UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the fiscal year ended: December 31 , 2021
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
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
(Address of principal executive offices) (Zip Code)
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||||||||
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 ☒ 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 ☒
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 ☒ 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 ☒ No ☐
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.
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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes ☐ No ☒
The aggregate market value of the voting common equity held by nonaffiliates of the registrant as of June 30, 2021, was $3.9 billion.
As of February 11, 2022, there were 80,544,197 outstanding shares of the Company’s common stock, including unvested common shares, $0.10 par value.
Aerojet Rocketdyne Holdings, Inc.
Annual Report on Form 10-K
For the Year Ended December 31, 2021
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 | Reserved | |||||||
| 7 | Management’s Discussion and Analysis of Financial Condition and Results of Operations | |||||||
| 7A. | Quantitative and Qualitative Disclosures About Market Risk | |||||||
| 8 | Financial Statements and Supplementary Data | |||||||
| 9 | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | |||||||
| 9A. | Controls and Procedures | |||||||
| 9B. | Other Information | |||||||
| 9C | Disclosure Regarding Foreign Jurisdictions that Prevent Inspections | |||||||
| 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 the termination of the proposed merger with Lockheed Martin Corporation ("Lockheed Martin"), the continuity of the Company’s Board of Directors and management and their strategic oversight, the uncertainties arising from the coronavirus ("COVID-19") pandemic, 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 the Company’s 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 are currently in the process of seeking zoning changes and other governmental approvals on our excess real estate assets.
Terminated Merger Agreement
On December 20, 2020, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Lockheed Martin and Mizar Sub, Inc., a wholly-owned subsidiary of Lockheed Martin ("Merger Sub"), pursuant to which each share of common stock of the Company would have been automatically converted into the right to receive cash in an amount equal to $51.00 per share, adjusted from $56.00 following the payment of a one-time cash dividend of $5.00 per share paid in March 2021 (the "Pre-Closing Dividend") and the Company would have become a wholly-owned subsidiary of Lockheed Martin (the "Merger").
On January 25, 2022, the Federal Trade Commission ("FTC") filed a complaint against the Company and Lockheed Martin in the FTC’s administrative court and a complaint in U.S. federal court seeking a preliminary injunction to stop the deal pending an administrative trial (the "FTC Litigation"). On February 13, 2022, Lockheed Martin notified the Company that it had elected to terminate the Merger Agreement. On February 14, 2022, pursuant to the parties’ joint motion, the administrative complaint and the U.S. federal court complaint were dismissed.
Aerospace and Defense
Aerojet Rocketdyne is a world-recognized technology-based engineering and manufacturing company that develops and produces specialized power and propulsion systems, as well as armament systems. We develop and manufacture liquid and solid rocket propulsion, air-breathing hypersonic engines, and electric power and propulsion for space, defense, civil and commercial applications. Principal customers and end users include the DoD (including the U.S. Air Force ("USAF"), U.S. Space Force, U.S. Army, Missile Defense Agency ("MDA"), and U.S. Navy), NASA, The Boeing Company ("Boeing"), Lockheed Martin, Raytheon Technologies Corporation ("Raytheon"), Northrop Grumman Corporation ("Northrop"), and United Launch Alliance ("ULA").
We have demonstrated a legacy of successfully meeting the most challenging missions by producing some of the world’s most technologically advanced propulsion systems to meet our nation's critical needs. We believe we maintain a unique competitive position due to our strategic focus on creating and maintaining a broad spectrum of propulsion and energetic products assisted by the growing market demand for our 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, 2021, our remaining performance obligations, also referred to as backlog, totaled $6.8 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 $3.1 billion.
1
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, including liquid propellant engines and solid rocket motors required for launch vehicle and in-space applications supporting defense, civil and commercial missions.
Our space propulsion and power systems have a long and distinguished flight heritage with the U.S. government and commercial customers. We provide liquid propulsion for the first and upper stages of ULA’s Delta IV Heavy launch vehicle, as well as the liquid upper-stage propulsion for their Atlas V launch vehicle. ULA’s new Vulcan Centaur launch vehicle is expected to make its debut flight in 2022 and we will supply two RL10 upper-stage engines for each Vulcan Centaur mission.
In 2021, propulsion hardware supplied by us helped put the U.S.’s newest land imaging satellite, Landsat 9, into orbit and propulsion systems onboard the spacecraft will play an ongoing role in mission operations. The Landsat 9 launch featured four firings of our RL10 engine. Additionally, the fifth Space Based Infrared System Geosynchronous Earth Orbit satellite launched this year with our propulsion. This launch marked an important milestone for us as it was the first operational use of an RL10 engine equipped with 3D-printed components.
We continue to support the exploration of deep space. In 2021, NASA’s new mega Moon rocket, the Space Launch System ("SLS"), simultaneously hot-fired four of our RS-25 engines. The Mega rocket is being prepared for its first launch in 2022.
Our RS-25 main engines will help propel SLS during its initial phase of flight by providing over two million pounds of combined thrust. We will also provide the RL10 engine that propels the Interim Cryogenic Propulsion Stage, or the second stage, of the SLS. This engine provides the thrust needed to accelerate the Orion spacecraft towards the Moon.
During 2021, we were awarded a contract to deliver up to 20 new Orion Main Engines for future missions. Additionally, we completed an expansion of our Los Angeles facility to support production of new RS-25 engines and support NASA’s exploration needs for decades to come.
NASA’s first planetary defense mission, the Double Asteroid Redirection Test mission, also launched in 2021. The spacecraft, which will be flown head-on into an asteroid to see if it can change its orbit, includes both chemical and electric propulsion systems built by Aerojet Rocketdyne. NASA’s Evolutionary Xenon Thruster – Commercial ("NEXT-C"). NEXT-C successfully fired on orbit for the first time for two hours in late December 2021.
Our key space programs include: (i) RL10 engines that power ULA launch vehicles, (ii) RS-25 main and RL10 upper stage engines that power NASA’s SLS heavy-lift rocket for deep space exploration, (iii) propulsion for the Orion human spacecraft and the Starliner Commercial Crew Transportation Capability capsule, (iv) power systems for science missions, and (v) multiple electric and chemical propulsion systems that provide in-space maneuvering capability for spacecraft and satellites.
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 and hypersonic scramjet) systems for missile applications. The majority of these applications are the primary axial propulsion for missile systems. 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 ground and sea-based strategic missiles. Using our energetics expertise we also design, develop, and produce warhead/lethality systems for tactical missiles and stored chemical energy propulsion for torpedoes. Our products have been successfully fielded on multiple active U.S. and international weapon system platforms. The breadth of our applications includes tactical missiles, missile defense interceptors, hypersonic systems, strategic boosters and post-boost systems and torpedo propulsion for a variety of applications.
During 2021, 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 programs, to include executing a three-year production contract with Lockheed Martin for PAC3 propulsion elements to include the Missile Segment Enhancement rocket motor, the Attitude Control Motors, and Lethality Enhancer. These franchise programs continue to be globally deployed in support of U.S. and allied armed forces.
In the hypersonic propulsion arena, we continued to advance the state of the art of air-breathing scramjet engines with tests that achieved record thrust levels in simulated hypersonic flight conditions. Our work on complementary air-breathing propulsion (ramjet/scramjet) for hypersonic missiles continued in 2021 with the completion of flight-ready engines.
In 2021, we were awarded engineering and manufacturing development contracts for various propulsion systems from both of the national teams working on the MDA's Next Generation Interceptor. This is a significant complement to the Ground Based Strategic Deterrent ("GBSD") work initiated in 2020 in both the post-boost and large solid propulsion areas.
Finally, in 2021, our Aerojet Rocketdyne Coleman Aerospace ("Coleman") business continued to expand its scope on the medium-range ballistic missile ("MRBM") target program with capture of significant propulsion system upgrades for future production which will provide more mission flexibility and capability.
A subset of our key defense programs include: (i) Boosters and Solid DACs for the Navy’s Standard Missile family, (ii) Booster and Liquid DACs for THAAD, (iii) PAC-3, (iv) GMLRS, (v) Stinger, (vi) Javelin, (vii) Tactical Tomahawk, (viii) Army Tactical Missile Systems ("ATACMS"), (ix) Tube-launched Optically-tracked Wire-guided ("TOW") warhead, and (x) GBSD.
2
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 business vary by product type and customer, but we experience many of the same challenges as the broader aerospace and defense industry. The large majority of products we manufacture are highly complex, technically sophisticated and extremely difficult or hazardous to build, which require rigorous manufacturing systems and highly specialized manufacturing equipment. While historically these factors contributed to substantial barriers to entry, modern design tools and manufacturing techniques (such as additive manufacturing) are enabling new entrants with the funding to enter this industry, leading to increased competition. For example, competitors such as SpaceX and Blue Origin have developed propulsion systems for their space launch vehicles. These new competitors have signaled their intent to compete primarily on price and are willing to take on substantial risk exposure on development programs with unproven market potential and are, therefore, disrupting existing cost paradigms and manufacturing methodologies. Additionally, Northrop is a longstanding competitor for nearly all of the Company’s propulsion products. For in-space propulsion, customer demand for small satellites is rapidly expanding, and small satellites are increasingly displacing large satellites, which comprise the core end use for the Company’s in-space propulsion products. We see a number of new startups entering into the supply of both chemical propulsion and electric propulsion systems for small satellites. In missiles and missile defense systems, the U.S. government has utilized its resources to facilitate entry and expansion by propulsion suppliers in order to shore up the U.S. rocket propulsion industrial base. For example, the Naval Surface Warfare Center has partnered with both Nammo Energetics Indian Head ("Nammo") and MBDA Incorporated ("MBDA") to support the development of solid propulsion, and the Defense Advanced Research Projects Agency and Air Force Research Laboratory have awarded Small Business Innovation Research contracts to Innoveering, LLC in support of its air-breathing hypersonic propulsion development.
