ROCKWELLLOGOA16.JPG

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
  þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2017

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


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


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

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

Indicate by check mark whether the registrant has submitted electronically 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  R  No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
 
Accelerated filer o
Non-accelerated filer   o
(Do not check if a smaller reporting company)
Smaller reporting company o
 
 
Emerging growth company o

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

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

163,942,914  shares of the registrant's Common Stock were outstanding on January 22, 2018 .

 


ROCKWELL COLLINS, INC.

INDEX


 
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


i

PART I.
FINANCIAL INFORMATION

Item 1.
Condensed Consolidated Financial Statements

ROCKWELL COLLINS, INC.
CONDENSED CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(Unaudited)
(in millions, except per share amounts)
 
December 31,
2017
 
September 30,
2017
ASSETS
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
583

 
$
703

Receivables, net
1,513

 
1,426

Inventories, net
2,557

 
2,451

Other current assets
173

 
180

Total current assets
4,826

 
4,760

 
 
 
 
Property
1,408

 
1,398

Goodwill
9,206

 
9,158

Customer Relationship Intangible Assets
1,475

 
1,525

Other Intangible Assets
587

 
604

Deferred Income Tax Asset
21

 
21

Other Assets
529

 
531

TOTAL ASSETS
$
18,052

 
$
17,997

LIABILITIES AND EQUITY
 

 
 

Current Liabilities:
 

 
 

Short-term debt
$
877

 
$
479

Accounts payable
758

 
927

Compensation and benefits
272

 
385

Advance payments from customers
332

 
361

Accrued customer incentives
236

 
287

Product warranty costs
186

 
186

Other current liabilities
433

 
444

Total current liabilities
3,094

 
3,069

 
 
 
 
Long-term Debt, Net
6,498

 
6,676

Retirement Benefits
1,124

 
1,208

Deferred Income Tax Liability
250

 
331

Other Liabilities
725

 
663

 
 
 
 
Equity:
 

 
 

Common stock ($0.01 par value; shares authorized: 1,000; shares issued: December 31, 2017, 175.0; September 30, 2017, 175.0)
2

 
2

Additional paid-in capital
4,556

 
4,559

Retained earnings
4,064

 
3,838

Accumulated other comprehensive loss
(1,548
)
 
(1,575
)
Common stock in treasury, at cost (shares held: December 31, 2017, 11.1; September 30, 2017, 12.1)
(720
)
 
(781
)
Total shareowners’ equity
6,354

 
6,043

Noncontrolling interest
7

 
7

Total equity
6,361

 
6,050

TOTAL LIABILITIES AND EQUITY
$
18,052

 
$
17,997

See Notes to Condensed Consolidated Financial Statements.

1

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

 
Three Months Ended
 
December 31
 
2017
 
2016
Sales:
 
 
 
Product sales
$
1,766

 
$
980

Service sales
245

 
213

Total sales
2,011

 
1,193

 
 
 
 
Costs, expenses and other:
 
 
 
Product cost of sales
1,300

 
668

Service cost of sales
163

 
148

Selling, general and administrative expenses
204

 
148

Transaction and integration costs
27

 
11

Interest expense
64

 
20

Other income, net
(4
)
 
(5
)
Total costs, expenses and other
1,754

 
990

 
 
 
 
Income before income taxes
257

 
203

Income tax (benefit) expense
(23
)
 
58

 
 
 
 
Net income
$
280

 
$
145

 
 
 
 
Earnings per share:
 
 
 
Basic earnings per share
$
1.71

 
$
1.11

Diluted earnings per share
$
1.69

 
$
1.10

 
 
 
 
Weighted average common shares:
 
 
 
Basic
163.4

 
130.4

Diluted
165.4

 
131.9

 
 
 
 
Cash dividends per share
$
0.33

 
$
0.33


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
 
2017
 
2016
Net income
$
280

 
$
145

Unrealized foreign currency translation and other adjustments
15

 
(21
)
Pension and other retirement benefits adjustments (net of taxes for the three months ended December 31, 2017 and 2016 of $8 and $9, respectively)
14

 
16

Foreign currency cash flow hedge adjustments (net of taxes for the three months ended December 31, 2017 and 2016 of $(1) and $0, respectively)
(2
)
 
(3
)
Comprehensive income
$
307

 
$
137


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
 
2017
 
2016
Operating Activities:
 
 
 
Net income
$
280

 
$
145

Adjustments to arrive at cash provided by operating activities:
 
 
 
Depreciation
51

 
37

Amortization of intangible assets, pre-production engineering costs and other
95

 
23

Amortization of acquired contract liability
(30
)
 
—

Stock-based compensation expense
9

 
6

Compensation and benefits paid in common stock
13

 
16

Deferred income taxes
(123
)
 
11

Pension plan contributions
(58
)
 
(58
)
Changes in assets and liabilities, excluding effects of acquisitions and foreign currency adjustments:
 
 
 
Receivables
(74
)
 
47

Production inventory
(96
)
 
(84
)
Pre-production engineering costs
(32
)
 
(38
)
Accounts payable
(151
)
 
(49
)
Compensation and benefits
(114
)
 
(71
)
Advance payments from customers
(30
)
 
(29
)
Accrued customer incentives
(50
)
 
11

Product warranty costs
(1
)
 
(3
)
Income taxes
91

 
(16
)
Other assets and liabilities
(39
)
 
(49
)
Cash (Used for) Operating Activities
(259
)
 
(101
)
Investing Activities:
 
 
 
Property additions
(74
)
 
(52
)
Acquisition of business, net of cash acquired
—

 
(11
)
Other investing activities
6

 
—

Cash (Used for) Investing Activities
(68
)
 
(63
)
Financing Activities:
 
 
 
Repayment of long-term debt, including current portion
(176
)
 
(300
)
Purchases of treasury stock (1)
(11
)
 
(5
)
Cash dividends
(54
)
 
(43
)
Increase in short-term commercial paper borrowings, net
398

 
480

Proceeds from the exercise of stock options
47

 
15

Other financing activities
(2
)
 
(1
)
Cash Provided by Financing Activities
202

 
146

Effect of exchange rate changes on cash and cash equivalents
5

 
(14
)
Net Change in Cash and Cash Equivalents
(120
)
 
(32
)
Cash and Cash Equivalents at Beginning of Period
703

 
340

Cash and Cash Equivalents at End of Period
$
583

 
$
308

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


See Notes to Condensed Consolidated Financial Statements.

