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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
 þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2018

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


Commission file number 001-16445  
 
Rockwell Collins, Inc.
(Exact name of registrant as specified in its charter)


Delaware
52-2314475
(State or other jurisdiction
(I.R.S. Employer
of incorporation or organization)
Identification No.)
 
 
400 Collins Road NE
 
Cedar Rapids, Iowa
52498
(Address of principal executive offices)
(Zip Code)

Registrant's telephone number, including area code: (319) 295-1000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes R No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
 
Accelerated filer o
Non-accelerated filer  o
 
Smaller reporting company o
 
 
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No  þ

164,365,741 shares of the registrant's Common Stock were outstanding on July 23, 2018.

 



ROCKWELL COLLINS, INC.

INDEX


 
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


i


PART I.
FINANCIAL INFORMATION

Item 1.
Condensed Consolidated Financial Statements

ROCKWELL COLLINS, INC.
CONDENSED CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(Unaudited)
(in millions, except per share amounts)
 
June 30,
2018
 
September 30,
2017
ASSETS
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
621

 
$
703

Receivables, net
1,811

 
1,426

Inventories, net
2,641

 
2,451

Business held for sale
66

 

Other current assets
258

 
180

Total current assets
5,397

 
4,760

 
 
 
 
Property, Net
1,402

 
1,398

Goodwill
9,103

 
9,158

Customer Relationship Intangible Assets
1,358

 
1,525

Other Intangible Assets
553

 
604

Deferred Income Tax Asset
22

 
21

Other Assets
524

 
531

TOTAL ASSETS
$
18,359

 
$
17,997

LIABILITIES AND EQUITY
 

 
 

Current Liabilities:
 

 
 

Short-term debt
$
864

 
$
479

Accounts payable
832

 
927

Compensation and benefits
353

 
385

Advance payments from customers
325

 
361

Accrued customer incentives
274

 
287

Product warranty costs
192

 
186

Other current liabilities
434

 
444

Total current liabilities
3,274

 
3,069

 
 
 
 
Long-term Debt, Net
6,317

 
6,676

Retirement Benefits
1,046

 
1,208

Deferred Income Tax Liability
277

 
331

Other Liabilities
647

 
663

 
 
 
 
Equity:
 

 
 

Common stock ($0.01 par value; shares authorized: 1,000; shares issued: June 30, 2018, 175.0; September 30, 2017, 175.0)
2

 
2

Additional paid-in capital
4,589

 
4,559

Retained earnings
4,468

 
3,838

Accumulated other comprehensive loss
(1,576
)
 
(1,575
)
Common stock in treasury, at cost (shares held: June 30, 2018, 10.7; September 30, 2017, 12.1)
(692
)
 
(781
)
Total shareowners’ equity
6,791

 
6,043

Noncontrolling interest
7

 
7

Total equity
6,798

 
6,050

TOTAL LIABILITIES AND EQUITY
$
18,359

 
$
17,997

See Notes to Condensed Consolidated Financial Statements.

1


ROCKWELL COLLINS, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
(in millions, except per share amounts)

 
Three Months Ended
 
Nine Months Ended
 
June 30
 
June 30
 
2018
 
2017
 
2018
 
2017
Sales:
 
 
 
 
 
 
 
Product sales
$
1,941

 
$
1,836

 
$
5,644

 
$
3,935

Service sales
267

 
258

 
755

 
694

Total sales
2,208

 
2,094

 
6,399

 
4,629

 
 
 
 
 
 
 
 
Costs, expenses and other:
 
 
 
 
 
 
 
Product cost of sales
1,448

 
1,352

 
4,184

 
2,799

Service cost of sales
177

 
172

 
502

 
471

Selling, general and administrative expenses
212

 
213

 
610

 
514

Transaction and integration costs
29

 
64

 
91

 
80

Interest expense
66

 
77

 
196

 
122

Other income, net
7

 
(5
)
 
(16
)
 
(14
)
Total costs, expenses and other
1,939

 
1,873

 
5,567

 
3,972

 
 
 
 
 
 
 
 
Income before income taxes
269

 
221

 
832

 
657

Income tax (benefit) expense
(6
)
 
42

 
40

 
165

 
 
 
 
 
 
 
 
Net income
$
275

 
$
179

 
$
792

 
$
492

 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic earnings per share
$
1.67

 
$
1.13

 
$
4.83

 
$
3.52

Diluted earnings per share
$
1.66

 
$
1.12

 
$
4.78

 
$
3.48

 
 
 
 
 
 
 
 
Weighted average common shares:
 
 
 
 
 
 
 
Basic
164.3

 
158.2

 
163.9

 
139.8

Diluted
165.9

 
159.9

 
165.7

 
141.4

 
 
 
 
 
 
 
 
Cash dividends per share
$
0.33

 
$
0.33

 
$
0.99

 
$
0.99


See Notes to Condensed Consolidated Financial Statements.

2


ROCKWELL COLLINS, INC.
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited)
(in millions)

 
Three Months Ended
 
Nine Months Ended
 
June 30
 
June 30
 
2018
 
2017
 
2018
 
2017
Net income
$
275

 
$
179

 
$
792

 
$
492

Unrealized foreign currency translation and other adjustments
(109
)
 
50

 
(48
)
 
41

Pension and other retirement benefits adjustments (net of taxes for the three and nine months ended June 30, 2018 of $5 and $18, respectively; net of taxes for the three and nine months ended June 30, 2017 of $9 and $27, respectively)
20

 
15

 
49

 
47

Foreign currency cash flow hedge adjustments (net of taxes for the three and nine months ended June 30, 2018 of $0 and $(1), respectively; net of taxes for the three and nine months ended June 30, 2017 of $0 and $1, respectively)
(1
)
 
2

 
(2
)
 
4

Comprehensive income
$
185

 
$
246

 
$
791

 
$
584


See Notes to Condensed Consolidated Financial Statements.



3


ROCKWELL COLLINS, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(in millions)
 
Nine Months Ended
 
June 30
 
2018
 
2017
Operating Activities:
 
 
 
Net income
$
792

 
$
492

Adjustments to arrive at cash provided by operating activities:
 
 
 
Depreciation
153

 
118

Amortization of intangible assets, pre-production engineering costs and other
284

 
132

Amortization of acquired contract liability
(100
)
 
(42
)
Amortization of inventory fair value adjustment

 
44

Non-cash impairment charges and settlement of a contract matter

31

 

Stock-based compensation expense
27

 
21

Compensation and benefits paid in common stock
43

 
48

Deferred income taxes
(60
)
 
18

Pension plan contributions
(77
)
 
(66
)
Changes in assets and liabilities, excluding effects of acquisitions and foreign currency adjustments:
 
 
 
Receivables
(393
)
 
(60
)
Production inventory
(216
)
 
(88
)
Pre-production engineering costs
(65
)
 
(108
)
Accounts payable
(76
)
 
21

Compensation and benefits
(31
)
 
(19
)
Advance payments from customers
(35
)
 
1

Accrued customer incentives
(12
)
 
(17
)
Product warranty costs
6

 
(4
)
Income taxes
(7
)
 
(56
)
Other assets and liabilities
(68
)
 
(19
)
Cash Provided by Operating Activities
196

 
416

Investing Activities:
 
 
 
Property additions
(190
)
 
(165
)
Acquisition of business, net of cash acquired

 
(3,429
)
Other investing activities
4

 
(5
)
Cash (Used for) Investing Activities
(186
)
 
(3,599
)
Financing Activities:
 
 
 
Repayment of long-term debt, including current portion
(351
)
 
(338
)
Repayment of acquired long-term debt

 
(2,119
)
Purchases of treasury stock(1)
(11
)
 
(46
)
Cash dividends
(162
)
 
(140
)
Increase in long-term borrowings

 
6,099

Increase (decrease) in short-term commercial paper borrowings, net
385

 
(78
)
Proceeds from the exercise of stock options
60

 
41

Other financing activities
(4
)
 
(4
)
Cash Provided by (Used for) Financing Activities
(83
)
 
3,415

Effect of exchange rate changes on cash and cash equivalents
(9
)
 
6

Net Change in Cash and Cash Equivalents
(82
)
 
238

Cash and Cash Equivalents at Beginning of Period
703

 
340

Cash and Cash Equivalents at End of Period
$
621

 
$
578

(1) Includes net settlement of employee tax withholding upon vesting of share-based payment awards.