The following table lists significant participants in the propulsion market (in alphabetical order):
| Parent Company | Propulsion Type | ||||
| Aerojet Rocketdyne Holdings, Inc. | Solid, liquid, air-breathing, electric | ||||
ArianeGroup | Solid, liquid, electric | ||||
| Avio S.p.A | Solid, liquid | ||||
| Busek Co. Inc. | Electric | ||||
| Blue Origin | Liquid | ||||
| Fakel | Liquid | ||||
| Frontier | Liquid | ||||
| General Dynamics | Solid | ||||
| IHI Aerospace | Liquid, electric | ||||
| Innoveering, LLC | Air-breathing | ||||
| MBDA | Solid | ||||
| Moog Inc. | Liquid | ||||
| Nammo | Solid, liquid | ||||
| Northrop | Solid, liquid, air-breathing | ||||
| Safran | Electric | ||||
| SpaceX | Liquid, electric | ||||
| Voyager Space | Solid | ||||
Industry Overview
Our primary aerospace and defense customers include DoD, NASA, and the prime contractors that supply products to these customers. We rely on U.S. government funding for aerospace and defense and our backlog depends, in large part, on the continued funding by the U.S. government for these programs. While Government Fiscal Year ("GFY") 2021 funding provided by the Consolidated Appropriations Act, 2021 (Public Law 116-260) expired on September 30, 2021, the Congress passed and the President signed into law two consecutive Continuing Resolutions. The Fiscal Year 2022 Extending Funding and Emergency Assistance Act (Public Law 117-43) extended GFY 2021 funding levels through December 3, 2021, and, subsequently, the Further Extending Government Funding Act (Public Law 117-70), extends GFY 2021 funding levels through February 18, 2022. Disruptions to our customer’s facilities or delays in supply chain as a result of COVID-19 could delay or decrease expenditures by U.S. government agencies. Such a decrease in DoD and/or NASA expenditures, the elimination or curtailment of a 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.
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."
3
Contract Types
Research and development ("R&D") 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. Our 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 2021, approximately 57% of our net sales were from fixed-price contracts and 43% 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, Other Transaction Agreement ("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 R&D 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. Generally, 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 R&D.
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.
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
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. See Note 1 in the consolidated financial statements in Item 8 of this Report for additional information on R&D expenditures.
4
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 11,277 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 previously used for our aerospace and defense operations, 628 acres available for future entitlement, and 5,446 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 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 a variety of 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 | 1,270 | 272 | 1,542 | — | ||||||||||||||||||||||
| Hillsborough (2) | 51 | 97 | 148 | 148 | ||||||||||||||||||||||
| Office Park and Auto Mall | 47 | 8 | 55 | 55 | ||||||||||||||||||||||
| Total Easton acreage | 4,229 | 1,217 | 5,446 | 3,904 | ||||||||||||||||||||||
| Former operations land (3) | 24 | 5,179 | 5,203 | |||||||||||||||||||||||
| Land available for future entitlement (4) | 386 | 242 | 628 | |||||||||||||||||||||||
| Total Sacramento Land | 4,639 | 6,638 | 11,277 | |||||||||||||||||||||||
_________
5
(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(b) 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) In 2019, we completed our manufacturing commitments in our Sacramento, California facility and transitioned the Sacramento site to host our shared services function.
(4) 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
We currently lease office space to various third parties that generated $2.5 million in revenue in 2021.
Environmental Matters
Our current and former business operations are subject to, and affected by, federal, state, and local 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 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 2021 nor do we anticipate any material capital expenditures in 2022 and 2023. See Management’s Discussion and Analysis in Part II, Item 7 "Environmental Matters" and "Environmental Reserves and Estimated Recoveries " 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, 2021, 8% of our 5,000 employees were covered by collective bargaining agreements. We believe that our relations with our employees and unions are good. Our workforce, along with their commitment to our values, provides the foundation of our Company’s success.
Human Capital Management
We believe our success depends on the strength of our workforce. Our integrated human capital management strategy includes the acquisition, development, and retention of talent, as well as the design of compensation and benefits programs, to deliver on our strategy.
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Development - We enable our employees to reach their full potential by providing a wide range of career development and opportunities, skill development and resources they need to be successful. Our Rocket University learning platform supplements our talent development strategies and enables employees to access instructor-led classroom or virtual courses and self-directed web-based courses. Our annual Succession Planning and Talent Management process is the formal identification and development of our next generation leaders and supports the development of our talent pipeline for key roles across the enterprise. We encourage advancement and movement across our organization to fill our open positions with strong and experienced management talent and individual contributors.
Inclusion, Diversity and Engagement ("ID&E") – We believe in the strength of engaged and diverse teams in an inclusive work environment to unleash the potential of our employees. Through the efforts of these diverse and collaborative teams, we seek to be on the cutting edge of technology and exceed customer expectations. We have established a corporate-wide ID&E council and a number of executive-sponsored employee resource groups ("ERG") across the enterprise, where employees can foster connections and develop in a supportive environment. Our ERGs support the acquisition of diverse talent internally and externally. To assess and improve employee engagement, we survey our employees and take actions to address areas of employee concern.
Health and Safety - Safety is one of our core values. We are committed to a safe work environment for our employees as well as being good stewards of the natural environment. Like many companies, the COVID-19 pandemic has been especially challenging as we focused our health and safety efforts on protecting our employees and their families from potential COVID-19 exposure while delivering excellent performance to our customers. Since the beginning of the COVID-19 pandemic, we have developed plans and taken focused actions aligned with the Centers for Disease Control and Prevention to protect, manage, and communicate with our employees to contain the impacts of COVID-19.
Retention – The labor market has been impacted by the COVID-19 pandemic and other global economic factors, causing more competition among employers, including us, and making it more difficult to find and retain quality employees. We are also periodically subject to our competitors seeking to entice our employees to leave the Company. Ongoing uncertainty surrounding internal governance matters and other recent developments, including the termination of the Merger Agreement with Lockheed Martin, have also impacted our ability to retain qualified employees at various levels within the Company. In keeping with our values discussed in the preceding paragraphs, we continue to see our employees as a significant asset and are working to encourage employee retention.
Corporate Information
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 Internet website 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).
Item 1A. Risk Factors
The following discussion describes the material factors, events, and uncertainties that make an investment in us risky, and these risk factors should be considered carefully together with all other information in this Report, including the financial statements and notes thereto. This discussion does not include all risks that we face, and additional risks or uncertainties that are currently not known to us, or that are not currently believed to be material may occur or become material. The occurrence of any of these factors, events, or uncertainties may, in ways we may or may not accurately predict, adversely affect our business, operations, financial condition, and results.
Risks Related to the Merger and Other Recent Developments
Failure to complete the Merger with Lockheed Martin has negatively impacted, and could continue in the future to negatively impact the price of our common stock, as well as our future business and financial results.
On December 20, 2020, we entered into the Merger Agreement, pursuant to which Lockheed Martin agreed to acquire us, as described in Part I, Item 1 of this Report. On January 25, 2022, the FTC filed a complaint against the Company and Lockheed Martin in the FTC’s administrative court and a complaint in U.S. federal court seeking a preliminary injunction to stop the FTC Litigation. On February 13, 2022, Lockheed Martin notified the Company that it had elected to terminate the Merger Agreement. On February 14, 2022, pursuant to the parties’ joint motion, the administrative complaint and U.S. federal court complaint were dismissed.
As a result of the failure to complete the Merger, our involvement in the Merger negatively impacted our business in a variety of ways. For example, the market price of our common stock has fluctuated significantly as a result of developments with respect to the Merger and the reaction of financial markets to those developments. During the time we were pursuing the proposed merger, some of management's attention was directed to the Merger instead of being directed to our own operations and the pursuit of other opportunities that could have been beneficial to us. Uncertainty surrounding the Company’s future ownership may negatively impact how customers, suppliers, and other third parties perceive us and our business, which in turn
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could affect our ability to compete for business. Similarly, uncertainty surrounding the Company’s future ownership impacted some employees’ perception of the Company and their ongoing employment prospects.
In addition, neither the Company nor the holders of our common stock realized the significant premium on the price of the Company’s common stock that would have been payable in the Merger. Moreover, we have nevertheless incurred substantial transaction-related fees and costs, including payment of the Pre-Closing Dividend and the loss of management time and resources. Payment of those costs has resulted in the Company having less cash on hand, which could adversely affect our operating results.
As a result of the failure to close the proposed Merger, stockholders may lack confidence in the Company and its ability to execute on future strategies and operations, and other strategic buyers may be more hesitant or unwilling to consider us as an acquisition target.
Expenses related to the Merger have been and may continue to be significant, and will adversely affect our operating results.
We have incurred significant expenses in connection with the Merger, including legal and investment banking fees, and fees related to the FTC Litigation. Despite termination of the Merger Agreement under circumstances not requiring payment of a termination fee to Lockheed Martin, we expect to continue to incur related expenses as we re-focus on operating as an independent company. We expect these costs to have an adverse effect on our operating results.
Uncertainties associated with termination of the Merger Agreement and internal governance matters may cause a loss of management and other key employees and disrupt our business relationships, which could adversely affect our business.
Termination of the Merger Agreement and uncertainty about the effect of internal governance matters may have an adverse effect on our business and our relationships with customers and suppliers. These uncertainties may impair our ability to attract, retain and motivate key personnel. Employee retention may be particularly challenging during the uncertainty created by failure of the Merger. If key employees depart as we face additional uncertainties relating to internal governance matters, our business relationships may be subject to disruption as customers, suppliers and other third parties attempt to negotiate changes in existing business relationships or consider entering into business relationships with parties other than the Company. If key employees depart or if our existing business relationships suffer, our results of operations may be adversely affected.
