EXHIBIT 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
General
The following discussion and analysis presents management's assessment of
material developments affecting the Company's results of operations, liquidity,
and capital resources for each of the three years in the period ended July 31,
1997. Years prior to 1997 have been restated for the effects of the accounting
change, as described below. These discussions should be read in conjunction
with the Company's Consolidated Financial Statements and the Notes thereto.
Industry Outlook
Commercial aircraft orders rose dramatically in calendar 1996 and have
continued at a strong pace in calendar 1997. In the first seven months of
calendar 1997, airlines ordered 460 new commercial aircraft (seating 70 or more
passengers), compared to a full years orders of 1,113 in 1996 and 662 in 1995.
Analysts expect commercial aircraft manufacturers to deliver approximately 600
aircraft in 1997, compared to 440 in 1996 and 443 in 1995. Based on production
rate increases recently announced by The Boeing Company and Airbus Industrie and
their respective order books, the Company expects commercial aircraft deliveries
to increase.
Orders for commercial aircraft are based in large part on consumer demand for
air travel and the financial condition of airline operators. Over the last
several years, airline passenger traffic has increased over 6 percent per year
on average and airline analysts expect that traffic will grow approximately 5
percent per year for the next 20 years. As a result, airlines are expected to
expand their fleets to meet the increased demand for travel. In addition,
airline operators are expected to purchase large numbers of aircraft in the next
five years to meet existing aircraft noise regulations and to replace aging
aircraft in their fleets. There are approximately 3,000 Stage Two aircraft in
operation throughout the world, many of which must be replaced or modified to
Stage Three noise requirements by 1999 in the United States and by mid-2002 in
most other developed countries.
Historically, the financial condition of airlines and their demand for new
aircraft has been related to the health of the world economies. Healthy world
economies, increases in demand for air travel, relatively stable fare
structures, aggressive cost reductions, increased load factors, and improved
utilization of aircraft have raised airline profitability to high levels over
the last several years and have enabled airlines to order and purchase new
aircraft.
2
Overall, the conditions of the market suggest that the commercial aircraft
industry is strong and poised for continued expansion.
Material and component shortages have been noted as an increasing problem
throughout the industry, as the rate of production of commercial aircraft has
rapidly accelerated. The Company has also encountered shortages and has taken
various steps to minimize the impact on its operations.
Company Outlook
As a result of increased production of new commercial aircraft and increased
deliveries of spare parts, the Company's sales increased 23 percent in fiscal
1997 as compared with the prior year. Predicated upon customer scheduled
delivery requirements, the Company expects its sales in fiscal 1998 to be
approximately 15 percent higher than in fiscal 1997.
The Company continued to realize improved efficiency in its manufacturing
processes, maintained its existing level of general and administrative expenses
in spite of the growth in sales, participated in new programs, and expanded its
level of support in the overhaul and repair market by opening a new repair
facility in Prestwick, Scotland. In addition, the Company improved its capital
structure by reducing debt and by contributing common stock and cash to fully
fund its pension plans. These activities are expected to strengthen the Company
to meet the growth in the industry and the future challenges and opportunities.
Management continues to focus on reducing cost and improving quality. For
example, the Company has implemented concurrent product development and is
continuing to implement its lean manufacturing initiative. Lean manufacturing
is a focused attack on non-value-added steps in the manufacturing process. Lean
enterprise techniques involve defining the value stream for each product and
eliminating the unnecessary steps from every value stream.
The Company's firm backlog, which includes the sales price of all undelivered
units covered by customers' orders, was approximately $1.5 billion at July 31,
1997, compared to $1.2 billion at July 31, 1996. Approximately $950 million of
the $1.5 billion backlog is scheduled to be delivered in fiscal 1998. (Sales
during any period includes sales which were not part of backlog at the end of
the prior period.) Customer orders in firm backlog are subject to rescheduling
and/or termination for customer convenience; however, in certain cases, the
Company is entitled to an adjustment in contract amounts.
3
Forward-Looking Information Is Subject to Risk and Uncertainty
This document includes forward-looking statements, as defined in the Private
Securities Litigation Reform Act of 1995, that involve risk and uncertainty.
Actual sales in fiscal year 1998 may be materially less than the sales projected
in the "Company Outlook" section if the Company's customers cancel or delay
current orders or reduce the rate at which the Company is building or expects to
build products for such customers. Such cancellations, delays or reductions may
occur if there is a substantial change in the health of the airline industry or
in the general economy, or if a customer were to experience major financial
difficulties. In addition, capital expenditures may exceed those projected in
the "Liquidity and Capital Resources" section if the Company obtains significant
new business.
4
Results of Operations
Change in Accounting
In the fourth quarter of fiscal 1997, the Company changed its accounting
principle related to long-term programs and contracts and restated its
historical results to reflect the application of the changed principle. The
change eliminated the use of program accounting so that all current and future
programs will be accounted for under the contract method of accounting as
described in "Notes to the Consolidated Financial Statements - Note 1." Prior
to the change, approximately half of the Company's revenues were accounted for
under the program method of accounting and approximately half were accounted for
under the contract method of accounting. Under contract accounting, the Company
accounts for the direct sale of spare parts to airlines separately from the sale
of production units. Previously, on programs that were accounted for under the
program method of accounting, the Company combined the estimated costs and
revenues associated with a program's production units and spare parts into a
single profit center.
While the Company's previous method of accounting was in accordance with
generally accepted accounting principles, the Company believes that the new
principle is preferable. By accounting for spare parts sales separately from
long-term production contracts, the amount of deferred costs included in
inventory has been reduced. The change will also decrease the significance of
the projections used in calculating the Company's financial results by
eliminating the need to project spare parts sales into the future. Instead,
spare parts sales will be accounted for as they occur and will not be aggregated
with the costs and expenses of multi-year production contracts. In addition,
under the changed principle, the Company's financial results will more clearly
reflect its current operating activities and cash flow. The Company also
believes that the change in accounting principle will enhance internal
accountability by allowing the Company to emphasize internal responsibility for
production and spare parts profitability.
The effect of this change in accounting for the periods through July 31, 1996,
was a charge of $59.6 million, net of income tax benefits of $40.0 million. In
accordance with Accounting Principles Board Opinion No. 20, "Accounting
Changes," prior year financial statements have been restated to reflect this
change on a retroactive basis. The effect of the change on fiscal 1997 results
was to increase operating income by $15.1 million (composed of $25.5 million of
additional operating income less $10.4 million of additional loss on the MD-90
contract, in each case arising from the change in accounting). The effect of
the change in accounting on fiscal 1997 net income was to increase net income by
$9.0 million, or 35 cents per share (composed of $15.3 million, or 60 cents per
share, of additional net income less $6.3 million, or 25 cents per share,
arising from the additional loss on the
5
MD-90 program). The total impact on fiscal 1996 and fiscal 1995 was to increase
net income by $19.1 million (92 cents per share) and $11.7 million (64 cents per
share), respectively.
The discussion in the remainder of "Results of Operations" reflects the impact
of the accounting change.
Fiscal 1997 Compared to Fiscal 1996
Fiscal 1996 has been restated to reflect the accounting change made during the
fourth quarter of fiscal 1997. See "Notes to Consolidated Financial Statements
- - Note 2."
Fiscal 1997 sales increased 23 percent to $944.4 million, up from $770.8
million in the prior fiscal year. Contributing to increased sales were
accelerated delivery rates on most commercial programs. The A340, MD-90, CFM56-
5, and RB211-535 programs all reflected significant increases in sales.
The Company reported an operating profit of $34.4 million, an operating margin
of 3.6 percent for fiscal 1997 as compared with operating profit of $88.6
million, an operating margin of 11.5 percent for fiscal 1996. Fiscal 1997
operating results were favorably impacted by the effects of the change in
accounting principle described above, and adversely impacted by the recognition
of a $84.5 million loss on the MD-90 production contract, as discussed below,
which reduced the fiscal 1997 overall operating margin by 9.0 percent. In
addition, fiscal 1997 results were also negatively impacted by the decision made
earlier in the year (and prior to the recognition of the $84.5 million loss) not
to record profit on the MD-90 production contract, on which profit was
recognized in the prior fiscal year. In fiscal 1997, operating results on other
programs benefited from increased delivery rates and improved operating
efficiencies. Fiscal 1996 operating results were also favorably effected by the
accounting change, but were adversely impacted by one-time charges of $12.4
million, which reduced the operating margin by 1.6 percent. This $12.4 million
represented a loss on the sale of an aircraft leasing subsidiary and an
impairment write-down on the Company's Arkadelphia, Arkansas facility to net
realizable value. Operating results will vary from period to period, in part
depending on the amount and mix of direct spare sales and the ratio of direct
spare sales to production sales. Direct spare sales generally carry a higher
margin than production sales.
The Company entered into a contract with International Aero Engines to produce
nacelles for McDonnell Douglas Corporation's ("McDonnell Douglas") MD-90
aircraft in 1990. Under the terms of the contract, the Company agreed to
recover its preproduction costs, and the higher than average production costs
associated with early production shipments, over a specified number of
deliveries. In light of the wide market acceptance of the MD-80 series, which
was the predecessor aircraft, the Company believed sufficient MD-90 aircraft
would be sold to allow it to recover its costs.
6
Over the last year, however, a series of developments created market
uncertainties regarding future sales of the MD-90 aircraft. The most
significant of these developments included: McDonnell Douglas' termination of
the MD-XX program and the doubts this action raised regarding McDonnell Douglas'
continued presence in the commercial aircraft industry; the decision of several
large airlines that have traditionally operated McDonnell Douglas aircraft to
order aircraft that compete with the MD-90; the announced (and subsequently
completed) acquisition of McDonnell Douglas by The Boeing Company, which
produces a family of competing aircraft; the announcement by Delta Airlines,
launch customer for the MD-90, of its intent to replace its existing fleet of
MD-90s and to seek a business resolution with McDonnell Douglas with respect to
its remaining orders for the aircraft; and the lack of significant MD-90 orders
during the past year.
In recognition of these developments, the Company reduced its estimates of
future MD-90 aircraft deliveries in the second quarter of fiscal 1997 to include
only deliveries which were supported by firm orders, options, and letters of
intent for the aircraft. During the fourth quarter of fiscal 1997, the Company
further reduced its market estimate of future MD-90 sales to existing firm
aircraft orders (excluding firm orders from Delta Airlines). Based on its
reduced estimate of future aircraft deliveries, the Company believes that future
MD-90 sales will not be sufficient to recover its existing contract investment
plus the costs it will be required to spend in the future to complete the
contract. As a result, the Company recognized a $84.5 million operating loss on
the contract in fiscal 1997 (which included a $10.4 million increase in the loss
as a result of the change in accounting). The change in accounting principle
adopted in the fourth quarter of fiscal 1997 resulted in $49.3 million of the
loss being reported in the second quarter of fiscal 1997 and $35.2 million being
reported in the fourth quarter of fiscal 1997. The MD-90 contract accounted for
13.9 percent and 11.2 percent of fiscal 1997 and 1996 sales, respectively.
The McDonnell Douglas MD-95 program is a new 100-passenger aircraft currently
under development. The Company has invested $51.7 million for design and
development costs on the MD-95 contract through July 31, 1997. The Company
anticipates spending approximately $23 million more for preproduction costs
through mid 1999, the aircraft's scheduled Federal Aviation Administration (FAA)
certification date. Most of this remaining $23 million of expenditures will
occur prior to the flight test program, which is scheduled to commence in April
1998. If the contract is canceled prior to FAA certification, the Company
expects substantial recovery of these costs. If the aircraft is certified and
actively marketed, the amount of these costs and initial production start-up
costs recovered by the Company will depend upon the number of aircraft
delivered. To date, McDonnell Douglas has announced 50 firm orders and 50
options from the launch customer, ValuJet.