See Notes to Condensed Consolidated Financial Statements.

4


ROCKWELL COLLINS, INC.
CONDENSED CONSOLIDATED STATEMENT OF EQUITY
(Unaudited)
(in millions)

 
Common Stock
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares Outstanding
 
Par Value
 
Additional Paid-In Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss
 
Treasury Stock
 
Noncontrolling Interest
 
Total Equity
Balance at September 30, 2017
162.9

 
$
2

 
$
4,559

 
$
3,838

 
$
(1,575
)
 
$
(781
)
 
$
7

 
$
6,050

Net income

 

 

 
792

 

 

 

 
792

Other comprehensive income

 

 

 

 
(1
)
 

 

 
(1
)
Cash dividends

 

 

 
(162
)
 

 

 

 
(162
)
Shares issued:
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Exercise of stock options
1.0

 

 
(6
)
 

 

 
66

 

 
60

Vesting of performance shares and restricted stock units
0.1

 

 
(14
)
 

 

 
3

 

 
(11
)
Employee savings plan
0.3

 

 
23

 

 

 
20

 

 
43

Stock-based compensation

 

 
27

 

 

 

 

 
27

Balance at June 30, 2018
164.3


$
2


$
4,589


$
4,468


$
(1,576
)

$
(692
)

$
7


$
6,798

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at September 30, 2016
130.2

 
$
1

 
$
1,506

 
$
3,327

 
$
(1,898
)
 
$
(858
)
 
$
6

 
$
2,084

Net income

 

 

 
492

 

 

 

 
492

Other comprehensive income

 

 

 

 
92

 

 

 
92

Cash dividends

 

 

 
(140
)
 

 

 

 
(140
)
Shares issued:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of stock options
0.7

 

 
(4
)
 

 

 
45

 

 
41

Vesting of performance shares and restricted stock units
0.2

 

 
(11
)
 

 

 
6

 

 
(5
)
Employee stock purchase plan
0.1

 

 
2

 

 

 
5

 

 
7

Employee savings plan
0.4

 

 
14

 

 

 
27

 

 
41

B/E Aerospace business acquisition
31.2

 
1

 
3,014

 

 

 

 

 
3,015

Stock-based compensation

 

 
21

 

 

 

 

 
21

Treasury share repurchases
(0.4
)
 

 

 

 

 
(39
)
 

 
(39
)
Balance at June 30, 2017
162.4

 
$
2

 
$
4,542

 
$
3,679

 
$
(1,806
)
 
$
(814
)
 
$
6

 
$
5,609


See Notes to Condensed Consolidated Financial Statements.



5


ROCKWELL COLLINS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1.
Business Description and Basis of Presentation

Rockwell Collins, Inc. (the Company or Rockwell Collins) designs, produces and supports cabin interior, communications and aviation systems and products for commercial and military customers and provides information management services through voice and data communication networks and solutions worldwide.

The Company operates on a 52/53 week fiscal year with quarters ending on the Friday closest to the last day of the calendar quarter. For ease of presentation, June 30 and September 30 are utilized consistently throughout these financial statements and notes to represent the period end dates.

The Company has two consolidated subsidiaries with income attributable to a noncontrolling interest. The net income and comprehensive income attributable to the noncontrolling interest is insignificant.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements have been condensed or omitted. These financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended September 30, 2017.

In the opinion of management, the unaudited financial statements contain all adjustments, consisting of adjustments of a normal recurring nature, necessary to present fairly the financial position, results of operations and cash flows for the periods presented. The results of operations for the three and nine months ended June 30, 2018 are not necessarily indicative of the results that may be expected for the full year.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates and assumptions.

On September 4, 2017, the Company entered into an Agreement and Plan of Merger (Merger Agreement) with United Technologies Corporation (UTC). The Merger Agreement provides that the Company will be acquired by UTC. Each Company shareowner will receive $93.33 per share in cash and $46.67 in shares of UTC common stock in the merger, subject to a 7.5 percent collar centered on UTC's August 22, 2017 closing share price of $115.69. The transaction is subject to the satisfaction of customary closing conditions and approval by certain regulators. The Company incurred $27 million of merger-related costs during the nine months ended June 30, 2018. These costs are included in Transaction and integration costs in the Condensed Consolidated Statement of Operations. At June 30, 2018, $10 million of merger-related costs were unpaid and included in Accounts payable and Compensation and benefits on the Condensed Consolidated Statement of Financial Position.

On April 13, 2017, the Company acquired B/E Aerospace, a leading manufacturer of aircraft cabin interior products and services. Prior to 2018, the financial results of the entire B/E Aerospace business were reported in the Interior Systems segment. Beginning in 2018, the B/E Aerospace thermal and electronic systems product lines, which primarily serve military and government customers, are now being reported in the Government Systems segment. This reorganization is expected to generate additional revenue synergy opportunities for the Company. The results of operations of the acquired B/E Aerospace business are now reported in the Interior Systems and Government Systems business segments. Interior Systems and Government Systems sales and operating earnings for the three and nine months ended June 30, 2017 have been reclassified to conform to the current year presentation.

2.
Recently Issued Accounting Standards

In March 2018, the Financial Accounting Standards Board (FASB) issued an amendment to formally codify the guidance provided by the Securities and Exchange Commission (SEC) in Staff Accounting Bulletin (SAB) 118. SAB 118 provides additional guidance allowing companies to use a one year measurement period, similar to that used in business combinations, to account for the impacts of the Tax Cuts and Jobs Act (the Act) in their financial statements. The Company has accounted for the impacts of the Act, including the use of reasonable estimates where necessary. The Company may continue to refine its estimates throughout the measurement period.

6


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



In February 2018, the FASB issued a new standard giving companies the option to reclassify tax effects stranded in accumulated other comprehensive income as a result of the Act to retained earnings. The guidance can be applied retrospectively or in the period of adoption and is effective for the Company in 2020, with early adoption permitted. The Company is currently evaluating the impact of this standard on the consolidated financial statements.

In March 2017, the FASB issued a new standard on presentation of the net periodic cost of postretirement benefit programs. The new standard requires sponsors of defined benefit postretirement plans to present the non-service cost components of net periodic benefit cost separate from the service cost component on the income statement. The new standard also requires that the non-service cost components of net periodic benefit cost no longer be capitalized within assets. The Company is evaluating the effects the standard will have on the Company's consolidated financial statements and related disclosures beyond the change in income statement presentation. This new standard is effective for the Company in 2019, with early adoption permitted.