Termination of the Merger Agreement and circumstances surrounding the FTC Litigation could discourage another potential acquirer of us.
The FTC’s objection to the Merger, its decision to file suit to block the Merger, and Lockheed Martin’s decision to terminate the Merger Agreement could discourage other potential third-party acquirers that might have an interest in acquiring all or a significant portion of us from considering or proposing that acquisition, or might otherwise result in a potential third-party acquirer proposing to pay a lower price to our stockholders than they might otherwise have proposed to pay due to the added uncertainty regarding regulatory approval of any potential transaction.
Payment of the Pre-Closing Dividend resulted in a significant outflow of cash and was not conditioned upon the closing of the Merger, which means that the Company is operating with less liquidity than was previously available to us and will continue to operate with less liquidity due to failure to complete the Merger.
The Pre-Closing Dividend was declared by the Board of Directors in connection with the announcement of the Merger. The Pre-Closing Dividend was paid on March 24, 2021, and resulted in a payment of $428.8 million in 2021. As a result, we have been, and will continue to be, required to operate the business with less cash on hand than we would have had if the Pre-Closing Dividend had not been paid. This decrease in liquidity could have an adverse effect on our operating results and financial condition as we continue to operate as an independent company.
Our stock price is subject to fluctuations.
The trading price of our common stock has been and may continue to be volatile. Our stock price has fluctuated in response to a number of events and factors, such as termination of the Merger Agreement, the FTC Litigation, internal governance matters, general economic and financial conditions, our own quarterly variations in operating results, changes in financial estimates and recommendations by securities analysts, changes in applicable laws or regulations, changes affecting our industry, and other events impacting our business. The stock market in general has experienced extreme volatility that may be unrelated to the operating performance of a particular company. These broad market and industry fluctuations may adversely affect the price of our common stock, regardless of our operating performance.
The termination of the Merger Agreement, and uncertainty regarding the ongoing litigation involving directors, deliberation and dialogue regarding director nominations, and other internal governance matters have exacerbated the volatility of our stock price. These matters distract management from their day-to-day responsibilities and can be disruptive to our business operations, as well as the overall strategic direction of the Company. In addition, our Board of Directors is comprised of eight directors, and the failure to achieve a majority vote with respect to proposed corporate action has prevented, and may in the future continue to prevent, the Company from taking certain actions. We expect developments to continue with respect to these matters and it is not possible to anticipate what such developments will be or how they will impact our stock price.
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Risks Related to our Business and Industry
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 sales. 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 the 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.
In addition, U.S. government agency budgets could be negatively impacted by several factors, including, but not limited to, a change in defense spending policy as a result of the presidential election or otherwise, the U.S. government’s budget deficits, spending priorities (e.g., allocating more spending to combat the effects of the COVID-19 pandemic), the cost of sustaining the U.S. military presence internationally and possible political pressure to reduce U.S. government military spending, each of which could cause agency budgets to remain unchanged or to decline. A significant decline in U.S. military expenditures could result in a reduction in the amount of our products sold to the various agencies and buying organizations of the U.S. government.
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 96% of our total net sales in 2021. 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 under a fixed-price type contract, typically we would be entitled to receive the purchase price for delivered items, reimbursement for allowable costs for work-in-process and an allowance for profit on the contract or adjustment for loss if completion of performance would have resulted in a loss. If terminated for convenience under a cost-reimbursable contract, typically we would be entitled to reimbursement of allowable costs plus a portion of the fee where allowable costs include our cost to terminate agreements with our suppliers and subcontractors. The amount of the fee recovered, if any, is related to the portion of the work accomplished prior to termination and is determined by negotiation.
In addition, we attempt to ensure that adequate funds are available by notifying the customer when its estimated costs, including those associated with a possible termination for convenience, approach levels specified as being allotted to its programs. Funds are typically appropriated on a fiscal year basis and costs of a termination for convenience may exceed the costs of continuing a program in a given fiscal year; however, programs occasionally do not have sufficient funds appropriated to cover the government’s termination liability if the government were to terminate them for convenience.
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 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 customers terminating their contract with us for default. A termination for default could expose us to liability and adversely affect our financial performance and our ability to win new contracts.
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 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.
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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. The abnormal escalation pricing language in our contracts and proposals 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. Efforts to minimize impacts through contracting levers may not be successful or sustainable.
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. Similarly, European laws and regulations that apply to our business have additional strategic material sourcing requirements. 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, the 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 from the U.S. government continue to evolve and continue to be a challenge as some small key/critical suppliers may not have the capability or infrastructure to support the requirements.
We have closely monitored the impacts of the COVID-19 pandemic on our supply chain. Several short term impacts were identified and mitigated, and we worked with suppliers who had staffing shortages. We identified a handful of components that had a wider reaching impact and continue to monitor the status on the impacted programs and products. Similarly, we are evaluating potential impacts from the Safer Federal Workforce Task Force guidance as we implement the guidelines.
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.
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, 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. 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.
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;
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•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 may have to wait years for a significant cash return.
Our results of operations and financial position may be negatively impacted by the COVID-19 pandemic, and the resulting economic disruption.
The World Health Organization declared COVID-19 a pandemic on March 11, 2020. Subsequently, all the states and local governments in communities where we operate issued various state of emergency decrees or "Stay at Home" orders restricting non-essential business activities. As a defense industrial-base U.S. government contractor, we are considered an essential business by the U.S. and state governments and we continue to operate as such during the COVID-19 pandemic. U.S., state, and local government restrictions continue to evolve, and the risk of future outbreaks or exposure of our workforce to COVID-19, which may impact employee health and absenteeism, remains uncertain. New strains of the virus have resulted in new outbreaks, and this could continue in the future as additional strains evolve. The efforts being undertaken to combat the virus may not be as successful or effective as intended. In September 2021, President Biden issued an Executive Order requiring all covered employees of covered federal contractors and subcontractors to be vaccinated against COVID-19, except in limited circumstances where an employee is legally entitled to an accommodation. The vaccination requirements initially were incorporated into some new government contracts, but effective December 7, 2021, a nationwide injunction paused enforcement of the requirement. We updated our policies and procedures to account for these requirements, but there can be no assurance that our updated policies and procedures will result in complete compliance in light of the uncertainty surrounding the enforceability of the Executive Order. The extent to which these requirements may impact our business remains uncertain, but may cause, among other things, reduced employee morale, the loss of employees and inability to maintain a sufficient workforce, litigation related to any vaccination requirements, production delays, increased costs, supply chain disruptions, inability to perform under our contracts and other business disruptions, all of which could have an adverse impact on our business operations and financial results. In addition, certain states in which we operate have proposed or enacted legislation that may be in conflict or hinder our ability to comply with our contractual obligations to implement these requirements and, if we are unable to comply with federal mandates or our contractual obligations, our business operations and financial results could be adversely affected.
We continue to actively monitor the COVID-19 pandemic and its future potential impact on our employees, customers, and supply chain. The increase in the number of our employees who are working remotely as a result of the COVID-19 pandemic has increased cyber and other security-related risks that are associated with operating in a remote environment. As a result, we have increased reliance on our remote employees following our procedures and protocols to protect our confidential information and information entrusted to us. If our workforce fails to properly adhere to these procedures, we could have increased vulnerability to data loss, security breaches, cyber-attacks and other similar events and intrusions.
While some of our employees are able to work remotely, a significant number can only perform their job functions on site, and we have promulgated policies designed to provide for appropriate social distancing, employee protection, mask-wearing, enhanced cleaning protocols, and health monitoring. We evaluate and modify these policies as needed on an ongoing basis, but there remains the risk of disruption or reduced efficiency caused by social distancing and other protective measures as well as elevated employee absence because of illness or required quarantines.
While our customers and suppliers generally continue to operate and perform their missions, some facilities have temporarily reduced or halted operations due to precautionary measures, staffing illness, or business disruptions. The length and severity of such delays and closures, and any impact they will have on our operations, remains uncertain. We cannot predict whether the current or future closures of our customer facilities related to the COVID-19 pandemic will have a material adverse effect on our financial results and operations. In addition, as we have a diverse supply chain utilizing companies of varying size, resources and complexity, there is no guarantee that our supply network will have sufficient resources or the ability to maintain their operations.
In addition, the COVID-19 pandemic and resulting global disruptions have caused significant economic uncertainty and volatility in financial markets. Moreover, additional or unforeseen effects from the COVID-19 pandemic and actions taken by governments, companies, and individuals in response to the pandemic may affect our results of operations and financial positions in unexpected ways.
Risks Related to Our Operations
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 2021, approximately 57% 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
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profitability would be adversely affected. Future profitability is subject to risks including the ability of suppliers to deliver components of acceptable quality on schedule and the successful implementation of automated tooling in production processes.
In 2021, approximately 43% 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. When 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.
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, or disagreements with such providers over the scope and nature of their services, 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.
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;
•local real estate market conditions;
•changes in neighborhood characteristics;
•impacts of natural or people disasters;
•changes in interest rates; and
•real estate tax rates.
If unfavorable economic or other conditions affect the region, our plans and business strategy could be adversely affected.
In order to be successful, we must attract and retain key personnel.
Our business has a continuing need to attract and retain 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. Our business must also attract and retain qualified officers and directors. Uncertainty associated with internal governance matters, the Merger, the FTC Litigation, and increased competition from our competitors may cause an increase in unwanted departures by employees, officers, and directors.
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, 2021, 8% of our 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.
Risks Related to Our Liquidity and Financing
We use estimates when accounting for certain contracts and changes in these estimates may have a significant impact on our financial results.
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
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milestones may fluctuate from quarter to quarter. We evaluate the contract value and cost estimates for performance obligations at least quarterly, and more frequently when circumstances change significantly which is described in more detail in Note 1 in the consolidated financial statements in Item 8 of this Report. Changes in estimates and assumptions related to the status of certain long-term contracts which could have a material adverse effect on our operating results, financial condition, and/or cash flows.
