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

 

 

 

Form 10-K

 

 

Commission file number 1-892

 

 

 

GOODRICH CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code: (704) 423-7000

 

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

 

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:  None

 

 

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

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

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

 

The aggregate market value of the voting and non-voting common equity of the registrant, consisting solely of common stock, held by nonaffiliates of the registrant as of June 30, 2006 was $5 billion.

 

The number of shares of common stock outstanding as of January 31, 2007 was 125,375,447 (excluding 14,000,000 shares held by a wholly owned subsidiary).

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the proxy statement dated March 12, 2007 are incorporated by reference into Part III (Items 10, 11, 12, 13 and 14).

 

 

PART I

 

 

Overview

 

We are one of the largest worldwide suppliers of components, systems and services to the commercial and general aviation airplane markets. We are also a leading supplier of systems and products to the global defense and space markets. Our business is conducted on a global basis with manufacturing, service and sales undertaken in various locations throughout the world. Our products and services are principally sold to customers in North America, Europe and Asia.

 

We were incorporated under the laws of the State of New York on May 2, 1912 as the successor to a business founded in 1870.

 

Our principal executive offices are located at Four Coliseum Centre, 2730 West Tyvola Road, Charlotte, North Carolina 28217 (telephone 704-423-7000).

 

We maintain an Internet site at http://www.goodrich.com. The information contained at our Internet site is not incorporated by reference in this report, and you should not consider it a part of this report. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports, are available free of charge on our Internet site as soon as reasonably practicable after they are filed with, or furnished to, the Securities and Exchange Commission. In addition, we maintain a corporate governance page on our Internet site that includes key information about our corporate governance initiatives, including our Guidelines on Governance, the charters for our standing board committees and our Business Code of Conduct. These materials are available to any shareholder upon request.

 

Unless otherwise noted herein, disclosures in this Annual Report on Form 10-K relate only to our continuing operations. Our discontinued operations include the Engineered Industrial Products (EIP) segment, which was spun-off to shareholders in May 2002, the Avionics business, which was sold in March 2003, the Passenger Restraints Systems (PRS), business which ceased operating during the first quarter of 2003, and the JCAir Inc. (Test Systems) business, which was sold in April 2005.

 

Unless the context otherwise requires, the terms “we”, “our”, “us”, “Company” and “Goodrich” as used herein refer to Goodrich Corporation and its subsidiaries.

 

As used in this Form 10-K, the following terms have the following meanings:

 

 

Business Segment Information

 

For 2006, we had three business segments: Engine Systems, Airframe Systems and Electronic Systems.

 

Engine Systems

 

The Engine Systems segment produces products associated with aircraft engines, including cowlings and their components, fuel delivery systems, and structural and rotating components. The segment includes the following business units:

 

 

 

 

 

 

 

Airframe Systems

 

The Airframe Systems segment provides systems and components pertaining to aircraft taxi, take-off, flight control, landing and stopping, and airframe maintenance. The segment includes the following business units:

 

 

 

 

 

 

 

 

 

Electronic Systems

 

The Electronic Systems segment produces a wide array of systems and components that provide flight performance measurements, flight management and control and safety data. The segment includes the following business units:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effective January 1, 2007, we will be reporting our results under a reorganized structure and will rename two of our three business segments. The three business segments will be Nacelles and Interior Systems, Actuation and Landing Systems, and Electronic Systems. Under the reorganized structure, several businesses will be combined into larger strategic business units and several businesses will be moved into different segments.

 

Key Products

 

Our key products include:

 

 

 

Customers

 

We serve a diverse group of customers worldwide in the commercial and general aviation airplane markets and in the global defense and space markets. We market our products, systems and services directly to our customers through an internal marketing and sales force.

 

In 2006, 2005 and 2004, direct and indirect sales to the United States (U.S.) government totaled approximately 15%, 18% and 20%, respectively, of consolidated sales. Indirect sales to the U.S. government include a portion of the direct and indirect sales to Boeing referred to in the following paragraph.

 

In 2006 direct and indirect sales to Airbus totaled approximately 17% of consolidated sales. In 2005 and 2004, direct and indirect sales to Airbus totaled approximately 16% of consolidated sales. In 2006, 2005 and 2004, direct and indirect sales to Boeing totaled approximately 14%, 12% and 13%, respectively, of consolidated sales.

 

Competition

 

The aerospace industry in which we operate is highly competitive. Principal competitive factors include price, product and system performance, quality, service, design and engineering capabilities, new product innovation and timely delivery. We compete worldwide with a number of U.S. and foreign companies that are both larger and smaller than us in terms of resources and market share, and some of which are our customers.

 

The following table lists the companies that we consider to be our major competitors for each major aerospace product or system platform for which we believe we are one of the leading suppliers.

 

 

 

 

Backlog

 

As of December 31, 2006, backlog approximated the following:

 

 

Firm commercial backlog includes orders for which we have definitive purchase contracts and the estimated sales value to be realized under firm agreements to purchase future aircraft maintenance and overhaul services. Firm backlog includes fixed, firm contracts that have not been shipped and for which cancellation is not anticipated.

 

Aircraft manufacturers, such as Boeing and Airbus may have firm orders for commercial aircraft that are in excess of the number of units covered under their firm contracts with us. We believe it is reasonable to expect that we will continue to provide products and services to these aircraft in the same manner as those under firm contract. Our unobligated commercial backlog includes the expected sales value for our product on the aircraft manufacturers’ firm orders for commercial aircraft in excess of the amount included in our firm commercial backlog.

 

Firm defense and space backlog represents the estimated remaining sales value of work to be performed under firm contracts the funding for which has been approved by the U.S. Congress, as well as commitments by international customers that are similarly funded and approved by their governments. Unobligated defense and space backlog represents the estimated remaining sales value of work to be performed under firm contracts for which funding has not been appropriated. Indefinite delivery, indefinite quantity contracts are not reported in backlog.

 

Backlog is subject to delivery delays or program cancellations which are beyond our control. Firm backlog approximated $4.4 billion at December 31, 2005.

 

Raw Materials and Components

 

We purchase a variety of raw materials and components for use in the manufacture of our products, including aluminum, titanium, steel, various specialty metals and carbon fiber. In some cases we rely on sole-source suppliers for certain of these raw materials and components, and a delay in delivery of these materials and components could create difficulties in meeting our production and delivery obligations. During 2006 and 2005, we experienced margin and cost pressures in some of our businesses due to increased market prices and limited availability of some raw materials, such as titanium, steel and various specialty metals. We are taking steps to address these market dynamics and we believe that we currently have adequate sources of supply for raw materials and components.

 

Environmental

 

We are subject to various domestic and international environmental laws and regulations which may require that we investigate and remediate the effects of the release or disposal of materials at sites associated with past and present operations, including sites at which we have been identified as a potentially responsible party under the federal Superfund laws and comparable state laws. We are currently involved in the investigation and remediation of a number of sites under these laws. For additional information concerning environmental matters, see “Item 3. Legal Proceedings — Environmental.”

 

Research and Development

 

We perform research and development under company-funded programs for commercial products and under contracts with customers. Research and development under contracts with others is performed on both defense and commercial products. Total research and development expenses from continuing operations in 2006, 2005 and 2004 were $360 million, $379 million and $346.2 million, respectively. These amounts are net of approximately $113 million, $112.1 million and $99.5 million, respectively, which were funded by customers.

 

Intellectual Property

 

We own or are licensed to use various intellectual property rights, including patents, trademarks, copyrights and trade secrets. While such intellectual property rights are important to us, we do not believe that the loss of any individual property right or group of related rights would have a material adverse effect on our overall business or on any of our business segments.

 

Human Resources

 

As of December 31, 2006, we employed approximately 15,600 people in the U.S. Additionally, we employed approximately 7,800 people in other countries. We believe that we have good relationships with our employees. The hourly employees who are unionized are covered by collective bargaining agreements with a number of labor unions and with varying contract termination dates through April 2011. Approximately 19% of our global labor force is covered by collective bargaining arrangements and approximately 6% of our global labor force is covered by collective bargaining arrangements that will expire within one year. There were no material work stoppages during 2006.

 

Foreign Operations

 

We are engaged in business in foreign markets. Our foreign manufacturing and service facilities are located in Australia, Canada, China, England, France, Germany, India, Indonesia, Northern Ireland, Japan, Mexico, Poland, Scotland, Singapore and the United Arab Emirates. We market our products and services through sales subsidiaries and distributors in a number of foreign countries. We also have joint venture agreements with various foreign companies.

 

Currency fluctuations, tariffs and similar import limitations, price controls and labor regulations can affect our foreign operations, including foreign affiliates. Other potential limitations on our foreign operations include expropriation, nationalization, restrictions on foreign investments or their transfers and additional political and economic risks. In addition, the transfer of funds from foreign operations could be impaired by the unavailability of dollar exchange or other restrictive regulations that foreign governments could enact.

 

For financial information about our U.S. and foreign sales and assets, see Note 3, “Business Segment Information” to our Consolidated Financial Statements.

 

 

Our business, financial condition, results of operations and cash flows can be affected by a number of factors, including but not limited to those set forth below and elsewhere in this Annual Report on Form 10-K, any one of which could cause our actual results to vary materially from recent results or from our anticipated future results.

 

Our future success is dependent on demand for and market acceptance of new commercial and military aircraft programs.

 

We are currently under contract to supply components and systems for a number of new commercial, general aviation and military aircraft programs, including the Airbus A380 and

A350 XWB, the Boeing 787, the Embraer 190, the Dassault Falcon 7X and the Lockheed Martin F-35 JSF and F-22 Raptor. We have made and will continue to make substantial investments and incur substantial development costs in connection with these programs. We cannot provide assurance that each of these programs will enter full-scale production as expected or that demand for the aircraft will be sufficient to allow us to recoup our investment in these programs. In addition, we cannot assure you that we will be able to extend our contracts relating to these programs beyond the initial contract periods. If any of these programs are not successful, it could have a material adverse effect on our business, financial condition or results of operations.

