UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

Commission file number 1-1520

 

 

Registrant’s telephone number, including area code

(916) 355-4000

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o      No  þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o      No  þ

 

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  þ      No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

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

 

The aggregate market value of the voting common equity held by nonaffiliates of the registrant as of May 31, 2008 was approximately $476 million.

 

As of January 30, 2009, there were 58.4 million outstanding shares of the Company’s Common Stock, $0.10 par value.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the 2009 Proxy Statement of GenCorp Inc. relating to its annual meeting of shareholders scheduled to be held on March 25, 2009 are incorporated by reference into Part III of this Report.

 

 

GENCORP INC.

Annual Report on Form 10-K
For the Fiscal Year Ended November 30, 2008

Table of Contents

 

 

 

 

 

amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (Exchange Act) as soon as reasonably practicable after such materials are electronically filed with, or furnished to, the SEC. We also make available on our Internet web site our corporate governance guidelines and the charters for each of the following committees of the Company’s Board of Directors: Audit; Corporate Governance & Nominating; and Organization & Compensation. Our corporate governance guidelines and such charters are also available in print to anyone who requests them.

 

Aerospace and Defense

 

For over 60 years, Aerojet has been an industry leader and pioneer in the development of critical products and technologies that have strengthened the U.S. military and enabled the exploration of space. Aerojet focuses on developing military, civil, and commercial systems and components that address the needs of the aerospace and defense industry markets. Due to the diversity of its propulsion technologies and the synergy of its product lines, Aerojet believes it is in a unique competitive position to offer its customers the most innovative and advanced solutions available in the domestic propulsion market. Aerojet has been able to capitalize on its strong technical capabilities to become a critical provider of components and systems for major propulsion programs. Aerojet propulsion systems have flown on human and robotic missions for NASA since the inception of the U.S. Space Program, and Aerojet has been a major supplier of propulsion products to the DoD since the founding of Aerojet. Principal customers include the DoD, NASA, United Launch Alliance (ULA), The Boeing Company (Boeing), Lockheed Martin Corporation (Lockheed Martin), and Raytheon Company (Raytheon).

 

 

Industry Overview

 

Broad support continues for DoD and NASA funding in the Government Fiscal Year ending September 30 (GFY), 2009 and beyond. However, these Federal department/agency budgets are under severe pressure due to the cost impacts of the global war on terrorism, the cost of military operations in Iraq and Afghanistan, the ongoing world-wide financial crisis, and a rising U.S. federal deficit. As a result, both the DoD and NASA budgets are expected to grow at modest levels through 2012.

 

Department of Defense

 

The Obama Administration has indicated that it is committed to maintaining adequate funding for the Department of Defense and building Defense capabilities for the 21 ^st  century. President Obama’s stated focus areas that directly relate to Aerojet products are: fully equipping U.S forces for the missions they face; preserving global reach in the Air; maintaining power projection at Sea; protecting the U.S in cyberspace; ensuring freedom of Space; and a pragmatic and cost-effective development of Missile Defense. Congress has indicated they plan to work closely with the new Administration on these focus areas.

 

Following a period of budget decreases in the post-Cold War era, the U.S. defense appropriations have increased in recent years. Defense appropriations have risen to over $487 billion in GFY 2009 from $439 billion in GFY 2008. We expect the U.S. defense budgets for research, development, test and evaluation (RDT&E) and procurement, the primary funding sources for Aerojet’s programs, to remain level, with annual forecasts for RDT&E declining slightly, while procurement continues to show a slight increase through GFY 2012. While the top line DoD budget continues to increase, the Pentagon has announced it plans to reduce the overall rate of growth. Although the ultimate distribution of the Defense budget remains uncertain, Aerojet is well positioned to benefit from DoD investment in: high-priority, transformational systems that address current war fighting requirements; the re-capitalization of weapon systems and equipment being expended during combat deployments; and, systems that meet new threats world-wide.

NASA

 

Congress and the Obama Administration have indicated they believe NASA funding needs to be increased and more balanced across exploration, science, and aeronautics. NASA is operating under a Continuing Resolution through March 2009, at an annual funding level of $17.3 billion. The Obama Administration and Congress are expected to increase NASA GFY 2009 appropriations above the current Continuing Resolution annual funding level. In addition, there is broad support to fund the Constellation Program which will provide a new crew exploration spacecraft and launch system to replace the Space Shuttle. Earth Science, Space Science, and Aeronautics should receive funding increases.

 

In 2009, NASA’s primary space exploration objectives will be to: (i) complete construction of the International Space Station; (ii) phase out the Space Shuttle by 2010 at the earliest; (iii) develop Orion, a new crew exploration spacecraft and its launch vehicle Ares I; and (iv) move forward with the Commercial Orbital Transport System, which is designed to resupply the International Space Station.

 

The Orion prime contractor, Lockheed Martin, selected Aerojet to develop and produce all in-space propulsion for the Orion service and crew modules. In addition, Orbital Sciences, under contract to Lockheed Martin for the Orion launch abort system (LAS) selected Aerojet for significant propulsion work on the LAS program. The Orion program as currently envisioned represents potentially a decade’s long production program for Aerojet that will be the focal point for future U.S. human space exploration.

 

In addition, we believe Aerojet is well-positioned to provide propulsion solutions for some of NASA’s special interest areas: advanced propellant technology, attitude/reaction control systems, and robotic exploration propulsion. Furthermore, as a result of NASA’s intention to retire the Space Shuttle from service as early as 2010, we believe that NASA will focus on maneuvering and long-duration propulsion systems that are currently available and flight-proven, which may present additional opportunities for existing Aerojet product lines.

 

Competition

 

As the only domestic supplier of all four propulsion types — solid, liquid, air-breathing, and electric — we believe that Aerojet is in a unique competitive position. The diversity of its technologies and synergy of its product lines offer Aerojet customers the most innovative and advanced solutions available in the domestic propulsion market. The basis on which Aerojet competes in the Aerospace and Defense industry varies by program, but generally is based upon technology, quality, service, and price. Although market competition is intense, we believe Aerojet possesses innovative and advanced propulsion solutions, combined with adequate resources to continue to compete successfully.

 

Participation in the defense and space propulsion market can be capital intensive requiring long research and development periods that represent significant barriers to entry. Aerojet may partner on various programs with its major customers or suppliers, some of whom are, from time to time, competitors on other programs.

 

The table below lists primary participants in the propulsion market:

 

The domestic solid and liquid propulsion markets remained unchanged in fiscal 2008 with Aerojet in the number two position in both markets, second to Alliant Techsystems in solid propulsion (solids) and Pratt & Whitney Rocketdyne in liquid propulsion (liquids).

 

Major Customers

 

As a merchant supplier to the Aerospace and Defense industry, we do not align ourselves with any single prime contractor except on a project-by-project basis. We believe that our position as a merchant supplier has helped us become a trusted partner to our customers, enabling us to maintain strong long-term relationships with a variety of prime contractors. Under each of our contracts, we act either as a subcontractor, where we sell our products to other prime contractors, or as a prime contractor, where we sell directly to the end user.

 

The principal end user customers of our products and technology are agencies of the U.S. government, U.S. prime contractors, and government agencies. Since a majority of Aerojet’s sales are, directly or indirectly, to the U.S. government, funding for the purchase of Aerojet’s products and services generally follows trends in U.S. defense spending. However, individual government agencies, which include the military services, the Defense Advanced Research Projects Agency, NASA, the Missile Defense Agency, and the prime contractors that serve these agencies, exercise independent purchasing power within “budget top-line” limits. Therefore, sales to the U.S. government are not regarded as sales to one customer, but rather each contracting agency is viewed as a separate customer.

 

Customers that represented more than 10% of net sales for the fiscal years presented are as follows:

 

 

 

 

Effective December 1, 2006, Lockheed Martin and Boeing formed the joint venture ULA. ULA operates the space launch systems using the Atlas ^®  V, Delta II, and Delta IV. The formation of ULA impacts the comparability of the net sales in fiscal 2008 and fiscal 2007 to fiscal 2006 for Lockheed Martin and Boeing.

 

Direct sales to the U.S. government and its agencies, or government customers, and indirect sales to U.S. government customers via direct sales to prime contractors accounted for a total of approximately 86% of sales, or approximately $641.7 million, in fiscal 2008. The following are percentages of net sales by principal end user in fiscal 2008:

 

 

Major Programs

 

Defense Systems — Aerojet maintained a strong position in the defense market segment in fiscal 2008 with key new and follow-on awards. Significant new wins included the propulsion system for the Joint Air to Ground Missile (JAGM), the Multiple Kill Vehicle System, and other controllable solids programs. Important follow-on awards were received on the propulsion system for the Ground Based Midcourse Defense Exoatmospheric Kill Vehicle Divert and Attitude Controls System (GMD EKV DACS), Standard Missile 3, Standard Missile 3 Throttling Divert Attitude Control System, and F-22 programs. These successes continue to strengthen our position as a propulsion leader in missile defense and tactical systems. In addition, in April 2008, the Company again earned the Boeing Company’s “Supplier of the Year Award” for its commitment to superior performance and customer satisfaction.

Aerojet, who also won a Boeing supplier of the year award in 2005, was one of eleven (11) companies honored for its 2007 performance. We believe Aerojet is in a unique competitive position due to the diversity of propulsion technologies (solid, liquid, and air-breathing), complete warhead capabilities, composites and metallic structures expertise, and the synergy of its product lines to offer defense customers the most innovative and advanced solutions available in the domestic market.

 

A subset of our key defense systems programs are listed below:

 

 

Space Systems  — In fiscal 2008, Aerojet maintained its strong market position in space systems by capturing important propulsion contracts. These included the Bigelow Sundancer propulsion model supporting the emerging entrepreneurial space market, the LOX Methane AME Support Exploration program, and the Taurus 2 program with Orbital Sciences.

 

Aerojet’s commitment to quality and excellence in its space systems programs was reflected in its fiscal 2008 100% success on several space exploration and other critical missions using Aerojet’s products, including touchdown of Phoenix; ATV successful first mission; launch of five (5) Delta II vehicles and two (2) Atlas V XSS missions; and launch of Cosmo 3.

These successes strengthen our legacy of supplying mission critical propulsion systems to the DoD and NASA as we have since the inception of the U.S. civil and military space programs and support our position as a critical supplier to our space systems customers.

 

A subset of our key space system programs is listed below:

 

 

Contract Types

 

Under each of its contracts, Aerojet acts either as a prime contractor, where it sells directly to the end user, or as a subcontractor, selling its products to other prime contractors. Research and development contracts are awarded during the inception stage of a program’s development. Production contracts provide for the production and delivery of mature products for operational use. Aerojet’s contracts are primarily categorized as either “fixed-price” or “cost-reimbursable.” During fiscal 2008, approximately 46% of our net sales was from fixed-price contracts and 41% from cost-reimbursable contracts.

 

Fixed-price contracts are typically (i) fixed-price, (ii) fixed-price-incentive fee, or (iii) fixed-price level of effort contracts. For fixed-price contracts, Aerojet performs work for a fixed price and realizes all of the profit or loss resulting from variations in costs of performance. For fixed-price-incentive contracts, Aerojet receives increased or decreased fees or profits based upon actual performance against established targets or other criteria. For fixed-price level of effort contracts, Aerojet generally receives a structured fixed price per labor hour, dependent upon the customer’s labor hour needs. All fixed-price contracts present the risk of unreimbursed cost overruns potentially resulting in losses.

Cost-reimbursable contracts are typically (i) cost plus fixed fee, (ii) cost plus incentive fee, or (iii) cost plus award fee contracts. For cost plus fixed fee contracts, Aerojet typically receives reimbursement of its costs, to the extent the costs are allowable under contractual provisions, in addition to receiving a fixed fee. For cost plus incentive fee contracts and cost plus award fee contracts, Aerojet receives adjustments to the contract fee, within designated limits, based on actual results as compared to contractual targets for factors such as cost, performance, quality, and schedule.

 

Many programs under contract have product life cycles exceeding 10 years, such as the Standard Missile, TOW, and Tomahawk programs. It is typical for U.S. government propulsion contracts to be relatively small during development phases that can last from two to five years, followed by low-rate and then full-rate production, where annual funding can grow as high as approximately $30 million to $60 million per year over many years.

