UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Amendment No. 2)
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the fiscal year ended: December 31 , 2022
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, 2022, was $3.3 billion.
As of February 9, 2023, there were 80,677,246 outstanding shares of the Company’s common stock, including unvested common shares, $0.10 par value.
DOCUMENTS INCORPORATED BY REFERENCE: None.
EXPLANATORY NOTE
Aerojet Rocketdyne Holdings, Inc. (the "Company") is filing this Amendment No. 2 on Form 10-K/A (the "Amended Filing") to amend the Annual Report on Form 10-K for the year ended December 31, 2022 filed with the Securities and Exchange Commission (the "SEC") on February 15, 2023, as subsequently amended by Amendment No 1 on Form 10-K/A filed with the SEC on April 28, 2023, (the "Original Filing") to (i) amend Item 1A to include an additional risk factor regarding the failure to maintain effective internal control over financial reporting in accordance with the rules and regulations of the SEC regarding compliance with the Sarbanes-Oxley Act; (ii) amend Item 9A to revise the discussion regarding the Company's disclosure controls and procedures and internal control over financial reporting and restate "Management's Report on Internal Control Over Financial Reporting"; and (iii) update Item 8 to reflect a revised “Report of Independent Registered Certified Public Accounting Firm” from PricewaterhouseCoopers LLP. These updates are a result of management identifying a material weakness in the Company’s internal control over financial reporting related to the completeness and accuracy of the Company's accounting for excess costs on fixed-price contracts in nearly complete or inactive status. Except for the inclusion of new certifications required by Rule 13a-14 under the Securities Exchange Act of 1934, as amended ("Exchange Act"), a revised report and new consent of the independent registered public accounting firm (and related amendment to the Exhibit Index to reflect the addition of such certifications and consent), and as required to reflect the change in Item 9A, this Amended Filing speaks only as of the date of the Original Filing and does not modify or update any other disclosures contained in our Original Filing. This Amended Filing should be read in conjunction with the Original Filing and reports filed with the SEC subsequent to the Original Filing.
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Part I
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
Failure to complete the Merger could negatively impact the price of our common stock, as well as our future business and financial results.
On December 17, 2022, we entered into the Merger Agreement, pursuant to which L3Harris will acquire us, as described in Part I, Item 1 of this Report. The Merger Agreement contains a number of conditions that must be satisfied or waived prior to the completion of the Merger, including stockholder approval and regulatory approval. We cannot assure you that all of the conditions to the Merger will be satisfied or waived on a timely basis. If the conditions to the Merger are not satisfied or waived on a timely basis, we may be unable to complete the Merger as quickly as expected or at all.
If the Merger is not completed, our ongoing business may be adversely affected as follows: (i) we may experience negative reactions from the financial markets, including negative impacts on the market price of our common stock; (ii) some of management's attention will have been 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; (iii) the manner in which customers, suppliers and other third parties perceive us may be negatively impacted, which in turn could affect our ability to compete for business; (iv) we may experience negative reactions from employees; (v) we will have expended time and resources that could otherwise have been spent on our business; and (vi) we may be required, in certain circumstances, to pay a termination fee of $95.6 million, as provided in the Merger Agreement. In addition, any significant delay in consummating the Merger could have an adverse effect on our operating results and adversely affect our relationships with customers and suppliers and would likely lead to a significant diversion of management and employee attention.
Additionally, in approving the Merger Agreement, the Board of Directors considered a number of factors and potential benefits, including the fact that the merger consideration to be received by holders of common stock represented a significant premium over the unaffected trading price as measured by the closing price on August 15, 2022 (the last full day of unaffected trading of the Common Stock). If the Merger is not completed, neither the Company nor the holders of our common stock will realize this benefit of the Merger. Moreover, we would also have nevertheless incurred substantial transaction-related fees and costs and the loss of management time and resources.
Our ability to complete the Merger is subject to certain closing conditions and the receipt of consents and approvals from government entities which may impose conditions that could adversely affect us or cause the Merger to be abandoned.
The Merger Agreement contains certain closing conditions, including, among others, the approval by the holders of a majority of all our outstanding shares to adopt the Merger Agreement and approve the Merger, and the absence of any injunction or similar order issued by any government entity with jurisdiction over any party to the Merger Agreement or law that has the effect of prohibiting the consummation of the Merger or that makes consummation of the Merger illegal. We cannot assure you that the various closing conditions will be satisfied or will not result in the abandonment or delay of the Merger.
In addition, before the Merger may be completed, regulatory approval under the HSR Act, must be obtained. The regulatory review under the HSR Act may impose conditions on the granting of such approval. Such conditions and the process of obtaining regulatory approvals could have the effect of delaying completion of the Merger or of imposing additional costs or limitations on the combined company following the completion of the Merger, and the conditions may result in the failure of a closing condition under the Merger Agreement. The regulatory approvals may not be received at all, may not be received in a timely fashion, or may contain conditions on the completion of the Merger that are unacceptable to L3Harris.
Expenses related to the pending Merger are significant and will adversely affect our operating results.
We have incurred and expect to continue to incur significant expenses in connection with the pending Merger, including legal and investment banking fees. We expect these costs to have an adverse effect on our operating results. If the Merger is not consummated, we may under certain circumstances be required to pay to L3Harris a termination fee of $95.6 million. Our financial position and results of operations would be adversely affected if we were required to pay the termination fee.
We are subject to business uncertainties, litigation risk, and contractual restrictions while the Merger is pending, which could adversely affect our business.
The Merger Agreement requires us to operate in the ordinary course of business and restricts us, without the consent of L3Harris, from taking certain specified actions agreed by the parties to be outside the ordinary course of business until the pending Merger occurs or the Merger Agreement terminates. These restrictions may prevent us from pursuing otherwise attractive business opportunities and making other changes to our business before completion of the Merger or, if the Merger is not completed, termination of the Merger Agreement. One of the conditions to the closing of the Merger is the absence of any injunction or similar order issued by government entity with jurisdiction over any party to the Merger Agreement or law that has
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the effect of prohibiting the consummation of the Merger or that makes consummation of the Merger illegal. Accordingly, if any of the plaintiffs is successful in obtaining an injunction prohibiting the consummation of the Merger, then such injunction may prevent the Merger from becoming effective, or delay its becoming effective within the expected time frame.
Uncertainties associated with the Merger may cause a loss of management and other key employees and disrupt our business relationships, which could adversely affect our business.
Uncertainty about the effect of the Merger on our employees, customers and suppliers may have an adverse effect on our business. These uncertainties may impair our ability to attract, retain and motivate key personnel until the Merger is completed and for a period of time thereafter. Employee retention may be particularly challenging during the pendency of the Merger. If key employees depart and as we face additional uncertainties relating to the Merger, 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. The adverse effects of such disruptions could be further exacerbated by any delay in the completion of the Merger.
The Merger Agreement contains provisions that could discourage a potential competing acquirer of us.
The Merger Agreement contains non-solicitation provisions that, subject to limited exceptions, restrict our ability to solicit, initiate, or knowingly encourage or induce competing third-party proposals (or knowingly cooperate in connection with such third party proposals) for the acquisition of our stock or assets. In addition, before our Board of Directors withdraws, qualifies or modifies its recommendation on the Merger or terminates the Merger Agreement to enter into a third-party acquisition proposal, L3Harris generally has an opportunity to offer to modify the terms of the Merger. In some circumstances, upon termination of the Merger Agreement, we will be required to pay a termination fee of $95.6 million.
These provisions could discourage a potential third-party acquirer that might have an interest in acquiring all or a significant portion of us from considering or proposing that acquisition, even if the acquirer was prepared to pay consideration with a higher per share cash or market value than the market value proposed to be received or realized in the Merger, 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 expense of the termination fee that may become payable in certain circumstances.
If the Merger Agreement is terminated and we decide to seek another business combination, we may not be able to negotiate or consummate a transaction with another party on terms comparable to, or better than, the terms of the Merger Agreement.
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, which is unpredictable. 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 government fiscal year 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 U.S. 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 can be negatively impacted by several factors, including, but not limited to, a change in defense spending policy as a result of shifts in political power or otherwise, the U.S. government’s budget deficits, spending priorities, 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 95% of our total net sales in 2022. 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,
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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. We may be unable to establish replacement materials and secure customer funding to address specific qualification needs of the programs. In addition, due to the rigorous customer and U.S. government specifications, at times, suppliers may experience schedule delays in meeting these requirements. From time to time, our supply chain may experience isolated events and disruptions such as weather, natural disasters and facility impacts which can also cause schedule delays.
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.
While the conflict in Ukraine has not caused any direct supply disruption as we do not source material from that region, the increased demand for our products as a result of this or other conflicts could put pressure on the capacity at key suppliers. In some cases we may need to qualify additional sources to meet this demand and/or secure customer funding to address specific qualification needs of the programs.
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 military conflict between Russia and Ukraine, and the global response to it could exacerbate certain risks we face, and could adversely impact our business, financial condition and results of operations.
On February 24, 2022, the Russian Federation commenced a military invasion of Ukraine. Russia’s invasion of Ukraine and the global response, including the imposition of sanctions by the United States and other countries, has exacerbated, and could continue to exacerbate risks facing our business. Due to the nature of our business and because we protect national security information, we face heightened risk of attack by highly organized adversaries, including nation states and hostile foreign
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governments such as Russia and its allies. 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, and may include cyber-attacks, security attacks and other targeted maneuvers affecting our properties and operations, including our mission critical systems. Such attacks may also be targeted at our employees, customers or partners. In the event that one or more of these attacks is directed at us or one of the third-parties we work with (including our suppliers, customers, or partners), our business, financial condition and results of operations could be materially adversely affected. We may be required to expend significant additional resources to investigate and fortify our security systems even if an attack is not successful.
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;
•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.
Climate change may have a long-term impact on our business.
There are inherent climate-related risks wherever our business is conducted. Global climate change may result in certain natural disasters and adverse weather, such as drought, wildfires, storms, sea-level rise, flooding, heat waves, and cold waves, occurring more frequently or with greater intensity. These disruptions could make it more difficult and costly for us to deliver our products and services, obtain components or other supplies through our supply chain, maintain or resume operations, and perform other critical corporate functions.
Concerns over climate change have resulted in, and are expected to continue to result in, the adoption of legal and regulatory requirements designed to address climate change, as well as legal and regulatory requirements requiring certain climate-related disclosures. Where new laws or regulations are more stringent than current legal or regulatory requirements, we may experience increased compliance costs and other burdens to meet such obligations. Ultimately, the impacts of climate change, whether involving physical risks (such as disruptions resulting from climate-related events or rising sea levels) or transition risks (such as regulatory changes, changes in market dynamics or increased operating costs, including the cost of insurance), are expected to be widespread and unpredictable and could have a material adverse effect on our operating results, financial condition, and/or cash flows.