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 December 31, 2021, the pension assets, projected benefit obligations, and unfunded pension obligation were $1,005.0 million, $1,279.3 million, and $274.3 million, respectively. In 2022, we expect to make cash contributions of approximately $15 million to our tax-qualified defined benefit pension plan. We generally are able to recover contributions related to our tax-qualified defined benefit pension plan as allowable costs on our U.S. government contracts, but there are differences between when we contribute to our tax-qualified defined benefit pension plan under pension funding rules and when it is recoverable 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 benefits 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.
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, 2021, we had $461.3 million of debt outstanding. 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.
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 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;
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•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, 2021. 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.
We may be adversely affected by changes in London Inter-Bank Offered Rate ("LIBOR") reporting practices or the method by which LIBOR is determined.
On March 5, 2021, the United Kingdom’s Financial Conduct Authority published the dates that the use of LIBOR as an index for commercial loans will be phased out. Foreign currency indices, including the British pound, the Euro, and Swiss franc, along with the U.S. dollar 1-week and 2-month settings ceased after December 31, 2021. Historically, we have not borrowed with these types of LIBOR terms. Additionally, after June 30, 2023, the remaining U.S. dollar LIBOR settings will cease. The uncertainty regarding the transition from LIBOR to any alternative reference rate or rates, could have adverse impacts on floating rate obligations, loans, deposits, derivatives and other financial instruments that currently use LIBOR as a benchmark rate. Borrowings under our Senior Credit Facility constitute our most significant exposure to this transition and there is no guarantee that a shift from LIBOR to a new reference rate will not result in increases to our borrowing costs.
Risks Related to Our Strategy
Our success and growth depends on our ability to execute long-standing programs and periodically secure new contracts in a competitive environment.
Our sales are primarily derived from long-standing contracts (often sole source) where we are the long-term incumbent. The challenge is to successfully utilize our technical, engineering, manufacturing, and management skills to execute these programs for the customer, to continue to innovate and refine our solutions, and to offer the customer increasing affordability in an era of fiscal restraint. Changes in management or other key personnel can make executing these programs more difficult. If we are unable to successfully execute these long-standing programs, our ability to retain existing customers and attract new customers may be impaired.
In addition, we continue to be subject to intense competition in certain sectors. For example, we face increasing competition from emerging spaceflight companies such as SpaceX and Blue Origin, who have developed liquid fuel propulsion capabilities which are primarily focused on the development of space propulsion systems for heavy lift launch vehicles. For the in-space propulsion market, we also see a number of new startups entering the market in both small chemical propulsion and small electric propulsion systems targeted at the rapidly expanding small satellite market. 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.
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.
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There may be liabilities of the acquired companies that we fail to, or were unable to, discover during our due diligence investigation of each business that we have acquired or may acquire 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.
Risks Related to Legislation, Regulation, and Compliance
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 and 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.
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 defend against various cyber and other security threats against our defenses to protect the confidentiality, integrity and availability of our information technology infrastructure, supply chain, business or customer information and other threats. We are also subject to similar security threats at customer sites that we operate and manage as a contractual requirement.
The threats we face range from attacks common to most industries to more advanced and persistent, highly organized adversaries, insider threats and other threat vectors targeting us and other defense and aerospace companies; because we protect national security information. In addition, cyber threats are evolving, growing in their frequency and include, but are not limited to, malicious software, destructive malware, attempts to gain unauthorized access to data, disruption or denial of service attacks, and other electronic security breaches that could lead to disruptions in mission critical systems, unauthorized release of confidential, personal or otherwise protected information (ours or that of our employees, customers or partners), and corruption of data, networks or systems. We also could be impacted by cyber threats or other disruptions or vulnerabilities found in products we use or in our partners’ or customers’ systems that are used in connection with our business.
If we are unable to protect sensitive information or the integrity of our systems, our customers or governmental authorities could question the adequacy of our threat mitigation and detection processes and procedures. There can be no assurance that the variety of efforts, procedures and controls we deploy to monitor and minimize the likelihood and impact of adverse cyber security incidents will be sufficient. 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, or our reputation. Such events could also result in the loss of competitive advantages derived from our R&D efforts or other intellectual property, early obsolescence of our products and services, or contractual penalties. 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.
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. The sophisticated and rigorous design, manufacturing and testing processes and practices we employ do not entirely prevent the risk that we may not be able to successfully launch or manufacture our products on schedule or that our products may not perform as intended.
When 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 when we fail to meet delivery schedules or other measures of contract
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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.
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, and local 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.
Given the many uncertainties involved in assessing liability for environmental claims, our established reserves may not be sufficient, which could adversely affect our financial results and cash flows.
As of December 31, 2021, the aggregate range of our estimated future environmental obligations was $296.4 million to $453.8 million and the accrued amount was $296.4 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. 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 allowed to be included in our U.S. government contracts. We currently estimate approximately 12% of our Aerospace and Defense segment environmental costs will not likely be reimbursable.
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 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. 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 Certificate of Incorporation provides that the Court of Chancery of the State of Delaware will be the sole and exclusive forum for certain stockholder litigation matters, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees or stockholders.
Our Certificate of Incorporation provides that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware ("Court of Chancery") will be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer, or employee of the Company to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, or (iv) any action asserting a claim governed by the internal affairs doctrine as that doctrine exists under the law of the State of Delaware. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock will be deemed to have notice of, and consented to, the provisions of our Certificate of Incorporation described in the preceding sentence. This exclusive forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that the stockholder finds favorable for disputes with us or our directors, officers, or other employees, which may discourage such lawsuits against us and such persons. Alternatively, if a court were to find these provisions of our Certificate of Incorporation inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition, or results of operations.
This exclusive forum provision would not apply to suits brought to enforce a duty or liability created by the Securities Act of 1933, as amended (the "Securities Act") or the Securities Exchange Act of 1934 (the "Exchange Act"), except that it may apply to such suits if brought derivatively on our behalf. There is, however, uncertainty as to whether a court would enforce such provision in connection with suits to enforce a duty or liability created by the Securities Act or the Exchange Act if brought derivatively on
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our behalf, and our stockholders will not be deemed to have waived our compliance with the federal securities laws and the rules and regulations thereunder.
General Risk Factors
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; information technology attacks; natural disasters; political and social unrest; 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.
Tax changes could affect our effective tax rate and future profitability
Our effective tax rate for 2021 was 26.3% compared with 23.6% for 2020. Changes in applicable U.S. tax laws and regulations, or their interpretation and application, including the possibility of retroactive effect, could affect our tax expense, operating results, and/or cash flows.
Beginning in 2022, the Tax Cuts and Jobs Act of 2017 eliminates the option to deduct research and development expenditures currently and requires taxpayers to amortize such costs incurred in the U.S. over five years. While it is possible that Congress may modify, defer or repeal this provision before it takes effect, we have no assurance that the provision will be modified, deferred or repealed. If this provision is not modified, deferred or repealed, it may have an adverse effect on our cash taxes and as a result, our 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 benefits 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.
Our inability to protect our trade secrets, patents and proprietary rights could adversely affect our businesses’ prospects and competitive positions.
If we are unable to obtain or maintain protections for proprietary technology and inventions through patents and other proprietary rights 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. Other parties may independently develop our know-how or otherwise obtain access to our technology.
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
El Segundo, California 90245
| Aerospace and Defense | ||||||||
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*; 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.
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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
See Note 8(a) in the consolidated financial statements in Item 8 of this Report for information relating to our legal proceedings.
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 11, 2022, there were 4,850 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 11, 2022, the last reported sale price of our common stock on the New York Stock Exchange was $39.08 per share.
On December 19, 2020, our Board of Directors declared the one-time Pre-Closing Dividend in cash of $5.00 per share (including shares underlying the 2¼% Notes participating on an as-converted basis). On March 24, 2021, the Company paid the Pre-Closing Dividend to holders of record as of March 10, 2021.
The table below provides information about shares surrendered to the Company during the three months ended December 31, 2021, to pay employee withholding taxes due upon the vesting of restricted stock.
| Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased under the Plans or Programs | ||||||||||||||||||||||
| October 1, 2021 through October 31, 2021 | — | $ | — | — | $ | — | ||||||||||||||||||||
| November 1, 2021 through November 30, 2021 | — | $ | — | — | — | |||||||||||||||||||||
| December 1, 2021 through December 31, 2021 | 10,943 | $ | 46.58 | — | — | |||||||||||||||||||||
| Total | 10,943 | $ | — | — | $ | — | ||||||||||||||||||||
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. Financial Statements and Supplementary Data at Note 6 in the consolidated financial statements.
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."
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Stock Performance Graph
The following graph compares the cumulative total stockholder returns, calculated on a dividend reinvested basis, on $100 invested in our common stock in December 2016 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,
December 2016 through December 2021
| Company/Index | Base Year 2016 | Year Ended December 31, | ||||||||||||||||||||||||||||||||||||
| 2017 | 2018 | 2019 | 2020 | 2021 | ||||||||||||||||||||||||||||||||||
| Aerojet Rocketdyne Holdings, Inc. | $ | 100.00 | $ | 173.82 | $ | 196.27 | $ | 254.37 | $ | 294.43 | $ | 289.09 | ||||||||||||||||||||||||||
| S&P 500 Index | 100.00 | 121.83 | 116.49 | 153.17 | 181.35 | 233.41 | ||||||||||||||||||||||||||||||||
| S&P 500 Aerospace & Defense | 100.00 | 141.38 | 129.97 | 169.39 | 142.18 | 160.98 | ||||||||||||||||||||||||||||||||
Item 6. Reserved
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Our operations are organized into two segments: (i) Aerospace and Defense and (ii) Real Estate. Refer to “Item 1 Business” for information related to our business segments.