 

Government Contracts and Regulations

 

Our sales are driven by pricing based on costs incurred to produce products or perform services under contracts with the U.S. government. U.S. government contracts generally are subject to Federal Acquisition Regulations (FAR), agency-specific regulations that implement or supplement FAR, such as the DoD’s Defense Federal Acquisition Regulations and other applicable laws and regulations. These regulations impose a broad range of requirements, many of which are unique to government contracting, including various procurement, import and export, security, contract pricing and cost, contract termination and adjustment, and audit requirements. A contractor’s failure to comply with these regulations and requirements could result in reductions of the value of contracts, contract modifications or termination, and the assessment of penalties and fines and could lead to suspension or debarment from government contracting or subcontracting for a period of time. In addition, government contractors are also subject to routine audits and investigations by U.S. government agencies such as the Defense Contract Audit Agency (DCAA). These agencies review a contractor’s performance, cost structure, and compliance with applicable laws, regulations, and standards. The DCAA also reviews the adequacy of, and a contractor’s compliance with, its internal control systems and policies, including the contractor’s purchasing, property, estimating, compensation, and information systems.

 

Backlog

 

As of November 30, 2008, our total contract backlog was $1,035 million compared with $912 million as of November 30, 2007. Of our November 30, 2008 contract backlog, approximately $535 million, or 52%, is not expected to be filled within one year. Funded backlog was $675 million and $566 million at November 30, 2008 and 2007, respectively.

 

Total backlog includes both funded backlog (the amount for which money has been directly authorized by the U.S. Congress, or for which a purchase order has been received from a commercial customer) and unfunded backlog (firm orders for which funding has not been appropriated). Indefinite delivery and quantity contracts and unexercised options are not reported in total backlog. Backlog is subject to delivery delays or program cancellations which are beyond our control.

 

Research and Development

 

We view Aerojet research and development efforts as critical to maintain its leadership position in markets in which it competes. We maintain an active research and development effort supported primarily by customer funding. Customer-funded research and development expenditures are funded under contract specifications, typically research and development contracts, several of which we believe may become key programs in the future. We believe customer-funded research and development activities are vital to our ability to compete for contracts and to enhance our technology base.

 

Aerojet’s company-funded research and development efforts include expenditures for technical activities that are vital to the development of new products, services, processes or techniques, as well as those expenses for significant improvements to existing products or processes.

The following table summarizes Aerojet’s research and development expenditures during the past three fiscal years:

 

 

Suppliers, Raw Materials and Seasonality

 

The national aerospace supply base continues to consolidate due to economic, environmental, and marketplace circumstances beyond Aerojet’s control. The loss of key qualified suppliers of technologies, components, and materials can cause significant disruption to Aerojet program performance and cost.

 

Availability of raw materials and supplies to Aerojet is generally sufficient. Aerojet is sometimes dependent, for a variety of reasons, upon sole-source or flight qualified suppliers and has in some instances in the past experienced difficulties meeting production and delivery obligations because of delays in delivery or reliance on such suppliers. We closely monitor sources of supply to assure adequate raw materials and other supplies needed in our manufacturing processes are available. As a U.S. government contractor, we are frequently limited to procuring materials and components from sources of supply that meet rigorous customer and/or government specifications. In addition, as business conditions, DoD budgets, and Congressional allocations change, suppliers of specialty chemicals and materials sometimes consider dropping low-volume items from their product lines. This may require us to qualify new suppliers for raw materials on key programs.

 

We are also impacted, as is the rest of the industry, by increases in the prices and lead-times of raw materials used in production on various fixed-price contracts. We have seen an increase in the price and lead-times for commodity metals, primarily steel, titanium and aluminum. Aerojet monitors the price and supply of these materials and wherever possible works closely with suppliers to schedule purchases far enough in advance and in the most economical means possible to minimize program impact.

 

Aerojet’s business is not subject to predictable seasonality. Primary factors affecting the timing of Aerojet’s sales include the timing of government awards, the availability of U.S. government funding, contractual product delivery requirements, and customer acceptances.

 

Intellectual Property

 

Where appropriate, Aerojet obtains patents in the U.S. and other countries covering various aspects of the design and manufacture of its products. We consider these patents to be important to Aerojet as they illustrate Aerojet’s innovative design ability and product development capabilities. We do not believe the loss or expiration of any single patent would have a material adverse effect on the business or financial results of Aerojet or on our business as a whole.

 

Real Estate

 

Through our Aerojet subsidiary, we own approximately 12,200 acres of land in the Sacramento metropolitan area (Sacramento Land). The Sacramento Land is located 15 miles east of downtown Sacramento, California along U.S. Highway 50, a key growth corridor in the region. We believe the Sacramento Land has competitive advantages over other land in the area, including being one of the largest single-owner land tracts suitable for development in the Sacramento region and being a desirable “in-fill” location surrounded by residential and business properties.

 

The Sacramento Land was acquired in the early 1950s for our aerospace and defense operations. Most of the Sacramento Land was used to provide safe buffer zones for testing and manufacturing operations. Changes in propulsion technology coupled with the relocation of certain of our propulsion operations led us to determine that some portions of the Sacramento Land were no longer needed for our operations in Sacramento. Consequently, our

plan has been to reposition the excess Sacramento Land to optimize its value. We currently have entitlement requests pending for the re-zoning of approximately 6,000 acres of excess Sacramento Land. Our entitlement efforts are expected to increase the excess land value over its current value. The term “entitlements” is generally used to denote the set of regulatory approvals required to allow land to be zoned for requested uses. Required regulatory approvals vary with each land zoning proposal and may include permits, land use master plans, zoning designations, state and federal environmental documentation, and other regulatory approvals unique to the land.

 

The housing market in the Sacramento region continued to struggle in 2008. However, we believe that this downturn does not change the long-term prospects for the Sacramento region, which we believe still remains an attractive and affordable alternative to the San Francisco Bay area and other large metropolitan areas of California. We believe the Sacramento area demographic and real estate fundamentals support our objective of creating value by re-zoning a substantial portion of the excess Sacramento Land.

 

Concurrent with our entitlements efforts, we will continue to explore how we might best obtain value from our excess Sacramento Land, including outright sales, and/or joint ventures with real estate developers, residential builders, and/or other third parties.

 

The Sacramento Land is comprised as follows (in acres):

 

 

 

 

Sacramento Land for Which We are Seeking Entitlement

 

We are currently seeking entitlement on approximately 6,000 acres of excess Sacramento Land under the brand name of Easton. Our Easton master plans reflect efforts to make Easton one of the finest master-planned communities in the region. Easton will include a broad range of housing as well as office, industrial, retail, and recreational uses. The broad range of land uses will ensure long-term value enhancement of our excess land. The entitlement process in California is long and uncertain with approvals required from various authorities, including local jurisdictions, the U.S. Army Corps of Engineers (USACE) and the U.S. Department of Interior, Fish and Wildlife Service (USFWS).

The acreage and other information regarding the various Easton projects are summarized as follows:

 

 

 

 

Due to the long-term nature and inability to estimate the timing of entitling land in California, we will no longer forecast “Expected Entitlement Dates.” Additional information concerning each of Easton projects is set forth below.

 

Glenborough at Easton and Easton Place

 

Background  — In 2004, we filed an application with the County for a general plan amendment and request for re-zoning of an approximate 1,400 acre master-planned community called Glenborough at Easton and Easton Place.

 

Status — The County began preparation of the Environmental Impact Review (EIR) for Glenborough at Easton and Easton Place in June 2005. The County released the administrative draft EIR for public review and comment in the first half of 2008. In December 2008, the Sacramento County Board of Supervisors unanimously approved the Final EIR and amendments to Sacramento County’s General Plan for the Glenborough at Easton and Easton Place project. We continue our efforts to obtain the necessary federal permits under Section 404 of the Clean Water Act for the project during 2009.

 

Environmental Restrictions — Approximately 350 acres in Glenborough at Easton are subject to federal environmental restrictions. A portion of such 350 acres includes a closed landfill. Before these 350 acres can be utilized, the existing federal environmental restrictions must be removed, and the landfill must be removed. Sacramento County has approved our landfill removal plan. We believe the timing on removal of these restrictions should not adversely affect the projected phasing of the project.

 

Rio del Oro

 

Background — In 2002, we filed an application with the County for a general plan amendment and request for re-zoning of an approximately 2,700 acre project called Rio del Oro. In 2003, this application was transferred to the newly incorporated City of Rancho Cordova (Rancho Cordova). Our application was submitted in conjunction with an application by Elliott Homes (Elliott) for an approximately 1,100 acre parcel of land that we sold to Elliott in 2001 adjacent to our Rio del Oro property. Pursuant to our agreement with Elliott, Elliott is obligated to pay the costs associated with seeking entitlement for the entire Rio del Oro project.

 

Status — We have been working with the Rancho Cordova staff on the EIR and Environmental Impact Statement (EIS) since December 2003. In December 2006, the draft EIR/EIS was released for public review. After public comments were received on the draft EIR/EIS and after consideration of recent court decisions involving other properties, Rancho Cordova decided that limited portions of the EIR/EIS should be re-written and re-circulated for public review and comment. These sections were re-circulated and the public review process has closed. The City and its consultants continue working on final EIR/EIS edits. We continue to work with Rancho Cordova on major issues of disagreement such as total fee burdens, affordable housing obligations and traffic mitigation. Along with Elliott Homes, we will continue our negotiations with Rancho Cordova regarding “Project Feasibility and Economics.”

Environmental Restrictions — In March 2008, the California Department of Toxic Substance Control (DTSC) released approximately 2,300 acres that were formally restricted under the DTSC’s environmental orders regarding soil contamination. The remaining 500 acres remain subject to the DTSC orders and will be released once the soil remediation has been completed. We believe the timing on removal of the remaining restrictions should not adversely affect the projected phasing of the project.

 

Water Supply — In California, all applications for a change in land use must identify a source of water to serve the proposed project. We initially addressed this issue for the Rio del Oro and Westborough projects with our 2003 water agreement (Aerojet/SCWA Agreement) with the Sacramento County Water Agency (SCWA). Under the Aerojet/SCWA Agreement, we transferred certain amounts of remediated groundwater from the Sacramento Land to SCWA (Transferred Water). Subject to conditions and limitations in the agreement, including all required approvals under the California Environmental Quality Act (CEQA), SCWA assumed the responsibility for providing replacement water to those water purveyors who lost wells as a result of groundwater contamination (Replacement Water), and committed to supply water to us for development of our Sacramento Land in an amount equal to the difference between the Transferred Water and the Replacement Water. SCWA terminated the Aerojet/SCWA Agreement. We are negotiating with SCWA on water supply issues and anticipates that these discussions will lead to a mutually satisfactory resolution and a new agreement.

 

Other — In 2001, we granted Elliott an option to purchase 400 acres of our Rio del Oro property at a fixed purchase price of $10.0 million. In fiscal 2008, a legal parcel was created and the environmental restrictions were lifted (discussed above) on the Rio del Oro property. As a result, Elliott exercised its option and purchased, in fiscal 2008, the 400 acres for $10.0 million.

 

Westborough

 

Background — In 2004, we filed an application with Rancho Cordova for a general plan amendment for an approximate 1,700 acre project named Westborough. We expect the Westborough project to be completed in two phases. In June 2005, we submitted an updated general plan amendment and a re-zoning application for approximately 1,100 acres as the first phase of Westborough. The second phase consisting of approximately 550 acres lies partially within the jurisdiction of Rancho Cordova and partially within the jurisdiction of the County. Consequently, over the next few years, we will be working with Rancho Cordova and the County to reach agreement on the terms and conditions for annexation of the County land by Rancho Cordova. Once an agreement is achieved, we will file a similar application for the second phase with Rancho Cordova.

 

Status — Rancho Cordova’s EIR consultant continues to work on the various technical studies necessary for the EIR for the first phase of this project. We are also working with the USACE to obtain the necessary permits under Section 404 of the Clean Water Act.

 

Environmental Restrictions — Approximately 270 acres of the second phase of Westborough is subject to federal environmental restrictions which we do not expect to be removed for several years. These environmental restrictions do not affect the first phase of the Westborough project.

