UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
  R QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2015

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


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


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

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

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

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):

Large accelerated filer R
 
Accelerated filer £
Non-accelerated filer   £
(Do not check if a smaller reporting company)
Smaller reporting company £
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No  R

131,131,426 shares of the registrant's Common Stock were outstanding on January 18, 2016.


 

1


ROCKWELL COLLINS, INC.

INDEX


 
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


i


PART I.
FINANCIAL INFORMATION

Item 1.
Condensed Consolidated Financial Statements

ROCKWELL COLLINS, INC.
CONDENSED CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(Unaudited)
(in millions, except per share amounts)
 
December 31,
2015
 
September 30,
2015
ASSETS
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
334

 
$
252

Receivables, net
1,036

 
1,038

Inventories, net
1,938

 
1,824

Other current assets
138

 
110

Total current assets
3,446

 
3,224

 
 
 
 
Property
973

 
964

Goodwill
1,903

 
1,904

Intangible Assets
693

 
703

Deferred Income Taxes
141

 
165

Other Assets
315

 
344

TOTAL ASSETS
$
7,471

 
$
7,304

LIABILITIES AND EQUITY
 

 
 

Current Liabilities:
 

 
 

Short-term debt
$
1,105

 
$
448

Accounts payable
443

 
487

Compensation and benefits
218

 
273

Advance payments from customers
336

 
365

Accrued customer incentives
234

 
232

Product warranty costs
87

 
89

Other current liabilities
152

 
166

Total current liabilities
2,575

 
2,060

 
 
 
 
Long-term Debt, Net
1,370

 
1,680

Retirement Benefits
1,381

 
1,466

Other Liabilities
240

 
218

 
 
 
 
Equity:
 

 
 

Common stock ($0.01 par value; shares authorized: 1,000; shares issued as of December 31, 2015 and September 30, 2015: 183.8)
2

 
2

Additional paid-in capital
1,520

 
1,519

Retained earnings
5,215

 
5,124

Accumulated other comprehensive loss
(1,693
)
 
(1,699
)
Common stock in treasury, at cost (shares held: December 31, 2015, 52.6; September
30, 2015, 51.9)
(3,145
)
 
(3,071
)
Total shareowners’ equity
1,899

 
1,875

Noncontrolling interest
6

 
5

Total equity
1,905

 
1,880

TOTAL LIABILITIES AND EQUITY
$
7,471

 
$
7,304

See Notes to Condensed Consolidated Financial Statements.

1


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

 
Three Months Ended
 
December 31
 
2015
 
2014
Sales:
 
 
 
Product sales
$
968

 
$
1,035

Service sales
201

 
191

Total sales
1,169

 
1,226

 
 
 
 
Costs, expenses and other:
 

 
 

Product cost of sales
691

 
718

Service cost of sales
145

 
139

Selling, general and administrative expenses
163

 
137

Interest expense
15

 
15

Other income, net
(2
)
 
(1
)
Total costs, expenses and other
1,012

 
1,008

 
 
 
 
Income from continuing operations before income taxes
157


218

Income tax expense
24

 
49

Income from continuing operations
133

 
169

 
 
 
 
Income (loss) from discontinued operations, net of taxes
2

 
(2
)
 
 
 
 
Net income
$
135

 
$
167

 
 
 
 
Earnings (loss) per share:
 

 
 

Basic
 
 
 
Continuing operations
$
1.01

 
$
1.28

Discontinued operations
0.02

 
(0.02
)
Basic earnings per share
$
1.03

 
$
1.26

 
 
 
 
Diluted
 
 
 
Continuing operations
$
1.00

 
$
1.26

Discontinued operations
0.02

 
(0.02
)
Diluted earnings per share
$
1.02

 
$
1.24

 
 
 
 
Weighted average common shares:
 
 
 
Basic
131.4

 
133.0

Diluted
132.8

 
134.5

 
 
 
 
Cash dividends per share
$
0.33

 
$
0.30


See Notes to Condensed Consolidated Financial Statements.

2


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

 
Three Months Ended
 
December 31
 
2015
 
2014
Net income
$
135

 
$
167

Unrealized foreign currency translation adjustments
(8
)
 
(14
)
Pension and other retirement benefits adjustments (net of taxes for the three months ended December 31, 2015 and 2014 of $8 and $7, respectively)
13

 
11

Foreign currency cash flow hedge adjustments (net of taxes for the three months ended December 31, 2015 and 2014 of $0 and $(2), respectively)
1

 
(4
)
Comprehensive income
$
141

 
$
160


See Notes to Condensed Consolidated Financial Statements.



3


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

 
Three Months Ended December 31
 
2015
 
2014
Operating Activities:
 
 
 
Net income
$
135

 
$
167

Income (loss) from discontinued operations, net of tax
2

 
(2
)
Income from continuing operations
133

 
169

Adjustments to arrive at cash used for operating activities:
 
 
 
Non-cash restructuring charges
6

 

Depreciation
35

 
38

Amortization of intangible assets and pre-production engineering costs
23

 
24

Stock-based compensation expense
6

 
5

Compensation and benefits paid in common stock
12

 
11

Excess tax benefit from stock-based compensation
(3
)
 
(7
)
Deferred income taxes
15

 
13

Pension plan contributions
(58
)
 
(58
)
Changes in assets and liabilities, excluding effects of acquisitions and foreign currency adjustments:
 
 
 
Receivables
16

 
(15
)
Production inventory
(84
)
 
(52
)
Pre-production engineering costs
(49
)
 
(43
)
Accounts payable
(32
)
 
(51
)
Compensation and benefits
(54
)
 
(59
)
Advance payments from customers
(28
)
 
13

Accrued customer incentives
2

 
(1
)
Product warranty costs
(2
)
 

Income taxes
7

 
8

Other assets and liabilities
(36
)
 
(55
)
Cash Used for Operating Activities from Continuing Operations
(91
)
 
(60
)
Investing Activities:
 

 
 

Property additions
(48
)
 
(62
)
Other investing activities

 
(14
)
Cash Used for Investing Activities from Continuing Operations
(48
)
 
(76
)
Financing Activities:
 

 
 

Purchases of treasury stock
(96
)
 
(173
)
Cash dividends
(43
)
 
(40
)
Increase in short-term commercial paper borrowings, net
357

 
327

Proceeds from the exercise of stock options
3

 
17

Excess tax benefit from stock-based compensation
3

 
7

Other financing activities
(1
)
 

Cash Provided by Financing Activities from Continuing Operations
223

 
138

Effect of exchange rate changes on cash and cash equivalents
(2
)
 
(9
)
Discontinued Operations:
 
 
 
Operating activities

 
(1
)
Cash (Used for) Discontinued Operations

 
(1
)
Net Change in Cash and Cash Equivalents
82

 
(8
)
Cash and Cash Equivalents at Beginning of Period
252

 
323

Cash and Cash Equivalents at End of Period
$
334

 
$
315


See Notes to Condensed Consolidated Financial Statements.