4

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

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

 
$
2

 
$
4,559

 
$
3,838

 
$
(1,575
)
 
$
(781
)
 
$
7

 
$
6,050

Net income
—

 
—

 
—

 
280

 
—

 
—

 
—

 
280

Other comprehensive income
—

 
—

 
—

 
—

 
27

 
—

 
—

 
27

Cash dividends
—

 
—

 
—

 
(54
)
 
—

 
—

 
—

 
(54
)
Shares issued:
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Exercise of stock options
0.8

 
—

 
(5
)
 
—

 
—

 
52

 
—

 
47

Vesting of performance shares and restricted stock units
0.1

 
—

 
(14
)
 
—

 
—

 
3

 
—

 
(11
)
Employee savings plan
0.1

 
—

 
7

 
—

 
—

 
6

 
—

 
13

Stock-based compensation
—

 
—

 
9

 
—

 
—

 
—

 
—

 
9

Balance at December 31, 2017
163.9


$
2


$
4,556


$
4,064


$
(1,548
)

$
(720
)

$
7


$
6,361

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at September 30, 2016
130.2

 
$
1

 
$
1,506

 
$
3,327

 
$
(1,898
)
 
$
(858
)
 
$
6

 
$
2,084

Net income
—

 
—

 
—

 
145

 
—

 
—

 
—

 
145

Other comprehensive income
—

 
—

 
—

 
—

 
(8
)
 
—

 
—

 
(8
)
Cash dividends
—

 
—

 
—

 
(43
)
 
—

 
—

 
—

 
(43
)
Shares issued:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of stock options
0.3

 
—

 
(2
)
 
—

 
—

 
17

 
—

 
15

Vesting of performance shares and restricted stock units
0.1

 
—

 
(12
)
 
—

 
—

 
5

 
—

 
(7
)
Employee stock purchase plan
—

 
—

 
1

 
—

 
—

 
2

 
—

 
3

Employee savings plan
0.1

 
—

 
3

 
—

 
—

 
10

 
—

 
13

Stock-based compensation
—

 
—

 
6

 
—

 
—

 
—

 
—

 
6

Balance at December 31, 2016
130.7

 
$
1

 
$
1,502

 
$
3,429

 
$
(1,906
)
 
$
(824
)
 
$
6

 
$
2,208


See Notes to Condensed Consolidated Financial Statements.



5

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

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

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

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

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

In the opinion of management, the unaudited financial statements contain all adjustments, consisting of adjustments of a normal recurring nature, necessary to present fairly the financial position, results of operations and cash flows for the periods presented. The results of operations for the three months ended December 31, 2017 are not necessarily indicative of the results that may be expected for the full year.

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

On September 4, 2017, the Company entered into an Agreement and Plan of Merger (Merger Agreement) with United Technologies Corporation (UTC). The Merger Agreement provides that the Company will be acquired by UTC. Each Company shareowner will receive $93.33 per share in cash and $46.67 in shares of UTC common stock in the merger, subject to a 7.5 percent collar centered on UTC's August 22, 2017 closing share price of $115.69 . The transaction, which is expected to close by the third calendar quarter of 2018, is subject to the satisfaction of customary closing conditions and approval by certain regulators. The Company incurred $ 10 million of merger-related costs during the three months ended December 31, 2017. These costs are included in Transaction and integration costs in the Condensed Consolidated Statement of Operations. At December 31, 2017, $ 18 million of merger-related costs, including amounts expensed in fiscal year 2017, were unpaid and included in Accounts payable and Compensation and benefits on the Condensed Consolidated Statement of Financial Position.

On April 13, 2017, the Company acquired B/E Aerospace, a leading manufacturer of aircraft cabin interior products and services. Prior to 2018, the financial results of the entire B/E Aerospace business were reported in a new Interior Systems segment. Beginning in 2018, the B/E Aerospace thermal and electronic systems product lines, which primarily serve military and government customers, are now being reported in the Government Systems segment. This reorganization is expected to generate additional revenue synergy opportunities for the Company. The results of operations of the acquired B/E Aerospace business are now reported in the Interior Systems and Government Systems business segments.

2.
Recently Issued Accounting Standards

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

6

ROCKWELL COLLINS, INC.

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



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

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

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

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

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

Other new accounting standards issued but not effective until after December 31, 2017 , are not expected to have a material impact on the Company's financial statements.

3.
Acquisitions, Goodwill and Intangible Assets

Acquisitions

B/E Aerospace
On April 13, 2017, the Company completed the acquisition of B/E Aerospace, a leading manufacturer of aircraft cabin interior products and services, for  $6.5 billion in cash and stock, plus the assumption of  $2.0 billion of debt, net of cash acquired. The transaction combines the Company's capabilities in flight deck avionics, cabin electronics, mission communication and navigation, simulation and training and information management services with B/E Aerospace's range of cabin interior

7

ROCKWELL COLLINS, INC.

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


products, which include seating, food and beverage preparation and storage equipment, lighting and oxygen systems and modular galley and lavatory systems for commercial airliners and business jets. The acquisition advances the Company’s global growth strategy by expanding the Company's previous focus on cockpit, cabin management, communication and connectivity solutions, and diversifies the Company's product portfolio and customer mix. Results of the acquired business are reported in the Interior Systems and Government Systems business segments (see Note 1).