 

Water Supply — Golden State Water Company (GSWC) has made filings with the California Public Utilities Commission (PUC) seeking approval to provide water service to the Westborough project. Westborough is contiguous to GSWC’s service territory in Eastern Sacramento County. SCWA filed a letter of protest with the PUC with respect to GSWC’s request to serve the Westborough project principally on the basis that the Aerojet/SCWA Agreement had terminated along with an agreement GSWC had entered with SCWA in 2003. We expect that the ongoing discussions between us, GSWC, and SCWA will lead to a mutually satisfactory resolution and agreement on water service and that GSWC will ultimately be approved by the PUC to provide water service to the Westborough project.

 

Other — In 2004, we entered into an agreement with Elliott to sell 100 acres of the Westborough property for $3.1 million. This transaction is expected to close in fiscal 2009. The purchase price will be paid at the time of closing.

 

Hillsborough

 

The Company and other land owners that together control approximately 3,500 acres within the City of Folsom’s Sphere of Influence (SOI) are working with the City of Folsom (Folsom) to develop a land use plan. Folsom has begun work on the EIR and various related technical studies. Our 629 acre Hillsborough project is

within this acreage. The proposed land uses for the 629 acres include residential, office, and retail. The annexation process of the SOI acreage by Folsom is expected to be complex and lengthy. The water source for the SOI will be addressed by Folsom as part of the annexation process.

 

Office Park and Auto Mall

 

In February 2005, we signed a joint venture agreement with Panattoni Development Company for the creation of an office park on a twenty acre parcel of the Sacramento Land. An office park is consistent with the existing zoning for the property. We are working with Panattoni and the USACE to obtain the necessary governmental approvals.

 

In fiscal 2006, we obtained County approval for a thirty-acre auto mall on Folsom Boulevard. We sold two parcels totaling approximately twenty acres to two automobile dealers in fiscal 2003 for $5.9 million. We are obligated to provide certain land improvements necessary to bring utilities to each of these parcels. These improvements are expected to be completed in the first half of 2009.

 

Other Real Estate

 

We own approximately 580 acres of excess land in Chino Hills, California, which includes 180 acres that was previously leased. This property was used for the manufacture and testing of ordnance. With the sale of our ordnance business in the mid-1990s, we closed this facility and commenced clean-up of the site. We continue to work with state regulators and the City of Chino Hills to complete those efforts. Once the remediation is complete, we will work to maximize the value of the property.

 

We currently lease to third parties approximately 300,000 square feet of office space. These leasing activities generated $6.1 million in revenue in fiscal 2008.

 

Environmental Matters

 

Our current and former business operations are subject to, and affected by, federal, state, local, and foreign environmental laws and regulations relating to the discharge, treatment, storage, disposal, investigation, and remediation of certain materials, substances, and wastes. Our policy is to conduct our business with due regard for the preservation and protection of the environment. We continually assess compliance with these regulations and management of environmental matters. We believe our current operations are in compliance with all applicable environmental laws and regulations.

 

Operation and maintenance costs associated with environmental compliance and management of contaminated sites are a normal, recurring part of our operations. Most of such costs are incurred by our Aerospace and Defense segment and are generally allowable costs under contracts with the U.S. government.

 

Under existing U.S. environmental laws, a Potentially Responsible Party (PRP) is jointly and severally liable, and therefore we are potentially liable to the government or third parties for the full cost of remediating the contamination at our facilities or former facilities or at third-party sites where we have been designated as a PRP by the Environmental Protection Agency or a state environmental agency. The nature of environmental investigation and cleanup activities often makes it difficult to determine the timing and amount of any estimated future costs that may be required for remediation measures. However, we review these matters and accrue for costs associated with environmental remediation when it becomes probable that a liability has been incurred and the amount of the liability, usually based on proportionate sharing, can be reasonably estimated. These liabilities have not been discounted to their present value as the timing of cash payments is not fixed or reliably determinable. See Management’s Discussion and Analysis in Part II, Item 7 of this Report for additional information.

 

Employees

 

As of November 30, 2008, 14% of our 3,057 employees were covered by collective bargaining agreements which are due to expire in the summer of 2009 through 2012. We believe that our relations with our employees are good.

 

Set forth below are the risks that we believe are material to our investors. This section contains forward-looking statements. You should refer to the explanation of the qualifications and limitations on forward-looking statements set forth at the beginning of Item 1 of this Report.

 

In fiscal 2008, we experienced a significant change in the composition of our Board of Directors and senior management, including the departure of our former Chief Executive Officer, Chief Financial Officer, and Controller. Failure of any new management and Board members to integrate themselves into, and effectively manage, our business, including any new strategies they may adopt, could result in material harm to the Company.

 

On March 5, 2008, Terry L. Hall resigned as a Director and as our Chief Executive Officer and President and our Board appointed three new Directors. The Board appointed J. Scott Neish, our Vice President and President of Aerojet, to serve as our interim Chief Executive Officer and President, pending the results of a search to identify qualified candidates to fill this position on a permanent basis. On May 15, 2008, Timothy A. Wicks, Chairman of the Board, Todd R. Snyder and Sheila E. Widnall resigned as Directors of the Company. Our Board of Directors appointed James H. Perry and Thomas A. Corcoran as new Directors on May 16, 2008 and September 25, 2008, respectively. On September 29, 2008, Yasmin R. Seyal, our former Senior Vice President and Chief Financial Officer, and R. Leon Blackburn, our former Vice President, Controller left the Company and our Board appointed Kathleen E. Redd, Vice President, Finance of Aerojet, to serve as our Vice President, Chief Financial Officer and Secretary.

 

The failure of our Directors or any new members of management to perform effectively or the loss of any of the Directors or former or current members of management could have a significant negative impact on our business, financial condition and results of operations. In addition, our Board and management may institute strategies that differ from those we are applying currently. If any new strategies are adopted, it may take management a significant amount of time to fully implement such new strategies. If any new strategies are unsuccessful or if we are unable to execute them successfully, there could be a significant negative impact on our business, financial condition, and results of operations.

 

We have a substantial amount of debt. Our ability to operate and our financial flexibility is limited by the agreements governing our debt.

 

We have a substantial amount of debt for which we are required to make interest and principal payments. As of November 30, 2008, we had $440.6 million of debt. Subject to the limits contained in some of the agreements governing our outstanding debt, we may incur additional debt in the future.

 

Our level of debt places significant demands on our cash resources, which could:

 

 

If we are unable to generate sufficient cash flow to service our debt and fund our operating costs, our liquidity may be adversely affected.

Economic conditions could materially adversely affect our ability to refinance our debt, and we face the risks of either not being able to do so, or doing so at higher interest expense.

 

The holders of our 4% Contingent Convertible Subordinated Notes (4% Notes) may require us to repurchase for cash all or a portion of our outstanding $125.0 million 4% Notes on January 16, 2010 at a price equal to 100% of the principal amount, plus accrued and unpaid interest, including contingent interest and liquidated damages, if any. Additionally, the holders of our 2 1 / 4 % Convertible Subordinated Debentures (2 1 / 4 % Debentures) may require us to repurchase for cash all or a portion of our outstanding $146.4 million 2 1 / 4 % Debentures on November 20, 2011 at a price equal to 100% of the principal amount plus accrued and unpaid interest, including liquidated damages, if any, payable in cash, to but not including the repurchase date, plus, in certain circumstances, a make-whole premium, payable in common stock. If we are required to repurchase our 4% Notes and 2 1 / 4 % Debentures, we are planning to use cash on hand and accessing capital markets to secure debt and equity financing. The timing, terms, size, and pricing of any debt and equity financing will depend on investor interest and market conditions, and there can be no assurance that we will be able to obtain any such financing.

 

We inadvertently failed to register with the SEC the issuance of certain of our common shares under our defined contribution 401(k) employee benefit plan (the Plan). As a result, certain purchasers of securities pursuant to the Plan may have the right to rescind their purchases for an amount equal to the purchase price paid for the securities (or if such security has been disposed of, to receive damages with respect to any loss on such disposition) plus interest from the date of purchase. We expect to make a registered rescission offer to eligible Plan participants, which could result in the purchase of approximately 0.8 million shares of common stock (see Note 8 in Notes to Consolidated Financial Statements).

 

We will need an amendment to our $280.0 million senior credit facility (Senior Credit Facility) in connection with the potential required repurchases of our 4% Notes and 2 1 / 4 % Debentures and the rescission offer. There can be no assurance that we will be able to obtain the consent of lenders under our Senior Credit Facility or that, as a condition to consent, the lenders will not require that the terms of the Senior Credit Facility be amended in a manner that is unfavorable to us, including a possible increase in interest, fees, reduction in the amount of the funds available, and covenant changes. Furthermore, the current financial turmoil affecting the banking system and financial markets and the possibility that financial institutions may consolidate or go out of business have resulted in a tightening in the credit markets, a low level of liquidity in many financial markets, and extreme volatility in fixed income, credit, currency, and equity markets. We likely will need to access credit markets to amend our Senior Credit Facility and repurchase our outstanding 4% Notes in January 2010 and 2 1 / 4 % Debentures in November 2011. Our inability to amend our Senior Credit Facility or obtain financing to repurchase our 4% Notes and 2 1 / 4 % Debentures on terms acceptable to us would have a material adverse effect on our operating results, financial condition, and/or cash flows.

 

We are obligated to comply with financial and other covenants outlined in our debt indentures and agreements that could restrict our operating activities and the failure to comply could result in defaults that accelerate the payment of our debt.

 

Our debt instruments generally contain various restrictive covenants which include, among others, provisions restricting our ability to:

 

 

 

Our secured debt also contains other customary covenants, including, among others, provisions:

 

 

In addition, certain covenants in our bank facilities require us and our subsidiaries to maintain certain financial ratios. Any of the covenants described in this risk factor may restrict our operations and our ability to pursue potentially advantageous business opportunities. Our failure to comply with these covenants could also result in an event of default that, if not cured or waived, could result in the acceleration of all or a substantial portion of our debt. In addition, our failure to pay principal when due is an immediate default, and in certain cases, causes cross defaults on most of our other debt. Our indebtedness under the Senior Credit facility is secured by substantially all of our assets, leaving us with limited collateral for additional financing.

 

If our operating subsidiaries do not generate sufficient cash flow or if they are not able to pay dividends or otherwise distribute their cash to us, or if we have insufficient funds on hand, we may not be able to service our debt.

 

All of the operations of our Aerospace and Defense and Real Estate segments are conducted through subsidiaries. Consequently, our cash flow and ability to service our debt obligations will be largely dependent upon the earnings and cash flows of our operating subsidiaries and the distribution of those earnings to us, or upon loans, advances or other payments made by these subsidiaries to us. The ability of our subsidiaries to pay dividends or make other payments or advances to us will depend upon their operating results and cash flows and will be subject to applicable laws and any contractual restrictions contained in the agreements governing their debt, if any.

 

Our pension plan is currently underfunded and we expect to be required to make cash contributions, which may reduce the cash available for our businesses.

 

As of November 30, 2008, our defined benefit pension plan assets and projected benefit obligations were $1.3 billion and $1.4 billion, respectively. The Pension Protection Act (PPA), enacted in August 2006, requires underfunded pension plans to improve their funding ratios within prescribed intervals based on the funded status of the plan as of specified measurement dates. The funded status of the pension plan may be adversely affected by the investment experience of the plan’s assets, by any changes in the law in the United States, and by changes in the statutory interest rates used by “tax-qualified” pension plans in the U.S. to calculate funding requirements. Accordingly, if the performance of our plan’s assets does not meet our assumptions, if there are changes to the U.S. Internal Revenue Service regulations or other applicable law or if other actuarial assumptions are modified, our future contributions to our underfunded pension plan could be higher than we expect. Significant cash contribution requirements to our pension plan may adversely affect our ability to meet certain covenants for our Senior Credit Facility, which absent an amendment or refinancing, would result in a default under our Senior Credit Facility and cross-defaults on our other debt instruments.

 

The level of returns on retirement benefit plan assets, changes in interest rates, changes in legislation, and other factors could affect our financial results.