4


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

 
Common Stock
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares Outstanding
 
Par Value
 
Additional Paid-In Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss
 
Treasury Stock
 
Noncontrolling Interest
 
Total Equity
Balance at September 30, 2015
131.9

 
$
2

 
$
1,519

 
$
5,124

 
$
(1,699
)
 
$
(3,071
)
 
$
5

 
$
1,880

Net income
 
 
 
 
 
 
135

 
 
 
 
 
 
 
135

Other comprehensive income
 
 
 
 
 
 
 
 
6

 
 
 
 
 
6

Cash dividends
 
 
 
 
 
 
(43
)
 
 
 
 
 
 
 
(43
)
Shares issued:
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Exercise of stock options
0.1

 
 
 
(1
)
 
 
 
 
 
4

 
 
 
3

Vesting of performance shares and restricted stock
0.1

 
 
 
(11
)
 
 
 
 
 
5

 
 
 
(6
)
Excess tax pools
 
 
 
 
3

 
 
 
 
 
 
 
 
 
3

Employee stock purchase plan

 
 
 
1

 
 
 
 
 
1

 
 
 
2

Employee savings plan
0.1

 
 
 
3

 
 
 
 
 
6

 
 
 
9

Stock-based compensation
 
 
 
 
6

 
 
 
 
 
 
 
 
 
6

Treasury share repurchases
(1.0
)
 
 
 
 
 
 
 
 
 
(90
)
 
 
 
(90
)
Other
 
 
 
 
 
 
(1
)
 
 
 
 
 
1

 

Balance at December 31, 2015
131.2

 
$
2

 
$
1,520

 
$
5,215

 
$
(1,693
)
 
$
(3,145
)
 
$
6

 
$
1,905


 
Common Stock
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares Outstanding
 
Par Value
 
Additional Paid-In Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss
 
Treasury Stock
 
Noncontrolling Interest
 
Total Equity
Balance at September 30, 2014
134.0

 
$
2

 
$
1,489

 
$
4,605

 
$
(1,366
)
 
$
(2,846
)
 
$
5

 
$
1,889

Net income
 
 
 
 
 
 
167

 
 
 
 
 
 
 
167

Other comprehensive loss
 
 
 
 
 
 
 
 
(7
)
 
 
 
 
 
(7
)
Cash dividends
 
 
 
 
 
 
(40
)
 
 
 
 
 
 
 
(40
)
Shares issued:
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Exercise of stock options
0.4

 
 
 
(8
)
 
 
 
 
 
25

 
 
 
17

Vesting of performance shares and restricted stock
0.2

 
 
 
(10
)
 
 
 
 
 
4

 
 
 
(6
)
Excess tax pools
 
 
 
 
6

 
 
 
 
 
 
 
 
 
6

Employee stock purchase plan

 
 
 
1

 
 
 
 
 
2

 
 
 
3

Employee savings plan
0.1

 
 
 
3

 
 
 
 
 
6

 
 
 
9

Stock-based compensation
 
 
 
 
5

 
 
 
 
 
 
 
 
 
5

Treasury share repurchases
(2.2
)
 
 
 
 
 
 
 
 
 
(174
)
 
 
 
(174
)
Other


 
 
 
 
 
 
 
 
 
 
 
1

 
1

Balance at December 31, 2014
132.5

 
$
2

 
$
1,486

 
$
4,732

 
$
(1,373
)
 
$
(2,983
)
 
$
6

 
$
1,870


See Notes to Condensed Consolidated Financial Statements.



5


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

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

The Company operates on a 52/53 week fiscal year with quarters ending on the Friday closest to the last day of the calendar quarter. For ease of presentation, December 31 and September 30 are utilized consistently throughout these financial statements and notes to represent the period end dates.

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

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements have been condensed or omitted. These financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended September 30, 2015 .

In the opinion of management, the unaudited financial statements contain all adjustments, consisting of adjustments of a normal recurring nature, necessary to present fairly the financial position, results of operations and cash flows for the periods presented. The results of operations for the three months ended December 31, 2015 are not necessarily indicative of the results that may be expected for the full year.

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

As discussed in Note 4, Discontinued Operations and Divestitures, on March 10, 2015, the Company divested its Aerospace Systems Engineering and Support (ASES) business, which provides military aircraft integration and modifications, maintenance and logistics and support. As a result, the ASES business has been accounted for as a discontinued operation for all periods presented.

2.
Recently Issued Accounting Standards

In November 2015, the Financial Accounting Standards Board (FASB) issued new guidance requiring all deferred tax assets and liabilities to be classified as noncurrent on the balance sheet instead of separating those balances into current and noncurrent amounts. The new guidance is effective for the Company in 2018, with early adoption permitted. In order to simplify the accounting for income taxes, the Company adopted the new guidance in the current quarter on a retrospective basis, which has resulted in the reclassification of $9 million of current deferred tax assets and $84 million of current deferred tax liabilities to noncurrent as of September 30, 2015.

In May 2014, the FASB issued a comprehensive new revenue recognition standard that effectively replaces all current guidance on the topic and expands disclosures regarding revenue. The guidance permits use of either a retrospective or cumulative effect transition method. Based upon the FASB's decision to approve a one year delay in implementation, the new standard is now effective for the Company in 2019, with early adoption permitted, but not earlier than 2018. The Company is evaluating the transition methods allowed under the new standard and the effect the standard will have on the Company's consolidated financial statements and related disclosures. Given the new standard's impact on business processes, systems and internal controls, analysis of the new guidance will likely extend over several future periods.

Other new accounting standards issued but not effective until after December 31, 2015 are not expected to have a material impact on the Company's financial statements.


6


ROCKWELL COLLINS, INC.

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


3.
Acquisitions, Goodwill and Intangible Assets

Acquisitions
On August 6, 2015, the Company acquired 100 percent of the outstanding shares of Newport News, Virginia-based International Communications Group, Inc. (ICG), a leading provider of satellite-based global voice and data communication products and services for the aviation industry. The purchase price, net of cash acquired, was $50 million . Additional post-closing consideration of up to $14 million may be paid, contingent upon the achievement of certain milestones. The Company recorded a $12 million liability on the acquisition date for the fair value of the contingent consideration. The Company is in the process of allocating the purchase price and performing a valuation for acquired intangible assets and their useful lives. Based on the Company's preliminary allocation of the purchase price, $38 million has been allocated to goodwill and $24 million to intangible assets. All goodwill resulting from the acquisition is tax deductible. The excess purchase price over net assets acquired, including intangible assets, reflects the Company's view that this acquisition will broaden the Company's flight deck and connectivity portfolio.