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

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

Total purchase price
$
6,536

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

The cash consideration was financed through the issuance of $4.35 billion of senior unsecured notes and  $1.5 billion  borrowed under a senior unsecured syndicated term loan facility (see Note 7). The remaining proceeds of the debt offering were used to repay assumed B/E Aerospace debt and a portion of the Company's outstanding short-term commercial paper borrowings.

The following table, which is preliminary and subject to change, summarizes the estimated fair value of assets acquired and liabilities assumed at the acquisition date. The final determination of the fair value of assets and liabilities will be completed within the one year measurement period as allowed by FASB Accounting Standards Codification Topic 805, Business Combinations. As of December 31, 2017 , the valuation studies necessary to determine the fair market value of the assets acquired and liabilities assumed are preliminary. The size and breadth of the B/E Aerospace acquisition necessitates use of the one -year measurement period to adequately analyze all the factors used in establishing the asset and liability fair values as of the acquisition date, including, but not limited to, intangible assets, acquired contract liabilities, inventory, real property, leases, deferred tax liabilities related to the unremitted earnings of foreign subsidiaries, certain reserves and the related tax impacts of any changes made. Any potential adjustments will be made retroactively and could be material to the preliminary values presented below.



8

ROCKWELL COLLINS, INC.

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


(in millions)
April 13, 2017
Cash and cash equivalents
$
104

Receivables, net
485

Inventories, net (1)
545

Other current assets
56

Property
279

Intangible Assets
1,586

Other Assets
53

Total Identifiable Assets Acquired
3,108

 
 
Accounts payable
(234
)
Compensation and benefits
(75
)
Advance payments from customers
(62
)
Accrued customer incentives
(48
)
Product warranty costs
(117
)
Other current liabilities (2)
(365
)
Long-term Debt, Net
(2,119
)
Retirement Benefits
(12
)
Deferred Income Tax Liability
(335
)
Other Liabilities (2)
(431
)
Total Liabilities Assumed
(3,798
)
Net Identifiable Assets Acquired, excluding Goodwill
(690
)
Goodwill
7,226

Net Assets Acquired
$
6,536

(1) Inventories, net includes a $74 million adjustment to state Work in process and Finished goods inventories at their fair value as of the acquisition date. The inventory fair value adjustment was amortized as a non-cash increase to Cost of sales during the year ended September 30, 2017 .
(2) As of the acquisition date, the Company made adjustments totaling $486 million related to acquired existing long-term contracts with terms less favorable than could be realized in market transactions as of the acquisition date. The adjustments were primarily recognized within Other current liabilities and Other Liabilities based upon estimates regarding the period in which the liabilities will be amortized to the Condensed Consolidated Statement of Operations as non-cash reductions to Cost of sales. $30 million of the acquired contract liabilities were recognized as a reduction to Cost of sales during the three months ended December 31, 2017 .

During the three months ended December 31, 2017 , revisions were made to the estimated acquisition-date fair value of assets acquired and liabilities assumed. The revisions were primarily due to a change in estimate with respect to the future repatriation of certain foreign earnings and recognition of a liability associated with the KLX Tax Sharing and Indemnification Agreement (see note 14). The measurement period adjustments resulted in a  $41 million  net increase to Goodwill and did not have a material impact on the financial results of prior periods.

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

Seating customer relationships
6
 
860

Other customer relationships
8
 
291

Total
7
 
$
1,586


The preliminary purchase price allocation resulted in the recognition of  $7.226 billion  of goodwill,  none  of which is expected to be deductible for tax purposes. The Company is in the process of allocating goodwill by segment, and as of December 31, 2017 the Company has preliminarily included the goodwill in the Interior Systems and Government Systems segments. The goodwill is a result of expected cost synergies from the consolidation of certain corporate and administrative functions, supply

9

ROCKWELL COLLINS, INC.

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


chain savings and low-cost manufacturing, expected revenue synergies from the integration of legacy products and technologies with those of B/E Aerospace and intangible assets that do not qualify for separate recognition, such as the assembled B/E Aerospace workforce.

B/E Aerospace's results of operations have been included in the Company's operating results for the periods subsequent to the completion of the acquisition on April 13, 2017. B/E Aerospace contributed sales of  $716 million  and net income of  $76 million , excluding the discrete impacts of the Tax Cuts and Jobs Act (see Note 11), for the three months ended December 31, 2017 .

Transaction, Integration and Financing Costs
The Company recorded total transaction, integration and financing costs related to the B/E Aerospace acquisition in the Condensed Consolidated Statement of Operations as follows:
 
 
Three Months Ended
 
 
December 31
(in millions)
 
2017
 
2016
Transaction and integration costs
 
$
17

 
$
11

Interest expense
 
—

 
3

Total Transaction, integration and financing costs
 
$
17

 
$
14


At December 31, 2017 , $12 million  of transaction, integration and financing costs were unpaid and included in Accounts payable on the Condensed Consolidated Statement of Financial Position.

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

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

The unaudited supplemental pro forma financial information was calculated by combining the Company's results with the stand-alone results of B/E Aerospace for the pre-acquisition periods, which were adjusted to account for certain transactions and other costs that would have been incurred during this pre-acquisition period. The pro forma information included herein is preliminary and may be revised as additional information becomes available and as additional analysis is performed within the one year measurement period allowed by ASC 805. Any potential future adjustments could be material.

 
Three Months Ended
 
December 31
 
2017
 
2016
(in millions, except per share amounts)
(as Reported)
 
(Pro forma)
Sales
$
2,011

 
$
1,923

Net income attributable to common shareowners
280

 
197

Basic earnings per share
1.71

 
1.22

Diluted earnings per share
1.69

 
1.21


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



10

ROCKWELL COLLINS, INC.