In February 2016, the FASB issued a comprehensive new lease accounting standard, which provides revised guidance on accounting for lease arrangements by both lessors and lessees. The central requirement of the new standard is that lessees must recognize lease-related assets and liabilities for all leases with a term longer than 12 months. The Company is evaluating the effect the standard will have on the Company's consolidated financial statements and related disclosures, but expects a material change to the balance sheet due to the recognition of right-of-use assets and lease liabilities related to the Company's portfolio of real estate leases. The new guidance is not expected to materially impact accounting for those leases the Company enters into with customers. The new standard is effective for the Company in 2020, with early adoption permitted.

In May 2014, the FASB issued a comprehensive new revenue recognition standard that effectively replaces all current guidance on the topic. Several amendments to the new standard have been issued, which are intended to resolve potential implementation challenges and drive consistent interpretation and application of the new standard. The new standard is effective for the Company in 2019, with early adoption permitted, but not earlier than 2018. The guidance permits use of either a retrospective or cumulative effect (modified retrospective) transition method.

The Company's interpretation of the new standard is substantially complete and the Company has prepared an initial assessment of the impacts of adoption on its consolidated financial statements and disclosures. Anticipated changes under the new standard include, among other items, accounting for development costs and associated customer funding related to commercial contracts, increased use of over time revenue recognition based on costs incurred for government contracts and the elimination of customer relationship intangible assets related to free products provided to customers as up-front sales incentives. The new standard also significantly enhances required disclosures regarding revenue and related assets and liabilities.

Of the anticipated changes, the Company expects that the change in accounting for commercial contract development costs and associated customer funding is likely to have the most significant impact on its financial statements. Customer funding received for development effort is currently recognized as revenue as the development activities are performed. Under the new standard, the Company has concluded that the development effort does not represent a performance obligation. Therefore, customer funding specific to the development effort must be deferred as a contract liability and recognized as revenue when products are delivered to the customer, delaying the timing of revenue recognition. The Company currently expenses development costs associated with commercial contracts unless the arrangement includes a contractual guarantee for reimbursement from the customer. Upon adoption of the new standard, development costs will be expensed as incurred except for those costs incurred pursuant to customer funding. The amount of development costs eligible for deferral will be equivalent to the associated customer funding. Subsequent to adoption, those deferred development costs will be recognized as expense when products are delivered to the customer, consistent with the amortization of deferred development specific customer funding into revenue. Development costs incurred pursuant to contractual guarantees for reimbursement will no longer be capitalized within Inventory as pre-production engineering costs. The balance of capitalized development costs within Inventory as of the adoption date will be eliminated and the related post-adoption amortization expense avoided.

The Company continues to evaluate the impacts associated with the new standard and refine estimated impacts of adoption on the financial statements and related disclosures. The Company is in the process of implementing changes to business processes, systems and internal controls required to implement the new accounting standard. The Company intends to utilize the modified retrospective transition approach.


7


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


Other new accounting standards issued but not effective until after June 30, 2018, are not expected to have a material impact on the Company's financial statements.

3.
Acquisitions, Goodwill and Intangible Assets

Acquisitions

B/E Aerospace
On April 13, 2017, the Company completed the acquisition of B/E Aerospace, a leading manufacturer of aircraft cabin interior products and services, for $6.5 billion in cash and stock, plus the assumption of $2.0 billion of debt, net of cash acquired. The transaction combines the Company's capabilities in flight deck avionics, cabin electronics, mission communication and navigation, simulation and training and information management services with B/E Aerospace's range of cabin interior products, which include seating, food and beverage preparation and storage equipment, lighting and oxygen systems and modular galley and lavatory systems for commercial airliners and business jets. The acquisition advances the Company’s global growth strategy by expanding the Company's previous focus on cockpit, cabin management, communication and connectivity solutions, and diversifies the Company's product portfolio and customer mix. Results of the acquired business are reported in the Interior Systems and Government Systems business segments (see Note 1).

The $6.5 billion gross purchase price for the acquisition of B/E Aerospace includes the following:
(in millions)
 
Cash consideration
$
3,521

Value of common stock issued for B/E Aerospace common stock(1)
3,015

Total purchase price
$
6,536

(1) 31.2 million shares of common stock issued to B/E Aerospace shareholders at the Company's April 13, 2017, closing share price of $96.63.

The cash consideration was financed through the issuance of $4.35 billion of senior unsecured notes and $1.5 billion borrowed under a senior unsecured syndicated term loan facility (see Note 8). The remaining proceeds of the debt offering were used to repay assumed B/E Aerospace debt and a portion of the Company's outstanding short-term commercial paper borrowings.

The purchase price allocation was finalized in the second quarter of 2018 and resulted in the recognition of $7.2 billion of goodwill, none of which is deductible for tax purposes. The goodwill is included in the Interior Systems and Government Systems segments. The goodwill is a result of expected cost synergies from the consolidation of certain corporate and administrative functions, supply chain savings and low-cost manufacturing, expected revenue synergies from the integration of legacy products and technologies with those of B/E Aerospace and intangible assets that do not qualify for separate recognition, such as the assembled B/E Aerospace workforce.


8


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


The following table summarizes the fair value of assets acquired and liabilities assumed at the acquisition date:
(in millions)
April 13, 2017
Cash and cash equivalents
$
104

Receivables, net
485

Inventories, net (1)
542

Other current assets
45

Property, net
271

Intangible Assets
1,586

Other Assets
53

Total Identifiable Assets Acquired
3,086

 
 
Accounts payable
(231
)
Compensation and benefits
(75
)
Advance payments from customers
(62
)
Accrued customer incentives
(48
)
Product warranty costs
(117
)
Other current liabilities (2)
(366
)
Long-term Debt, Net
(2,119
)
Retirement Benefits
(12
)
Deferred Income Tax Liability
(287
)
Other Liabilities (2)
(433
)
Total Liabilities Assumed
(3,750
)
Net Identifiable Assets Acquired, excluding Goodwill
(664
)
Goodwill
7,200

Net Assets Acquired
$
6,536

(1) Inventories, net includes a $74 million adjustment to state Work in process and Finished goods inventories at their fair value as of the acquisition date. The inventory fair value adjustment was amortized as a non-cash increase to Cost of sales during the year ended September 30, 2017.
(2) As of the acquisition date, the Company made adjustments totaling $486 million related to acquired existing long-term contracts with terms less favorable than could be realized in market transactions as of the acquisition date. The adjustments were primarily recognized within Other current liabilities and Other Liabilities based upon estimates regarding the period in which the liabilities will be amortized to the Condensed Consolidated Statement of Operations as non-cash reductions to Cost of sales. $100 million of the acquired contract liabilities were recognized as a reduction to Cost of sales during the nine months ended June 30, 2018.

Before the purchase price allocation was finalized in the second quarter of 2018, revisions were made to the estimated acquisition-date fair value of assets acquired and liabilities assumed. The revisions were primarily due to a change in estimate with respect to the future repatriation of certain foreign earnings, adjustments to the income tax accounts as a result of filing the pre-acquisition returns, recognition of a liability associated with the KLX Tax Sharing and Indemnification Agreement (see Note 15) and revisions to the fair value of certain acquired property. These fiscal year 2018 measurement period adjustments resulted in a $15 million net increase to Goodwill and did not have a material impact on the financial results of prior periods.

