ROCKWELL COLLINS INC 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2018

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

Commission file number 001-16445

Rockwell Collins, Inc.

(Exact name of registrant as specified in its charter)



Delaware	52-2314475
(State or other jurisdiction	(I.R.S. Employer
of incorporation or organization)	Identification No.)

400 Collins Road NE
Cedar Rapids, Iowa	52498
(Address of principal executive offices)	(Zip Code)

Registrant's telephone number, including area code: (319) 295-1000



SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of each class	Name of each exchange on which registered
Common Stock, par value $.01 per share	New York Stock Exchange
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 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 whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulations S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes 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 the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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



Large accelerated filer þ		Accelerated filer o
Non-accelerated filer o		Smaller reporting company o
		Emerging growth company o

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

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

The aggregate market value of the registrant's voting stock held by non-affiliates of the registrant on March 30, 2018 was approximately $22.1 billion. For purposes of this calculation, the registrant has assumed that its directors and executive officers are affiliates.

164,629,890 shares of the registrant's Common Stock were outstanding on October 31, 2018.

DOCUMENTS INCORPORATED BY REFERENCE

Certain information contained in the Proxy Statement for the Annual Meeting of Shareowners of the registrant to be held in 2019 is incorporated by reference into Part III.

ROCKWELL COLLINS, INC.

Annual Report on Form 10-K

Table of contents



			Page No.
PART I
	Item 1.	Business	1
	Item 1A.	Risk Factors	9
	Item 1B.	Unresolved Staff Comments	17
	Item 2.	Properties	18
	Item 3.	Legal Proceedings	19
	Item 4.	Mine Safety Disclosures	19
	Item 4A.	Executive Officers of the Company	20

PART II
	Item 5.	Market for the Company's Common Equity, Related Stockholder Matters and Company Purchases of Equity Securities	21
	Item 6.	Selected Financial Data	23
	Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	24
	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	53
	Item 8.	Financial Statements and Supplementary Data	55
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	105
	Item 9A.	Controls and Procedures	105
	Item 9B.	Other Information	106

PART III
	Item 10.	Directors, Executive Officers and Corporate Governance	107
	Item 11.	Executive Compensation	107
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	107
	Item 13.	Certain Relationships and Related Transactions, and Director Independence	108
	Item 14.	Principal Accounting Fees and Services	108

PART IV
	Item 15.	Exhibits and Financial Statement Schedules	109

SIGNATURES			S-1


PART I


Item 1.	Business.

General

Rockwell Collins, Inc. (the Company or Rockwell Collins) designs, produces and supports cabin interior, communications and aviation systems and products for commercial and military customers and provides information management services through voice and data communication networks and solutions worldwide. The integrated system solutions and products we provide to our served markets are oriented around a set of core competencies: communications, navigation, automated flight control, displays/surveillance, bespoke interior products, simulation and training, integrated electronics and information management systems. We also provide a wide range of services and support to our customers through a worldwide network of service centers, including equipment repair and overhaul, service parts, field service engineering, training, technical information services and aftermarket used equipment sales. The structure of our business allows us to leverage these core competencies across markets and applications to bring high value solutions to customers. We operate in multiple countries and are headquartered in Cedar Rapids, Iowa.

Our Company's heritage is rooted in the Collins Radio Company, established in 1933. Rockwell Collins, Inc., the parent company, is incorporated in Delaware. As used herein, the terms "we", "us", "our", "Rockwell Collins" or the "Company" include subsidiaries and predecessors unless the context indicates otherwise.

Whenever reference is made in any Item of this Annual Report on Form 10-K to information in our Proxy Statement for the Annual Meeting of Shareowners to be held in 2019 (2019 Proxy Statement), such information shall be deemed to be incorporated herein by such reference.

All date references contained herein relate to our fiscal year ending on the Friday closest to September 30 unless otherwise stated. For ease of presentation, September 30 is utilized consistently throughout this report to represent the fiscal year end date. Fiscal years 2018, 2017 and 2016 were 52-week fiscal years.

Proposed Acquisition by United Technologies Corporation

On September 4, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with United Technologies Corporation, a Delaware corporation (“UTC”), and Riveter Merger Sub Corp., a Delaware corporation and a wholly owned subsidiary of UTC (“Merger Sub”). Upon the terms and subject to the conditions set forth in the Merger Agreement, at the closing, Merger Sub will merge with and into Rockwell Collins, with Rockwell Collins surviving as a wholly owned subsidiary of UTC (the “UTC Merger”).

Pursuant to the Merger Agreement, at the effective time of the UTC Merger (the “Effective Time”), each share of Rockwell Collins common stock, par value $0.01 per share, issued and outstanding immediately prior to the Effective Time (other than (1) shares held by Rockwell Collins as treasury stock, UTC, or any subsidiaries of Rockwell Collins or UTC and (2) shares held by a holder who has properly exercised and perfected (and not effectively withdrawn or lost) such holder’s demand for appraisal rights under Section 262 of the General Corporation Law of the State of Delaware, which in each case will be treated as described in the Merger Agreement) will be converted into the right to receive (1) $93.33 in cash, without interest, plus (2) a fraction of a share of UTC common stock having a value equal to the quotient obtained by dividing $46.67 by the average of the volume-weighted average prices per share of UTC common stock on the New York Stock Exchange for each of the 20 consecutive trading days ending with the trading day immediately prior to the closing date (the “UTC stock price”), subject to a two-way collar mechanism described below (together, the “Merger Consideration”), less any applicable withholding taxes.

The fraction of a share of UTC common stock into which each such share of Rockwell Collins common stock will be converted is referred to as the exchange ratio. The exchange ratio will depend upon the UTC stock price. If the UTC stock price is greater than $107.01 but less than $124.37, the exchange ratio will be equal to the quotient of (i) $46.67 divided by (ii) the UTC stock price, which, in each case, will result in the stock consideration having a value equal to $46.67. If the UTC stock price is less than or equal to $107.01 or greater than or equal to $124.37, a two-way collar mechanism will apply, pursuant to which (i) if the UTC stock price is greater than or equal to $124.37, the exchange ratio will be fixed at 0.37525 and the value of the stock consideration will be more than $46.67, and (ii) if the UTC stock price is less than or equal to $107.01, the exchange ratio will be fixed at 0.43613 and the value of the stock consideration will be less than $46.67.

The completion of the UTC Merger is subject to customary conditions, including, without limitation, (1) the absence of any order or law that has the effect of enjoining or otherwise prohibiting the completion of the UTC Merger or resulting in the

occurrence of certain conditions specified in the Merger Agreement and (2) the absence of a material adverse effect on Rockwell Collins and UTC. The completion of the UTC Merger is not subject to the approval of UTC’s shareowners or the receipt of financing by UTC.

The Company and UTC have made customary representations and warranties in the Merger Agreement. The Merger Agreement also contains customary covenants and agreements, including covenants and agreements relating to (a) the conduct of each of the Company’s and UTC’s respective businesses between the date of the signing of the Merger Agreement and the consummation of the UTC Merger, and (b) the efforts of the parties to cause the UTC Merger to be completed.

The Merger Agreement includes termination provisions for both Rockwell Collins and UTC. The Merger Agreement provides that the Company may be required to pay UTC a termination fee equal to $695 million if the Merger Agreement is terminated by the Company under certain circumstances described in the Merger Agreement.

Financial Information About Our Operating Segments

Financial information with respect to our operating segments, including product line disclosures, revenues, operating earnings and total assets, is contained under the caption Segment Financial Results in Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 below and in Note 21 of the Notes to Consolidated Financial Statements in Item 8 below.

Access to the Company's Reports and Governance Information

We maintain an internet website at www.rockwellcollins.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on this site as soon as reasonably practicable after the reports are filed with or furnished to the Securities and Exchange Commission (SEC). All reports we file with the SEC are also available free of charge via EDGAR through the SEC website at www.sec.gov. We also post corporate governance information (including our corporate governance guidelines and Board committee charters) and other information related to our Company on our internet website where it is available free of charge. We will provide, without charge, upon written request, copies of our SEC reports and corporate governance information. Our internet website and the information contained therein or connected thereto are not incorporated into this Annual Report on Form 10-K.

Description of Business by Segment

We serve a worldwide customer base through our Interior Systems, Commercial Systems, Government Systems and Information Management Services operating segments. These four segments are described in detail below.

Interior Systems

On April 13, 2017, we acquired B/E Aerospace and formed the Interior Systems business segment. Our Interior Systems business manufactures cabin interior products for commercial aircraft and business aviation customers. We sell our products and provide our services directly to virtually all of the world’s major airlines and aerospace manufacturers. We have achieved a leading global market position in each of our major product categories, which include:


•	commercial aircraft seats, including an extensive line of super first class, first class, business class, economy class and regional aircraft seats


•	a full line of aircraft food and beverage preparation and storage equipment, including coffee and espresso makers, water boilers, beverage containers, refrigerators, freezers, chillers and a line of microwave, high efficiency convection and steam ovens


•	modular lavatory systems, wastewater management systems and galley systems


•	both chemical and gaseous aircraft oxygen storage, distribution and delivery systems, protective breathing equipment and a broad range of lighting products


•	business jet and general aviation interior products, including an extensive line of executive aircraft and helicopter seats, direct and indirect overhead lighting systems, exterior lighting systems, passenger and crew oxygen systems, air valve systems and high-end aircraft monuments

Interior Systems sales are categorized by product type into interior products and services and aircraft seating.

Interior products and services includes a portfolio of interior structure products (galley structures, food and beverage preparation equipment, water and waste systems), integrated engineering services, oxygen and passenger service equipment, cabin lighting systems, de-icing equipment and aftermarket services. These products and services are marketed and sold to original equipment manufacturers (OEMs) as well as airliner customers.

Aircraft seating includes a portfolio of innovative and bespoke seating products for applications on all classes of commercial, business aviation, executive and helicopter platforms for line fit and retrofit programs. These products are marketed and sold directly to OEMs, airlines and completion centers across the globe.

Commercial Systems

Our Commercial Systems segment supplies aviation electronics systems, products and services to customers located throughout the world. The customer base is comprised of OEMs of commercial air transport, business and regional aircraft, commercial airlines and business aircraft operators. Our systems and products are used in both OEM applications as well as in retrofit and upgrade applications designed to increase the efficiency and enhance the value of existing aircraft.

Our commercial aviation electronics systems, products and services include:


•	integrated avionics systems, such as Pro Line Fusion^®, which provide advanced avionics capabilities to meet the challenges of operating in the next generation global airspace. Pro Line Fusion^® capabilities include: touch control primary flight displays, advanced flight and performance management, flight guidance and information management


•	integrated cabin electronics solutions, including cabin management systems with touch-screen controls, wireless connectivity equipment, high definition video and audio, and entertainment and information content such as Airshow moving maps


•	communications systems and products, such as data link, high frequency (HF), very high frequency (VHF) and satellite communications systems


•	navigation systems and products, including landing sensors to enable fully automatic landings, radio navigation and geophysical sensors, as well as flight management systems


•	situational awareness and surveillance systems and products, such as synthetic and enhanced vision systems, surface surveillance and guidance solutions, head-up guidance systems, weather radar and collision avoidance systems


•	integrated flight controls including fly-by-wire, advanced flight guidance with auto-land capability


•	simulation and training systems, including full-flight simulators for crew training, visual system products, training systems and engineering services


•	maintenance, repair, parts, after-sales support services and aftermarket used equipment

Commercial Systems sales are categorized into air transport aviation electronics and business and regional aviation electronics. Product category sales are delineated based upon the difference in the underlying customer base, size of aircraft and markets served.

Air transport aviation electronics include avionics, cabin systems and flight control systems for large commercial transport aircraft platforms. We design these items as sub-systems and work with OEMs to integrate with other suppliers' products into the flight deck and broader aircraft systems. Our products offered for OEM applications in the air transport category are marketed directly to aircraft OEMs and airline operators, while our products offered for aftermarket applications are primarily marketed to airline operators.

Business and regional aviation electronics include integrated avionics, cabin management and flight control systems for application on regional and business aircraft platforms. We develop integrated avionics, cabin and flight control solutions for business and regional aircraft OEMs and support them with integration into other aircraft systems. Products offered for OEM applications in the business and regional aircraft category are marketed directly to the aircraft OEMs. Products offered for aftermarket applications are primarily marketed through distributors for business aviation and directly to regional airline operators.

Government Systems

Our Government Systems segment provides a broad range of electronic products, systems and services to customers including the U.S. Department of Defense, various ministries of defense, other government agencies and defense contractors around the world. Our defense electronic solutions are designed to meet a wide range of customer requirements, but tend to share certain characteristics including design for rugged environments and use in size, weight and power constrained applications. These applications also typically have stringent product integrity and certification requirements with a high degree of customer oversight. These products, systems and services support airborne, precision weapon, ground and maritime applications on new equipment as well as in retrofit and upgrade applications designed to extend the service life and enhance the capability of existing aircraft, vehicle and weapon platforms.

Our defense-related systems, products and services include:


•	communications systems and products designed to enable the transmission of information across the communications spectrum


•	navigation products and systems, including radio navigation products, global positioning system (GPS) equipment and multi-mode receivers


•	avionics systems for aircraft flight decks, including cockpit display products (multipurpose flat panel head-down displays, wide field of view head-up and helmet-mounted displays), flight controls, information/data processing and communications, navigation, safety and surveillance systems


•	precision targeting, electronic warfare and range and training systems


•	simulation and training systems, including visual system products, training systems and services


•	space wheels for satellite stabilization


•	maintenance, repair, parts, after-sales support services and aftermarket used equipment

Government Systems sales are categorized into avionics and communication and navigation products. Product category sales are delineated based upon underlying product technologies.

Avionics consists of electronic solutions for a broad range of airborne platforms including fixed wing aircraft and military and civil rotary wing aircraft, unmanned aerial systems (UAS) and the associated aircrew and maintenance training devices and services. We provide complete avionics solutions, including cockpit avionics, mission system applications and system integration, and also provide individual avionics products to platform integrators. We serve various roles within these markets including system and sub-systems integrator as well as provider of various electronic products. For the UAS market we provide cost effective, high performance integrated flight control, navigation, communication and sensor capabilities. Simulation and training solutions are provided for both fixed and rotary wing aircraft.

Communication and navigation products include full spectrum communication solutions for voice and data connectivity for government and military use in the air, on the ground and at sea. These communication products support military user requirements for high availability, highly secure, jam resistant wireless communication. Products include radio communication, data links, electronic warfare and networked communication systems. The navigation products are primarily comprised of global positioning system based products used for precision navigation and targeting applications. These applications include airborne, vehicular, maritime, soldier navigation devices, precision targeting subsystems, precision-guided weapons products, range and training systems and a variety of embedded GPS applications. Additional offerings include customized fully integrated thermal and power management solutions for participants in the defense industry, OEMs and the airlines.

Information Management Services

Our Information Management Services (IMS) segment provides communications services, systems integration and security solutions across the aviation, airport, rail and nuclear security markets to customers located around the world. The customer base includes commercial airlines, business aircraft operators, the U.S. Federal Aviation Administration (FAA), airport and critical infrastructure operators and major passenger and freight railroads. In October 2018, we announced that IMS will become part of the Commercial Systems segment. This reorganization will enable us to further capitalize on customers' increasing need for aviation connectivity solutions. This change will require us to revise our segment reporting beginning in the first quarter of fiscal 2019 to report the IMS business within the Commercial Systems segment.