 

Our earnings may be positively or negatively impacted by the amount of expense or income we record for our employee retirement benefit plans. We calculate the expense for the plans using actuarial valuations. These valuations are based on assumptions that we make relating to financial market and other economic conditions. Changes in key economic indicators can result in changes in the assumptions we use. The key assumptions used to estimate retirement benefit plan expense for the following year are: the discount rate and the expected long-term rate of return on plan assets. Our pension expense\income can also be affected by legislation and other government regulatory actions. For an additional discussion of our retirement benefits accounting policies refer to Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations under the caption “Critical Accounting Policies” and Note 1 in Notes to Consolidated Financial Statements.

Our operations and properties are currently the subject of significant environmental liabilities, and the numerous environmental and other government regulations to which we are subject may become more stringent in the future.

 

We are subject to federal, state and local laws and regulations that, among other things, require us to obtain permits to operate and install pollution control equipment and regulate the generation, storage, handling, transportation, treatment, and disposal of hazardous and solid wastes. We may also be subject to fines and penalties relating to the operation of our existing and formerly owned businesses. We are subject to toxic tort and asbestos lawsuits as well as other third-party lawsuits, due to either our past or present use of hazardous substances or the alleged on-site or off-site contamination of the environment through past or present operations. We may incur material costs in defending these claims and lawsuits. Any adverse judgment or cash outlay could have a significant adverse effect on our operating results, financial condition, and/or cash flows.

 

For additional discussion of legal and environmental matters, please see the discussion in Note 7 in Notes to Consolidated Financial Statements.

 

Although some of our environmental costs may be recoverable and we have established reserves, given the many uncertainties involved in assessing liability for environmental claims, our reserves may not be sufficient which could adversely affect our financial results.

 

As of November 30, 2008, the aggregate range of our environmental costs was $258.2 million to $463.6 million and the accrued amount was $258.2 million, of which $245.2 million relates to Aerojet sites and $13.0 million relates to non-Aerojet sites. We believe the accrued amount to be sufficient to cover our future remediation costs that could be incurred by us over the contractual term, if any, or next fifteen years of the estimated remediation. However, given the many uncertainties involved in assessing liability for environmental claims, our reserves may prove to be insufficient. We evaluate the adequacy of those reserves on a quarterly basis, and they could change. In addition, the reserves are based only on known sites and the known contamination at those sites. It is possible that additional sites needing remediation may be identified or that unknown contamination at previously identified sites may be discovered. It is also possible that the regulatory agencies may change clean-up standards for chemicals of concern such as ammonium perchlorate and trichloroethylene. This could lead to additional expenditures for environmental remediation in the future and given the uncertainties involved in assessing liability for environmental claims, our reserves may prove to be insufficient.

 

Under an agreement with the U.S. government, the Company’s environmental expenses related to our Aerojet Sacramento and former Azusa sites are allowable for reimbursement through our government contracts up to 88% of environmental expenses (Global Settlement). Environmental expenses at other Aerojet sites are eligible for reimbursement and treated under the normal rules of cost allowability. Aerojet’s mix of contracts can affect the actual reimbursement made by the U.S. government. Because these costs are recovered through forward pricing arrangements, our ability to continue recovering these costs from the U.S. government depends on Aerojet’s sustained business volume under U.S. government contracts and programs and the relative size of Aerojet’s commercial business. Additionally, in conjunction with the sale of the EIS business in 2001, Aerojet entered into an agreement with Northrop Grumman Corporation (Northrop) whereby Aerojet is reimbursed by Northrop for a portion of environmental expenditures eligible for recovery under the Global Settlement subject to annual and cumulative limitations. If we are unable to recover environmental expenses from the U.S. government that exceed the cumulative limitations from Nothrop, a significant increase in Aerojet estimated environmental expenses could have a significant adverse effect on our operating results, financial condition, and/or cash flows.

 

Our environmental expenses related to non-Aerojet sites are not recoverable and a significant increase in the estimated environmental expenses could have a significant adverse effect on our operating results, financial condition, and/or cash flows.

 

For additional discussion of environmental matters including the recoverability of amounts from Northrop, please see the environmental discussion in Notes 7(c) and 7(d) in Notes to Consolidated Financial Statements.

We are from time to time subject to significant litigation, the outcome of which could adversely affect our financial results.

 

We and our subsidiaries are subject to material litigation. We may be unsuccessful in defending or pursuing these lawsuits or claims. Regardless of the outcome, litigation can be very costly and can divert management’s efforts. Adverse outcomes in litigation, including toxic tort claims pending against Aerojet, product liability claims by former customers of our GDX Automotive (GDX) business, and the appeals of the unfair labor claims brought by former employees of the Company’s Snappon SA subsidiary in France could have a significant adverse effect on our operating results, financial condition, and/or our cash flows. See Item 3, Legal Proceedings and Note 7(b) in Notes to Consolidated Financial Statements for more detailed information on legal proceedings.

 

The cancellation or material modification of one or more significant contracts could adversely affect our financial results.

 

Sales, directly and indirectly, to the U.S. government and its agencies accounted for approximately 86% of our total net sales in fiscal 2008. Our contracts typically permit the U.S. government to unilaterally modify or terminate a contract or to discontinue funding for a particular program at any time. The cancellation of one or more significant contracts and/or programs could have a material adverse effect on our ability to realize anticipated sales and profits. The cancellation of a contract, if terminated for cause, could also subject us to liability for the excess costs incurred by the U.S. government in procuring undelivered items from another source. If terminated for convenience, our recovery of costs would be limited to amounts already incurred or committed, and our profit would be limited to work completed prior to termination.

 

Future reductions or changes in U.S. government spending could adversely affect our financial results.

 

Our primary aerospace and defense customers include the DoD and its agencies, the government prime contractors that supply products to these customers, and NASA. As a result, we rely on particular levels of U.S. government spending on propulsion systems for defense and space applications and armament systems for precision tactical weapon systems and munitions applications, and our backlog depends, in a large part, on continued funding by the U.S. government for the programs in which we are involved. These spending levels are not generally correlated with any specific economic cycle, but rather follow the cycle of general political support for this type of spending. Moreover, although our contracts often contemplate that our services will be performed over a period of several years, Congress usually must approve funds for a given program each government fiscal year and may significantly reduce or eliminate funding for a program. A decrease in U.S. DoD and/or NASA expenditures, or the elimination or curtailment of a material program in which we are involved, could have a material adverse effect on our operating results, financial condition, and/or cash flows.

 

A significant percentage of our sales are generated from fixed-price contracts. If we experience cost overruns on these contracts, we would have to absorb the excess costs which could adversely affect our financial results.

 

In fiscal 2008, approximately 46% of our net sales were from fixed-price contracts. Under fixed-price contracts, we agree to perform specified work for a fixed price and realize all of the profit or loss resulting from variations in the costs of performing the contract. As a result, all fixed-price contracts involve the inherent risk of unreimbursed cost overruns. To the extent we were to incur unanticipated cost overruns on a program or platform subject to a fixed-price contract, our profitability would be adversely affected. Future profitability is subject to risks including the ability of suppliers to deliver components of acceptable quality on schedule and the successful implementation of automated tooling in production processes.

 

Our success and growth in our Aerospace and Defense segment depends on our ability to secure contracts.

 

We encounter intense competition in bidding for contracts. Many of our competitors have financial, technical, production, and other resources substantially greater than ours. Although the downsizing of the defense industry in the early 1990s has resulted in a reduction in the aggregate number of competitors, the consolidation has also

strengthened the capabilities of some of the remaining competitors resulting in an increasingly competitive environment. The U.S. government also has its own manufacturing capabilities in some areas. We may be unable to compete successfully with our competitors and our inability to do so could result in a decrease in sales, profits, and cash flows that we historically have generated from certain contracts. Further, the U.S. government may open to competition programs on which we are currently the sole supplier, which could have a material adverse effect on our operating results, financial condition, and/or cash flows.

 

Our Aerospace and Defense segment is subject to procurement and other related laws and regulations inherent in contracting with the U.S. government, non-compliance with which could adversely affect our financial results.

 

In the performance of contracts with the U.S. government, we are subject to complex and extensive procurement and other related laws and regulations. Possible consequences of a failure to comply, even inadvertently, with these laws and regulations include civil and criminal fines and penalties, in some cases, double or triple damages, and suspension or debarment from future government contracts and exporting of goods for a specified period of time.

 

These laws and regulations provide for ongoing audits and reviews of incurred costs as well as contract procurement, performance and administration. The U.S. government may, if it deems appropriate, conduct an investigation into possible illegal or unethical activity in connection with these contracts. Investigations of this nature are common in the aerospace and defense industry, and lawsuits may result. In addition, the U.S. government and its principal prime contractors periodically investigate the financial viability of its contractors and subcontractors as part of its risk assessment process associated with the award of new contracts. If the U.S. government or one or more prime contractors were to determine that we were not financially viable, our ability to continue to act as a government contractor or subcontractor would be impaired.

 

Our inability to adapt to rapid technological changes could impair our ability to remain competitive.

 

The aerospace and defense industry continues to undergo rapid and significant technological development. Our competitors may implement new technologies before we are able to, allowing them to provide more effective products at more competitive prices. Future technological developments could:

 

 

We may experience warranty claims for product failures, schedule delays or other problems with existing or new products and systems.

 

Many of the products we develop and manufacture are technologically advanced systems that must function under demanding operating conditions. Even though we believe that we employ sophisticated and rigorous design, manufacturing and testing processes and practices, we may not be able to successfully launch or manufacture our products on schedule or our products may not perform as intended.

 

If our products fail to perform adequately, some of our contracts require us to forfeit a portion of our expected profit, receive reduced payments, provide a replacement product or service or reduce the price of subsequent sales to the same customer. Performance penalties may also be imposed if we fail to meet delivery schedules or other measures of contract performance. We do not generally insure against potential costs resulting from any required remedial actions or costs or loss of sales due to postponement or cancellation of scheduled operations or product deliveries.

The release or explosion of dangerous materials used in our business could disrupt our operations and could adversely affect our financial results.

 

Our business operations involve the handling and production of potentially explosive materials and other dangerous chemicals, including materials used in rocket propulsion and explosive devices. Despite our use of specialized facilities to handle dangerous materials and intensive employee training programs, the handling and production of hazardous materials could result in incidents that temporarily shut down or otherwise disrupt our manufacturing operations and could cause production delays. It is possible that a release of these chemicals or an explosion could result in death or significant injuries to employees and others. Material property damage to us and third parties could also occur. The use of these products in applications by our customers could also result in liability if an explosion or fire were to occur. Any release or explosion could expose us to adverse publicity or liability for damages or cause production delays, any of which could have a material adverse effect on our operating results, financial condition, and/or cash flows.

 

Future reductions in airbag propellant volume could adversely affect our financial results.

 

One of our plants produces large volumes of propellants used in automobile airbags sold to a single customer. These products are subject to trends in vehicle sales and cost competition from other domestic and foreign suppliers. The loss of significant volume could affect fixed cost absorption for the plant, which could have a material adverse effect on our operating results, financial condition, and/or our cash flows.

 

Disruptions in the supply of key raw materials and difficulties in the supplier qualification process, as well as increases in prices of raw materials, could adversely affect our financial results.

 

We closely monitor sources of supply to assure that adequate raw materials and other supplies needed in our manufacturing processes are available. As a U.S. government contractor, we are frequently limited to procuring materials and components from sources of supply that meet rigorous customer and/or government specifications. In addition, as business conditions, DoD budgets, and Congressional allocations change, suppliers of specialty chemicals and other materials sometime consider dropping low-volume items from their product lines, which may require us to qualify new suppliers for raw materials on key programs.

 

Current suppliers of some raw materials used in the manufacturing of rocket nozzles, composite cases and explosives have announced plans to relocate, close, and/or discontinue certain product lines. These materials, which include TPB/Flexzone, Iron Oxide lacquer and other constituents, are used industry-wide and are key to many of our motor and warhead programs. We continue our efforts at qualifying new suppliers and products for these materials and we expect that materials will be available in time to meet our future production needs. In some situations, increased costs related to new suppliers may not be recoverable under our contracts. In addition, some of these materials may have to be procured from offshore suppliers.

 

The supply of ammonium perchlorate, a principal raw material used in solid propellant, is limited to a single source that supplies the entire domestic solid propellant industry with actual pricing based on the total industry demand. Significant reductions in the total national demand will likely result in significant unit price increases. Where possible Aerojet has protective price re-determinable language incorporated into all contracts with our customers.