The Intangible Assets included above consist of the following:
 
Weighted Average Life (in years)
 
Fair Value
(in millions)
Developed technology
9
 
$
435

Seating customer relationships
6
 
860

Other customer relationships
8
 
291

Total
7
 
$
1,586



9


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


B/E Aerospace's results of operations have been included in the Company's operating results for the periods subsequent to the completion of the acquisition on April 13, 2017. B/E Aerospace contributed sales of $733 million and $2.225 billion for the three and nine months ended June 30, 2018, respectively. Excluding the discrete impacts of the Tax Cuts and Jobs Act (see Note 12) and transaction, integration and financing costs, B/E Aerospace contributed net income of $91 million and $265 million for the three and nine months ended June 30, 2018, respectively.

Transaction, Integration and Financing Costs
The Company recorded total transaction, integration and financing costs related to the B/E Aerospace acquisition in the Condensed Consolidated Statement of Operations as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
June 30
 
June 30
(in millions)
 
2018
 
2017
 
2018
 
2017
Transaction and integration costs
 
$
23

 
$
64

 
$
64

 
$
80

Bridge facility fees (included in Interest expense)
 

 
18

 

 
29

Total Transaction, integration and financing costs
 
$
23

 
$
82

 
$
64

 
$
109


At June 30, 2018, $11 million of transaction, integration and financing costs were unpaid and included in Accounts payable and Compensation and benefits on the Condensed Consolidated Statement of Financial Position.

Supplemental Pro Forma Data
The following unaudited supplemental pro forma data presents consolidated pro forma information as if the acquisition and related financing had been completed as of the beginning of the year prior to acquisition, or on October 1, 2015.

The unaudited supplemental pro forma financial information does not reflect the potential realization of revenue synergies or cost savings, nor does it reflect other costs relating to the integration of the two companies. This pro forma data should not be considered indicative of the results that would have actually occurred if the acquisition and related financing been consummated on October 1, 2015, nor are they indicative of future results.

The unaudited supplemental pro forma financial information was calculated by combining the Company's results with the stand-alone results of B/E Aerospace for the pre-acquisition periods, which were adjusted to account for certain transactions and other costs that would have been incurred during this pre-acquisition period.
 
Three Months Ended
 
Nine Months Ended
 
June 30
 
June 30
 
2018
 
2017
 
2018
 
2017
(in millions, except per share amounts)
(as Reported)
 
(Pro forma)
 
(as Reported)
 
(Pro forma)
Sales
$
2,208

 
$
2,219

 
$
6,399

 
$
6,182

Net income attributable to common shareowners
275

 
277

 
792

 
664

Basic earnings per share
1.67

 
1.71

 
4.83

 
4.10

Diluted earnings per share
1.66

 
1.70

 
4.78

 
4.06


The following significant adjustments were made to account for certain transactions and costs that would have occurred if the acquisition had been completed on October 1, 2015. These adjustments are net of any applicable tax impact and were included to arrive at the pro forma results above.


10


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


 
Three Months Ended
 
Nine Months Ended
 
June 30
 
June 30
(in millions)
2018
 
2017
 
2018
 
2017
Increases / (decreases) to pro forma net income:
 
 
 
 
 
 
 
Net reduction to depreciation resulting from fixed asset adjustments (1)
$

 
$
1

 
$

 
$
12

Advisory, legal and accounting service fees (2)

 
123

 

 
156

Amortization of acquired B/E Aerospace intangible assets, net (3)

 
(7
)
 

 
(83
)
Interest expense incurred on acquisition financing, net (4)

 
8

 

 
(17
)
Long-term contract program adjustments (5)

 
(6
)
 

 
(59
)
Acquired contract liability amortization (6)

 

 

 
61

Inventory fair value adjustment amortization (7)

 
33

 

 
33

Compensation adjustments (8)

 

 

 
6

(1) Captures the net impact to depreciation expense resulting from various purchase accounting adjustments to fixed assets.
(2) Reflects the elimination of transaction-related fees incurred by B/E Aerospace and Rockwell Collins in connection with the acquisition and assumes all of the fees were incurred during the first quarter of 2016.
(3) Eliminates amortization of the historical B/E Aerospace intangible assets and replaces it with the new amortization for the acquired intangible assets.
(4) Reflects the addition of interest expense for the debt incurred by Rockwell Collins to finance the B/E Aerospace acquisition, net of interest expense that was eliminated on the historical B/E Aerospace debt that was repaid at the acquisition date. The adjustment also reflects the elimination of interest expense incurred by Rockwell Collins for bridge loan financing which was assumed to not be required for purposes of the pro forma periods presented.
(5) Eliminates B/E Aerospace capitalized development costs and deferred revenues on certain long-term contracts.
(6) Reflects amortization of liabilities recognized for acquired contracts with terms less favorable than could be realized in market transactions as of the acquisition date.
(7) Reflects amortization of adjustment made to state Work in process and Finished goods inventories at fair value as of the acquisition date.
(8) Reflects reduction in compensation expense due to the vesting of B/E Aerospace stock awards upon the acquisition and the termination of certain B/E Aerospace executives and board members.

Pulse.aero
On December 20, 2016, the Company acquired 100 percent of the outstanding shares of Pulse.aero, a United Kingdom based company specializing in self-bag drop technologies used by airlines and airports. The purchase price, net of cash acquired, was $17 million, of which $14 million was paid during the year ended September 30, 2017 and $3 million was paid during the nine months ended June 30, 2018. On the acquisition date, the Company recorded a $5 million liability for the fair value of post-closing consideration that may be paid, contingent upon the achievement of certain revenue targets and development milestones. The Company made contingent consideration payments of $2 million during the year ended September 30, 2017 and $2 million during the nine months ended June 30, 2018. In the third quarter of 2017, the purchase price allocation was finalized, with $12 million allocated to goodwill and $6 million to intangible assets. The intangible assets have a weighted average life of approximately 9 years. None of the goodwill resulting from the acquisition is tax deductible. The excess purchase price over net assets acquired, including intangible assets, reflects the Company's view that this acquisition will expand the Company's airport passenger processing offerings.

The B/E Aerospace acquisition is included in the Interior Systems and Government Systems segments (see Note 1) and the Pulse.aero acquisition is included in the Information Management Services segment. The results of operations for the acquisitions have been included in the Company's operating results for the periods subsequent to the acquisition dates. Pro forma results of operations have not been presented for Pulse.aero as the effect of the acquisition is not material to the Company's consolidated results of operations.

11


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Goodwill
Changes in the carrying amount of goodwill are summarized as follows:
(in millions)
Interior Systems
 
Commercial
Systems
 
Government
Systems
 
Information Management Services
 
Total
Balance at September 30, 2017
$
7,223

 
$
325

 
$
506

 
$
1,104

 
$
9,158

B/E Aerospace acquisition adjustments
(370
)
 

 
385

 

 
15

Reclassification of business to held for sale (see Note 4)
(59
)
 

 

 

 
(59
)
Foreign currency translation adjustments
(9
)
 

 
(2
)
 

 
(11
)
Balance at June 30, 2018
$
6,785

 
$
325

 
$
889

 
$
1,104

 
$
9,103


The reorganization of the B/E Aerospace thermal and electronic systems product lines (see Note 1) resulted in the reclassification of $385 million of Goodwill from Interior Systems to Government Systems.

The Company performs an annual impairment test of goodwill and indefinite-lived intangible assets during the fourth quarter of each fiscal year, or at any time there is an indication goodwill or indefinite-lived intangibles are more-likely-than-not impaired, commonly referred to as triggering events. There have been no such triggering events during any of the periods presented and the Company's fourth quarter 2017 impairment tests resulted in no impairment.