Our information management services include:


•	voice and data communication services, such as air-to-ground GLOBALink^SM and ground-to-ground AviNet^® services, which enable satellite, VHF and HF transmissions between the cockpit, air traffic control, airline operation centers, reservation systems and other third parties ensuring safety and efficiency for commercial airlines and other related entities in the aviation ecosystem


•	global, high throughput cabin connectivity solutions enabling airlines to provide an enhanced experience for their passengers and improved operational efficiency for crews


•	robust connectivity management services that ensure interoperability between smart aircraft and legacy airline systems, allowing airlines to increase efficiency, reduce costs and enhance operations


•	cybersecurity as a service to protect the integrity of our customers’ information systems across a wide variety of domains including aviation, airports, rail and critical infrastructure


•	around the clock global flight support services for business aircraft operators, under the ARINCDirect^SMbrand, including flight planning and datalink, international trip support, cabin connectivity solutions and flight operations management software


•	airport communications and information systems designed to ease congestion and improve airport efficiency via airline agent and self-service check-in, airport operations, baggage management, boarding and access control solutions


•	train dispatching and information systems including solutions to support positive train control as mandated by the 2008 Railroad Safety Improvement Act


•	mission critical security command and control systems for nuclear power facilities with functions such as intrusion detection, access control, video and credential management and vehicle identification

Customers, Sales and Marketing

We serve a broad range of customers worldwide, including the U.S. Department of Defense, U.S. Coast Guard, civil agencies, airports, defense contractors, foreign ministries of defense, manufacturers of commercial helicopters, manufacturers of commercial air transport, airframe manufacturers, defense manufacturers, business and regional aircraft, commercial airlines, aerospace OEMs, fractional and other business jet operators, the FAA, critical infrastructure operators and major passenger and freight railroads. We market our systems, products and services directly to our customers through an internal marketing and sales force. In addition, we utilize a worldwide dealer network to distribute our products and international sales representatives to assist with international sales and marketing. In 2018, various branches of the U.S. Government, both directly and indirectly through subcontracts, accounted for 23 percent of our total sales. Sales to The Boeing Company represented 16 percent of total sales in 2018.

Our largest customers have substantial bargaining power with respect to price and other commercial terms. Although we believe that we generally enjoy good relations with our customers, the loss of all or a substantial portion of our sales to any of our large volume customers for any reason, including the loss of contracts, bankruptcy, reduced or delayed customer requirements, strikes or other work stoppages affecting production by these customers, could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Competition

We operate in a highly competitive environment. Principal competitive factors include total cost of ownership, product and system performance, network coverage, quality, service, warranty and indemnification terms, technology, design engineering capabilities, new product innovation and timely delivery. We compete worldwide with a number of U.S. and non-U.S. companies in each of our businesses. Many of these competitors are also our suppliers or customers. Principal competitors include BAE Systems Aerospace, Inc.; CAE Inc.; Diehl Aerosystems Holding GmBH; Elbit Systems Ltd.; Esterline Technologies Corp.; FlightSafety International; Garmin International Inc.; General Dynamics Corporation; General Electric Co.; Harris Corp.; Honeywell International, Inc.; Jamco America, Inc.; L3 Communications, Inc.; Northrop Grumman Corp.; Raytheon Co.; Recaro Aircraft Seating GmbH & Co. KG; Safran; Satcom Direct, Inc.; SITA; Thales S.A.; The Boeing Company; and Thompson Aero Seating Ltd. Several of our competitors are significantly larger than we are in terms of resources and market share and can offer a broader range of products. We believe that our systems, products and services are well positioned to compete in our served markets.

Industry consolidation has from time to time had a major impact on the competitive environment in which we operate. Our competitors periodically undertake mergers, alliances and realignments that contribute to a dynamic competitive landscape. We have contributed to this changing landscape in the past two years by completing a significant acquisition (B/E Aerospace, Inc.), one smaller acquisition and several strategic alliances to improve our competitive position and expand our market reach.

Raw Materials, Supplies and Working Capital

We believe we have adequate sources for the supply of raw materials and components for our manufacturing and service needs with suppliers located around the world. Electronic components and other raw materials used in the manufacturing of our products are generally available from several suppliers. We continue to work with our supply base for raw materials and components to ensure an adequate source of supply, utilizing strategic alliances, dual sourcing, identification of substitute or alternate parts that meet performance requirements and life-time buys. These life-time buys involve purchases of multiple years of supply in order to meet production and service requirements over the life span of a product. Although historically we have not experienced any significant difficulties in obtaining an adequate supply of raw materials and components necessary for our manufacturing operations or service needs, the loss of a significant supplier or the inability of a supplier to meet performance and quality specifications or delivery schedules could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Our investment in inventory is a significant part of our working capital, and historically we have maintained sufficient inventory to meet our customers' requirements on a timely basis. This investment includes production stock, work-in-process, pre-production engineering costs, finished goods, spare parts and goods on consignment. Our accounts receivable also constitute a significant part of our working capital. Accounts receivable includes unbilled receivables which are primarily related to sales recorded under the percentage-of-completion method of accounting in accordance with applicable contract terms that have not been billed to customers. The critical accounting policies involving pre-production engineering costs and long-term contracts are discussed under the caption Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 below. Additional information relating to accounts receivable and inventory is contained in Notes 2, 5 and 6 of the Notes to Consolidated Financial Statements in Item 8 below.

Backlog

The following table summarizes our backlog:



	September 30
(in billions)	2018		2017
Interior Systems	$	3.9	$	3.6
Commercial Systems	2.4		2.2
Government Systems:
Funded orders	2.8		2.7
Unfunded orders	0.7		0.8
Information Management Services	0.3		0.3
Total backlog	$	10.1	$	9.6

Our backlog represents the aggregate of the sales price of orders received from customers, but not recognized as revenue, and excludes unexercised options. Although we believe that the orders included in backlog are firm, most of our backlog orders can be modified or terminated by the customer. Our backlog at September 30, 2018 includes approximately $4.4 billion of orders that are expected to be filled after 2019.

Joint Ventures

Joint ventures, strategic alliances, strategic investments and other cooperative arrangements are part of our business strategies to broaden the market for our products and develop new technologies.

We have a 50 percent ownership interest in each of the following:


•	ACCEL (Tianjin) Flight Simulation Co., Ltd, a joint venture with Haite Group, for the joint development and production of commercial flight simulators in China


•	ADARI Aviation Technology Company Limited, a joint venture with Aviation Data Communication Corporation Co., LTD, operates remote ground stations around China and develops certain content delivery management software


•	AVIC Leihua Rockwell Collins Avionics Company, a joint venture with China Leihua Electronic Technology Research Institute, a subsidiary of the Aviation Industry Corporation of China (AVIC), which provides integrated surveillance system products for the C919 aircraft in China


•	Data Link Solutions LLC, a joint venture with BAE Systems, plc, for joint pursuit of the worldwide military data link market


•	ESA Vision Systems LLC, a joint venture with Elbit Systems, Ltd., for joint pursuit of helmet-mounted cueing systems for the worldwide military fixed wing aircraft market


•	Quest Flight Training Limited, a joint venture with Quadrant Group, plc, which provides aircrew training services primarily for the United Kingdom Ministry of Defence


•	Rockwell Collins CETC Avionics Co., Ltd. a joint venture with CETC Avionics Co., Ltd. to develop, produce and maintain communication and navigation products on Chinese commercial OEM platforms

Acquisitions and Dispositions

We regularly consider various business opportunities, including strategic acquisitions and alliances, licenses and marketing arrangements. We review the prospects of our existing businesses to determine whether any of them should be modified, sold or otherwise discontinued.

We completed two acquisitions in the past two years to augment our growth plans. These acquisitions were:


•	in April 2017, we acquired B/E Aerospace, which provides aircraft cabin interior products and services


•	in December 2016, we acquired Pulse.aero, a company specializing in self-bag drop technologies used by airlines and airports

We reached definitive agreements to divest the following three businesses, each of which is still subject to certain conditions to closing:


•	in August 2018, we reached an agreement to sell our air transport in-flight entertainment (IFE) business, which designs, manufactures and services in-seat video, overhead video and content services and other products for the air transport IFE market


•	in July 2018, we reached an agreement to sell our ElectroMechanical Systems business, which designs, manufactures and services actuation, pilot control and other specialty products for commercial and military aerospace applications. The business is being sold in order to comply with regulatory commitments associated with the pending UTC merger


•	in May 2018, we reached an agreement to sell our engineered components business, which manufactures, sells and services diversified engineering components for niche aerospace, military and industrial applications. The business is being sold in order to comply with regulatory commitments associated with the pending UTC merger

Additional information relating to our acquisitions, dispositions and joint ventures is contained in Notes 3, 4 and 8 of the Notes to Consolidated Financial Statements in Item 8 below.

Intellectual Property

Our intellectual property rights include valuable patents, trademarks, copyrights, trade secrets, inventions and other proprietary rights. We own numerous U.S. and foreign patents and have numerous pending patent applications, including patents and patent applications purchased in our acquisitions. We also license certain patents relating to our manufacturing and other activities. While in the aggregate we consider our patents and licenses important to the operation of our business, we do not consider any individual patent or license to be of such importance that the loss or termination of any one patent or license would materially affect us.

Rockwell Automation, Inc. (Rockwell) owns the "Rockwell" name. In connection with our spin-off from Rockwell in 2001, we were granted the exclusive right to continue to use the Rockwell Collins name for use in our business other than in connection with the Rockwell Automation business or industrial automation products. Unless extended, this exclusive right would terminate following certain change of control events, including the completion of the UTC Merger, as described in our distribution agreement with Rockwell.

Employees

As of September 30, 2018, we had approximately 31,200 employees and approximately 67 percent of them were located in the U.S. Approximately 10 percent of our employees located within the U.S. and 9 percent of our employees located outside of the U.S. are covered by collective bargaining agreements. Many of our employees located outside of the U.S. who are not covered by a collective bargaining agreement are represented by workers' councils or statutory labor unions. The collective bargaining agreements for most of our employees covered by collective bargaining were negotiated in 2018 and have varying contract terms between 3 and 5 years.

Cyclicality and Seasonality

The markets in which we sell our products are, to varying degrees, cyclical and have experienced periodic upswings and downturns. For example, markets for our commercial aerospace products have experienced downturns during periods of slowdowns in the commercial airline industry and during periods of weak conditions in the economy in general, as demand for new aircraft generally declines during these periods. We believe that we are currently benefiting from robust backlogs in commercial air transportation and increasing content as next generation aircraft enter into service. While we believe our Government Systems business is well positioned, it is also subject to some cyclicality, primarily as a result of U.S. Government defense budget cycles. Additional information related to the defense budget environment can be found under the caption Risk Factors in Item 1A below.

Our business tends to be seasonal with our fourth quarter usually producing relatively higher sales and cash flow and our first quarter usually producing relatively lower sales and cash flow. A large part of this seasonality variance is attributable to our Government Systems business and relates to the U.S. Government procurement cycle.

Regulatory Matters

As a defense contractor, our contract costs are audited and reviewed on a continual basis by the Defense Contract Management Agency and the Defense Contract Audit Agency. Audits and investigations are conducted from time to time to determine if our performance and administration of our U.S. Government contracts are compliant with applicable contractual requirements and procurement regulations and other applicable federal statutes and regulations. Under present U.S. Government procurement regulations, if indicted or adjudged in violation of procurement or other federal civil laws, a contractor, such as us, could be subject to fines, penalties, repayments or other damages. U.S. Government regulations also provide that certain findings against a contractor may lead to suspension or debarment from eligibility for awards of new U.S. Government contracts for up to three years. In addition, we are subject to various non-U.S. governmental contracting requirements.

The sale, installation and operation of our products in commercial aviation applications is subject to continued compliance with applicable regulatory requirements and future changes to those requirements. In the U.S., our commercial aviation products are

required to comply with FAA regulations governing production and quality systems, airworthiness and installation approvals, repair procedures and continuing operational safety. Some of our products, such as radio frequency transmitters and receivers, must also comply with Federal Communications Commission (FCC) regulations governing authorization and operational approval of telecommunications equipment. Our communication services offered in the Information Management Services business are also subject to certain FCC regulations.

Internationally, similar requirements exist for communication services, airworthiness, installation and operational approvals. These requirements are administered by the national aviation authorities of each country and, in the case of Europe, coordinated by the European Joint Aviation Authorities. Many countries also impose specific telecommunications equipment requirements, administered through their national aviation authorities or telecommunications authorities. In Europe, approval to import products also requires compliance with European Commission directives, such as those associated with electrical safety, electro-magnetic compatibility, use of metric units of measurement and restrictions on the use of lead.

Products already in service may also become subject to mandatory changes for continued regulatory compliance as a result of any identified safety issue, which can arise from an aircraft accident, incident or service difficulty report.

Our products and technical data are controlled for export and import under various regulatory agencies. Audits and investigations by these agencies are a regular occurrence to ensure compliance with applicable federal statutes and regulations. Violations, including as a successor to an acquired business, can result in fines and penalties assessed against the Company as well as individuals, and the most egregious acts may result in a complete loss of export privileges.

Various anti-bribery and anti-corruption laws, as well as data privacy laws, are applicable to our business operations throughout the world.

Although we do not have any significant regulatory action pending against us, any such action could have a material adverse impact on our business, financial condition, results of operations and cash flows.

Environmental Matters

Federal, state and local requirements relating to the discharge of substances into the environment, the disposal of hazardous waste and other activities affecting the environment have had and will continue to have an impact on our manufacturing operations. To date, compliance with environmental requirements and resolution of environmental claims have been accomplished without material effect on our liquidity and capital resources, competitive position or financial condition. We believe that our expenditures for environmental capital investment and remediation necessary to comply with present regulations governing environmental protection and other expenditures for the resolution of environmental claims will not have a material adverse effect on our business or financial condition. Additional information on environmental matters is contained in Note 18 of the Notes to Consolidated Financial Statements in Item 8 below.


Item 1A.	Risk Factors.

Risks Related to Our Business/Industry:

Reduction in U.S. Government spending adversely impacts Government Systems sales and profitability.

In 2018, 23 percent of our sales were derived from U.S. Government contracts, both directly and indirectly through subcontracts. While in 2018 the U.S. Congress acted to increase defense funding for the government's fiscal 2018 and 2019 budget periods, U.S. defense funding is expected to continue to be under pressure due to the overall economic environment, budget deficits and competing budget priorities. Cost cutting, efficiency initiatives, reprioritization and other affordability analysis by the U.S. Government on defense spending could present opportunities for us, but continued pressure on U.S. Government spending on defense could also adversely impact our Government Systems sales and profitability.

The U.S. Government has implemented various initiatives to address its fiscal challenges. In August 2011, Congress enacted the Budget Control Act (BCA) of 2011 which imposed spending caps and certain reductions in defense spending over a ten-year period through 2021. These spending caps and reductions, referred to as sequestration, went into effect in March 2013. Through a series of bipartisan agreements, Congress has been able to temporarily lift discretionary spending limits every year through 2019. However, unless a new agreement is enacted, the BCA will again be in force beginning in 2020. The continued uncertainty surrounding the U.S. defense budget could have a material adverse effect on the Company and the defense industry in general.