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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 2022, approximately 55% of our net sales were from fixed-price contracts, most of which are in mature production mode. Under fixed-price contracts, we agree to perform specified work for a fixed price and realize all of the profit or loss resulting from variations in the costs of performing the contract. As a result, all fixed-price contracts involve the inherent risk of unreimbursed cost overruns. To the extent we incur unanticipated cost overruns on a program or platform subject to a fixed-price contract, our profitability would be adversely affected. Future profitability is subject to risks including the ability of suppliers to deliver components of acceptable quality on schedule and the successful implementation of automated tooling in production processes.
In 2022, approximately 45% 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.
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, 2022, 7% 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.
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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 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 would reduce the cash available for our businesses.
As of December 31, 2022, the pension assets, projected benefits obligations, and unfunded pension obligations were $706.9 million, $949.7 million, and $242.8 million, respectively. In 2023, we expect to make cash contributions of approximately $7 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, 2022, we had $303.1 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.
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We are obligated to comply with financial and other covenants outlined in our debt indentures and agreements that could restrict our operating activities. A failure to comply could result in a default which would, if not waived by the lenders, likely come with substantial cost and accelerate the payment of our debt.
Our debt instruments generally contain various restrictive covenants which include, among others, provisions which may restrict our ability to:
•access the full amount of our revolving credit facility and/or incur additional debt;
•enter into certain leases;
•make certain distributions, investments, and other restricted payments;
•cause our restricted subsidiaries to make payments to us;
•enter into transactions with affiliates;
•create certain liens;
•purchase assets or businesses;
•sell assets and, if sold, retain excess cash flow from these sales; and
•consolidate, merge or sell all or substantially all of our assets.
Our secured debt also contains other customary covenants, including, among others, provisions restricting our ability to pledge assets or create other liens. In addition, certain covenants in our bank facility require that we maintain certain financial ratios.
Based on our existing debt agreements, we were in compliance with our financial and non-financial covenants as of December 31, 2022. 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 (the "Senior Credit Facility"). In addition, our failure to pay principal and interest when due is a default under the Senior Credit Facility.
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.
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
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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, even if untrue. 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 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.
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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, 2022, the aggregate range of our estimated future environmental obligations was $290.5 million to $447.1 million and the accrued amount was $290.5 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 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 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
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duty or liability created by the Securities Act or the Exchange Act if brought derivatively on 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
Failure to maintain effective internal control over financial reporting in accordance with rules and regulations of the SEC regarding compliance with the Sarbanes-Oxley Act can affect our ability to record, process, and report financial information accurately, impair our ability to prepare required financial statements, negatively affect investor confidence, cause reputational harm, and negatively impact the market price of our common stock.
Effective internal control over financial reporting is necessary for us to provide reliable and accurate financial reporting and financial statements for external purposes in accordance with generally accepted accounting principles. A failure to maintain effective internal control processes could lead to violations, unintentional or otherwise, of laws and regulations. Subsequent to the Original Filing, we identified a material weakness in our internal control over financial reporting related to the completeness and accuracy of our accounting for excess costs on fixed-price contracts in nearly complete or inactive status. As a result of this material weakness, immaterial errors in sales, cost of sales, contract assets, and contract liabilities in the consolidated financial statements for the years ended December 31, 2022, 2021, and 2020 and the unaudited quarterly financial information for each of the quarters in 2022 and 2021, were not timely detected. Additionally, this material weakness could result in misstatements of the aforementioned account balances or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Due to the material weakness, management concluded that as of December 31, 2022, our internal control over financial reporting was not effective based on the Committee of Sponsoring Organizations of the Treadway Commission criteria described in Internal Control - Integrated Framework (2013). If we fail to achieve and maintain an effective internal control environment, we could suffer misstatements in our financial statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial information, damage our reputation, require the attention and resources of management, and possibly lead to litigation, government investigations, and regulatory enforcement actions. This could result in significant expenses to remediate any internal control deficiencies and lead to a decline in our stock price.
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, including general economic and financial conditions, regulatory actions, 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, speculation associated with merger and acquisition activity, 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.
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 2022 was 31.7% compared with 24.8% for 2021. 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 experimental expenditures currently and requires taxpayers to amortize such costs incurred in the U.S. over five years. As a result, we expect to make additional income tax payments over the next four years which will have an adverse effect on 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.
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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.
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Part II
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, 2022 and 2021, 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, 2022, 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, 2022, 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, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO because a material weakness in internal control over financial reporting existed as of that date related to the ineffective design and maintenance of controls over the accounting for excess costs on fixed-price contracts in nearly complete or inactive status.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness referred to above is described in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. We considered this material weakness in determining the nature, timing, and extent of audit tests applied in our audit of the 2022 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements.
Restatement of Management’s Conclusion Regarding Internal Control over Financial Reporting
Management and we previously concluded that the Company maintained effective internal control over financial reporting as of December 31, 2022. However, management has subsequently determined that a material weakness in internal control over financial reporting related to the ineffective design and maintenance of controls over the accounting for excess costs on fixed-price contracts in nearly complete or inactive status existed as of that date. Accordingly, management’s report has been restated and our present opinion on internal control over financial reporting, as presented herein, is different from that expressed in our previous report.
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 referred to above. 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
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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.
Revenue recognition - estimated total cost at completion on fixed-price contracts
As described in Note 1 to the consolidated financial statements, approximately 55% of total net sales of $2,237.6 million are from fixed-price revenue contracts for the year ended December 31, 2022. 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 15, 2023, except with respect to our opinion on internal control over financial reporting insofar as it relates to the effects of the matter described in the penultimate paragraph of Management’s Report on Internal Control over Financial Reporting, as to which the date is May 4, 2023
We have served as the Company’s auditor since 2006.
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Aerojet Rocketdyne Holdings, Inc.
Consolidated Statements of Operations
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| (In millions, except per share amounts) | |||||||||||||||||
| Net sales | $ | 2,237.6 | $ | 2,188.0 | $ | 2,072.7 | |||||||||||
| Operating costs and expenses: | |||||||||||||||||
| Cost of sales (exclusive of items shown separately below) | 1,906.2 | 1,800.1 | 1,701.3 | ||||||||||||||
| Selling, general and administrative expense | 56.5 | 46.0 | 56.1 | ||||||||||||||
| Depreciation and amortization | 57.3 | 61.4 | 65.3 | ||||||||||||||
| Other expense, net | |||||||||||||||||
| Proxy costs and related litigation | 27.8 | — | — | ||||||||||||||
| Legal matters | 15.7 | — | — | ||||||||||||||
| Other | 28.8 | 23.5 | 9.4 | ||||||||||||||
| Total operating costs and expenses | 2,092.3 | 1,931.0 | 1,832.1 | ||||||||||||||
| Operating income | 145.3 | 257.0 | 240.6 | ||||||||||||||
| Non-operating: | |||||||||||||||||
| Retirement benefits expense | 1.1 | 33.9 | 36.6 | ||||||||||||||
| Loss on debt | 22.7 | 10.5 | — | ||||||||||||||
| Interest income and other | (5.4) | (2.5) | (6.3) | ||||||||||||||
| Interest expense | 18.6 | 20.1 | 30.1 | ||||||||||||||
| Total non-operating expense, net | 37.0 | 62.0 | 60.4 | ||||||||||||||
| Income before income taxes | 108.3 | 195.0 | 180.2 | ||||||||||||||
| Income tax provision | 34.3 | 48.4 | 42.7 | ||||||||||||||
| Net income | $ | 74.0 | $ | 146.6 | $ | 137.5 | |||||||||||
| Earnings per share of common stock | |||||||||||||||||
| Basic earnings per share | $ | 0.92 | $ | 1.84 | $ | 1.76 | |||||||||||
| Diluted earnings per share | $ | 0.90 | $ | 1.78 | $ | 1.66 | |||||||||||
| Weighted average shares of common stock outstanding, basic | 80.3 | 79.2 | 77.4 | ||||||||||||||
| Weighted average shares of common stock outstanding, diluted | 83.3 | 81.7 | 81.9 | ||||||||||||||
| Cash dividends paid per share | $ | — | $ | 5.00 | $ | — | |||||||||||
See Notes to Consolidated Financial Statements.
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Aerojet Rocketdyne Holdings, Inc.
Consolidated Statements of Comprehensive Income
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Net income | $ | 74.0 | $ | 146.6 | $ | 137.5 | |||||||||||
| Other comprehensive income: | |||||||||||||||||
Amortization of net actuarial losses, net of $7.3 million, $15.1 million, and $13.4 million of income taxes in 2022, 2021, and 2020, respectively | 20.4 | 46.0 | 40.3 | ||||||||||||||
Actuarial (losses) gains, net of $2.5 million, $26.5 million, and $10.4 million of income taxes in 2022, 2021, and 2020, respectively | (7.0) | 80.5 | (31.5) | ||||||||||||||
| Amortization of prior service costs, net of income taxes | 0.1 | 0.1 | 0.1 | ||||||||||||||
| Other comprehensive income, net of income taxes | 13.5 | 126.6 | 8.9 | ||||||||||||||
| Comprehensive income | $ | 87.5 | $ | 273.2 | $ | 146.4 | |||||||||||
See Notes to Consolidated Financial Statements.
16
Aerojet Rocketdyne Holdings, Inc.