Intangible Assets
Intangible assets are summarized as follows:
 
June 30, 2018
 
September 30, 2017
(in millions)
Gross
 
Accum
Amort
 
Net
 
Gross
 
Accum
Amort
 
Net
Intangible assets with finite lives:
 
 
 
 
 
 
 
 
 
 
 
Developed technology and patents
$
805

 
$
(306
)
 
$
499

 
$
806

 
$
(256
)
 
$
550

Backlog
6

 
(5
)
 
1

 
6

 
(5
)
 
1

Customer relationships:
 

 
 
 
 
 
 
 
 
 
 
Acquired
1,489

 
(363
)
 
1,126

 
1,495

 
(213
)
 
1,282

Up-front sales incentives
341

 
(109
)
 
232

 
336

 
(93
)
 
243

License agreements
16

 
(11
)
 
5

 
15

 
(10
)
 
5

Trademarks and tradenames
15

 
(14
)
 
1

 
15

 
(14
)
 
1

Intangible assets with indefinite lives:
 
 
 
 
 
 
 
 
 
 
 
Trademarks and tradenames
47

 

 
47

 
47

 

 
47

Intangible assets
$
2,719

 
$
(808
)
 
$
1,911

 
$
2,720

 
$
(591
)
 
$
2,129


The Company provides up-front sales incentives prior to delivering products or performing services to certain commercial customers in connection with sales contracts. Up-front sales incentives are recorded as a customer relationship intangible asset and are amortized using a units-of-delivery method over the period the Company has received a contractually enforceable right related to the incentives, up to 15 years after entry into service. Amortization is based on the Company's expectation of delivery rates on a program-by-program basis. Amortization begins when the Company starts recognizing revenue as the Company delivers equipment for the program.
Up-front sales incentives consisting of cash payments or customer account credits are amortized as a reduction of sales, whereas incentives consisting of free products are amortized as cost of sales. As of June 30, 2018, the weighted average amortization period remaining for up-front sales incentives was approximately 10 years.

12


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


Anticipated annual amortization expense for intangible assets is as follows:
(in millions)
2018
 
2019
 
2020
 
2021
 
2022
 
Thereafter
Anticipated amortization expense for up-front sales incentives
$
20

 
$
23

 
$
25

 
$
26

 
$
26

 
$
129

Anticipated amortization expense for all other intangible assets
267

 
265

 
264

 
263

 
260

 
513

Total
$
287

 
$
288

 
$
289

 
$
289

 
$
286

 
$
642


Amortization expense for intangible assets for the three and nine months ended June 30, 2018 was $71 million and $216 million, respectively, compared to $61 million and $86 million for the three and nine months ended June 30, 2017.

4.
Business Held for Sale

On May 31, 2018, the Company reached a definitive agreement to sell its engineered components business, formerly known as SMR Technologies. SMR Technologies manufactures, sells and services diversified engineering components for niche aerospace, military and industrial applications. The sale is subject to customary closing conditions and is expected to close by the fourth calendar quarter of 2018. The business is being sold in order to comply with regulatory commitments associated with the pending UTC merger (see Note 1).

During the three months ended June 30, 2018, the Company classified the engineered components business as held for sale and a pre-tax loss of $9 million ($22 million after tax) for the write-down to fair value less costs to sell was recorded within Other income, net on the Condensed Consolidated Statement of Operations. The high effective tax rate is primarily attributable to the non-deductibility of goodwill for income tax purposes. Assets of $66 million are included within Business held for sale and liabilities of $3 million are included within Other current liabilities on the Condensed Consolidated Statement of Financial Position. The major classes of assets and liabilities primarily include Goodwill of $59 million and Intangible assets of $8 million. The operating results of the held for sale business are included in the Interior Systems segment.

5.
Receivables, Net

Receivables, net are summarized as follows:
(in millions)
June 30,
2018
 
September 30,
2017
Billed
$
1,305

 
$
1,055

Unbilled
621

 
461

Less progress payments
(99
)
 
(78
)
Total
1,827

 
1,438

Less allowance for doubtful accounts
(16
)
 
(12
)
Receivables, net
$
1,811

 
$
1,426


Receivables expected to be collected beyond the next twelve months are classified as long-term and are included in Other Assets. Receivables, net due from equity affiliates were $44 million and $42 million at June 30, 2018 and September 30, 2017, respectively.

Unbilled receivables principally represent sales recorded under the percentage-of-completion method of accounting that have not yet been billed to customers in accordance with applicable contract terms.

The Company sells certain accounts receivable on a non-recourse basis to unrelated financial institutions under factoring agreements arranged by certain customers. Under the terms of the agreements, the Company retains no rights or interest and has no obligations with respect to the sold receivables. The Company accounts for these transactions as sales of receivables and records cash proceeds when received as cash provided by operating activities in the Condensed Consolidated Statement of Cash Flows. Cash generated by participating in these programs was $76 million and $198 million during the nine months ended

13


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


June 30, 2018 and 2017, respectively. The impact on cash provided by (used for) operating activities during the nine months ended June 30, 2018 and 2017, was $(78) million and $138 million, respectively. The cost of participating in these programs was immaterial to the Company's results.

6.
Inventories, Net

Inventories, net are summarized as follows:
(in millions)
June 30,
2018
 
September 30,
2017
Finished goods
$
293

 
$
259

Work in process
376

 
347

Raw materials, parts and supplies
819

 
677

Less progress payments
(19
)
 
(7
)
Total
1,469

 
1,276

Pre-production engineering costs
1,172

 
1,175

Inventories, net
$
2,641

 
$
2,451


The Company defers certain pre-production engineering costs during the development phase of a program, in connection with long-term supply arrangements that contain contractual guarantees for reimbursement from customers. Such customer guarantees generally take the form of a minimum order quantity with quantified reimbursement amounts if the minimum order quantity is not taken by the customer. These costs are deferred to the extent of the contractual guarantees and are amortized over their estimated useful lives using a units-of-delivery method, up to 15 years. This amortization expense is included as a component of cost of sales. Amortization is based on the Company's expectation of delivery rates on a program-by-program basis and begins when the Company starts recognizing revenue as the Company delivers equipment for the program. The estimated useful life is limited to the amount of time the Company is virtually assured to earn revenues under long-term supply arrangements with the Company's customers. Pre-production engineering costs incurred pursuant to supply arrangements that do not contain contractual guarantees for reimbursement are expensed as incurred.

Anticipated annual amortization expense for pre-production engineering costs is as follows:
(in millions)
2018
 
2019
 
2020
 
2021
 
2022
 
Thereafter
Anticipated amortization expense for pre-production engineering costs
$
91

 
$
138

 
$
147

 
$
142

 
$
134

 
$
581


Amortization expense for pre-production engineering costs for the three and nine months ended June 30, 2018 was $23 million and $61 million, respectively, compared to $18 million and $43 million for the three and nine months ended June 30, 2017. As of June 30, 2018, the weighted average amortization period remaining for pre-production engineering costs included in Inventories, net was approximately 9 years.

7.
Other Assets

Other assets are summarized as follows:
(in millions)
June 30,
2018
 
September 30,
2017
Long-term receivables
$
206

 
$
211

Investments in equity affiliates
6

 
7

Exchange and rental assets (net of accumulated depreciation of $111 at June 30, 2018 and $106 at September 30, 2017)
71

 
71

Other
241

 
242

Other Assets
$
524

 
$
531


14


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)



Long-Term Receivables
Long-term receivables expected to be collected beyond the next twelve months are principally comprised of unbilled accounts receivables pursuant to sales recorded under the percentage-of-completion method of accounting that have not yet been billed to customers in accordance with applicable contract terms.