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


 
Three Months Ended
 
December 31
(in millions)
2017
 
2016
Increases / (decreases) to pro forma net income:
 
 
 
Net reduction to depreciation resulting from fixed asset adjustments (1)
$
—

 
$
5

Advisory, legal and accounting service fees (2)
—

 
26

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

 
(38
)
Interest expense incurred on acquisition financing, net (4)
—

 
(14
)
Long-term contract program adjustments (5)
—

 
(11
)
Acquired contract liability amortization (6)
—

 
21

Compensation adjustments (7)
—

 
3

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

Pulse.aero
On December 20, 2016, the Company acquired 100 percent of the outstanding shares of Pulse.aero, a United Kingdom based company specializing in self-bag drop technologies used by airlines and airports. The purchase price, net of cash acquired, was $16 million , of which $14 million was paid during the year ended September 30, 2017 and $1 million was paid during the three months ended December 31, 2017 . On the acquisition date, the Company recorded a  $5 million  liability for the fair value of post-closing consideration that may be paid, contingent upon the achievement of certain revenue targets and development milestones. The Company made contingent consideration payments of $2 million during the year ended September 30, 2017 and $1 million during the three months ended December 31, 2017 . In the third quarter of 2017, the purchase price allocation was finalized, with $12 million allocated to goodwill and $6 million to intangible assets. The intangible assets have a weighted average life of approximately 9 years. None of the goodwill resulting from the acquisition is tax deductible. The excess purchase price over net assets acquired, including intangible assets, reflects the Company's view that this acquisition will expand the Company's airport passenger processing offerings.

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

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

 
$
325

 
$
506

 
$
1,104

 
$
9,158

B/E Aerospace acquisition adjustments
(344
)
 
—

 
385

 
—

 
41

Foreign currency translation adjustments
7

 
—

 
—

 
—

 
7

Balance at December 31, 2017
$
6,886

 
$
325

 
$
891

 
$
1,104

 
$
9,206



11

ROCKWELL COLLINS, INC.

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


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

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

Intangible Assets
Intangible assets are summarized as follows:
 
December 31, 2017
 
September 30, 2017
(in millions)
Gross
 
Accum
Amort
 
Net
 
Gross
 
Accum
Amort
 
Net
Intangible assets with finite lives:
 
 
 
 
 
 
 
 
 
 
 
Developed technology and patents
$
807

 
$
(274
)
 
$
533

 
$
806

 
$
(256
)
 
$
550

Backlog
6

 
(5
)
 
1

 
6

 
(5
)
 
1

Customer relationships:
 

 
 
 
 
 
 
 
 
 
 
Acquired
1,495

 
(263
)
 
1,232

 
1,495

 
(213
)
 
1,282

Up-front sales incentives
340

 
(97
)
 
243

 
336

 
(93
)
 
243

License agreements
16

 
(11
)
 
5

 
15

 
(10
)
 
5

Trademarks and tradenames
15

 
(14
)
 
1

 
15

 
(14
)
 
1

Intangible assets with indefinite lives:
 
 
 
 
 
 
 
 
 
 
 
Trademarks and tradenames
47

 
—

 
47

 
47

 
—

 
47

Intangible assets
$
2,726

 
$
(664
)
 
$
2,062

 
$
2,720

 
$
(591
)
 
$
2,129


The Company provides up-front sales incentives prior to delivering products or performing services to certain commercial customers in connection with sales contracts. Up-front sales incentives are recorded as a customer relationship intangible asset and are amortized using a units-of-delivery method over the period the Company has received a contractually enforceable right related to the incentives, up to 15 years after entry into service. Amortization is based on the Company's expectation of delivery rates on a program-by-program basis. Amortization begins when the Company starts recognizing revenue as the Company delivers equipment for the program.
Up-front sales incentives consisting of cash payments or customer account credits are amortized as a reduction of sales, whereas incentives consisting of free products are amortized as cost of sales. As of December 31, 2017 , 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)
2018
 
2019
 
2020
 
2021
 
2022
 
Thereafter
Anticipated amortization expense for up-front sales incentives
$
20

 
$
24

 
$
26

 
$
27

 
$
27

 
$
123

Anticipated amortization expense for all other intangible assets
268

 
266

 
265

 
265

 
262

 
515

Total
$
288

 
$
290

 
$
291

 
$
292

 
$
289

 
$
638


Amortization expense for intangible assets for the three months ended December 31, 2017 and 2016 was $73 million and $12 million , respectively.


12

ROCKWELL COLLINS, INC.

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


4.
Receivables, Net

Receivables, net are summarized as follows:
(in millions)
December 31,
2017
 
September 30,
2017
Billed
$
1,118

 
$
1,055

Unbilled
492

 
461

Less progress payments
(84
)
 
(78
)
Total
1,526

 
1,438

Less allowance for doubtful accounts
(13
)
 
(12
)
Receivables, net
$
1,513

 
$
1,426


Receivables expected to be collected beyond the next twelve months are classified as long-term and are included in Other Assets. Receivables, net due from equity affiliates were $64 million and $42 million at December 31, 2017 and September 30, 2017 , respectively.

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

The Company sells certain accounts receivable on a non-recourse basis to unrelated financial institutions under factoring agreements arranged by certain customers. Under the terms of the agreements, the Company retains no rights or interest and has no obligations with respect to the sold receivables. The Company accounts for these transactions as sales of receivables and records cash proceeds when received as cash provided by operating activities in the Condensed Consolidated Statement of Cash Flows. Cash generated by participating in these programs was $146 million and $98 million during the three months ended December 31, 2017 and 2016 , respectively. The impact on cash provided by (used for) operating activities during the three months ended December 31, 2017 and 2016 , was $(8) million and $38 million , respectively. The cost of participating in these programs was immaterial to the Company's results.

5.
Inventories, Net

Inventories, net are summarized as follows:
(in millions)
December 31,
2017
 
September 30,
2017
Finished goods
$
271

 
$
259

Work in process
364

 
347

Raw materials, parts and supplies
741

 
677

Less progress payments
(7
)
 
(7
)
Total
1,369

 
1,276

Pre-production engineering costs
1,188

 
1,175

Inventories, net
$
2,557

 
$
2,451


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

13

ROCKWELL COLLINS, INC.