Consolidated Balance Sheets
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions, except per share amounts) | |||||||||||
| ASSETS | |||||||||||
| Current Assets | |||||||||||
| Cash and cash equivalents | $ | 322.1 | $ | 700.4 | |||||||
| Restricted cash | 3.1 | 3.0 | |||||||||
| Marketable securities | 10.5 | 10.6 | |||||||||
| Accounts receivable | 126.6 | 60.6 | |||||||||
| Contract assets | 451.1 | 354.2 | |||||||||
| Other current assets | 155.6 | 99.5 | |||||||||
| Total Current Assets | 1,069.0 | 1,228.3 | |||||||||
| Noncurrent Assets | |||||||||||
| Right-of-use assets | 54.5 | 52.6 | |||||||||
| Property, plant and equipment, net | 420.2 | 421.1 | |||||||||
| Recoverable environmental remediation costs | 221.5 | 226.2 | |||||||||
| Deferred income taxes | 208.7 | 55.6 | |||||||||
| Goodwill | 161.4 | 161.4 | |||||||||
| Intangible assets | 28.3 | 34.9 | |||||||||
| Other noncurrent assets | 208.2 | 243.3 | |||||||||
| Total Noncurrent Assets | 1,302.8 | 1,195.1 | |||||||||
| Total Assets | $ | 2,371.8 | $ | 2,423.4 | |||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||
| Current Liabilities | |||||||||||
| Current portion of long-term debt | $ | 14.7 | $ | 166.7 | |||||||
| Accounts payable | 142.1 | 132.2 | |||||||||
| Reserves for environmental remediation costs | 36.9 | 37.7 | |||||||||
| Contract liabilities | 334.7 | 366.5 | |||||||||
| Other current liabilities | 218.7 | 172.7 | |||||||||
| Total Current Liabilities | 747.1 | 875.8 | |||||||||
| Noncurrent Liabilities | |||||||||||
| Long-term debt | 288.4 | 294.6 | |||||||||
| Reserves for environmental remediation costs | 253.6 | 258.7 | |||||||||
| Pension benefits | 229.3 | 255.9 | |||||||||
| Operating lease liabilities | 46.2 | 41.3 | |||||||||
| Other noncurrent liabilities | 265.9 | 173.8 | |||||||||
| Total Noncurrent Liabilities | 1,083.4 | 1,024.3 | |||||||||
| Total Liabilities | 1,830.5 | 1,900.1 | |||||||||
| Commitments and contingencies (Note 8) | |||||||||||
| Stockholders’ Equity | |||||||||||
Preferred stock, par value of $1.00; 15.0 million shares authorized; none outstanding | — | — | |||||||||
Common stock, par value of $0.10; 150.0 million shares authorized; 80.7 million shares outstanding as of December 31, 2022; 80.1 million shares outstanding as of December 31, 2021 | 8.0 | 8.0 | |||||||||
| Other capital | 507.2 | 578.1 | |||||||||
Treasury stock at cost, 2.0 million at December 31, 2022; 2.1 million shares as of December 31, 2021 | (63.0) | (64.4) | |||||||||
| Retained earnings | 176.6 | 102.6 | |||||||||
| Accumulated other comprehensive loss, net of income taxes | (87.5) | (101.0) | |||||||||
| Total Stockholders’ Equity | 541.3 | 523.3 | |||||||||
| Total Liabilities and Stockholders’ Equity | $ | 2,371.8 | $ | 2,423.4 | |||||||
See Notes to Consolidated Financial Statements.
17
Aerojet Rocketdyne Holdings, Inc.
Consolidated Statements of Stockholders’ Equity
| Common Stock | Retained Earnings | Accumulated Other Comprehensive Loss | Total Stockholders' Equity | ||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Other Capital | Treasury Stock | (Accumulated Deficit) | |||||||||||||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||||||||||||||
| December 31, 2019 | 77.3 | $ | 7.7 | $ | 552.4 | $ | (12.7) | $ | 252.9 | $ | (236.5) | $ | 563.8 | ||||||||||||||||||||||||||||
| Net income | — | — | — | — | 137.5 | — | 137.5 | ||||||||||||||||||||||||||||||||||
| Other comprehensive income, net of income taxes | — | — | — | — | — | 8.9 | 8.9 | ||||||||||||||||||||||||||||||||||
| Cash dividends declared | — | — | — | — | (447.8) | — | (447.8) | ||||||||||||||||||||||||||||||||||
| Purchase of treasury stock | (1.3) | — | — | (51.7) | — | — | (51.7) | ||||||||||||||||||||||||||||||||||
| Repurchase of shares for option cost and to satisfy tax withholding obligations | (0.3) | — | (20.0) | — | — | — | (20.0) | ||||||||||||||||||||||||||||||||||
| Stock-based compensation and shares issued under equity plans, net | 1.1 | — | 29.7 | — | — | — | 29.7 | ||||||||||||||||||||||||||||||||||
| December 31, 2020 | 76.8 | 7.7 | 562.1 | (64.4) | (57.4) | (227.6) | 220.4 | ||||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | 146.6 | — | 146.6 | ||||||||||||||||||||||||||||||||||
| Other comprehensive income, net of income taxes | — | — | — | — | — | 126.6 | 126.6 | ||||||||||||||||||||||||||||||||||
| Adjustment to dividends paid | — | — | — | — | 13.4 | — | 13.4 | ||||||||||||||||||||||||||||||||||
| Settlement of debt | 2.9 | 0.3 | (4.2) | — | — | — | (3.9) | ||||||||||||||||||||||||||||||||||
| Repurchase of shares for option cost and to satisfy tax withholding obligations | (0.1) | — | (5.8) | — | — | — | (5.8) | ||||||||||||||||||||||||||||||||||
| Stock-based compensation and shares issued under equity plans, net | 0.5 | — | 26.0 | — | — | — | 26.0 | ||||||||||||||||||||||||||||||||||
| December 31, 2021 | 80.1 | 8.0 | 578.1 | (64.4) | 102.6 | (101.0) | 523.3 | ||||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | 74.0 | — | 74.0 | ||||||||||||||||||||||||||||||||||
| Other comprehensive income, net of income taxes | — | — | — | — | — | 13.5 | 13.5 | ||||||||||||||||||||||||||||||||||
| Adjustment to dividends paid | — | — | — | — | 1.0 | — | 1.0 | ||||||||||||||||||||||||||||||||||
| Issuance of treasury stock | 0.1 | — | 1.9 | 1.4 | — | — | 3.3 | ||||||||||||||||||||||||||||||||||
| Cumulative effect of change in accounting guidance (see Note 1) | — | — | (5.6) | — | (1.0) | — | (6.6) | ||||||||||||||||||||||||||||||||||
| Settlement of debt | — | — | (73.2) | — | — | — | (73.2) | ||||||||||||||||||||||||||||||||||
| Repurchase of shares for option cost and to satisfy tax withholding obligations | (0.1) | — | (19.3) | — | — | — | (19.3) | ||||||||||||||||||||||||||||||||||
| Stock-based compensation and shares issued under equity plans, net | 0.6 | — | 25.3 | — | — | — | 25.3 | ||||||||||||||||||||||||||||||||||
| December 31, 2022 | 80.7 | $ | 8.0 | $ | 507.2 | $ | (63.0) | $ | 176.6 | $ | (87.5) | $ | 541.3 | ||||||||||||||||||||||||||||
See Notes to Consolidated Financial Statements.
18
Aerojet Rocketdyne Holdings, Inc.
Consolidated Statements of Cash Flows
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Operating Activities | |||||||||||||||||
| Net income | $ | 74.0 | $ | 146.6 | $ | 137.5 | |||||||||||
| Adjustments to reconcile net income to net cash (used in) provided by operating activities: | |||||||||||||||||
| Depreciation and amortization | 57.3 | 61.4 | 65.3 | ||||||||||||||
| Amortization of debt discount and deferred financing costs | 1.5 | 5.9 | 9.9 | ||||||||||||||
| Stock-based compensation | 26.6 | 20.7 | 31.4 | ||||||||||||||
| Retirement benefits, net | (17.9) | 12.7 | 18.1 | ||||||||||||||
| Loss on debt repurchased | 22.7 | 10.5 | — | ||||||||||||||
| Other, net | 1.7 | (1.7) | (0.4) | ||||||||||||||
| Changes in assets and liabilities: | |||||||||||||||||
| Accounts receivable, net | (66.0) | 15.0 | 36.9 | ||||||||||||||
| Contract assets | (96.9) | (65.6) | (64.5) | ||||||||||||||
| Other current assets, net | (56.1) | 29.9 | 11.2 | ||||||||||||||
| Recoverable for environmental remediation costs | 4.7 | 1.5 | 7.1 | ||||||||||||||
| Other noncurrent assets | 36.5 | 10.0 | 0.6 | ||||||||||||||
| Accounts payable | 6.1 | 24.3 | (36.8) | ||||||||||||||
| Contract liabilities | (31.8) | (40.7) | 144.9 | ||||||||||||||
| Other current liabilities | 49.6 | 7.6 | (4.4) | ||||||||||||||
| Deferred income taxes | (157.9) | (22.0) | 36.1 | ||||||||||||||
| Reserves for environmental remediation costs | (5.9) | (4.2) | (8.6) | ||||||||||||||
| Other noncurrent liabilities and other | 103.1 | (12.3) | (20.5) | ||||||||||||||
| Net Cash (Used in) Provided by Operating Activities | (48.7) | 199.6 | 363.8 | ||||||||||||||
| Investing Activities | |||||||||||||||||
| Capital expenditures | (40.7) | (37.3) | (54.6) | ||||||||||||||
| Purchases of marketable securities | (1.7) | (1.9) | (31.7) | ||||||||||||||
| Sale of marketable securities | — | — | 25.0 | ||||||||||||||
| Other | — | — | 0.3 | ||||||||||||||
| Net Cash Used in Investing Activities | (42.4) | (39.2) | (61.0) | ||||||||||||||
| Financing Activities | |||||||||||||||||
| Dividend payments | (2.7) | (428.8) | — | ||||||||||||||
| Debt principal payments | (263.8) | (182.6) | (21.7) | ||||||||||||||
| Proceeds from shares issued under equity plans | 0.4 | 7.7 | 7.5 | ||||||||||||||
| Repurchase of shares for withholding taxes and option costs under employee equity plans | (19.3) | (5.8) | (20.0) | ||||||||||||||
| Purchase of treasury stock | — | — | (51.7) | ||||||||||||||
| Debt amendment costs | (1.7) | — | — | ||||||||||||||
| Net Cash Used in Financing Activities | (287.1) | (609.5) | (85.9) | ||||||||||||||
| Net (Decrease) Increase in Cash, Cash Equivalents and Restricted Cash | (378.2) | (449.1) | 216.9 | ||||||||||||||
| Cash, Cash Equivalents and Restricted Cash at Beginning of Year | 703.4 | 1,152.5 | 935.6 | ||||||||||||||
| Cash, Cash Equivalents and Restricted Cash at End of Year | $ | 325.2 | $ | 703.4 | $ | 1,152.5 | |||||||||||
| Supplemental disclosures of cash flow information | |||||||||||||||||
| Cash paid for interest | $ | 16.0 | $ | 14.0 | $ | 19.7 | |||||||||||
| Cash paid for income taxes | 71.3 | 39.7 | 56.0 | ||||||||||||||
| Cash refund for income taxes | 0.6 | 1.6 | 13.3 | ||||||||||||||
| Issuance of treasury stock | 3.3 | — | — | ||||||||||||||
See Notes to Consolidated Financial Statements.
19
Aerojet Rocketdyne Holdings, Inc.