On March 20, 2015, the Company acquired 100 percent of the outstanding shares of Pacific Avionics Pty. Limited (Pacific Avionics), a Singapore-based company specializing in technologies used for wireless information distribution, including in-flight entertainment and connectivity. The purchase price, net of cash acquired, was $24 million . In the fourth quarter of 2015, the purchase price allocation was finalized, with $10 million allocated to intangible assets and $15 million to goodwill, none of which is deductible for tax purposes. The excess purchase price over net assets acquired, including intangible assets, reflects the Company's view that this acquisition will further enhance the Company's cabin products and information management services portfolios.

The ICG and Pacific Avionics acquisitions are included in the Commercial Systems segment and the results of operations have been included in the Company's operating results for the periods subsequent to the respective acquisition dates. Pro-forma results of operations have not been presented as the effect of the acquisitions are not material to the Company's consolidated results of operations.

Goodwill
Changes in the carrying amount of goodwill are summarized as follows:
(in millions)
Commercial
Systems
 
Government
Systems
 
Information Management Services
 
Total
Balance at September 30, 2015
$
314

 
$
500

 
$
1,090

 
$
1,904

Foreign currency translation adjustments

 
(1
)
 

 
(1
)
Balance at December 31, 2015
$
314

 
$
499

 
$
1,090

 
$
1,903


The Company performs an annual impairment test of goodwill and indefinite-lived intangible assets during the second quarter of each fiscal year, or at any time there is an indication goodwill or indefinite-lived intangibles are more-likely-than-not impaired, commonly referred to as triggering events. There have been no such triggering events during any of the periods presented and the Company's second quarter 2015 impairment tests resulted in no impairment.


7


ROCKWELL COLLINS, INC.

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


Intangible Assets
Intangible assets are summarized as follows:
 
December 31, 2015
 
September 30, 2015
(in millions)
Gross
 
Accum
Amort
 
Net
 
Gross
 
Accum
Amort
 
Net
Intangible assets with finite lives:
 
 
 
 
 
 
 
 
 
 
 
Developed technology and patents
$
346

 
$
(201
)
 
$
145

 
$
346

 
$
(195
)
 
$
151

Backlog
5

 
(2
)
 
3

 
5

 
(2
)
 
3

Customer relationships:
 

 
 
 
 
 
 
 
 
 
 
Acquired
338

 
(91
)
 
247

 
338

 
(87
)
 
251

Up-front sales incentives
305

 
(65
)
 
240

 
301

 
(62
)
 
239

License agreements
13

 
(10
)
 
3

 
13

 
(9
)
 
4

Trademarks and tradenames
15

 
(14
)
 
1

 
15

 
(14
)
 
1

Intangible assets with indefinite lives:
 
 
 
 
 
 
 
 
 
 
 
Trademarks and tradenames
47

 

 
47

 
47

 

 
47

In process research and development
7

 

 
7

 
7

 

 
7

Intangible assets
$
1,076

 
$
(383
)
 
$
693

 
$
1,072

 
$
(369
)
 
$
703


Rockwell Collins provides up-front sales incentives prior to delivering products or performing services to certain commercial customers in connection with sales contracts. Up-front sales incentives are recorded as a customer relationship intangible asset and are amortized using a units-of-delivery method over the period the Company has received a contractually enforceable right related to the incentives, up to 15 years after entry into service. Amortization is based on the Company's expectation of delivery rates on a program-by-program basis. Amortization begins when the Company starts recognizing revenue as the Company delivers equipment for the program.
Up-front sales incentives consisting of cash payments or customer account credits are amortized as a reduction of sales, whereas incentives consisting of free products are amortized as cost of sales. As of December 31, 2015 , the weighted average amortization period remaining for up-front sales incentives was approximately 10 years.
Anticipated annual amortization expense for intangible assets is as follows:
(in millions)
2016
 
2017
 
2018
 
2019
 
2020
 
Thereafter
Anticipated amortization expense for up-front sales incentives
$
16

 
$
18

 
$
21

 
$
25

 
$
25

 
$
138

Anticipated amortization expense for all other intangible assets
44

 
39

 
38

 
34

 
32

 
223

Total
$
60

 
$
57

 
$
59

 
$
59

 
$
57

 
$
361


Amortization expense for intangible assets for the three months ended December 31, 2015 and 2014 was $14 million and $12 million , respectively.

4.
Discontinued Operations and Divestitures

On March 10, 2015, the Company sold its ASES business, which provides military aircraft integration and modifications, maintenance and logistics and support to align with the Company's long-term primary business strategies. The sale price was $3 million and additional post-closing consideration of up to $4 million may be received contingent upon the achievement of certain revenue growth by ASES. The Company recognized a pre-tax loss of $5 million ( $3 million after-tax) related to the ASES divestiture. The operating results of ASES have been included in discontinued operations in the Company's Condensed Consolidated Statement of Operations for all periods presented. During the three months ended December 31, 2015 , the Company recorded $3 million of income from discontinued operations ( $2 million after-tax) from the favorable settlement of a contractual matter with a customer of the ASES business.


8


ROCKWELL COLLINS, INC.

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


In April 2014, the FASB issued guidance that modifies the definition of a discontinued operation and provides new disclosure requirements for divestitures. This guidance is effective for the Company in 2016, and any divestiture in 2016 or after will be subject to the new guidance. The ASES divestiture occurred in 2015 and is being reported based upon the previous guidance for discontinued operations.

Results of discontinued operations are as follows:
 
 
Three Months Ended
 
 
December 31
(in millions)
 
2015
 
2014
Sales
 
$

 
$
8

Income (loss) from discontinued operations before income taxes
 
3

 
(3
)
Income tax benefit (expense) from discontinued operations
 
(1
)
 
1


5.
Receivables, Net

Receivables, net are summarized as follows:
(in millions)
December 31,
2015
 
September 30,
2015
Billed
$
729

 
$
752

Unbilled
435

 
403

Less progress payments
(121
)
 
(110
)
Total
1,043

 
1,045

Less allowance for doubtful accounts
(7
)
 
(7
)
Receivables, net
$
1,036

 
$
1,038


Receivables expected to be collected beyond the next twelve months are classified as long-term and are included in Other Assets. Receivables, net due from equity affiliates were $52 million and $64 million at December 31, 2015 and September 30, 2015 , respectively.

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

6.
Inventories, Net

Inventories, net are summarized as follows:
(in millions)
December 31,
2015
 
September 30,
2015
Finished goods
$
248

 
$
216

Work in process
263

 
250

Raw materials, parts and supplies
388

 
353

Less progress payments
(13
)
 
(7
)
Total
886

 
812

Pre-production engineering costs
1,052

 
1,012

Inventories, net
$
1,938

 
$
1,824


The Company defers certain pre-production engineering costs during the development phase of a program in connection with long-term supply arrangements that contain contractual guarantees for reimbursement from customers. Such customer guarantees generally take the form of a minimum order quantity with quantified reimbursement amounts if the minimum order quantity is not taken by the customer. These costs are deferred to the extent of the contractual guarantees and are amortized over their estimated useful lives using a units-of-delivery method, up to 15 years. This amortization expense is included as a

9


ROCKWELL COLLINS, INC.