In years when the U.S. Government does not complete its annual budget and appropriations process prior to the beginning of its fiscal year (October 1), government operations are typically funded through a continuing resolution that authorizes agencies of the U.S. Government to continue to operate in the new year, but generally does not authorize new spending initiatives. During periods covered by a continuing resolution (or until the regular appropriation bills are passed), we may experience delays by the government in the procurement of new or existing products and services which can adversely impact our results of operations and cause variability in the timing of revenue between periods. During 2018, the U.S. Government completed the fiscal year 2019 Defense budget authorization and approval timeline on schedule and thus avoided the need for a continuing resolution for this part of government operations. Should the U.S. Government not complete fiscal year 2020 budgeting and appropriations in the same manner, we expect to be exposed to the effects of a continuing resolution in the future.

We offer a diverse range of defense products and services. We believe that this makes it less likely that cuts in any specific contract or program will have a long-term effect on our business; however, delays or termination of multiple or large programs or contracts could adversely affect our business and future financial performance. Potential changes in funding priorities may afford new or additional opportunities for our businesses in terms of existing, follow-on or replacement programs. While we would expect to compete and be well positioned as the incumbent on existing programs, we may not be successful, and any replacement programs may be funded at lower levels.

We depend to a significant degree on U.S. Government contracts, which are subject to unique risks.

In addition to normal business risks, our supply of systems and products to the U.S. Government is subject to unique risks which are largely beyond our control. These risks include:


•	dependence on Congressional appropriations and administrative allotment of funds


•	the ability of the U.S. Government to terminate, without prior notice, partially completed government programs and contracts that were previously authorized (although we may recover certain costs if terminated for convenience)


•	changes in governmental procurement legislation and regulations and other policies which may reflect military and political developments, including U.S. Government initiatives to gain increased access to intellectual property


•	significant changes in contract scheduling or program structure, which generally result in delays or reductions in deliveries or timing of cash receipts


•	intense competition for available U.S. Government business necessitating increases in time and investment for design and development


•	difficulty of forecasting costs and schedules when bidding on developmental and highly sophisticated technical work


•	changes over the life of U.S. Government contracts, particularly development contracts, which generally result in adjustments of contract prices


•	claims based on U.S. Government work and violation of associated compliance and other requirements, which may result in fines, the cancellation or suspension of payments or suspension or debarment proceedings affecting potential further business with the U.S. Government

We are subject to risks arising from changes in the competitive environment in which we operate.

We operate in a highly competitive environment. Many of our competitors are also our suppliers or customers on our programs and may be significantly larger than us. Among others, risks in the competitive environment include:


•	increased competition resulting from industry consolidation and original equipment manufacturers' efforts to vertically integrate


•	customers seeking more rights in intellectual property developed in connection with their program, price concessions, extensive liability protections and other customer favorable contract terms


•	competitors offering lower prices and new solutions, developing new technologies or otherwise capturing more market share

International conflicts and terrorism may adversely affect our business.

Conflicts and political turmoil in certain regions outside the United States and the possibility of future terrorist attacks cause significant uncertainty with respect to business and financial markets and may adversely affect our business. These international conflicts also affect the price of oil, which has a significant impact on the financial health of our commercial customers. Although our Government Systems business may experience greater demand for its products as a result of increased government defense spending, factors arising (directly or indirectly) from international conflicts or terrorism which may adversely affect our commercial business include reduced aircraft build rates, upgrades, maintenance and spending on discretionary products, as well as increases in the cost of property and aviation products insurance and increased restrictions placed on our insurance policies.

Our business is heavily concentrated in the aviation industry.

As a provider of products and services to the aviation industry, we are significantly affected by the overall economic condition of that industry. The aviation industry is historically cyclical.

Our business, financial condition, results of operations and cash flows may be adversely impacted, among other things, by the following:


•	reductions in demand for aircraft and delayed aircraft delivery schedules


•	increased vertical integration efforts of the original equipment manufacturers of aircraft


•	bankruptcy or other significant financial difficulties of our existing and potential customers


•	reductions in the need for, or the deferral of, aircraft maintenance and repair services and spare parts support


•	deferral of discretionary spending by our airline customers for cabin retrofit activities


•	retirement or storage of older generation aircraft, resulting in fewer retrofits and less demand for services for those aircraft, as well as the increased availability of used or recycled equipment on the market


•	limited availability of financing for airlines or aircraft


•	impact on the aviation industry due to the volatility of fuel prices


•	disruptions to commercial air travel demand

A global or regional recession may adversely affect us.

If a recession emerges that impacts where we do business, risks may include:


•	declines in revenues, profitability and cash flows from reduced orders, payment delays or other factors caused by the economic problems of our customers


•	adverse impacts on our access to short-term commercial paper borrowings or other credit sources


•	supply problems associated with any financial constraints faced by our suppliers

We derive a significant portion of our revenues from international sales and are subject to the risks of doing business outside the U.S.

In 2018, 48 percent of our total revenues were from sales of our products and services internationally, including foreign military sales. We expect that international sales will continue to account for a significant portion of our total sales. As a result, we are subject to risks of doing business internationally, including:


•	laws, regulations and policies of non-U.S. governments relating to investments and operations, as well as U.S. laws affecting the activities of U.S. companies abroad


•	the imposition of tariffs or embargoes, export controls and other trade restrictions, including the recent tariffs imposed by the U.S. and China and the possibility of additional tariffs or other trade restrictions relating to trade between the two countries


•	regulatory requirements and potential changes, including anti-bribery, anti-money laundering, antitrust and data privacy requirements


•	changes in government spending on defense programs


•	uncertainties and restrictions concerning the availability of funding, credit or guarantees


•	requirements of certain customers which obligate us to specified levels of in-country purchases, manufacturing or investments, known as offsets, and penalties in the event we fail to perform in accordance with the offset requirements


•	impacts associated with foreign currency volatility


•	uncertainties as to local laws and enforcement of contract and intellectual property rights


•	rapid changes in government, economic and political policies, political or civil unrest or the threat of international boycotts or U.S. anti-boycott legislation

We have made, and expect to continue to make, strategic acquisitions and partnerships that involve risks and uncertainties.

We completed two acquisitions in the past two fiscal years. We will consider making minor acquisitions and partnerships in the future in an effort to enhance shareowner value. Acquisitions and partnerships involve certain risks and uncertainties, such as:


•	difficulty in integrating newly-acquired businesses and commencing partnership operations in an efficient and cost-effective manner and the risk that we encounter significant unanticipated costs or other problems associated with integration or commencement


•	challenges in achieving strategic objectives, cost and revenue synergies and other expected benefits


•	risk that our markets do not evolve as anticipated and the targeted technologies do not prove to be those needed to be successful in those markets


•	risk that we assume significant liabilities that exceed the limitations of any applicable indemnification provisions or the financial resources of any indemnifying parties


•	loss of key employees of the acquired businesses or joint venture


•	risk of diverting the attention of senior management from our existing operations


•	risk of litigation associated with an acquisition

We enter into fixed-price contracts that could subject us to losses in the event that we have cost overruns.

During 2018, approximately 94 percent of our total sales were, and a significant portion of our anticipated future sales will be, from fixed-price contracts. This allows us to benefit from cost savings, but it carries the burden of potential cost overruns since we assume all of the cost risk. If our initial cost estimates are incorrect, we can incur losses on these contracts. These fixed-price contracts can expose us to potentially large losses because the customer may compel us to complete a project or, in the event of a termination for default, pay the entire incremental cost of its replacement by another provider regardless of the size of any cost overruns that occur over the life of the contract. Because many of these projects involve new technologies and applications and can last for years, unforeseen events such as technological difficulties, fluctuations in the price of raw

materials (including added tariffs), problems with subcontractors and cost overruns can result in the contractual price becoming less favorable or even unprofitable to us over time. Furthermore, if we do not meet project deadlines or specifications, we may need to renegotiate contracts on less favorable terms, be forced to pay penalties or liquidated damages or suffer major losses if the customer exercises its right to terminate. In addition, some of our contracts have provisions relating to cost controls and audit rights, and if we fail to meet the terms specified in those contracts we may not realize their full benefits. Our results of operations are dependent on our ability to maximize earnings from our contracts. Lower earnings caused by cost overruns could have an adverse impact on our financial condition, results of operations and cash flows.

We are subject to risks in our integration processes and production systems, including potential issues in meeting stringent performance and reliability standards.

The aerospace and defense business is complex, involving extensive coordination and integration with U.S. and non-U.S. suppliers and customers, highly-skilled labor, stringent regulatory and contractual requirements and performance and reliability standards. As a result, our ability to deliver products and systems on time, satisfy regulatory and customer requirements, and achieve or maintain program profitability is subject to significant risk. Operational delays or defects could result in increased production costs, as well as delayed deliveries and disruption to our customers.

Tax changes could affect our effective tax rate and future profitability.

Our future results could be adversely affected by changes in the effective tax rate as a result of changes in our overall profitability and changes in the mix of earnings in countries with differing statutory tax rates, changes in tax legislation, the results of audits and examination of previously filed tax returns and continuing assessment of our tax exposures. For example, in 2018 the U.S. Government enacted the Tax Cuts and Jobs Act (the Act), which contains significant changes to the U.S. tax system. We are analyzing the Act to determine the full impact of the new tax law, and to the extent any future guidance differs from our preliminary interpretation of the law, it could have a material effect on our financial position and results of operations.

We depend on critical suppliers and subcontractors.

We do not always have alternate sources of supply readily available for certain goods or services, such as liquid crystal displays. A shortage of raw materials or components, the loss of a significant supplier or subcontractor or their inability to meet performance, quality or delivery requirements due to natural disaster, financial stress, capacity constraints, military conflicts or other causes could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We depend on specialized test equipment.

Some of our specialized test equipment that supports the reliability of our products and systems is the result of significant investment. Back-up test equipment may not be readily available. Damage to our specialized test equipment may result in protracted production recovery and may adversely impact our ability to service our products.

A cybersecurity incident, network failure, data privacy breach or other business disruption could have negative impacts.

We face cyber threats, threats to the physical security of our facilities, potential cyber attacks to the integrity of our networks and/or products, and the potential release or theft of our intellectual property or other important data as well as the potential for business disruptions associated with information technology (IT) failures. Possible areas of significant exposure to cyber threats or other disruptions include our enterprise information technology resources, our information management network that provides communication services to customers and our flight deck communication products and solutions. Any of these threats or disruptions may result in a material adverse effect on our business, financial condition, results of operations and cash flows. Risks may include:


•	adverse effects to future results due to the theft, destruction, loss, corruption or release of personal data, confidential information or intellectual property


•	operational or business disruptions resulting from the failure of IT or other systems and subsequent mitigation activities


•	fines, penalties or negative publicity resulting in reputation or brand damage with our customers, suppliers, employees, shareowners and others

Risks Related to Our B/E Aerospace Transaction:

We may be unable to successfully integrate B/E Aerospace's business and realize the anticipated benefits of the merger.

The success of the merger will depend, in part, on our ability to successfully combine our business with B/E Aerospace's business and realize the anticipated benefits, including synergies, cost savings, innovation and operational efficiencies, from the combination. If we are unable to achieve these objectives within the anticipated time frame, or at all, the anticipated benefits may not be realized fully, or at all, or may take longer to realize than expected.

The merger involves the integration of B/E Aerospace's business with our existing business, which is a complex, costly and time-consuming process. We have not previously completed a transaction comparable in size or scope to the merger. The integration of the two companies may result in material challenges, including, without limitation:


•	the diversion of management's attention from ongoing business concerns and performance shortfalls at one or both of the companies as a result of the devotion of management's attention to the integration


•	maintaining employee morale and retaining key management and other employees


•	the possibility of faulty assumptions underlying expectations


•	retaining existing business and operational relationships and attracting new business and operational relationships


•	consolidating corporate and administrative infrastructures and eliminating duplicative operations


•	coordinating geographically separate organizations


•	unanticipated issues in integrating information technology, communications and other systems


•	unforeseen expenses or delays associated with the integration

Many of these factors are outside of our control and any one of them could result in delays, increased costs, decreases in the amount of expected revenues and diversion of management's time and energy, which could materially affect our financial position, results of operations and cash flows.

Risks Related to the Pending Acquisition of the Company by UTC:

The UTC Merger is subject to conditions, some or all of which may not be satisfied, or completed on a timely basis, if at all. Failure to complete the UTC Merger could have material adverse effects on us.

The completion of the UTC Merger is subject to a number of conditions. On November 23, 2018, UTC announced that the final regulatory approval required to close its acquisition of Rockwell Collins had been received and that the acquisition was expected to close within three business days.

The failure to satisfy all of the required conditions could delay the completion of the UTC Merger or prevent it from occurring at all. There can be no assurance that the conditions to the closing of the UTC Merger will be satisfied or waived or that the UTC Merger will be completed. Also, subject to limited exceptions, either we or UTC may terminate the Merger Agreement if the UTC Merger has not been completed by 5:00 p.m. (Eastern time) on March 4, 2019.

If the UTC Merger is not completed, our ongoing business may be materially adversely affected and, without realizing any of the benefits of having completed the UTC Merger, we will be subject to a number of risks, including the following:


•	the market price of our common stock could decline


•	we could owe a $695 million termination fee to UTC under certain circumstances, including a material breach by us


•	time and resources, financial and other, committed by our management to integration planning or other matters relating to the UTC Merger could otherwise have been devoted to pursuing other beneficial opportunities


•	we may experience negative reactions from the financial markets or from our customers, suppliers or employees


•	we will be required to pay our costs relating to the UTC Merger, such as legal, accounting, financial advisory and printing fees, whether or not the UTC Merger is completed

In addition, if the UTC Merger is not completed, we could be subject to litigation related to any failure to complete the UTC Merger or related to any enforcement proceeding commenced against us to perform our obligations under the UTC Merger Agreement. Any of these risks could materially and adversely impact our ongoing business, financial condition, financial results and stock price.

Similarly, delays in the completion of the UTC Merger could, among other things, result in additional transaction costs, loss of revenue or other negative effects associated with uncertainty about completion of the UTC Merger and could materially and adversely affect our ongoing business, financial condition, financial results and stock price.

The Merger Agreement contains provisions that limit our ability to pursue alternatives to the UTC Merger, could discourage a potential competing acquiror of the Company from making a favorable alternative transaction proposal and, in specified circumstances, could require us to pay a substantial termination fee to UTC.

The Merger Agreement contains provisions that make it more difficult for us to be acquired by any company other than UTC. The Merger Agreement contains certain provisions that restrict our ability to, among other things, initiate, seek, solicit, knowingly facilitate, knowingly encourage, knowingly induce or knowingly take any other action reasonably expected to lead to, or engage in negotiations or discussions relating to, or approve or recommend, any third-party acquisition proposal.

In some circumstances, including a material breach by us, upon termination of the Merger Agreement, we would be required to pay a termination fee of $695 million to UTC.