Investments in Equity Affiliates
The Company's investments in equity affiliates primarily consist of seven joint ventures, each 50 percent owned and accounted for under the equity method. The Company records income or loss from equity affiliates in Other income, net on the Condensed Consolidated Statement of Operations. The Company's sales to equity affiliates were $49 million and $159 million for the three and nine months ended June 30, 2018, respectively, compared to $57 million and $193 million for the three and nine months ended June 30, 2017. Deferred profit from sales to equity affiliates was $2 million at June 30, 2018, and $2 million at September 30, 2017.

Exchange and Rental Assets
Exchange and rental assets consist primarily of Company products that are either exchanged or rented to customers on a short-term basis in connection with warranty and other service-related activities. These assets are recorded at acquisition cost or production cost and depreciated using the straight-line method over their estimated lives, up to 15 years. Depreciation methods and lives are reviewed periodically with any changes recorded on a prospective basis. Depreciation expense for exchange and rental assets was $2 million and $8 million for the three and nine months ended June 30, 2018, respectively, and $3 million and $8 million for the three and nine months ended June 30, 2017.

8.
Debt

Short-term Debt
(in millions, except weighted average amounts)
June 30,
2018
 
September 30,
2017
Short-term commercial paper borrowings outstanding (1)
$
715

 
$
330

Current portion of long-term debt
149

 
149

Short-term debt
$
864

 
$
479

Weighted average annualized interest rate of commercial paper borrowings
2.36
%
 
1.45
%
Weighted average maturity period of commercial paper borrowings (days)
13

 
18

(1) The maximum amount of short-term commercial paper borrowings outstanding during the nine months ended June 30, 2018, was $1.148 billion.

Commercial Paper Program
Under the Company’s commercial paper program, the Company may sell up to $1.5 billion face amount of unsecured short-term promissory notes in the commercial paper market. The commercial paper program is supported by the Company's $1.5 billion revolving credit facility.

Revolving Credit Facilities
The Company has a $1.5 billion five-year senior unsecured revolving credit agreement with various banks. At June 30, 2018 and September 30, 2017, there were no outstanding borrowings under the Company's revolving credit facility.

Short-term credit facilities available to non-U.S. subsidiaries were $20 million as of June 30, 2018, of which $2 million was utilized to support commitments in the form of commercial letters of credit. At June 30, 2018 and September 30, 2017, there were no borrowings outstanding under these credit facilities.

At June 30, 2018 and September 30, 2017, there were no significant commitment fees or compensating balance requirements under any of the Company’s credit facilities.

Bridge Credit Facility
On December 16, 2016, pursuant to the B/E Aerospace acquisition, the Company entered into a $4.35 billion 364-day senior unsecured bridge term loan credit agreement with various banks. This bridge facility terminated upon receipt of proceeds from the notes issued to finance a portion of the B/E Aerospace acquisition.

15


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


Long-term Debt
On December 16, 2016, pursuant to the B/E Aerospace acquisition, the Company entered into a $1.5 billion three-year senior unsecured term loan credit agreement with various banks. As of June 30, 2018, borrowings outstanding under this facility were $519 million and bear interest at LIBOR plus 1.25 percent amortized in equal quarterly installments of 2.5 percent, or $38 million, with the balance payable on April 13, 2020. During the nine months ended June 30, 2018, the Company made principal prepayments of $238 million in accordance with the loan's prepayment provisions. Proceeds of borrowings under the term loan facility were used to finance a portion of the B/E Aerospace acquisition and to pay related transaction fees and expenses.

The revolving credit agreement and term loan credit agreement each include one financial covenant requiring the Company to maintain a consolidated debt to total capitalization ratio of not greater than 68 percent (excluding the equity impact on accumulated other comprehensive loss related to defined benefit retirement plans). The Company was in compliance with this financial covenant at June 30, 2018. The credit facilities also contain covenants that require the Company to satisfy certain conditions in order to incur debt secured by liens, engage in sale/leaseback transactions or merge or consolidate with another entity.

On April 10, 2017, the Company issued $4.65 billion of senior unsecured notes. The net proceeds of the offering were principally used to finance a portion of the B/E Aerospace acquisition and to pay related transaction fees and expenses. Net proceeds of $300 million were used to repay a portion of the Company's outstanding short-term commercial paper borrowings.

The principal amount of long-term debt, net of discount and debt issuance costs, is summarized as follows:
(in millions, except interest rate figures)
Interest Rate
 
June 30,
2018
 
September 30,
2017
Fixed-rate notes due:
 
 
 
 
 
July 2019
1.95%
 
$
300

 
$
300

July 2019
5.25%
 
300

 
300

November 2021
3.10%
 
250

 
250

March 2022
2.80%
 
1,100

 
1,100

December 2023
3.70%
 
400

 
400

March 2024
3.20%
 
950

 
950

March 2027
3.50%
 
1,300

 
1,300

December 2043
4.80%
 
400

 
400

April 2047
4.35%
 
1,000

 
1,000

Variable-rate term loan due:
 
 
 
 
 
April 2020
1 month LIBOR + 1.25%(1)
 
519

 
870

Fair value swap adjustment (see Notes 13 and 14)
 
 
(1
)
 
14

Total
 
 
6,518

 
6,884

Less unamortized debt issuance costs and discounts
 
 
52

 
59

Less current portion of long-term debt
 
 
149

 
149

Long-term Debt, Net
 
 
$
6,317

 
$
6,676

(1) The Company has the option to elect a one, two, three or six-month LIBOR interest rate and has elected the one-month rate during the third quarter of 2018. The one-month LIBOR rate at June 30, 2018, was approximately 2.09 percent.
   
Cash payments for debt interest and fees during the nine months ended June 30, 2018 were $175 million. Cash payments for debt interest and fees during the nine months ended June 30, 2017 were $129 million, of which $28 million related to fees incurred in connection with the bridge credit facility.

9.
Retirement Benefits

The Company sponsors defined benefit pension (Pension Benefits) and other postretirement (Other Retirement Benefits) plans which provide monthly pension and other benefits to eligible employees upon retirement.


16


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


Components of Expense (Income)
The components of expense (income) for Pension Benefits and Other Retirement Benefits for the three and nine months ended June 30, 2018 and 2017, are summarized as follows:
 
Pension Benefits
 
Other Retirement Benefits
 
Three Months Ended
 
Three Months Ended
 
June 30
 
June 30
(in millions)
2018
 
2017
 
2018
 
2017
Service cost
$
3

 
$
4

 
$
1

 
$
1

Interest cost
30

 
28

 
1

 
1

Expected return on plan assets
(61
)
 
(61
)
 

 

Amortization:
 
 
 

 
 
 
 

Prior service credit

 

 

 
(1
)
Net actuarial loss
20

 
23

 
1

 
2

Net benefit expense (income)
$
(8
)
 
$
(6
)
 
$
3

 
$
3


 
Pension Benefits
 
Other Retirement Benefits
 
Nine Months Ended
 
Nine Months Ended
 
June 30
 
June 30
(in millions)
2018
 
2017
 
2018
 
2017
Service cost
$
9

 
$
10

 
$
2

 
$
2

Interest cost
90

 
83

 
4

 
4

Expected return on plan assets
(182
)
 
(181
)
 
(1
)
 
(1
)
Amortization:
 
 
 
 
 
 
 
Prior service credit

 

 

 
(1
)
Net actuarial loss
61

 
69

 
5

 
6

Net benefit expense (income)
$
(22
)
 
$
(19
)
 
$
10

 
$
10


Pension Plan Funding
The Company’s objective with respect to the funding of its pension plans is to provide adequate assets for the payment of future benefits. Pursuant to this objective, the Company will fund its pension plans as required by governmental regulations. During the nine months ended June 30, 2018, the Company contributed $68 million to its U.S. qualified pension plans. In July 2018, the Company made a $387 million discretionary contribution to its U.S. qualified pension plans (see Note 19). There is no minimum statutory funding requirement for 2018. Any additional future contributions necessary to satisfy minimum statutory funding requirements are dependent upon actual plan asset returns, interest rates and actuarial assumptions. During the nine months ended June 30, 2018, the Company made contributions to the non-U.S. plans and the U.S. non-qualified pension plan of $9 million.