 

The industry also currently relies on one primary supplier for carbon fiber, which is used in the production of composite materials. This supplier has multiple manufacturing lines for such material. Although other sources of carbon fiber exist, the addition of a new supplier would require us to qualify the new source for use. The Japanese government has imposed export restrictions on materials that are to be used in offensive weapons systems. To date, this has not impacted our production but has increased the lead times associated with the product as its export has to be approved by the Japanese Defense Ministry. Characterization of domestic sources of carbon fiber is underway by the extended aerospace industry.

 

We are also impacted, as is the rest of the industry, by increases in the prices and lead-times of raw materials used in production on various fixed-price contracts. We continue to experience increases in the price and lead-times of certain commodity metals, primarily steel and aluminum. Titanium mill products continue to be monitored and we have seen some softening in the schedules and pricing, however, both remain well above historical levels. We

monitor the price and supply of these materials and work closely with suppliers to schedule purchases far enough in advance and in the most economical means possible to reduce program impact. Additionally, whenever possible, we have negotiated with our customers economic and/or price adjustment clauses tied to commodity indices. Our past success in negotiating these terms is no indication of our ability to continue to do so. The U.S. Department of Defense has begun to rigorously enforce the provisions of the “Berry Amendment” (DFARS 225-7002, 252.225-7014) which imposes a requirement to procure certain strategic materials critical to national security only from U.S. sources. Due to the limited U.S. supply of these metals and the requirement to use domestic sources, lead times and cost impacts have been significant to our defense programs.

 

Prolonged disruptions in the supply of any of our key raw materials, difficulty qualifying new sources of supply, implementing use of replacement materials or new sources of supply, and/or a continuing increase in the prices of raw materials could have a material adverse effect on our operating results, financial condition, and/or cash flows.

 

The real estate market is inherently risky.

 

Our real estate activities may subject us to various risks including the following:

 

 

Substantially all of our real estate is located in Sacramento County, California making us vulnerable to changes in economic and other conditions in that particular market.

 

As a result of the geographic concentration of our properties, our long-term performance and the value of our properties will depend upon conditions in the Sacramento region, including:

 

 

 

If unfavorable economic or other conditions occur in the region, our plans and business strategy could be adversely affected.

 

We have limited experience in real estate activities.

 

While we have owned our Sacramento real estate for over 50 years, we have limited real estate experience. Therefore, we do not have substantial history from which you can draw conclusions about our ability to execute our real estate plans.

 

We may expand our operations through acquisitions, which may divert management’s attention and expose us to unanticipated liabilities and costs. We may experience difficulties integrating any acquired operations, and we may incur costs relating to acquisitions that are never consummated.

 

Our business strategy may include continued expansion of our Aerospace and Defense segment through acquisitions that make both strategic and economic sense. However, our ability to consummate any future acquisitions on terms that are favorable to us may be limited by the number of attractive acquisition targets, internal demands on our resources, and our ability to obtain financing. Our success in integrating newly acquired businesses will depend upon our ability to retain key personnel, avoid diversion of management’s attention from operational matters, integrate general and administrative services, and key information processing systems and, where necessary, re-qualify our customer programs. In addition, future acquisitions could result in the incurrence of additional debt, costs, and contingent liabilities. We may also incur costs and divert management attention to acquisitions that are never consummated. Integration of acquired operations may take longer, or be more costly or disruptive to our business, than originally anticipated.

 

Although we undertake a due diligence investigation of each business that we have or may acquire, there may be liabilities of the acquired companies that we fail to, or are unable to, discover during the due diligence investigation and for which we, as a successor owner, may be responsible. In connection with acquisitions, we generally seek to minimize the impact of these types of potential liabilities through indemnities and warranties from the seller. However, these indemnities and warranties, if obtained, may not fully cover the liabilities due to limitations in scope, amount or duration, financial limitations of the indemnitor or warrantor or other reasons.

 

We may incur additional costs related to divestitures, which could adversely affect our financial results.

 

In connection with our divestitures of the Fine Chemicals and GDX businesses in fiscal 2005 and fiscal 2004, respectively, we have incurred and may incur additional costs, including costs related to the closure of a manufacturing facility in Chartres, France. As part of these and other divestitures, we have provided customary indemnification to the purchasers for such matters as claims arising from the operation of the businesses prior to disposition, including warranty and income tax matters, and liability to investigate and remediate environmental contamination existing prior to disposition. These additional costs and the indemnification of the purchasers of our former businesses may require additional cash expenditures, which could have a material adverse effect on our operating results, financial condition, and/or cash flows.

 

A strike or other work stoppage, or our inability to renew collective bargaining agreements on favorable terms, could adversely affect our financial results.

 

As of November 30, 2008, 14% of our 3,057 employees were covered by collective bargaining agreements which are due to expire in the summer of 2009 through 2012. However, due to recent changes in our retirement benefits provided to non-union employees as discussed in Note 6 in Notes to Consolidated Financial Statements, we are in current discussions with employees covered under collective bargaining agreements.

 

We will be negotiating one labor agreement in fiscal 2009 and if we are not able to negotiate an acceptable new agreement with the union, upon expiration of the existing contract, we could experience a strike or work stoppage. Even if we are successful in negotiating a new agreement, the new agreement could call for higher wages or benefits

paid to union members, which would increase our operating costs and could adversely affect our profitability. If our unionized workers were to engage in a strike or other work stoppage, or other non-unionized operations were to become unionized, we could experience a significant disruption of operations at our facilities or higher ongoing labor costs. A strike or other work stoppage in the facilities of any of our major customers could also have similar effects on us.

 

In order to be successful, we must attract and retain key employees.

 

Our business has a continuing need to attract large numbers of skilled personnel, including personnel holding security clearances, to support the growth of the enterprise and to replace individuals who have terminated employment due to retirement or for other reasons. To the extent that the demand for qualified personnel exceeds supply, we could experience higher labor, recruiting, or training costs in order to attract and retain such employees, or could experience difficulties in performing under our contracts if our needs for such employees were unmet.

 

Due to the nature of our business, our sales levels may fluctuate causing our quarterly operating results to fluctuate.

 

Changes in our operating results from quarter to quarter may result in volatility in the market price of our common stock. Our quarterly and annual sales are affected by a variety of factors that may lead to significant variability in our operating results:

 

 

We face certain significant risk exposures and potential liabilities that may not be adequately covered by indemnity or insurance.

 

A significant portion of our business relates to developing and manufacturing propulsion systems for defense and space applications, armament systems for precision tactical weapon systems and munitions applications. New technologies may be untested or unproven. In addition, we may incur significant liabilities that are unique to our products and services. In some, but not all, circumstances, we may receive indemnification from the U.S. government. While we maintain insurance for certain risks, the amount of our insurance coverage may not be adequate to cover all claims or liabilities, and it is not possible to obtain insurance to protect against all operational risks and liabilities. Accordingly, we may be forced to bear substantial costs resulting from risks and uncertainties of our business which could have a material adverse effect on our operating results, financial condition, and/or cash flows.

 

We use estimates in accounting for most of our programs. Changes in our estimates could affect our future financial results.

 

Contract accounting requires judgment relative to assessing risks, estimating contract sales and costs, and making assumptions for schedule and technical issues. Due to the size and nature of many of our contracts, the estimation of total sales and cost at completion is complicated and subject to many variables. For example, assumptions have to be made regarding the length of time to complete the contract because costs also include expected increases in wages and prices for materials. Similarly, assumptions have to be made regarding the future impacts of efficiency initiatives and cost reduction efforts. Incentives or penalties related to performance on contracts are considered in estimating sales and profit rates, and are recorded when there is sufficient information for us to assess anticipated performance. Estimates of award and incentive fees are also used in estimating sales and profit rates based on actual and anticipated awards. Because of the significance of the judgments and estimation processes described above, it is likely that materially different amounts could be recorded if we used different assumptions or if the underlying circumstances were to change. Changes in underlying assumptions, circumstances, or estimates may adversely affect our future period operating results, financial condition, and/or cash flows. For an additional discussion of our revenue recognition policy refer to Part II, Item 7. Management’s Discussion and

Analysis of Financial Condition and Results of Operations under the caption “Critical Accounting Policies” and Note 1 in Notes to Consolidated Financial Statements.

 

New accounting standards could result in changes to our methods of quantifying and recording accounting transactions, and could affect our financial results.

 

Changes to generally accepted accounting principles in the United States of America arise from new and revised standards, interpretations and other guidance issued by the Financial Accounting Standards Board, the SEC, and others. In addition, the U.S. government may issue new or revised Cost Accounting Standards (CAS) or Cost Principles. The effects of such changes may include prescribing an accounting method where none had been previously specified, prescribing a single acceptable method of accounting from among several acceptable methods that currently exist, or revoking the acceptability of a current method and replacing it with an entirely different method, among others. Such changes could result in unanticipated effects on our operating results, financial condition, and/or our cash flows. In addition, should legislation and CAS alignment related to PPA not occur, some of our cash contributions required under PPA to our defined benefit pension plan may not be immediately recoverable which could result in material adverse effect on our operating results, financial condition, and cash flows. Further, our current Forward Pricing Rates (FPR) did not yet reflect the full effect of the PPA requirements at November 30, 2008. PPA funding requirements are expected to be incorporated into our FPRs in the first half of fiscal 2009, which will minimize any adverse effects on contract’s price negotiations.

 

Failure to maintain effective internal controls in accordance with the Sarbanes-Oxley Act could negatively impact the market price of our stock price.

 

If, in the future, we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with the Sarbanes-Oxley Act. Failure to achieve and maintain an effective internal control environment could negatively impact the market price of our common stock.

 

 

 

 

 

We believe each of the facilities is adequate for the business conducted at that facility. The facilities are suitable and adequate for their intended purpose and taking into account current and planned future needs. A portion of Aerojet’s property in California, and its Redmond, Washington and Orange, Virginia facilities are encumbered by a deed of trust or mortgage. In addition, we own and lease properties (primarily machinery and warehouse and office facilities) in various locations for use in the ordinary course of our business.

 

entities on the basis that they introduced perchlorate-containing Colorado River water to the basin. Those water entities have filed motions to dismiss Aerojet’s complaints. The motions as well as discovery have been stayed, pending efforts to resolve the litigation through mediation.

 

Sacramento Cases

 

In December 2007, Aerojet was named as a defendant in a lawsuit brought by six individuals who allegedly resided in the vicinity of Aerojet’s Sacramento facility. The case is entitled Caldwell et al. v. Aerojet-General Corporation , Case No. 34-2000-00884000CU-TT-GDS, Sacramento County (CA) Superior Court and was served April 3, 2008. Plaintiffs allege that Aerojet contaminated groundwater to which plaintiffs were exposed and which caused plaintiffs illness and economic injury. Plaintiffs filed an amended complaint on February 25, 2008, naming additional plaintiffs. The amended complaint brings the total number of individuals on whose behalf suit has been filed to fourteen. Aerojet filed a demurrer to the complaint, which was denied by the trial court in December 2008. Aerojet has filed an answer to the complaint, denying liability. The Company is unable to make a reasonable estimate of the future costs of these claims.

 

Vinyl Chloride Litigation

 

Between the early 1950s and 1985, the Company produced polyvinyl chloride (PVC) resin at its former Ashtabula, Ohio facility. PVC is one of the most common forms of plastic currently on the market. A building block compound of PVC is vinyl chloride (VC), now listed as a known carcinogen by several governmental agencies. The Occupational Safety and Health Administration (OSHA) have regulated workplace exposure to VC since 1974.

 

Since the mid-1990s, the Company has been named in numerous cases involving alleged exposure to VC. In the majority of such cases, the Company is alleged to be a “supplier/manufacturer” of PVC and/or a civil co-conspirator with other VC and PVC manufacturers as a result of membership in a trade association. Plaintiffs generally allege that the Company and other defendants suppressed information about the carcinogenic risk of VC to industry workers, and placed VC or PVC into commerce without sufficient warnings. A few of these cases alleged VC exposure through various aerosol consumer products, in that VC had been used as an aerosol propellant during the 1960s. Defendants in these “aerosol” cases included numerous consumer product manufacturers, as well as the more than 30 chemical manufacturers. The Company used VC internally, but never supplied VC for aerosol or any other use.