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


component of cost of sales. Amortization is based on the Company's expectation of delivery rates on a program-by-program basis and begins when the Company starts recognizing revenue as the Company delivers equipment for the program. The estimated useful life is limited to the amount of time the Company is virtually assured to earn revenues under long-term supply arrangements with the Company's customers. Pre-production engineering costs incurred pursuant to supply arrangements that do not contain contractual guarantees for reimbursement are expensed as incurred.

Anticipated annual amortization expense for pre-production engineering costs is as follows:
(in millions)
2016
 
2017
 
2018
 
2019
 
2020
 
Thereafter
Anticipated amortization expense for pre-production engineering costs (1)
$
53

 
$
81

 
$
111

 
$
132

 
$
131

 
$
526


(1) On October 29, 2015, Bombardier announced the cancellation of the Learjet 85 program. Pre-production engineering costs associated with the Learjet 85 program have been excluded from anticipated amortization expense, as these costs are expected to be recovered through consideration received from Bombardier pursuant to contractual guarantees and not amortized against future hardware deliveries.

Amortization expense for pre-production engineering costs for the three months ended December 31, 2015 and 2014 was $9 million and $12 million , respectively. As of December 31, 2015 , the weighted average amortization period remaining for pre-production engineering costs included in Inventories, net was approximately 11 years.

7.
Other Assets

Other assets are summarized as follows:
(in millions)
December 31,
2015
 
September 30,
2015
Long-term receivables
$
92

 
$
109

Investments in equity affiliates
11

 
13

Exchange and rental assets (net of accumulated depreciation of $98 at December 31, 2015 and $97 at September 30, 2015)
65

 
66

Other
147

 
156

Other assets
$
315

 
$
344


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

Investments in Equity Affiliates
The Company's investments in equity affiliates primarily consist of eight joint ventures, each 50 percent owned and accounted for under the equity method. During the second quarter of 2015, the Company established ACCEL (Tianjin) Flight Simulation Co., Ltd (ACCEL), a 50 percent owned joint venture with Beijing Bluesky Aviation Technology. Consistent with the terms of the joint venture agreement, the Company contributed $5 million cash to ACCEL in 2015 and expects to contribute an additional $2 million cash in 2016.

The Company records income or loss from equity affiliates in Other income, net on the Condensed Consolidated Statement of Operations. The Company's sales to equity affiliates were $ 46 million and $39 million for the three months ended December 31, 2015 and 2014, respectively. Deferred profit from sales to equity affiliates was $ 1 million at December 31, 2015 and $ 1 million at September 30, 2015 .


10


ROCKWELL COLLINS, INC.

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


Exchange and Rental Assets
Exchange and rental assets consist primarily of Company products that are either exchanged or rented to customers on a short-term basis in connection with warranty and other service-related activities. These assets are recorded at acquisition or production cost and depreciated using the straight-line method over their estimated lives, up to 15  years. Depreciation methods and lives are reviewed periodically with any changes recorded on a prospective basis. Depreciation expense for exchange and rental assets was $2 million and $2 million for the three months ended December 31, 2015 and 2014, respectively.

8.
Debt

Short-term Debt
(in millions, except weighted average amounts)
December 31,
2015
 
September 30,
2015
Short-term commercial paper borrowings outstanding (1)
$
805

 
$
448

Current portion of long-term debt
300

 

Short-term debt
$
1,105

 
$
448

Weighted average interest rate of commercial paper borrowings
0.67
%
 
0.52
%
Weighted average maturity period of commercial paper borrowings (days)
8

 
25

(1) The maximum amount of short-term commercial paper borrowings outstanding during the three months ended December 31, 2015 was $858 million

Commercial Paper Program
Under the Company’s commercial paper program, the Company may sell up to $1 billion face amount of unsecured short-term promissory notes in the commercial paper market. The commercial paper program is supported by the Company's $1 billion five-year revolving credit facility.

Revolving Credit Facilities
The Company has a five-year $1 billion credit facility that expires in December 2018. At December 31, 2015 and September 30, 2015 , there were no outstanding borrowings under this revolving credit facility.

The credit facility includes one financial covenant requiring the Company to maintain a consolidated debt to total capitalization ratio of not greater than 60 percent (excluding the equity impact on accumulated other comprehensive loss related to defined benefit retirement plans). The ratio was 41 percent at December 31, 2015 . The credit facility also contains covenants that require the Company to satisfy certain conditions in order to incur debt secured by liens, engage in sale/leaseback transactions or merge or consolidate with another entity.

Short-term credit facilities available to non-U.S. subsidiaries were $38 million as of December 31, 2015 , of which $8 million was utilized to support commitments in the form of commercial letters of credit. At December 31, 2015 and September 30, 2015 , there were no borrowings outstanding under these credit facilities.

At December 31, 2015 and September 30, 2015 , there were no significant commitment fees or compensating balance requirements under any of the Company’s credit facilities.

11


ROCKWELL COLLINS, INC.

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



Long-term Debt
The principal amount of long-term debt, net of discount, is summarized as follows:
(in millions, except interest rate figures)
Interest Rate
 
December 31,
2015
 
September 30,
2015
Fixed-rate notes due:
 
 
 
 
 
December 2043
4.80%
 
$
398

 
$
398

December 2023
3.70%
 
399

 
399

November 2021
3.10%
 
250

 
250

July 2019
5.25%
 
299

 
299

Variable-rate note due:
 
 
 
 
 
December 2016
3 month LIBOR + 0.35% (1)
 
300

 
300

Fair value swap adjustment (see Notes 13 and 14)
 
 
24

 
34

Total
 
 
1,670

 
1,680

Less current portion of long-term debt
 
 
300

 

Long-term Debt, Net
 
 
$
1,370

 
$
1,680

(1) The three-month LIBOR rate as of December 31, 2015 was approximately 0.61 percent

The notes listed above are included in the Condensed Consolidated Statement of Financial Position net of any unamortized discount within the caption Long-term Debt, Net. Debt issuance costs are capitalized within Other Assets on the Condensed Consolidated Statement of Financial Position. Debt issuance costs and any discounts are amortized over the life of the debt and recorded in Interest expense.

Interest paid on debt for the three months ended December 31, 2015 and 2014 was $20 million and $20 million , respectively.