 

The market segments we serve are cyclical and sensitive to domestic and foreign economic considerations that could adversely affect our business and financial results.

 

The market segments in which we sell our products are, to varying degrees, cyclical and have experienced periodic downturns in demand. For example, certain of our commercial aviation products sold to aircraft manufacturers have experienced downturns during periods of slowdowns in the commercial airline industry and during periods of weak general economic conditions, as demand for new aircraft typically declines during these periods. Although we believe that aftermarket demand for many of our products may reduce our exposure to these business downturns, we have experienced these conditions in our business in the recent past and may experience downturns in the future.

 

Capital spending by airlines and aircraft manufacturers may be influenced by a variety of factors including current and predicted traffic levels, load factors, aircraft fuel pricing, labor issues, competition, the retirement of older aircraft, regulatory changes, terrorism and related safety concerns, general economic conditions, worldwide airline profits and backlog levels. Also, since a substantial portion of commercial airplane OE deliveries are scheduled beyond 2006, changes in economic conditions may cause customers to request that firm orders be rescheduled or canceled. Aftermarket sales and service trends are affected by similar factors, including usage, pricing, regulatory changes, the retirement of older aircraft and technological improvements that increase reliability and performance. A reduction in spending by airlines or aircraft manufacturers could have a significant effect on the demand for our products, which could have an adverse effect on our business, financial condition, results of operations or cash flows.

 

Current conditions in the airline industry could adversely affect our business and financial results.

 

Increases in fuel costs, high labor costs and heightened competition from low cost carriers have adversely affected the financial condition of some commercial airlines. Recently, several airlines have declared bankruptcy. A portion of our sales are derived from the sale of products directly to airlines, and we sometimes provide sales incentives to airlines and record unamortized sales incentives as other assets. If an airline declares bankruptcy, we may be unable to collect our outstanding accounts receivable from the airline and we may be required to record a charge related to unamortized sales incentives to the extent they cannot be recovered.

 

A significant decline in business with Airbus or Boeing could adversely affect our business and financial results.

 

For the year 2006, approximately 17% and 14% of our sales were made to Airbus and Boeing, respectively, for all categories of products, including original equipment (OE) and aftermarket products for commercial and military aircraft and space applications. Accordingly, a significant reduction in purchases by either of these customers could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Demand for our defense and space-related products is dependent upon government spending.

 

Approximately 25% of our sales for the year 2006 were derived from the defense and space market segment. Included in that category are direct and indirect sales to the U.S. Government, which represented approximately 15% of our sales for the year 2006. The military and space market segments are largely dependent upon government budgets, particularly the U.S. defense budget. We cannot assure you that an increase in defense spending will be allocated to programs that would benefit our business. Moreover, we cannot assure you that new military aircraft programs in which we participate will enter full-scale production as expected. A change in levels of defense spending or levels of military flight operations could curtail or enhance our prospects in these market segments, depending upon the programs affected.

 

Our business could be adversely affected if we are unable to obtain the necessary raw materials and components.

 

We purchase a variety of raw materials and components for use in the manufacture of our products, including aluminum, titanium, steel, various specialty metals and carbon fiber. The loss of a significant supplier or the inability of a supplier to meet our performance and quality specifications or delivery schedules could affect our ability to complete our contractual obligations to our customers on a satisfactory, timely and/or profitable basis. These events may adversely affect our operating results, result in the termination of one or more of our customer contracts or damage our reputation and relationships with our customers. All of these events could have a material adverse effect on our business.

 

We use a number of estimates in accounting for some long-term contracts. Changes in our estimates could materially affect our future financial results.

 

We account for sales and profits on some long-term contracts in accordance with the percentage-of-completion method of accounting, using the cumulative catch-up method to account for revisions in estimates. The percentage-of-completion method of accounting involves the use of various estimating techniques to project revenues and costs at completion and various assumptions and projections relative to the outcome of future events, including the quantity and timing of product deliveries, future labor performance and rates, and material and overhead costs. These assumptions involve various levels of expected performance improvements. Under the cumulative catch-up method, the impact of revisions in our estimates related to units shipped to date is recognized immediately.

 

Because of the significance of the judgments and estimates described above, it is likely that we could record materially different amounts if we used different assumptions or if the underlying circumstances or estimates were to change. Accordingly, changes in underlying assumptions, circumstances or estimates may materially affect our future financial performance.

 

Competitive pressures may adversely affect our business and financial results.

 

The aerospace industry in which we operate is highly competitive. We compete worldwide with a number of U.S. and foreign companies that are both larger and smaller than we are in terms of resources and market share, and some of which are our customers. While we are the market and technology leader in many of our products, in certain areas some of our competitors may have more extensive or more specialized engineering, manufacturing or marketing capabilities and lower manufacturing cost. As a result, these competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or may be able to devote greater resources to the development, promotion and sale of their products than we can.

 

The significant consolidation occurring in the aerospace industry could adversely affect our business and financial results.

 

The aerospace industry in which we operate has been experiencing significant consolidation among suppliers, including us and our competitors, and the customers we serve. Commercial airlines have increasingly been merging and creating global alliances to achieve greater economies of scale and enhance their geographic reach. Aircraft manufacturers have made acquisitions to expand their product portfolios to better compete in the global marketplace. In addition, aviation suppliers have been consolidating and forming alliances to broaden their product and integrated system offerings and achieve critical mass. This supplier consolidation is in part attributable to aircraft manufacturers and airlines more frequently awarding long-term sole source or preferred supplier contracts to the most capable suppliers, thus reducing the total number of suppliers from whom components and systems are purchased. Our business and financial results may be adversely impacted as a result of consolidation by our competitors or customers.

 

Expenses related to employee and retiree medical and pension benefits may continue to rise.

 

We have periodically experienced significant increases in expenses related to our employee and retiree medical and pension benefits. Although we have taken action seeking to contain these cost increases, including making material changes to some of these plans, there are risks that our expenses will rise as a result of continued increases in medical costs due to increased usage of medical benefits and medical cost inflation in the U.S. Pension expense may increase if investment returns on our pension plan assets do not meet our long-term return assumption, if there are reductions in the discount rate used to determine the present value of our benefit obligation, or if other actuarial assumptions are not realized.

 

The aerospace industry is highly regulated.

 

The aerospace industry is highly regulated in the U.S. by the Federal Aviation Administration and in other countries by similar regulatory agencies. We must be certified by these agencies and, in some cases, by individual OE manufacturers in order to engineer and service systems and components used in specific aircraft models. If material authorizations or approvals were revoked or suspended, our operations would be adversely affected. New or more stringent governmental regulations may be adopted, or industry oversight heightened, in the future, and we may incur significant expenses to comply with any new regulations or any heightened industry oversight.

 

We may have liabilities relating to environmental laws and regulations that could adversely affect our financial results.

 

We are subject to various domestic and international environmental laws and regulations which may require that we investigate and remediate the effects of the release or disposal of materials at sites associated with past and present operations. We are currently involved in the investigation and remediation of a number of sites for which we have been identified as a potentially responsible party under these laws. Based on currently available information, we do not believe that future environmental costs in excess of those accrued with respect to such sites will have a material adverse effect on our financial condition. We cannot assure you that additional future developments, administrative actions or liabilities relating to environmental matters will not have a material adverse effect on our results of operations and/or cash flows in a given period.

 

In connection with the divestiture of our tire, vinyl and other businesses, we received contractual rights of indemnification from third parties for environmental and other claims arising out of the divested businesses. If these third parties do not honor their indemnification obligations

to us, it could have a material adverse effect on our financial condition, results of operations and/or cash flows.

 

Any material product liability or environmental claims in excess of insurance may adversely affect us.

 

We are exposed to potential liability for personal injury or death with respect to products that have been designed, manufactured, serviced or sold by us, including potential liability for asbestos and other toxic tort claims. In addition, we are exposed to potential liability pursuant to various domestic and international environmental laws and regulations. While we believe that we have substantial insurance coverage available to us related to any such claims, our insurance may not cover all liabilities. Additionally, insurance coverage may not be available in the future at a cost acceptable to us. Any material liability not covered by insurance or for which third-party indemnification is not available could have a material adverse effect on our financial condition, results of operations and/or cash flows.

 

Any material product warranty obligations may adversely affect us.

 

Our operations expose us to potential liability for warranty claims made by third parties with respect to aircraft components that have been designed, manufactured, distributed or serviced by us. Any material product warranty obligations could have a material adverse effect on our financial condition, results of operations and/or cash flows.

 

Our operations depend on our production facilities throughout the world. These production facilities are subject to physical and other risks that could disrupt production.

 

Our production facilities could be damaged or disrupted by a natural disaster, labor strike, war, political unrest, terrorist activity or a pandemic. Although we have obtained property damage and business interruption insurance, a major catastrophe such as an earthquake or other natural disaster at any of our sites, or significant labor strikes, work stoppages, political unrest, war or terrorist activities in any of the areas where we conduct operations, could result in a prolonged interruption of our business. Any disruption resulting from these events could cause significant delays in shipments of products and the loss of sales and customers. We cannot assure you that we will have insurance to adequately compensate us for any of these events.

 

We have significant international operations and assets and are therefore subject to additional financial and regulatory risks.

 

We have operations and assets throughout the world. In addition, we sell our products and services in foreign countries and seek to increase our level of international business activity. Accordingly, we are subject to various risks, including: U.S.-imposed embargoes of sales to specific countries; foreign import controls (which may be arbitrarily imposed or enforced); price and currency controls; exchange rate fluctuations; dividend remittance restrictions; expropriation of assets; war, civil uprisings and riots; government instability; the necessity of obtaining governmental approval for new and continuing products and operations; legal systems of decrees, laws, taxes, regulations, interpretations and court decisions that are not always fully developed and that may be retroactively or arbitrarily applied; and difficulties in managing a global enterprise. We may also be subject to unanticipated income taxes, excise duties, import taxes, export taxes or other governmental assessments. Any of these events could result in a loss of business or other unexpected costs that could reduce sales or profits and have a material adverse effect on our financial condition, results of operations and/or cash flows.