These provisions could discourage a potential third-party acquiror or merger partner that might have an interest in acquiring all or a significant portion of us or pursuing an alternative transaction from considering or proposing such a transaction, even if it were prepared to pay consideration with a higher per share value than the value proposed to be received in the UTC Merger. In particular, the termination fee, if applicable, would be substantial, and could result in a potential third-party acquiror or merger partner proposing to pay a lower price to our shareowners than it might otherwise have proposed to pay absent such a fee.

If the Merger Agreement is terminated and we determine to seek another business combination, we may not be able to negotiate a transaction with another party on terms comparable to, or better than, the terms of the UTC Merger.

The value of the stock portion of the Merger Consideration is subject to changes based on fluctuations in the value of UTC common stock.

Upon completion of the UTC Merger, each issued and outstanding share of Rockwell Collins common stock (other than certain excluded shares) will be converted into the right to receive the Merger Consideration, which is equal to $93.33 in cash, without interest, plus a fraction of a share of UTC common stock having a value equal to the quotient obtained by dividing $46.67 by the average of the volume-weighted average prices per share of UTC common stock on the NYSE on each of the 20 consecutive trading days ending with the trading day immediately prior to the closing date, subject to adjustment based on a two-way collar mechanism as described below. If the UTC stock price is greater than $107.01 but less than $124.37, the exchange ratio will be equal to the quotient of (1) $46.67 divided by (2) the UTC stock price. However, if the UTC stock price is less than or equal to $107.01 or greater than or equal to $124.37, then a two-way collar mechanism will apply, pursuant to which (a) if the UTC stock price is greater than or equal to $124.37, the exchange ratio will be fixed at 0.37525 and result in more than $46.67 in value, and (b) if the UTC stock price is less than or equal to $107.01, the exchange ratio will be fixed at 0.43613 and result in less than $46.67 in value. Accordingly, the actual number of shares and the value of UTC common stock

delivered to our shareowners will depend on the UTC stock price, and the value of the shares of UTC common stock delivered for each such share of our common stock may be greater than, less than or equal to $46.67. On November 23, 2018, UTC announced that the final regulatory approval required to close its acquisition of Rockwell Collins had been received and that the acquisition was expected to close within three business days.

We are subject to business uncertainties and contractual restrictions while the UTC Merger is pending, which could adversely affect our business and operations.

In connection with the pendency of the UTC Merger, it is possible that some customers, suppliers and other persons with whom we have a business relationship may delay or defer certain business decisions or might decide to seek to terminate, change or renegotiate their relationships with us as a result of the UTC Merger, which could negatively affect our revenues, earnings and/or cash flows, as well as the market price of our common stock, regardless of whether the UTC Merger is completed.

Under the terms of the Merger Agreement, we are subject to certain restrictions on the conduct of our business prior to completing the UTC Merger which may adversely affect our ability to execute certain of our business strategies, including the ability in certain cases to enter into or amend contracts, acquire or dispose of assets, incur indebtedness or incur capital expenditures. Such limitations could adversely affect our business and operations prior to the completion of the UTC Merger. Each of the risks described above may be exacerbated by delays or other adverse developments with respect to the completion of the UTC Merger.

Completion of the UTC Merger will trigger change in control or other provisions in certain customer and other agreements to which we are a party, which may have an adverse impact on our or UTC’s business and results of operations following completion of the UTC Merger.

The completion of the UTC Merger will trigger change in control and other provisions in certain customer and other agreements to which we are a party. If we or UTC are unable to negotiate waivers of those provisions, customers or other counterparties may exercise their rights and remedies under the agreements, potentially terminating the agreements or seeking monetary damages or equitable remedies. Even if we and UTC are able to negotiate consents or waivers, the customers or other counterparties may require a fee for such waivers or seek to renegotiate the agreements on terms less favorable to us or the combined company. Certain of our customers have commented on the potential impact of the UTC Merger, including potential benefits, questions and concerns. Any of the foregoing or similar developments may have an adverse impact on our or UTC’s business and results of operations following completion of the UTC Merger.

Uncertainties associated with the UTC Merger may cause a loss of management personnel and other key employees, which could adversely affect our future business and operations.

We are dependent on the experience and industry knowledge of our officers and other key employees to execute their business plans. Our success will depend in part upon our ability to retain certain key management personnel and employees. Prior to completion of the UTC Merger, current and prospective employees of us and UTC may experience uncertainty about their roles within UTC following the completion of the UTC Merger, which may have an adverse effect on our ability to attract or retain key management and other key personnel. In addition, no assurance can be given that UTC, after the completion of the UTC Merger, will be able to attract or retain key management personnel and other key employees to the same extent that we and UTC have previously been able to attract or retain their own employees.

The UTC common stock to be received by our shareowners upon completion of the UTC Merger will have different rights from shares of Rockwell Collins common stock.

Upon completion of the UTC Merger, our shareowners will no longer be shareowners of Rockwell Collins, but will instead become shareowners of UTC and their rights as UTC shareowners will be governed by the terms of UTC’s certificate of incorporation and by-laws. The terms of UTC’s certificate of incorporation and by-laws are in some respects materially different than the terms of our certificate of incorporation and by-laws, which currently govern the rights of our shareowners.

Cautionary Statement

This Annual Report on Form 10-K, and documents that are incorporated by reference in this Annual Report on Form 10-K, contains statements, including statements regarding certain projections, business trends and the proposed acquisition of Rockwell Collins by UTC, that are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected as a result of certain risks and uncertainties, including but not limited to those disclosed in Risk Factors in Item 1A above and otherwise detailed herein, as well as other risks and uncertainties, including but not limited to those detailed from time to time in our SEC filings and, with respect to the proposed acquisition of Rockwell Collins, UTC’s filings with the SEC. With respect to the business and operations of Rockwell Collins, these risks include but are not limited to: the financial condition of our customers and suppliers, including bankruptcies; the health of the global economy, including potential deterioration in economic and financial market conditions; adjustments to the commercial OEM production rates and the aftermarket; the impacts of natural disasters and pandemics, including operational disruption, potential supply shortages and other economic impacts; cybersecurity threats, including the potential misappropriation of assets or sensitive information, corruption of data or operational disruption; delays related to the award of domestic and international contracts; delays in customer programs, including new aircraft programs entering service later than anticipated; the continued support for military transformation and modernization programs; potential impact of volatility in oil prices, currency exchange rates or interest rates on the commercial aerospace industry or our business; the impact of terrorist events, regional conflicts or governmental sanctions on other nations on the commercial aerospace industry; changes in domestic and foreign government spending, budgetary, procurement and trade policies adverse to our businesses; market acceptance of our new and existing technologies, products and services; reliability of and customer satisfaction with our products and services; potential unavailability of our mission-critical data and voice communication networks; unfavorable outcomes on or potential cancellation or restructuring of contracts, orders or program priorities by our customers; recruitment and retention of qualified personnel; regulatory restrictions on air travel due to environmental concerns; effective negotiation of collective bargaining agreements by us, our customers, and our suppliers; performance of our customers and subcontractors; risks inherent in development and fixed-price contracts, particularly the risk of cost overruns; risk of significant reduction to air travel or aircraft capacity beyond our forecasts; our ability to execute to internal performance plans such as restructuring activities, productivity and quality improvements and cost reduction initiatives; achievement of B/E Aerospace integration and synergy plans; continuing to maintain our planned effective tax rates; our ability to develop contract compliant systems and products on schedule and within anticipated cost estimates; risk of fines and penalties related to noncompliance with laws and regulations including compliance requirements associated with U.S. Government work, export control, anticorruption and environmental regulations; risk of asset impairments; our ability to win new business and convert those orders to sales within the fiscal year in accordance with our annual operating plan; the uncertainties of the outcome of lawsuits, claims and legal proceedings. With respect to the proposed acquisition, these risks include but are not limited to: the ability of Rockwell Collins and UTC to satisfy the conditions to the closing of the transaction; the occurrence of events that may give rise to a right of one or both of the parties to terminate the merger agreement; negative effects of the announcement or the consummation of the transaction on the market price of UTC and/or Rockwell Collins common stock and/or on their respective businesses, financial conditions, results of operations and financial performance; risks relating to the value of UTC’s shares to be issued in the transaction, significant transaction costs and/or unknown liabilities; the possibility that the anticipated benefits from the proposed transaction cannot be realized in full or at all or may take longer to realize than expected; risks associated with third party contracts containing consent and/or other provisions that may be triggered by the proposed transaction; risks associated with transaction-related litigation; the possibility that costs or difficulties related to the integration of Rockwell Collins’ operations with those of UTC will be greater than expected; the outcome of legally required consultation with employees, their works councils or other employee representatives; and the ability of Rockwell Collins and the combined company to retain and hire key personnel. There can be no assurance that the proposed acquisition will in fact be consummated in the manner described or at all. For additional information on risks associated with the proposed merger and on other identifying factors that may cause actual results to vary materially from those stated in forward-looking statements, see the reports of United Technologies and Rockwell Collins on Forms 10-K, 10-Q and 8-K filed with or furnished to the SEC from time to time. In addition, in connection with the pending merger, UTC has filed a registration statement that includes a prospectus from UTC and a proxy statement from Rockwell Collins, which is effective and contains important information about UTC, Rockwell Collins, the transaction and related matters. Readers are cautioned not to place undue reliance on forward-looking statements. These forward-looking statements are made only as of the date hereof and Rockwell Collins assumes no obligation to update any forward-looking statement, except as otherwise required by law.


Item 1B.	Unresolved Staff Comments.

None.


Item 2.	Properties.

As of September 30, 2018, we operated various manufacturing and engineering facilities, sales offices, warehouses and service locations throughout the U.S. and around the world. These facilities have aggregate floor space of approximately 10.8 million square feet. Of this floor space, 47 percent is owned and 53 percent is leased. There are no major encumbrances on any of our plants or equipment. In the opinion of management, our properties have been well maintained, are in sound operating condition and contain all equipment and facilities necessary to operate at present levels. A summary of floor space of these facilities at September 30, 2018 is as follows:



Location (in thousands of square feet)	Owned Facilities	Leased Facilities	Total
Interior Systems
U.S.	394	2,016	2,410
Europe / Africa / Middle East	277	230	507
Asia-Pacific	705	150	855
Americas, excluding U.S.	—	264	264
Total	1,376	2,660	4,036

Commercial and Government Systems
U.S.	3,355	1,668	5,023
Europe / Africa / Middle East	330	225	555
Asia-Pacific	—	416	416
Americas, excluding U.S.	—	148	148
Total	3,685	2,457	6,142

Information Management Services
U.S.	39	556	595
Europe / Africa / Middle East	—	42	42
Asia-Pacific	—	26	26
Americas, excluding U.S.	—	1	1
Total	39	625	664
Combined Total	5,100	5,742	10,842

Type of Facility (in thousands of square feet)	Owned Facilities	Leased Facilities	Total
Interior Systems
Manufacturing and service	1,300	2,219	3,519
Sales, engineering and general office space	76	441	517

Commercial and Government Systems
Manufacturing and service	1,247	1,017	2,264
Sales, engineering and general office space	2,438	1,440	3,878

Information Management Services
Manufacturing and service	39	81	120
Sales, engineering and general office space	—	544	544
Combined Total	5,100	5,742	10,842

We have facilities with a total of at least 200,000 square feet (in rounded thousands) in the following cities: Cedar Rapids, Iowa (2,910,000 square feet), Tanauan City, Philippines (770,000 square feet), Winston-Salem, North Carolina (660,000 square feet), Melbourne, Florida (400,000 square feet), Annapolis, Maryland (370,000 square feet), Richardson, Texas (280,000 square feet), Everett, Washington (240,000 square feet), Heidelberg, Germany (240,000 square feet), Nogales, Mexico (230,000 square feet), Irvine, California (210,000 square feet) and Coralville, Iowa (200,000 square feet). Most of our facilities for our Commercial

Systems and Government Systems businesses are shared and have therefore been presented together in the tables above. We have excluded from the tables above hundreds of leased locations wherein our Information Management Services business has radio frequency equipment in various locations throughout the world.

We purchase property insurance covering physical damage to our facilities and resulting business interruption from perils including fire, windstorm, flood and earthquake. This insurance generally provides replacement cost coverage subject to a $10 million deductible with certain exceptions. For example, certain of our facilities, including those located in California and Mexico, are located near major earthquake fault lines. For those facilities we maintain earthquake insurance with limits that may be less than full replacement cost. These exceptions are largely driven by the availability and cost of catastrophe coverage from the insurance markets.


Item 3.	Legal Proceedings.

Various lawsuits, claims and proceedings have been or may be instituted or asserted against us relating to the conduct of our business, including those pertaining to product liability, intellectual property, environmental, safety and health, exporting or importing, contract, employment and regulatory matters. Although the outcome of litigation cannot be predicted with certainty and some lawsuits, claims or proceedings may be disposed of unfavorably to us, management believes there are no material pending legal proceedings.

Related to the acquisition and post-closing compliance review of B/E Aerospace, as previously disclosed, the Company identified and is investigating the circumstances surrounding an employee's submission of certain expense reports for customer entertainment and gifts that preceded the acquisition and do not appear to have complied with applicable company policy. In March 2018, the Company voluntarily notified the Department of Justice (DOJ) and SEC Division of Enforcement of its investigation. The Company's investigation into this and other customer related expenditures is ongoing, and the outcome or the consequences thereof cannot be predicted at this time.


Item 4.	Mine Safety Disclosures.

Not applicable.


Item 4A.	Executive Officers of the Company.

The name, age, office, position held with us and principal occupations and employment during the past five years of each of our executive officers as of November 26, 2018 are as follows:



Name, Office and Position, and Principal Occupations and Employment		Age
Robert K. Ortberg—Chairman of the Board of Directors since November 2015; Chief Executive Officer and a Director since August 2013; President since September 2012		58
Patrick E. Allen—Senior Vice President and Chief Financial Officer since January 2005		54
Tatum J. Buse—Vice President, Finance and Corporate Controller since September 2013		44
Philip J. Jasper—Executive Vice President and Chief Operating Officer, Government Systems since September 2012		50
Bruce M. King—Senior Vice President, Operations since May 2011		57
Jeffrey D. MacLauchlan—Senior Vice President, Corporate Development since September 2014; Vice President, Corporate Development of Lockheed Martin Corporation prior thereto		59
Colin R. Mahoney—Senior Vice President, International and Service Solutions since February 2013		53
Nan Mattai—Senior Vice President, Engineering and Information Technology since August 2015; Senior Vice President, Engineering and Technology prior thereto		66
David J. Nieuwsma—Executive Vice President and Chief Operating Officer, Interior Systems since October 2018; Senior Vice President, Information Management Services from April 2016 to October 2018; Vice President, Strategy and Business Development, Government Systems prior thereto		54
Robert J. Perna—Senior Vice President, General Counsel and Secretary since February 2014; Senior Vice President, General Counsel from January 2014 to February 2014; Vice President, General Counsel and Secretary for AM Castle & Co. prior thereto		54
Jeffrey A. Standerski—Senior Vice President, Human Resources since April 2016; Senior Vice President, Information Management Services from December 2013 to April 2016; Vice President and General Manager, Business and Regional Systems prior thereto		52
Kent L. Statler—Executive Vice President and Chief Operating Officer, Commercial Systems since February 2010		53
Douglas E. Stenske—Vice President, Treasurer and Risk Management since September 2013		52
Robert A. Sturgell—Senior Vice President, Washington Operations since April 2009		59

There are no family relationships, as defined, between any of the above executive officers and any other executive officer or any director. No officer was selected pursuant to any arrangement or understanding between the officer and any person other than us. All executive officers are elected annually.