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. Pursuant to instruction 1 of the instructions to paragraph 303(b) of Regulation S-K, discussion of the results of operations for the fiscal year ended December 31, 2019, has been omitted. Such omitted discussion can be found under Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, filed with the SEC on February 18, 2021.
Overview
On December 20, 2020, the Company entered into the Merger Agreement with Lockheed Martin and Mizar Sub, Inc., a wholly-owned subsidiary of Lockheed Martin, pursuant to which each share of common stock of the Company would have been automatically converted into the right to receive cash in an amount equal to $51.00 per share, adjusted from $56.00 following the payment of a one-time cash dividend of $5.00 per share paid in March 2021 and the Company would have become a wholly-owned subsidiary of Lockheed Martin.
On January 25, 2022, the FTC filed a complaint against the Company and Lockheed Martin in the FTC’s administrative court and a complaint in U.S. federal court seeking a preliminary injunction to stop the FTC Litigation. On February 13, 2022, Lockheed Martin notified the Company that it had elected to terminate the Merger Agreement. On February 14, 2022, pursuant to the parties’ joint motion, the administrative complaint and the U.S. federal court complaint were dismissed.
A summary of the significant financial highlights for the years ended December 31, 2021 and 2020, which management uses to evaluate our operating performance and financial condition, is presented below.
| Year Ended December 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| (In millions, except percentage and per share amounts) | |||||||||||
| Net sales | $ | 2,188.0 | $ | 2,072.7 | |||||||
| Net income | 143.7 | 137.7 | |||||||||
| Net income as a percentage of net sales | 6.6 | % | 6.6 | % | |||||||
| Adjusted Net Income (Non-GAAP measure*) | 161.6 | 138.4 | |||||||||
| Adjusted Net Income (Non-GAAP measure*) as a percentage of net sales | 7.4 | % | 6.7 | % | |||||||
| Earnings Per Share ("EPS") - Diluted | 1.75 | 1.66 | |||||||||
| Adjusted EPS (Non-GAAP measure*) | 1.97 | 1.67 | |||||||||
| Adjusted EBITDAP (Non-GAAP measure*) | 298.5 | 270.2 | |||||||||
| Adjusted EBITDAP (Non-GAAP measure*) as a percentage of net sales | 13.6 | % | 13.0 | % | |||||||
| Cash provided by operating activities | 199.6 | 363.8 | |||||||||
| Free cash flow (Non-GAAP measure*) | 162.3 | 309.2 | |||||||||
* 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."
Our business outlook is affected by both increasing complexity in the global security environment and continuing worldwide economic pressures, including those resulting from the COVID-19 pandemic. A significant component of our strategy in this environment is to focus on protecting our employees' health and safety, 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: uncertainty associated with the COVID-19 pandemic and the actions taken by governments, companies, and individuals in response, including the efficacy, distribution and approval of vaccines and booster shots, vaccine mandates, dependence upon U.S. government programs and contracts, future reductions or changes in U.S. government spending in our markets, environmental matters, capital structure, underfunded pension plan, and cyber security. In addition, uncertainty regarding the ongoing litigation involving directors, deliberation and dialogue regarding director nominations, and other internal governance matters pose challenges to the Company because these issues distract management from their day-to-day responsibilities and disrupt our normal business operations.
COVID-19
During 2020, there was minimal adverse impact to our financial results and operations as a result of the COVID-19 outbreak. The safety and welfare of our employees remains our top priority, and throughout the year, we have continued to
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operate within our established safety protocols, which include selected and site-specific work and travel restrictions, in addition to other measures intended to reduce the spread of COVID-19. We have also continued to evaluate new opportunities to protect our employees. Although we have not experienced significant absenteeism or supply chain disruption, the extent to which the COVID-19 pandemic impacts our future financial results depends on future developments which are highly uncertain and cannot be predicted, including new information and COVID-19 variants which may emerge and impact the severity of the pandemic and the actions being taken to contain and treat it, including the efficacy, distribution and approval of vaccines and booster shots, vaccine mandates and other indirect effects that may come as a result of actions taken by governments, companies, and individuals in response to the pandemic and its economic impact.
We continue to be considered an essential business by the U.S. and state governments and continue to operate as such during the COVID-19 pandemic. We are taking a variety of measures to maintain the availability and functionality of our critical infrastructure, to promote the safety and security of our employees and to support the communities in which we operate. In making decisions regarding our operations, we take into account public and private sector policies and initiatives to reduce the transmission of COVID-19, such as the adoption of mask-wearing protocols, enhanced cleaning protocols and health monitoring, as well as the imposition of travel limitations, the promotion of social distancing, and the adoption of work-from-home requirements for employees where practicable. All of these policies and initiatives could impact our operations.
Due to the evolving nature of the COVID-19 pandemic, corresponding U.S. government policies, vaccine mandates, and the uncertainty relating to vaccination rates and vaccine efficacy against new COVID-19 variants, we are not able at this time to estimate its full impact on our financial results and operations.
The CARES Act was enacted on March 27, 2020, in response to the COVID-19 pandemic and the negative impacts that it is having on the global economy and U.S. companies. The CARES Act includes various financial measures to assist companies, including temporary changes to income and non-income-based tax laws. Through these provisions, as of December 31, 2021, we have delayed $21.2 million of payroll tax payments that otherwise would have been paid in 2020. Additionally, in accordance with the provisions of the CARES Act, we accelerated depreciation on qualified improvement property placed in service after December 31, 2017 for income tax purposes.
See impact of The American Rescue Plan Act of 2021 ("ARPA") on our retirement benefit plans below.
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.
The following table summarizes end user 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 | ||||
| 2021 | 96 | % | |||
| 2020 | 96 | ||||
The following table summarizes net sales by principal end user in 2021:
| NASA | 24 | % | |||
| MDA | 22 | ||||
| U.S. Army | 20 | ||||
| U.S. Air Force | 14 | ||||
| U.S. Navy | 11 | ||||
| Other U.S. government | 5 | ||||
| Total U.S. government customers | 96 | ||||
| Other customers | 4 | ||||
| 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:
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| Year Ended December 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| RS-25 program | 17 | % | 18 | % | |||||||
| Standard Missile program | 12 | 13 | |||||||||
| PAC-3 program | 10 | 10 | |||||||||
| THAAD program | 8 | 11 | |||||||||
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, | |||||||||||
| 2021 | 2020 | ||||||||||
| Lockheed Martin | 32 | % | 34 | % | |||||||
| NASA | 20 | 21 | |||||||||
| Raytheon | 17 | 17 | |||||||||
Industry Update
Information concerning our industry appears in Part I, Item 1. Business under the caption "Industry Overview."
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 totaled $10.4 million in 2021.
The following table summarizes our recoverable amounts, environmental reserves, and range of liability, as of December 31, 2021:
| Recoverable Amount (1) | Reserve | Estimated Range of Liability | |||||||||||||||
| (In millions) | |||||||||||||||||
| Aerojet Rocketdyne - Sacramento | $ | 188.9 | $ | 214.7 | $214.7 - $347.7 | ||||||||||||
| Aerojet Rocketdyne - Baldwin Park Operable Unit ("BPOU") | 56.9 | 64.7 | 64.7 - 78.0 | ||||||||||||||
| Other Aerojet Rocketdyne sites | 11.8 | 11.8 | 11.8 - 21.5 | ||||||||||||||
| Other sites | 0.8 | 5.2 | 5.2 - 6.6 | ||||||||||||||
| Total | $ | 258.4 | $ | 296.4 | $296.4 - $453.8 | ||||||||||||
_____
(1)Excludes the receivable from Northrop of $40.5 million as of December 31, 2021, related to environmental costs already paid (and therefore not reserved) by us in prior years and reimbursable under our agreement with Northrop.
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, 2021, we had $461.3 million of debt outstanding.
Pension Plan
As of the last measurement date at December 31, 2021, the pension assets, projected benefit obligations, and unfunded pension obligation were $1,005.0 million, $1,279.3 million, and $274.3 million, respectively. We estimate that 87% of our unfunded pension obligation as of December 31, 2021, is related to our U.S. government contracting business, Aerojet Rocketdyne.
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The ARPA that was signed into law on March 11, 2021, provided funding relief to sponsors of defined benefit pension plans. In line with provisions of ARPA, we expect to make cash contributions of approximately $15 million to our tax-qualified defined benefit pension plan in 2022. We generally are able to recover contributions related to our tax-qualified defined benefit pension plan as allowable costs on our U.S. government contracts, but there are differences between when we contribute to our tax-qualified defined benefit pension plan under pension funding rules and when it is recoverable under CAS.
The COVID-19 pandemic and resulting global disruptions have continued to cause significant economic uncertainty and volatility in financial markets which could adversely impact the funded status of our tax-qualified defined benefit pension plan. The funded status of our pension plan is impacted by the investment experience of the plan assets, by any changes in U.S. law, and by changes in the statutory interest rates used by the tax-qualified pension plan in the U.S. to calculate funding requirements. Accordingly, if the performance of our plan assets does not meet our assumptions, if there are changes to the Internal Revenue Service regulations or other applicable law or if other actuarial assumptions are modified, our future contributions to our underfunded pension plan could be higher than we expect.
Cyber Security
We routinely defend against various cyber and other security threats against our defenses to protect the confidentiality, integrity and availability of our information technology infrastructure, supply chain, business or customer information and other threats. We are also subject to similar security threats at customer sites that we operate and manage as a contractual requirement.