 

As of November 30, 2008, there was one vinyl chloride case pending against the Company which involved an employee at a facility owned or operated by others.

 

The following table sets forth information related to vinyl chloride litigation:

 

 

Legal and administrative fees for the vinyl chloride cases for fiscal years 2008, 2007, and 2006 were $0.3 million, $0.3 million, and $0.4 million, respectively.

 

Asbestos Litigation

 

The Company has been, and continues to be, named as a defendant in lawsuits alleging personal injury or death due to exposure to asbestos in building materials, products, or in manufacturing operations. The majority of cases have been filed in Madison County, Illinois and San Francisco, California. Since 1998, more than 200 of these asbestos lawsuits have been resolved with the majority being dismissed.

Given the lack of any significant consistency to claims (i.e., as to product, operational site, or other relevant assertions) filed against the Company, the Company is unable to make a reasonable estimate of the future costs of pending claims or unasserted claims. Accordingly, no estimate of future liability has been accrued for such contingencies.

 

The following table sets forth information related to asbestos litigation:

 

 

 

 

Legal and administrative fees for the asbestos cases for fiscal years 2008, 2007, and 2006 were $0.5 million, $0.9 million, and $0.5 million, respectively.

 

Snappon SA Wrongful Discharge Claims

 

In November 2003, the Company announced the closing of a manufacturing facility in Chartres, France owned by Snappon SA, a subsidiary of the Company, previously involved in the automotive business. In accordance with French law, Snappon SA negotiated with the local works’ council regarding the implementation of a social plan for the employees. Following the implementation of the social plan, approximately 188 of the 249 former Snappon employees sued Snappon SA in the Chartres Labour Court alleging wrongful discharge. The claims were heard in two groups. On April 11, 2006, the Labour Court rejected most of the claims of the first group of 44 former employees and held Snappon SA responsible for €12,000 as damages. After two hearings, the Labour Court rejected the claims filed by the second group of former employees, which group had claimed damages in excess of €12.7 million. A total of 175 former employees have appealed these decisions. A hearing with respect to the appeal for 132 of these claims was heard in October 2008. A decision with respect to these appeals is expected in February 2009. A hearing for the remaining 43 claims was held in December 2008. A decision with respect to these 43 claims is expected in March 2009.

 

Other Legal Proceedings

 

On August 31, 2004, the Company completed the sale of its GDX business to an affiliate of Cerberus Capital Management, L.P. (Cerberus). In accordance with the divestiture agreement, the Company provided customary indemnification to Cerberus for certain liabilities accruing prior to the closing of the transaction (the Closing). Cerberus notified the Company of a claim by a GDX customer that alleges that certain parts manufactured by GDX prior to the Closing failed to meet customer specifications. The Company has assumed the defense of this matter and continues to investigate the underlying facts and defenses to determine what liability, if any, the Company may have for this claim.

 

In August 2007, the Company, along with numerous other companies, received from the United States Department of Interior Fish and Wildlife Service (USFWS) a notice of a Natural Resource Damage (NRD) Assessment Plan for the Ottawa River and Northern Maumee Bay. The Company previously manufactured products for the automotive industry at a Toledo, Ohio site, which was adjacent to the Ottawa River. This facility was divested in 1990 and the Company indemnified the buyer for claims and liabilities arising out of certain pre-divestiture environmental matters. A group of PRPs, including GenCorp, was formed to respond to the NRD assessment and to pursue funding from the Great Lakes Legacy Act for primary restoration. The group has undertaken a restoration scoping study. Early data collection indicates that the primary restoration project total cost may be in the range of $34 — $41 million. The group has received a commitment for matching federal funds for the restoration project, which will consist of river dredging and land-filling river sediments. Based on a review of the current facts and

circumstances with counsel, management has provided for what is believed to be a reasonable estimate of the loss exposure for this matter. Still unresolved at this time is the actual Natural Resource Damage Assessment itself. It is not possible to predict the outcome or timing of these types of assessments, which are typically lengthy processes lasting several years, or the amounts of or responsibility for these damages.

 

The Company and its subsidiaries are subject to other legal actions, governmental investigations, and proceedings relating to a wide range of matters in addition to those discussed above. While there can be no certainty regarding the outcome of any litigation, investigation, or proceeding, after reviewing the information that is currently available with respect to such matters, we believe that any liability that may ultimately be incurred with respect to these matters is not expected to materially affect our consolidated financial condition. It is possible that amounts incurred could be significant to the Company’s results of operations or cash flows in any particular reporting period.

 

PART II

 

Stock Performance Graph

 

The following graph compares the cumulative total shareholder returns on $100 invested in November 2003 assuming reinvestment of dividends of the Company’s Common Stock with the cumulative total return, assuming reinvestment of dividends, of (i) the Standard & Poor’s 500 Composite Stock Price Index (S&P 500 Index), and (ii) the Standard & Poor’s 500 Aerospace & Defense Index. The stock price performance shown on the graph is not necessarily indicative of future performance.

 

 

The following selected financial data is qualified by reference to and should be read in conjunction with the Consolidated Financial Statements, including the Notes thereto in Item 8. Consolidated Financial Statements and Supplementary Data, and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

 

 

We begin Management’s Discussion and Analysis of Financial Condition and Results of Operations with an overview of our business and operations, followed by a discussion of our business outlook and results of operations, including results of our operating segments, for the past two fiscal years. We then provide an analysis of our liquidity and capital resources, including discussions of our cash flows, debt arrangements, sources of capital, and financial commitments. In the next section, we discuss the critical accounting policies that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results.

 

The following discussion should be read in conjunction with the other sections of this Report, including the Consolidated Financial Statements and Notes thereto appearing in Item 8. Consolidated Financial Statements and Supplementary Data of this Report, the risk factors appearing in Item 1A. Risk Factors of this Report and the disclaimer regarding forward-looking statements appearing at the beginning of Item 1. Business of this Report. Historical results set forth in Item 6. Selected Financial Data and Item 8. Consolidated Financial Statements and Supplementary Data of this Report should not be taken as indicative of our future operations.

 

Overview

 

We are a manufacturer of aerospace and defense systems with a real estate segment that includes activities related to the entitlement, sale, and leasing of our excess real estate assets. Our continuing operations are organized into two segments:

 

Aerospace and Defense  — includes the operations of Aerojet-General Corporation, or Aerojet, which develops and manufactures propulsion systems for defense and space applications, armament systems for precision tactical weapon systems and munitions applications. We are one of the largest providers of such propulsion systems in the United States (U.S.) and the only U.S. company that provides both solid and liquid propellant based systems. Primary customers served include major prime contractors to the U.S. government, the Department of Defense (DoD), and the National Aeronautics and Space Administration (NASA).

 

Real Estate  — includes activities related to the entitlement, sale, and leasing of our excess real estate assets. We own approximately 12,200 acres of land adjacent to U.S. Highway 50 between Rancho Cordova and Folsom, California, east of Sacramento (Sacramento Land). We are currently in the process of seeking zoning changes, removal of environmental restrictions and other governmental approvals on a portion of the Sacramento Land to optimize its value. We have filed applications with and submitted information to governmental and regulatory authorities for approvals necessary to re-zone approximately 6,000 acres of the Sacramento Land. We also own approximately 580 acres in Chino Hills, California. We are currently seeking removal of environmental restrictions on the Chino Hills property to optimize the value of such land.

 

On August 31, 2004, we completed the sale of our GDX business. On November 30, 2005, we completed the sale of our Fine Chemicals business. On November 17, 2006, we completed the sale of our Turbo product line. The GDX and Fine Chemicals businesses and the Turbo product line are classified as discontinued operations in the Consolidated Financial Statements and Notes to Consolidated Financial Statements (see Note 12 in Notes to Consolidated Financial Statements).

Results of Operations

 

 

Net Sales

 

Consolidated net sales decreased to $742.3 million in fiscal 2008 compared to $745.4 million in fiscal 2007. The decrease was primarily the result of the close-out activities of the Titan program in fiscal 2007 partially offset by the $10.0 million sale of 400 acres of our Sacramento Land in the second quarter of fiscal 2008. In addition, fiscal 2008 includes one additional week of net sales of $19.1 million from Aerojet compared to the comparable periods in fiscal 2007 (see Note 1 in Notes to Consolidated Financial Statements).

 

Consolidated net sales increased to $745.4 million in fiscal 2007 compared to $621.1 million in fiscal 2006. The increase was the result of higher sales on numerous space and defense programs, including the Standard Missile, Orion, and Titan programs. The increase in the Standard Missile program was primarily due to deliveries associated with awards received in fiscal 2006 and the award of a new contract in fiscal 2007 to develop and qualify the Throttling Divert Attitude Control Systems for the Standard Missile 3 program. Capturing the Orion award in fiscal 2006 is another factor driving the fiscal 2007 increase in net sales. The increase in Titan sales during fiscal 2007 was the result of the final close-out activities of the program.

Customers that represented more than 10% of net sales for the fiscal years presented are as follows:

 

 

 

 

Effective December 1, 2006, Lockheed Martin and Boeing formed the joint venture United Launch Alliance (ULA). ULA operates the space launch systems using the Atlas V, Delta II, and Delta IV. The formation of ULA impacts the comparability of the net sales in fiscal 2008 and fiscal 2007 to fiscal 2006 for Lockheed Martin and Boeing.

 

Sales in fiscal 2008, 2007, and 2006 directly and indirectly to the U.S. government and its agencies, including sales to the Company’s significant customers discussed above, totaled $641.7 million, $665.9 million, and $523.5 million, respectively. The demand for certain of the Company’s services and products is directly related to the level of funding of government programs.

 

During fiscal 2008, approximately 46% of our net sales were from fixed-price contracts and 41% from cost reimbursable contracts.

 

Income (Loss) from Continuing Operations Before Income Taxes and Cumulative Effect of Changes in Accounting Principles

 

For fiscal 2008, we reported income from continuing operations before income taxes and cumulative effect of changes in accounting principles of $2.5 million compared to $23.0 million for fiscal 2007. The lower operating results were primarily due to the following:

 

 

The factors discussed above were partially offset by the following:

 

 

For fiscal 2007, we reported income from continuing operations before income taxes and cumulative effect of changes in accounting principles of $23.0 million compared to a loss of $43.7 million for fiscal 2006. The improved operating results were primarily due to the following:

 

 

 

The factors discussed above were partially offset by the following:

 

 

Segment Results

 

We evaluate our operating segments based on several factors, of which the primary financial measure is segment performance. Segment performance, which is a non-GAAP financial measure, represents net sales from continuing operations less applicable costs, expenses and provisions for unusual items relating to the segment. Excluded from segment performance are: corporate income and expenses, interest expense, interest income, income taxes, income or expenses related to divested businesses, and provisions for unusual items not related to the segment. We believe that segment performance provides information useful to investors in understanding our underlying operational performance. Specifically, we believe the exclusion of the items listed above permits an evaluation and a comparison of results for ongoing business operations, and it is on this basis that management internally assesses operational performance.

 

 

 

 

Aerospace and Defense

 

Fiscal 2008

 

Aerojet reports its fiscal year sales and income under a 52/53 week accounting convention. Fiscal 2008 is a 53 week year with the extra week accounted for in the first quarter of fiscal 2008, or one more week than as reported in fiscal 2007. Sales of $725.5 million for fiscal 2008 decreased from $739.1 million in fiscal 2007, reflecting decreases in various programs, including the Titan program, partially offset by the additional week of net sales of $19.1 million in fiscal 2008.

 

Segment performance was income of $40.8 million in fiscal 2008 compared to income of $61.3 million in fiscal 2007. The decrease in segment performance is primarily the result of: (i) the favorable performance on the close-out of the Titan program in fiscal 2007; (ii) an unusual charge in fiscal 2008 related to the freeze of the defined benefit pension plan; and (iii) higher estimated environmental remediation costs in fiscal 2008; partially offset by decreased retirement benefit plan expense in fiscal 2008.

 

Fiscal 2007

 

Sales for fiscal 2007 were $739.1 million compared to $614.6 million for fiscal 2006, representing a 20% increase. Higher sales volume on numerous space and defense system programs generated the improvement in fiscal 2007. Individual programs with sales increases of greater than $20.0 million during fiscal 2007 compared to fiscal 2006 were Standard Missile, Orion, and Titan.