PART II


Item 5.	Market for the Company's Common Equity, Related Stockholder Matters and Company Purchases of Equity Securities.

Shareowner Return Performance⁽¹⁾

(including dividend reinvestment)

Fiscal year ended September 30

Cumulative Total Returns⁽¹⁾



	2013		2014		2015		2016		2017		2018
Rockwell Collins, Inc.	$	100.00	$	114.61	$	123.58	$	128.73	$	202.17	$	219.40
S&P 500	100.00		118.78		120.24		136.54		161.95		190.95
Peer Group	100.00		114.97		122.29		143.03		205.32		254.10
Closing market price of COL at fiscal year end	68.59		77.35		82.24		84.34		130.71		140.47

⁽¹⁾The cumulative total returns table and adjacent line graph compare the cumulative total shareowner return on the company’s Common Stock against the cumulative total return of the S&P Aerospace and Defense Select Industry Index (Peer Group) and the S&P 500 Composite Index (S&P 500) for the five-year period ended September 30, 2018. In each case a fixed investment of $100 at the respective closing prices on September 30, 2013 and reinvestment of all dividends are assumed.

Market Information

Our common stock, par value $.01 per share, is listed on the New York Stock Exchange and trades under the symbol COL. On October 31, 2018, there were 15,404 shareowners of record of our common stock.

Dividends

The following table sets forth the cash dividends per share paid by us during each quarter of our years ended September 30, 2018 and 2017:



Fiscal Quarters	2018		2017
First	$	0.33	$	0.33
Second	0.33		0.33
Third	0.33		0.33
Fourth	0.33		0.33

Based on our current dividend policy, we have been paying quarterly cash dividends which, on an annual basis, equal $1.32 per share. The declaration and payment of dividends, however, will be at the sole discretion of our Board of Directors, subject to certain restrictions in the Merger Agreement. There can be no assurance that we will continue to pay dividends at our current levels.

Repurchases

Our Board of Directors has authorized certain repurchases of our common stock. During 2018, there were no repurchases of our common stock. During 2017, we repurchased approximately 0.4 million shares of our common stock at a total cost of $39 million, at a weighted average cost of $104.32 per share.

The following table provides information with respect to purchases made by or on behalf of us or any "affiliated purchaser" (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934) of shares of our common stock during the three months ended September 30, 2018:

Period

Total

Number of

Purchased

Average Price

Paid per Share

Total Number of

Shares Purchased as

Part of Publicly

Announced

Plans or Programs

Maximum Number

(or Approximate

Dollar Value) of

Shares that May Yet

Be Purchased Under the

Plans or Programs⁽¹⁾

July 1, 2018 through July 31, 2018

—

285 million

August 1, 2018 through August 31, 2018

—

285 million

September 1, 2018 through September 30, 2018

—

285 million

Total / Average

—

⁽¹⁾On July 7, 2017, we announced that our Board authorized the repurchase of an additional $200 million of our common stock. The authorization has no stated expiration.


Item 6.	Selected Financial Data.

The following selected financial data should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8 below. The Statement of Operations, Statement of Financial Position and other data have been derived from our audited financial statements. The Company operates on a 52/53 week fiscal year ending on the Friday closest to September 30. Fiscal years 2018, 2017, 2016 and 2015 were 52-week fiscal years while fiscal year 2014 was a 53-week fiscal year.



	Years Ended September 30
(dollars in millions, except per share amounts)	2018(a)			2017(b)			2016(c)			2015(d)			2014(e)
Statement of Operations Data:
Sales	$	8,665		$	6,822		$	5,259		$	5,244		$	4,979
Cost of sales	6,382			4,868			3,642			3,630			3,469
Selling, general and administrative expenses	817			732			638			606			594
Income from continuing operations	1,032			705			727			694			618
Income (loss) from discontinued operations, net of taxes	—			—			1			(8		)	(14		)
Net income	1,032			705			728			686			604
Net income as a percent of sales	11.9		%	10.3		%	13.8		%	13.1		%	12.1		%
Diluted earnings per share from continuing operations	6.22			4.79			5.50			5.19			4.52
Statement of Financial Position Data:
Working capital(f)	$	1,092		$	1,691		$	1,144		$	1,164		$	1,054
Property, Net	1,429			1,398			1,035			964			919
Goodwill and intangible assets	11,299			11,287			2,586			2,607			2,551
Total assets	19,026			17,997			7,699			7,294			6,994
Short-term debt	2,248			479			740			448			504
Long-term debt, net	5,681			6,676			1,374			1,670			1,652
Shareowners' equity	7,107			6,043			2,078			1,875			1,884
Other Data:
Capital expenditures	$	257		$	240		$	193		$	210		$	163
Depreciation and amortization	449			399			253			252			225
Dividends per share	1.32			1.32			1.32			1.26			1.20
Stock Price:
High	$	142.61		$	135.31		$	95.11		$	99.37		$	84.06
Low	130.01			78.54			76.03			72.35			65.76

(a)

Income from continuing operations includes a $130 million income tax benefit due to the enactment of the Tax Cuts and Jobs Act (the Act). In addition, income from continuing operations includes $57 million of B/E Aerospace acquisition-related costs ($78 million before income taxes) and $31 million of transaction costs associated with the pending acquisition of the Company by UTC ($34 million before income taxes). Income from continuing operations also includes $44 million of restructuring, asset impairment and settlement of a contract matter charges ($39 million before income taxes). Approximately $30 million of the pre-tax expense was recorded within cost of sales and $9 million was included within other income, net.

(b)

On April 13, 2017, we completed the acquisition of B/E Aerospace for $6.5 billion in cash and stock, plus the assumption of $2.0 billion of debt, net of cash acquired. To finance the acquisition and repay assumed debt, we issued 31.2 million shares of common stock, issued $4.35 billion of senior unsecured notes and borrowed $1.5 billion under a new senior unsecured syndicated term loan facility. Income from continuing operations includes $86 million of transaction, integration and financing costs associated with the acquisition of B/E Aerospace ($125 million before income taxes) and $15 million of transaction costs associated with the pending acquisition of the Company by UTC ($24 million before income taxes).

(c)

Income from continuing operations includes a $24 million income tax benefit from the retroactive reinstatement of the previously expired Federal Research and Development Tax Credit and a $41 million income tax benefit due to the release of a valuation allowance for a U.S. capital loss carryforward. In addition, income from continuing operations includes $28 million of restructuring and asset impairment charges ($45 million before income taxes) primarily related to employee severance costs. Approximately $33 million of the pre-tax expense was recorded within cost of sales and $12 million was included within selling, general and administrative expenses.


(d)	Income from continuing operations includes a $22 million income tax benefit from the retroactive reinstatement of the previously expired Federal Research and Development Tax Credit and a $16 million income tax benefit related to the remeasurement of certain prior year tax positions.

(e)

Income from continuing operations includes $18 million of restructuring, pension settlement and ARINC transaction costs ($25 million before income taxes). Approximately $18 million of the pre-tax expense was recorded in selling, general and administrative expenses, $4 million was included within cost of sales, and $3 million was classified as interest expense. Income from continuing operations also includes a $9 million gain ($10 million before income taxes) resulting from the sale of the KOSI business. On December 23, 2013, we acquired ARINC for $1.405 billion. This acquisition was funded through a combination of new long-term debt and short-term commercial paper borrowings.


(f)	Working capital consists of all current assets and liabilities, including cash and short-term debt.


Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto in Item 8 below. The following discussion and analysis contains forward-looking statements and estimates that involve risks and uncertainties. Actual results could differ materially from these estimates. Factors that could cause or contribute to differences from estimates include those discussed under Cautionary Statement and Risk Factors contained in Item 1A above.

We operate on a 52/53 week fiscal year ending on the Friday closest to September 30. For ease of presentation, September 30 is utilized consistently throughout Management's Discussion and Analysis of Financial Condition and Results of Operations to represent the fiscal year end date. Fiscal years 2018, 2017 and 2016 were 52-week fiscal years. All date references contained herein relate to our fiscal year unless otherwise stated.



OVERVIEW AND OUTLOOK

On September 4, 2017, we entered into the Merger Agreement providing for the acquisition of the Company by UTC. If the UTC Merger is consummated, we will become a wholly owned subsidiary of UTC. The agreement includes covenants and agreements relating to the conduct of our business between the date of signing the Merger Agreement and the consummation of the UTC Merger. In light of the announced transaction with UTC, we do not intend to issue financial guidance for fiscal year 2019. During 2018, we incurred $34 million of transaction costs associated with the pending UTC Merger. On November 23, 2018, UTC announced that the final regulatory approval required to close its acquisition of Rockwell Collins had been received and that the acquisition was expected to close within three business days.

On April 13, 2017, we completed our acquisition of B/E Aerospace for $6.5 billion in cash and stock, plus the assumption of $2.0 billion of debt, net of cash acquired. To finance the acquisition and repay assumed debt, we issued 31.2 million shares of common stock, issued $4.35 billion of senior unsecured notes and borrowed $1.5 billion under a senior unsecured syndicated term loan facility. Beginning in 2018, the B/E Aerospace thermal and electronic systems product lines, previously included in Interior products and services within the Interior Systems segment, are now being reported in the Government Systems segment. As these product lines primarily serve military and government customers, the reorganization is expected to generate additional revenue synergy opportunities for the Company. The results of operations of the acquired B/E Aerospace business are now reported in the Interior Systems and Government Systems business segments. Interior Systems and Government Systems sales and operating earnings for the year ended September 30, 2017, have been reclassified to conform to the current year presentation. See Note 3 of the Notes to Consolidated Financial Statements in Item 8 below for more information regarding the acquisition.

The B/E Aerospace acquisition expands our reach and broadens our portfolio of aircraft content with the addition of a wide range of cabin interior products for commercial aircraft and business jets including seating, food and beverage preparation and storage equipment, lighting and oxygen systems and modular galley and lavatory systems. The Company's portfolio of aircraft content now spans the aircraft from cockpit to cabin, communications to connectivity. The acquisition also further diversifies our geographic presence and customer mix as Interior Systems products and services are sold to airlines and original equipment manufacturers across the globe. In addition, the acquisition enhances our diversified and balanced business, serving both commercial and government markets. During 2018, we incurred $78 million of B/E Aerospace acquisition-related expenses.

Our Commercial Systems business supplies aviation electronics systems, products and services to customers located throughout the world. The Commercial Systems customer base is comprised of commercial air transport and business and regional aircraft OEMs, commercial airlines and business aircraft operators. The Government Systems business provides communication and navigation products and avionics to the U.S. Department of Defense, state and local governments, other government agencies, civil agencies, defense contractors and foreign ministries of defense around the world. These systems, products and services

support airborne (fixed and rotary wing), ground and shipboard applications. Our Information Management Services (IMS) business enables mission-critical data and voice communications throughout the world to customers including the U.S. Federal Aviation Administration, commercial airlines, business aircraft operators, airport and critical infrastructure operators and major passenger and freight railroads. These communications are enabled by our high-performance, high-quality and high-assurance proprietary radio and terrestrial networks, enhancing customer efficiency, safety and connectivity. In October 2018, we announced that IMS will become part of the Commercial Systems segment. This reorganization will enable us to further capitalize on customers' increasing need for aviation connectivity solutions. This change will require that we revise our segment reporting beginning in the first quarter of fiscal 2019 to report the IMS business within the Commercial Systems segment.

Total sales increased $1.843 billion, or 27 percent, in 2018 compared to 2017, primarily due to the B/E Aerospace acquisition, which contributed a revenue increase of $1.577 billion. Sales excluding the B/E Aerospace acquisition (organic sales) increased $261 million, or 4 percent, compared to 2017, due to revenue growth across all of our legacy businesses.⁽¹⁾

Total segment operating earnings⁽²⁾increased $290 million to $1.616 billion in 2018 compared to 2017. The Interior Systems business contributed a $238 million increase in operating earnings, in addition, operating earnings increased across each of our legacy businesses.

Our effective tax rate decreased in 2018, primarily due to the Enactment of the Tax Cuts and Jobs Act (the Act) which resulted in a $154 million reduction in deferred tax liabilities, partially offset by a $24 million obligation related to unremitted foreign earnings. In addition to these discrete impacts, the effective tax rate was favorably impacted by a lower U.S. Federal statutory tax rate under the Act.

Diluted earnings per share increased 30 percent to $6.22 in 2018 compared to $4.79 in 2017, as higher segment operating earnings and the benefit of a lower effective tax rate in 2018 were partially offset by higher interest expense from debt issued to fund the B/E Aerospace acquisition and $39 million of pre-tax restructuring, impairment and settlement of a contract matter charges. In addition, diluted earnings per share was negatively impacted in 2018 by higher weighted average shares outstanding from the 31.2 million shares of common stock issued to finance the B/E Aerospace acquisition. Adjusted earnings per share increased 11 percent to $6.81 in 2018 compared to 2017 (see the below reconciliation between GAAP earnings per share and adjusted earnings per share).

Our cash flow used for operating activities was $310 million during 2018, compared to cash flow provided by operating activities of $1.264 billion in 2017. The increase in cash used for operating activities in 2018 was primarily due to higher discretionary contributions to our pension plan (to achieve a tax deduction at the pre-reform rate and reduce future Pension Benefit Guaranty Corporation premiums), higher incentive payments to customers, the timing of other operating cash payments and receipts and the accelerated payment of 2018 employee incentive compensation (consistent with requirements of the Merger Agreement, given that the UTC Merger was expected to close prior to our 2018 fiscal year end), as discussed in the Financial Condition and Liquidity section below. We continued to deploy cash for the benefit of our shareowners in 2018 by paying aggregate dividends of $216 million.

Fiscal year 2018 results are as follows:



(in billions, except per share amounts)		FY18 Results
Total sales		$8.665
Diluted earnings per share		$6.22
Operating cash flow used for continuing operations		$(0.310)
Capital expenditures		$0.257
Total research and development investment⁽³⁾		$1.348

⁽¹⁾Organic sales, organic growth, and similar measures excluding the effects of the B/E Aerospace acquisition are non-GAAP measures which measure the applicable item (e.g., sales or sales growth) without giving effect to the contribution for such item as a result of the B/E Aerospace acquisition. Such non-GAAP measures are believed to be important indicators of our operations for purposes of period-to-period comparisons of the underlying businesses. The Company does not intend for any of the non-GAAP information to be considered in isolation or as a substitute for the related GAAP measures.

⁽²⁾Total segment operating earnings is a non-GAAP measure and is reconciled to the related GAAP measure, Income from continuing operations before income taxes, in Note 21 of the Notes to Consolidated Financial Statements. Total segment operating earnings is calculated as the total of segment operating earnings of our four segments. The non-GAAP total segment operating earnings information included in this disclosure is believed to be useful to investors in comparing our operating performance from period to period by isolating the effects of some items that vary from period to period without any correlation to core operating performance.