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



Anticipated annual amortization expense for pre-production engineering costs is as follows:
(in millions)
2018
 
2019
 
2020
 
2021
 
2022
 
Thereafter
Anticipated amortization expense for pre-production engineering costs
$
90

 
$
132

 
$
149

 
$
147

 
$
139

 
$
550


Amortization expense for pre-production engineering costs for the three months ended December 31, 2017 and 2016 was $19 million and $11 million , respectively. As of December 31, 2017 , the weighted average amortization period remaining for pre-production engineering costs included in Inventories, net was approximately 10 years.

6.
Other Assets

Other assets are summarized as follows:
(in millions)
December 31,
2017
 
September 30,
2017
Long-term receivables
$
204

 
$
211

Investments in equity affiliates
6

 
7

Exchange and rental assets (net of accumulated depreciation of $109 at December 31, 2017 and $106 at September 30, 2017)
71

 
71

Other
248

 
242

Other Assets
$
529

 
$
531


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

Investments in Equity Affiliates
The Company's investments in equity affiliates primarily consist of seven joint ventures, each 50 percent owned and accounted for under the equity method. The Company records income or loss from equity affiliates in Other income, net on the Condensed Consolidated Statement of Operations. The Company's sales to equity affiliates were $50 million and $67 million for the three months ended December 31, 2017 and 2016 , respectively. Deferred profit from sales to equity affiliates was $1 million at December 31, 2017 , and $2 million at September 30, 2017 .

Exchange and Rental Assets
Exchange and rental assets consist primarily of Company products that are either exchanged or rented to customers on a short-term basis in connection with warranty and other service-related activities. These assets are recorded at acquisition cost or production cost and depreciated using the straight-line method over their estimated lives, up to 15  years. Depreciation methods and lives are reviewed periodically with any changes recorded on a prospective basis. Depreciation expense for exchange and rental assets was $3 million and $2 million for the three months ended December 31, 2017 and 2016 , respectively.


14

ROCKWELL COLLINS, INC.

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


7.
Debt

Short-term Debt
(in millions, except weighted average amounts)
December 31,
2017
 
September 30,
2017
Short-term commercial paper borrowings outstanding (1)
$
728

 
$
330

Current portion of long-term debt
149

 
149

Short-term debt
$
877

 
$
479

Weighted average annualized interest rate of commercial paper borrowings
1.63
%
 
1.45
%
Weighted average maturity period of commercial paper borrowings (days)
11

 
18

(1) The maximum amount of short-term commercial paper borrowings outstanding during the three months ended December 31, 2017 , was $879 million .

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

Revolving Credit Facilities
The Company has a $1.5 billion five -year senior unsecured revolving credit agreement with various banks. At December 31, 2017 and September 30, 2017 , there were no outstanding borrowings under the Company's revolving credit facility.

Short-term credit facilities available to non-U.S. subsidiaries were $20 million as of December 31, 2017 , of which $2 million was utilized to support commitments in the form of commercial letters of credit. At December 31, 2017 and September 30, 2017 , there were no borrowings outstanding under these credit facilities.

At December 31, 2017 and September 30, 2017 , there were no significant commitment fees or compensating balance requirements under any of the Company’s credit facilities.

Bridge Credit Facility
On December 16, 2016, pursuant to the B/E Aerospace acquisition, the Company entered into a $4.35 billion 364 -day senior unsecured bridge term loan credit agreement with various banks. This bridge facility terminated upon receipt of proceeds from the new notes issued to finance a portion of the B/E Aerospace acquisition.
Long-term Debt
On December 16, 2016, pursuant to the B/E Aerospace acquisition, the Company entered into a $1.5 billion three -year senior unsecured term loan credit agreement with various banks. As of December 31, 2017 , borrowings outstanding under this facility were $694 million and bear interest at LIBOR plus 1.25 percent amortized in equal quarterly installments of 2.5 percent , or $38 million , with the balance payable on April 13, 2020. During the three months ended December 31, 2017 , the Company made principal prepayments of $138 million in accordance with the loan's prepayment provisions. Proceeds of borrowings under the term loan facility were used to finance a portion of the B/E Aerospace acquisition and to pay related transaction fees and expenses.

The revolving credit agreement and term loan credit agreement each include one financial covenant requiring the Company to maintain a consolidated debt to total capitalization ratio of not greater than 68 percent (excluding the equity impact on accumulated other comprehensive loss related to defined benefit retirement plans). The Company was in compliance with this financial covenant at December 31, 2017 . The credit facilities also contain covenants that require the Company to satisfy certain conditions in order to incur debt secured by liens, engage in sale/leaseback transactions or merge or consolidate with another entity.

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


15

ROCKWELL COLLINS, INC.

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


The principal amount of long-term debt, net of discount and debt issuance costs, is summarized as follows:
(in millions, except interest rate figures)
Interest Rate
 
December 31,
2017
 
September 30,
2017
Fixed-rate notes due:
 
 
 
 
 
July 2019
1.95%
 
$
300

 
$
300

July 2019
5.25%
 
300

 
300

November 2021
3.10%
 
250

 
250

March 2022
2.80%
 
1,100

 
1,100

December 2023
3.70%
 
400

 
400

March 2024
3.20%
 
950

 
950

March 2027
3.50%
 
1,300

 
1,300

December 2043
4.80%
 
400

 
400

April 2047
4.35%
 
1,000

 
1,000

Variable-rate term loan due:
 
 
 
 
 
April 2020
1 month LIBOR + 1.25% (1)
 
694

 
870

Fair value swap adjustment (see Notes 12 and 13)
 
 
9

 
14

Total
 
 
6,703

 
6,884

Less unamortized debt issuance costs and discounts
 
 
56

 
59

Less current portion of long-term debt
 
 
149

 
149

Long-term Debt, Net
 
 
$
6,498

 
$
6,676

(1) The Company has the option to elect a one, two, three or six-month LIBOR interest rate and has elected the one-month rate during the first quarter of 2018. The one-month LIBOR rate at December 31, 2017 , was approximately 1.57 percent .
   