Notes to Consolidated Financial Statements
Note 1. Summary of Significant Accounting Policies
a. Basis of Presentation and Nature of Operations
The consolidated financial statements of Aerojet Rocketdyne Holdings, Inc. ("Aerojet Rocketdyne Holdings" or the "Company") include the accounts of the Company and its 100% owned and majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to financial information for prior years to conform to the current year’s presentation.
The Company’s 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 the Company’s wholly-owned subsidiary Easton Development Company, LLC ("Easton") related to the re-zoning, entitlement, sale, and leasing of the Company’s excess real estate assets.
The year of the Company's subsidiary, Aerojet Rocketdyne, ends on the last Saturday in December. Further, as a result of the 2022 calendar, Aerojet Rocketdyne had 53 weeks of operations in 2022 compared with 52 weeks of operations in 2021 and 2020. The additional week of operations, which occurred in the fourth quarter of 2022, accounted for $42.3 million in additional net sales.
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires the Company to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Revision of Previously Issued Consolidated Financial Statements
During the three months ended March 31, 2022, the Company identified an error in its accounting for income taxes associated with its 2.25% Convertible Senior Notes ("2¼% Notes"). Upon issuance of the 2¼% Notes in 2016, the Company did not record the applicable deferred tax liability associated with the conversion option that had been recorded in other capital, which resulted in an overstatement of other capital, an understatement of deferred tax liabilities and an error in income tax expense in subsequent periods. The Company evaluated the errors and concluded that the errors were not material, either individually or in aggregate, to its current or previously issued consolidated financial statements.
To correct the immaterial errors, the Company has revised its previously issued consolidated financial statements as of December 31, 2021, and for each of the years ended December 31, 2021 and 2020. Accordingly, the accompanying financial statements and relevant footnotes to the consolidated financial statements in this Annual Report on Form 10-K have been revised to correct for such immaterial errors. See Note 12 for additional information.
L3Harris Technologies, Inc. ("L3Harris") Merger Agreement
On December 17, 2022, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement"), with L3Harris and Aquila Merger Sub Inc., a Delaware corporation and a wholly-owned subsidiary of L3Harris ("Merger Sub"), pursuant to which, subject to the terms and conditions thereof, Merger Sub will merge with and into the Company (the "Merger") with the Company being the surviving corporation and a wholly-owned subsidiary of L3Harris.
Subject to the terms and conditions set forth in the Merger Agreement, each share of the Company's common stock outstanding as of immediately prior to the effective time of the Merger will be canceled and converted into the right to receive $58.00 in cash, without interest, plus, if the closing occurs after September 17, 2023, $0.0025 for each calendar day elapsed after such date to and including the closing date.
Closing of the Merger is anticipated to occur in 2023, subject to various customary conditions, including stockholder approval and regulatory clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.
Lockheed Terminated Merger Agreement
On December 20, 2020, the Company entered into an Agreement and Plan of Merger (the "Lockheed Terminated Merger Agreement") with Lockheed Martin Corporation ("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 (the "Terminated 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. On February 13, 2022, Lockheed Martin notified the Company that it had elected to terminate the
20
Lockheed Terminated Merger Agreement. On February 14, 2022, pursuant to the parties’ joint motion, the administrative complaint and the U.S. federal court complaint were dismissed.
Coronavirus ("COVID-19") Pandemic
The Company’s financial results and operations have not been materially adversely impacted by the COVID-19 pandemic. The Company is not aware of any specific event or circumstance that would require an update to its estimates or judgments or a revision of the carrying value of its assets or liabilities as of the date of issuance of this Annual Report on Form 10-K. These estimates may change, as new events occur and additional information is obtained. Actual results could differ materially from these estimates under different assumptions or conditions.
b. Cash and Cash Equivalents
All highly liquid debt instruments purchased with a remaining maturity at the date of purchase of three months or less are considered to be cash equivalents. The Company aggregates its cash balances by bank, and reclassifies any negative balances, if applicable, to other current liabilities.
c. Restricted Cash
Restricted cash as of December 31, 2022 and 2021 totaled $3.1 million and $3.0 million, respectively. The restrictions on cash were to satisfy indemnification obligations for environmental remediation coverage.
d. Fair Value of Financial Instruments
Financial instruments are classified using a three-tiered fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
| Fair value measurement as of December 31, 2022 | |||||||||||||||||||||||
| Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Other Observable Inputs (Level 2) | Unobservable Inputs (Level 3) | ||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||
| Money market funds | $ | 206.1 | $ | 206.1 | $ | — | $ | — | |||||||||||||||
| Commercial paper | 49.9 | — | 49.9 | — | |||||||||||||||||||
| Registered investment companies | 0.7 | 0.7 | — | — | |||||||||||||||||||
| Equity securities | 10.5 | 10.5 | — | — | |||||||||||||||||||
| Total | $ | 267.2 | $ | 217.3 | $ | 49.9 | $ | — | |||||||||||||||
| Fair value measurement as of December 31, 2021 | |||||||||||||||||||||||
| Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Other Observable Inputs (Level 2) | Unobservable Inputs (Level 3) | ||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||
| Money market funds | $ | 388.6 | $ | 388.6 | $ | — | $ | — | |||||||||||||||
| Commercial paper | 35.0 | — | 35.0 | — | |||||||||||||||||||
| Registered investment companies | 1.3 | 1.3 | — | — | |||||||||||||||||||
| Equity securities | 10.6 | 10.6 | — | — | |||||||||||||||||||
| Total | $ | 435.5 | $ | 400.5 | $ | 35.0 | $ | — | |||||||||||||||
As of December 31, 2022 and 2021, the total estimated fair value for commercial paper was classified as cash and cash equivalents as the remaining maturity at date of purchase was less than three months. Unrealized (losses) gains on equity securities (component of interest income in the consolidated statements of operations) in 2022 and 2021 totaled $(2.0) million and $1.5 million, respectively.
The carrying amounts of certain of the Company’s financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accounts payable, accrued compensation, and other accrued liabilities, approximate fair value because of their short maturities.
The following table summarizes the estimated fair value and principal amount for outstanding debt obligations excluding finance lease obligations:
21
| Fair Value | Principal Amount | ||||||||||||||||||||||
| As of December 31, | As of December 31, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||
| Term loan | $ | 259.4 | $ | 275.8 | $ | 262.3 | $ | 282.2 | |||||||||||||||
2 1/4% Notes | — | 266.1 | — | 145.9 | |||||||||||||||||||
| $ | 259.4 | $ | 541.9 | $ | 262.3 | $ | 428.1 | ||||||||||||||||
The fair value of the 2¼% Notes was determined using broker quotes that are based on open markets for the Company's debt securities (Level 2 securities). The fair value of the term loan was estimated based on a third-party model used to derive a relative value price using comparable corporate loans within a similar industry, credit quality, and currency.
e. Accounts Receivable
Accounts Receivable represent the Company's unconditional right to consideration under the contract and include amounts billed and currently due from long-term contract customers. The amounts are stated at their net estimated realizable value.
Other receivables represent amounts billed for revenue not derived from long-term contracts.
f. Inventories
Inventories are stated at cost (generally using the average cost method) or net realizable value. The Company capitalizes costs incurred in advance of contract award or funding in inventories if it determines that contract award or funding is probable. Amounts previously capitalized are expensed when changes in facts and circumstances indicate that a contract award or funding is no longer probable. General and administrative costs incurred throughout 2022 and 2021 totaled $256.4 million and $237.1 million, respectively, and the cumulative amount of general and administrative costs in long-term contract inventories were estimated to be $1.9 million and $1.3 million as of December 31, 2022 and 2021, respectively. Inventories are included as a component of other current assets.
g. Income Taxes
The Company files a consolidated U.S. federal income tax return with its 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 the Company’s deferred tax assets is dependent upon its 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 the Company’s past and future performance, the market environment in which it operates, the utilization of tax attributes in the past, the length of carryback and carryforward periods, and evaluation of potential tax planning strategies.
h. Property, Plant and Equipment, net
Property, plant and equipment are recorded at cost. Refurbishment costs that extend the life or increase the value of an asset are capitalized in the property accounts, whereas ordinary maintenance and repair costs are expensed as incurred. Depreciation is computed principally by accelerated methods based on the following useful lives:
| Buildings and improvements | 9 - 40 years | ||||
| Machinery and equipment | 6 - 10 years | ||||
Costs related to software acquired, developed or modified solely to meet the Company's internal requirements (including cloud computing arrangements) and for which there are no substantive plans to market for sale are capitalized and depreciated over 3 to 7 years. Only costs incurred after the preliminary planning stage of the project and after management has authorized and committed funds to the project are eligible for capitalization.
i. Leases
The Company determines if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use ("ROU") assets, other current liabilities, and operating lease liabilities. Finance leases are included in property, plant and equipment and debt. Operating ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. Finance leases are recorded as an asset and an obligation at an amount equal to the present value of the minimum lease payments during the lease term. Amortization expense related to finance leases is included in depreciation and amortization expense.
For certain technology equipment leases, when appropriate, the Company accounts for lease and nonlease (service) components separately based on a relative fair market value basis. For all other leases, the Company accounts for the lease and nonlease components (e.g., common area maintenance) on a combined basis.
The discount rate used for leases is the Company's incremental borrowing rate for collateralized debt based on information available at the lease commencement date. Lease terms may include options to extend or terminate the lease when it is
22
reasonably certain that the option will be exercised. Leases with a term of twelve months or less and that do not include a purchase option that is likely to be exercised are treated as short-term leases and are not reflected on the balance sheet. The Company leases certain facilities, machinery and equipment (including information technology equipment), and office buildings under long-term, non-cancelable operating and finance leases.
j. Real Estate Held for Entitlement and Leasing
The Company capitalizes all costs associated with the real estate entitlement and leasing process. The Company classifies activities related to the entitlement, sale, and leasing of its excess real estate assets as operating activities in the consolidated statements of cash flows. Real estate held for entitlement and leasing is included as a component of other noncurrent assets.
k. Goodwill
Goodwill represents the excess of the purchase price of an acquired enterprise or assets over the fair values of the identifiable assets acquired and liabilities assumed. All of the Company's recorded goodwill resides in the Aerospace and Defense reporting unit. Tests for impairment of goodwill are performed on an annual basis, or at any other time if events occur or circumstances indicate that the carrying amount of goodwill may not be recoverable. Circumstances that could trigger an impairment test include but are not limited to: a significant adverse change in the business climate or legal factors; adverse cash flow trends; an adverse action or assessment by a regulator; unanticipated competition; loss of key personnel; decline in stock price; and results of testing for recoverability of a significant asset group within a reporting unit.