9.
Retirement Benefits

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

Components of Expense (Income)
The components of expense (income) for Pension Benefits and Other Retirement Benefits for the three months ended December 31, 2015 and 2014 are summarized as follows:
 
Pension Benefits
 
Other Retirement Benefits
 
Three Months Ended
 
Three Months Ended
 
December 31
 
December 31
(in millions)
2015
 
2014
 
2015
 
2014
Service cost
$
3

 
$
3

 
$

 
$

Interest cost
32

 
39

 
1

 
1

Expected return on plan assets
(60
)
 
(60
)
 

 

Amortization:
 
 
 

 
 
 
 

Prior service credit

 
(1
)
 

 
(1
)
Net actuarial loss
19

 
18

 
2

 
2

Net benefit expense (income)
$
(6
)
 
$
(1
)
 
$
3

 
$
2


In 2015 and prior, the Company used a single-weighted average discount rate to calculate pension interest and service cost. Beginning in 2016, a "spot rate approach" is being used to calculate pension interest and service cost. The spot rate approach applies separate discount rates for each projected benefit payment in the calculation of pension interest and service cost. This calculation change is considered a change in accounting estimate and is being applied prospectively in 2016. For the three

12


ROCKWELL COLLINS, INC.

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


months ended December 31, 2015, the use of the spot rate approach resulted in an increase to pension income and pre-tax earnings of $9 million relative to the estimated pension income amount had the Company not changed its approach.

In October 2014, the Society of Actuaries published a new set of mortality tables (RP-2014) and a new mortality improvement scale (MP-2014), which update life expectancy assumptions. The newly published tables generally reflect longer life expectancy than was projected by past tables. For the Company's 2015 year-end pension liability valuation, the Company used the RP-2014 tables with an adjustment for plan experience and the MP-2014 improvement scale adjusted to reflect convergence to an ultimate annual rate of mortality improvement of 0.75 percent by 2022. For the three months ended December 31, 2015, these changes resulted in a decrease to pension income and pre-tax earnings of $4 million relative to the estimated pension income amount had the Company not used new mortality table and improvement scale assumptions.

Pension Plan Funding
The Company’s objective with respect to the funding of its pension plans is to provide adequate assets for the payment of future benefits. Pursuant to this objective, the Company will fund its pension plans as required by governmental regulations and may consider discretionary contributions as conditions warrant. In October 2015, the Company voluntarily contributed $55 million to its U.S. qualified pension plans. There is no minimum statutory funding requirement for 2016 and the Company does not currently expect to make any additional discretionary contributions during 2016 to its U.S. qualified pension plans. Any additional future contributions necessary to satisfy minimum statutory funding requirements are dependent upon actual plan asset returns, interest rates and actuarial assumptions. Contributions to the non-U.S. plans and the U.S. non-qualified pension plan are expected to total $13 million in 2016. During the three months ended December 31, 2015 , the Company made contributions to the non-U.S. plans and the U.S. non-qualified pension plan of $3 million .

10.
Stock-Based Compensation and Earnings Per Share

Stock-based compensation expense and related income tax benefit included within the Condensed Consolidated Statement of Operations is as follows:
 
 
Three Months Ended
 
 
December 31
(in millions)
 
2015
 
2014
Stock-based compensation expense included in:
 
 
 
 
Product cost of sales
 
$
2

 
$
2

Selling, general and administrative expenses
 
4

 
3

Total
 
$
6

 
$
5

Income tax benefit
 
$
2

 
$
2


The Company issued awards of equity instruments under the Company's various incentive plans for the three months ended December 31, 2015 and 2014 as follows:

 
Options
 
Performance Shares
 
Restricted Stock Units
(shares in thousands)
Number Issued
Weighted Average Fair Value
 
Number Issued
Weighted Average Fair Value
 
Number Issued
Weighted Average Fair Value
Three months ended December 31, 2015
622.9

$
17.78

 
127.5

$
85.11

 
55.4

$
86.67

Three months ended December 31, 2014
555.6

$
19.60

 
129.7

$
82.63

 
52.8

$
83.60


The maximum number of shares of common stock that can be issued in respect of performance shares granted in 2016 based on the achievement of performance targets for years 2016 through 2018 is approximately 306,000 .


13


ROCKWELL COLLINS, INC.

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


The fair value of each option granted by the Company was estimated using a binomial lattice pricing model and the following weighted average assumptions:
 
2016 Grants
 
2015 Grants
Risk-free interest rate
0.9% - 2.5%

 
0.5% - 2.6%

Expected dividend yield
1.5
%
 
1.6
%
Expected volatility
20.0
%
 
24.0
%
Expected life
7 years

 
7 years


Employee Benefits Paid in Company Stock
During the three months ended December 31, 2015 and 2014 , 0.1 million and 0.1 million shares, respectively, of the Company's common stock were issued to employees under the Company's employee stock purchase and defined contribution savings plans at a value of $12 million and $11 million for the respective periods.

Earnings Per Share and Diluted Share Equivalents
The computation of basic and diluted earnings per share is as follows:
 
 
Three Months Ended
 
 
December 31
(in millions, except per share amounts)
 
2015
 
2014
Numerator for basic and diluted earnings per share:
 
 
 
 
Income from continuing operations
 
$
133

 
$
169

Income (loss) from discontinued operations, net of taxes
 
2

 
(2
)
Net income
 
$
135

 
$
167

Denominator:
 
 

 
 

Denominator for basic earnings per share – weighted average common shares
 
131.4

 
133.0

Effect of dilutive securities:
 
 
 
 
Stock options
 
0.9

 
1.1

Performance shares, restricted stock and restricted stock units
 
0.5

 
0.4

Dilutive potential common shares
 
1.4

 
1.5

Denominator for diluted earnings per share – adjusted weighted average shares and assumed conversion
 
132.8

 
134.5

Earnings (loss) per share:
 
 

 
 

Basic
 
 
 
 
Continuing operations
 
$
1.01

 
$
1.28

Discontinued operations
 
0.02

 
(0.02
)
Basic earnings per share
 
$
1.03

 
$
1.26

Diluted
 
 
 
 
Continuing operations
 
$
1.00

 
$
1.26

Discontinued operations
 
0.02

 
(0.02
)
Diluted earnings per share
 
$
1.02

 
$
1.24


The average outstanding diluted shares calculation excludes options with an exercise price that exceeds the average market price of shares during the period. Stock options excluded from the average outstanding diluted shares calculation were zero and 0.6 million for the three months ended December 31, 2015 and 2014 , respectively.


14


ROCKWELL COLLINS, INC.

