existing contract.
We recognize revenue as each performance obligation is satisfied. The majority of our aerospace and defense performance obligations are satisfied over time either as the service is provided, or as control transfers to the customer. Transfer of control is evidenced by our contractual right to payment for work performed to date plus a reasonable profit on contracts with highly customized products that we have no alternative use for. We measure progress on substantially all our performance obligations using the cost-to-cost method, which we believe best depicts the transfer of control of goods and services to the customer. Under the cost-to-cost method, we record revenues based upon costs incurred to date relative to the total estimated cost at completion. Contract costs include labor, material, overhead, and general and administrative expenses, as appropriate.  
Recognition of revenue and profit on long-term contracts requires the use of assumptions and estimates related to the total contract value, the total cost at completion, and the measurement of progress towards completion for each performance obligation. Due to the nature of the programs, developing the estimated total contract value and total cost at completion for each performance obligation requires the use of significant judgment.
The contract value of long-term contracts may include variable consideration, such as incentives, awards, or penalties. The value of variable consideration is generally determined by contracted performance metrics, which may include targets for cost, performance, quality, and schedule. We include variable consideration in the transaction price for the respective performance obligation at either estimated value, or most likely amount to be earned, based upon our assessment of expected performance. We record these amounts only to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved.
We evaluate the contract value and cost estimates for performance obligations at least quarterly and more frequently when circumstances significantly change. Factors considered in estimating the work to be completed include, but are not limited to: labor productivity, the nature and technical complexity of the work to be performed, availability and cost volatility of materials, subcontractor and vendor performance, warranty costs, volume assumptions, anticipated labor agreements, inflationary trends, schedule and performance delays, availability of funding from the customer, and the recoverability of costs incurred outside the original contract included in any estimates to complete. When our estimate of total costs to be incurred to satisfy a performance obligation exceeds the expected revenue, we recognize the loss immediately. When we determine that a change in estimates has an impact on the associated profit of a performance obligation, we record the cumulative positive or negative adjustment to the statement of operations. Changes in estimates and assumptions related to the status of certain long-term contracts may have a material effect on our operating results. The following table summarizes the impact of the changes in significant contract

32




accounting estimates on our Aerospace and Defense segment operating results:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(In millions, except per share amounts)
Net favorable effect of the changes in contract estimates on net sales
$
68.2

 
$
33.7

 
$
2.7

Favorable effect of the changes in contract estimates on income before income taxes
59.1

 
37.2

 
14.1

Favorable effect of the changes in contract estimates on net income (loss)
43.1

 
22.3

 
8.5

Favorable effect of the changes in contract estimates on basic net income (loss) per share
0.56

 
0.31

 
0.13

Favorable effect of the changes in contract estimates on diluted net income (loss) per share
0.55

 
0.31

 
0.11

See Note 1(p) in the consolidated financial statements in Item 8 of this Report for additional information.
Other Contract Considerations
The majority of Aerospace and Defense segment sales are driven by pricing based on costs incurred to produce products and perform services under contracts with the U.S. government. Cost-based pricing is determined under the FAR and CAS. The FAR and CAS provide guidance on the types of costs that are allowable and allocable in establishing prices for goods and services from U.S. government contracts. For example, costs such as charitable contributions, advertising, interest expense, and public relations are unallowable, and therefore not recoverable through sales. In addition, we may enter into agreements with the U.S. government that address the subjects of allowability and allocability of costs to contracts for specific matters.
We closely monitor compliance with and the consistent application of our critical accounting policies related to contract accounting. We review the status of contracts through periodic contract status and performance reviews. Also, regular and recurring evaluations of contract cost, scheduling and technical matters are performed by management personnel independent from the business segment performing work under the contract. Costs incurred and allocated to contracts with the U.S. government are reviewed for compliance with regulatory standards by our personnel, and are subject to audit by the DCAA. Accordingly, we record an allowance on our unbilled receivables for amounts of potential contract overhead costs which may not be successfully negotiated and collected.
Goodwill
Goodwill represents the excess of the purchase price of an acquired enterprise or assets over the fair values of the identifiable assets acquired and liabilities assumed. All of our recorded goodwill resides in the Aerospace and Defense reporting unit. Tests for impairment of goodwill are performed on an annual basis, or at any other time if events occur or circumstances indicate that the carrying amount of goodwill may not be recoverable. Circumstances that could trigger an impairment test include but are not limited to: a significant adverse change in the business climate or legal factors; adverse cash flow trends; an adverse action or assessment by a regulator; unanticipated competition; loss of key personnel; decline in stock price; and results of testing for recoverability of a significant asset group within a reporting unit.
We evaluate qualitative factors (including macroeconomic conditions, industry and market considerations, cost factors, and overall financial performance) to determine whether it is necessary to perform the first step of the goodwill test. This step is referred to as the "Step Zero" analysis. If it is determined that it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount, we will proceed to the quantitative ("Step One") analysis to determine the existence and amount of any goodwill impairment. We may also perform a Step One analysis from time to time to augment our qualitative assessment. We evaluated goodwill using a "Step One" analysis as of October 1, 2018, and determined that goodwill was not impaired. We evaluated goodwill using a "Step Zero" analysis as of October 1, 2017, and determined that goodwill was not impaired.
There can be no assurance that our estimates and assumptions made for purposes of our goodwill impairment testing will prove to be accurate predictions of the future. If our assumptions and estimates are incorrect, we may be required to record goodwill impairment charges in future periods.
Retirement Benefit Plans
We discontinued future benefit accruals for our defined benefit pension plans in 2009. We provide medical and life insurance benefits to certain eligible retired employees, with varied coverage by employee group. Annual charges are made for the cost of the plans, including interest costs on benefit obligations, and net amortization and deferrals, increased or reduced by the return on assets. We also sponsor a defined contribution 401(k) plan and participation in the plan is available to all employees.
Retirement benefits are a significant cost of doing business and represent obligations that will be ultimately settled far in the future and therefore are subject to estimates. We generally are able to recover cash contributions related to our tax-qualified defined benefit pension plan as allowable costs on our U.S. government contracts, but there is a lag between when we contribute cash to our tax-qualified defined benefit pension plan under pension funding rules and recover it under our U.S.