The Company evaluates qualitative factors (including macroeconomic conditions, industry and market considerations, cost factors, and overall financial performance) to determine whether it is necessary to perform the first step of the goodwill test. This step is referred to as the "Step Zero" analysis. If it is determined that it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount, the Company will proceed to the quantitative ("Step One") analysis to determine the existence and amount of any goodwill impairment. The Company may also perform a Step One analysis from time to time to augment its qualitative assessment. The Company evaluated goodwill using a Step Zero analysis as of October 1, 2022 and 2021, and determined that goodwill was not impaired.
There can be no assurance that the Company’s estimates and assumptions made for purposes of its goodwill impairment testing will prove to be accurate predictions of the future. If the Company’s assumptions and estimates are incorrect, the Company may be required to record goodwill impairment charges in future periods.
The goodwill balance as of December 31, 2022 and 2021, relates to the Company’s Aerospace and Defense segment.
l. Intangible Assets
Identifiable intangible assets, such as patents, trademarks, and licenses are recorded at cost or when acquired as part of a business combination at estimated fair value. Identifiable intangible assets are amortized based on when they provide the Company economic benefit, or using the straight-line method, over their estimated useful life. Amortization periods for identifiable intangible assets range from 7 years to 30 years.
m. Environmental Remediation
The Company expenses, on a current basis, recurring costs associated with managing hazardous substances and contamination in ongoing operations. The Company reviews on a quarterly basis estimated future remediation costs and has an established practice of estimating environmental remediation costs over a 15 year period, except for those environmental remediation costs with a specific contractual term. Environmental liabilities at the Baldwin Park Operable Unit ("BPOU") site are currently estimated through the term of the project agreement, which expires in May 2027. In establishing 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 the Company may be jointly or severally liable.
At the time a liability is recorded for future environmental costs, the Company records an asset for estimated future recoveries that are estimable and probable. Some of the Company’s environmental costs are eligible for future recovery in the pricing of its products and services to the U.S. government and under existing third party agreements. The Company considers the recovery probable based on the Global Settlement, U.S. government contracting regulations, and its long history of receiving reimbursement for such costs (see Notes 8(b) and 8(c)).
n. Retirement Benefits
The Company discontinued future benefit accruals for the defined benefit pension plans in 2009. The Company provides medical and life insurance benefits ("postretirement 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 benefits obligations, and net amortization and deferrals, increased or reduced by the return on assets. The Company also sponsors a defined contribution 401(k) plan and participation in the plan is available to all employees (see Note 7).
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o. Conditional Asset Retirement Obligations
Conditional asset retirement obligations ("CAROs") are legal obligations associated with the retirement of long-lived assets. These liabilities are initially recorded at fair value and the expected asset retirement costs are capitalized by increasing the carrying amount of the related assets by the same amount as the liability. Asset retirement costs are subsequently depreciated over the useful lives of the related assets. Subsequent to initial recognition, the Company records period-to-period changes in the CARO liability resulting from the passage of time and revisions to either the timing or the amount of the estimate of the undiscounted cash flows.
CAROs associated with owned properties are based on estimated costs necessary for the legally required removal or remediation of various regulated materials, primarily asbestos disposal and radiological decontamination of an ordnance manufacturing facility. For leased properties, CAROs are based on the estimated cost of contractually required property restoration.
The following table summarizes the changes in the carrying amount of CAROs:
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Balance at beginning of year | $ | 51.8 | $ | 51.4 | $ | 51.4 | |||||||||||
| Additions/(reductions) and other, net | 3.0 | (2.3) | (2.7) | ||||||||||||||
| Accretion | 2.6 | 2.7 | 2.7 | ||||||||||||||
| Balance at end of year | $ | 57.4 | $ | 51.8 | $ | 51.4 | |||||||||||
p. Loss Contingencies
The Company is currently involved in certain legal proceedings and has accrued its estimate of the probable costs and recoveries (in relation to environmental costs) for resolution of these claims. These estimates are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. It is possible, however, that future results of operations or cash flows for any particular period could be materially affected by changes in estimates or the effectiveness of strategies related to these proceedings.
q. Warranties
The Company provides product warranties in conjunction with certain product sales. The majority of the Company’s warranties are a one-year standard warranty for parts, workmanship, and compliance with specifications. On occasion, the Company has made commitments beyond the standard warranty obligation. While the Company has contracts with warranty provisions, there is not a history of any significant warranty claims experience. A reserve for warranty exposure is made on a product by product basis when it is both estimable and probable. These costs are included in the program’s estimate at completion and are expensed in accordance with the Company’s revenue recognition methodology for that particular contract.
r. Revenue Recognition
In the Company’s Aerospace and Defense segment, the majority of revenue is earned from long-term contracts to design, develop, and manufacture aerospace and defense products for, and provide related services to, the Company’s customers, including the U.S. government and major aerospace and defense prime contractors. Each customer contract defines the Company’s 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, the Company allocates the contracted transaction price to each performance obligation based upon the relative standalone selling price, which represents the price at which the Company would sell the promised good or service separately to the customer. The Company determines the standalone selling price based upon the facts and circumstances of each obligated good or service. The majority of the Company’s 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 the Company’s forecast of the total cost to satisfy the performance obligation plus an appropriate profit margin.
Contract modifications are routine in the performance of the Company's 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.
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. The Company measures progress on substantially all its performance obligations using the cost-to-cost method, which the Company believes best depicts the transfer of control of goods and services to the customer. Under the cost-to-cost method, the Company records 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
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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. The Company includes variable consideration in the transaction price for the respective performance obligation at either estimated value, or most likely amount to be earned, based upon the Company’s assessment of expected performance. The Company records 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.
The Company evaluates 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 the Company’s estimate of total costs to be incurred to satisfy a performance obligation exceeds the expected revenue, the Company recognizes the loss immediately. When the Company determines that a change in estimates has an impact on the associated profit of a performance obligation, the Company records 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 the Company’s operating results. The following table summarizes the impact of the changes in significant contract accounting estimates on the Company’s Aerospace and Defense segment operating results:
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| (In millions, except per share amounts) | |||||||||||||||||
| Net (unfavorable) favorable effect of the changes in contract estimates on net sales | $ | (21.4) | $ | 34.8 | $ | 38.5 | |||||||||||
| (Unfavorable) favorable effect of the changes in contract estimates on income before income taxes | (33.8) | 31.2 | 45.1 | ||||||||||||||
| (Unfavorable) favorable effect of the changes in contract estimates on net income | (23.1) | 23.5 | 34.5 | ||||||||||||||
| (Unfavorable) favorable effect of the changes in contract estimates on basic earnings per share ("EPS") of common stock | (0.29) | 0.29 | 0.44 | ||||||||||||||
| (Unfavorable) favorable effect of the changes in contract estimates on diluted EPS | (0.29) | 0.29 | 0.42 | ||||||||||||||
The 2022 net unfavorable changes in contract estimates were primarily driven by cost growth from supply chain disruptions and necessary technical and manufacturing changes identified on a portion of the Standard Missile program. The 2021 net favorable changes in contract estimates were primarily driven by improved performance and risk retirements on the RS-68, Terminal High Altitude Area Defense ("THAAD"), Patriot Advanced Capability-3 ("PAC-3"), and RL10 programs partially offset by cost growth on a portion of the Standard Missile program and the Commercial Crew program. The 2020 net favorable changes in contract estimates were primarily driven by improved performance and risk retirements on the THAAD, RS-68, RL10, and PAC-3 programs partially offset by cost growth on a portion of the Standard Missile program and the Commercial Crew program.
In the Company’s Aerospace and Defense segment, the timing of revenue recognition, customer invoicing, and collections produces accounts receivable, contract assets, and contract liabilities on the Company’s Consolidated Balance Sheet. The Company invoices in accordance with contract payment terms either based upon a recurring contract payment schedule, or as contract milestones are achieved. Customer invoices, net of reserves, represent an unconditional right of consideration. When revenue is recognized in advance of customer invoicing, a contract asset is recorded. Conversely, when customers are invoiced in advance of revenue recognition, a contract liability is recorded. Unpaid customer invoices are reflected as accounts receivable. Amounts for overhead disallowances or billing decrements are reflected in contract assets and primarily represent estimates of potential overhead costs which may not be successfully negotiated and collected. The following table summarizes contract assets and liabilities:
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions) | |||||||||||
| Contract assets | $ | 458.3 | $ | 359.6 | |||||||
| Reserve for overhead rate disallowance | (7.2) | (5.4) | |||||||||
| Contract assets, net of reserve | 451.1 | 354.2 | |||||||||
| Contract liabilities | 334.7 | 366.5 | |||||||||
| Net contract asset (liabilities), net of reserve | $ | 116.4 | $ | (12.3) | |||||||
Net contract assets increased by $128.7 million primarily due to an increase in unbilled receivables. During 2022, the Company recognized sales of $310.6 million that were included in the Company’s contract liabilities as of December 31, 2021. During 2021, the Company recognized sales of $364.9 million that were included in the Company’s contract liabilities as of December 31, 2020. Contract assets included unbilled receivables of $445.3 million and $347.1 million as of December 31, 2022
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and 2021, respectively. Approximately 19% of unbilled receivables at December 31, 2022, are expected to be collected after one year.
As of December 31, 2022, the Company’s total remaining performance obligations, also referred to as backlog, totaled $6.8 billion. The Company expects to recognize approximately 33%, or $2.3 billion, of the remaining performance obligations as sales over the next twelve months, an additional 27% the following twelve months, and 40% thereafter.
The Company's contracts are largely categorized as either "fixed-price" (largely used by the U.S. government for production-type contracts) or "cost-reimbursable" (largely used by the U.S. government for development-type contracts). Fixed-price contracts present the risk of unreimbursed cost overruns, potentially resulting in lower than expected contract profits and margins. This risk 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, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| Fixed-price | 55 | % | 57 | % | 61 | % | |||||||||||
| Cost-reimbursable | 45 | 43 | 39 | ||||||||||||||
Revenue from real estate asset sales is recognized when a sufficient down-payment has been received, financing has been arranged and title, possession and other attributes of ownership have been transferred to the buyer. The allocation to cost of sales on real estate asset sales is based on a relative fair market value computation of the land sold which includes the basis on the Company’s book value, capitalized entitlement costs, and an estimate of the Company’s continuing financial commitment.
s. Research and Development ("R&D")
Company-funded R&D expenses (reported as a component of cost of sales) were $58.4 million, $50.6 million, and $55.8 million in 2022, 2021, and 2020, respectively. Company-funded R&D expenses include the costs of technical activities that are useful in developing new products, services, processes, or techniques, as well as expenses for technical activities that may significantly improve existing products or processes. These expenses are generally allocated among all contracts and programs in progress under U.S. government contractual arrangements.