The threats we face range from attacks common to most industries to more advanced and persistent, highly organized adversaries, insider threats and other threat vectors targeting us and other defense and aerospace companies; because we protect national security information. In addition, cyber threats are evolving, growing in their frequency and include, but are not limited to, malicious software, destructive malware, attempts to gain unauthorized access to data, disruption or denial of service attacks, and other electronic security breaches that could lead to disruptions in mission critical systems, unauthorized release of confidential, personal or otherwise protected information (ours or that of our employees, customers or partners), and corruption of data, networks or systems. We also could be impacted by cyber threats or other disruptions or vulnerabilities found in products we use or in our partners’ or customers’ systems that are used in connection with our 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, | |||||||||||||||||
| 2021 | 2020 | Change | |||||||||||||||
| (In millions) | |||||||||||||||||
| Net sales | $ | 2,188.0 | $ | 2,072.7 | $ | 115.3 | |||||||||||
Primary reason for change. The increase in net sales was primarily driven by the GBSD and ATACMS programs partially offset by declines on the THAAD and RS-68 programs.
Cost of Sales (exclusive of items shown separately below)
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2020 | Change | |||||||||||||||
| (In millions, except percentage amounts) | |||||||||||||||||
Cost of sales (exclusive of items shown separately below) | $ | 1,800.1 | $ | 1,701.3 | $ | 98.8 | |||||||||||
| Percentage of net sales | 82.3 | % | 82.1 | % | |||||||||||||
Primary reason for change. Cost of sales as a percentage of net sales was comparable with the prior year period.
Selling, General and Administrative Expense ("SG&A")
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2020 | Change | |||||||||||||||
| (In millions, except percentage amounts) | |||||||||||||||||
| Components of SG&A: | |||||||||||||||||
| SG&A excluding stock-based compensation | $ | 25.3 | $ | 24.7 | $ | 0.6 | |||||||||||
| Stock-based compensation | 20.7 | 31.4 | (10.7) | ||||||||||||||
| SG&A | $ | 46.0 | $ | 56.1 | $ | (10.1) | |||||||||||
| Percentage of net sales | 2.1 | % | 2.7 | % | |||||||||||||
| Percentage of net sales excluding stock-based compensation | 1.2 | % | 1.2 | % | |||||||||||||
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Primary reason for change. The decrease in SG&A expense was driven by stock-based compensation primarily as a result of the impact of changes in the fair value of the stock appreciation rights. For detailed information about stock-based compensation refer to Note 9(e) in the consolidated financial statements in Item 8 of this Report.
Depreciation and Amortization
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2020 | Change | |||||||||||||||
| (In millions) | |||||||||||||||||
| Components of depreciation and amortization: | |||||||||||||||||
| Depreciation | $ | 48.8 | $ | 49.2 | $ | (0.4) | |||||||||||
| Amortization | 9.9 | 13.4 | (3.5) | ||||||||||||||
| Accretion | 2.7 | 2.7 | — | ||||||||||||||
| Depreciation and amortization | $ | 61.4 | $ | 65.3 | $ | (3.9) | |||||||||||
Primary reason for change. The decrease in depreciation and amortization expense was primarily due to the completion of amortization expense for a significant portion of the customer related intangible assets associated with the acquisition of the Rocketdyne Business from United Technologies Corporation in 2013.
Other Expense, Net
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2020 | Change | |||||||||||||||
| (In millions) | |||||||||||||||||
| Other expense, net | $ | 23.5 | $ | 9.4 | $ | 14.1 | |||||||||||
Primary reason for change. The increase in other expense, net was primarily due to an increase of $10.8 million in unusual items related to Merger costs. For detailed information about unusual expenses refer to Note 11 in the consolidated financial statements in Item 8 of this Report.
Loss on Debt
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2020 | Change | |||||||||||||||
| (In millions) | |||||||||||||||||
| Loss on debt | $ | 10.5 | $ | — | $ | 10.5 | |||||||||||
Primary reason for change. In 2021, we settled $154.1 million of our 2¼% Notes as a result of receiving conversion notices from the noteholders. The principal amount of $154.1 million was settled in cash and the conversion premium was settled in 2.9 million common shares. We incurred a pre-tax charge of $10.5 million in 2021, associated with the settlement of the 2¼% Notes.
Interest Income
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2020 | Change | |||||||||||||||
| (In millions) | |||||||||||||||||
| Interest income | $ | 2.5 | $ | 6.3 | $ | (3.8) | |||||||||||
Primary reason for change. The decrease in interest income was primarily due to lower average cash balances and market rates.
Interest Expense
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2020 | Change | |||||||||||||||
| (In millions) | |||||||||||||||||
| Components of interest expense: | |||||||||||||||||
| Contractual interest and other | $ | 14.2 | $ | 20.2 | $ | (6.0) | |||||||||||
| Amortization of debt discount and deferred financing costs | 5.9 | 9.9 | (4.0) | ||||||||||||||
| Interest expense | $ | 20.1 | $ | 30.1 | $ | (10.0) | |||||||||||
Primary reason for change. The decrease in interest expense was primarily due to (i) the settlement of $154.1 million of our 2¼% Notes in 2021, and (ii) lower average obligations on our Senior Credit Facility.
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Income Tax Provision
| Year Ended December 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| (In millions) | |||||||||||
| Income tax provision | $ | 51.3 | $ | 42.5 | |||||||
In 2021, our effective tax rate was 26.3%. Our effective tax rate differed from the 21% statutory federal income tax rate primarily due to state income taxes, uncertain tax positions, and certain expenditures which are permanently not deductible for tax purposes, offset by R&D credits, excess tax benefits related to our stock-based compensation and deductible premiums paid upon the redemption of a portion of our convertible debt.
As of December 31, 2021, the liability for uncertain income tax positions was $20.0 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.
In 2020, our effective tax rate was 23.6%. Our effective tax rate differed from the 21% statutory federal income tax rate primarily due to state income taxes, uncertain tax positions, and certain expenditures which are permanently not deductible for tax purposes, offset by R&D credits and excess tax benefits related to our stock-based compensation.
Retirement Benefits Expense
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2020 | Change | |||||||||||||||
| (In millions) | |||||||||||||||||
| Components of retirement benefits expense: | |||||||||||||||||
| Interest cost on benefit obligation | $ | 34.0 | $ | 43.3 | $ | (9.3) | |||||||||||
| Assumed return on assets | (61.4) | (60.5) | (0.9) | ||||||||||||||
| Amortization of prior service costs | 0.1 | 0.1 | — | ||||||||||||||
| Amortization of net losses | 61.2 | 53.7 | 7.5 | ||||||||||||||
| Retirement benefits expense | $ | 33.9 | $ | 36.6 | $ | (2.7) | |||||||||||
Primary reason for change. The decrease in retirement benefits expense was primarily due to lower interest costs on the benefit obligation, partially offset by higher actuarial losses in the current period as a result of a decrease in the discount rate used to calculate the benefit obligation at December 31, 2020.
We estimate that our retirement benefits expense will be approximately $1 million in 2022. Additionally, we estimate the CAS recoverable amounts related to the retirement benefits plans to be approximately $38 million in 2022. See "Critical Accounting Policies and Estimates - 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, and unusual items not related to the segment. We believe that segment performance provides information useful to investors in understanding our operational performance.
Aerospace and Defense Segment
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2020 | Change | |||||||||||||||
| (In millions, except percentage amounts) | |||||||||||||||||
| Net sales | $ | 2,179.3 | $ | 2,069.4 | $ | 109.9 | |||||||||||
| Segment performance | 285.9 | 275.6 | 10.3 | ||||||||||||||
| Segment margin | 13.1 | % | 13.3 | % | |||||||||||||
Primary reason for change. The increase in net sales was primarily driven by the GBSD and ATACMS programs partially offset by declines on the THAAD and RS-68 programs.
The decrease in segment margin was primarily driven by costs associated with the Merger. For detailed information about costs associated with the Merger, refer to Note 11 in the consolidated financial statements in Item 8 of this Report.
Our 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). Fixed-price contracts present the risk of unreimbursed cost overruns, potentially resulting in lower than expected contract profits and margins. This risk
25
is generally lower for cost-reimbursable contracts which, as a result, generally have a lower margin. The following table summarizes the percentages of net sales by contract type:
| Year Ended December 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| Fixed-price | 57 | % | 61 | % | |||||||
| Cost-reimbursable | 43 | 39 | |||||||||
During 2021, we had $31.2 million of net favorable changes in contract estimates on operating results before income taxes compared with net favorable changes of $45.1 million during 2020.
Real Estate Segment
| Year Ended December 31, | |||||||||||||||||
| 2021 | 2020 | Change | |||||||||||||||
| (In millions) | |||||||||||||||||
| Net sales | $ | 8.7 | $ | 3.3 | $ | 5.4 | |||||||||||
| Segment performance | 2.9 | (1.8) | 4.7 | ||||||||||||||
Primary reason for change. During 2021, we recognized net sales of $6.2 million associated with an industrial land sale which resulted in a pre-tax gain of $2.3 million. During 2020, net sales and segment performance consisted primarily of rental property operations.
Backlog
As of December 31, 2021, our total remaining performance obligations, also referred to as backlog, totaled $6.8 billion. We expect to recognize approximately 34%, or $2.3 billion, of the remaining performance obligations as sales over the next twelve months, an additional 28% the following twelve months, and 38% thereafter. The following table summarizes backlog:
| As of December 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| (In billions) | |||||||||||
| Funded backlog | $ | 3.1 | $ | 3.0 | |||||||
| Unfunded backlog | 3.7 | 3.7 | |||||||||
| Total backlog | $ | 6.8 | $ | 6.7 | |||||||
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.
Use of Non-GAAP Financial Measures
Adjusted EBITDAP, Adjusted Net Income, and Adjusted EPS
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, ongoing and customary course of our business. Accordingly, we define Adjusted EBITDAP as GAAP net income 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, ongoing 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, ongoing and customary activities. Adjusted Net Income and Adjusted EPS do not represent, and should not be considered an alternative to, net income or diluted EPS as determined in accordance with GAAP.