Cash payments for debt interest and fees during the three months ended December 31, 2017 and 2016 , were $50 million and $41 million , respectively.

8.
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, 2017 and 2016 , are summarized as follows:
 
Pension Benefits
 
Other Retirement Benefits
 
Three Months Ended
 
Three Months Ended
 
December 31
 
December 31
(in millions)
2017
 
2016
 
2017
 
2016
Service cost
$
3

 
$
3

 
$
—

 
$
—

Interest cost
30

 
28

 
1

 
1

Expected return on plan assets
(60
)
 
(60
)
 
—

 
—

Amortization:
 
 
 

 
 
 
 

Prior service credit
—

 
—

 
—

 
—

Net actuarial loss
20

 
23

 
2

 
2

Net benefit expense (income)
$
(7
)
 
$
(6
)
 
$
3

 
$
3


16

ROCKWELL COLLINS, INC.

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



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 2017, the Company voluntarily contributed $55 million to its U.S. qualified pension plan. There is no minimum statutory funding requirement for 2018. Any additional future contributions necessary to satisfy minimum statutory funding requirements are dependent upon actual plan asset returns, interest rates and actuarial assumptions. During the three months ended December 31, 2017 , the Company made contributions to the non-U.S. plans and the U.S. non-qualified pension plan of $3 million .

9.
Stock-Based Compensation and Earnings Per Share

Stock-based compensation expense, which is calculated net of an assumed forfeiture rate, and related income tax benefit included within the Condensed Consolidated Statement of Operations is as follows:
 
Three Months Ended
 
December 31
(in millions)
2017
 
2016
Stock-based compensation expense included in:
 
 
 
Product cost of sales
$
3

 
$
2

Selling, general and administrative expenses
6

 
4

Total
$
9

 
$
6

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, 2017 and 2016 , 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, 2017
—

 
$
—

 
140.8

 
$
138.68

 
252.4

 
$
133.36

Three months ended December 31, 2016
646.6

 
$
17.18

 
125.0

 
$
87.95

 
2.8

 
$
85.37


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

In light of the pending UTC merger, the Company replaced the annual stock option grant with a restricted stock unit grant. As a result, no stock options were granted for the three months ended December 31, 2017 and the number of restricted stock units granted increased when compared to the prior year.

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

Expected dividend yield
 
1.3% - 1.5%

Expected volatility
 
19.0
%
Expected life
 
7 years



17

ROCKWELL COLLINS, INC.

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


Employee Benefits Paid in Company Stock
During the three months ended December 31, 2017 and 2016 , 0.1 million and 0.2 million shares, respectively, of the Company's common stock were issued to employees under the employee stock purchase (ESPP) and defined contribution savings plans at a value of $13 million and $16 million for the respective periods. Further purchases under the ESPP were suspended on September 29, 2017 pursuant to the UTC Merger Agreement. If the UTC merger is completed, the ESPP will be terminated.

Earnings Per Share and Diluted Share Equivalents
The computation of basic and diluted earnings per share is as follows:
 
Three Months Ended
 
December 31
(in millions, except per share amounts)
2017
 
2016
Numerator for basic and diluted earnings per share:
 
 
 
Net income
$
280

 
$
145

Denominator:
 

 
 

Denominator for basic earnings per share – weighted average common shares
163.4

 
130.4

Effect of dilutive securities:
 
 
 
Stock options
1.3

 
1.0

Performance shares, restricted stock and restricted stock units
0.7

 
0.5

Dilutive potential common shares
2.0

 
1.5

Denominator for diluted earnings per share – adjusted weighted average shares and assumed conversion
165.4

 
131.9

Earnings per share:
 

 
 

Basic
$
1.71

 
$
1.11

Diluted
$
1.69

 
$
1.10


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 0.0 million and 0.7 million for the three months ended December 31, 2017 and 2016 , respectively.


18

ROCKWELL COLLINS, INC.

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


10.
Accumulated Other Comprehensive Loss

Changes in accumulated other comprehensive loss (AOCL), net of tax, by component for the three months ended December 31, 2017 and 2016 , are as follows:
(in millions)
Foreign Exchange Translation Adjustment
 
Pension and Other Postretirement Adjustments (1)
 
Change in the Fair Value of Effective Cash Flow Hedges
 
Total
Balance at September 30, 2017
$
1

 
$
(1,575
)
 
$
(1
)
 
$
(1,575
)
Other comprehensive income (loss) before reclassifications
15

 
—

 
(1
)
 
14

Amounts reclassified from accumulated other comprehensive loss
—

 
14

 
(1
)
 
13

Net current period other comprehensive income (loss)
15

 
14

 
(2
)
 
27

Balance at December 31, 2017
$
16

 
$
(1,561
)
 
$
(3
)
 
$
(1,548
)
 
 
 
 
 
 
 
 
Balance at September 30, 2016
$
(76
)
 
$
(1,818
)
 
$
(4
)
 
$
(1,898
)
Other comprehensive loss before reclassifications
(21
)
 
—

 
(4
)
 
(25
)
Amounts reclassified from accumulated other comprehensive loss
—

 
16

 
1

 
17

Net current period other comprehensive income (loss)
(21
)
 
16

 
(3
)
 
(8
)
Balance at December 31, 2016
$
(97
)
 
$
(1,802
)
 
$
(7
)
 
$
(1,906
)
(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 $22 million ( $14 million net of tax) and $25 million ( $16 million net of tax) for the three months ended December 31, 2017 and 2016 , respectively. The reclassifications are included in the computation of net benefit expense. See Note 8 for additional details.