Customer-funded R&D expenditures, which are funded from U.S. government contracts, totaled $754.4 million, $700.7 million, and $628.7 million in 2022, 2021, and 2020, respectively. Expenditures under customer-funded R&D U.S. government contracts are accounted for as sales and cost of sales.
t. Stock-based Compensation
The Company recognizes stock-based compensation in the statements of operations at the grant-date fair value of stock awards issued to employees and directors over the vesting period. The Company also grants Stock Appreciation Rights ("SARs") awards which are similar to the Company’s employee stock options, but are settled in cash rather than in shares of common stock, and are classified as liability awards. Compensation cost for these awards is determined using a fair-value method and remeasured at each reporting date until the date of settlement. The Company accounts for forfeitures when they occur for consistency with the U.S. government recovery accounting practice.
u. Impairment or Disposal of Long-Lived Assets
Impairment of long-lived assets is recognized when events or circumstances indicate that the carrying amount of the asset, or related groups of assets, may not be recoverable. Circumstances which could trigger a review include, but are not limited to: significant decreases in the market price of the asset; significant adverse changes in the business climate or legal factors; accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset; or a current expectation that the asset will more likely than not be sold or disposed of significantly before the end of its estimated useful life. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If the Company determines that an asset is not recoverable, then the Company would record an impairment charge if the carrying value of the asset exceeds its fair value.
A long-lived asset classified as "held for sale" is initially measured at the lower of its carrying amount or fair value less costs to sell. In the period that the "held for sale" criteria are met, the Company recognizes an impairment charge for any initial adjustment of the long-lived asset amount. Gains or losses not previously recognized resulting from the sale of a long-lived asset are recognized on the date of sale.
v. Concentrations
Dependence upon U.S. Government Programs and Contracts
The principal end user customers of the Company's products and technology are primarily agencies of the U.S. government. The following table summarizes the percentages of net sales by principal end user:
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| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| U.S. government | 95 | % | 96 | % | 96 | % | |||||||||||
| Non U.S. government customers | 5 | 4 | 4 | ||||||||||||||
The following table summarizes the percentages of net sales for significant programs, all of which are included in the U.S. government sales and are comprised of multiple contracts:
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| RS-25 program | 15 | % | 17 | % | 18 | % | |||||||||||
| Standard Missile program | 12 | 12 | 13 | ||||||||||||||
PAC-3 program | 10 | 10 | 10 | ||||||||||||||
| THAAD program | 7 | 8 | 11 | ||||||||||||||
Major Customers
The following table summarizes the customers that represented more than 10% of net sales, each of which involves sales of several product lines and programs:
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| Lockheed Martin | 32 | % | 32 | % | 34 | % | |||||||||||
| NASA | 19 | 20 | 21 | ||||||||||||||
| Raytheon Technologies Corporation ("Raytheon") | 19 | 17 | 17 | ||||||||||||||
Credit Risk
Aside from investments held in the Company’s retirement benefit plans, financial instruments that could potentially subject the Company to concentration of credit risk consist primarily of cash, cash equivalents, and trade receivables. The Company’s cash and cash equivalents are held and managed by recognized financial institutions and are subject to the Company’s investment policy. The investment policy outlines minimum acceptable credit ratings for each type of investment and limits the amount of credit exposure to any one security issue. The Company does not believe significant concentration of credit risk exists with respect to these investments.
The following table summarizes customers that represented more than 10% of accounts receivable, including unbilled receivables which are a component of contract assets:
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Raytheon | 39 | % | 26 | % | |||||||
| Lockheed Martin | 14 | 17 | |||||||||
| The Boeing Company | 13 | 17 | |||||||||
| United Launch Alliance ("ULA") | * | 11 | |||||||||
| NASA | * | 10 | |||||||||
________
* Less than 10%.
Dependence on Single Source and Other Third Party Suppliers
The Company uses a significant quantity of raw materials that are highly dependent on market fluctuations and government regulations. Further, as a U.S. government contractor, the Company is 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. The Company is often forced to either qualify new materials or pay higher prices to maintain the supply. To date the Company has been successful in establishing replacement materials and securing customer funding to address specific qualification needs of the programs. Prolonged disruptions in the supply of any of the Company’s 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 the Company’s operating results, financial condition, and/or cash flows.
Workforce
As of December 31, 2022, 7% of the Company’s employees were covered by collective bargaining agreements.
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w. Related Parties
GAMCO Investors, Inc. ("GAMCO") owned 7% and 6% of the Company's common stock at December 31, 2022 and 2021, respectively. The Company received services of $0.8 million, $1.0 million, and $0.8 million in 2022, 2021, and 2020, respectively, from GAMCO for investment management fees of the Company’s defined benefit pension plan assets.
BlackRock, Inc. ("BlackRock") owned 16% and 15% of the Company's common stock at December 31, 2022 and 2021, respectively. The Company invests in money market funds managed by BlackRock.
The Vanguard Group, Inc. ("Vanguard") owned 10% of the Company’s common stock at December 31, 2022 and 2021. Certain investments held by the Company and investment alternatives offered through the Company’s 401(k) plan are managed by Vanguard.
x. Accounting Pronouncements
Recently Issued Accounting Pronouncements
In August 2020, the Financial Accounting Standards Board issued guidance which simplifies the accounting for convertible instruments. This guidance eliminates certain models that require separate accounting for embedded conversion features, in certain cases. Additionally, among other changes, the guidance eliminates certain of the conditions for equity classification for contracts in an entity’s own equity. The guidance also requires entities to use the if-converted method for all convertible instruments in the diluted earnings per share calculation and include the effect of share settlement for instruments that may be settled in cash or shares, except for certain liability-classified share-based payment awards. The Company adopted the new guidance as of January 1, 2022, using the modified retrospective approach, resulting in the following adjustments: (i) a decrease of $1.9 million in deferred tax liabilities, (ii) a decrease of $5.6 million in other capital, (iii) a decrease of $1.0 million in retained earnings, and (iv) an increase of $8.5 million in debt. During the three months ended September 30, 2022, the Company settled its outstanding convertible debt. See Note 6.
Note 2. Earnings Per Share
The following table reconciles the numerator and denominator used to calculate basic and diluted EPS:
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| (In millions, except per share amounts) | |||||||||||||||||
| Numerator: | |||||||||||||||||
| Net income | $ | 74.0 | $ | 146.6 | $ | 137.5 | |||||||||||
| Income allocated to participating securities | (0.2) | (0.9) | (1.7) | ||||||||||||||
| Net income for basic EPS | 73.8 | 145.7 | 135.8 | ||||||||||||||
Interest on 21/4% Notes | 1.4 | — | — | ||||||||||||||
| Net income for diluted EPS | $ | 75.2 | $ | 145.7 | $ | 135.8 | |||||||||||
| Denominator: | |||||||||||||||||
| Basic weighted average shares | 80.3 | 79.2 | 77.4 | ||||||||||||||
| Effect of: | |||||||||||||||||
21/4% Notes | 3.0 | 2.4 | 4.5 | ||||||||||||||
| Awards issued under equity plans | — | 0.1 | — | ||||||||||||||
| Diluted weighted average shares | 83.3 | 81.7 | 81.9 | ||||||||||||||
Basic EPS | $ | 0.92 | $ | 1.84 | $ | 1.76 | |||||||||||
Diluted EPS | $ | 0.90 | $ | 1.78 | $ | 1.66 | |||||||||||
Securities which would have been anti-dilutive are insignificant and are excluded from the computation of diluted earnings per share in all periods presented.
The increase in the dilutive effect of the 2¼% Notes in 2022 is the result of the adoption of new accounting guidance. During the three months ended September 30, 2022, the Company settled its outstanding 2¼% Notes. See Notes 1 and 6.
Note 3. Balance Sheet Accounts and Supplemental Disclosures
a. Accounts Receivable
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions) | |||||||||||
| Billed | $ | 126.3 | $ | 60.3 | |||||||
| Other trade receivables | 0.3 | 0.3 | |||||||||
| Accounts receivable | $ | 126.6 | $ | 60.6 | |||||||
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b. Other Current Assets
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions) | |||||||||||
| Deferred costs recoverable from the U.S. government | $ | 36.9 | $ | 37.4 | |||||||
| Income tax receivable (see Note 5) | 24.7 | 13.8 | |||||||||
| Prepaid expenses | 16.4 | 15.3 | |||||||||
| Inventories | 15.8 | 10.0 | |||||||||
| Other | 61.8 | 23.0 | |||||||||
| Other current assets | $ | 155.6 | $ | 99.5 | |||||||
c. Property, Plant and Equipment, net
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions) | |||||||||||
| Land | $ | 71.1 | $ | 71.1 | |||||||
| Buildings and improvements | 535.4 | 503.0 | |||||||||
| Machinery and equipment, including capitalized software | 517.5 | 499.1 | |||||||||
| Construction-in-progress | 37.5 | 50.0 | |||||||||
| 1,161.5 | 1,123.2 | ||||||||||
| Less: accumulated depreciation | (741.3) | (702.1) | |||||||||
| Property, plant and equipment, net | $ | 420.2 | $ | 421.1 | |||||||
Depreciation expense for 2022, 2021, and 2020 was $48.1 million, $48.8 million, and $49.2 million, respectively. The Company had $3.8 million of property, plant and equipment additions included in accounts payable as of December 31, 2022.
d. Intangible Assets
| As of December 31, 2022 | |||||||||||||||||
| Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||||||||||
| (In millions) | |||||||||||||||||
| Customer related | $ | 87.2 | $ | 84.0 | $ | 3.2 | |||||||||||
| Intellectual property\trade secrets | 34.2 | 24.9 | 9.3 | ||||||||||||||
| Trade name | 21.0 | 6.9 | 14.1 | ||||||||||||||
| Acquired technology | 19.2 | 17.5 | 1.7 | ||||||||||||||
| Intangible assets | $ | 161.6 | $ | 133.3 | $ | 28.3 | |||||||||||
| As of December 31, 2021 | |||||||||||||||||
| Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||||||||||
| (In millions) | |||||||||||||||||
| Customer related | $ | 87.2 | $ | 81.3 | $ | 5.9 | |||||||||||
| Intellectual property\trade secrets | 34.2 | 22.3 | 11.9 | ||||||||||||||
| Trade name | 21.0 | 6.1 | 14.9 | ||||||||||||||
| Acquired technology | 19.2 | 17.0 | 2.2 | ||||||||||||||
| Intangible assets | $ | 161.6 | $ | 126.7 | $ | 34.9 | |||||||||||
The intangible assets relate to the Company’s Aerospace and Defense segment. Amortization expense related to intangible assets was $6.6 million, $9.9 million, and $13.4 million in 2022, 2021, and 2020, respectively.