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


11.
Accumulated Other Comprehensive Loss

Changes in accumulated other comprehensive loss (AOCL), net of tax, by component for the three months ended December 31, 2015 and 2014 are as follows:
 
 
Foreign Exchange Translation Adjustment
 
Pension and Other Postretirement Adjustments (1)
 
Change in the Fair Value of Effective Cash Flow Hedges
 
Total
Balance at September 30, 2015
 
$
(56
)
 
$
(1,637
)
 
$
(6
)
 
$
(1,699
)
Other comprehensive loss before reclassifications
 
(8
)
 

 
(1
)
 
(9
)
Amounts reclassified from accumulated other comprehensive loss
 

 
13

 
2

 
15

Net current period other comprehensive income(loss)
 
(8
)
 
13

 
1

 
6

Balance at December 31, 2015
 
$
(64
)
 
$
(1,624
)
 
$
(5
)
 
$
(1,693
)
 
 
Foreign Exchange Translation Adjustment
 
Pension and Other Postretirement Adjustments (1)
 
Change in the Fair Value of Effective Cash Flow Hedges
 
Total
Balance at September 30, 2014
 
$
(15
)
 
$
(1,348
)
 
$
(3
)
 
$
(1,366
)
Other comprehensive loss before reclassifications
 
(14
)
 

 
(5
)
 
(19
)
Amounts reclassified from accumulated other comprehensive loss
 

 
11

 
1

 
12

Net current period other comprehensive income(loss)
 
(14
)
 
11

 
(4
)
 
(7
)
Balance at December 31, 2014
 
$
(29
)
 
$
(1,337
)
 
$
(7
)
 
$
(1,373
)

(1) Reclassifications from AOCL to net income, related to the amortization of net actuarial losses and prior service credits for the Company's retirement benefit plans, were $ 21 million ($ 13 million net of tax) and $18 million ( $11 million net of tax) for the three months ended December 31, 2015 and 2014, respectively. The reclassifications are included in the computation of net benefit expense. See Note 9, Retirement Benefits, for additional details.

12.
Income Taxes

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

During the three months ended December 31, 2015 and 2014 , the effective income tax rate from continuing operations was 15.3 percent and 22.5 percent, respectively. The lower current year effective income tax rate from continuing operations was primarily due to the permanent extension of the Federal R&D Tax Credit which had previously expired on December 31, 2014. On December 18, 2015, the Protecting Americans from Tax Hikes Act was enacted, which retroactively reinstated and permanently extended the Federal R&D Tax Credit.

The Company's U.S. Federal income tax returns for the tax year ended September 30, 2011 and prior years have been audited by the IRS and are closed to further adjustments by the IRS. The IRS is currently auditing the Company's tax returns for the years ended September 30, 2012 and 2013. A subsidiary is also under examination by the IRS for calendar years 2009 and 2012 legacy tax filings. The Company is also currently under audit in various U.S. states and non-U.S. jurisdictions. The U.S. states and non-U.S. jurisdictions have statutes of limitations generally ranging from 3 to 5 years. The Company believes it has adequately provided for any tax adjustments that may result from the various audits.

15


ROCKWELL COLLINS, INC.

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



The Company had net income tax payments of $2 million and $23 million during the three months ended December 31, 2015 and 2014 , respectively.

The Company has gross unrecognized tax benefits recorded within Other Liabilities in the Condensed Consolidated Statement of Financial Position of $43 million and $39 million as of December 31, 2015 and September 30, 2015 , respectively. The total amount of unrecognized tax benefits that, if recognized, would affect the effective income tax rate was $14 million and $11 million as of December 31, 2015 and September 30, 2015 , respectively. Although the timing and outcome of tax settlements are uncertain, it is reasonably possible that during the next 12 months a reduction in unrecognized tax benefits may occur in the range of $0 to $13 million based on the outcome of tax examinations or as a result of the expiration of various statutes of limitations.

The Company includes interest and penalties related to unrecognized tax benefits in income tax expense. The total amount of interest and penalties recognized within Other Liabilities in the Condensed Consolidated Statement of Financial Position was $2 million and $1 million as of December 31, 2015 and September 30, 2015 , respectively. The total amount of interest and penalties recorded as an expense or (income) within Income tax expense in the Condensed Consolidated Statement of Operations was $0 million and $ 0 million during the three months ended December 31, 2015 and 2014 , respectively.

13.
Fair Value Measurements

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

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

Assets and liabilities
The fair value of the Company's financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2015 and September 30, 2015 are as follows:
 
 
 
December 31, 2015
 
September 30, 2015
(in millions)
Fair Value
Hierarchy
 
Fair Value
Asset (Liability)
 
Fair Value
Asset (Liability)
Deferred compensation plan investments
Level 1
 
$
54

 
$
50

Interest rate swap assets
Level 2
 
24

 
34

Foreign currency forward exchange contract assets
Level 2
 
8

 
7

Foreign currency forward exchange contract liabilities
Level 2
 
(10
)
 
(11
)
Contingent consideration for ICG acquisition
Level 3
 
(12
)
 
(12
)

During the three months ended December 31, 2015 , a corporate asset was written down to its fair market value of $3 million , resulting in an asset impairment charge of $4 million recorded in Selling, general and administrative expenses on the Condensed Consolidated Statement of Operations (see Note 18). The asset is recognized at fair value on a nonrecurring basis and is classified within Level 2 of the fair value hierarchy.

There were no transfers between Levels of the fair value hierarchy during the three months ended December 31, 2015 or 2014.


16


ROCKWELL COLLINS, INC.

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


Valuation Techniques
The deferred compensation plan investments consist of investments in marketable securities (primarily mutual funds) and the fair value is determined using the market approach based on quoted market prices of identical assets in active markets.

The fair value of the interest rate swaps is determined using the market approach and is calculated by a pricing model with observable market inputs.

The fair value of foreign currency forward exchange contracts is determined using the market approach and is calculated as the value of the quoted forward currency exchange rate less the contract rate multiplied by the notional amount.

The contingent consideration for the ICG acquisition represents the estimated fair value of post-closing consideration owed to the sellers associated with the acquisition. This is categorized as Level 3 in the fair value hierarchy and the fair value is determined using a probability-weighted approach. The liability recorded was derived from the estimated probability that certain contingent payment milestones will be met in accordance with the terms of the purchase agreement.

As of December 31, 2015 , there has not been any impact to the fair value of derivative liabilities due to the Company's own credit risk. Similarly, there has not been any impact to the fair value of derivative assets based on the Company's evaluation of counterparties' credit risks.

Financial instruments
The carrying amounts and fair values of the Company's financial instruments are as follows:
 
Asset (Liability)
 
December 31, 2015
 
September 30, 2015
(in millions)
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
Cash and cash equivalents
$
334

 
$
334

 
$
252

 
$
252

Short-term debt
(1,105
)
 
(1,105
)
 
(448
)
 
(448
)
Long-term debt
(1,346
)
 
(1,429
)
 
(1,646
)
 
(1,750
)

The fair value of cash and cash equivalents, and the commercial paper portion of short-term debt, approximates their carrying value due to the short-term nature of the instruments. These items are within Level 1 of the fair value hierarchy. Fair value information for notes due December 2016 classified as short-term debt and all long-term debt is within Level 2 of the fair value hierarchy. The fair value of these financial instruments was based on current market interest rates and estimates of current market conditions for instruments with similar terms, maturities and degree of risk. The carrying amount and fair value of short-term and long-term debt excludes the interest rate swaps fair value adjustment. These fair value estimates do not necessarily reflect the amounts the Company would realize in a current market exchange.