⁽³⁾Total research and development (R&D) investment is comprised of company- and customer-funded R&D expenditures and the net change in pre-production engineering costs capitalized within Inventory.

Adjusted earnings per share is a non-GAAP metric and is believed to be useful to investors' understanding and assessment of our ongoing operations and performance of the B/E Aerospace acquisition, which occurred on April 13, 2017. Adjusted earnings per share excludes certain one-time and non-cash expenses that we believe are not indicative of our ongoing operating results. We believe these measures are important indicators of the Company's operations for purposes of period-to-period comparison of our operating results. The non-GAAP information is not intended to be considered in isolation or as a substitute for the related GAAP measures.

A reconciliation between GAAP earnings per share and adjusted earnings per share is presented below for 2018 and 2017.



	2018			2017
Earnings per share (GAAP)	$	6.22		$	4.79
B/E Aerospace acquisition-related expenses	0.34			0.58
United Technologies transaction expenses	0.19			0.10
Amortization of acquisition-related intangible assets	1.25			0.71
Amortization of B/E Aerospace acquired contract liability	(0.78		)	(0.41		)
Amortization of B/E Aerospace inventory fair value adjustment	—			0.38
Restructuring and impairment charges and settlement of a contract matter	0.27			—
Discrete income tax impact from Tax Cuts and Jobs Act and pension contribution	(0.68		)	—
Adjusted earnings per share	$	6.81		$	6.15

The below tables reconcile pre- and post-tax income on a GAAP basis with pre- and post-tax adjusted income for 2018 and 2017.



	2018											2017
(dollars in millions)	Pre-tax			Tax Expense			Net			Tax Rate		Pre-tax			Tax Expense			Net			Tax Rate
Net income (GAAP)	$	1,112		$	80		$	1,032		7.2	%	$	931		$	226		$	705		24.3	%
B/E Aerospace acquisition-related expenses	78			21			57					125			39			86
United Technologies transaction expenses	34			3			31					24			9			15
Amortization of acquisition-related intangible assets	268			62			206					149			45			104
Amortization of B/E Aerospace acquired contract liability	(141		)	(12		)	(129		)			(69		)	(8		)	(61		)
Amortization of B/E Aerospace inventory fair value adjustment	—			—			—					74			18			56
Restructuring and impairment charges and settlement of a contract matter	39			(5		)	44					—			—			—
Discrete income tax impact from Tax Cuts and Jobs Act and pension contribution	—			112			(112		)			—			—			—
Adjusted net income	$	1,390		$	261		$	1,129		18.8	%	$	1,234		$	329		$	905		26.7	%

Our long-term strategies are focused on the following:


•	accelerate sales growth


•	expand operating margins and improve cash flow conversion


•	deploy capital with priorities on growth and shareowner return

Accelerate sales growth

Accelerating our business growth is a fundamental objective of our management team. For the past decade we have been in a period of significant investment in research and development to support market share gains throughout our businesses. Our

record of success in migrating technologies across the enterprise is a core strength and enables us to realize the benefits of investment even if market conditions change. We are realizing the benefits of completing investments in these programs as new platforms enter service. Our focus on developing solutions aimed at making Rockwell Collins the supplier of choice is evidenced by our significant investment in research and development. Over the past 5 years, we invested approximately $5.3 billion in research and development, which has allowed us to develop new systems, products and software solutions for our customers and capture strategically important positions on a variety of air transport, business aviation and military aircraft.

Highlights of our strategy to accelerate top-line sales growth are as follows:

Strong positions will fuel growth

Our Interior Systems segment was created in April 2017 with the acquisition of B/E Aerospace. The Interior Systems current backlog of $3.9 billion increased $287 million during 2018. Increased aircraft production rates at commercial air transport and business jet OEMs fuel opportunities for continued growth. Backlog growth results from favorable trends in airline selectable equipment, including seating, lighting systems and food preparation and storage, as well as increased production of aircraft with standard Interior Systems equipment. Additionally, the large installed base provides a robust flow of aftermarket retrofit and spares opportunities to support long-term growth.

Within Commercial Systems, over the past several years we have captured key positions and market share gains on platforms such as the Boeing 737 MAX and 777X, as well as the Airbus A220. We successfully completed numerous milestones on these and other aircraft development programs throughout the year, including the certification of ProLine Fusion on the Bombardier Global 7500 which is scheduled to enter into service later this year. We believe these accomplishments have positioned us to continue to grow our market share. We previously announced that Airbus has selected our flight operations and maintenance exchanger solution, called FOMAX, as standard on their A320 family. Under this agreement, we will supply each A320 aircraft with a secure router to wirelessly send aircraft performance and maintenance data to ground-based operations.

Within Government Systems, we increased our backlog by $60 million during 2018. Defense budgets have been improving not only in the United States, but also throughout the world. During 2018, we were selected for our first international E2-D Advanced Hawkeye weapons system trainer, which is an important extension of our E2-D training system capabilities for the U.S. Navy into the Foreign Military Sales (FMS) market. We were also one of two companies selected by the U.S. Air Force for the technology maturation and risk reduction phase of the Airborne Launch Control System Replacement program (ALCS-R). ALCS-R will upgrade the survivable launch control system that is part of the United States' intercontinental ballistic missile deterrent, and is part of the broader initiative to modernize U.S. nuclear capabilities.

We are capitalizing on aviation’s information age

In today’s information-enabled world, the industry continues to trend away from hardware-based solutions to more software-based applications and the needs for connectivity are increasing for airlines, airports and passengers. Through organic innovations and acquisitions, our Information Management Services portfolio positions us as a leader in aviation information management, delivering efficiency and safety to our customers and their passengers.

As traffic on our air-to-ground network increases, we’re taking steps to enhance its capacity and usefulness. In the cockpit, more robust data streams and sophisticated applications are enhancing operational efficiencies, safety and on-time flight performance. In the cabin, broadband connectivity is enabling passengers to stay connected throughout their flight, and it also provides new ways to enhance the passenger experience. In 2018, we introduced our GlobalConnect offering that leverages our standard information management hardware positions on the Airbus A350XWB, A320NEO and A330NEO and the Boeing 787 to expand our portfolio of communications and data management services for airlines. Approximately 10 airlines have already subscribed to the new services.

We will continue to grow globally

Market opportunities outside the United States continue to evolve, driven in part by expanding populations and emerging economies. Security needs are on the rise in places around the globe, as countries seek to establish indigenous capabilities to protect their borders, infrastructure and resources. At the same time, global commercial air travel is expected to increase as we see a growing middle class in developing countries, generating higher traffic and demand for new aircraft. We believe we are positioned to grow by capturing new programs at emerging international OEMs, strategically positioning service centers around the globe and by launching joint ventures.

Expand operating margins and improve cash flow conversion

Operational excellence is a fundamental objective at our Company. We have extended Lean concepts beyond the factory floor to virtually every aspect of our business. We focus on streamlining processes, reducing costs and increasing quality while

enhancing our ability to respond quickly to customer needs. In addition, our shared service model uses a centralized organizational structure to leverage resources across the business. This is evidenced by our product and technology centers of excellence, through which we apply our core competencies to solutions across our segments. By applying common tools and systems across our businesses, we can better manage our cost structure and maximize our R&D investments.

We believe our Company has a proven ability to both react quickly to changing business conditions and to execute business plans. For example, as we faced challenging conditions in business aviation and the defense environment in the past several years, we took actions to manage our cost structure, while focusing on our customers, continuing our commitment to operational excellence and maintaining our balanced business model. We will also distinguish ourselves through strong customer relationships, high returns on invested capital and continued investment in market differentiating technologies and programs. As we grow our Company, our goal is to generate long-term double-digit cash flow growth. In 2018, our operating cash flow was significantly impacted by discretionary cash contributions to our pension plans, an increase in cash incentive payments to customers and the timing of employee incentive compensation payments. See the Financial Condition and Liquidity section below.

Deploy capital with priorities on growth and shareowner return

We plan to allocate capital across our Company to prioritize debt repayment and to fund growth through investments in R&D, capital expenditures and minor acquisitions. On April 13, 2017, the Company completed the acquisition of B/E Aerospace for $6.5 billion in cash and stock, plus the assumption of $2.0 billion in net debt. The transaction combines our capabilities in flight deck avionics, cabin electronics, mission communications, simulation and training and information management systems with B/E Aerospace's range of cabin interior products, which include seating, food and beverage preparation and storage equipment, lighting and oxygen systems, and modular galley and lavatory systems for commercial airliners and business jets. The acquisition significantly increases our scale and diversifies our product portfolio, customer mix and geographic presence.

See the following sections for further discussion of our results of operations. For additional disclosure on segment operating earnings see Note 21 of the Notes to Consolidated Financial Statements in Item 8 below. Please also see our Risk Factors and Cautionary Statement in Item 1A of this Form 10-K.

RESULTS OF OPERATIONS

The following management discussion and analysis of results of operations is based on reported financial results for 2016 through 2018 and should be read in conjunction with our consolidated financial statements and the notes thereto in Item 8 below.

Consolidated Financial Results

Sales



(in millions)	2018			2017			2016
U.S.^{(1) (2)}	$	4,666		$	3,873		$	3,292
Non-U.S.⁽¹⁾	3,999			2,949			1,967
Total	$	8,665		$	6,822		$	5,259
Percent increase	27		%	30		%

⁽¹⁾Sales are attributed to geographic region based on the location of our customers.

⁽²⁾For the years ended September 30, 2018, 2017 and 2016, U.S. sales include revenue from foreign military sales of $163 million, $139 million and $171 million, respectively.

Sales for 2018 compared to 2017

Total sales increased $1.843 billion, or 27 percent, for the year ended September 30, 2018, compared to the prior year. B/E Aerospace, which was acquired on April 13, 2017, contributed $1.577 billion of the overall revenue growth. Sales excluding the B/E Aerospace acquisition (organic sales) increased $261 million, or 4 percent, compared to the prior year, driven by a $162 million increase within Commercial Systems, a $107 million increase within Government Systems and a $27 million increase within Information Management Services, partially offset by a $35 million organic revenue decrease within Interior Systems. Refer to the Interior Systems, Commercial Systems, Government Systems and Information Management Services sections of the Segment Financial Results below for a detailed discussion of sales by segment in 2018 and 2017.

U.S. sales increased $793 million, or 20 percent, primarily due to sales from the B/E Aerospace acquisition. The remaining increase results primarily from higher Boeing 737 production rates and increased aftermarket revenues in Commercial Systems, as well as higher Government Systems sales to the U.S. Government.

Non-U.S. sales increased $1.050 billion, or 36 percent, primarily due to sales from the B/E Aerospace acquisition. The remaining variance is primarily driven by higher Airbus A320 and A350 production rates and increased aftermarket revenues in Commercial Systems.

Sales for 2017 compared to 2016

Total sales increased $1.563 billion, or 30 percent, for the year ended September 30, 2017, compared to the prior year. B/E Aerospace, which was acquired on April 13, 2017, contributed $1.406 billion of the overall revenue growth. Sales excluding the B/E Aerospace acquisition (organic sales) increased $157 million, or 3 percent, compared to the prior year, driven by a $74 million increase within Government Systems, a $60 million increase within Information Management Services and a $23 million increase within Commercial Systems. Refer to the Interior Systems, Commercial Systems, Government Systems and Information Management Services section of the Segment Financial Results below for a detailed discussion of sales by segment in 2017 and 2016.

U.S. sales increased $581 million, or 18 percent, primarily due to $567 million of sales from the B/E Aerospace acquisition. The remaining increase results primarily from higher Government Systems sales to the U.S. Government.

Non-U.S. sales increased $982 million, or 50 percent, primarily due to $839 million of sales from the B/E Aerospace acquisition. The remaining variance is primarily driven by higher Airbus A350 production rates, a favorable mix of international airline selectable equipment sales and higher customer-funded development program revenues in Commercial Systems and increased international usage of connectivity services at Information Management Services.

B/E Aerospace Pro Forma Sales⁽¹⁾

Sales for the recently acquired B/E Aerospace business were $2.983 billion and $2.960 billion, on a pro forma basis, for the years ended September 30, 2018 and 2017, respectively. These pro forma results include sales of the Interior Systems segment and the two B/E Aerospace product lines now reported within the Government Systems segment. The $23 million, or 1 percent, increase in pro forma sales was primarily due to the following:


•	a $64 million increase in thermal and electronic systems sales in Government Systems, primarily due to higher deliveries of cooling equipment


•	partially offset by a $41 million decrease in Interior Systems pro forma sales discussed in the Interior Systems sales section below

⁽¹⁾ This pro forma sales information is believed to be useful to investors' understanding of the overall performance of the B/E Aerospace acquisition.

Cost of Sales



(in millions)	2018			2017			2016
Total cost of sales	$	6,382		$	4,868		$	3,642
Percent of total sales	73.7		%	71.4		%	69.3		%

Cost of sales consists of all costs incurred to design and manufacture our products and provide our services and includes R&D, raw material, labor, facility, product warranty, depreciation, amortization, service and support and other related expenses.

Cost of sales for 2018 compared to 2017

Total cost of sales increased $1.514 billion primarily due to the following:


•	$1.272 billion of inorganic cost of sales from the recently acquired B/E Aerospace business


•	a $191 million increase from higher organic sales, which was unfavorably impacted by sales mix as discussed in the Government Systems and Information Management Services sections of the Segment Financial Results below


•	a $65 million organic increase in company-funded R&D, as detailed in the Research and Development expense section below


•	a $30 million increase due to an impairment charge associated with the settlement of a contract matter and employee separation costs


•	a $28 million increase in amortization of pre-production engineering costs


•	partially offset by the absence of $74 million of inventory fair value adjustment amortization recorded in the prior year related to the acquisition of B/E Aerospace

The increase in cost of sales as a percent of revenues was primarily due to sales mix, including impact of the acquired B/E aerospace business, and increased company-funded R&D expenses.

Cost of sales for 2017 compared to 2016

Total cost of sales increased $1.226 billion primarily due to the following:


•	$1.140 billion of inorganic cost of sales from the recently acquired B/E Aerospace business


•	an $83 million increase from higher organic sales, which was favorably impacted by benefits from cost savings initiatives


•	a $40 million increase in employee incentive compensation costs


•	partially offset by $33 million of asset and restructuring charges recorded in 2016


•	further offset by a $9 million organic decrease in company-funded R&D expense in Government Systems and Information Management Services, as detailed in the Research and Development Expense section below

The increase in cost of sales as a percent of revenues was primarily due to the recently acquired B/E Aerospace business.

Research and Development Expense

R&D expense is included as a component of cost of sales and is summarized as follows:



(in millions)	2018			2017			2016
Customer-funded:
Interior Systems	$	113		$	54		$	—
Commercial Systems	253			262			231
Government Systems	483			421			381
Information Management Services	6			9			9
Total customer-funded	855			746			621
Company-funded:
Interior Systems	208			109			—
Commercial Systems	201			143			143
Government Systems	93			75			79
Information Management Services ⁽¹⁾	—			—			2
Total company-funded	502			327			224
Total research and development expense	$	1,357		$	1,073		$	845
Percent of total sales	15.7		%	15.7		%	16.1		%

⁽¹⁾R&D expenses for the Information Management Services segment do not include costs of internally developed software and other costs associated with the expansion and construction of network-related assets. These costs are capitalized as Property on the Consolidated Statement of Financial Position.