7
Net interest expense was $40.1 million in fiscal 1997 compared to $46.0
million for fiscal 1996. Interest expense declined primarily as a result of
reduced debt levels while interest income increased due to a higher level of
invested funds.
Net loss before the extraordinary item, noted below, was $3.4 million or 13
cents per share for fiscal 1997, compared to net income of $22.3 million or
$1.07 per share for fiscal 1996. The loss associated with the MD-90 contract
adversely impacted fiscal 1997 net income by $50.5 million or $1.99 per share.
Fiscal 1996 results were adversely impacted by the charge for the exchange of
the convertible notes, the loss from the sale of an aircraft leasing subsidiary,
and an impairment write-down which, in the aggregate, totaled $10.6 million or
51 cents per share.
Extraordinary Item
In line with the Company's objective of reducing its debt and interest
expense, the Company used existing funds to prepay a significant portion of its
9.33% and 9.35% Senior Notes during the fourth quarter of fiscal 1997. The
premium and certain other expenses associated with the early extinguishment of
this debt have been reported as an extraordinary item. The cost of the
prepayment, net of income tax benefit of $1.8 million, was $2.6 million or 11
cents per share for fiscal 1997. See "Notes to the Consolidated Financial
Statements -- Note 7."
Fiscal 1996 compared to Fiscal 1995
Fiscal 1996 and 1995 have been restated to reflect the accounting change made
during the fourth quarter of fiscal 1997. See "Notes to Consolidated Financial
Statements - Note 2."
Sales declined to $770.8 million in fiscal 1996 from $805.0 million in fiscal
1995. Sales in fiscal 1996 benefited from increased MD-90 deliveries and
approximately $30 million of one-time sales related to Boeing and International
Aero Engines contracts. Overall, sales declined from fiscal 1995 levels
primarily due to delivery rate reductions on the PW4000, RB211-535, and CF6-80C
programs. In addition, government sales declined due to the near completion of
the C-130 and the Titan Space programs.
The Company's operating income for fiscal 1996 was $88.6 million, an operating
margin of 11.5 percent. Fiscal 1996 operating results were adversely impacted
by a $12.4 million loss, which reduced operating margin by 1.6 percent, as a
result of the sale of an aircraft leasing subsidiary and an impairment write-
down on the Company's Arkadelphia, Arkansas facility to estimated net realizable
value. Operating results in fiscal 1995, were $84.2 million, a margin of 10.5
percent. Operating results
8
in fiscal 1996 were impacted by the change in sales described above, several
one-time items, and the positive settlement of outstanding contract terms on the
IL96 and the A340 contracts, some of which will have a favorable on-going
impact.
During fiscal 1996, the Company negotiated the sale of its aircraft leasing
subsidiary. This subsidiary's principal assets were beneficial interests in two
aircraft (an A300 and a DC-10) on lease through 2003 and 2004, respectively.
The Company recorded a $5.2 million pre-tax loss as a result of this sale, but
retained an interest in the residual value of these assets through which it
could recover additional amounts in the future. The Company also recorded a
receivable in the amount of $20.1 million (collected in fiscal 1997) and a
secured note in the amount of $7.5 million in connection with the sale.
The Company has been reviewing its long-range site strategy and assessing the
facilities necessary to meet its future needs including the potential favorable
operating effect of lean manufacturing. As a result of the review during fiscal
1996, the Company recognized a $7.2 million pre-tax impairment write-down on its
Arkadelphia, Arkansas facility to estimated net realizable value. Many of the
Company's facilities are operating below capacity and the Company intends to
continue to review its site strategy and facilities with respect to its current
and projected needs.
Net interest expense was $46.0 million in fiscal 1996 compared to $50.0
million for fiscal 1995. Interest expense declined primarily due to principal
payments made in the fourth quarter of fiscal 1995 on the Company's 9.33% and
9.35% Senior Notes and the conversion of the Convertible Subordinated Notes, as
discussed below.
During fiscal 1996, the Company exchanged 4.0 million shares of the Company's
common stock for $37.8 million of its 7.75% Convertible Subordinated Notes due
2004. The Convertible Subordinated Notes, of which $19.7 million remained
outstanding at July 31, 1996, are convertible into shares of common stock at a
conversion price of $10.35 per share and are redeemable at the Company's option,
beginning in May 1998, at a price of 104.7 percent, declining to par at
maturity. The shares of common stock issued in the exchanges in excess of the
shares required for conversion were valued at $5.4 million, which was expensed
in fiscal 1996. The value of the additional shares of common stock issued
represents only a portion of the interest expense the Company would have
incurred on the exchanged notes through May 1998, the first date on which the
Company could force conversion by calling the notes for redemption.
9
Net income from operations for fiscal 1996 was $22.3 million or $1.07 per
share. Fiscal 1996 results were adversely impacted by the charge for the
exchange of the convertible notes, the loss from the sale of an aircraft leasing
subsidiary, and an impairment write-down which, in the aggregate, totaled $10.6
million or 51 cents per share. Fiscal 1995 income from continuing operations
was $20.2 million or $1.11 per share. Fiscal 1995 net income included $3.8
million or 21 cents per share from the discontinuance of the business jet line
of business and a loss associated with the prepayment of debt as described below
of $1.1 million or 6 cents per share.
Discontinued Operations
In the fourth quarter of fiscal 1994, the Company sold and commenced the
transfer of its business jet line of business which was accounted for as a
discontinued operation in accordance with Accounting Principles Board Opinion
No. 30. The purchase agreement required the Company to manufacture and deliver
certain components and transfer program engineering and tooling tasks which were
substantially completed in fiscal 1995. The business jet line of business sales
were approximately $22.3 million in fiscal 1995. Income from discontinued
operations, net of income tax benefit, was $3.8 million or 21 cents per share
for fiscal 1995. See "Notes to the Consolidated Financial Statements - Note
13."
Extraordinary Item
In line with the objective of reducing its debt and interest expense, the
Company prepaid a portion of its 9.33% and 9.35% Senior Notes during the fourth
quarter of fiscal 1995. The cost associated with the early extinguishment of
this debt has been reported as an extraordinary item. Loss from the
extraordinary item, net of income tax benefit, was $1.1 million or 6 cents per
share for fiscal 1995. See "Notes to the Consolidated Financial Statements -
Note 7."
Liquidity and Capital Resources
The primary factors that affect the Company's liquidity are cash flow from
operations and investment in new programs (which depending upon contract terms
may require significant developmental expenditures and inventory buildup that
may be partially offset through the participation of major subcontractors).
Delivery levels under existing contracts, payment terms with customers, capital
facilities expenditures, debt service, and the timing of defined benefit plan
and federal income tax payments also affect the Company's liquidity and cash
flow.
10
Over the next several years, the Company expects to increase its investment in
production inventory in connection with increased deliveries on existing
contracts. Additionally, the Company continues to seek business opportunities
which would require future investments. The Company believes that its financial
resources will be adequate to meet its requirements during such period.
The Company is in the process of implementing a new revolving credit agreement
as a replacement to the credit agreement that expired on April 25, 1997. The
Company has engaged two banks as agents and expects to have a satisfactory
credit agreement in place prior to any need for funds from such agreement.
At July 31, 1997, the Company had $43.1 million of cash, cash equivalents, and
short-term investments. Cash provided by operating activities during fiscal
1997 totaled $34.7 million, compared to $7.8 million for the prior fiscal year.
Contributing to the positive cash flow in fiscal 1997 was cash generated from
the higher level of deliveries on mature programs, an increase in spare parts
sales, and several one-time payments received for non-recurring tasks. This was
partially offset by the investment in preproduction costs on the MD-95 contract.
Cash provided by operations is subject to significant variation from period to
period.
Receivables were up $31.8 million to $161.3 million at July 31, 1997. This
increase was primarily due to an increase in sales, customer mix, and the timing
of deliveries.
The Company's net inventories decreased to $227.2 million at July 31, 1997,
from $282.8 million at July 31, 1996. As its contracts mature, the Company's
inventory is declining through amortization of cost over unit deliveries. In
fiscal 1997, preproduction and excess-over-average inventory declined primarily
due to the loss recognized on the MD-90 contract. In addition, preproduction
inventory declined on the A340 contract due to amortization of cost over unit
deliveries. Preproduction inventory increased on the MD-95 contract due to
design and tooling expenditures which are expected to be recovered as units are
delivered. Production inventory increased due to a build up for scheduled
future deliveries. Over the next several years, the Company expects to increase
its investments in inventory in connection with expenditures on new contracts,
increased deliveries on existing contracts, and anticipated new business
opportunities.
Cash flow used in investing activities was $5.5 million in fiscal 1997 compared
to $9.9 million in the prior fiscal year. Included in cash flow from investing
activities in fiscal 1997 was the collection of a note receivable of $20.1
million from the sale of an aircraft leasing subsidiary. Cash of $11.2 million
was used in investing activities for the purchase of short-term investments.
Capital expenditures for property, plant, and equipment totaled $17.1 million
for fiscal 1997, up from $13.0 million for fiscal 1996. Capital expenditures
for property, plant, and equipment are projected to approximate $20 million for
fiscal 1998 and are expected to be financed by internally generated cash flow.
11
The Company's total financings declined to $483.5 million at July 31, 1997,
compared to $569.2 million at July 31, 1996. Total financings decreased due to
$12.0 million and $8.9 million of scheduled principle payments made during the
year on the Company's 9.35% Senior Notes and 9.33% Senior Notes, respectively.
In line with the Company's objective of reducing debt and interest expense, the
Company used existing funds to make additional voluntary prepayments of $22.4
million on its 9.35% Senior Notes and $34.3 million on its 9.33% Senior Notes.
Total financings at July 31, 1997, included balance sheet debt, a $40.0 million
accounts receivable sales program, and $19.1 million of equipment leases.
The Company's $40 million accounts receivable sales program will begin to
phase-out, as scheduled in October 1997, and is scheduled to be repaid in full
by December 1997. If the Company obtains a substantial amount of new business,
it may seek additional financing which may include a replacement receivable
facility.
The Company has been striving to improve the funding of its defined benefit
pension plans. During fiscal 1997, the Company contributed 2.9 million shares
of common stock valued at $48.0 million and made cash contributions of $10.3
million to its defined benefit pension plans. The plans also benefited from
substantial market gains on plan assets and the use of an increased discount
rate. Reflecting the increase in market interest rates, the Company increased
its pension plan discount rate to 8.25 percent in fiscal 1997, up from the 7.75
percent used for the prior year's valuation. The Company also updated its
mortality rate assumptions which increased the plans' accrued benefit
obligation. Primarily as a result of the Company's contributions to the plan
and market gains, the market value of plan assets exceeded plan benefit
obligations. As a result, the Company was able to reverse the liability and
deferred asset related to the underfunded position and to eliminate a related
$26.4 million charge to shareholders' equity, net of the tax benefit of $17.8
million.
12
Environmental Matters
The Company has been identified as a potentially responsible party ("PRP")
under the Comprehensive Environmental Response, Compensation and Liability Act
of 1980, as amended ("CERCLA" or "Superfund"), and under certain analogous state
laws for the cleanup of contamination resulting from past disposal of hazardous
substances at several sites to which the Company, among others, sent such
substances in the past. CERCLA requires the cleanup of sites from which there
has been a release or threatened release of hazardous substances, and authorizes
the Environmental Protection Agency ("EPA") to take any necessary response
actions at such sites, including ordering PRPs to clean up or contribute to the
cleanup of a Superfund site. Courts have interpreted CERCLA to impose strict,
joint, and several liability upon all persons liable for response cost.
In June 1987, the U.S. District Court of Los Angeles, in U.S. et al., vs.