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Future amortization expense for the five succeeding years is estimated to be as follows:
| Year Ending December 31, | Future Amortization Expense | ||||
| (In millions) | |||||
| 2023 | $ | 6.1 | |||
| 2024 | 4.8 | ||||
| 2025 | 3.7 | ||||
| 2026 | 2.1 | ||||
| 2027 | 0.7 | ||||
| $ | 17.4 | ||||
e. Other Noncurrent Assets
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions) | |||||||||||
| Real estate held for entitlement and leasing | $ | 105.9 | $ | 103.7 | |||||||
| Receivable from Northrop Grumman Corporation ("Northrop") for environmental remediation costs | 28.5 | 34.5 | |||||||||
| Deferred costs recoverable from the U.S. government | 61.9 | 62.1 | |||||||||
| Other | 11.9 | 43.0 | |||||||||
| Other noncurrent assets | $ | 208.2 | $ | 243.3 | |||||||
f. Other Current Liabilities
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions) | |||||||||||
| Accrued compensation and employee benefits | $ | 157.2 | $ | 122.0 | |||||||
| Other | 61.5 | 50.7 | |||||||||
| Other current liabilities | $ | 218.7 | $ | 172.7 | |||||||
f. Other Noncurrent Liabilities
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions) | |||||||||||
| Uncertain income tax positions (see Note 5) | $ | 151.3 | $ | 20.7 | |||||||
| Other | 114.6 | 153.1 | |||||||||
| Other noncurrent liabilities | $ | 265.9 | $ | 173.8 | |||||||
g. Accumulated Other Comprehensive Loss, Net of Income Taxes
The following table presents the changes in accumulated other comprehensive loss by components, net of income taxes:
| Actuarial Losses, Net | Prior Service Costs, Net | Total | |||||||||||||||
| (In millions) | |||||||||||||||||
| December 31, 2020 | $ | (227.6) | $ | — | $ | (227.6) | |||||||||||
| Actuarial gains, net of income taxes | 80.5 | — | 80.5 | ||||||||||||||
| Amortization of net actuarial losses and prior service costs, net of income taxes | 46.0 | 0.1 | 46.1 | ||||||||||||||
| December 31, 2021 | (101.1) | 0.1 | (101.0) | ||||||||||||||
| Actuarial losses, net of income taxes | (7.0) | — | (7.0) | ||||||||||||||
| Amortization of net actuarial losses and prior service costs, net of income taxes | 20.4 | 0.1 | 20.5 | ||||||||||||||
| December 31, 2022 | $ | (87.7) | $ | 0.2 | $ | (87.5) | |||||||||||
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Note 4. Leases
The Company and its subsidiaries lease certain facilities, machinery and equipment, and office buildings under long-term, non-cancelable operating leases. The leases generally provide for renewal options ranging from one to 20 years.
The following table summarizes the Company's lease costs:
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Operating lease cost | $ | 14.7 | $ | 16.0 | $ | 15.5 | |||||||||||
| Finance lease cost: | |||||||||||||||||
| Amortization | 2.2 | 2.6 | 2.9 | ||||||||||||||
| Interest on lease liabilities | 2.5 | 2.6 | 2.7 | ||||||||||||||
| Short-term lease cost | 0.5 | 0.5 | 0.5 | ||||||||||||||
| Total lease costs | $ | 19.9 | $ | 21.7 | $ | 21.6 | |||||||||||
The following table summarizes the supplemental cash flow information related to leases:
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Cash paid for amounts included in the measurement of lease liabilities: | |||||||||||||||||
Operating cash flows for operating leases | $ | 15.6 | $ | 15.6 | $ | 13.7 | |||||||||||
Operating cash flows for finance leases | 2.5 | 2.6 | 2.7 | ||||||||||||||
Financing cash flows for finance leases | 1.9 | 2.2 | 2.1 | ||||||||||||||
| Assets obtained in exchange for lease obligations: | |||||||||||||||||
Operating leases | 14.7 | 36.3 | 11.9 | ||||||||||||||
The following table summarizes the supplemental balance sheet information related to leases:
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions) | |||||||||||
| Operating leases: | |||||||||||
Operating lease right-of-use assets | $ | 54.5 | $ | 52.6 | |||||||
Operating lease liabilities (component of other current liabilities) | $ | 9.5 | $ | 13.4 | |||||||
Operating lease liabilities, noncurrent | 46.2 | 41.3 | |||||||||
| Total operating lease liability | $ | 55.7 | $ | 54.7 | |||||||
| Finance leases: | |||||||||||
Property, plant and equipment | $ | 47.8 | $ | 52.9 | |||||||
Accumulated depreciation | (8.4) | (11.3) | |||||||||
Property, plant and equipment, net | $ | 39.4 | $ | 41.6 | |||||||
Current portion of long-term debt | $ | 1.3 | $ | 1.9 | |||||||
Long-term debt | 40.3 | 41.5 | |||||||||
Total finance lease liability | $ | 41.6 | $ | 43.4 | |||||||
| Weighted-average remaining lease term (in years): | |||||||||||
Operating leases | 7 | 7 | |||||||||
Finance leases | 16 | 16 | |||||||||
| Weighted-average discount rate: | |||||||||||
Operating leases | 4.5 | % | 3.8 | % | |||||||
Finance leases | 5.8 | % | 5.9 | % | |||||||
The Company has an additional finance lease that has not yet commenced amounting to $22.9 million. This finance lease is expected to commence in 2023 with an expected lease term of 15 years.
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The following table presents the maturities of lease liabilities and lease revenue in effect as of December 31, 2022:
| Year Ending December 31, | Operating Leases | Finance Leases | Future Minimum Rental Income | ||||||||||||||
| (In millions) | |||||||||||||||||
| 2023 | $ | 11.8 | $ | 3.7 | $ | 1.4 | |||||||||||
| 2024 | 9.0 | 3.8 | 1.1 | ||||||||||||||
| 2025 | 8.4 | 3.8 | 1.2 | ||||||||||||||
| 2026 | 8.2 | 3.9 | 1.2 | ||||||||||||||
| 2027 | 7.1 | 3.9 | 1.0 | ||||||||||||||
| Thereafter | 20.6 | 45.9 | 4.5 | ||||||||||||||
| Total minimum rentals | 65.1 | 65.0 | 10.4 | ||||||||||||||
| Less: imputed interest | (9.4) | (23.4) | — | ||||||||||||||
Total | $ | 55.7 | $ | 41.6 | $ | 10.4 | |||||||||||
The Company also leases certain surplus facilities to third parties. The Company recorded lease income of $2.4 million, $2.5 million, and $3.3 million in 2022, 2021 and 2020, respectively, related to these arrangements, which have been included in net sales.
Note 5. Income Taxes
The Company files a consolidated U.S. federal income tax return with its wholly-owned subsidiaries. The following table presents the components of the Company’s income tax provision:
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Current | |||||||||||||||||
| U.S. federal | $ | 149.7 | $ | 56.1 | $ | 6.6 | |||||||||||
| State and local | 40.7 | 14.4 | 0.1 | ||||||||||||||
| 190.4 | 70.5 | 6.7 | |||||||||||||||
| Deferred | |||||||||||||||||
| U.S. federal | (129.9) | (21.0) | 24.5 | ||||||||||||||
| State and local | (26.2) | (1.1) | 11.5 | ||||||||||||||
| (156.1) | (22.1) | 36.0 | |||||||||||||||
| Income tax provision | $ | 34.3 | $ | 48.4 | $ | 42.7 | |||||||||||
The following table presents the reconciling items between the income tax provision using the U.S. federal statutory rate and the Company's reported income tax provision.
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Statutory U.S. federal income tax | $ | 22.7 | $ | 41.0 | $ | 37.9 | |||||||||||
| State income taxes, net of federal benefit | 11.4 | 11.9 | 9.1 | ||||||||||||||
| Reserve adjustments | (1.1) | 0.1 | 1.2 | ||||||||||||||
| Nondeductible compensation | 4.8 | 1.6 | 3.4 | ||||||||||||||
| Tax credits and special deductions | (4.3) | 0.6 | (4.6) | ||||||||||||||
| Convertible debt | (0.4) | (6.3) | 0.2 | ||||||||||||||
| Stock-based compensation excess tax benefits | (1.4) | (1.0) | (4.4) | ||||||||||||||
| False Claims Act settlement | 1.9 | — | — | ||||||||||||||
| Other | 0.7 | 0.5 | (0.1) | ||||||||||||||
| Income tax provision | $ | 34.3 | $ | 48.4 | $ | 42.7 | |||||||||||
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The following table presents a reconciliation of the U.S. federal statutory income tax rate to the Company’s effective income tax rate on earnings in percentages.
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| Statutory U.S. federal income tax rate | 21.0 | % | 21.0 | % | 21.0 | % | |||||||||||
| State income taxes, net of federal benefit | 10.6 | 6.1 | 5.1 | ||||||||||||||
| Reserve adjustments | (1.0) | — | 0.7 | ||||||||||||||
| Nondeductible compensation | 4.4 | 0.8 | 1.9 | ||||||||||||||
| Tax credits and special deductions | (4.0) | 0.3 | (2.6) | ||||||||||||||
| Convertible debt | (0.4) | (3.3) | 0.1 | ||||||||||||||
| Stock-based compensation excess tax benefits | (1.3) | (0.5) | (2.4) | ||||||||||||||
| False Claims Act settlement | 1.8 | — | — | ||||||||||||||
| Other | 0.6 | 0.4 | (0.1) | ||||||||||||||
| Effective income tax rate | 31.7 | % | 24.8 | % | 23.7 | % | |||||||||||
In 2022, the Company’s effective tax rate was 31.7%. The Company’s effective tax rate differed from the 21% statutory federal income tax rate primarily due to state income taxes and certain other expenditures which are permanently not deductible for tax purposes, partially offset by R&D credits.
In 2021, the Company's effective tax rate was 24.8%. The Company's 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 the Company’s stock-based compensation and deductible premiums paid upon the redemption of a portion of the Company’s convertible debt.
In 2020, the Company’s effective tax rate was 23.7%.The Company's 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 the Company's stock-based compensation.
On August 16, 2022, the "Inflation Reduction Act" was signed into law in the U.S. The Company evaluated the impact and the Inflation Reduction Act does not have a material impact on its financial results..
The Company is routinely examined by domestic tax authorities. While it is difficult to predict the outcome or timing of a particular tax matter, the Company believes it has adequately provided reserves for any reasonable foreseeable outcome related to these matters.
As of January 31, 2023, the Company had no income tax audits open.