 

The $50.8 million improvement in segment performance during fiscal 2007 compared to fiscal 2006 is the result of the following: (i) significantly improved margin on the Titan program as the result of favorable performance on close-out activities; (ii) higher sales volume; (iii) lower retirement benefit plan expense; (iv) lower estimated environmental remediation costs in fiscal 2007; and (v) higher expenses in fiscal 2006 related to legal matters.

 

Real Estate

 

Fiscal 2008

 

Sales for fiscal 2008 were $16.8 million compared to $6.3 million for fiscal 2007. Segment performance was $10.3 million and $3.5 million for fiscal 2008 and 2007, respectively. The increases in sales and segment performance are primarily due to the sale of 400 acres of the Sacramento Land to Elliott Homes Inc. (Elliott) for $10.0 million in cash during the second quarter of fiscal 2008.

 

Fiscal 2007

 

Real Estate sales and segment performance for fiscal 2007 were $6.3 million and $3.5 million, respectively, compared to $6.5 million and $2.3 million, respectively, for fiscal 2006. Results for fiscal 2007 and 2006 consist of rental property operations and there were no significant sales of real estate assets. During the third quarter of fiscal 2007, we began recognizing nominal royalty income on a mining agreement with Granite Construction Company.

 

Corporate and Other Expenses

 

Corporate and other expenses decreased to $16.2 million for fiscal 2008 compared to $19.7 million for fiscal 2007. The decrease primarily related to the reversal of previously recognized stock-based compensation due to the lower fair value of the stock appreciation rights, partially offset by higher charges for estimated future environmental remediation obligations in fiscal 2008.

 

Corporate and other expenses decreased to $19.7 million in fiscal 2007 compared to $24.2 million in fiscal 2006. The decrease was primarily due to higher expenses related to the election of the Company’s directors in fiscal 2006 and lower costs in fiscal 2007 associated with workers’ compensation matters, partially offset by higher charges for estimated future environmental remediation obligations in fiscal 2007.

Corporate and other expenses include costs associated with divested businesses, including legal and environmental costs.

 

 

These decreases are primarily related to an increase in the discount rate used to determine benefit obligations and a reduction in the impact of amortizing prior years’ actuarial losses.

 

 

On November 25, 2008, we decided to amend our defined benefit pension and benefits restoration plans to freeze future accruals under such plans. Effective February 1, 2009, we discontinued future benefit accruals for current salaried employees. No employees lost their previously earned pension benefit. As a result of the amendment and freeze, we incurred a curtailment charge of $14.6 million in the fourth quarter of fiscal 2008 primarily due to the immediate recognition of unrecognized prior service costs.

 

On March 5, 2008, we entered into a second amended and restated shareholder agreement (Shareholder Agreement) with Steel Partners II L.P. with respect to the election of Directors for the 2008 Annual Meeting and certain other related matters which resulted in a charge of $13.8 million in the first half of fiscal 2008. Additionally,

during the fourth quarter of fiscal 2008, we incurred a charge of $3.0 million associated with two executive severance agreements. The charges were comprised of the following (in millions):

 

 

As a result of the Shareholder Agreement, we were required to fund into a grantor trust on March 12, 2008, from cash on hand, an amount equal to $34.8 million, which represents liabilities associated with the Benefits Restoration Plan (BRP) and amounts payable to certain officers party to executive severance agreements in the event of qualifying terminations of employment following a change of control (as defined in the BRP and the executive severance agreements) of GenCorp. In addition, as a result of the resignation of three additional Board members on May 16, 2008, we were required to fund $0.4 million into a grantor trust on May 22, 2008, which primarily represents the amount payable to an officer party to an executive severance agreement in the event of a qualifying termination of employment following a change of control.

 

In fiscal 2008, we recorded a charge of $2.9 million related to the estimated unrecoverable costs of legal matters, including $1.7 million associated with the failure to register with the SEC the issuance of certain of our common shares under our defined contribution 401(k) employee benefit plan and $1.2 million related to a legal settlement and other legal matters. We also recorded a $1.2 million gain related to an insurance settlement for an environmental claim.

 

In fiscal 2007, we recorded $3.8 million related to estimated costs associated with environmental toxic tort legal matters. We recorded an expense of $2.3 million for tax refunds that will be repaid to our defense customers. We also recorded a gain of $6.0 million related to an adjustment of reserves for the allocation of pension benefit costs to U.S. government contracts. We incurred a charge of $0.6 million associated with the replacement of the previous credit facility.

 

In fiscal 2006, Aerojet recorded a charge of $8.5 million related to a $25 million settlement of a group of environmental toxic tort cases that had been pending in Sacramento Superior Court since 1997.

 

Environmental Matters

 

Our policy is to conduct our businesses with due regard for the preservation and protection of the environment. We devote a significant amount of resources and management attention to environmental matters and actively manage our ongoing processes to comply with environmental laws and regulations. We are involved in the remediation of environmental conditions that resulted from generally accepted manufacturing and disposal practices at certain plants in the 1950s and 1960s. In addition, we have been designated a potentially responsible party (PRP) with other companies at third party sites undergoing investigation and remediation.

 

Estimating environmental remediation costs is difficult due to the significant uncertainties inherent in these activities, including the extent of remediation required, changing governmental regulations and legal standards regarding liability, evolving technologies and the long period of time over which most remediation efforts take place. In accordance with the American Institute of Certified Public Accountants’ Statement of Position 96-1 (SOP 96-1), Environmental Remediation Liabilities , and Staff Accounting Bulletin No. 92 (SAB 92), Accounting and Disclosure Relating to Loss Contingencies , we:

 

 

 

In addition to the costs associated with environmental remediation discussed above, we incur expenditures for recurring costs associated with managing hazardous substances or pollutants in ongoing operations which totaled $13.5 million in fiscal 2008, $6.3 million in fiscal 2007, and $7.1 million in fiscal 2006.

 

Reserves

 

We review on a quarterly basis estimated future remediation costs that could be incurred over the contractual term or next fifteen years of the expected remediation. We have an established practice of estimating environmental remediation costs over a fifteen year period, except for those environmental remediation costs with a specific contractual term to allow reasonable costs estimates to be developed beyond a fifteen year period. As the period for which estimated environmental remediation costs increases, the reliability of such estimates decrease. These estimates consider the investigative work and analysis of engineers, outside environmental consultants, and the advice of legal staff regarding the status and anticipated results of various administrative and legal proceedings. In most cases, only a range of reasonably possible costs can be estimated. In establishing our reserves, the most probable estimate is used when determinable; otherwise, the minimum amount is used when no single amount in the range is more probable. Accordingly, such estimates can change as we periodically evaluate and revise such estimates as new information becomes available. Management cannot predict whether new information gained as projects progress will affect the estimated liability accrued. The timing of payment for estimated future environmental costs depends on the timing of regulatory approvals for planned remedies and the construction and completion of the remedies.

 

A summary of the Company’s environmental reserve activity is shown below:

 

 

As of November 30, 2008, the Aerojet reserves include $162.8 million for the Sacramento site, $68.0 million for Baldwin Park Operable Unit (BPOU), and $14.4 million for other Aerojet reserves.

 

The effect of the final resolution of environmental matters and our obligations for environmental remediation and compliance cannot be accurately predicted due to the uncertainty concerning both the amount and timing of future expenditures and due to regulatory or technological changes. We believe, on the basis of presently available information, that the resolution of environmental matters and our obligations for environmental remediation and compliance will not have a material adverse effect on our results of operations, liquidity, and/or financial condition. We will continue our efforts to mitigate past and future costs through pursuit of claims for recoveries from insurance coverage and other PRPs and continued investigation of new and more cost effective remediation alternatives and associated technologies.

Estimated Recoveries

 

On January 12, 1999, Aerojet and the U.S. government implemented the October 1997 Agreement in Principle (Global Settlement) resolving certain prior environmental and facility disagreements, with retroactive effect to December 1, 1998. Under the Global Settlement, Aerojet and the U.S. government resolved disagreements about an appropriate cost-sharing ratio with respect to costs associated with the clean up of the environmental contamination at the Sacramento and Azusa sites. The Global Settlement provides that the cost-sharing ratio will continue for a number of years. Additionally, in conjunction with the sale of the EIS business in 2001, Aerojet entered into an agreement with Northrop (Northrop Agreement) whereby Aerojet is reimbursed by Northrop for a portion of environmental expenditures eligible for recovery under the Global Settlement.

 

Pursuant to the Global Settlement covering environmental costs associated with Aerojet’s Sacramento site and its former Azusa site, the Company can recover up to 88% of its environmental remediation costs for these sites through the establishment of prices for Aerojet’s products and services sold to the U.S. government. Allowable environmental costs are charged to these contracts as the costs are incurred. Aerojet’s mix of contracts can affect the actual reimbursement made by the U.S. government. Because these costs are recovered through forward-pricing arrangements, the ability of Aerojet to continue recovering these costs from the U.S. government depends on Aerojet’s sustained business volume under U.S. government contracts and programs and the relative size of Aerojet’s commercial business. Annually, we evaluate Aerojet’s forecasted business volume under U.S. government contracts and programs and the relative size of Aerojet’s commercial business as part of our long-term business review. In fiscal 2007, as a result of a forecasted increase in U.S government contracts and programs volume, future recoverable amounts from the U.S. government increased; accordingly, we recorded a benefit of $8.6 million in fiscal 2007.

 

Pursuant to the Northrop Agreement, environmental expenditures to be reimbursed are subject to annual limitations, with excess amounts carried over to subsequent periods, the total reimbursements will not exceed $189.7 million over the term of the agreement, which ends in 2028. A summary of the Northrop Agreement activity is shown below (in millions):

 

 

As part of the acquisition of the Atlantic Research Corporation (ARC) propulsion business, Aerojet entered into an agreement with ARC pursuant to which Aerojet is responsible for up to $20.0 million of costs (Pre-Close Environmental Costs) associated with environmental issues that arose prior to Aerojet’s acquisition of the ARC propulsion business, of which $8.5 million has been spent through November 30, 2008. Pursuant to a separate agreement with the U.S. government which was entered into prior to the completion of the ARC acquisition, these Pre-Close Environmental Costs are not subject to the 88% limitation under the Global Settlement, and are recovered through the establishment of prices for Aerojet’s products and services sold to the U.S. government.

 

As a part of the ARC acquisition, Aerojet signed a Memorandum of Understanding (MOU) with the U.S. government agreeing to key assumptions and conditions that preserved the original methodology used in recalculating the percentage split between Aerojet and Northrop. In December 2008, Aerojet and the U.S. government entered into an Advance Agreement as was contemplated in the MOU which finalized the calculation methodology and recalculated the allocation percentage of site restoration from Aerojet to Northrop. In anticipation of executing this Advance Agreement, we incurred a charge of $1.5 million to cost of sales in the fourth quarter of fiscal 2007 related to the retroactive adjustment to the allocation split going back to fiscal 2005.

Environmental reserves and recoveries impact to Consolidated Statement of Operations

 

The expenses and benefits associated with adjustments to the environmental reserves are recorded as a component of other (income) expense, net in the Consolidated Statements of Operations. Summarized financial information for the impact of environmental reserves and recoveries to the Consolidated Statements of Operations is set forth below:

 

 

 

 

Income Tax Provision (Benefit)

 

Although we generated $2.5 million in income from continuing operations, we had a tax loss primarily related to the impact of fiscal 2008 change in tax method of accounting adopted for unbilled revenue recognized for book accounting purposes. The new tax method of accounting adopted in fiscal 2008 in accordance with guidance published by the Internal Revenue Service in Technical Advice Memorandum 200803017 defers such revenue until the all events test is met for tax purposes, which is generally when it is billed. The fiscal 2008 tax net operating loss from continuing operations resulted in an income tax benefit of $9.5 million for carryback to prior years and a refund of previously paid taxes. Due to the tightening of the credit market in the fourth quarter of fiscal 2008, a tax planning strategy relied on for realizability of a portion of the deferred tax assets ceased to be prudent and feasible, resulting in a charge to deferred income tax expense of $8.0 million and a corresponding increase to the valuation allowance.