26
| Year Ended December 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| (In millions, except per share and percentage amounts) | |||||||||||
| Net income | $ | 143.7 | $ | 137.7 | |||||||
| Interest expense | 20.1 | 30.1 | |||||||||
| Interest income | (2.5) | (6.3) | |||||||||
| Income tax provision | 51.3 | 42.5 | |||||||||
| Depreciation and amortization | 61.4 | 65.3 | |||||||||
| GAAP retirement benefits expense | 33.9 | 36.6 | |||||||||
| CAS recoverable retirement benefits expense | (38.8) | (43.8) | |||||||||
| Unusual items | 29.4 | 8.1 | |||||||||
| Adjusted EBITDAP | $ | 298.5 | $ | 270.2 | |||||||
| Net income as a percentage of net sales | 6.6 | % | 6.6 | % | |||||||
| Adjusted EBITDAP as a percentage of net sales | 13.6 | % | 13.0 | % | |||||||
| Net income | $ | 143.7 | $ | 137.7 | |||||||
| GAAP retirement benefits expense | 33.9 | 36.6 | |||||||||
| CAS recoverable retirement benefits expense | (38.8) | (43.8) | |||||||||
| Unusual items | 29.4 | 8.1 | |||||||||
| Income tax impact of adjustments (1) | (6.6) | (0.2) | |||||||||
| Adjusted Net Income | $ | 161.6 | $ | 138.4 | |||||||
| Diluted EPS | $ | 1.75 | $ | 1.66 | |||||||
| Adjustments | 0.22 | 0.01 | |||||||||
| Adjusted EPS | $ | 1.97 | $ | 1.67 | |||||||
| Diluted weighted average shares, as reported and as adjusted | 81.7 | 81.9 | |||||||||
_________
(1) The income tax impact is calculated using the federal and state statutory rates in the corresponding year.
Free Cash Flow
We also provide the Non-GAAP financial measure of Free Cash Flow. Free Cash Flow 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 to investors because it provides supplemental information to assist them in viewing the business using the same tools that management uses to evaluate progress in achieving our goals. The following table summarizes Free Cash Flow:
| Year Ended December 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| (In millions) | |||||||||||
| Net cash provided by operating activities | $ | 199.6 | $ | 363.8 | |||||||
| Capital expenditures | (37.3) | (54.6) | |||||||||
| Free Cash Flow | $ | 162.3 | $ | 309.2 | |||||||
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.
Liquidity and Capital Resources
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. As of December 31, 2021, we had $700.4 million of cash and cash equivalents as well as $622.2 million of available borrowings under our Senior Credit Facility. However, there are a number of factors that could positively or negatively impact our liquidity position, including:
27
•effects of the termination of the proposed merger with Lockheed Martin;
•reductions, delays or changes in U.S. government spending;
•cost overruns on the Company's contracts that require the Company to absorb excess costs;
•issuance or repurchase of debt or equity securities;
•potential funding of pension liabilities either voluntarily or as required by law or regulation;
•compliance with covenants and other terms and conditions related to our financing arrangements;
•environmental claims related to the Company's current and former businesses and operations;
•reductions in the amount recoverable from environmental claims;
•changes or clarifications to current tax law;
•impact of the COVID-19 pandemic on our financial condition; and
•risks and uncertainties detailed in Item 1A of our Annual Report on Form 10-K.
Cash and Cash Equivalents and Short Term Investments
Our cash and cash equivalents and marketable securities consist of cash, time deposits, money market funds, and investment grade corporate debt securities. Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. Our strategy is focused on the preservation of capital and supporting our liquidity requirements that meet high credit quality standards, as specified in our investment policy approved by the Audit Committee of our Board of Directors.
We continually evaluate opportunities to sell additional equity or debt securities, obtain credit facilities, obtain finance and operating lease arrangements, enter into financing obligations, repurchase common stock, pay dividends, or repurchase, refinance, or otherwise restructure our debt for strategic reasons or to further strengthen our financial position.
As of December 31, 2021, our combined balance of cash and cash equivalents and restricted cash decreased by $449.1 million to $703.4 million from a balance of $1,152.5 million as of December 31, 2020.
The cash provided by operating activities in 2021 of $199.6 million was primarily due to cash provided by net income adjusted for non-cash items offset by a decrease in our net contract liabilities primarily due to a decrease in contract advances and an increase in unbilled receivables.
The cash used in investing activities in 2021 of $39.2 million was primarily related to $37.3 million of cash used for capital expenditures and $1.9 million of net investments in marketable securities.
Cash used in financing activities in 2021 was $609.5 million primarily resulting from (i) cash payments of $428.8 million for the Pre-Closing Dividend; (ii) debt cash payments of $182.6 million (see table below); and (iii) $1.9 million of net cash provided from our equity plans.
The following table summarizes our debt principal activity:
| December 31, 2020 | Cash Payments | December 31, 2021 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Term loan | $ | 308.5 | $ | (26.3) | $ | 282.2 | |||||||||||
2 1/4% Notes | 300.0 | (154.1) | 145.9 | ||||||||||||||
| Finance leases | 45.6 | (2.2) | 43.4 | ||||||||||||||
| Total debt activity | $ | 654.1 | $ | (182.6) | $ | 471.5 | |||||||||||
Senior Credit Facility
The Senior Credit Facility matures on September 20, 2023, and consists of (i) a $650.0 million revolving line of credit (the "Revolver") and (ii) a $350.0 million Term Loan. The Term Loan and any borrowings under the Revolver bear interest at LIBOR plus an applicable margin ranging from 175 to 250 basis points based on our leverage ratio (the "Consolidated Net Leverage Ratio") measured at the end of each quarter. In addition to interest, we must pay certain fees including (i) letter of credit fees ranging from 175 to 250 basis points per annum on the amount of issued but undrawn letters of credit and eurocurrency rate loans and (ii) commitment fees ranging from 30 to 45 basis points per annum on the unused portion of the Revolver. The Term Loan amortized at a rate of 7.5% per annum as of December 31, 2021, and increasing to 10.0% per annum from December 31, 2022, to be paid in equal quarterly installments with any remaining amounts, along with outstanding borrowings under the Revolver, due on the maturity date. The Company was in compliance with its financial and non-financial covenants as of December 31, 2021.
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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, 2021:
| Payments due by period | |||||||||||||||||||||||||||||
| Total | Less than 1 year | 1-3 years | 3-5 years | After 5 years | |||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||
| Senior debt | $ | 282.2 | $ | 28.4 | $ | 253.8 | $ | — | $ | — | |||||||||||||||||||
| Convertible senior notes (1) | 145.9 | 145.9 | — | — | — | ||||||||||||||||||||||||
| Interest on senior debt and convertible senior notes (2) | 15.0 | 8.3 | 6.7 | — | — | ||||||||||||||||||||||||
| Finance lease obligations | 69.4 | 4.4 | 7.5 | 7.7 | 49.8 | ||||||||||||||||||||||||
| Operating lease obligations | 62.9 | 15.2 | 15.0 | 9.8 | 22.9 | ||||||||||||||||||||||||
| Postretirement medical and life insurance benefits (3) | 16.8 | 2.7 | 4.5 | 3.6 | 6.0 | ||||||||||||||||||||||||
Purchase obligations (4) | 1,409.6 | 921.4 | 483.7 | 3.9 | 0.6 | ||||||||||||||||||||||||
| Conditional asset retirement obligations (5) | 51.8 | — | 19.8 | 1.5 | 30.5 | ||||||||||||||||||||||||
| Total | $ | 2,053.6 | $ | 1,126.3 | $ | 791.0 | $ | 26.5 | $ | 109.8 | |||||||||||||||||||
________
(1) Holders may convert their 2¼% Notes at their option from January 1, 2022, through March 31, 2022, because our closing stock price exceeded $33.80 for at least 20 days in the 30 day period prior to December 31, 2021. 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, 2021.
(2) Includes interest on variable debt calculated based on interest rates at December 31, 2021.
(3) 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.
(4) 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.
(5) 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 $15 million to our tax-qualified defined benefit pension plan in 2022. We generally are able to recover 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 to our tax-qualified defined benefit pension plan under pension funding rules and recover it under CAS.
As part of our ongoing business, we have not participated in transactions that generate material relationships with unconsolidated entities or financial partnerships, as is defined in rules promulgated by the SEC, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. See Note 8(d) in the consolidated financial statements in Item 8 of this Report for information relating to our off-balance sheet risk.
Critical Accounting Policies and Estimates
Our Consolidated Financial Statements have been prepared with GAAP, which require management to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities, net revenue and expenses, and the disclosure of contingent assets and liabilities. Our estimates are based on historical experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. We believe that the accounting estimates employed and the resulting balances are reasonable; however, actual results may differ from these estimates and such differences may be material. We believe the following critical accounting policies are affected by significant estimates, assumptions or judgments used in the preparation of our Consolidated Financial Statements.
The areas most affected by our accounting policies and estimates are revenue recognition, retirement benefit plans, 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.
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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 accounting estimates on our Aerospace and Defense segment operating results:
| Year Ended December 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| (In millions, except per share amounts) | |||||||||||
| Net favorable effect of the changes in contract estimates on net sales | $ | 34.8 | $ | 38.5 | |||||||
| Favorable effect of the changes in contract estimates on income before income taxes | 31.2 | 45.1 | |||||||||
| Favorable effect of the changes in contract estimates on net income | 23.0 | 34.5 | |||||||||
| Favorable effect of the changes in contract estimates on basic EPS | 0.29 | 0.44 | |||||||||
| Favorable effect of the changes in contract estimates on diluted EPS | 0.28 | 0.42 | |||||||||
See Note 1 in the consolidated financial statements in Item 8 of this Report for additional information.