11.
Income Taxes

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

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

On December 22, 2017, the SEC issued Staff Accounting Bulletin 118 that provides additional guidance allowing companies to use a measurement period, similar to that used in business combinations, to account for the impacts of the Act in their financial statements. The Company has accounted for the impacts of the Act to the extent a reasonable estimate could be made during the three months ended December 31, 2017. The Company will continue to refine its estimates throughout the measurement period or until the accounting is complete.

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

19

ROCKWELL COLLINS, INC.

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



As a result of the reduction in the U.S. corporate income tax rate from 35.0 percent to 21.0 percent under the Act, the Company has recorded a provisional reduction to its net deferred tax liability of $102 million , and a corresponding decrease to income tax expense in the Company’s Condensed Consolidated Statement of Operations for the three months ended December 31, 2017. The Company’s revaluation of its deferred tax liability is subject to further adjustments during the measurement period due to the complexity of determining its net deferred tax liability as of the enactment date. Some of the information necessary to determine the accounting impacts of the tax rate change includes final calculations related to the Company’s 2017 tax return as well as refining the analysis of which existing deferred balances at the enactment date will reverse in 2018 at the 24.6 percent tax rate and which deferred balances will reverse after 2018 at the 21.0 percent tax rate.

As of the December 31, 2017 deemed repatriation date, the Company estimates that it had approximately $1.048 billion of unremitted foreign earnings that would be subject to the tax imposed under Section 965 of the Internal Revenue Code. The Act imposes a tax on these earnings at either a 15.5 percent rate or an 8.0 percent rate. The higher rate applies to the extent the Company's foreign subsidiaries have cash and cash equivalents at certain measurement dates, whereas the lower rate applies to any earnings that are in excess of the cash and cash equivalents balance. After accounting for foreign tax credits related to the deemed repatriated earnings, the Company estimates the tax to be approximately $75 million . The Company recorded a provisional amount of $40 million of tax expense in the Company’s Condensed Consolidated Statement of Operations for the three months ended December 31, 2017, and it has established a $35 million liability related to certain B/E Aerospace unremitted foreign earnings through purchase accounting. The Company’s accounting for the tax on unremitted foreign earnings is incomplete due to the complexity of determining the various components of the calculation. Some of the information necessary to determine the amount of the tax includes the future profitability of its foreign subsidiaries, cash balances as of September 30, 2018, and detailed tax computations that need to be completed as part of the Company’s 2017 tax return.
 
During the three months ended December 31, 2017 and 2016 , the effective income tax rate was (8.9) percent and 28.6 percent, respectively. The lower current year effective income tax rate was primarily due to a $102 million reduction in deferred tax liabilities resulting from enactment of the Act, a lower U.S. Federal statutory tax rate under the Act and benefits from the jurisdictional mix of income as a result of the B/E Aerospace acquisition, partially offset by a $40 million obligation related to the tax on unremitted foreign earnings imposed by the Act.

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

The Company had net income tax payments of $7 million and $63 million during the three months ended December 31, 2017 and 2016 , respectively. During the quarter, a provision of $35 million was recorded through purchase accounting related to approximately $250 million of B/E Aerospace’s pre-acquisition foreign earnings that the Company views as available for repatriation.

The Company has gross unrecognized tax benefits recorded within Deferred Income Tax Liability and Other Liabilities in the Condensed Consolidated Statement of Financial Position of $214 million and $201 million as of December 31, 2017 and September 30, 2017 , respectively. The total amount of unrecognized tax benefits that, if recognized, would affect the effective income tax rate was $183 million and $169 million as of December 31, 2017 and September 30, 2017 , respectively. Although the timing and outcome of tax settlements are uncertain, it is reasonably possible that during the next 12 months a reduction in unrecognized tax benefits may occur in the range of $ 0 million to $ 49 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 $9 million and $8 million as of December 31, 2017 and September 30, 2017 , respectively. The total amount of interest and penalties recorded as an expense or (income) within Income tax expense in the Condensed Consolidated Statement of Operations were not significant for the three months ended December 31, 2017 and 2016 , respectively.

20

ROCKWELL COLLINS, INC.

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



12.
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, 2017 and September 30, 2017 , are as follows:
 
 
 
December 31, 2017
 
September 30, 2017
(in millions)
Fair Value
Hierarchy
 
Fair Value
Asset (Liability)
 
Fair Value
Asset (Liability)
Deferred compensation plan investments
Level 1
 
$
69

 
$
63

Deferred compensation plan investments
Level 2
 
26

 
24

Interest rate swap assets
Level 2
 
10

 
14

Interest rate swap liabilities
Level 2
 
(1
)
 
—

Foreign currency forward exchange contract assets
Level 2
 
5

 
8

Foreign currency forward exchange contract liabilities
Level 2
 
(5
)
 
(7
)
Acquisition-related contingent consideration
Level 3
 
(16
)
 
(17
)

There were no transfers between Levels of the fair value hierarchy during the three months ended December 31, 2017  or  2016 .

Valuation Techniques
The Level 1 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 Level 2 deferred compensation plan investments consist of investments in variable insurance trust funds and the fair value is determined using the market approach and is calculated by a pricing model with observable market inputs.

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.

As of December 31, 2017 , 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.

Contingent consideration represents the estimated fair value of post-closing consideration owed to the sellers associated with the International Communications Group (ICG) acquisition, which occurred on August 6, 2015, and the Pulse.aero acquisition, which occurred on December 20, 2016. The contingent consideration is categorized as Level 3 in the fair value hierarchy and

21

ROCKWELL COLLINS, INC.

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


the fair value is determined using a probability-weighted approach. The liabilities recorded were derived from the estimated probability that certain contingent payment milestones will be met in accordance with the terms of the purchase agreements.