33




government contracts. Our pension and medical and life insurance benefit obligations and related costs are calculated using actuarial concepts in accordance with GAAP. We are required to make assumptions regarding such variables as the expected long-term rate of return on assets and the discount rate applied to determine the retirement benefit obligations and expense (income) for the year.
The following table presents the assumptions to determine the benefit obligations:
 
Pension
Benefits
 
Medical and
Life Insurance Benefits
 
As of December 31,
 
As of December 31,
 
2018
 
2017
 
2018
 
2017
Discount rate
4.27
%
 
3.59
%
 
4.09
%
 
3.37
%
The following table presents the assumptions to determine the retirement benefits expense (income):
 
Pension Benefits
 
Medical and
Life Insurance Benefits 
 
Year Ended December 31,
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
2018
 
2017
 
2016
Discount rate
3.59
%
 
4.02
%
 
4.36
%
 
3.37
%
 
3.68
%
 
3.99
%
Expected long-term rate of return on assets
7.00
%
 
7.00
%
 
7.00
%
 
*

 
*

 
*

____
*
Not applicable as our medical and life insurance benefits are unfunded.
The discount rate represents the current market interest rate used to determine the present value of future cash flows currently expected to be required to settle pension obligations. Based on market conditions, discount rates can experience significant variability. Changes in discount rates can significantly change the liability and, accordingly, the funded status of the pension plan. The assumed discount rate represents the market rate available for investments in high-quality fixed income instruments with maturities matched to the expected benefit payments for pension and medical and life insurance benefit plans.
The expected long-term rate of return on assets represents the rate of earnings expected in the funds invested, and funds to be invested, to provide for anticipated benefit payments to plan participants. We evaluated the historical investment performance, current and expected asset allocation, and, with input from our external advisors, developed best estimates of future investment performance. 
 Market conditions and interest rates significantly affect assets and liabilities of our pension plans. Pension accounting permits market gains and losses to be deferred and recognized over a period of years. This "smoothing" results in the creation of other accumulated income or loss which will be amortized to pension costs in future years. The accounting method we utilize recognizes one-fifth of the unamortized gains and losses in the market-related value of pension assets and all other gains and losses including changes in the discount rate used to calculate the benefit obligation each year. Investment gains or losses for this purpose are the difference between the expected return and the actual return on the market-related value of assets which smoothes asset values over three years. Although the smoothing period mitigates some volatility in the calculation of annual pension costs, future pension costs are impacted by changes in the market value of assets and changes in interest rates.
The following table summarizes the effects of a one-percentage-point change in key assumptions on the projected benefit obligations as of December 31, 2018, and on retirement benefits expense for 2018:
 
Pension Benefits and
Medical and Life Insurance Benefits Discount Rate
 
Expected Long-term
Rate of Return
 
Assumed Healthcare
Cost Trend Rate
 
Net Periodic
Benefit Expense
 
Projected
Benefit
Obligation
 
Net Periodic Pension
Benefit Expense
 
Net Periodic
Medical and Life
Insurance Benefit Expense
 
Accumulated
Benefit
Obligation
 
(In millions)
1% decrease
$20.5</