Stringfellow, granted partial summary judgment against the Company and 14 other
defendants on the issue of liability under CERCLA, at the Stringfellow site near
Riverside, California. Subsequently, the State of California was found liable
and an allocation of its responsibility was made. The most recent estimate the
Company has made of its liability, assuming the court order allocating
substantial liability to the State of California is upheld, assuming the 1989
EPA estimate of total cleanup costs is not exceeded (although the EPA cautioned
the actual costs could have a variation of 30 percent less or 50 percent higher
than its estimate), and assuming tentative allocations among the Company and all
other users of the site will approximate the final allocation of aggregate user
liability, shows a Company expenditure ranging from $5 million to $8 million
over and above sums spent to date. However, the Company's estimates further
assume that the EPA selects a final remedial action of moderate technology and
cost, rather than one of several more radical ones previously suggested, but
apparently discarded at this point, by the EPA. Expenditures by the Company for
cleanup of this site during fiscal 1997 were approximately $0.4 million and are
expected to be approximately the same during fiscal 1998. From inception to July
31, 1997, the Company has expended approximately $4.1 million on cleanup costs
for this site. Applicable law provides for continuing liability for future
remedial work beyond existing agreements and consent decrees. The Company has
reached settlement agreements with its primary comprehensive general liability
insurers and has retained the right to file future claims against its excess
carriers. The Company recorded the proceeds from such settlements received from
its carriers as reserves. The Company has not recorded any other amounts with
respect to its rights against its insurers.
The Company is also involved in several other proceedings and investigations
related to waste disposal sites and other environmental matters. It is
difficult to estimate the ultimate level of environmental expenditures for these
various other environmental matters due to a number of uncertainties at this
early stage, including the complexity of the related laws and their
interpretation,
13
alternative cleanup technologies and methods, insurance, and other recoveries,
and in some cases the extent or uncertainty of the Company's involvement.
Included is the Casmalia waste disposal site wherein, estimated cleanup costs
approximate $70 million, and the Company's share (based on estimated,
respective volumes of discharges into such sites by all generators, all of which
cannot now be known with certainty) could approximate $2.0 million. The Company
does not yet know about the ability of all of the other waste generators using
the Casmalia site to fund their allocable share, and the Company could be found
jointly and severally liable with all waste generators using such site. The
Company has made claims against its insurance carriers for certain of these
items, and has received claims acknowledgment letters reserving the rights of
such carriers. The insurers have alleged or may allege various defenses to
coverage, although no litigation has been commenced.
During the year ended July 31, 1997, the Company expended, for the
environmental items described above and also for other environmental matters
(including environmental protection activities in the normal operation of its
plants), a total of approximately $7.0 million. These expenditures covered
various environmental elements, including hazardous waste treatment and disposal
costs, environmental permits, environmental consultants, fines or donations
(which were not material, either individually or in the aggregate), and
environmental remediation (including Stringfellow), no significant part of which
was capitalized. Assuming the usage of all of these various environmental
elements remains substantially the same for fiscal 1998 as in fiscal 1997, which
the Company anticipates costs for these elements in fiscal 1998 should be
comparable to the current rate of expenditure for fiscal 1997.
Based upon presently available information, the Company believes it has
sufficient reserves and that aggregate costs in relation to all environmental
matters of the Company will not have a material adverse effect on the Company's
financial condition, liquidity, results of operations, or capital expenditures.
Income Taxes
At July 31, 1997, the Company's net deferred tax asset was $130.4 million,
consisting of $112.4 million for federal tax purposes and $18.0 million for
state tax purposes. The ultimate realization of the Company's deferred tax
asset is dependent upon the generation of sufficient future taxable income
during the available federal and state net operating loss ("NOL") carryforward
periods. Management expects that the Company will report a sufficient level of
taxable income prior to the expiration of the NOLs to realize the deferred tax
asset recorded as of July 31, 1997.
14
The Company's long-term contracts and programs provide the Company
opportunities to generate future taxable income necessary to realize the
deferred tax asset recorded. During the rapid growth cycle in the late 1980s
and early 1990s, the Company made significant investments in new facilities and
in new programs. As programs mature, the Company expects to utilize its
investments, resources, and experience to reduce the cost of production. In
addition, direct sales of spare parts to the airlines are expected to increase
as a program matures. Generally, the Company earns a higher margin on the
direct sales of spare parts to the airlines. Based on tax rates in effect on
July 31, 1997, the Company must generate approximately $340 million of future
taxable income (net of $119 million of taxable income that the Company will
report as a result of the automatic reversal of existing taxable temporary
differences between asset and liability values for financial reporting and
income tax purposes) prior to the expiration of the Company's NOLs in 2004
through 2012 for full realization of the net deferred tax asset.
The availability of the Company's NOLs may be limited under the Tax Reform Act
of 1986 as a result of significant changes that could occur in the ownership of
the Company's stock in the future. Management has considered this factor in
reaching its conclusion that it is "more likely than not" that future taxable
income will be sufficient to realize fully the deferred tax asset reflected on
the balance sheet.
Late in fiscal 1996, the Company received a Revenue Agent's Report ("RAR")
from the Internal Revenue Service in connection with the audit of the Company's
federal income tax returns for fiscal years 1986 through 1989. In the RAR, the
agent challenged the timing of various deductible items, some of which are
significant. The Company is contesting substantially all the proposed
adjustments and believes it will prevail on all material items. The Company
anticipates that any adjustment made to its reported taxable income for the
years under audit will increase the amount of the net operating loss available
for carryback purposes and therefore the audit adjustments will not have a
material adverse impact on the financial position of the Company.
15
CONSOLIDATED BALANCE SHEETS
(in thousands)
July 31,
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
(restated)
Assets
Cash and cash equivalents $ 31,881 $ 88,403
Short-term investments 11,190 -
Accounts receivable 161,275 129,523
Inventories:
Work-in-process 264,356 323,715
Raw materials, purchased parts, and supplies 22,909 26,220
Less customers' progress payments and advances (60,066) (67,165)
- --------------------------------------------------------------------------------
Inventories - net 227,199 282,770
Deferred tax asset 45,998 -
Prepaid expenses and other current assets 12,315 14,587
- --------------------------------------------------------------------------------
Total Current Assets 489,858 515,283
Property, Plant, and Equipment - Net 188,764 196,052
Deferred Tax Asset 84,358 156,863
Prepaid Pension Costs 84,386 -
Other Assets 36,612 64,742
- --------------------------------------------------------------------------------
$883,978 $932,940
================================================================================
Liabilities and Shareholders' Equity
Trade accounts and other payables $138,342 $125,974
Salaries, wages, and benefits 38,197 44,094
Deferred tax liability - 16,213
Short-term debt and current portion of long-term debt 12,928 25,962
- --------------------------------------------------------------------------------
Total Current Liabilities 189,467 212,243
Long-Term Debt 411,467 481,481
Pension and Post-Retirement Obligations - Long-term 20,449 46,096
Other Obligations 16,315 17,503
Commitments and Contingencies (Note 8)
Shareholders' Equity:
Preferred stock, $1 par value per share,
10 million shares authorized, none issued - -
Common stock, $1 par value per share,
authorized 50,000,000 shares; issued and
outstanding 25,329,725 and 22,329,793 shares,
respectively 25,330 22,330
Additional paid-in capital 189,910 142,656
Retained earnings 31,040 37,062
Minimum pension liability adjustment - (26,431)
- --------------------------------------------------------------------------------
Total Shareholders' Equity 246,280 175,617
- --------------------------------------------------------------------------------
$883,978 $932,940
================================================================================
The accompanying Notes to the Consolidated Financial Statements are an integral
part of these statements.
16
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except for per share data)
Year ended July 31,
- -------------------------------------------------------------------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------------------------------
(restated) (restated)
Sales $944,357 $770,814 $805,000
Costs and Expenses 797,691 642,614 694,576
Charge for MD-90 Contract (Note 12) 84,541 - -
Loss on Sale of Aircraft Leasing Subsidiary and
Impairment Write-down (Note 12) - 12,395 -
General and Administrative Expenses 27,704 27,233 26,198
- -------------------------------------------------------------------------------------------------------
Operating Income 34,421 88,572 84,226
Interest Income 4,509 2,735 4,015
Interest Expense 44,562 48,702 54,001
Charge for Exchange of Convertible Notes (Note 7) - 5,350 -
- -------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations
Before Taxes (Benefit) on Income (5,632) 37,255 34,240
Taxes (Benefit) on Income (2,264) 14,977 14,029
- -------------------------------------------------------------------------------------------------------
Income (Loss) from Continuing Operations (3,368) 22,278 20,211
Income from Discontinued Operations -
Net of Taxes (Note 13) - - 3,879
- -------------------------------------------------------------------------------------------------------
Income (Loss) before Extraordinary Item (3,368) 22,278 24,090
Loss from Extraordinary Item - Net of Taxes (Note 7) (2,654) - (1,146)
- -------------------------------------------------------------------------------------------------------
Net Income (Loss) $ (6,022) $ 22,278 $ 22,944
=======================================================================================================
Primary Earnings (Loss) Per Average Share
of Common Stock from:
Continuing Operations $ (0.13) $ 1.07 $ 1.11
Discontinued Operations - - 0.21
Extraordinary Item (0.11) - (0.06)
- -------------------------------------------------------------------------------------------------------
Net Primary Earnings (Loss) Per Average Share $ (0.24) $ 1.07 $ 1.26
=======================================================================================================
Fully Diluted Earnings (Loss) Per Average Share
of Common Stock from:
Continuing Operations $ (0.13) $ 1.05 $ 0.95
Discontinued Operations - - 0.16
Extraordinary Item (0.11) - (0.05)
- -------------------------------------------------------------------------------------------------------
Net Fully Diluted Earnings (Loss) Per Average Share $ (0.24) $ 1.05 $ 1.06
=======================================================================================================
The accompanying Notes to the Consolidated Financial Statements are an
integral part of these statements.
17
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
- -----------------------------------------------------------------------------------------------------------------------------------
Common Stock Additional Minimum Pension
Par Value Paid-In Retained Liability
$1 per Share Capital Earnings Adjustment
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 1994 as previously reported $18,042 $102,598 $ 82,168 $(55,899)
Change in accounting (Note 2) - - (90,328) -
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 1994 (restated) 18,042 102,598 (8,160) (55,899)
Stock plans activity 26 289 - -
Net Income - - 22,944 -
Minimum pension liability adjustment (Note 9) - - - 17,481
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 1995 (restated) 18,068 102,887 14,784 (38,418)
Stock plans activity 253 1,472 - -
Conversion of 7.75% Convertible Subordinated Notes 4,009 38,297 - -
Net Income - - 22,278 -
Minimum pension liability adjustment (Note 9) - - - 11,987
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 1996 (restated) 22,330 142,656 37,062 (26,431)
Stock plans activity 133 2,621 - -
Pension retirement contribution 2,867 44,633 - -
Net Loss - - (6,022) -
Minimum pension liability adjustment (Note 9) - - - 26,431
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 1997 $25,330 $189,910 $ 31,040 $ -
====================================================================================================================================
The accompanying Notes to the Consolidated Financial Statements are an integral
part of these statements.