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
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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. 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, | ||||||||||||||||||||||
2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||
| Discount rate | 2.90 | % | 2.52 | % | 2.77 | % | 2.28 | % | |||||||||||||||
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, | ||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||
| Discount rate | 2.52 | % | 3.28 % | 2.28 | % | 3.19 % | |||||||||||||||||
| Expected long-term rate of return on assets | 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, 2021, and on retirement benefits expense for 2021:
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 | $18.9 | $132.3 | $8.8 | $(0.1) | $(0.2) | ||||||||||||||||||||||||
| 1% increase | (16.1) | (111.5) | (8.8) | 0.1 | 0.2 | ||||||||||||||||||||||||
Environmental Reserves and Estimated Recoveries
We accrue for costs associated with the remediation of environmental contamination when it becomes probable that a liability has been incurred, and when our costs can be reasonably estimated. In most cases, only a range of reasonably probable
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costs can be estimated. In establishing the reserves, the most probable estimated amount is used when determinable, and the minimum amount is used when no single amount in the range is more probable. Environmental reserves include the costs of completing remedial investigation and feasibility studies, remedial and corrective actions, regulatory oversight costs, the cost of operation and maintenance of the remedial action plan, and employee compensation costs for employees who are expected to devote a significant amount of time to remediation efforts. Calculation of environmental reserves is based on the evaluation of currently available information with respect to each individual environmental site and considers factors such as existing technology, presently enacted laws and regulations, and prior experience in remediation of contaminated sites. Such estimates are based on the expected costs of investigation and remediation and the likelihood that other potentially responsible parties will be able to fulfill their commitments at sites where we may be jointly or severally liable.
The following table summarizes our environmental reserve activity in 2021 (in millions):
| Balance at January 1, 2021 | $ | 300.6 | |||
| Additions | 35.3 | ||||
| Expenditures | (39.5) | ||||
| Balance at December 31, 2021 | $ | 296.4 | |||
The $35.3 million of environmental reserve additions in 2021 was primarily due to the following items: (i) $13.7 million of additional operations and maintenance for treatment facilities; (ii) $13.2 million of remediation related to operable treatment units; and (iii) $8.4 million related to other environmental clean-up matters.
At the time a liability is recorded for future environmental costs, we record an asset for estimated future recoveries that are estimable and probable. Some of our environmental costs are eligible for future recovery in the pricing of our products and services to the U.S. government and under existing third party agreements. We consider the recovery probable based on the Global Settlement, U.S. government contracting regulations, and our long history of receiving reimbursement for such costs.
The following table summarizes the activity in the current and non-current recoverable amounts from the U.S. government and Northrop in 2021 (in millions):
| Balance at January 1, 2021 | $ | 308.3 | |||
| Additions | 31.2 | ||||
| Reimbursements | (34.6) | ||||
| Other adjustments | (6.0) | ||||
| Balance at December 31, 2021 | $ | 298.9 | |||
The activity for recoveries is commensurate with the activity associated with the environmental reserve activity.
The expenses associated with adjustments to the environmental reserves are recorded as a component of other expense, net in the consolidated statements of operations. Expenses associated with adjustments to the environmental reserves incurred throughout 2021 totaled $4.1 million.
Income Taxes
We file a consolidated U.S. federal income tax return for the Company and our 100% owned consolidated subsidiaries. The deferred tax assets and/or liabilities are determined by multiplying the differences between the financial reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in the period of the enactment date of the change.
The carrying value of our deferred tax assets is dependent upon our ability to generate sufficient taxable income in the future. A valuation allowance is required when it is more likely than not that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence is considered, including our past and future performance, the market environment in which we operate, the utilization of tax attributes in the past, the length of carryback and carryforward periods, and evaluation of potential tax planning strategies.
We believe that certain positions may be challenged by taxing authorities. Settlement of any challenge can result in no change, a complete disallowance, or a partial adjustment reached through negotiations or litigation. Our tax reserves reflect the difference between the tax benefit claimed on tax returns and the amount recognized in the financial statements. The accounting standards provide guidance for the recognition and measurement in financial statements of uncertain tax positions taken or expected to be taken in a tax return. The evaluation of a tax position is a two-step process, the first step being recognition. We determine whether it is more likely than not that a tax position will be sustained upon tax examination, including resolution of any related appeals or litigation, based on only the technical merits of the position. The technical merits of a tax position are derived from both statutory and judicial authority (legislation and statutes, legislative intent, regulations, rulings, and case law) and their applicability to the facts and circumstances of the tax position. If a tax position does not meet the more likely than not recognition threshold, the benefit of that position is not recognized in the financial statements. The second step is measurement. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate resolution with a taxing authority. As the examination process progresses with tax authorities, adjustments to tax reserves may be necessary to reflect taxes payable upon settlement. Tax reserve adjustments related to positions
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impacting the effective tax rate affect the provision for income taxes. Tax reserve adjustments related to positions impacting the timing of deductions impact deferred tax assets and liabilities.
Recently Adopted Accounting Pronouncements
See Note 1 in the consolidated financial statements in Item 8 of this Report for information relating to our discussion of the effects of recent accounting pronouncements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Policies and Procedures
As an element of our normal business practice, we have established policies and procedures for managing our exposure to changes in interest rates.
The objective in managing exposure to interest rate changes is to limit the impact of interest rate changes on earnings and cash flow and to make overall borrowing costs more predictable. To achieve this objective, we may use interest rate hedge transactions or other interest rate hedge instruments to manage the net exposure to interest rate changes related to our portfolio of borrowings and to balance our fixed rate compared with variable rate debt. We did not enter into any interest rate hedge transactions or instruments during the past three years.
Interest Rate Risk
We are exposed to market risk principally due to changes in interest rates related to our borrowings, cash and cash equivalents, marketable securities, and pension assets and liabilities.
Borrowings
Debt with interest rate risk includes borrowings under our Senior Credit Facility. As of December 31, 2021, our debt principal amounts excluding finance lease obligations totaled $428.1 million: $145.9 million, or 34%, was at a fixed rate of 2.25%; and $282.2 million, or 66%, was at a variable rate of 1.85%.
The following table summarizes the estimated fair value and principal amount for outstanding debt obligations excluding finance lease obligations:
| Fair Value | Principal Amount | ||||||||||||||||||||||
| As of December 31, | As of December 31, | ||||||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||
| Term loan | $ | 275.8 | $ | 306.5 | $ | 282.2 | $ | 308.5 | |||||||||||||||
| 2¼% Notes | 266.1 | 609.5 | 145.9 | 300.0 | |||||||||||||||||||
| $ | 541.9 | $ | 916.0 | $ | 428.1 | $ | 608.5 | ||||||||||||||||
The fair value of the 2¼% Notes was determined using broker quotes that are based on open markets for our debt securities (Level 2 securities). The fair value of the term loan at December 31, 2021 and 2020, was estimated based on a third-party model used to derive a relative value price using comparable corporate loans within the same industry, credit quality, and currency.
Cash and Marketable Securities
We also have exposure to changes in interest rates related to interest earned and market value on our cash and cash equivalents and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, time deposits, money market funds, and investment grade corporate debt securities. Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities.
Pension Assets and Liabilities
Our tax-qualified pension assets and liabilities are subject to interest rate risk. The interest rate risk related to our tax-qualified pension assets and liabilities can be found in the "Retirement Benefit Plans" discussion above.
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Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Aerojet Rocketdyne Holdings, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Aerojet Rocketdyne Holdings, Inc. and its subsidiaries (the “Company”) as of December 31, 2021 and 2020, and the related consolidated statements of operations, of comprehensive income, of stockholders’ equity and of cash flows for each of the three years in the period ended December 31, 2021, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
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Revenue recognition - estimated total cost at completion on fixed-price contracts
As described in Note 1 to the consolidated financial statements, approximately 57% of total net sales of $2,188.0 million are from fixed-price revenue contracts for the year ended December 31, 2021. These contracts present the risk of unreimbursed cost overruns, potentially resulting in lower than expected contract profits and margins. The Company recognizes revenue as each performance obligation is satisfied. The majority of the Company’s 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 the Company’s contractual right to payment for work performed to date plus a reasonable profit on contracts with highly customized products that have no alternative use to the Company. Management measures progress on substantially all its performance obligations using the cost-to-cost method, which management believes best depicts the transfer of control of goods and services to the customer. Under the cost-to-cost method, management records revenues based upon costs incurred to date relative to the total estimated cost at completion. 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. As described in Note 1, 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.
The principal considerations for our determination that performing procedures relating to revenue recognition - estimated total cost at completion on fixed-price contracts is a critical audit matter are the significant judgment by management when estimating the total cost at completion for such contracts; this in turn led to a high degree of auditor judgment, subjectivity, and effort in performing procedures to evaluate significant assumptions used in management’s estimated total cost at completion for fixed-price contracts related to labor productivity, the nature and technical complexity of the work to be performed, availability and cost volatility of materials, subcontractor and vendor performance, and schedule and performance delays.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the revenue recognition process, including controls over the development of estimated total cost at completion on fixed-price contracts. These procedures also included, among others, testing management’s process for the estimate of its total cost at completion for a sample of contracts, which included testing inception-to-date actual costs, and evaluating the reasonableness of significant assumptions related to labor productivity, the nature and technical complexity of the work to be performed, availability and cost volatility of materials, subcontractor and vendor performance, and schedule and performance delays. Evaluating the reasonableness of significant assumptions involved assessing management’s ability to reasonably estimate the total cost to complete on fixed-price contracts by (i) performing a comparison of estimated labor and material costs to complete to agreements with third parties or actual costs incurred on the sampled contract or similar completed contracts, (ii) evaluating the timely identification of circumstances that may warrant a modification to estimated total cost to complete, and (iii) testing management’s process for identifying and estimating risks that could result in schedule or performance delays.
/s/ PricewaterhouseCoopers LLP
February 18, 2022