14.
Derivative Financial Instruments

Interest Rate Swaps
The Company manages its exposure to interest rate risk by maintaining a mix of fixed and variable rate debt, which over time should moderate the costs of debt financing. To help meet this objective, the Company may use financial instruments in the form of interest rate swaps. In January 2010, the Company entered into two interest rate swap contracts which expire on July 15, 2019 and effectively converted $150 million of the 2019 Notes to floating rate debt based on six-month LIBOR plus 1.235 percent . In June 2015, the Company entered into two interest rate swap contracts which expire on July 15, 2019 and effectively converted the remaining $ 150 million of the 2019 Notes to floating rate debt based on three-month LIBOR plus 3.56 percent (collectively the 2019 Swaps).

In March 2014, the Company entered into three interest rate swap contracts (the 2023 Swaps) which expire on December 15, 2023 and effectively converted $200 million of the 2023 Notes to floating rate debt based on one-month LIBOR plus 0.94 percent .

The Company designated both the 2019 and the 2023 Swaps (the Swaps) as fair value hedges. The Swaps are recorded within Other Assets at a fair value of $24 million , offset by a fair value adjustment to Long-term Debt (Note 8) of $24 million at

17


ROCKWELL COLLINS, INC.

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


December 31, 2015 . At September 30, 2015 , the Swaps were recorded within Other Assets at a fair value of $34 million , offset by a fair value adjustment to Long-term Debt (Note 8) of $34 million . Cash payments or receipts between the Company and the counterparties to the Swaps are recorded as an adjustment to interest expense.

Foreign Currency Forward Exchange Contracts
The Company transacts business in various foreign currencies which subjects the Company’s cash flows and earnings to exposure related to changes in foreign currency exchange rates. These exposures arise primarily from purchases or sales of products and services from third parties and intercompany transactions. Foreign currency forward exchange contracts provide for the purchase or sale of foreign currencies at specified future dates at specified exchange rates and are used to offset changes in the fair value of certain assets or liabilities or forecasted cash flows resulting from transactions denominated in foreign currencies. As of December 31, 2015 and September 30, 2015 , the Company had outstanding foreign currency forward exchange contracts with notional amounts of $323 million and $359 million , respectively. These notional values consist primarily of contracts for the British pound sterling, European euro and Japanese yen, and are stated in U.S. dollar equivalents at spot exchange rates at the respective dates.

Fair Value of Derivative Instruments
Fair values of derivative instruments in the Condensed Consolidated Statement of Financial Position as of December 31, 2015 and September 30, 2015 are as follows:
 
 
 
Asset Derivatives
(in millions)
Classification
 
December 31,
2015
 
September 30, 2015
Foreign currency forward exchange contracts
Other current assets
 
$
8

 
$
7

Interest rate swaps
Other assets
 
24

 
34

Total
 
 
$
32

 
$
41

 
 
 
Liability Derivatives
(in millions)
Classification
 
December 31,
2015
 
September 30, 2015
Foreign currency forward exchange contracts
Other current liabilities
 
$
10

 
$
11


The fair values of derivative instruments are presented on a gross basis as the Company does not have any derivative contracts which are subject to master netting arrangements. As of December 31, 2015 there were undesignated foreign currency forward exchange contracts classified within Other current assets of $1 million and Other current liabilities of $0 million .


18


ROCKWELL COLLINS, INC.

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


The effect of derivative instruments on the Condensed Consolidated Statement of Operations for the three months ended December 31, 2015 and 2014 is as follows:
 
 
 
Amount of Gain (Loss)
 
 
 
Three Months Ended
 
 
 
December 31
(in millions)
Location of Gain (Loss)
 
2015
 
2014
Derivatives Designated as Hedging Instruments:
 
 
 
 
 
Fair Value Hedges
 
 
 
 
 
Interest rate swaps
Interest expense
 
$
3

 
$
3

Cash Flow Hedges
 
 
 
 
 
Foreign currency forward exchange contracts:
 
 
 
 
 
Amount of (loss) recognized in AOCL (effective portion, before deferred tax impact)
AOCL
 
(1
)
 
(7
)
Amount of (loss) reclassified from AOCL into income
Cost of sales
 
(2
)
 
(1
)
Derivatives Not Designated as Hedging Instruments:
 
 
 
 
 
Foreign currency forward exchange contracts
Cost of sales
 
(3
)
 
(2
)

There was no significant impact to the Company’s earnings related to the ineffective portion of any hedging instruments during the three months ended December 31, 2015 . In addition, there was no significant impact to the Company’s earnings when a hedged firm commitment no longer qualified as a fair value hedge or when a hedged forecasted transaction no longer qualified as a cash flow hedge during the three months ended December 31, 2015 .

The Company did not have any hedges with credit-risk-related contingent features or that required the posting of collateral as of December 31, 2015 . The cash flows from derivative contracts are recorded in operating activities in the Condensed Consolidated Statement of Cash Flows.

The Company expects to reclassify approximately $4 million of AOCL losses from cash flow hedges into earnings over the next 12 months. The maximum duration of a foreign currency cash flow hedge contract at December 31, 2015 was 55 months.

15.
Guarantees and Indemnifications

Product warranty costs
Accrued liabilities are recorded to reflect the Company’s contractual obligations relating to warranty commitments to customers. Warranty coverage of various lengths and terms is provided to customers depending on standard offerings and negotiated contractual agreements. An estimate for warranty expense is recorded at the time of sale based on the length of the warranty and historical warranty return rates and repair costs.

Changes in the carrying amount of accrued product warranty costs are summarized as follows:
 
Three Months Ended
 
December 31
(in millions)
2015
 
2014
Balance at beginning of year
$
89

 
$
104

Warranty costs incurred
(10
)
 
(11
)
Product warranty accrual
9

 
11

Changes in estimates for prior years
(1
)
 

Foreign currency translation adjustments and other

 
(1
)
Balance at December 31
$
87

 
$
103



19


ROCKWELL COLLINS, INC.

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


Guarantees
The Company provides a parent company guarantee related to various obligations of its 50 percent owned joint venture, Quest Flight Training Limited (Quest). The Company has guaranteed, jointly and severally with Quadrant Group plc (Quadrant), the other joint venture partner, the performance of Quest in relation to its contract with the United Kingdom Ministry of Defence (which expires in 2030) and the performance of certain Quest subcontractors (up to $2 million ). In addition, the Company has also pledged equity shares in Quest to guarantee payment by Quest of a loan agreement executed by Quest. In the event of default on this loan agreement, the lending institution can request that the trustee holding such equity shares surrender them to the lending institution in order to satisfy all amounts then outstanding under the loan agreement. As of December 31, 2015 , the outstanding loan balance was approximately $ 3 million . Quadrant has made an identical pledge to guarantee this obligation of Quest.