18
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents (in thousands)
Year ended July 31,
- ------------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
(restated) (restated)
Operating Activities:
Net income (loss) $ (6,022) $ 22,278 $ 22,944
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 21,751 21,442 22,148
Loss on sale of subsidiary and impairment write-down - 12,395 -
Charge for exchange of 7.75% Convertible Notes - 5,350 -
Changes due to (increase) decrease in operating assets:
Accounts receivable (51,894) (50,729) 29,059
Inventories - net 55,571 (23,949) (41,631)
Prepaid expenses and other assets 3,241 (28) 5,291
Changes due to increase (decrease) in operating liabilities:
Trade accounts, salaries and wages, and other payables 16,252 13,186 (10,206)
Pension and post-retirement obligations 993 (8,544) (26,642)
Deferred taxes (4,732) 14,541 16,211
Other (426) 1,895 10,373
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 34,734 7,837 27,547
- -----------------------------------------------------------------------------------------------------------------------------------
Investing Activities:
Proceeds from sale of aircraft leasing subsidiary 20,142 - -
Purchase of property, plant, and equipment (17,124) (13,029) (8,135)
Sale (purchase) of short-term investments (11,190) - 17,568
Proceeds from sale of assets 2,480 2,905 -
Repurchase of sale-leaseback transactions - - (21,782)
Net advances on discontinued operations - - (5,045)
Other 148 269 1,280
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (5,544) (9,855) (16,114)
- -----------------------------------------------------------------------------------------------------------------------------------
Financing Activities:
Annual principal payment of 9.33% and 9.35% Senior Notes (20,875) (12,025) (12,500)
Net prepayment of 9.33% and 9.35% Senior Notes (59,324) - (22,481)
Net short-term borrowings (3,615) 3,615 -
Repayment of other long-term borrowings (858) (1,678) (2,323)
Reduction in sales of receivable sales program - - (20,000)
Cash collateral for receivable sales program - 13,500 13,003
Long-term borrowings - 1,106 -
Other (1,040) 1,319 1,456
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (85,712) 5,837 (42,845)
- -----------------------------------------------------------------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents (56,522) 3,819 (31,412)
Cash and Cash Equivalents, Beginning of Year 88,403 84,584 115,996
- -----------------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents, End of Year $ 31,881 $ 88,403 $84,584
===================================================================================================================================
Supplemental Cash Flow Information:
Cash Paid (Received) During the Year for:
Interest, net of amount capitalized $ 44,821 $ 48,436 $ 52,010
Income taxes 565 367 (1,958)
Non-Cash Investing and Financing Activities
Aircraft leasing subsidiary sold for notes receivable (Note 12) - 27,594 -
Exchange of 7.75% Convertible Notes - (37,780) -
Change in equity due to exchange of 7.75% Convertible Notes - 43,130 -
Stock contributions to pension plans 48,000 - -
====================================================================================================================================
The accompanying Notes to the Consolidated Financial Statements are an integral
part of these statements.
19
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of Significant Accounting Policies
a. Principles of consolidation
The consolidated statements include the accounts of Rohr, Inc. and all
subsidiaries ("Company"). Total assets and sales of foreign subsidiaries are
not significant.
Certain reclassifications have been made to prior years to conform to current
year presentation.
b. Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results may differ from those estimates. On an ongoing basis, predicated
upon information then available, management reviews and updates its estimates to
reflect changes in facts and circumstances including those related to
inventories and contracts along with litigation, taxes, environmental, pensions,
and other matters.
c. Sales and operating income
The Company's sales are primarily under fixed-priced contracts, many of which
contain escalation clauses, requiring delivery of products over several years
and frequently provide the buyer with option pricing on follow-on orders. Sales
and profits on each contract are recognized primarily in accordance with the
percentage-of-completion method of accounting, using the units-of-delivery
method.
As discussed in Note 2, following the change in accounting made in the fourth
quarter of fiscal 1997, the Company follows the guidelines of Statement of
Position 81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts" (the contract method of accounting) for commercial
and governmental contracts, except that the Company's contract accounting
policies differ from the recommendations of SOP 81-1 in that revisions of
estimated profits on contracts are included in earnings by the Company under the
reallocation method rather than the cumulative catch-up method.
20
Profit is estimated based on the difference between total estimated revenue
and total estimated cost of a contract excluding that reported in prior periods
and is recognized evenly in the current and future periods as a uniform
percentage of sales value on all remaining units to be delivered. Current
revenue does not anticipate higher or lower future prices, but includes units
delivered at actual sales prices. A constant contract margin is achieved by
deferring or accelerating a portion of the average unit cost on each unit
delivered. Cost includes the estimated cost of the preproduction effort
(primarily tooling and design), plus the estimated cost of manufacturing a
specified number of production units. The specified number of production units
used to establish the profit margin is predicated upon contractual terms
adjusted for market forecasts and does not exceed the lesser of those quantities
assumed in original contract pricing or those quantities which the Company now
expects to deliver in the periods assumed in the original contract pricing.
Option quantities are combined with prior orders when follow-on orders are
released. Any anticipated losses on contracts and overruns of preproduction
costs are charged to earnings when identified.
The contract method of accounting involves the use of various estimating
techniques to project costs at completion and includes estimates of recoveries
asserted against the customer for changes in specifications. These estimates
involve various assumptions and projections relative to the outcome of future
events including the quantity and timing of product deliveries. Also included
are assumptions relative to future labor performance and rates, and projections
relative to material and overhead costs. These assumptions involve various
levels of expected performance improvements. The Company reevaluates its
contract estimates periodically and reflects changes in estimates in the current
and future periods.
Included in sales are amounts arising from contract terms that provide for
invoicing a portion of the contract price at a date after delivery. Also
included are: negotiated values for units delivered; and anticipated price
adjustments for contract changes, claims, escalation, and estimated earnings in
excess of billing provisions resulting from the percentage-of-completion method
of accounting. Certain contract costs are estimated based on the learning curve
concept discussed in Note 1d.
21
d. Inventories
Inventories of raw materials, purchased parts, and supplies are stated at the
lower of average cost or estimated realizable value. Inventoried costs on long-
term contracts include certain preproduction costs, consisting primarily of
tooling and design costs, and production costs, including applicable overhead.
As the production costs for early units are charged to work-in-process inventory
at an actual unit cost in excess of the estimated average cost for all units
projected to be delivered over the entire contract, a segment of inventory
described as the excess of production costs over estimated average unit cost
(and referred to as excess-over-average inventory) is created. Generally,
excess-over-average inventory, which may include production (but not
preproduction) cost overruns, builds during the early years of the contract when
the efficiencies resulting from learning are not yet fully realized and declines
as the contract matures. Under the learning curve concept, an estimated
decrease in unit labor hours is assumed as tasks and production techniques
become more efficient through repetition of the same manufacturing operation and
through management action such as simplifying product design, improving tooling,
purchasing new capital equipment, improving manufacturing techniques, etc.
Inventoried costs are reduced by the estimated average cost of deliveries
computed as a uniform percentage of sales value.
In the event that work-in-process inventory plus estimated costs to complete a
specific contract exceeds the anticipated remaining sales value of such
contract, such excess is charged to current earnings, thus reducing inventory to
estimated realizable value.
In accordance with industry practice, costs in inventory include amounts
relating to contracts with long production cycles, some of which is not expected
to be realized within one year.
e. Property, plant, and equipment
Property, plant, and equipment is recorded at cost or, in the case of assets
under capital leases, the lower of the present value of minimum lease payments
or fair market value. Depreciation and amortization is computed by the
straight-line method over the estimated useful lives of the various classes of
assets or, in the case of capitalized leased assets, over the lease term if
shorter.
The Company periodically assesses its ability to recover the carrying value of
its long-lived assets. If management concludes that the carrying value will not
be recovered, an impairment write-down is recorded to reduce the asset to its
estimated fair value (see Note 12).
22
f. Pension
Pension costs include current costs plus the amortization of transition assets
over periods up to 14 years. The Company funds pension costs in accordance with
plan and legal requirements.
g. Research and development, general and administrative expenses
Research and development costs incurred for the development of proprietary
products (which have not been material to operations during the periods
presented) and general and administrative expenses are charged to operating
income as incurred. Design efforts performed under contract generally consist
of the adaptation of an existing capability to a particular customer need and
are accounted for as an element of contract costs.
h. Income taxes
Deferred tax assets and liabilities are recognized based upon temporary
differences between financial statement and tax bases of assets and liabilities
using presently enacted tax rates (see Note 6).
i. Net income per average share of common stock
Primary earnings per share was determined by dividing net income by the
weighted average number of common shares and common share equivalents (stock
options and warrants) outstanding during the year. Fully diluted earnings per
share reflect the maximum dilution of per share earnings, if applicable, which
would have occurred if the convertible notes and debentures of the Company which
are dilutive had been converted as of the beginning of the period.
j. Cash equivalents
For purpose of the statement of cash flows, the Company considers all
investments and highly liquid debt instruments with a maturity of three months
or less at date of purchase to be cash equivalents. Cash equivalents are stated
at cost which approximates market.
k. Short-term investments
Short-term investments are highly liquid investments with a maturity of 91
days to one year and generally issued by the U.S. Treasury, federal agencies,
municipalities, banks, and major corporations. Short-term investments are
stated at cost which approximates market.
23
l. Industry segments
The Company considers itself to operate in one industry segment.
m. New accounting standards
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation," requires expanded disclosures of stock-based
compensation arrangements with employees and encourages, but does not require,
compensation cost to be measured based on the fair value of the equity
instrument awarded. Corporations are permitted, and the Company continues, to
apply Accounting Principles Board (APB) Opinion No. 25 with the required
disclosure for the pro forma effect on net income and earnings per share (see
Note 11).
In February 1997, the Financial Accounting Standard Board issued SFAS No. 128
"Earnings per Share." This statement specifies the computation, presentation,
and disclosure requirements for earnings per share for entities with publicly
held common stock. SFAS No. 128 is not in effect for the Company in fiscal
1997, but will be in effect for financial statements issued for periods ending
after December 15, 1997, including interim periods. The Company does not expect
the adoption of SFAS No. 128 to have a material effect on its net income per
share.
24
Note 2 - Change in Accounting
In the fourth quarter of fiscal 1997, the Company changed its accounting
principle related to long-term programs and contracts and restated its
historical results to reflect the application of the new principle. The change
eliminated the use of program accounting so that all current and future programs
will be accounted for under the contract method of accounting as described in
Note 1. Prior to the change, approximately half of the Company's revenues were
accounted for under the program method of accounting and approximately half were
accounted for under the contract method of accounting. Under contract
accounting, the Company accounts for the direct sale of spare parts to airlines
separately from the sale of production units. Previously, on programs that were
accounted for under the program method of accounting, the Company combined the
estimated costs and revenues associated with a program's production units and
spare parts into a single profit center.
While the Company's previous method of accounting was in accordance with
generally accepted accounting principles, the Company believes that the new
principle is preferable. By accounting for spare parts sales separately from
long-term production contracts, the amount of deferred costs included in
inventory has been reduced. The change will also decrease the significance of
the projections used in calculating the Company's financial results by
eliminating the need to project spare parts sales into the future. In addition,
under the changed principle, the Company's financial results will more clearly
reflect its current operating activities and cash flow. The Company also
believes that the change in accounting principle will enhance internal
accountability.
The effect of this change in accounting for the periods through July 31, 1996,
was a charge of $59.6 million, net of income tax benefits of $40.0 million. In
accordance with Accounting Principles Board Opinion No. 20, "Accounting
Changes," prior year financial statements have been restated to reflect this
change on a retroactive basis. The effect of the change on fiscal 1997 results
was to increase operating income by $15.1 million (composed of $25.5 million of
additional operating income less $10.4 million of additional loss on the MD-90
contract, in each case arising from the change in accounting). The effect of
the change in accounting on fiscal 1997 net income was to increase net income by
$9.0 million, or 35 cents per share (composed of $15.3 million, or 60 cents per
share, of additional net income less $6.3 million, or 25 cents per share,
arising from the additional loss on the MD-90 program). The total impact on
fiscal 1996 and fiscal 1995 was to increase net income by $19.1 million (92
cents per share) and $11.7 million (64 cents per share), respectively.