 

We are exposed to foreign currency risks that arise from normal business operations. These risks include transactions denominated in foreign currencies and the translation of certain non-functional currency balances of our subsidiaries. Our international operations also expose us to

translation risk when the local currency financial statements are translated to U.S. Dollars, our parent company’s functional currency. As currency exchange rates fluctuate, translation of the statements of income of international businesses into U.S. Dollars will affect comparability of revenues and expenses between years.

 

Creditors may seek to recover from us if the businesses that we spun off are unable to meet their obligations in the future, including obligations to asbestos claimants.

 

On May 31, 2002, we completed the spin-off of our wholly owned subsidiary, EnPro Industries, Inc. (EnPro). Prior to the spin-off, we contributed the capital stock of Coltec Industries Inc (Coltec) to EnPro. At the time of the spin-off, two subsidiaries of Coltec were defendants in a significant number of personal injury claims relating to alleged asbestos-containing products sold by those subsidiaries. It is possible that asbestos-related claims might be asserted against us on the theory that we have some responsibility for the asbestos-related liabilities of EnPro, Coltec or its subsidiaries, even though the activities that led to those claims occurred prior to our ownership of any of those subsidiaries. Also, it is possible that a claim might be asserted against us that Coltec’s dividend of its aerospace business to us prior to the spin-off was made at a time when Coltec was insolvent or caused Coltec to become insolvent. Such a claim could seek recovery from us on behalf of Coltec of the fair market value of the dividend.

 

A limited number of asbestos-related claims have been asserted against us as “successor” to Coltec or one of its subsidiaries. We believe that we have substantial legal defenses against these claims, as well as against any other claims that may be asserted against us on the theories described above. In addition, the agreement between EnPro and us that was used to effectuate the spin-off provides us with an indemnification from EnPro covering, among other things, these liabilities. The success of any such asbestos-related claims would likely require, as a practical matter, that Coltec’s subsidiaries were unable to satisfy their asbestos-related liabilities and that Coltec was found to be responsible for these liabilities and was unable to meet its financial obligations. We believe any such claims would be without merit and that Coltec was solvent both before and after the dividend of its aerospace business to us. If we are ultimately found to be responsible for the asbestos-related liabilities of Coltec’s subsidiaries, we believe it would not have a material adverse effect on our financial condition, but could have a material adverse effect on our results of operations and cash flows in a particular period. However, because of the uncertainty as to the number, timing and payments related to future asbestos-related claims, there can be no assurance that any such claims will not have a material adverse effect on our financial condition, results of operations and cash flows. If a claim related to the dividend of Coltec’s aerospace business were successful, it could have a material adverse impact on our financial condition, results of operations and/or cash flows.

 

 

Not applicable.

 

 

We operate manufacturing plants and service and other facilities throughout the world.

 

Information with respect to our significant facilities that are owned or leased is set forth below:

 

 

 

 

Our headquarters is in Charlotte, North Carolina. In May 2000, we leased approximately 120,000 square feet for an initial term of ten years, with two five-year options to 2020. The offices provide space for our corporate and segment headquarters.

 

We and our subsidiaries are lessees under a number of cancelable and non-cancelable leases for real properties, used primarily for administrative, maintenance, repair and overhaul of aircraft, aircraft wheels and brakes and evacuation systems and warehouse operations.

 

In the opinion of management, our principal properties, whether owned or leased, are suitable and adequate for the purposes for which they are used and are suitably maintained for such purposes. See Item 3, “Legal Proceedings-Environmental” for a description of proceedings under applicable environmental laws regarding some of our properties.

 

 

General

 

There are pending or threatened against us, various claims, lawsuits and administrative proceedings, arising from the ordinary course of business, including commercial, product liability, asbestos and environmental matters, which seek remedies or damages. Although no assurance can be given with respect to the ultimate outcome of these matters, we believe that any liability

that may finally be determined with respect to commercial and non-asbestos product liability claims should not have a material effect on our consolidated financial position, results of operations or cash flow. From time to time, we are also involved in legal proceedings as a plaintiff involving tax, contract, patent protection, environmental and other matters. Gain contingencies, if any, are recognized when they are realized. Legal costs are generally expensed as incurred.

 

Environmental

 

We are subject to various domestic and international environmental laws and regulations which may require that we investigate and remediate the effects of the release or disposal of materials at sites associated with past and present operations, including divested sites for which we have contractual obligations relating to the environmental conditions of such site. At certain sites, we have been identified as a potentially responsible party under the federal Superfund laws and comparable state laws. We are currently involved in the investigation and remediation of a number of sites under these laws.

 

Estimates of our environmental liabilities are based on currently available facts, present laws and regulations and current technology. Such estimates take into consideration our prior experience in site investigation and remediation, the data concerning cleanup costs available from other companies and regulatory authorities and the professional judgment of our environmental specialists in consultation with outside environmental specialists, when necessary. Estimates of our environmental liabilities are further subject to uncertainties regarding the nature and extent of site contamination, the range of remediation alternatives available, evolving remediation standards, imprecise engineering evaluations and estimates of appropriate cleanup technology, methodology and cost, the extent of corrective actions that may be required and the number and financial condition of other potentially responsible parties, as well as the extent of their responsibility for the remediation.

 

Accordingly, as investigation and remediation of these sites proceed, it is likely that adjustments in our accruals will be necessary to reflect new information. The amounts of any such adjustments could have a material adverse effect on the results of operations in a given period, but the amounts, and the possible range of loss in excess of the amounts accrued, are not reasonably estimable. Based on currently available information, however, we do not believe that future environmental costs in excess of those accrued with respect to sites for which we have been identified as a potentially responsible party are likely to have a material adverse effect on our financial condition. There can be no assurance, however, that additional future developments, administrative actions or liabilities relating to environmental matters will not have a material adverse effect on our results of operations or cash flows in a given period.

 

Environmental liabilities are recorded when the liability is probable and the costs are reasonably estimable, which generally is not later than at completion of a feasibility study or when we have recommended a remedy or have committed to an appropriate plan of action. The liabilities are reviewed periodically and, as investigation and remediation proceed, adjustments are made as necessary. Liabilities for losses from environmental remediation obligations do not consider the effects of inflation and anticipated expenditures are not discounted to their present value. The liabilities are not reduced by possible recoveries from insurance carriers or other third parties, but do reflect anticipated allocations among potentially responsible parties at federal Superfund sites or similar state-managed sites and an assessment of the likelihood that such parties will fulfill their obligations at such sites.

 

Our Consolidated Balance Sheet included an accrued liability for environmental remediation obligations of $74.3 million and $81 million at December 31, 2006 and 2005, respectively. At December 31, 2006 and 2005, $17.7 million and $18.3 million, respectively, of the accrued liability for environmental remediation was included in current liabilities as accrued expenses. At

December 31, 2006 and 2005, $31 million and $31.4 million, respectively, was associated with ongoing operations and $43.3 million and $49.6 million, respectively, was associated with businesses previously disposed of or discontinued.

 

The timing of expenditures depends on a number of factors that vary by site, including the nature and extent of contamination, the number of potentially responsible parties, the timing of regulatory approvals, the complexity of the investigation and remediation, and the standards for remediation. We expect that we will expend present accruals over many years, and will generally complete remediation in less than 30 years at all sites for which it has been identified as a potentially responsible party. This period includes operation and monitoring costs that are generally incurred over 15 to 25 years.

 

Asbestos

 

We and a number of our subsidiaries have been named as defendants in various actions by plaintiffs alleging injury or death as a result of exposure to asbestos fibers in products, or which may have been present in our facilities. A number of these cases involve maritime claims, which have been and are expected to continue to be administratively dismissed by the court. These actions primarily relate to previously owned businesses. We believe that pending and reasonably anticipated future actions, net of anticipated insurance recoveries, are not likely to have a material adverse effect on our financial condition, results of operations or cash flows. There can be no assurance, however, that future legislative or other developments will not have a material adverse effect on our results of operations or cash flow in a given period.

 

Insurance Coverage

 

We believe that we have substantial insurance coverage available to us related to third party claims. However, the pre-1976 primary layer of insurance coverage was provided by the Kemper Insurance Companies (Kemper). Kemper has indicated that, due to capital constraints and downgrades from various rating agencies, it has ceased underwriting new business and now focuses on administering policy commitments from prior years. Kemper has also indicated that it is currently operating under a “run-off” plan under the supervision of the Illinois Division of Insurance. We cannot predict the impact of Kemper’s financial position on the availability of the Kemper insurance.

 

In addition, a portion of our primary and excess layers of pre-1986 insurance coverage for third party claims was provided by certain insurance carriers who are either insolvent or undergoing solvent schemes of arrangement. We have entered into settlement agreements with a number of these insurers pursuant to which we agreed to give up our rights with respect to certain insurance policies in exchange for negotiated payments, some of which are subject to increase under certain circumstances. These settlements represent negotiated payments for our loss of insurance coverage, as we no longer have insurance available for claims that may have qualified for coverage. These settlements have been recorded as income for reimbursement of past claim payments under the settled insurance policies and as a deferred settlement credit for future claim payments.

 

At December 31, 2006, the deferred settlement credit was approximately $38 million for which $2.8 million is reported in accrued expenses and $35.2 million was reported in other non-current liabilities. The proceeds from such insurance settlements were reported as a component of net cash provided by operating activities.