We make significant investments in research and development to allow our customers to benefit from the latest technological advancements. Total R&D expense is comprised of both company-funded and customer-funded expenditures. In addition to the

R&D expenditures shown in the table above, we capitalize in inventory the cost of certain pre-production engineering effort incurred during the development phase of programs when the customer has provided us a long-term supply arrangement and a contractual guarantee for reimbursement. Pre-production engineering costs are then amortized over their useful lives. This amortization cost is included within customer-funded R&D expense and totaled $87 million, $59 million and $49 million for 2018, 2017 and 2016, respectively. Refer to Critical Accounting Policies section found in Item 7 below for further discussion of our investments in pre-production engineering effort.

Customer-funded R&D expenditures are incurred pursuant to contractual arrangements and are typically accounted for as contract costs within cost of sales, with the reimbursement accounted for as a sale in accordance with the percentage-of-completion method of accounting.

Company-funded R&D expenditures relate to the development of new products and the improvement of existing products and are expensed as incurred and included in cost of sales, as disclosed in Note 2 of the Notes to Consolidated Financial Statements in Item 8 below. Company-funded R&D expense consists primarily of payroll-related expenses of employees engaged in R&D activities, engineering-related product materials and equipment and subcontracting costs.

Total R&D expense increased $284 million from 2017 to 2018. The customer-funded portion of R&D increased $109 million from 2017 to 2018, primarily due to customer-funded expenditures from the recently acquired B/E Aerospace business. In addition, customer-funded expenditures for Government Systems increased $62 million due to fixed wing and test and training range programs while Commercial Systems decreased $9 million due to international regional jet programs. Company-funded R&D expenditures increased $175 million from 2017 to 2018, primarily due to company-funded expenditures from the recently acquired B/E Aerospace business. In addition, company-funded expenditures for Commercial Systems increased $58 million due to the Bombardier Global 7500 and Boeing 777X programs while Government Systems increased $18 million due to spending on various Avionics programs.

Total R&D expense increased $228 million from 2016 to 2017. The customer-funded portion of R&D increased $125 million from 2016 to 2017, primarily due to $54 million of customer-funded expenditure from the recently acquired B/E Aerospace business. In addition, customer-funded expenditures for Government Systems increased $40 million due to fixed wing programs and Commercial Systems increased $31 million due to international regional jet programs and higher amortization of pre-production engineering costs. Company-funded R&D expenditures increased $103 million from 2016 to 2017 primarily due to $112 million of company-funded expenditures from the recently acquired B/E Aerospace business.

In addition to the R&D expenses above, development expenditures incurred primarily for the Airbus A350 and A220 platforms and the Bombardier Global 7500 program in 2018 resulted in a gross $85 million increase to our investments in pre-production engineering programs capitalized within inventory. The gross increase of $85 million for 2018 was $46 million less than the $131 million gross increase in pre-production engineering costs capitalized within inventory during 2017, primarily due to lower costs incurred on the Bombardier Global 7500 and Boeing 737 MAX platforms, partially offset by an increase in costs incurred for the Airbus A350 program.

Development expenditures incurred on the Bombardier Global 7500, Airbus A220, Boeing 737 MAX and certain military transport programs in 2017 resulted in a gross $131 million increase to our investments in pre-production engineering programs capitalized within inventory. The gross increase of $131 million for 2017 was $46 million less than the $177 million net increase in pre-production engineering costs capitalized within inventory during 2016, primarily due to lower costs incurred for the Boeing 737 MAX platform.

Refer to Note 6 of the Notes to Consolidated Financial Statements in Item 8 below for further discussion of our investments in pre-production engineering effort.

Selling, General and Administrative Expenses



(in millions)	2018			2017			2016
Selling, general and administrative expenses	$	817		$	732		$	638
Percent of total sales	9.4		%	10.7		%	12.1		%

Selling, general and administrative (SG&A) expenses consist primarily of personnel, facility and other expenses related to employees not directly engaged in manufacturing or R&D activities. These activities include marketing and business development, finance, legal, information technology and other administrative and management functions.

Total SG&A expenses increased $85 million, or 12 percent, in 2018 compared to 2017, primarily due to the following:


•	SG&A costs from the recently acquired B/E Aerospace business


•	partially offset by the absence of international customer bankruptcy and employee severance charges recorded in 2017


•	also offset by the benefits of cost savings initiatives

Total SG&A expenses increased $94 million, or 15 percent, in 2017 compared to 2016, primarily due to the following:


•	$99 million of SG&A costs from the recently acquired B/E Aerospace business


•	international customer bankruptcy and employee severance charges in 2017


•	a $3 million increase in employee incentive compensation costs


•	partially offset by $12 million of restructuring and asset impairment charges recorded in 2016 and the benefits of cost savings initiatives

Interest Expense



(in millions)	2018		2017		2016
Interest expense	$	262	$	187	$	64

Interest expense increased by $75 million in 2018 compared to 2017, primarily due to the following:


•	$89 million of incremental interest on the debt issued to fund the B/E Aerospace acquisition


•	the combination of higher commercial paper balances and higher interest rates on commercial paper compared to the prior year


•	partially offset by the absence of $29 million of bridge facility fees incurred in the prior year related to the

B/E Aerospace acquisition

Interest expense increased by $123 million in 2017 compared to 2016, primarily due to to the following:


•	$92 million of incremental interest on the new debt issued to fund the B/E Aerospace acquisition


•	$29 million of fees incurred in 2017 associated with the bridge credit agreement entered into in December 2016 pursuant to the acquisition of B/E Aerospace

See Note 9 of the Notes to Consolidated Financial Statements in Item 8 below for more detail regarding outstanding debt.

Other Income, Net

Other income, net increased by $4 million in 2018 compared to 2017, primarily due to favorable resolution of certain claims associated with a divested business, as discussed in the Information Management Services section of the Segment Financial Results below, partially offset by asset impairment charges due to the planned sale of SMR Technologies (see Note 4 of the Notes to Consolidated Financial Statements in Item 8 below).

Other income, net decreased by $4 million in 2017 compared to 2016, primarily due to the absence of a favorable settlement of a contractual matter with a customer of the ASES business. See Note 4 of the Notes to Consolidated Financial Statements in Item 8 below for more detail regarding this settlement.

Income Tax Expense from Continuing Operations



(in millions)	2018			2017			2016
Income tax expense	$	80		$	226		$	208
Effective income tax rate	7.2		%	24.3		%	22.2		%

On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (the Act). The Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits and deductions for individuals and businesses. For businesses, the Act reduces the corporate federal tax rate from a maximum of 35.0 percent to a flat 21.0 percent rate, effective January 1, 2018, and transitions from a worldwide tax system to a modified territorial tax system. The Act also adds many new provisions including changes to bonus depreciation, changes to the deduction for executive compensation and interest expense, a tax on global intangible low-taxed income (GILTI), the base erosion anti-abuse tax (BEAT) and a deduction for foreign-derived intangible income (FDII). Many of these provisions, including the tax on GILTI, the BEAT and the deduction for FDII, do not apply to the Company until 2019 and the Company continues to assess the impact of these provisions. The Company has elected to account for the tax on GILTI as a period cost and thus has not adjusted any of the deferred tax assets/liabilities of its foreign subsidiaries for the new tax. The two material items that impact the Company for 2018 are the reduction in the tax rate and a one-time tax that is imposed on the Company’s unremitted foreign earnings.

The difference between our effective income tax rate in 2018 and the statutory tax rate is primarily due to the benefit derived from the rate change on our deferred tax liabilities due to the enactment of the Act and the Federal Research and Development Tax Credit (Federal R&D Tax Credit), which provides a tax benefit on certain incremental R&D expenditures, partially offset by the tax on unremitted foreign earnings imposed by the Act.

The effective income tax rate in 2018 decreased from 2017 primarily due to the $154 million reduction in deferred tax liabilities resulting from the Act and the $73 million benefit of the lower U.S. Federal statutory rate on current year earnings, partially offset by the $24 million tax on unremitted foreign earnings imposed by the Act.

The effective income tax rate in 2017 increased from 2016 primarily due to the retroactive reinstatement of the Federal R&D Tax Credit and the release of a $41 million valuation allowance related to a U.S. capital loss carryforward in the prior year. In addition, the effective income tax rate in 2017 was favorably impacted by the jurisdictional mix of income as a result of the B/E Aerospace acquisition.

Net Income and Diluted Earnings Per Share



(in millions, except per share amounts)	2018			2017			2016
Income from continuing operations	$	1,032		$	705		$	727
Percent of sales	11.9		%	10.3		%	13.8		%

Income from discontinued operations, net of taxes	—			—			1
Net income	$	1,032		$	705		$	728

Diluted earnings per share from continuing operations	$	6.22		$	4.79		$	5.50
Diluted earnings per share from discontinued operations	—			—			0.01
Diluted earnings per share	$	6.22		$	4.79		$	5.51

Weighted average diluted common shares	165.8			147.2			132.1

Income from continuing operations, net of taxes, for 2018 was $1.032 billion, up 46 percent, or $327 million, from the $705 million in income from continuing operations, net of taxes, reported for 2017. Diluted earnings per share from continuing operations increased 30 percent to $6.22 during this same time period. The rate of increase in diluted earnings per share from continuing operations was less than the rate of increase in income from continuing operations, net of taxes, due to the 31.2 million shares of common stock issued to finance the B/E Aerospace acquisition.

Income from continuing operations, net of taxes, and diluted earnings per share from continuing operations in 2018 increased primarily due to:


•	a $238 million increase in Interior Systems operating earnings, a $38 million increase in Commercial Systems operating earnings, a $13 million increase in Government Systems operating earnings and a $1 million increase in Information Management Services operating earnings


•	a $146 million decrease in income tax expense as detailed in the Income Taxes section below


•	an $8 million decrease in pre-tax transaction and integration costs associated with the acquisition of B/E Aerospace and the pending acquisition of Rockwell Collins by UTC


•	partially offset by a $75 million increase in interest expense, primarily due to the debt issued to fund the B/E Aerospace acquisition


•	also offset by $39 million of pre-tax restructuring, impairment and settlement of a contract matter charges recorded in 2018 (see Note 20 of the Notes to Consolidated Financial Statements in Item 8 below)

Income from continuing operations, net of taxes, for 2017 was $705 million, down 3 percent, or $22 million, from the $727 million in income from continuing operations, net of taxes, reported for 2016. Diluted earnings per share from continuing operations decreased 13 percent to $4.79 during this same time period. The rate of decrease in diluted earnings per share from continuing operations was more than the rate of decrease in income from continuing operations, net of taxes, due to the 31.2 million shares of common stock issued to finance the B/E Aerospace acquisition.

Income from continuing operations, net of taxes, and diluted earnings per share from continuing operations in 2017 decreased primarily due to:


•	$125 million of pre-tax transaction, integration and financing costs associated with the acquisition of B/E Aerospace


•	$92 million of incremental interest expense on the new debt issued to fund the B/E Aerospace acquisition


•	$24 million of pre-tax transaction costs associated with the pending acquisition of Rockwell Collins by UTC


•	an $18 million increase in income tax expense as detailed in the Income Tax Expense from Continuing Operations section above


•	partially offset by a $168 million increase in operating earnings from the recently acquired Interior Systems business, a $30 million increase in Information Management Services operating earnings and a $25 million increase in Government Systems operating earnings, net of a $12 million decrease in Commercial Systems operating earnings


•	also offset by the absence of $45 million of pre-tax restructuring and asset impairment charges recorded in 2016

Segment Financial Results

One of the key metrics we use to describe year-over-year changes in operating income for each segment is the incremental (or reduced) earnings derived from higher (or lower) sales volumes. Similarly, the gross margin derived from these incremental (or reduced) earnings is often used to describe changes in segment operating margins. The incremental (or reduced) margin realized on the sales volume change tends to be disproportionately higher than the overall operating margin reported for the segment. This is because the overall operating margin for the segment contemplates more elements of our cost structure, such as company-funded R&D expense, depreciation, amortization and selling, general and administrative expenses.

Interior Systems

Overview

On April 13, 2017, we acquired B/E Aerospace and formed the Interior Systems business segment. As described in the Overview and Outlook section, sales and earnings of the B/E Aerospace thermal and electronic systems product lines, previously included in Interior products and services within the Interior Systems segment, are now being reported in the Government Systems segment. Interior Systems and Government Systems sales and operating earnings for the year ended

September 30, 2017, have been reclassified to conform to the current year presentation. See Note 3 of the Notes to Consolidated Financial Statements in Item 8 below for more information regarding the acquisition.

The Interior Systems business manufactures cabin interior products for the commercial aircraft and business aviation markets, including aircraft seats, a full line of aircraft food and beverage preparation and storage equipment, modular lavatory systems, wastewater management systems, galley systems, lighting products and oxygen systems. We sell our products and provide our services directly to virtually all of the world’s major airlines and aerospace manufacturers. The near and long-term performance of our Interior Systems business is impacted by general worldwide economic health, commercial airline flight hours, commercial aircraft production and retirement rates and the financial condition of airlines worldwide.

For risks to the Interior Systems segment, see Risk Factors in Item 1A above. For additional disclosure on Interior Systems segment results see Note 21 of the Notes to Consolidated Financial Statements in Item 8 below.

Interior Systems Sales

The following table presents Interior Systems sales by product category:



(in millions)	2018			2017		2016
Interior products and services	$	1,472		$	717	$	—
Aircraft seating	1,237			585		—
Total	$	2,709		$	1,302	$	—
Percent increase	108		%

The 2017 results above reflect sales by the Interior Systems segment from April 13, 2017 through September 30, 2017.

Interior Systems Sales for 2018 compared to 2017

Total interior products and services sales increased $755 million, or 105 percent, compared to the same period in the prior year, primarily due to the following:


•	a $781 million inorganic revenue increase due to the timing of the April 13, 2017, B/E Aerospace acquisition


•	partially offset by $26 million in other net decreases to revenue, primarily due to timing of original equipment galley revenues and the absence of oxygen equipment retrofit deliveries which occurred in the prior year

Total aircraft seating sales increased $652 million, or 111 percent, compared to the same period in the prior year, primarily due to the following:


•	a $661 million inorganic revenue increase due the timing of the April 13, 2017, B/E Aerospace acquisition


•	partially offset by $9 million in other net decreases to revenue, primarily due to the completion of certain super first class programs

Interior Systems Pro Forma Sales

Note 3 of the Notes to Consolidated Financial Statements in Item 8 below presents supplemental pro forma financial data as if the acquisition of B/E Aerospace had been completed on October 1, 2015. The pro forma data included in Note 3 combines the Company's consolidated results with the stand-alone results of B/E Aerospace for the pre-acquisition periods. The supplemental pro forma data is not necessarily indicative of results that actually would have occurred had the acquisition been consummated on October 1, 2015.