25
Note 3 - Accounts Receivable
Accounts receivable, which relate primarily to long-term contracts, consist of
the following (in thousands):
July 31,
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
Amount billed $143,710 $ 80,661
Receivable for sale of aircraft leasing subsidiary
(see Note 12) - 20,142
Recoverable costs and accrued profit on
units delivered but not billed 6,090 6,504
Recoverable costs and accrued profit on
progress completed but not billed 30 8,276
Unrecovered costs and estimated profit
subject to future negotiations 11,445 13,940
- --------------------------------------------------------------------------------
$161,275 $129,523
================================================================================
"Recoverable costs and accrued profit on units delivered but not billed"
represent revenue recognized on contracts for amounts not billable to customers
at the balance sheet date. This amount principally represents delayed payment
terms along with escalation and repricing predicated upon deliveries and final
payment after acceptance. Of these recoverable costs, $0.4 million is expected
to be billed and collected in the normal course of business beyond one year.
"Recoverable costs and accrued profit on progress completed but not billed"
represent revenue recognized on contracts based on the percentage-of-completion
method of accounting and is anticipated to be billed and collected in accordance
with contract terms.
"Unrecovered costs and estimated profit subject to future negotiations"
consist of contract tasks completed for which a final price has not been
negotiated with the customer. Amounts in excess of agreed upon contract prices
are recognized when it is probable that the claim will result in additional
contract revenue and the amounts can be reliably estimated. Included in this
amount at July 31, 1997, are estimated recoveries on constructive change claims
related to government imposed redefined acceptance criteria on the Grumman F-14
contract, which may not be collected within one year. Management believes that
amounts reflected in the financial statements are reasonable estimates of the
ultimate settlements.
The Company has a $40 million accounts receivable sales program under which it
sells qualified receivables through a subsidiary to a trust on an ongoing basis.
The investors' interests in the trust, net of the cash collateral discussed
below, are reported as a reduction to accounts receivable. The Company's
subsidiary holds the remaining interest in the trust which fluctuates in value
depending upon
26
the amount of receivables owned by the trust from time to time. The cost
associated with the sale of receivables under the current facility is 7.57
percent per year. These costs, which have been reflected as a reduction in sales
values, were $3.0 million, $3.0 million, and $3.6 million in fiscal 1997, 1996,
and 1995, respectively. The Company's accounts receivable sales program begins
to phase out as scheduled in October 1997 and is scheduled to be repaid in full
by December 1997. If the Company obtains a substantial amount of new business,
it may seek additional financing which may include a replacement receivable
facility.
27
Sales
The Company's sales to major customers including related program spares,
expressed as a percentage of total sales, during the following periods are
summarized as follows:
Year ended July 31,
- --------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
International Aero Engines 23% 22% 14%
CFM International 17 12 11
The Boeing Company 15 19 17
Airbus Industrie 9 6 6
Rolls-Royce 8 7 13
Pratt & Whitney 7 8 10
General Electric 6 7 7
McDonnell Douglas* 6 7 8
United Technology 1 1 4
Lockheed 0 3 5
Other 8 8 5
================================================================================
*In August 1997, McDonnell Douglas Corporation was acquired by The Boeing
Company.
Total sales to the U.S. Government (including direct sales and indirect sales
through some of the prime contractors shown above) accounted for 3 percent, 8
percent, and 12 percent of sales from continuing operations in the years ended
July 31, 1997, 1996, and 1995, respectively.
Commercial products sold by the Company to jet engine manufacturers are
ultimately installed on aircraft produced by the major commercial airframe
manufacturers, Airbus Industrie, Boeing, and McDonnell Douglas. Sales to
foreign customers accounted for 42 percent, 39 percent, and 38 percent of total
sales for fiscal 1997, 1996, and 1995, respectively. Of the total sales, 37
percent, 31 percent, and 33 percent, were ultimately delivered to customers in
Europe for fiscal 1997, 1996, and 1995, respectively.
28
Note 4 - Inventories
Work-in-process inventories as of July 31, 1997, with a detail break-out of
contracts which have significant deferred costs, are summarized as follows (in
thousands, except quantities which are number of aircraft):
Aircraft Order Status (1) Company Order Status Work-in-Process Inventory
------------------------------- ------------------------------------------- -------------------------
(3) (5)
Delivered (2) Firm Fiscal
to Unfilled Unfilled Contract Unfilled Year Pre-
Contract Airlines Orders Options Quantity Delivered Orders Complete Production Production
- ---------------------------------------------------------------------------------------------------------------------------------
A340 (4) 115 69 75 267 124 44 2003 $ 15,760 $ 6,390
PW4000 for the
A300/A310 and
MD-11 (4) 275 19 31 319 288 18 2003 24,490 12,945
GE90 (4) 20 74 24 55 31 24 1998 2,106 10,450
737-700 - 627 1,028 TBD(6) 11 239 TBD(6) 5,755 4,990
MD-95 - 50 50 TBD(6) - 5 TBD(6) 3,828 51,723
Others 91,048 439
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at July 31, 1997 $142,987 $ 86,937
=================================================================================================================================
Balance at July 31, 1996 $114,349 $151,540
=================================================================================================================================
Work-in-Process Inventory
--------------------------
Excess-
Contract Over-Average Total
- -------------------------------------------------------
A340 (4) $ - $ 22,150
PW4000 for the
A300/A310 and
MD-11 (4) 30,682 68,117
GE90 (4) - 12,556
737-700 2,273 13,018
MD-95 - 55,551
Others 1,477 92,964
- ------------------------------------------------------
Balance at July 31, 1997 $34,432 $264,356
======================================================
Balance at July 31, 1996 $57,826 $323,715
======================================================
(1) Represents the aircraft order status as reported by Airclaims and/or other
sources the Company believes reliable for the related aircraft and engine
option. The Company's orders frequently are less than the announced orders
shown above.
(2) Represents the number of aircraft used to obtain average unit cost.
(3) Represents the number of aircraft for which the Company has firm unfilled
orders.
(4) Contract quantity represents the lesser of those quantities assumed in
original contract pricing or those quantities which the Company now expects
to deliver in the periods assumed in original contract pricing.
(5) The year presented represents the fiscal year in which the final production
units included in the contract quantity will be delivered. The contract may
continue in effect beyond this date.
(6) "To Be Determined" - New contracts on which the amortization quantity is yet
to be determined.
Contractual terms on certain contracts provide varying levels of recovery
commitments often over a specified number of deliveries for specified amounts of
costs (primarily tooling and design). The number of deliveries over which
production costs are to be amortized is predicated upon initial pricing
agreements and does not exceed the Company's overall assessment of the market
for that program. Certain contracts also provide for the repricing of units in
the event that less than a specified quantity is sold, which allows for recovery
of additional excess-over-average inventory in such circumstances. The Company,
in turn, has provided certain subcontractors with similar recovery commitments
and repricing provisions on certain contracts. The PW4000 contract was revised
in 1993 and provides that if Pratt & Whitney accepts delivery of less than 500
units between 1993 through 2003 an "equitable" adjustment will be made. Recent
market projections on the PW4000 contract indicate that less than 500 units will
be delivered. The Company has submitted a "request for equitable adjustment"
to the customer and believes it will achieve a recovery such that there will be
no material adverse effect on the financial position of the Company.
29
The excess of deferred contract costs over the total costs allocated to units
in process and delivered (less recoveries from customers due to repricing
provisions) that would not be recovered based on existing firm orders as of July
31, 1997, is $2.3 million on the 737-700 contract. The MD-95 contract which is
currently in development has preproduction inventory of $51.7 million. If the
contract is cancelled prior to FAA certification, the Company expects
substantial recovery of these costs. If the aircraft is certified and actively
marketed, the Company estimates that it would require orders for approximately
300 aircraft to fully recover its costs. To date, McDonnell Douglas has
received orders for 50 firm and 50 options from ValuJet . The Company has firm
orders for five aircraft.
Excess-over-average inventory represents the costs of in-process and delivered
units less, for each such unit, the current estimated average cost of the units
in the contract. Recovery of these inventoried costs assumes certain production
efficiencies and the sale of the contract quantity used in estimating the profit
margin. If these contract assumptions are not attained, such will be reflected
as a change in estimate and impact future operating margins.
To the extent that a forward loss is encountered on a contract, the amount of
such loss is offset against the inventory of such contract, (until such
inventory has been depleted). The loss is offset first against excess-over-
average inventory, followed by preproduction inventory, then production
inventory.
The Company has used forward contracts, on a limited basis, to manage its
exchange risk on a portion of its purchase commitments from vendors of aircraft
components denominated in foreign currencies and to manage its exchange risk for
sums paid to its French subsidiary for services. The extent to which the
Company utilizes forward contracts varies and depends upon management's
evaluation of current and projected foreign currency exchange rates, but the
Company does not acquire forward contracts in excess of its current hedging
requirements. At July 31, 1997, the Company had $16.5 million of foreign
exchange contracts outstanding to purchase foreign currencies. There were no
significant deferred gains or losses associated with these foreign exchange
contracts.
30
Note 5 - Property, Plant, and Equipment
Property, plant, and equipment consist of the following (in thousands):
July 31,
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
Land $ 24,348 $ 24,660
Buildings 194,996 195,153
Machinery and equipment 294,375 287,035
Construction in progress 11,583 12,183
- --------------------------------------------------------------------------------
525,302 519,031
Less accumulated depreciation and amortization (336,538) (322,979)
- --------------------------------------------------------------------------------
Property, plant, and equipment - net $ 188,764 $ 196,052
================================================================================
Included in the above categories are assets recorded under capitalized leases
with original costs totaling $50.6 million at July 31, 1997, and 1996.
Note 6 - Taxes (Benefit) on Income
Taxes (benefit) on income is comprised of the following (in thousands):
July 31,
- -------------------------------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------
(restated) (restated)
Currently Payable:
Federal income taxes $ 1,080 $ 80 $ 900
Foreign income taxes (290) 350 (90)
State income taxes 440 130 240
Deferred:
Federal income taxes (1,754) 12,239 9,169
State income taxes (1,740) 2,178 3,810
- -------------------------------------------------------------------
$(2,264) $14,977 $14,029
===================================================================
31
The difference between the tax (benefit) on income computed at the
federal statutory rate and the actual tax (benefit) on income is as follows (in
thousands):
July 31,
- --------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
(restated) (restated)
Taxes computed at the federal
statutory tax rate $(1,971) $13,039 $11,984
Increase (decrease) resulting from:
State income taxes, net of federal
tax benefit (293) 1,937 1,780
Tax-exempt income from Foreign Sales
Corporation (152) (152) (395)
Non-deductible items 402 1,453 922
Corporate-owned life insurance (387) (433) (236)
Sale of investment leases - (1,048) -
Other 137 181 (26)
- --------------------------------------------------------------------------------
$(2,264) $14,977 $14,029
================================================================================
Deferred income taxes reflect the net tax effects of (a) temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes and (b) operating loss and
tax credit carryforwards.
The components of the Company's deferred tax asset (liability) which reflect
the tax effects of the Company's temporary differences, tax credit
carryforwards, and net operating loss carryforwards (NOLs) are listed below (in
thousands):
July 31,
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
(restated)
Current:
Inventories $ 48,750 $ 15,186
Employee benefits 3,100 3,597
State taxes (5,852) (7,180)
Sale of investment leases - (27,816)
- --------------------------------------------------------------------------------
Net deferred tax asset (liabilities) - current $ 45,998 $(16,213)
================================================================================
Long-term:
Depreciation $ 761 $ 9,332
Deferred gain on sale/leaseback 7,502 7,876
Minimum pension liability adjustment - 17,767
Net operating loss carryforward 91,415 120,485
Tax credit carryforward 9,549 8,432
Investment in leases (3,151) (3,525)
Other - net (21,718) (3,504)
- --------------------------------------------------------------------------------
Net deferred tax asset - long-term $ 84,358 $156,863
================================================================================
The Company has federal NOLs totaling approximately $233 million at July 31,
1997, which expire in the years 2004 through 2012, and tax credit carryforwards
totaling $9.5 million which expire in the years 2003 through 2013.