17


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


10.
Stock-Based Compensation and Earnings Per Share

Stock-based compensation expense, which is calculated net of an assumed forfeiture rate, and related income tax benefit included within the Condensed Consolidated Statement of Operations is as follows:
 
Three Months Ended
 
Nine Months Ended
 
June 30
 
June 30
(in millions)
2018
 
2017
 
2018
 
2017
Stock-based compensation expense included in:
 
 
 
 
 
 
 
Product cost of sales
$
2

 
$
2

 
$
8

 
$
6

Selling, general and administrative expenses
6

 
6

 
19

 
15

Total
$
8

 
$
8

 
$
27

 
$
21

Income tax benefit
$
2

 
$
3

 
$
6

 
$
7


The Company issued awards of equity instruments under the Company's various incentive plans for the nine months ended June 30, 2018 and 2017, as follows:
 
Options
 
Performance Shares
 
Restricted Stock Units
(shares in thousands)
Number Issued
 
Weighted Average Fair Value
 
Number Issued
 
Weighted Average Fair Value
 
Number Issued
 
Weighted Average Fair Value
Nine months ended June 30, 2018

 
$

 
142.2

 
$
138.66

 
263.9

 
$
133.57

Nine months ended June 30, 2017
667.2

 
$
17.26

 
129.0

 
$
87.38

 
224.2

 
$
91.94


The maximum number of shares of common stock that can be issued in respect of performance shares granted in 2018 based on the achievement of performance targets for years 2018 through 2020 is approximately 338,000.

In light of the pending UTC merger, the Company replaced the annual stock option grant with a restricted stock unit grant. As a result, no stock options were granted for the nine months ended June 30, 2018 and the number of restricted stock units granted increased when compared to the prior year.

The fair value of each option granted was estimated using a binomial lattice pricing model and the following weighted average assumptions:
 
 
2017 Grants
Risk-free interest rate
 
1.0% - 2.7%

Expected dividend yield
 
1.3% - 1.5%

Expected volatility
 
19.0
%
Expected life
 
7 years



18


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


Employee Benefits Paid in Company Stock
During the nine months ended June 30, 2018 and 2017, 0.3 million and 0.5 million shares, respectively, of the Company's common stock were issued to employees under the employee stock purchase (ESPP) and defined contribution savings plans at a value of $43 million and $48 million for the respective periods. Further purchases under the ESPP were suspended on September 29, 2017 pursuant to the UTC Merger Agreement. If the UTC merger is completed, the ESPP will be terminated.

Earnings Per Share and Diluted Share Equivalents
The computation of basic and diluted earnings per share is as follows:
 
Three Months Ended
 
Nine Months Ended
 
June 30
 
June 30
(in millions, except per share amounts)
2018
 
2017
 
2018
 
2017
Numerator for basic and diluted earnings per share:
 
 
 
 
 
 
 
Net income
$
275

 
$
179

 
$
792

 
$
492

Denominator:
 

 
 

 
 
 
 
Denominator for basic earnings per share – weighted average common shares
164.3

 
158.2

 
163.9

 
139.8

Effect of dilutive securities:
 
 
 
 
 
 
 
Stock options
0.9

 
1.1

 
1.2

 
1.1

Performance shares, restricted stock and restricted stock units
0.7

 
0.6

 
0.6

 
0.5

Dilutive potential common shares
1.6

 
1.7

 
1.8

 
1.6

Denominator for diluted earnings per share – adjusted weighted average shares and assumed conversion
165.9

 
159.9

 
165.7

 
141.4

Earnings per share:
 

 
 

 
 
 
 
Basic
$
1.67

 
$
1.13

 
$
4.83

 
$
3.52

Diluted
$
1.66

 
$
1.12

 
$
4.78

 
$
3.48


The average outstanding diluted shares calculation excludes options with an exercise price that exceeds the average market price of shares during the period. There were no stock options excluded from the average outstanding diluted shares calculation for the three and nine months ended June 30, 2018 and June 30, 2017.


19


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


11.
Accumulated Other Comprehensive Loss

Changes in accumulated other comprehensive loss (AOCL), net of tax, by component for the three and nine months ended June 30, 2018 and 2017, are as follows:
(in millions)
Foreign Exchange Translation Adjustment
 
Pension and Other Postretirement Adjustments (1)
 
Change in the Fair Value of Effective Cash Flow Hedges
 
Total
Balance at March 31, 2018
$
62

 
$
(1,546
)
 
$
(2
)
 
$
(1,486
)
Other comprehensive income (loss) before reclassifications
(109
)
 
3

 
(1
)
 
(107
)
Amounts reclassified from accumulated other comprehensive loss

 
17

 

 
17

Net current period other comprehensive income (loss)
(109
)
 
20

 
(1
)
 
(90
)
Balance at June 30, 2018
$
(47
)
 
$
(1,526
)
 
$
(3
)
 
$
(1,576
)
 
 
 
 
 
 
 
 
Balance at September 30, 2017
$
1

 
$
(1,575
)
 
$
(1
)
 
$
(1,575
)
Other comprehensive income (loss) before reclassifications
(48
)
 
1

 
(1
)
 
(48
)
Amounts reclassified from accumulated other comprehensive loss

 
48

 
(1
)
 
47

Net current period other comprehensive income (loss)
(48
)
 
49

 
(2
)
 
(1
)
Balance at June 30, 2018
$
(47
)
 
$
(1,526
)
 
$
(3
)
 
$
(1,576
)
 
 
 
 
 
 
 
 
Balance at March 31, 2017
$
(85
)
 
$
(1,786
)
 
$
(2
)
 
$
(1,873
)
Other comprehensive income before reclassifications
50

 

 
2

 
52

Amounts reclassified from accumulated other comprehensive loss

 
15

 

 
15

Net current period other comprehensive income
50

 
15

 
2

 
67

Balance at June 30, 2017
$
(35
)
 
$
(1,771
)
 
$

 
$
(1,806
)
 
 
 
 
 
 
 
 
Balance at September 30, 2016
$
(76
)
 
$
(1,818
)
 
$
(4
)
 
$
(1,898
)
Other comprehensive income before reclassifications
41

 

 
2

 
43

Amounts reclassified from accumulated other comprehensive loss

 
47

 
2

 
49

Net current period other comprehensive income
41

 
47

 
4

 
92

Balance at June 30, 2017
$
(35
)
 
$
(1,771
)
 
$

 
$
(1,806
)
(1) Reclassifications from AOCL to net income, related to the amortization of net actuarial losses and prior service credits for the Company's retirement benefit plans, were $21 million ($17 million net of tax) and $24 million ($15 million net of tax) for the three months ended June 30, 2018 and 2017, respectively, and were $66 million ($48 million net of tax) and $74 million ($47 million net of tax) for the nine months ended June 30, 2018 and 2017, respectively. The reclassifications are included in the computation of net benefit expense. See Note 9 for additional details.