 

In December 2008, new guidance was published by the Chief Counsel’s Office of the IRS clarifying which costs qualify for ten-year carryback of tax net operating losses for refund of prior years’ taxes. As a result of the clarifying language, we will file a refund claim in the first quarter of fiscal 2009 carrying back these qualifying costs embedded in the tax net operating losses. Accordingly, in the first quarter of fiscal 2009, we will record a benefit to the statement of operations of $19.7 million in accordance with the subsequent event rules of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), of which $14.5 million is for the release of the valuation allowance associated with the utilization of part of the tax net operating losses and $5.2 million is from the recognition of uncertain tax positions associated with prior years’ refund claims related to the qualifying costs.

 

Our income tax benefit in fiscal 2007 reflects a $6.3 million benefit from continuing operations for the carryback of current and prior year losses resulting in refunds of previously paid taxes and a $12.2 million benefit primarily from U.S. federal and state income tax settlements including research and development credit claim benefits, manufacturer’s investment credit claim benefits, and certain statute expirations, which is partially offset by $0.4 million of current state tax expense. Our income tax benefit in fiscal 2006 reflects a $6.0 million benefit from continuing operations for the carryback of current and prior year losses resulting in refunds of previously paid taxes.

 

At November 30, 2008, we had a U.S. federal net operating loss carryforward of approximately $225.6 million of which $61.2 million expires in fiscal 2024, $160.6 million expires in fiscal 2025, $1.1 million expires in fiscal 2027, and $2.7 million expires in fiscal 2028, if not utilized. Approximately $9.2 million of the net operating loss carryforward relates to the exercise of stock options, the benefit of which will be credited to equity when realized. In addition, we also have U.S. federal and state capital loss carryforwards of approximately $159.8 million and $64.3 million, respectively, most of which expire in fiscal 2009. For state tax purposes, we have approximately $227.5 million in net operating loss carryforwards of which $35.6 million expires in fiscal 2014, $132.0 million

expires in fiscal 2015, $28.7 million expires in fiscal 2016, $15.1 million expires in fiscal 2017, and $16.1 million expires in fiscal 2018, if not utilized.

 

We also have a U.S. federal research credit carryforward of $6.0 million which begins expiring in fiscal 2021; and a California manufacturing investment credit carryforward of $1.0 million which begins expiring in fiscal 2010; and a foreign tax credit carryforward of $5.9 million which begins expiring in fiscal 2010, if not utilized. These tax carryforwards are subject to examination by the tax authorities.

 

(Loss) Income from Discontinued Operations

 

During fiscal 2006, we classified our Turbo product line as a discontinued operation as a result of our plan to sell the product line. The product line was not core to the Aerospace and Defense segment and required increased management oversight and costs because of increased competition and investments for on-going maintenance of the product line. On November 17, 2006, we completed the sale of the Turbo product line to Aerosource Inc. for $1.1 million, subject to adjustment. The loss on the sale of the Turbo product line during fiscal 2006 was $0.4 million. An additional loss of $0.1 million was recorded in fiscal 2007 to reflect the net assets of the Turbo product line and management’s estimate of the net proceeds from the sale. For operating segment reporting, the Turbo product line was previously reported as a part of the Aerospace and Defense segment.

 

On November 30, 2005, we sold our Fine Chemicals business to American Pacific Corporation (AMPAC) for $88.5 million of cash paid at closing, an unsecured subordinated seller note of $25.5 million delivered at closing, an earn-out provision of up to $6.0 million contingent upon the business’ achieving certain earnings targets, and the assumption by the buyer of certain liabilities. We recorded a full allowance on both the $25.5 million unsecured subordinated seller note in fiscal 2005 and $6.0 million earnings target receivable in fiscal 2006. During fiscal 2005, we recorded a loss of $28.7 million on the difference between the estimated cash proceeds to be received on disposition less the carrying value of the net assets being sold and related transaction selling costs. An additional loss of $0.1 million was recorded in fiscal 2006 to reflect the net assets of the Fine Chemicals business and management’s estimate of the proceeds from the sale. During the first quarter of fiscal 2007, we entered into an earn-out and seller note repayment agreement (Repayment Agreement) with AMPAC under which AMPAC was required to pay $29.7 million in consideration for the early retirement of the seller note (including interest due thereunder), the full payment of the earn-out amount and the release of certain liabilities. During the first quarter of fiscal 2007, we recorded a gain from discontinued operations of $31.2 million as a result of receiving $29.7 million of cash from AMPAC and being released from certain liabilities in accordance with the Repayment Agreement. For operating segment reporting, the Fine Chemicals business was previously reported as a separate operating segment.

 

In June 2006, we entered into a Final Settlement and Release Agreement with Cerberus Capital Management, L.P. (Cerberus) related to the sale of GDX which resulted in a $2.9 million income tax benefit and $2.0 million pre-tax gain that was recorded during the second quarter of fiscal 2006. For operating segment reporting, GDX was previously reported as a separate operating segment.

 

We adjusted certain pre-acquisition obligations during the second quarter of fiscal 2006 associated with our purchase of the Draftex group in December 2000 which resulted in a $1.7 million charge. During the third quarter of fiscal 2006, we reached a settlement on these pre-acquisition obligations which resulted in a gain of $1.3 million.

 

In November 2003, we announced the closing of a GDX manufacturing facility in Chartres, France. The decision resulted primarily from declining sales volumes with French automobile manufacturers. In June 2004, we completed the legal process for closing the facility and establishing a social plan. In fiscal 2004, an expense of approximately $14.0 million related to employee social costs was recorded in accordance with Statement of Financial Accounting Standards (SFAS) No. 146, Accounting for Costs Associated with Exit or Disposal Activities. An expense of $1.0 million was recorded during fiscal 2005 primarily related to employee social costs that became estimable in fiscal 2005. We have not yet recorded expenses associated with other social benefits due to the uncertainty of these costs which could total up to a pre-tax expense of $2.0 million and may be incurred within the next few years.

Summarized financial information for discontinued operations is set forth below:

 

 

Adoption of New Accounting Principles

 

On December 1, 2007, we adopted the provisions of FIN 48. As of December 1, 2007, we had $3.2 million of unrecognized tax benefits, $3.0 million of which would impact our effective tax rate if recognized. The adoption resulted in a reclassification of certain tax liabilities from current to non-current, a reclassification of certain tax indemnification liabilities from income taxes payable to other current liabilities, and a cumulative effect adjustment benefit of $9.1 million that was recorded directly to our accumulated deficit. We recognize interest and penalties related to uncertain tax positions in income tax expense. Interest and penalties are immaterial at the date of adoption and are included in unrecognized tax benefits. As of November 30, 2008, we had approximately $0.1 million of accrued interest and penalties related to uncertain tax positions. The tax years ended November 30, 2005 through November 30, 2008 remain open to examination for U.S. federal income tax purposes. For our other major taxing jurisdictions, the tax years ended November 30, 2004 through November 30, 2008 remain open to examination.

 

On December 1, 2007, we adopted the provisions of SFAS No. 157 (SFAS 157), Fair Value Measurements , for financial instruments. Although the adoption of SFAS 157 did not materially impact our financial condition, results of operations, or cash flows, we are now required to provide additional disclosures in the notes to our financial statements.

 

On December 1, 2007, we adopted SFAS No. 159 (SFAS 159), The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 . At the date of adoption, we did not elect to use the fair value option for any of our outstanding financial assets or liabilities. Accordingly, the adoption of SFAS 159 did not have an impact on our financial position, results of operations, or cash flows.

 

As of November 30, 2007, we adopted SFAS No. 158 (SFAS 158), Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans , which requires that the Consolidated Balance Sheets reflect the funded status of the pension and postretirement plans. The funded status of the plans is measured as the difference between the plan assets at fair value and the projected benefit obligation. We have recognized the aggregate of all overfunded plans in prepaid pension assets and the aggregate of all unfunded plans in either postretirement medical and life benefits or accrued pension benefits. At November 30, 2007, previously unrecognized actuarial (gains)/losses and the prior services (credits)/costs are included in accumulated other comprehensive loss in the Consolidated Balance Sheet as required by SFAS 158. In future periods, the additional actuarial (gains)/losses and prior service (credits)/costs will be recognized in accumulated other comprehensive loss in the period in which they occur.

 

As of November 30, 2006, we adopted FASB Interpretation No. 47 (FIN 47), Accounting for Conditional Asset Retirement Obligations , an interpretation of SFAS No. 143, Accounting for Asset Retirement Obligations . FIN 47 requires that the fair value of a liability for a conditional asset retirement obligation be recognized in the period in which it is incurred and the settlement date is estimable, and is capitalized as part of the carrying amount of the related tangible long-lived asset. The adoption of FIN 47 resulted in our recording conditional asset retirement obligations in the amount of $10.2 million. Of this amount, $1.4 million was recorded as an incremental cost of the underlying property, plant and equipment, less $0.8 million of accumulated depreciation. We also recorded an asset of $8.4 million which represents the amount of the conditional asset retirement obligation that is estimated to be recoverable under U.S. government contracts. As of November 30, 2006, the cumulative effect related to the accretion of the liability and depreciation of the asset net of the amount recoverable under U.S. government contracts was $1.2 million (see Note 7(e) in Notes to Consolidated Financial Statements).

As of December 1, 2005, we adopted SFAS No. 123(R) (SFAS 123(R)), Share-Based Payment , which requires companies to recognize in the statement of operations the grant-date fair value of stock awards issued to employees and directors. We adopted SFAS 123(R) using the modified prospective transition method. In accordance with the modified prospective transition method, our Consolidated Financial Statements for prior periods have not been restated to reflect the impact of SFAS 123(R). As a result of applying SFAS 123(R), the loss from continuing operations before the cumulative effect of changes in accounting principles for fiscal 2006 was increased by $0.6 million. In addition, we recognized an increase to our net loss of $0.7 million related to the cumulative effect of changes accounting principles as of December 1, 2005 (see Note 9(c) in Notes to Consolidated Financial Statements).

 

Continuing operations generated cash of $26.2 million in fiscal 2007 compared to $0.6 million in fiscal 2006. The improvement is primarily due to improved operating performance from the Aerospace and Defense segment partially offset by a decrease in the generation of cash from income tax related items.

 

Discontinued Operations

 

Discontinued operations used $0.8 million and $2.4 million of cash in fiscal 2008 and 2007, respectively, primarily related to the retained portions of our former automotive business. Discontinued operations used cash of $13.7 million in fiscal 2006 primarily due to payments associated with the Fine Chemicals business divestiture, including purchase price adjustments and transaction costs, and the Final Settlement and Release Agreement we entered into with Cerberus in June 2006 related to the fiscal 2004 sale of GDX.

 

Net Cash (Used In) Provided by Investing Activities

 

Continuing Operations

 

During fiscal 2008, 2007, and 2006, we spent $21.3 million, $21.8 million, and $19.0 million, respectively, in capital expenditures. The majority of our capital expenditures directly supports our contract and customer requirements and are primarily made for asset replacement, capacity expansion, development of new projects, and safety and productivity improvements.

 

As of November 30, 2006, we designated $19.8 million as restricted cash related to the cash collateralization of the 5 3 / 4 % Convertible Subordinated Notes (5 3 / 4 % Notes). In April 2007, the $19.8 million of restricted cash was used to repay the 5 3 / 4 % Notes.

 

Proceeds from sale of Discontinued Operations

 

During fiscal 2007, we received $29.7 million from AMPAC in consideration for the cancellation and termination of an unsecured subordinated note receivable from AMPAC, including any interest due thereunder, and AMPAC’s obligation to make an earnings target payment associated with the sale of the Fine Chemicals business. During fiscal 2006, we received $1.1 million of proceeds from the sale of the Turbo product line.

 

Net Cash (Used in) Provided by Financing Activities

 

During fiscal 2008, cash of $6.3 million was used for debt principal payments (see table below), $5.0 million of which was required to be repaid in conjunction with a real estate sale. Under the terms of the $280.0 million senior credit facility (Senior Credit Facility), we were required to use 50% of the net sale proceeds of $10.0 million from the sale of 400 acres of our Sacramento Land in the second quarter of fiscal 2008, or $5.0 million, to repay outstanding principal on the term loan subfacilty.

 

Cash of $20.4 million was used in fiscal 2007 primarily for the net retirements of approximately $18.9 million of debt. Cash of $20.3 million was generated in fiscal 2006 primarily from the net issuances of approximately $18.5 million of debt.