 

Liabilities of Divested Businesses

 

Asbestos

 

In May 2002, we completed the tax-free spin-off of our Engineered Products (EIP) segment, which at the time of the spin-off included EnPro and Coltec. At that time, two subsidiaries of Coltec were defendants in a significant number of personal injury claims relating to alleged asbestos-containing products sold by those subsidiaries. It is possible that asbestos-related claims might be asserted against us on the theory that we have some responsibility for the asbestos-related liabilities of EnPro, Coltec or its subsidiaries, even though the activities that led to those claims occurred prior to our ownership of any of those subsidiaries. Also, it is possible that a claim might be asserted against us that Coltec’s dividend of its aerospace business to us prior to the spin-off was made at a time when Coltec was insolvent or caused Coltec to become insolvent. Such a claim could seek recovery from us on behalf of Coltec of the fair market value of the dividend.

 

A limited number of asbestos-related claims have been asserted against us as “successor” to Coltec or one of its subsidiaries. We believe that we have substantial legal defenses against these claims, as well as against any other claims that may be asserted against us on the theories described above. In addition, the agreement between EnPro and us that was used to effectuate the spin-off provides us with an indemnification from EnPro covering, among other things, these liabilities. The success of any such asbestos-related claims would likely require, as a practical matter, that Coltec’s subsidiaries were unable to satisfy their asbestos-related liabilities and that Coltec was found to be responsible for these liabilities and was unable to meet its financial obligations. We believe any such claims would be without merit and that Coltec was solvent both before and after the dividend of its aerospace business to us. If we are ultimately found to be responsible for the asbestos-related liabilities of Coltec’s subsidiaries, it believes such finding would not have a material adverse effect on its financial condition, but could have a material adverse effect on its results of operations and cash flows in a particular period. However, because of the uncertainty as to the number, timing and payments related to future asbestos-related claims, there can be no assurance that any such claims will not have a material adverse effect on our financial condition, results of operations and cash flows. If a claim related to the dividend of Coltec’s aerospace business were successful, it could have a material adverse impact on our financial condition, results of operations and cash flows.

 

Tax

 

We are continuously undergoing examination by the Internal Revenue Service (IRS), as well as various state and foreign jurisdictions. The IRS and other taxing authorities routinely challenge certain deductions and credits reported by us on our income tax returns. In accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” (SFAS 109) and Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (SFAS 5), we establish reserves for tax contingencies that reflect our best estimate of the deductions and credits that we may be unable to sustain, or that we could be willing to concede as part of a broader tax settlement. Differences between the reserves for tax contingencies and the amounts ultimately owed by us are recorded in the period they become known. Adjustments to our reserves could have a material effect on our financial statements. As of December 31, 2006, we had recorded tax contingency reserves of approximately $173 million.

 

In 2000, Coltec, a former Goodrich subsidiary, paid $113.7 million to the IRS. This payment represented the tax and accrued interest arising out of the IRS’s disallowance of a capital loss and certain tax credits relating to Coltec’s 1996 tax year. On February 13, 2001, Coltec filed suit against the U.S. Government in the U.S. Court of Federal Claims for a refund of this payment. The case went to trial, and on November 2, 2004, the trial court ruled in favor of Coltec. During 2005, the government appealed the decision to the U.S. Court of Appeals for the Federal Circuit.

The appeals court reversed the decision of the trial court on July 12, 2006. On August 2, 2006, we paid the tax and accrued interest relating to subsequent years of approximately $57 million to the IRS. On November 8, 2006, Coltec filed a petition for a writ of certiorari with the Supreme Court of the United States asking the Court to review the decision of the appeals court. On February 20, 2007 the Supreme Court of the United States denied Coltec’s petition. Coltec does not owe any additional federal income tax or interest with respect to these matters for the years 1996 through 2000. There is no financial statement effect since all related impacts for this case were previously recorded.

 

In 2000, the IRS issued a statutory notice of deficiency asserting that Rohr, Inc. (Rohr), a subsidiary of ours was liable for $85.3 million of additional income taxes for the fiscal years ended July 31, 1986 through 1989. In 2003, the IRS issued an additional statutory notice of deficiency asserting that Rohr was liable for $23 million of additional income taxes for the fiscal years ended July 31, 1990 through 1993. The proposed assessments relate primarily to the timing of certain tax deductions and tax credits. Rohr filed petitions in the U.S. Tax Court opposing the proposed assessments. We previously reached a tentative settlement agreement with the IRS with regard to the proposed assessments that required further review by the Joint Committee on Taxation (JCT). On March 15, 2006, we received notification that the JCT approved the tentative settlement agreement entered into with the IRS. As a result of receiving the JCT notification, we recorded a tax benefit of approximately $74.1 million, primarily related to the reversal of tax reserves, during 2006.

 

The current IRS examination cycle began on September 29, 2005 and involves the taxable years ended December 31, 2000 through December 31, 2004. Based on communications with the IRS exam team, we expect field examination of the current cycle to be completed during 2007. The prior examination cycle which began in March 2002, includes the consolidated income tax groups in the audit periods identified below:

 

 

There were numerous tax issues that had been raised by the IRS as part of the prior examination, including, but not limited to, transfer pricing, research and development credits, foreign tax credits, tax accounting for long-term contracts, tax accounting for inventory, tax accounting for stock options, depreciation, amortization and the proper timing for certain other deductions for income tax purposes. We previously reached tentative settlement agreements with the IRS on substantially all of the issues raised with respect to the prior examination cycle. Due to the amount of tax involved, certain portions of the tentative settlement agreements were required to be reviewed by the JCT. We received notification on April 25, 2006 that the JCT approved the tentative settlement agreement entered into with the IRS with regard to Rohr, Inc. and Subsidiaries (for the period from July, 1995 through December, 1997). As a result of receiving the JCT notification, we recorded a tax benefit of approximately $14.9 million, primarily related to the reversal of tax reserves, during 2006. In addition to the JCT approvals with regard to Rohr, we reached agreement with the IRS regarding most of the issues with respect to Coltec Industries Inc and Subsidiaries (for the period from December, 1997 through July, 1999). Consequently, we recorded a tax benefit of approximately $44.4 million, primarily related to the reversal of tax reserves, during 2006. During 2006, we reached final settlement with the IRS on substantially all of the issues relating to the Goodrich Corporation and Subsidiaries 1998-1999 examination cycle. As a result, we recorded a benefit of approximately $13.5 million, primarily related to the reversal of tax reserves. We anticipate filing a petition with the U.S. Tax Court to contest the remaining unresolved issues which involve the proper

timing of certain deductions. The amount of the estimated tax liability if the IRS were to prevail is fully reserved. We cannot predict the timing or ultimate outcome of the remaining issues.

 

Rohr has been under examination by the State of California for the tax years ended July 31, 1985, 1986 and 1987. The State of California has disallowed certain expenses incurred by one of Rohr’s subsidiaries in connection with the lease of certain tangible property. California’s Franchise Tax Board held that the deductions associated with the leased equipment were non-business deductions. The additional tax associated with the Franchise Tax Board’s position was approximately $4.5 million. The amount of accrued interest associated with the additional tax was approximately $20 million as of December 31, 2006. In addition, the State of California enacted an amnesty provision that imposes nondeductible penalty interest equal to 50% of the unpaid interest amounts relating to taxable years ended before 2003. The penalty interest was approximately $10 million as of December 31, 2006. The tax and interest amounts continue to be contested by Rohr. We believe that we are adequately reserved for this contingency. During 2005, Rohr made payments of approximately $3.9 million ($0.6 million for tax and $3.3 million for interest) related to items that are not being contested and approximately $4.5 million related to items that are being contested. No payment has been made for the $20 million of interest or $10 million of penalty interest. Under California law, Rohr may be required to pay the full amount of interest prior to filing any suit for refund. If required, Rohr expects to make this payment and file suit for a refund in late 2007 or early 2008.

 

 

Not applicable.

 

Executive Officers of the Registrant

 

Marshall O. Larsen, age 58, Chairman, President and Chief Executive Officer

 

Mr. Larsen joined the Company in 1977 as an Operations Analyst. In 1981, he became Director of Planning and Analysis and subsequently Director of Product Marketing. In 1986, he became Assistant to the President and later served as General Manager of several divisions of the Company’s aerospace business. He was elected a Vice President of the Company and named a Group Vice President of Goodrich Aerospace in 1994 and was elected an Executive Vice President of the Company and President and Chief Operating Officer of Goodrich Aerospace in 1995. He was elected President and Chief Operating Officer and a director of the Company in February 2002, Chief Executive Officer in April 2003 and Chairman in October 2003. Mr. Larsen is a director of Lowe’s Companies, Inc. He received a B.S. in engineering from the U.S. Military Academy and an M.S. in industrial management from the Krannert Graduate School of Management at Purdue University.

 

John J. Carmola, age 51, Vice President and Segment President, Actuation and Landing Systems

 

Mr. Carmola joined the Company in 1996 as President of the Landing Gear Division. He served in that position until 2000, when he was appointed President of the Engine Systems Division. Later in 2000, Mr. Carmola was elected a Vice President of the Company and Group President, Engine and Safety Systems. In 2002, he was elected Vice President and Group President, Electronic Systems. He was elected Vice President and Segment President, Engine Systems, in 2003, Vice President and Segment President, Airframe Systems, in 2005, and Vice President and Segment President, Actuation and Landing Systems in 2007. Prior to joining the Company, Mr. Carmola served in various management positions with General Electric Company. Mr. Carmola received a B.S. in mechanical and aerospace engineering from the University of Rochester and an M.B.A. in finance from Xavier University.