32
When tax effected at the rates in effect July 31, 1997, the net deductible
temporary differences, tax credit carryforwards, and NOLs result in a deferred
tax asset of $130.4 million, consisting of $112.4 million for federal tax
purposes and $18.0 million for state tax purposes. Based on rates in effect
July 31, 1997, approximately $340 million of future taxable income is required
prior to expiration of the Company's NOLs and credits for full realization of
the deferred tax asset. The Company believes that its future taxable income
will be sufficient for full realization of the deferred tax asset.
Late in fiscal 1996, the Company received a Revenue Agent's Report ("RAR")
from the Internal Revenue Service in connection with the audit of the Company's
federal income tax returns for fiscal years 1986 through 1989. In the RAR, the
agent challenged the timing of various deductible items, some of which are
significant. The Company is contesting substantially all the proposed
adjustments and believes it will prevail on all material items. The Company
anticipates that any adjustment made to its reported taxable income for the
years under audit will increase the amount of the net operating loss available
for carryback purposes and therefore the audit adjustments will not have a
material adverse impact on the financial position of the Company.
33
Note 7 - Indebtedness
The maturity schedule of the Company's debt is summarized as follows (in
thousands):
Total at
Fiscal Year Ended July 31, July 31,
- -------------------------------------------------------------------------------------------------------------------------------
1998 1999 2000 2001 2002 Thereafter 1997 1996
- -------------------------------------------------------------------------------------------------------------------------------
11.625% Senior Notes $100,000 $100,000 $100,000
9.35% Senior Notes $ 2,287 $ 2,287 $ 695 5,269 39,732
9.33% Senior Notes 1,713 1,713 1,713 $ 1,713 $ 1,372 8,224 51,343
Other Debt 417 236 241 196 202 17,318 18,610 21,935
- -------------------------------------------------------------------------------------------------------------------------------
4,417 4,236 2,649 1,909 1,574 117,318 132,103 213,010
Capital Leases 1,611 1,522 1,433 1,344 1,256 2,989 10,155 13,502
Less Imputed Interest (600) (518) (436) (356) (276) (372) (2,558) (3,789)
- -------------------------------------------------------------------------------------------------------------------------------
1,011 1,004 997 988 980 2,617 7,597 9,713
Subordinated Debt:
7.75% Convertible Notes 19,695 19,695 19,720
9.25% Debentures 7,500 7,500 7,500 7,500 7,500 112,500 150,000 150,000
7.00% Convertible Debentures 5,750 5,750 5,750 5,750 92,000 115,000 115,000
- -------------------------------------------------------------------------------------------------------------------------------
7,500 13,250 13,250 13,250 13,250 224,195 284,695 284,720
- -------------------------------------------------------------------------------------------------------------------------------
Total Indebtedness $12,928 $18,490 $16,896 $16,147 $15,804 $344,130 $424,395 $507,443
- -------------------------------------------------------------------------------------------------------------------------------
Less Current Portion (12,928) (25,962)
- -------------------------------------------------------------------------------------------------------------------------------
Long-Term Debt $411,467 $481,481
===============================================================================================================================
The fair value of the Company's total indebtedness as of July 31, 1997, is
estimated to be $445.2 million compared to the carrying value of $424.4 million
reflected in the table above. This fair value was derived using quoted market
prices on publicly traded debt and estimated market value of the privately held
debt.
The Company's total financings were $483.5 million and $569.2 million at July
31, 1997, and 1996, respectively. The Company's total financings at July 31,
1997, included: indebtedness, shown in the table above; the accounts receivable
sales program in the amount of $40.0 million, which is reported as a reduction
to accounts receivable (see Note 3); and two sale-leaseback transactions,
accounted for as operating leases, totaling $19.1 million.
The Company's privately placed 9.35% Senior Notes require principal payments
of approximately $2.3 million in January 1998 and 1999, and a final payment of
$0.7 million in January 2000. The Company's privately placed 9.33% Senior Notes
require principal payments of approximately $1.7 million in December 1997
through 2000, and a final payment of $1.4 million in December 2001. In the
fourth quarter of fiscal 1997, the Company voluntarily prepaid $34.3 million of
its 9.33% Senior Notes and $22.4 million of its 9.35% Senior Notes. The Company
used existing funds to extinguish this debt. A premium and certain other
expenses associated with this early extinguishment of debt were recorded as an
extraordinary item. The net loss associated with this early extinguishment
totaled $2.6 million or 11 cents per share, net of income tax benefit of $1.8
million. The noteholders can require the Company to purchase the remaining
principal amount of the
34
notes plus accrued interest and premium for yield adjustment in the event of
certain changes in control or ownership of the Company.
The $100 million of 11.625% Senior Notes due May 2003 are general unsecured
obligations of the Company and do not have sinking fund requirements. These
Senior Notes are redeemable after May 1999, at a premium price of 105.8 percent,
declining annually to par at maturity. The noteholders can require the Company
to purchase the principal, plus accrued interest and premium in the event of
certain changes in control or ownership of the Company. The Company's 7.75%
Convertible Subordinated Notes due May 2004 have no sinking fund requirements.
The Convertible Subordinated Notes are convertible at the option of the holder
into shares of the Company's common stock at a conversion price of $10.35 per
share, subject to adjustment under certain conditions. At the Company's option,
the Convertible Subordinated Notes are redeemable after May 1998, at a premium
price of 104.7 percent, declining to par at maturity. The Company's 9.25%
Subordinated Debentures due March 2017 are subject to mandatory annual sinking
fund payments of $7.5 million beginning March 1998. The Company's 7.00%
Convertible Subordinated Debentures due October 2012 are subject to mandatory
annual sinking fund payments of $5.8 million beginning October 1998. These
debentures are convertible at the option of the holder into shares of the
Company's common stock at a conversion price of $43.00 per share, subject to
adjustment under certain conditions. The 7.00% debentures are currently
redeemable at the Company's option at a premium price of 102.1 percent and the
9.25% debentures are redeemable at a premium price of 105.6 percent, both
declining to par over specified time periods.
The Company's principal financing agreements contain certain covenants and
ratios, the most significant of which relate to tangible net worth, debt to
equity, and income available for fixed charges. The Company was in compliance
with these covenants at July 31, 1997. These financing agreements also contain
other restrictions, including restrictions on new indebtedness, prepayments and
redemptions of indebtedness, amendments to debt agreements, liens, dividends,
lease obligations, mergers, sales of assets, investments, and capital
expenditures. If the Company were to breach a covenant in any of its principal
financing agreements, the lenders under such agreement could, at their option,
accelerate the maturity of the debt evidenced by such agreement. In addition,
any such default (or, in some cases, an acceleration after the occurrence of
such a default) would cause defaults under cross-default provisions (or cross-
acceleration provisions) in other Company financing agreements.
35
Note 8 - Commitments and Contingencies
Minimum rental commitments under operating leases with non-cancelable terms of
more than one year as of July 31, 1997, are as follows (in thousands):
- ------------------------------------------------------
1998 $ 7,900
1999 6,100
2000 4,400
2001 4,100
2002 4,000
Thereafter 2,300
- ------------------------------------------------------
$28,800
======================================================
Generally, leases have provisions for rent escalation based on inflation.
Certain leases provide for options to renew with substantially similar terms
(except negotiable rent increases). The total expense under all operating
leases was approximately $7.2 million, $6.3 million, and $8.5 million for fiscal
1997, 1996, and 1995, respectively.
In June 1987, the U.S. District Court of Los Angeles, in U.S. et al, vs.
Stringfellow, granted partial summary judgment against the Company and 14 other
defendants on the issue of liability under the Comprehensive Environmental
Response, Compensation and Liability Act ("CERCLA"). This suit alleges that the
defendants are jointly and severally liable for all damage in connection with
the Stringfellow hazardous waste disposal site in Riverside County, California.
In June 1989, a federal jury and a special master appointed by the federal court
found the State of California also liable for the cleanup costs. On November
30, 1993, the special master released his "Findings of Fact, Conclusions of Law
and Reporting Recommendations of the Special Master Regarding the State Share
Fact Finding Hearing." In it, he allocated liability between the State of
California and other parties. As this hearing did not involve the valuation of
future tasks and responsibilities, the order did not specify dollar amounts of
liability. The order, phrased in percentages of liability, recommended
allocating liability on the CERCLA claims as follows: 65 percent to the State
of California and 10 percent to the Stringfellow entities, leaving 25 percent to
the generator/counterclaimants (including the Company) and other users of the
site (or a maximum of up to 28 percent depending on the allocation of any
Stringfellow entity orphan share). On the state law claims, the special master
recommended a 95 percent share for the State of California, and 5 percent for
the Stringfellow entities, leaving 0 percent for the generator/counterclaimants.
This special master's finding was substantially approved by the federal judge
but that decision is subject to an appeal. The Company and the other generators
of wastes disposed at the Stringfellow site, which include numerous
36
companies with assets and equity significantly greater than the Company, are
jointly and severally liable for the share of cleanup costs for which the
generators, as a group, may ultimately be found to be responsible.
Notwithstanding, CERCLA liability is sometimes allocated among hazardous waste
generators who used a waste disposal site based on the volume of hazardous waste
they disposed at the site. The Company is the second largest generator of waste
by volume disposed at the site, although it and certain other generators have
argued the final allocation of cleanup costs among generators should not be
determined solely by volume. The largest volume generator of wastes disposed at
the Stringfellow site has indicated it is significantly dependent on insurance
to fund its share of any cleanup costs, and that it is in litigation with
certain of its insurers.
From inception to date, the Company has expended approximately $4.1 million on
clean-up costs for this site. The Company also estimates that its future clean-
up expenditures for this site are likely to range from $5 million to $8 million
over and above the sums spent to date, as explained in greater detail in
"Management's Discussion and Analysis of Financial Condition and Results of
Analysis - Environmental Matters."
The Company intends to continue to vigorously defend itself in the
Stringfellow matter. Based upon the information currently available to it,
including the fact that the Company has reached settlement agreements with its
primary comprehensive general liability insurers with respect to this matter and
has established reserves in connection with its expected future clean-up
liabilities, the Company believes that the ultimate resolution of this matter
will not have a material adverse effect on the financial position, liquidity or
results of operations of the Company.
The Company is involved as plaintiff or defendant in various other legal and
regulatory actions and inquiries incident to its business, none of which are
believed by management to have a material adverse effect on the financial
position or results of operations of the Company.
Note 9 - Employee Benefit Plans
a. Pension plan
The Company has non-contributory pension plans covering substantially all of
its employees. Benefits for the salaried employees' plan are based on age and
years of service plus interest at specified levels. Benefits under the pension
plan covering certain union employees are based on a negotiated amount per year
of service. The Company has made contributions to independent trusts in excess
of the minimum funding requirements of these plans under IRS regulations. The
37
Company also has supplemental retirement plans which are generally unfunded.