Should Quest fail to meet its obligations under these agreements, these guarantees may become a liability of the Company. As of December 31, 2015 , the Quest guarantees are not reflected on the Company’s Condensed Consolidated Statement of Financial Position because the Company believes that Quest will meet all of its performance and financial obligations in relation to its contract with the United Kingdom Ministry of Defence and the loan agreement.

Letters of credit
The Company has contingent commitments in the form of letters of credit. Outstanding letters of credit are issued by banks on the Company’s behalf to support certain contractual obligations to its customers. If the Company fails to meet these contractual obligations, these letters of credit may become liabilities of the Company. Total outstanding letters of credit at December 31, 2015 were $ 242 million . These commitments are not reflected as liabilities on the Company’s Condensed Consolidated Statement of Financial Position.

Indemnifications
The Company enters into indemnifications with lenders, counterparties in transactions such as administration of employee benefit plans and other customary indemnifications with third parties in the normal course of business. The following are other than customary indemnifications based on the judgment of management:

In connection with agreements for the sale of portions of its business, the Company at times retains various liabilities of a business that relate to events occurring prior to its sale, such as tax, environmental, litigation and employment matters. The Company at times indemnifies the purchaser of a Rockwell Collins business in the event that a third party asserts a claim that relates to a liability retained by the Company.

The Company also provides indemnifications of varying scope and amounts to certain customers against claims of product liability or intellectual property infringement made by third parties arising from the use of Company or customer products or intellectual property. These indemnifications generally require the Company to compensate the other party for certain damages and costs incurred as a result of third party product liability or intellectual property claims arising from these transactions.

The amount the Company could be required to pay under its indemnification agreements is generally limited based on amounts specified in the underlying agreements, or in the case of some agreements, the maximum potential amount of future payments that could be required is not limited. When a potential claim is asserted under these agreements, the Company considers such factors as the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. A liability is recorded when a potential claim is both probable and estimable. The nature of these agreements prevents the Company from making a reasonable estimate of the maximum potential amount it could be required to pay should counterparties to these agreements assert a claim; however, the Company currently has no material claims pending related to such agreements.


20


ROCKWELL COLLINS, INC.

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


16.
Environmental Matters

The Company is subject to federal, state and local regulations relating to the discharge of substances into the environment, the disposal of hazardous wastes and other activities affecting the environment that have had and will continue to have an impact on the Company’s manufacturing operations. These environmental protection regulations may require the investigation and remediation of environmental impairments at current and previously owned or leased properties. In addition, lawsuits, claims and proceedings have been asserted on occasion against the Company alleging violations of environmental protection regulations, or seeking remediation of alleged environmental impairments, principally at previously owned or leased properties. As of December 31, 2015 , the Company is involved in the investigation or remediation of eight sites under these regulations or pursuant to lawsuits asserted by third parties. Management estimates that the total reasonably possible future costs the Company could incur for seven of these sites is not significant. Management estimates that the total reasonably possible future costs the Company could incur from one of these sites to be approximately $ 12 million . The Company has recorded environmental reserves for this site of $ 6 million as of December 31, 2015 , which represents management’s best estimate of the probable future cost for this site.

To date, compliance with environmental regulations and resolution of environmental claims has been accomplished without material effect on the Company’s liquidity and capital resources, competitive position or financial condition. Management believes that expenditures for environmental capital investment and remediation necessary to comply with present regulations governing environmental protection and other expenditures for the resolution of environmental claims will not have a material effect on the Company’s business or financial position.

17.
Legal Matters

The Company is subject to various lawsuits, claims and proceedings that have been or may be instituted or asserted against the Company relating to the conduct of the Company's business, including those pertaining to product liability, antitrust, intellectual property, safety and health, exporting and importing, contract, employment and regulatory matters. Although the outcome of these matters cannot be predicted with certainty and some lawsuits, claims or proceedings may be disposed of unfavorably to the Company, management believes there are no material pending legal proceedings.

18.
Restructuring and Asset Impairment Charges

During the three months ended December 31, 2015, the Company recorded corporate restructuring and asset impairment charges totaling $45 million as follows:
(in millions)
Cost of Sales
 
Selling, General and Administrative Expenses
 
Total
Employee separation costs
$
31

 
$
8

 
$
39

Asset impairment charges
2

 
4

 
6

Restructuring and asset impairment charges
$
33

 
$
12

 
$
45


The employee separation costs primarily resulted from the Company's execution of a voluntary separation incentive program in response to certain challenging market conditions, particularly in business aviation. During the first quarter of 2016, the Company made cash separation payments of $5 million , and as of December 31, 2015 , $34 million of employee separation costs remain to be paid in future periods. Asset impairment charges primarily relate to the write-down to fair market value and write-off of certain long-lived assets.


21


ROCKWELL COLLINS, INC.

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


19.
Business Segment Information

The sales and earnings of continuing operations of the Company's operating segments are summarized as follows
 
 
Three Months Ended
 
 
December 31
(in millions)
 
2015
 
2014
Sales:
 
 
 
 
Commercial Systems
 
$
562

 
$
568

Government Systems
 
451

 
509

Information Management Services
 
156

 
149

Total sales
 
$
1,169

 
$
1,226

 
 
 
 
 
Segment operating earnings:
 
 

 
 

Commercial Systems
 
$
125

 
$
125

Government Systems
 
86

 
106

Information Management Services
 
24

 
21

Total segment operating earnings
 
235

 
252

 
 
 
 
 
Interest expense
 
(15
)
 
(15
)
Stock-based compensation
 
(6
)
 
(5
)
General corporate, net
 
(12
)
 
(14
)
Restructuring and asset impairment charges
 
(45
)
 

 
 
 
 
 
Income from continuing operations before income taxes
 
157

 
218

Income tax expense
 
(24
)
 
(49
)
Income from continuing operations
 
$
133

 
$
169


The Company evaluates performance and allocates resources based upon, among other considerations, segment operating earnings. The Company's definition of segment operating earnings excludes income taxes, stock-based compensation, unallocated general corporate expenses, interest expense, gains and losses from the disposition of businesses, restructuring and asset impairment charges and other special items as identified by management from time to time. Intersegment sales are not material and have been eliminated.


22


ROCKWELL COLLINS, INC.

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


The following table summarizes sales by category for the three months ended December 31, 2015 and 2014 :
 
 
Three Months Ended
 
 
December 31
(in millions)
 
2015
 
2014
Commercial Systems sales categories:
 
 
 
 

Air transport aviation electronics
 
$
327

 
$
338

Business and regional aviation electronics
 
235

 
230

Commercial Systems sales
 
562

 
568

 
 
 
 
 
Government Systems sales categories:
 
 

 
 

Avionics
 
293

 
327

Communication and navigation
 
158

 
182

Government Systems sales
 
451

 
509

 
 
 
 
 
Information Management Services sales
 
156

 
149

 
 
 
 
 
Total sales
 
$
1,169

 
$