 

Cynthia M. Egnotovich, age 49, Vice President and Segment President, Nacelles and Interior Systems

 

Ms. Egnotovich joined the Company in 1986 and served in various positions with the Ice Protection Systems Division, including Controller from 1993 to 1996, Director of Operations from 1996 to 1998 and Vice President and General Manager from 1998 to 2000. Ms. Egnotovich was appointed as Vice President and General Manager of Commercial Wheels and Brakes in 2000. She was elected a Vice President of the Company and Group President, Engine and Safety Systems in 2002. In 2003, she was elected Vice President and Segment President, Electronic Systems. Ms. Egnotovich was elected Vice President and Segment President, Engine Systems in 2005. In 2007, she was elected Vice President and Segment President, Nacelles and Interior Systems. Ms. Egnotovich received a B.B.A. in accounting from Kent State University and a B.S. in biology from Immaculata College.

 

Gerald T. Witowski, age 59, Vice President and Segment President, Electronic Systems

 

Mr. Witowski joined the Company in 1978 as a Marketing Engineer in the Sensor Systems business. He was promoted to Vice President of Marketing and Sales in 1988 and was named Vice President and General Manager for the Commercial Transport Business Unit of Sensor Systems as well the head of Goodrich’s Test System Business Unit in New Century, Kansas in 1997. In January 2001, he was named President and General Manager of Sensor Systems. He was elected to his current position in March 2006. Prior to joining Goodrich, Mr. Witowski spent 10 years on active duty in the U.S. Navy where he was a commissioned officer and pilot. Mr. Witowski received a B.S. in Aerospace Engineering, Naval Science from the U.S. Naval Academy and an M.A. in Management and Human Relations from Webster University.

 

John J. Grisik, age 60, Executive Vice President, Operational Excellence and Technology

 

Mr. Grisik joined the Company in 1991 as General Manager of the De-Icing Systems Division. He served in that position until 1993, when he was appointed General Manager of the Landing Gear Division. In 1995, he was appointed Group Vice President of Safety Systems and served in that position until 1996 when he was appointed Group Vice President of Sensors and Integrated Systems. In 2000, Mr. Grisik was elected a Vice President of the Company and Group President, Landing Systems. He was elected Vice President and Segment President, Airframe Systems, in 2003, Vice President and Segment President, Electronic Systems, in 2005 and Executive Vice President, Operational Excellence and Technology in March 2006. Prior to joining the Company, Mr. Grisik served in various management positions with General Electric Company and U.S. Steel Company. Mr. Grisik received a B.S., M.S. and D.S. in engineering from the University of Cincinnati and an M.S. in management from Stanford University.

 

Terrence G. Linnert, age 60, Executive Vice President, Administration and General Counsel

 

Mr. Linnert joined the Company in 1997 as Senior Vice President and General Counsel. In 1999, he was elected to the additional positions of Senior Vice President, Human Resources and Administration, and Secretary. He was elected Executive Vice President, Human Resources and Administration, General Counsel in 2002 and Executive Vice President, Administration and General Counsel in February 2005. Prior to joining Goodrich, Mr. Linnert was Senior Vice President of Corporate Administration, Chief Financial Officer and General Counsel of Centerior Energy Corporation. Mr. Linnert received a B.S. in electrical engineering from the University of Notre Dame and a J.D. from the Cleveland-Marshall School of Law at Cleveland State University.

 

Scott E. Kuechle, age 47, Senior Vice President and Chief Financial Officer

 

Mr. Kuechle joined the Company in 1983 as a Financial Analyst in the Company’s former Tire Division. He has held several subsequent management positions, including Manager of Planning

and Analysis in the Tire Division, Manager of Analysis in Corporate Analysis and Control as well as Director of Planning and Control for the Company’s former Water Systems and Services Group. He was promoted to Director of Finance and Banking in 1994 and elected Vice President and Treasurer in 1998. Mr. Kuechle was elected Vice President and Controller in September 2004 and served in that position until his election as Senior Vice President and Chief Financial Officer in August 2005. Mr. Kuechle received a B.B.A. in economics from the University of Wisconsin — Eau Claire and an M.S.I.A. in finance from Carnegie-Mellon University.

 

Jennifer Pollino, age 42, Senior Vice President, Human Resources

 

Ms. Pollino joined the Company in 1992 as an Accounting Manager at Aircraft Evacuation Systems and since that time has served in a variety of positions, including Controller of Aircraft Evacuation Systems from 1995 to 1998, Vice President, Finance of the Safety Systems from 1999 to 2000, Vice President and General Manager of Aircraft Seating Products from 2000 to 2001, President and General Manager of Turbomachinery Products from 2001 to 2002 and President and General Manager of Aircraft Wheels and Brakes from 2002 to 2005. She was elected as Senior Vice President, Human Resources in February 2005. Prior to joining Goodrich, Ms. Pollino served as a Field Accounting Officer for the Resolution Trust Corporation from 1990 to 1992, as Controller of Lincoln Savings and Loan Association from 1987 to 1990 and as an Auditor for Peat Marwick Main & Co. from 1986 to 1987. Ms. Pollino received a B.B.A. in accounting from the University of Notre Dame.

 

Scott A. Cottrill, age 41, Vice President and Controller

 

Mr. Cottrill joined the Company in 1998 as Director — External Reporting. He later served as Director — Accounting and Financial Reporting from 1999 to 2002 and as Vice President, Internal Audit from 2002 to 2005. Mr. Cottrill was elected as Vice President and Controller effective October 2005. Prior to joining the Company, Mr. Cottrill served as a Senior Manager with PricewaterhouseCoopers LLP. Mr. Cottrill received a B.S. in accounting from The Pennsylvania State University and is a Certified Public Accountant and a Certified Internal Auditor.

 

PART II

 

 

Our common stock (symbol GR) is listed on the New York Stock Exchange. The following table sets forth on a per share basis, the high and low sale prices for our common stock for the periods indicated as reported on the New York Stock Exchange composite transactions reporting system, and the cash dividends declared on our common stock for these periods.

 

 

As of December 31, 2006, there were 8,736 holders of record of our common stock.

 

Our debt agreements contain various restrictive covenants that, among other things, place limitations on the payment of cash dividends and our ability to repurchase our capital stock. Under the most restrictive of these agreements, $990.2 million of income retained in the business and additional capital was free from such limitations at December 31, 2006.

 

The following table summarizes our purchases of our common stock for the quarter ended December 31, 2006:

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

 

 

 

 

Selected Financial Data(a)

 

 

 

 

YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS IN CONJUNCTION WITH OUR AUDITED CONSOLIDATED FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THIS DOCUMENT.

 

THIS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS. SEE “FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY” FOR A DISCUSSION OF CERTAIN OF THE UNCERTAINTIES, RISKS AND ASSUMPTIONS ASSOCIATED WITH THESE STATEMENTS.

 

OUR FORMER JCAIR INC. (TEST SYSTEMS) BUSINESS HAS BEEN ACCOUNTED FOR AS DISCONTINUED OPERATIONS. UNLESS OTHERWISE NOTED HEREIN, DISCLOSURES PERTAIN ONLY TO OUR CONTINUING OPERATIONS.

 

OVERVIEW

 

We are one of the largest worldwide suppliers of aerospace components, systems and services to the commercial and general aviation airplane markets. We are also a leading supplier of systems and products to the global defense and space markets. Our business is conducted globally with manufacturing, service and sales undertaken in various locations throughout the world. Our products and services are principally sold to customers in North America, Europe and Asia.

 

Key Market Channels for Products and Services, Growth Drivers and Industry and our Highlights

 

We participate in three key market channels:  commercial and general aviation airplane original equipment (OE); commercial and general aviation airplane aftermarket; and defense and space.

 

Commercial and General Aviation Airplane OE

 

Commercial and general aviation airplane OE includes sales of products and services for new airplanes produced by Airbus S.A.S. (Airbus) and The Boeing Company (Boeing), as well as regional, business and small airplane manufacturers.

 

The key growth drivers in this market channel include the number of orders for new airplanes, which will be delivered to the manufacturers’ customers over a period of several years, OE manufacturer production and delivery rates and introductions of new airplane models such as the Boeing 787 and 747-8, the Airbus A380 and A350 XWB and the Embraer 190 airplanes.

 

We have significant sales content on most of the airplanes manufactured in this market channel. We have benefited from increased production rates and deliveries of Airbus and Boeing airplanes and from our substantial content on many of the regional and general aviation airplanes. We were also awarded several new contracts for our products on airplanes currently in a pre-production stage, including the Boeing 787 and 747-8 and the Airbus A380 and A350 XWB, which should provide substantial future sales growth for us.

 

During 2006 and 2005, orders for Airbus and Boeing commercial airplanes were at record levels, with many of the orders for deliveries beyond 2008. While orders for regional airplanes were not nearly as strong in 2006 as those for the larger airplanes, the unfilled backlog of orders remained substantial. During 2006, orders for general aviation airplanes, including business jets, continued to be strong as well. These orders are expected to generate substantial future sales for us.

 

Commercial and General Aviation Airplane Aftermarket

 

The commercial and general aviation airplane aftermarket channel includes sales of products and services for existing commercial and general aviation airplanes, primarily to airlines and package carriers around the world.

 

The key growth drivers in this channel include worldwide passenger capacity growth measured by Available Seat Miles (ASM) and the size and activity level of the airplane fleet. Other important factors affecting growth in this market channel are the age of the airplanes in the fleet and Gross Domestic Product (GDP) trends in countries and regions around the world.

 

We estimate that capacity in the global airline system, as measured by ASMs, will grow approximately 4% to 5% annually in 2007 through 2011. We expect that the global airplane fleet will continue to grow in 2007 and beyond, as the OE manufacturers are expected to deliver more airplanes than are retired.

 

We have significant product content on most of the airplane models that are currently in service. We have benefited from good growth in ASMs, especially in Asia, and from the aging of the worldwide fleet of airplanes.

 

Defense and Space

 

Worldwide defense and space sales include sales to prime contractors such as Boeing, Northrop Grumman, Lockheed Martin, the U.S. Government and foreign companies and governments.

 

The key growth drivers in this channel include the level of defense spending by the U.S. and foreign governments, the number of new platform starts, the level of military flight operations and the level of upgrade, overhaul and maintenance activities associated with existing platforms.