Defined benefit plans expense consists of the following components (in
thousands):
Year ended July 31,
- --------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
Service cost $ 8,031 $ 8,336 $ 9,574
Interest cost on projected benefit obligation 40,201 38,726 36,462
Actual gain on plan assets (69,809) (90,646) (43,245)
Net amortization and deferral 33,791 59,173 12,118
- --------------------------------------------------------------------------------
Total $12,214 $15,589 $14,909
================================================================================
The following table summarizes the funded status of these plans and the
amounts recognized in the Consolidated Balance Sheets (in thousands):
July 31,
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
Actuarial present value of benefit obligations:
Vested $528,905 $507,659
Non-vested 19,364 20,714
- --------------------------------------------------------------------------------
Accumulated benefit obligation 548,269 528,373
Effect of projected future salary increases 5,777 5,545
- --------------------------------------------------------------------------------
Projected benefit obligation for service rendered to date 554,046 533,918
Plan assets at fair value, primarily stocks, bonds,
other fixed income obligations and real estate 554,135 475,343
- --------------------------------------------------------------------------------
Plan assets greater (less) than projected benefit
obligation 89 (58,575)
Unrecognized net loss 42,601 52,937
Unrecognized net asset from initial application of SFAS
No. 87 being recognized over plans' average remaining
service life (6,814) (9,816)
Unrecognized prior service cost 29,037 31,859
Additional minimum liability - (72,735)
- --------------------------------------------------------------------------------
Net pension asset (liability) recognized in the
consolidated balance sheets $64,913 $(56,330)
================================================================================
In fiscal 1997, the Company's defined benefit pension plans' assets exceeded
the accumulated benefit obligation primarily due to its contribution of $48
million of common stock and $10.3 million cash in addition to market gain on
plan assets, and therefore no additional minimum liability was recorded. The
amounts recorded in fiscal 1996 relating to the plans' underfunded position were
reversed in fiscal 1997. At July 31, 1996, the plans' accumulated benefit
obligations exceeded plan assets and the additional minimum liability for the
Company's defined benefit plans was in excess of the unrecognized prior service
costs and net transition obligation and was recorded as a reduction
38
of $26.4 million to shareholders' equity, net of tax benefits of $17.8 million,
in accordance with SFAS No. 87, "Employers' Accounting for Pensions."
The weighted-average discount rate used in determining the present value of
the projected benefit obligation was 8.25 percent, 7.75 percent, and 8.25
percent for the years ended July 31, 1997, 1996, and 1995, respectively. For
compensation-based plans, the rate of increase in future compensation levels
used in determining the actuarial present value of the projected benefit
obligation and service cost was based upon an experience-related table and
approximated 5.0 percent on current salaries through January 1, 1997, in
accordance with plan terms. The expected long-term rate of return on plan
assets was 9 percent for the periods presented. Plan assets are invested
primarily in stocks, bonds, and real estate.
The Company also has certain defined contribution plans covering most
employees. Expenses for these plans amounted to $3.8 million, $3.5 million, and
$2.8 million in fiscal 1997, 1996, and 1995, respectively.
b. Post-Retirement benefit obligations other than pensions
The Company has a retirement health care program that pays a specified fixed
amount to supplement the medical insurance payments made by retirees who are
under age 65 and their spouses and covered dependents. Eligibility for and the
amount of the supplement provided by the Company is based on age and years of
service. The program requires employee contributions.
SFAS No. 106 requires disclosure of the effect on the Company's accumulated
post-retirement benefit obligation, and net periodic post-retirement benefit
cost, using the assumption that the health care cost trend will increase by 1
percent each year. This disclosure is not applicable because the Company is not
affected by future health care cost trends since its obligation is to pay a
fixed amount as a health care supplement for retirees entitled to this benefit.
39
Post-retirement benefit costs, net of expected retiree contributions, included
the following components (in thousands):
Year ended July 31,
- --------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
Service cost - benefits attributed to service
during the period $ 106 $ 125 $ 146
Interest cost on accumulated post-retirement
benefit obligation 371 419 408
Net amortization and deferral (10) 13 32
- --------------------------------------------------------------------------------
Net periodic post-retirement benefit cost $ 467 $ 557 $ 586
================================================================================
The liability for post-retirement health care benefits included the following
components (in thousands):
July 31,
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
Accumulated post-retirement benefit obligation:
Retirees $1,840 $2,660
Fully eligible active plan participants 310 236
Other active plan participants 2,058 2,159
Unrecognized net loss 421 (380)
- --------------------------------------------------------------------------------
Liability for post-retirement health care benefits $4,629 $4,675
================================================================================
The accumulated post-retirement benefit obligation was determined using
weighted average discount rates of 8.25 percent, 7.75 percent, and 8.25 percent,
respectively, for the years ended July 31, 1997, 1996, and 1995. The plan is
unfunded. Each year the Company funds the benefits paid.
40
Note 10 - Shareholders' Equity
The Company has not paid a cash dividend since 1975 and is restricted from
paying cash dividends by covenants within its primary loan agreements.
The Company's stockholder rights plan generally entitles the holder of each
right to purchase one one-hundredths of a share of Series C preferred stock, $1
par value, from the Company for $100, subject to adjustment. A right is included
with, and attaches to, each share of common stock issued and expires on August
25, 1999, and is redeemable by the Company. The rights become exercisable and
separate from the common stock under certain circumstances -- generally when a
person or group of affiliated or associated persons has acquired or obtained the
right to acquire 15 percent or more of the Company's outstanding voting stock or
has made a tender offer to acquire 15 percent or more of such voting stock.
Under certain circumstances, each right would entitle the holder to purchase a
certain number of the Company's common stock at one-half of fair market value.
In May 1993, in connection with certain amendments to the financial covenants
of its principal financing agreements, the Company issued warrants to certain
lenders. The warrants are exercisable for 600,000 shares of common stock at
$9.00 per share and expire in August 2000.
Authorized, unissued shares of common stock were reserved for the following:
July 31,
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
Various stock plans 3,598,978 3,983,911
Conversion of subordinated debentures and notes 4,577,318 4,579,732
Warrants 600,000 600,000
- --------------------------------------------------------------------------------
8,776,296 9,163,643
================================================================================
Note 11 - Stock Based Plans
The Company's 1995 Stock Incentive Plan provides that qualified employees are
eligible to receive stock options and various other stock-based awards. Subject
to certain adjustments, the plan provides that up to 1,800,000 shares of common
stock may be sold or issued under the plan. The terms and conditions of the
stock-based awards are determined by a Committee of the Board of Directors on
each grant date and may include provisions for the exercise price, expiration,
41
vesting, restriction on sale and forfeiture, as applicable. Under the terms of
the plan, the Company may not change the exercise price of or replace any stock
option previously granted (except pursuant to certain plan adjustments), nor
grant an option with an exercise price less than 100 percent of the fair market
value of the underlying common stock on the date the Committee approves such
stock option. Restricted shares purchased under the plan are subject to
restrictions on sale or disposal, which lapse in varying installments from one
to ten years. During fiscal 1997, 63,728 restricted shares were awarded to
employees.
The Company's 1982 Stock Option Plan and the 1989 Stock Incentive Plan, under
both of which no future options will be granted, provided for the issuance of
non-qualified stock options at the market price of the Company's common stock at
the date of grant. The options become exercisable in installments from one to
six years after date of grant and expire ten years from date of grant. Under
the 1989 Stock Incentive Plan, restricted shares purchased under the plan are
subject to restrictions on sale or disposal, which lapse in varying installments
from one to ten years. During fiscal 1996, 26,076 shares were awarded to
various employees. At July 31, 1997, there were no shares available for grants
under these plans.
The Company has a director stock plan under which non-employee directors are
automatically granted, on the first business day following the annual meeting of
shareholders, an option to purchase 1,000 shares of common stock. The option
exercise price is equal to the fair market value of the stock on the date the
option is granted. Options granted under the plan generally become exercisable
six months after the date of grant and expire ten years from the date of grant.
Subject to certain adjustments, the plan provides that up to 100,000 shares of
common stock may be sold or issued under the plan. As a result of previous
option grants under the plan, 30,000 shares remained available for grant at July
31, 1997.
The Company also has a stock compensation plan for non-employee directors
pursuant to which the Company will issue or deliver to each such director, in
partial consideration for the services rendered by such director during the
Company's prior fiscal year, 250 shares of the Company's common stock, subject
to certain adjustments. The shares will be issued or delivered on the date of
the first meeting of the Board of Directors that occurs after the end of each
fiscal year.
42
Under the various stock option plans, outstanding options for 2,383,500 and
2,035,452 shares of common stock were exercisable with weighted-average exercise
price of $17.015 and $17.479 as of July 31, 1997, and 1996, respectively.
Activity in these stock option plans for the three years ended July 31, 1997, is
summarized as follows:
Weighted-Average
Options Exercise Price
- --------------------------------------------------------------------------------
Balance Outstanding at July 31, 1994 2,723,044 $16.618
Granted 19,000 9.717
Relinquished (7,180) 25.812
Forfeited (44,300) 17.861
Exercised (26,000) 10.889
- --------------------------------------------------------------------------------
Balance Outstanding at July 31, 1995 2,664,564 $16.588
Granted 1,123,936 16.120
Relinquished (77,465) 27.470
Forfeited (47,667) 19.026
Exercised (394,707) 11.845
- --------------------------------------------------------------------------------
Balance Outstanding at July 31, 1996 3,268,661 $16.686
Granted 281,705 21.265
Relinquished (34,200) 28.402
Forfeited (33,500) 21.938
Exercised (287,005) 13.368
- --------------------------------------------------------------------------------
Balance Outstanding at July 31, 1997 3,195,661 $17.207
================================================================================
The following table summarizes information about stock options outstanding at
July 31, 1997.
Options Outstanding Options Exercisable
- -----------------------------------------------------------------------------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Range of Exercise Contractual Exercise Exercise
Price Shares Life (Yrs.) Price Shares Price
- -----------------------------------------------------------------------------------------
$8.50 to $13.49 968,166 5.0 $10.47 912,166 $10.53
$13.50 to $18.49 1,018,565 7.6 15.18 646,941 15.14
$18.50 to $23.49 829,780 6.1 21.39 445,243 21.37
$23.50 to $28.49 17,500 2.8 25.49 17,500 25.49
$28.50 to $33.49 361,650 1.4 30.95 361,650 30.95
- -----------------------------------------------------------------------------------------
3,195,661 2,383,500
=========================================================================================
43
The Company's accounting for stock-based plans is in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." For stock options granted, the option prices is not less than the
market value of shares on the grant date; therefore, no compensation expense has
been recognized for fixed stock option plans.
Had compensation expense for the Company's stock-based plans been accounted
for using the fair value method prescribed by SFAS No. 123, net income (loss)
and earnings (loss) per share would have been as follows:
1997 1996
- --------------------------------------------------------------------------------
(restated)
Net earnings (loss) as reported $(6,022) $22,287
Pro forma net earnings (loss) under SFAS No. 123 $(7,619) $21,552
Earnings (loss) per share as reported $ (0.24) $ 1.07
Pro forma earnings (loss) per share under SFAS No. 123 $ (0.30) $ 1.04
================================================================================
As required by SFAS No. 123, the Company has determined the weighted-average
fair value of each option granted in fiscal 1997 and 1996 to be $10.38 and
$7.58, respectively. The fair value of each option grant was estimated on the
date of grant using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1997 and 1996, respectively;
risk-free interest rates of 6.6 percent and 5.6 percent; no expected dividends;
expected volatility of 43.8 percent and 43.1 percent; and expected lives of 5.3
years for both years.
The effects of applying SFAS No. 123 in the above pro forma disclosure are not
indicative of future amounts. SFAS No. 123 does not apply to awards granted
prior to fiscal 1996.
Note 12 - Charge for MD-90, Loss on Sale of Aircraft Leasing Subsidiary, and
Impairment Write-down
The Company entered into a contract with International Aero Engines to produce
nacelles for McDonnell Douglas' MD-90 aircraft in 1990. Under the terms of the
contract, the Company agreed to recover its preproduction costs, and the higher
than average production costs associated with early production shipments, over a
specified number of deliveries. In light of the wide market acceptance of the
MD-80 series, which was the predecessor aircraft, the Company believed
sufficient MD-90 aircraft would be sold to allow it to recover its costs.