The change in fair value of the Level 3 contingent consideration related to the ICG and Pulse.aero acquisitions is as follows:
(in millions)
Fair Value (Liability)
Balance at September 30, 2017
$
(17
)
Payment of contingent consideration (see Note 3)
1

Balance at December 31, 2017
$
(16
)

Financial instruments
The carrying amounts and fair values of the Company's financial instruments are as follows:
 
Asset (Liability)
 
December 31, 2017
 
September 30, 2017
(in millions)
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
Cash and cash equivalents
$
583

 
$
583

 
$
703

 
$
703

Short-term debt
(877
)
 
(877
)
 
(479
)
 
(479
)
Long-term debt
(6,489
)
 
(6,732
)
 
(6,662
)
 
(6,898
)

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 the current portion of long-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.

13.
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 5.25 percent 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 5.25 percent 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 the 2019 and the 2023 Swaps (the Swaps) as fair value hedges. At December 31, 2017 , the Swaps are recorded within Other Assets at a fair value of $10 million and Other Liabilities at a fair value of $1 million , offset by a fair value adjustment to Long-term Debt (see Note 7) of $9 million . At September 30, 2017 , the Swaps were recorded within Other Assets at a fair value of $14 million , offset by a fair value adjustment to Long-term Debt (see Note 7) of $14 million . Cash payments or receipts between the Company and the counterparties to the Swaps are recorded as an adjustment to interest expense.


22

ROCKWELL COLLINS, INC.

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


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, 2017 and September 30, 2017 , the Company had outstanding foreign currency forward exchange contracts with notional amounts of $690 million and $1.312 billion , respectively. The decrease in the notional amount of outstanding foreign currency contracts is due to the maturation of certain foreign currency contracts entered into to offset remeasurement of certain intercompany loans that matured in the current quarter. These notional values consist primarily of contracts for the European euro and British pound sterling, 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, 2017 and September 30, 2017 , are as follows:
 
 
 
Asset Derivatives
(in millions)
Classification
 
December 31,
2017
 
September 30, 2017
Foreign currency forward exchange contracts
Other current assets
 
$
5

 
$
8

Interest rate swaps
Other assets
 
10

 
14

Total
 
 
$
15

 
$
22


 
 
 
Liability Derivatives
(in millions)
Classification
 
December 31,
2017
 
September 30, 2017
Foreign currency forward exchange contracts
Other current liabilities
 
$
5

 
$
7

Interest rate swaps
Other liabilities
 
1

 
—

 
 
 
$
6

 
$
7


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, 2017 , there were undesignated foreign currency forward exchange contracts classified within Other current assets of $3 million and Other current liabilities of $1 million .


23

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, 2017 and 2016 , is as follows:
 
 
 
Amount of Gain (Loss)
 
 
 
Three Months Ended
 
 
 
December 31
(in millions)
Location of Gain (Loss)
 
2017
 
2016
Derivatives Designated as Hedging Instruments:
 
 
 
 
 
Fair Value Hedges
 
 
 
 
 
Interest rate swaps
Interest expense
 
$
1

 
$
2

Cash Flow Hedges
 
 
 
 
 
Foreign currency forward exchange contracts:
 
 
 
 
 
Amount of (loss) recognized in AOCL (effective portion, before deferred tax impact)
AOCL
 
(2
)
 
(4
)
Amount of gain (loss) reclassified from AOCL into income
Cost of sales
 
1

 
(1
)
Derivatives Not Designated as Hedging Instruments:
 
 
 
 
 
Foreign currency forward exchange contracts
Cost of sales
 
(4
)
 
(1
)

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, 2017 . 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, 2017 .

The Company did not have any hedges with credit-risk-related contingent features or that required the posting of collateral as of December 31, 2017 . The cash flows from derivative contracts are recorded in operating activities in the Condensed Consolidated Statement of Cash Flows.

The Company expects to have no net impact from the reclassification of AOCL gains and 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, 2017 , was 66 months.

14.
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)
2017
 
2016
Balance at beginning of year
$
186

 
$
87

Warranty costs incurred
(21
)
 
(10
)
Product warranty accrual
21

 
9

Changes in estimates for prior years
—

 
(2
)
Balance at December 31, 2017
$
186

 
$
84



24

ROCKWELL COLLINS, INC.

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


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, 2017 , were $216 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 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.

Under a 2014 Tax Sharing and Indemnification Agreement entered into by B/E Aerospace prior to its acquisition by the Company, the Company assumes certain potential tax liabilities related to the 2014 KLX spin-off from B/E Aerospace. If it is determined that the KLX spin-off by B/E Aerospace fails to qualify for certain tax-free treatment as a result of the Company's merger with B/E Aerospace (for example, if the merger is viewed as part of a plan or series of related transactions that includes the KLX spin-off or the KLX spin-off is found to have been used principally as a device for the distribution of earnings and profits), or because of the failure of the KLX spin-off to initially qualify for the tax-free treatment, the B/E Aerospace subsidiary could incur significant tax liabilities pursuant to the Tax Sharing and Indemnification Agreement or otherwise. During the three months ended December 31, 2017, the Company received notification of the resolution of a competent authority filing between the U.K. and U.S. related to 2010 pre-acquisition U.K. tax adjustments. Pursuant to the Tax Sharing and Indemnification Agreement the Company accrued, through purchase accounting, a $9 million payable to KLX.

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.


25

ROCKWELL COLLINS, INC.

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


15.
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, 2017 , the Company is involved in the investigation or remediation of nine 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 eight of these sites is not significant. Management estimates that the total reasonably possible future costs the Company could incur for 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, 2017 , 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.

16.
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.


26

ROCKWELL COLLINS, INC.

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


17. Business Segment Information

Sales and earnings of the Company's operating segments are summarized as follows:
 
Three Months Ended
 
December 31
(in millions)
2017
 
2016
Sales:
 
 
 
Interior Systems
$
656

 
$
—

Commercial Systems
608

 
549

Government Systems
573

 
475

Information Management Services
174

 
169

Total sales
$
2,011

 
$
1,193

 
 
 
 
Segment operating earnings:
 

 
 

Interior Systems
$
94

 
$
—

Commercial Systems
139

 
125

Government Systems
109

 
96

Information Management Services
29

 
30