 

The market for our defense and space products is global, and is not dependent on any single program, platform or customer. While we anticipate fewer new platform starts over the next several years, which are expected to negatively affect OE sales, we anticipate that upgrades on existing defense and space platforms will be necessary and will provide long-term growth in this market channel. Additionally, we are participating in, and developing new products for the rapidly expanding homeland security and intelligence, surveillance and reconnaissance sectors, which should further strengthen our position in this market channel.

 

Long-term Sustainable Growth

 

We believe that we are well positioned to continue to grow our commercial airplane and defense and space sales due to:

 

 

 

Year Ended December 31, 2006 Sales Content by Market Channel

 

During 2006, approximately 94% of our sales were from our three primary market channels described above. Following is a summary of the percentage of sales by market channel:

 

 

Summary Performance — Year Ended December 31, 2006 as Compared to the Year Ended December 31, 2005

 

 

 

 

Our 2006 sales and income performance was driven primarily by sales growth in our commercial, regional and general aviation airplane market channels as follows:

 

 

The sales growth described above was partially offset by a decrease in defense and space OE and aftermarket sales of approximately 1%, which is net of defense and space sales growth in the Electronic Systems segment of 12%.

 

The change in income from continuing operations before income taxes during 2006 as compared to 2005 was impacted by the following items:

 

 

The change in our foreign exchange impact during 2006 as compared to 2005 was comprised of the following:

 

 

For additional information on our cash flow hedges and other forward contracts see Note 19, “Derivatives and Hedging Activities” to our Consolidated Financial Statements.

 

During 2006, share-based compensation expense was approximately $23.8 million higher than in 2005. The increase was primarily driven by approximately $18 million of incremental compensation expense recognized during 2006 as a result of recognizing an accelerated portion of the total compensation expense on awards granted to retirement eligible employees in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based

Payment” (SFAS 123(R)). Approximately $10 million of the $18 million was recorded in the fourth quarter of 2006 upon approval of the 2007 grants. For additional information, see “Adoption of SFAS No. 123(R)” under “Results of Operations”.

 

During 2005, we incurred charges approximating $16.2 million to reserve for costs associated with the redesign and retrofit of actuators for the A380 aircraft.

 

During 2005, we recorded net cumulative catch-up charges of $17.3 million and a charge of $7.3 million related to the termination of the Boeing 737NG contract at our aerostructures business. During 2006, net cumulative catch-up charges were $3.8 million. The net cumulative catch-up charges during 2005 resulted from significant increased cost estimates primarily on two contracts, which more than offset reduced cost estimates on other contracts.

 

During 2006, we exchanged approximately $530 million of our long-term notes for similar notes of longer duration. The exchange reduces the amount of debt that matures in the years from 2008 to 2012 and the interest rates associated with the refinanced debt is lower than the debt it replaced. We recorded a charge of $4.8 million for costs associated with the transaction. During 2005, we recorded premiums and other costs of $11.6 million associated with the early retirement of $182.1 million of long-term debt.

 

During 2006, we reported an effective tax rate benefit of 4.2%, including a benefit of approximately 32% related to the Rohr and Coltec tax cases and for several additional settlements and refunds. The effective tax rate excluding the benefit related to these items would have been approximately 28% for 2006.

 

Income from discontinued operations, after tax, was $0.3 million ($0.01 per diluted share) and $19.8 million ($0.16 per diluted share), during 2006 and 2005, respectively. During 2005, we recognized a $13.2 million after tax gain on the sale of Test Systems. During 2006 and 2005, income from discontinued operations included insurance settlements with several insurers relating to the recovery of past costs. For additional information, see Note 6, “Discontinued Operations” to our Consolidated Financial Statements.

 

Net cash provided by operating activities for 2006 was $276.3 million, a decrease of $68.6 million from net cash provided by operating activities of $344.9 million for 2005. The decrease was primarily related to:

 

 

During 2006 and 2005, capital expenditures totaled $256.8 million and $215.5 million, respectively.

 

2007 Outlook

 

We expect the following results for the year ending December 31, 2007:

 

 

 

 

We expect that 2007 will be another year of strong sales growth with improving segment operating income margins. We expect that full year 2007 sales will be in the range of $6.2 to $6.4 billion and 2007 net income per diluted share to be $2.95 to $3.15.

 

The 2007 outlook assumes, among other factors, an effective tax rate of 32% to 33% and successful completion of negotiations of a new long-term agreement to supply landing gear to Boeing. The benefit of the slightly lower tax rate for 2007 is likely to be offset by higher costs associated with pension expense and foreign exchange translation.

 

To provide the most meaningful comparison between net income per diluted share for 2006 and 2007 expected net income per diluted share, we believe that the net income per diluted share of $3.81 for 2006 should be adjusted to remove the $1.15 per diluted share related primarily to the Rohr and Coltec tax settlements since tax benefits of this magnitude are not expected to recur in 2007. Excluding these tax settlements, net income per diluted share for 2006 was $2.66, compared to expected results of $2.95 to $3.15 for 2007.

 

We expect net cash provided by operating activities, minus capital expenditures, to be in the range of 60% to 75% of net income in 2007. This outlook reflects a continuation of cash expenditures for investments in the Boeing 787 and the Airbus A350 XWB and capital expenditures for facility expansions to support increased aftermarket demand, low cost country manufacturing and productivity initiatives designed to enhance margins over the near and long-term. We expect capital expenditures for 2007 to be in a range of $270 to $290 million. Of these capital expenditures, approximately 40% are expected to be associated with investments in low cost country manufacturing, previously announced maintenance, repair and overhaul (MRO) facility expansions and new facilities to support aftermarket sales growth, and expenditures related to the company-wide implementation of an Enterprise Resource Planning (ERP) system. Also included are worldwide pension contributions of $100 million to $125 million, most of which are voluntary contributions.

 

The sales, net income and net cash provided by operating activities outlook for 2007 do not include the impact of acquisitions or divestitures or resolution of an A380 claim against Northrop.

 

Our 2007 outlook is based on certain market assumptions, including the following:

 

 

 

RESULTS OF OPERATIONS

 

Adoption of SFAS No. 123(R)

 

On December 16, 2004, the FASB issued SFAS 123. SFAS 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and amends Statement of Financial Accounting Standards No. 95, “Statement of Cash Flows”. We adopted the SFAS 123 fair value-based method of accounting for share-based payments effective January 1, 2004 using the “modified prospective method” described in Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”. We adopted SFAS 123(R) on January 1, 2006 using the modified-prospective transition method.

 

At December 31, 2006, we had seven types of share-based compensation awards, which are described in Note 23, “Share-Based Compensation Plans,” to our Consolidated Financial Statements. Because we adopted the accounting provisions of SFAS 123 effective January 1, 2004, the compensation cost recognized in accordance with SFAS 123 during 2004 and 2005 should be consistent with the cost that would have been recorded under SFAS 123(R), except for the following differences:

 

 

 

 

The compensation cost recorded for share-based compensation plans during 2006 totaled $57.1 million ($35.8 million after tax, or $0.28 per diluted share) as compared to $33.3 million ($21.7 million after tax, or $0.18 per diluted share) during 2005 and $21.7 million ($15.8 million after tax, or $0.13 per diluted share) during 2004. The increase of $23.8 million from 2005 to 2006 was primarily driven by approximately $18 million of incremental compensation expense during 2006 as a result of recognizing an accelerated portion of the total compensation expense on awards granted to employees who are retirement eligible or will become retirement eligible prior to the normal vesting date.

 

Changes in Accounting Methods

 

Effective January 1, 2004, we changed two aspects of the application of contract accounting to preferable methods for our aerostructures business, which is included in the Engine Systems segment. The first is a change to the cumulative catch-up method from the reallocation method for accounting for changes in contract estimates of revenue and costs. The change was effected

by adjusting contract profit rates from the balance to complete gross profit rate to the estimated gross profit rate at completion of the contract. The second change related to pre-certification costs. Under the old policy, pre-certification costs exceeding the level anticipated in our original investment model used to negotiate contractual terms were expensed when determined regardless of overall contract profitability. Under the new policy, pre-certification costs, including those in excess of original estimated levels, are included in total contract costs used to evaluate overall contract profitability. The impact of the changes in accounting method was to record a $16.2 million after tax gain ($23.3 million before tax gain) as a cumulative effect of change in accounting.

 

Year Ended December 31, 2006 Compared with Year Ended December 31, 2005

 

 

Changes in sales and segment operating income are discussed within the “Business Segment Performance” section below.

 

Corporate general and administrative costs increased $16.6 million for 2006 as compared 2005. The increase was primarily the result of increased share-based compensation of approximately $6 million, which resulted from recognizing additional expense for the 2006 and certain 2007 grants to retirement eligible employees as previously discussed, and due to additional administrative costs relating to the growth in sales.

 

Net interest expense decreased $4.8 million for 2006 as compared to 2005, primarily due to lower debt levels in 2006 and to the interest savings as a result of the debt exchange completed during the second quarter 2006.

 

Other income (expense) — net increased by $18 million for 2006 as compared to 2005, primarily as a result of:

 

 

Our effective tax rate from continuing operations was a benefit of 4.2% during 2006 and an expense of 32.9% during 2005. The decrease in our effective tax rate resulted primarily from the Rohr and Coltec tax cases. The decrease is also due to the absence of tax associated with repatriated earnings under the American Jobs Creation Act during 2005.

 

Income from discontinued operations during 2006 primarily represents net insurance settlements with several insurers relating to the recovery of environmental remediation costs at a former plant previously recorded as a discontinued operation. Income from discontinued operations during 2005, primarily included the $13.2 million gain from the sale of Test Systems and a $7.5 million gain recognized as a result of our settlement with several insurers relating to the recovery of environmental remediation costs at a former plant previously recorded as a discontinued operation.