U.S. federal tax returns for the years ended December 31, 2019, through December 31, 2021, remain open to examination. Tax returns for the years ended December 31, 2018, through December 31, 2021, remain open to examination for state income tax jurisdictions.
The following table presents a reconciliation of unrecognized tax benefits:
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Balances at beginning of year | $ | 20.0 | $ | 14.2 | $ | 58.0 | |||||||||||
| Increases based on tax positions in prior years | 0.4 | 0.3 | 2.7 | ||||||||||||||
| Decreases based on tax position in prior years | (2.0) | (0.4) | (51.5) | ||||||||||||||
| Increases based on tax positions in current year | 134.1 | 6.6 | 5.6 | ||||||||||||||
| Lapse of statute of limitations | (2.2) | (0.7) | (0.6) | ||||||||||||||
| Balances at end of year | $ | 150.3 | $ | 20.0 | $ | 14.2 | |||||||||||
As of December 31, 2022, the total amount of unrecognized tax benefits was $150.3 million. Of the $150.3 million, $20.9 million would affect the effective tax rate. The increase in liabilities associated with uncertain tax positions and corresponding increase to net deferred tax assets is primarily resulting from the Tax Cuts and Jobs Act of 2017 elimination of the option to deduct research and experimental expenditures in the year incurred and requirement to amortize such costs incurred over five years.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of December 31, 2022, 2021, and 2020, the Company had $1.1 million, $0.6 million, and $0.4 million, respectively, in accrued interest and penalties related to uncertain tax positions. During 2022, 2021, and 2020, the Company recorded additional interest and penalties of $0.5 million, $0.2 million, and ($1.4) million, respectively. It is reasonably possible that a reduction of up to
33
$5.4 million of unrecognized tax benefits and related interest and penalties may occur within the next 12 months as a result of the expiration of certain statutes of limitations.
Deferred Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of the Company’s assets and liabilities for financial reporting and income tax purposes. Deferred tax assets and liabilities are determined by multiplying such differences by the enacted tax rates expected to be in effect when such differences are recovered or settled.
The following table presents the deferred tax assets and liabilities:
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions) | |||||||||||
| Deferred Tax Assets | |||||||||||
| Capitalized research and experimental expenditures | $ | 156.0 | $ | — | |||||||
| Accrued estimated costs | 51.2 | 47.6 | |||||||||
| Basis difference in assets and liabilities | 76.9 | 58.8 | |||||||||
| Operating lease liabilities | 14.0 | 13.7 | |||||||||
| Tax losses and credit carryforwards | 1.2 | 0.4 | |||||||||
| Net cumulative defined benefit pension plan losses | 56.5 | 58.8 | |||||||||
| Retiree medical and life insurance benefits | 3.6 | 4.7 | |||||||||
| Total deferred tax assets | 359.4 | 184.0 | |||||||||
| Deferred Tax Liabilities | |||||||||||
| Revenue recognition differences | 123.7 | 104.8 | |||||||||
| Basis differences in intangible assets | 13.3 | 10.7 | |||||||||
| ROU assets | 13.7 | 12.9 | |||||||||
| Total deferred tax liabilities | 150.7 | 128.4 | |||||||||
| Total net deferred tax assets | $ | 208.7 | $ | 55.6 | |||||||
Realization of deferred tax assets is primarily dependent on generating sufficient taxable income in future periods. The Company believes it is more likely than not its deferred tax assets will be realized. Accordingly, no valuation allowance was recorded for 2022 and 2021.
The Company fully utilized its federal net operating loss carryforwards and income tax credits as of December 31, 2018. The Company utilized all of its state net operating loss carryforwards and credit carryforwards as of December 31, 2021.
Note 6. Long-Term Debt
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions) | |||||||||||
| Senior debt | $ | 261.5 | $ | 281.4 | |||||||
| Convertible senior notes | — | 136.5 | |||||||||
| Finance leases (see Note 4) | 41.6 | 43.4 | |||||||||
| Total debt, carrying amount | 303.1 | 461.3 | |||||||||
| Less: Amounts due within one year | (14.7) | (166.7) | |||||||||
| Total long-term debt, carrying amount | $ | 288.4 | $ | 294.6 | |||||||
The following table presents as of December 31, 2022, the Company’s contractual debt principal maturities excluding finance lease obligations (see Note 4):
| Total | 2023 | 2024 | 2025 | ||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||
| Senior debt | $ | 262.3 | $ | 13.5 | $ | 13.5 | $ | 235.3 | |||||||||||||||
The Company amortizes deferred financing costs over the estimated life of the related debt (a portion of which is classified as a contra liability). Amortization of deferred financing costs was $1.5 million, $1.6 million, and $2.0 million in 2022, 2021, and 2020, respectively.
34
a. Senior Debt
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions) | |||||||||||
Term loan, bearing interest at variable rates (rate of 6.17% as of December 31, 2022), maturing in September 2025 | $ | 262.3 | $ | 282.2 | |||||||
| Unamortized deferred financing costs | (0.8) | (0.8) | |||||||||
| Total senior debt | $ | 261.5 | $ | 281.4 | |||||||
On September 28, 2022, the senior secured credit facility (the "Senior Credit Facility") was amended and consists of (i) a $650.0 million revolving line of credit (the "Revolver") and (ii) a $269.1 million term loan (the "Term Loan"). The Term Loan facility decreased from an aggregate principal amount of up to $350.0 million to $269.1 million and the amendment extended the maturity date from September 20, 2023, to September 20, 2025, amortized at a rate of 5.0% per annum. The amended Senior Credit Facility also changed the interest rate benchmark for loans from the London Inter-Bank Offered Rate ("LIBOR") to the Secured Overnight Financing Rate ("SOFR"). Other than the changes mentioned above, the amended Senior Credit Facility has substantially similar terms as the original facility.
As of December 31, 2022, the Company had zero borrowings under the Revolver and had issued $28.9 million letters of credit.
The Term Loan and any borrowings under the Revolver bear interest at SOFR plus a SOFR adjustment of 10 basis points for all terms and an applicable margin ranging from 175 to 250 basis points based on the Company's leverage ratio (the "Consolidated Net Leverage Ratio") measured at the end of each quarter. In addition to interest, the Company 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 alternative currency 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 5.0% per annum as of December 31, 2022. Outstanding borrowings under the Revolver and the Term Loan may be voluntarily repaid at any time, in whole or in part, without premium or penalty.
The Senior Credit Facility is secured by a first priority security interest in the Company’s assets, subject to certain customary exceptions, as well as pledges of its equity interests in certain subsidiaries.
The Senior Credit Facility contains financial covenants requiring the Company to (i) maintain an interest coverage ratio of not less than 3.00 to 1.00 and (ii) maintain a Consolidated Net Leverage Ratio not to exceed 3.50 to 1.00 provided that the maximum leverage ratio for all periods shall be increased by 0.50 to 1.00 for two consecutive quarters after consummation of a qualified acquisition.
The Company was in compliance with its financial and non-financial covenants as of December 31, 2022.
b. Convertible Senior Notes
| As of December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In millions) | |||||||||||
Senior convertible notes, bearing interest at 2.25% per annum, interest payments due in June and December, maturing in December 2023 | $ | — | $ | 145.9 | |||||||
| Unamortized discount and deferred financing costs | — | (9.4) | |||||||||
| Total convertible senior notes | $ | — | $ | 136.5 | |||||||
On December 14, 2016, the Company issued $300.0 million aggregate principal amount of 2¼% Notes in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended.
In 2021, the Company settled $154.1 million of its 2¼% Notes. The principal amount was settled in cash and the conversion premium was settled in common shares. See Note 11.
On July 15, 2022, the Company announced that it issued a notice of redemption to holders of its outstanding 2¼% Notes stating its intention to redeem all outstanding 2¼% Notes in full on September 19, 2022, in accordance with the terms of the indenture governing the 2¼% Notes. The Company elected to settle conversions of the 2¼% Notes using Cash Settlement, as defined in the indenture for the 2¼% Notes. In the three months ended September 30, 2022, the Company settled the outstanding balance of $145.9 million of its 2¼% Notes with cash totaling $242.0 million, including principal, conversion premium, irrevocable cash conversion option value, and interest. See Note 11.
35
The Company adopted the new accounting guidance for convertible instruments effective January 1, 2022, using the modified retrospective method, with the cumulative effect recognized as of January 1, 2022. The primary impact of the new guidance was removing the requirement for the Company to account for beneficial conversion features and cash conversion features in equity, separately from the 2¼% Notes and requires the Company to use the if-converted method for the 2¼% Notes in the diluted earnings per share calculation. See Notes 1 and 2.
The following table summarizes information regarding the 2¼% Notes as of December 31, 2021:
| Remaining amortization period (years) | 2.0 | ||||
| Effective interest rate | 5.8 | % | |||
| Conversion rate (shares of common stock per $1,000 principal amount) | 38.4615 | ||||
| Conversion price (per share of common stock) | $ | 26.00 | |||
The following table presents the interest expense components for the 2¼% Notes:
| Year Ended December 31, | |||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Interest expense-contractual interest | $ | 2.3 | $ | 3.3 | $ | 6.8 | |||||||||||
| Interest expense-amortization of debt discount | — | 4.3 | 7.9 | ||||||||||||||
| Interest expense-amortization of deferred financing costs | 0.3 | 0.4 | 0.6 | ||||||||||||||
Note 7. Retirement Benefits
a. Plan Descriptions
Pension Benefits
The Company's defined benefit pension plan future benefit accrual was discontinued in 2009. As of December 31, 2022, the assets, projected benefits obligations, and unfunded pension obligations were $706.9 million, $949.7 million, and $242.8 million, respectively.
The American Rescue Plan Act of 2021 ("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, the Company expects to make cash contributions of approximately $7 million to its tax-qualified defined benefit pension plan in 2023. The Company is generally able to recover contributions related to its tax-qualified defined benefit pension plan as allowable costs on its U.S. government contracts, but there are differences between when the Company contributes to its tax-qualified defined benefit pension plan under pension funding rules and when it is recoverable under Cost Accounting Standards ("CAS"). The Company estimates the CAS recoverable amounts related to the Company's retirement benefits plans to be approximately $32 million in 2023. During 2022, the Company made cash contributions of $15.4 million and used $18.4 million of prepayment credits to fund its tax-qualified defined benefit pension plan.
The funded status of the Company's tax-qualified pension plan may be adversely affected by the investment experience of the plan's 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 the plan's assets does not meet assumptions, if there are changes to income tax regulations or other applicable law, or if other actuarial assumptions are modified, future contributions to the underfunded pension plans could be higher than the Company expects.
Medical and Life Insurance Benefits