20


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


12.
Income Taxes

At the end of each interim reporting period, the Company makes an estimate of the annual effective income tax rate. Tax items included in the annual effective income tax rate are pro-rated for the full year and tax items discrete to a specific quarter are included in the effective income tax rate for that quarter. The estimate used in providing for income taxes on a year-to-date basis may change in subsequent interim periods.

On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (the Act). The Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits and deductions for individuals and businesses. For businesses, the Act reduces the corporate federal tax rate from a maximum of 35.0 percent to a flat 21.0 percent rate and transitions from a worldwide tax system to a territorial tax system. The Act also adds many new provisions including changes to bonus depreciation, changes to the deduction for executive compensation and interest expense, a tax on global intangible low-taxed income (GILTI), the base erosion anti-abuse tax (BEAT) and a deduction for foreign-derived intangible income (FDII). Many of these provisions, including the tax on GILTI, the BEAT and the deduction for FDII, do not apply to the Company until 2019 and the Company continues to assess the impact of these provisions. The Company has elected to account for the tax on GILTI as a period cost and thus has not adjusted any of the deferred tax assets/liabilities of its foreign subsidiaries for the new tax. The two material items that impact the Company for 2018 are the reduction in the tax rate and a one-time tax that is imposed on the Company’s unremitted foreign earnings.

On December 22, 2017, the SEC issued Staff Accounting Bulletin 118 that provides additional guidance allowing companies to use a one year measurement period, similar to that used in business combinations, to account for the impacts of the Act in their financial statements. During the nine months ended June 30, 2018, the Company has accounted for the impacts of the Act, including the use of reasonable estimates where necessary. The Company may continue to refine its estimates throughout the measurement period.

Due to the Company’s fiscal year, the Company expects its 2018 U.S. federal statutory tax rate to be approximately 24.6 percent. The Company’s U.S. federal statutory tax rate will be 21.0 percent starting in 2019.

The Company has completed its analysis of the rate impact on the deferred tax accounts due to the reduction in the U.S.
corporate income tax rate from 35.0 percent to 21.0 percent under the Act. During the three months ended June 30, 2018, the Company recorded a reduction in net deferred tax liability and a corresponding decrease to income tax expense in the Company’s Condensed Consolidated Statement of Operations.

As of the December 31, 2017 deemed repatriation date, the Company estimates that it had approximately $1.048 billion of unremitted foreign earnings that would be subject to the tax imposed under Section 965 of the Internal Revenue Code. The Act imposes a tax on these earnings at either a 15.5 percent rate or an 8.0 percent rate. The higher rate applies to the extent the Company's foreign subsidiaries have cash and cash equivalents at certain measurement dates, whereas the lower rate applies to any earnings that are in excess of the cash and cash equivalents balance. After accounting for foreign tax credits related to the deemed repatriated earnings, the Company estimates the tax to be approximately $75 million. The Company recorded a provisional amount of $40 million of tax expense in the Company’s Condensed Consolidated Statement of Operations for the nine months ended June 30, 2018, and has established a $35 million liability related to certain B/E Aerospace unremitted foreign earnings through purchase accounting. The Company’s accounting for the tax on unremitted foreign earnings is incomplete due to the complexity of determining the various components of the calculation. Some of the information necessary to determine the amount of the tax includes the future earnings of its foreign subsidiaries and cash balances as of September 30, 2018.
 
During the three months ended June 30, 2018 and 2017, the effective income tax rate was (2.2) percent and 19.0 percent, respectively. The lower current year effective income tax rate was primarily due to a $70 million reduction in deferred tax liabilities as a result of impacts of the Act, including the impact of a $387 million additional discretionary pension contribution made in July 2018 (see Note 19), a lower U.S. Federal statutory tax rate under the Act and benefits from the jurisdictional mix of income as a result of the B/E Aerospace acquisition.

During the nine months ended June 30, 2018 and 2017, the effective income tax rate was 4.8 percent and 25.1 percent, respectively. The lower current year effective income tax rate was primarily due to a $154 million reduction in deferred tax liabilities resulting from enactment of the Act, a lower U.S. Federal statutory tax rate under the Act and benefits from the

21


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


jurisdictional mix of income as a result of the B/E Aerospace acquisition, partially offset by a $40 million obligation related to the tax on unremitted foreign earnings imposed by the Act.

The Company's U.S. Federal income tax returns for the tax year ended September 30, 2013 and prior years have been audited by the IRS and are closed to further adjustments. The IRS is currently auditing the Company's tax returns for the years ended September 30, 2014 and 2015. The IRS is currently auditing the legacy tax filings of an acquired subsidiary for the 2014 calendar year. The Company is also currently under audit in various U.S. states and non-U.S. jurisdictions. The U.S. states and non-U.S. jurisdictions have statutes of limitations generally ranging from 3 to 5 years. The Company believes it has adequately provided for any tax adjustments that may result from the various audits.

The Company had net income tax payments of $105 million and $202 million during the nine months ended June 30, 2018 and 2017, respectively.

The Company has gross unrecognized tax benefits recorded within Deferred Income Tax Liability and Other Liabilities in the Condensed Consolidated Statement of Financial Position of $238 million and $201 million as of June 30, 2018 and September 30, 2017, respectively. The total amount of unrecognized tax benefits that, if recognized, would affect the effective income tax rate was $207 million and $169 million as of June 30, 2018 and September 30, 2017, respectively. Although the timing and outcome of tax settlements are uncertain, it is reasonably possible that during the next 12 months a reduction in unrecognized tax benefits may occur in the range of $0 million to $82 million, based on the outcome of tax examinations or as a result of the expiration of various statutes of limitations.

The Company includes interest and penalties related to unrecognized tax benefits in Income tax expense. The total amount of interest and penalties recognized within Other Liabilities in the Condensed Consolidated Statement of Financial Position was $12 million and $8 million as of June 30, 2018 and September 30, 2017, respectively. The total amount of interest and penalties recorded as an expense or (income) within Income tax expense in the Condensed Consolidated Statement of Operations were not significant for the nine months ended June 30, 2018 and 2017, respectively.

13.
Fair Value Measurements

The FASB defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The FASB guidance classifies the inputs used to measure fair value into the following hierarchy:
Level 1 -
quoted prices (unadjusted) in active markets for identical assets or liabilities
Level 2 -
quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument
Level 3 -
unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value

A financial asset's or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.


22


ROCKWELL COLLINS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)


Assets and liabilities
The fair value of the Company's financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2018 and September 30, 2017, are as follows:
 
 
 
June 30, 2018
 
September 30, 2017
(in millions)
Fair Value
Hierarchy
 
Fair Value
Asset (Liability)
 
Fair Value
Asset (Liability)
Deferred compensation plan investments
Level 1
 
$
66

 
$
63

Deferred compensation plan investments
Level 2
 
27

 
24

Interest rate swap assets
Level 2
 
1

 
14

Interest rate swap liabilities
Level 2
 
(2
)
 

Foreign currency forward exchange contract assets
Level 2
 
5

 
8

Foreign currency forward exchange contract liabilities
Level 2
 
(11
)
 
(7
)
Acquisition-related contingent consideration
Level 3
 
(15
)
 
(17
)

There were no transfers between Levels of the fair value hierarchy during the nine months ended June 30, 2018