 

The cumulative effect from the change in accounting resulted in a gain of $0.6 million from the adoption of SFAS 123(R) on January 1, 2006 as previously discussed.

 

Year Ended December 31, 2005 Compared with Year Ended December 31, 2004

 

 

Changes in sales and segment operating income are discussed within the “Business Segment Performance” section below.

 

Corporate general and administrative costs decreased $4.6 million for 2005 as compared to 2004 primarily due to the following:

 

 

Net interest expense decreased $14 million in 2005 as compared to 2004 primarily due to lower debt levels in 2005.

 

Other income (expense) — net decreased by $16.3 million, primarily from the absence in 2005 of a $7 million impairment of a note receivable that was recorded during 2004 and lower expenses

related to divested operations of $10.3 million. Premiums and associated costs related to the early retirement of debt totaled $11.6 million during 2005 and $15.4 million during 2004.

 

Our effective tax rate from continuing operations was 32.9% during 2005 and 21.6% during 2004. The increase in our effective tax rate resulted from U.S. income tax associated with dividends from certain foreign subsidiaries, growth in before tax book income relative to our significant permanent items, the phase-in of the American Jobs Creation Act, which replaces certain export sales deductions with a deduction for income from qualified domestic production activities, and the absence of favorable state and foreign tax settlements, offset in part by additional reserves for certain income tax issues.

 

Income from discontinued operations, after tax, was $19.8 million during 2005 and primarily included a $13.2 million gain from the sale of Test Systems, which was sold during the second quarter of 2005. Income from discontinued operations for Test Systems included net income of $0.9 million in 2005 and net income of $1.7 million in 2004. Income from discontinued operations also included a $7.5 million gain recognized as a result of our settlement with several insurers relating to the recovery of past costs to remediate environmental issues at a former chemical plant.

 

As noted previously in the “Changes in Accounting Methods” section, effective January 1, 2004, we changed two aspects of the application of contract accounting for our aerostructures business which resulted in a $16.2 million after tax gain ($23.3 million before tax gain) that was recorded as a cumulative effect of change in accounting in 2004.

 

BUSINESS SEGMENT PERFORMANCE

 

For 2006, 2005 and 2004, our operations were reported as three business segments: Engine Systems, Airframe Systems and Electronic Systems. Segment operating income is total segment revenue reduced by operating expenses directly identifiable with our business segments except for the pension curtailment charge, which was not allocated to our segments. Segment operating income is used by management to assess the operating performance by the segments. For a reconciliation of total segment operating income to total operating income, see Note 3, “Business Segment Information” to our Consolidated Financial Statements.

 

During 2004, we entered into a $99 million partial settlement agreement with Northrop Grumman Corporation (Northrop), as successor to TRW Inc. (TRW), relating to our acquisition of TRW’s aeronautical systems businesses in October 2002. The partial settlement agreement primarily relates to customer warranty and other contract claims for products that were designed, manufactured or sold by TRW prior to our purchase of aeronautical systems. Under the terms of the settlement, we have assumed certain liabilities associated with future customer warranty and other contract claims for these products. The settlement excluded amounts associated with any claims that we may have against Northrop relating to the Airbus A380 actuation systems development program and certain other liabilities retained by TRW under the acquisition agreement. As a result of the partial settlement in 2004, we recorded a liability for the estimated undiscounted future liabilities of $71.7 million that we assumed. We recorded a charge of $23.4 million to cost of sales representing the amount by which our estimated undiscounted future liabilities plus our receivable from Northrop for these matters exceeded the settlement amount. The charge is reflected in the applicable segments’ operating income for 2004.

 

Year Ended December 31, 2006 Compared with the Year Ended December 31, 2005

 

 

Engine Systems:  Engine Systems segment sales of $2,455.3 million in 2006 increased $217.7 million, or 9.7%, from $2,237.6 million in 2005. The increase was primarily due to the following:

 

 

The increase in sales was partially offset by a decline in defense sales volume of approximately $84 million, primarily associated with contracts completed in mid-2005 in our aerostructures and customer services businesses.

 

Engine Systems segment operating income of $471 million in 2006 increased $71.2 million, or 17.8%, from $399.8 million in 2005. This increase in operating income was primarily a result of the following:

 

 

The increase in the Engine Systems segment operating income from the factors above was partially offset by:

 

 

 

Airframe Systems:  Airframe Systems segment sales of $1,950.6 million for 2006 increased $96.4 million, or 5.2%, from $1,854.2 million for 2005. The increase was primarily due to the following:

 

 

The increase was partially offset by lower airframe heavy maintenance sales volume of approximately $35 million.

 

Airframe Systems segment operating income of $97.5 million for 2006 increased $21.5 million, or 28.3%, from $76 million for 2005. This increase in operating income was primarily a result of the following:

 

 

The increase in the Airframe Systems segment operating income from the factors above was partially offset by:

 

 

Electronic Systems:  Electronic Systems segment sales of $1,472.4 million for 2006 increased $167.7 million, or 12.9%, from $1,304.7 million for 2005. The increase was primarily due to:

 

 

Electronic Systems segment operating income of $192.8 million for 2006 increased $46.9 million, or 32.1%, from $145.9 million for 2005. Segment operating income was higher due to higher sales volume and improved mix, generating operating income of approximately $68 million.

 

The increase in segment operating income was partially offset by:

 

 

Future Restructuring and Consolidation Costs for Programs Announced and Initiated

 

During 2005, we announced and initiated a restructuring program to downsize a German facility in the Electronic Systems segment with partial transfers of operations to existing facilities in Florida and India. The goal of this program is to reduce operating costs and foreign exchange exposure. The total restructuring cost for the program is expected to be approximately $13 million, for which $6.4 million has been expensed in 2005 and 2006 and approximately $6.6 million will be incurred in 2007.

 

Year Ended December 31, 2005 Compared with Year Ended December 31, 2004

 

Engine Systems:  Engine Systems segment sales of $2,237.6 million in 2005 increased $298 million, or 15.4%, from $1,939.6 million in 2004. The increase was due to the following:

 

 

Engine Systems segment operating income increased $134.9 million, or 50.9%, from $264.9 million in 2004 to $399.8 million in 2005. Segment operating income was higher due to:

 

 

The increase in Engine Systems segment operating income was partially offset by:

 

 

Airframe Systems:  Airframe Systems segment sales of $1,854.2 million for 2005 increased $224.5 million, or 13.8%, from $1,629.7 million for 2004. The increase was primarily due to:

 

 

The increases in sales volume were partially offset by a decrease in regional and general aviation aftermarket sales volume in our actuation systems business.

 

Airframe Systems segment operating income decreased $14.1 million, or 15.6%, from $90.1 million for 2004 to $76 million for 2005. The increased volume from sales described above was more than offset by the following:

 

 

 

Partially offsetting the higher operating costs was the impact of:

 

 

Electronic Systems:  Electronic Systems segment sales of $1,304.7 million in 2005 increased $173.6 million, or 15.3%, from $1,131.1 million in 2004. The increase was primarily due to:

 

 

Electronic Systems segment operating income increased $10.7 million, or 7.9%, from $135.2 million in 2004 to $145.9 million in 2005. Segment operating income was higher due to:

 

 

The increase in segment operating income was partially offset by:

 

 

Segment Reorganization and Other Changes

 

Beginning with our Form 10-Q for the period ended March 31, 2007, we will reflect the following changes in our business segment reporting:

 

 

Prior period results will be reclassified to conform to the 2007 presentation.

 

FOREIGN OPERATIONS

 

We are engaged in business in foreign markets. Our foreign manufacturing and service facilities are located in Australia, Canada, China, England, France, Germany, India, Indonesia, Northern Ireland, Japan, Mexico, Poland, Scotland, Singapore and the United Arab Emirates. We market our products and services through sales subsidiaries and distributors in a number of foreign countries. We also have joint venture agreements with various foreign companies.

 

Currency fluctuations, tariffs and similar import limitations, price controls and labor regulations can affect our foreign operations, including foreign affiliates. Other potential limitations on our foreign operations include expropriation, nationalization, restrictions on foreign investments or their transfers and additional political and economic risks. In addition, the transfer of funds from foreign operations could be impaired by the unavailability of dollar exchange or other restrictive regulations that foreign governments could enact.

 

Sales to non-U.S. customers were $2,807.6 million or 48% of total sales, $2,501.7 million or 46% of total sales and $2,270.1 million or 48% of total sales for 2006, 2005 and 2004, respectively.

 

LIQUIDITY AND CAPITAL RESOURCES

 

We currently expect to fund expenditures for capital requirements, as well as other liquidity needs from a combination of cash, internally generated funds and financing arrangements. We believe that our internal liquidity, together with access to external capital resources, will be sufficient to satisfy existing plans and commitments including our stock buy back program, and also provide adequate financial flexibility.

 

Cash

 

At December 31, 2006, we had cash and marketable securities of $201.3 million, as compared to $251.3 million at December 31, 2005.

 

Credit Facilities

 

We have a $500 million committed global syndicated revolving credit facility that expires in May 2011. In May 2006, we exercised an option within the credit facility to extend the maturity of the facility by one year from May 2010 to May 2011. This facility permits borrowing, including letters of credit, up to a maximum of $500 million. At December 31, 2006, there were $34.9 million in borrowings, classified as long-term debt, and $20.4 million in letters of credit outstanding under this facility. At December 31, 2005, there were $34.9 million in borrowings and $19.6 million in letters of credit outstanding under this facility.

 

The level of unused borrowing capacity under our committed syndicated revolving credit facility varies from time to time depending in part upon our compliance with financial and other covenants set forth in the related agreement, including the consolidated net worth requirement and maximum leverage ratio. We are currently in compliance with all such covenants. As of December 31, 2006, we had borrowing capacity under this facility of $444.7 million, after reductions for borrowings and letters of credit outstanding under the facility.