Over the last year, however, a series of developments created market
uncertainties regarding
44
future sales of the MD-90 aircraft. The most significant of these developments
included: McDonnell Douglas' termination of the MD-XX contract and the doubts
this action raised regarding McDonnell Douglas' continued presence in the
commercial aircraft industry; the decision of several large airlines that have
traditionally operated McDonnell Douglas aircraft to order aircraft that compete
with the MD-90; the announced (and subsequently completed) acquisition of
McDonnell Douglas by The Boeing Company, which produces a family of competing
aircraft; the announcement by Delta Airlines, launch customer for the MD-90, of
its intent to replace its existing fleet of MD-90s and to seek a business
resolution with McDonnell Douglas with respect to its remaining orders for the
aircraft; and the lack of significant MD-90 orders during the past year.
In the recognition of these developments, the Company reduced its estimates of
future MD-90 aircraft deliveries in the second quarter of fiscal 1997 to include
only deliveries which were supported by firm orders, options, and letters of
intent for the aircraft. During the fourth quarter of fiscal 1997, the Company
further reduced its market estimate of future MD-90 sales to existing firm
aircraft orders (excluding firm orders from Delta Airlines). Based on its
reduced estimate of future aircraft deliveries, the Company now believes that
future MD-90 sales will not be sufficient to recover its existing contract
investment plus the costs it will be required to spend in the future to complete
the contract. As a result, the Company realized an $84.5 million operating loss
on the contract in fiscal 1997 (which included a $10.4 million increase in the
loss as a result of the change in accounting). The change in accounting
principles adopted in the fourth quarter of fiscal 1997 resulted in $49.3
million of the loss being reported in the second quarter of fiscal 1997 and
$35.2 million being reported in the fourth quarter of fiscal 1997. The MD-90
contract accounted for 13.9 percent and 11.2 percent of fiscal 1997 and 1996
sales, respectively.
During fiscal 1996, the Company negotiated the sale of its aircraft leasing
subsidiary, whose principal assets were beneficial interests in two aircraft (an
A300 and a DC-10), on lease through 2003 and 2004, respectively. The Company
recorded a $5.2 million pre-tax loss as a result of this sale, but retained an
interest in the residual value of these assets through which it could recover
additional amounts in the future. The Company also recorded a receivable in the
amount of $20.1 million (collected in fiscal 1997) and a secured note in the
amount of $7.5 million in connection with the sale.
The Company has been reviewing its long-range site strategy and assessing the
facilities necessary to meet its future needs including the potential favorable
operating effect of lean manufacturing. During fiscal 1996, the Company
recognized a $7.2 million pre-tax impairment write-down on its Arkadelphia,
Arkansas facility to its estimated net realizable value. The Company intends to
continue to review its site strategy and facilities with respect to its current
and projected needs.
45
Note 13 - Discontinued Operations
In the fourth quarter of fiscal 1994, the Company sold and commenced the
transfer of its business jet line of business. The purchase agreement required
the Company to manufacture and deliver certain components and transfer program
engineering and tooling which was substantially completed in fiscal 1995. The
operating results of the business jet line of business are included in earnings
from discontinued operations summarized as follows (in thousands):
Year ended July 31,
- -------------------------------------------------------------
1995
- -------------------------------------------------------------
Net sales $22,287
Income before taxes 6,486
Taxes on income 2,607
- -------------------------------------------------------------
Net income $ 3,879
=============================================================
Net income per average share
of common stock $ 0.21
=============================================================
46
Note 14 - Quarterly Results of Operations (Unaudited)
(In thousands except for per share data)
Year ended July 31, 1997
- -----------------------------------------------------------------------------------------------------
1st 2nd 3rd 4th
- -----------------------------------------------------------------------------------------------------
(restated) (restated) (restated)
Sales $201,905 $213,274 $249,308 $279,870
Cost & expenses 172,621 182,238 212,761 230,071
Charge on MD-90 contract -- 49,357 -- 35,184
General and administrative expenses 7,447 6,352 7,127 6,778
Income (loss) from operations 21,837 (24,673) 29,420 7,837
Income (loss) before extraordinary items 6,787 (20,769) 11,774 (1,160)
Loss from extraordinary item - net of tax -- -- -- (2,654)
Net income (loss) 6,787 (20,769) 11,774 (3,814)
Primary earnings (loss) per average share
of common stock $ 0.29 $ (0.79) $ 0.45 $ (0.15)
Fully diluted earnings (loss) per average share
of common stock $ 0.28 $ (0.79) $ 0.43 $ (0.15)
=====================================================================================================
Proforma quarterly results (prior to accounting change as described in Note 2)
Year ended July 31, 1997
- -----------------------------------------------------------------------------------------------------
1st 2nd 3rd 4th
- -----------------------------------------------------------------------------------------------------
Sales $201,905 $213,274 $249,308 $279,870
Cost and expenses 178,354 188,700 214,360 241,738
Charge on MD-90 contract -- -- -- 74,105
General and administrative expenses 7,447 6,352 7,127 6,778
Income (loss) from operations 16,104 18,222 27,821 (42,751)
Income (loss) before extraordinary items 3,358 4,883 10,818 (31,411)
Loss from extraordinary item - net of tax -- -- -- (2,654)
Net income (loss) 3,358 4,883 10,818 (34,065)
Primary earnings (loss) per average share
of common stock $ 0.14 $ 0.19 $ 0.42 $ (1.30)
Fully diluted earnings (loss) per average
share of common stock $ 0.14 $ 0.18 $ 0.39 $ (1.30)
====================================================================================================
47
(In thousands except for per share data)
Year ended July 31, 1996
- ----------------------------------------------------------------------------------------------------------------------------
1st 2nd 3rd 4th
- ----------------------------------------------------------------------------------------------------------------------------
(restated) (restated) (restated) (restated)
Sales $150,400 $180,702 $203,711 $236,001
Cost and expenses 136,015 144,596 170,377 191,626
Loss on sale of aircraft subsidiary
and impairment write-down - - - 12,395
General and administrative 6,728 5,247 7,336 7,922
Operating income 7,657 30,859 25,998 24,058
Net income (loss) (2,199) 8,861 8,576 7,040
Primary earnings (loss) per average share
of common stock $ (0.12) $ 0.45 $ 0.38 $ 0.31
Fully diluted earnings (loss) per average share
of common stock $ (0.12) $ 0.42 $ 0.36 $ 0.30
==========================================================================================================================
Pro forma quarterly results (prior to accounting change as described in Note 2)
Year ended July 31, 1996
- ----------------------------------------------------------------------------------------------------------------------------
1st 2nd 3rd 4th
- ----------------------------------------------------------------------------------------------------------------------------
Sales $150,400 $180,702 $203,711 $236,001
Cost and expenses 131,533 159,071 177,810 206,057
Loss on sale of aircraft Subsidiary
and impairment write-down - - - 12,395
General and administrative 6,728 5,247 7,336 7,922
Operating income 12,139 16,384 18,565 9,627
Net income (loss) 482 205 4,130 (1,589)
Primary earnings (loss) per average share
of common stock $ 0.03 $ 0.01 $ 0.19 $ (0.07)
Fully diluted earnings (loss) per average share
of common stock $ 0.03 $ 0.01 $ 0.18 $ (0.07)
========================================================================================================================
48
Report by Management
To the Shareholders and Board of Directors of Rohr, Inc.
The management of the Company has prepared and is responsible for the
consolidated financial statements and all related financial information
contained in this report. The accompanying financial statements have been
prepared in conformity with generally accepted accounting principles and reflect
the effects of certain estimates and judgments made by management.
The Company maintains a system of internal accounting controls designed and
intended to provide reasonable assurance that assets are safeguarded,
transactions are properly executed and recorded in accordance with management's
authorization, and accountability for assets is maintained. The system is
continuously monitored by direct management review, by internal auditors who
conduct an extensive program of audits, and by independent auditors in
connection with their annual audit.
Management recognizes its responsibility to foster a strong ethical climate
and has formalized ethics as an integral part of the organization. Management
has issued written policy statements and the importance of ethical behavior is
regularly communicated to all employees. These communications include
distribution of written codes of ethics and standards of business conduct and
through ongoing education and review programs designed to create a strong
compliance environment.
The Company's consolidated financial statements have been audited by Deloitte
& Touche LLP, independent certified public accountants. Their audits were
conducted in accordance with generally accepted auditing standards, and included
a review of financial controls and tests of accounting records and other
procedures as they considered necessary in the circumstances.
The Audit and Ethics Committee of the Board of Directors is composed of five
outside directors. This committee meets periodically with management, the
internal auditors, and the independent accountants to review accounting,
reporting, auditing, internal control, and ethics matters. The committee has
direct and private access to both internal and external auditors and held five
meetings during fiscal 1997.
L. A. Chapman R. H. Rau
Senior Vice President and President and Chief Executive Officer
Chief Financial Officer
A. L. Majors
Vice President and Controller
(Chief Accounting Officer)
================================================================================
49
Independent Auditors' Report
To the Shareholders and Board of Directors of Rohr, Inc.
We have audited the accompanying consolidated balance sheets of Rohr, Inc. and
its subsidiaries as of July 31, 1997 and 1996, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
three years in the period ended July 31, 1997. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Rohr, Inc. and its subsidiaries as
of July 31, 1997 and 1996, and the results of its operations and its cash flows
for each of the three years in the period ended July 31, 1997, in conformity
with generally accepted accounting principles.
As discussed in Note 2 to the Consolidated Financial Statements, in fiscal
1997 the Company changed its accounting principle related to long-term contracts
and retroactively restated the fiscal 1996 and 1995 financial statements for the
change.
================================================================================
San Diego, California
September 11, 1997
50
================================================================================
SELECTED FINANCIAL DATA
(in thousands except for per share data, number of employees, percentages, and
ratios)
Year ended July 31,
- ---------------------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------
(restated) (restated) (restated) (restated)
Results of continuing operations :
Sales $ 944,357 $ 770,814 $ 805,000 $ 918,141 $1,149,503
Operating income (1) $ 34,421 $ 88,572 $ 84,226 $ 79,911 $ 4,887
Operating profit margin (1) 3.6% 11.5% 10.5% 8.7% 0.4%
Income (loss) $ (3,368) $ 22,278 $ 20,211 $ 23,341 $ (26,488)
Primary earnings (loss) per average share
of common stock $ (0.13) $ 1.07 $ 1.11 $ 1.29 $ (1.48)
Cash dividends per share of
common stock - - - - -
====================================================================================================================
Financial Position at July 31:
Total assets $ 883,978 $ 932,940 $ 897,930 $ 966,519 $ 908,785
Indebtedness 424,395 507,443 554,777 588,990 531,608
Net financings (2) 440,428 480,828 520,970 537,567 601,669
Shareholders' equity 246,280 175,617 97,321 56,581 73,242
Debt-to-equity ratio 1.72:1 2.89:1 5.70:1 10.41:1 7.26:1
Return on average equity - 16.3% 29.8% 39.4% -
Book value per common share $ 9.72 $ 7.86 $ 5.39 $ 3.14 $ 4.07
Number of full-time employees
at year end 4,600 3,800 4,000 4,900 6,500
Backlog $1,500,000 $1,200,000 $1,000,000 $1,200,000 $1,400,000
=====================================================================================================================
(1) Operating income and operating profit margin was adversely impacted by
certain items and special provisions of $84.5 million in fiscal 1997, $12.4
million in fiscal 1996, $7.9 million in fiscal 1994, and $25.0 million in
fiscal 1993.
(2) Net financings include indebtedness plus the receivables sales program
(which is reflected as a reduction to accounts receivable) and two sale-
leaseback transactions (accounted for as operating leases), reduced by cash,
including cash equivalents, and short-term investments. (See Notes 3 and 7
of the Notes to the Consolidated Financial Statements.)
51