 

At December 31, 2006, we maintained $75 million of uncommitted domestic money market facilities and $149.8 million of uncommitted and committed foreign working capital facilities with various banks to meet short-term borrowing requirements. As of December 31, 2006, there was $11.8 million outstanding under these facilities. At December 31, 2005, we maintained $75 million of uncommitted domestic money market facilities and $111.5 million of uncommitted and committed foreign working capital facilities with $22.4 million outstanding in borrowings under these facilities. These credit facilities are provided by a small number of commercial banks that also provide us with committed credit through the syndicated revolving credit facility and with various cash management, trust and other services.

 

Our credit facilities do not contain any credit rating downgrade triggers that would accelerate the maturity of our indebtedness. However, a ratings downgrade would result in an increase in the interest rate and fees payable under our committed syndicated revolving credit facility. Such a downgrade also could adversely affect our ability to renew existing or obtain access to new credit facilities in the future and could increase the cost of such new facilities. In May 2006, Standard & Poor’s Rating Services raised our credit rating to BBB from BBB- which reduced our facility fee from 15 basis points per annum to 12.5 basis points per annum.

 

Long-Term Financing

 

At December 31, 2006, we had long-term debt and capital lease obligations, including current maturities, of $1,723.1 million with maturities ranging from 2007 to 2046. Long-term debt includes $34.9 million borrowed under the committed revolving syndicated credit facility to facilitate our implementation of the cash repatriation provisions in 2005 of the American Jobs Creation Act. The earliest maturity of a material long-term debt obligation is April 2008. We also maintain a shelf registration statement that allows us to issue up to $1.4 billion of debt securities, series preferred stock, common stock, stock purchase contracts and stock purchase units.

 

In June 2006, we exchanged the following notes for $290.7 million principal amount of a new series of 6.29% notes due in 2016:

 

 

Additionally, in June 2006, we exchanged $242.5 million principal amount of our outstanding 7.625% notes due 2012 for $254.6 million principal amount of a new series of our 6.8% notes due in 2036.

 

We paid an aggregate cash premium of $8.6 million to exchange the 6.29% notes due in 2016 and paid an aggregate premium of $24 million, including $12 million in cash and $12 million financed by issuing additional notes, for the exchange of the 6.8% notes due 2036. The premiums will be amortized over the lives of the new notes. We recorded $4.8 million of transaction costs associated with the exchange offers in other income (expense) — net during 2006.

 

The 6.29% notes due in 2016 and the 6.8% notes due in 2036 were issued in a transaction exempt from the registration requirements of the Securities Act of 1933, as amended (the Securities Act). As required by a registration rights agreement entered into in connection with the issuance of the new notes, on October 4, 2006, we completed exchange offers, registered under the Securities Act, of notes of the same series in exchange for the outstanding 6.29% notes due in 2016 and 6.8% notes due in 2036.

 

Lease Agreements

 

We finance some of our office and manufacturing facilities and machinery and equipment, including corporate aircraft, under committed lease arrangements provided by financial institutions. Some of these arrangements allow us to claim a deduction for the tax depreciation on the assets, rather than the lessor, and allow us to lease aircraft and equipment having a maximum unamortized value of $55 million at December 31, 2006 for which $16.6 million of future minimum lease payments were outstanding under these arrangements. The other arrangements are standard operating leases. Future minimum lease payments under the standard operating leases approximated $135.2 million at December 31, 2006.

 

Additionally, at December 31, 2006, we had guarantees of residual values of lease obligations of $32.7 million. The residual values relate primarily to corporate aircraft which we are obligated to either purchase at the end of the lease term or remarket. Under some of these operating lease agreements, we receive rent holidays, which represent periods of free or reduced rent. Rent holidays are recorded as a liability and recognized on a straight-line basis over the lease term. In addition, we may receive incentives or allowances from the lessor as part of the lease agreement. We recognize these payments as a liability and amortize them as reductions to lease expense over the lease term. We capitalize leasehold improvements and amortize them over the shorter of the lease term or the asset’s useful life.

 

Sale of Receivables

 

Effective June 30, 2006, we terminated the variable rate trade receivables securitization program and repaid the outstanding balance of $97.1 million.

 

Cash Flow Hedges

 

We have subsidiaries that conduct a substantial portion of their business in Euros, Great Britain Pounds Sterling, Canadian Dollars and Polish Zlotys, but have significant sales contracts that are denominated in U.S. Dollars. Approximately 10% of our revenues and approximately 25% of our costs are denominated in currencies other than the U.S. Dollar. Approximately 90% of these net costs are in Euros, Great Britain Pounds Sterling and Canadian Dollars. Periodically, we enter into forward contracts to exchange U.S. Dollars for Euros, Great Britain Pounds Sterling, Canadian Dollars and Polish Zlotys to hedge a portion of our exposure from U.S. Dollar sales.

 

The forward contracts described above are used to mitigate the potential volatility of earnings and cash flow arising from changes in currency exchange rates that impact our U.S. Dollar sales for certain foreign operations. The forward contracts are being accounted for as cash flow hedges. The forward contracts are recorded on our Consolidated Balance Sheet at fair value with the net change in fair value reflected in accumulated other comprehensive income (loss), net of deferred taxes. The notional value of the forward contracts at December 31, 2006 was

$1,639.4 million. The fair value of the forward contracts at December 31, 2006, was a net asset of $85.2 million, including:

 

 

The total fair value of our forward contracts of $85.2 million (before deferred taxes of $29.9 million) at December 31, 2006, combined with $0.9 million of gains on previously matured hedges of intercompany sales and gains from forward contracts terminated prior to the original maturity dates, is recorded in accumulated other comprehensive income (loss) and will be reflected in income as the earnings are affected by the hedged items. As of December 31, 2006, the portion of the $86.1 million fair value that would be reclassified into earnings as an increase in sales to offset the effect of the hedged item in the next 12 months is a net gain of $46.9 million. During 2006, hedge ineffectiveness of a charge of $0.6 million was recorded in other income (expense) — net. There was a negligible amount of ineffectiveness during 2005.

 

In June 2006, we entered into treasury locks and reverse treasury locks in connection with our long-term debt exchange offers. In accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), the treasury locks were accounted for as cash flow hedges. We entered into $288.5 million of treasury locks to offset changes in the issue price of our 6.29% notes due 2016 and entered into $288.5 million of reverse treasury locks to offset changes in the exchange prices of the 7.5% notes due in 2008, 6.45% notes due in 2008 and 6.6% notes due in 2009 attributable to movements in treasury rates prior to the exchange date. We paid $0.3 million in cash to settle the locks, and the amount was recorded in accumulated other comprehensive income (loss) during 2006, and will be amortized over the life of the 6.29% notes due 2016. In June 2006, we also entered into $235.5 million of treasury locks to offset changes in the issue price of the 6.8% notes due 2036 and entered into $235.5 million of reverse treasury locks to offset changes in the exchange price of the 7.625% notes due in 2012 attributable to movements in treasury rates prior to the exchange date. We paid $1.9 million in cash to settle the locks, and the amount was recorded in accumulated other comprehensive income (loss) during 2006 and will be amortized over the life of the 6.8% notes due 2036.

 

Fair Value Hedges

 

We enter into interest rate swaps to increase our exposure to variable interest rates. We have the following interest rate swaps outstanding as of December 31, 2006:

 

 

In September 2006, we entered into a $50 million fixed to floating interest rate swap on our 6.29% senior notes due in 2016. The settlement and maturity dates on the swap are the same as those on the referenced notes. In accordance with SFAS 133, the interest rate swap is being accounted for as a fair value hedge and the carrying value of the notes has been adjusted to reflect the fair value of the interest rate swap.

 

In June 2006, we terminated $7 million of a $50 million fixed-to-floating interest rate swap on our 6.45% notes due in 2008 in connection with our long-life debt exchange offers. We paid $0.3 million in cash to terminate this portion of the interest rate swap, which was recorded as an expense in other income (expense) — net during 2006. This portion of the interest rate swap

was terminated so that the outstanding notional amount of the fixed-to-floating interest rate swap would match the outstanding principal amount, subsequent to the exchange of the 6.45% notes due in 2008.

 

The settlement and maturity dates on each swap are the same as those on the referenced notes. In accordance with SFAS 133, the interest rate swaps are being accounted for as fair value hedges and the carrying value of the notes has been adjusted to reflect the fair values of the interest rate swaps. The fair value of the interest rate swaps was a net liability/(loss) of $2.6 million at December 31, 2006.

 

Other Forward Contracts

 

As a supplement to the foreign exchange cash flow hedging program, we enter into forward contracts to manage our foreign currency risk related to the translation of monetary assets and liabilities denominated in currencies other than the relevant functional currency. These forward contracts mature monthly and the notional amounts are adjusted periodically to reflect changes in net monetary asset balances. Since these contracts are not designated as hedges, the gains or losses on these forward contracts are recorded in cost of sales. These contracts are utilized to mitigate the earnings impact of the translation of net monetary assets and liabilities. Under this program, as of December 31, 2006, we had forward contracts with a notional value of $63.1 million to buy Great Britain Pounds Sterling, forward contracts with a notional value of $120.7 million to buy Euros and forward contracts with a notional value of $11 million to buy Canadian Dollars. These contracts mature within one month.

 

During 2006, we recorded a transaction loss on our monetary assets of approximately $19 million, which was partially offset by gains on the forward contracts described above of approximately $6 million. During 2005, we recorded a transaction gain on our monetary assets of approximately $21 million, which was partially offset by losses on the forward contracts described above of approximately $17 million.

 

Contractual Obligations and Other Commercial Commitments

 

The following charts reflect our contractual obligations and commercial commitments as of December 31, 2006. Commercial commitments include lines of credit, guarantees and other potential cash outflows resulting from a contingent event that requires performance by us pursuant to a funding commitment.