Interior Systems Sales for 2018 compared to Pro Forma Sales for 2017

On a pro forma basis, sales for the Interior Systems segment would be $2.709 billion and $2.750 billion for the years ended September 30, 2018 and 2017, respectively. The $41 million, or 1 percent, decrease in the pro forma sales was primarily due to the following:


•	a $65 million decrease in aircraft seating sales, primarily due to softening of the super first class seating market and the timing of other new seating equipment deliveries


•	partially offset by a $24 million increase in interior products and services sales, primarily due to increased original equipment deliveries of galley inserts, advanced lavatories and cabins

Interior Systems Pro Forma Sales for 2017 compared to Pro Forma Sales for 2016

On a pro forma basis, sales for the Interior Systems segment would be $2.750 billion and $2.703 billion for the years ended September 30, 2017 and 2016, respectively. The $47 million, or 2 percent, increase in the pro forma sales was primarily due to the following:


•	a $159 million increase in interior products and services sales, primarily due to increased original equipment deliveries of Airbus A350 galleys, Boeing 737 advanced lavatories and oxygen generators across multiple platforms


•	partially offset by a $112 million decrease in aircraft seating, primarily due to the completion of certain super first class and retrofit programs

Refer to Note 3 of the Notes to Consolidated Financial Statements in Item 8 below for additional pro forma disclosures.

Interior Systems Segment Operating Earnings



(in millions)	2018			2017			2016
Segment operating earnings	$	406		$	168		$	—
Percent of sales	15.0		%	12.9		%	—		%

Interior Systems Operating Earnings for 2018 compared to 2017

Interior Systems operating earnings increased $238 million, or 142 percent, compared to the same period in the prior year, primarily due to the following:

•

the $1.442 billion inorganic revenue increase discussed in the Interior Systems sales section above, which resulted in a $1.120 billion increase in cost and incremental earnings of $322 million, or 22 percent of the higher sales volume. The margins on the sales increase were favorably impacted by the benefit of cost synergies in the current year and unfavorably impacted by increases to certain product quality reserves


•	the absence of $63 million of inventory fair value adjustment amortization recorded in the prior year


•	partially offset by a $123 million increase in intangible asset amortization expense

•

further offset by the $35 million organic revenue decrease discussed in the Interior Systems sales section above, which resulted in a $19 million decrease in cost and decreased earnings of $16 million, or 46 percent of the lower sales volume. The margins on the sales decrease were unfavorably impacted by sales mix due to the absence of higher margin oxygen retrofit deliveries which occurred in the prior year


•	also offset by an $8 million increase in employee incentive compensation costs

2018 operating earnings include $229 million of intangible asset amortization expense, partially offset by $141 million of favorable acquired contract liability amortization. The 2017 results above reflect operating earnings of the Interior Systems segment from April 13, 2017, through September 30, 2017, and include $106 million of intangible asset amortization expense and $63 million of inventory fair value adjustment amortization that unfavorably impacted operating earnings, partially offset by $69 million of favorable acquired contract liability amortization.

Commercial Systems

Overview

Our Commercial Systems business supplies aviation electronics systems, products and services to customers located throughout the world. The customer base is comprised of OEMs of commercial air transport, business and regional aircraft, commercial airlines and business aircraft operators. The near and long-term performance of our Commercial Systems business is impacted by general worldwide economic health, commercial airline flight hours, corporate profits and the financial condition of airlines worldwide.

For risks to the Commercial Systems segment, see Risk Factors in Item 1A above. For additional disclosure on Commercial Systems segment results see Note 21 of the Notes to Consolidated Financial Statements in Item 8 below.

Commercial Systems Sales

The following table presents Commercial Systems sales by product category:



(in millions)	2018			2017			2016
Air transport aviation electronics:
Original equipment	$	965		$	910		$	850
Aftermarket	593			541			542
Wide-body in-flight entertainment	15			19			38
Total air transport aviation electronics	1,573			1,470			1,430
Business and regional aviation electronics:
Original equipment	495			477			534
Aftermarket	512			471			431
Total business and regional aviation electronics	1,007			948			965
Total	$	2,580		$	2,418		$	2,395
Percent increase	7		%	1		%

Commercial Systems Sales for 2018 compared to 2017

Total air transport aviation electronics sales increased $103 million, or 7 percent, primarily due to the following:


•	original equipment sales increased $55 million, or 6 percent, primarily due to higher Boeing 737, Airbus A320 and A350 production rates, partially offset by lower legacy wide-body production rates


•	aftermarket sales increased $52 million, or 10 percent, primarily due to higher spares provisioning, service and support activity and regulatory mandate upgrade activity


•	wide-body IFE sales decreased $4 million, or 21 percent, as airlines decommissioned their legacy IFE systems

Total business and regional aviation electronics sales increased $59 million, or 6 percent, primarily due to the following:


•	original equipment sales increased $18 million, or 4 percent, primarily due to higher business jet equipment deliveries, partially offset by lower customer-funded development program revenues


•	aftermarket sales increased $41 million, or 9 percent, primarily due to higher service and support, regulatory mandate upgrade and flight deck retrofit activities

Commercial Systems Sales for 2017 compared to 2016

Total air transport aviation electronics sales increased $40 million, or 3 percent, primarily due to the following:


•	original equipment sales increased $60 million, or 7 percent, primarily due to higher Boeing 737 and Airbus A350 production rates, partially offset by lower legacy wide-body production rates


•	aftermarket sales decreased $1 million, primarily due to lower retrofit and service and support sales, partially offset by higher regulatory mandate upgrade activity and higher used aircraft equipment sales


•	wide-body IFE sales decreased $19 million, or 50 percent, as airlines decommissioned their legacy IFE systems

Total business and regional aviation electronics sales decreased $17 million, or 2 percent, primarily due to the following:


•	original equipment sales decreased $57 million, or 11 percent, primarily due to lower business and regional aircraft OEM production rates, partially offset by higher product deliveries for the Airbus A220 and Global 7500 programs and higher customer-funded development program revenues


•	aftermarket sales increased $40 million, or 9 percent, primarily due to higher regulatory mandate upgrade and flight deck retrofit activity

Commercial Systems Segment Operating Earnings



(in millions)	2018			2017			2016
Segment operating earnings	$	557		$	519		$	531
Percent of sales	21.6		%	21.5		%	22.2		%

Commercial Systems Operating Earnings for 2018 compared to 2017

Commercial Systems operating earnings increased $38 million, or 7 percent, primarily due to the following:

•

the $162 million increase in sales volume discussed in the Commercial Systems sales section above, which resulted in a $50 million increase in cost and incremental earnings of $112 million, or 69 percent of the higher sales volume. The margins on the sales increase were favorably impacted by sales mix as higher margin equipment and aftermarket sales increased and lower margin customer-funded development revenues decreased


•	partially offset by a $58 million increase in company-funded R&D expense


•	also offset by a $16 million increase in amortization of pre-production engineering

The increase in Commercial Systems operating earnings as a percent of sales was primarily due to higher sales volume and favorable sales mix, partially offset by higher company-funded R&D and pre-production engineering amortization costs.

Commercial Systems Operating Earnings for 2017 compared to 2016

Commercial Systems operating earnings decreased $12 million, or 2 percent, primarily due to the following:


•	a $19 million increase in employee incentive compensation costs


•	a $12 million increase in international customer bankruptcy and employee severance charges in 2017


•	partially offset by benefits from cost savings initiatives


•	in addition, the benefits of a $23 million increase in sales were unfavorably impacted by sales mix, as lower margin customer-funded development revenues increased and higher margin business jet OEM sales decreased

The decrease in Commercial Systems operating earnings as a percent of sales was primarily due to increased employee incentive compensation costs, international customer bankruptcy and employee severance charges, and unfavorable sales mix, partially offset by the benefits of cost savings initiatives.

Government Systems

Overview

The Government Systems business provides communication and navigation products and avionics to the U.S. Department of Defense, state and local governments, other government agencies, civil agencies, defense contractors and foreign ministries of defense around the world. These systems, products and services support airborne (fixed and rotary wing), ground and shipboard applications. The short- and long-term performance of our Government Systems business is affected by a number of factors, including the amount and prioritization of defense spending by the U.S. and non-U.S. governments, which is generally based on the security environment and underlying political landscape.

As described in the Overview and Outlook section, sales and earnings of the B/E Aerospace thermal and electronic systems product lines, previously included in Interior products and services within the Interior Systems segment, are now being reported in the Government Systems segment. Interior Systems and Government Systems sales and operating earnings for the year ended September 30, 2017, have been reclassified to conform to the current year presentation. See Note 3 of the Notes to Consolidated Financial Statements for more information regarding the acquisition.

For risks to the Government Systems segment, see Risk Factors in Item 1A above. For additional disclosure on Government Systems segment results see Note 21 of the Notes to Consolidated Financial Statements in Item 8 below.

Government Systems Sales

The following table presents Government Systems sales by product category:



(in millions)	2018			2017			2016
Avionics	$	1,503		$	1,472		$	1,483
Communication and navigation	1,128			912			723
Total	$	2,631		$	2,384		$	2,206
Percent increase	10		%	8		%

Government Systems Sales for 2018 compared to 2017

Avionics sales increased $31 million, or 2 percent, primarily due to the following:


•	a $45 million increase from higher fixed wing sales, primarily due to higher development program sales and higher deliveries for various fighter platforms


•	partially offset by $14 million in other net decreases to revenue, primarily due to lower deliveries on various rotary wing platforms

Communication and navigation sales increased $216 million, or 24 percent, primarily due to the following:


•	a $170 million increase from higher thermal and electronic systems sales, including a $140 million inorganic revenue increase due to the timing of the April 13, 2017, B/E Aerospace acquisition


•	$69 million in other net increases to revenue, primarily due to higher test and training range sales and higher deliveries of GPS-related products


•	partially offset by a $23 million decrease due to lower legacy communication product deliveries

Government Systems Sales for 2017 compared to 2016

Avionics sales decreased $11 million, or 1 percent, primarily due to the following:


•	a $25 million decrease from lower fixed wing sales, primarily due to the wind-down of legacy tanker hardware deliveries and lower deliveries for various fighter platforms as a result of production issues, net of higher development program sales


•	partially offset by a $14 million increase from higher simulation and training sales

Communication and navigation product sales increased $189 million, or 26 percent, primarily due to the following:


•	a $104 million increase due to the B/E Aerospace acquisition as discussed above


•	a $23 million increase from higher data links sales


•	a $22 million increase from higher deliveries of GPS-related products


•	$40 million in other net increases to revenue, primarily due to higher test and training range sales and higher legacy communication sales

Government Systems Segment Operating Earnings



(in millions)	2018			2017			2016
Segment operating earnings	$	515		$	502		$	477
Percent of sales	19.6		%	21.1		%	21.6		%

Government Systems Operating Earnings for 2018 compared to 2017

Government Systems operating earnings increased $13 million, or 3 percent, primarily due to the following:


•	the $247 million increase in sales volume discussed in the Government Systems sales section above, which resulted in

a $209 million increase in cost and incremental earnings of $38 million, or 15 percent of the higher sales volume. The

margins on the sales increase were unfavorably impacted by sales mix as lower margin customer-funded development

revenues and B/E Aerospace thermal and electronic systems sales increased and higher margin product sales decreased


•	partially offset by an $18 million increase in company-funded R&D expense


•	also offset by a $7 million organic increase in amortization of pre-production engineering

The decrease in Government Systems operating earnings as a percent of sales was primarily due to unfavorable sales mix and higher company-funded R&D and preproduction engineering amortization costs.

Government Systems Operating Earnings for 2017 compared to 2016

Government Systems operating earnings increased $25 million, or 5 percent, primarily due to the following:


•	the $74 million increase in sales volume discussed in the Government Systems sales section above, which resulted in a $43 million increase in cost and incremental earnings of $31 million, or 42 percent of the higher sales volume. The margins on the sales increase were favorably impacted by benefits from cost savings initiatives


•	a $7 million decrease in company-funded R&D expense


•	a $6 million increase due to reclassification of the operating earnings of the B/E Aerospace thermal and electronic systems product lines as discussed above


•	partially offset by a $19 million increase in employee incentive compensation costs

The decrease in Government Systems operating earnings as a percent of sales was primarily due to margins on the B/E Aerospace thermal and electronic systems sales and increased employee incentive compensation costs, partially offset by earnings from the higher sales volume, the benefits of cost savings initiatives and decreased company-funded R&D expense.

Information Management Services

Overview

Our Information Management Services business enables mission-critical data and voice communications throughout the world to customers including the FAA, commercial airlines, business aircraft operators, airport and critical infrastructure operators and major passenger and freight railroads. These communications are enabled by our high-performance, high-quality and high-assurance proprietary radio and terrestrial networks, enhancing customer efficiency, safety and connectivity. The near and long-term performance of our Information Management Services business is impacted by general worldwide economic health, commercial airline and business aircraft flight hours and corporate profits.

For risks to the Information Management Services segment, see Risk Factors in Item 1A above. For additional disclosure on Information Management Services segment results see Note 21 of the Notes to Consolidated Financial Statements in Item 8 below.

Information Management Services Sales

The following table presents Information Management Services sales:



(in millions)	2018			2017			2016
Sales	$	745		$	718		$	658
Percent increase	4		%	9		%

Information Management Services Sales for 2018 compared to 2017

Total Information Management Services sales increased $27 million, or 4 percent. Aviation-related sales grew 6 percent, primarily due to increased usage of connectivity services, partially offset by the absence of a bulk sale of connectivity related equipment that occurred in the prior year. Non-aviation sales decreased 2 percent, primarily due to the completion of nuclear security mandate revenues.

Information Management Services Sales for 2017 compared to 2016

Total Information Management Services sales increased $60 million, or 9 percent. Aviation-related sales grew 11 percent, primarily due to increased usage of connectivity services and increased connectivity related equipment deliveries. Non-aviation sales grew 6 percent, primarily due to nuclear security mandate revenue.

Information Management Services Segment Operating Earnings



(in millions)	2018			2017			2016
Segment operating earnings	$	138		$	137		$	107
Percent of sales	18.5		%	19.1		%	16.3		%

Information Management Services Operating Earnings for 2018 compared to 2017

Information Management Services operating earnings increased $1 million, or 1 percent, primarily due to:


•	favorable resolution of certain claims associated with a divested business


•	a $27 million increase in sales volume discussed in the Information Management Services sales section above, which resulted in a $19 million increase in cost and an increase in earnings of $8 million, or 30 percent of the higher sales volume. The margins on the sales increase were unfavorably impacted by lower margin equipment related sales


•	partially offset by the absence of favorable resolution of certain international business jet support services claims in the prior year


•	also offset by asset disposition and customer bankruptcy costs and an increase in the allowance for doubtful accounts related to specific customer collection risks


•	further offset by a $5 million increase in employee incentive compensation costs

The decrease in operating earnings as a percent of sales was primarily due to the above mentioned favorable claims resolution, partially offset by asset disposition and customer bankruptcy costs, an increase in the allowance for doubtful accounts and increased employee incentive compensation costs.

Information Management Services Operating Earnings for 2017 compared to 2016

Information Management Services operating earnings increased $30 million, or 28 percent, primarily due to:


•	a $60 million increase in sales volume discussed in the Information Management Services sales section above, which resulted in a $33 million increase in cost and an increase in earnings of $27 million, or 45 percent of the higher sales volume. The margins on the sales increase were favorably impacted by benefits from cost savings initiatives


•	operating earnings were positively impacted in 2017 by the favorable resolution of certain prior year claims associated with international business jet support services, in excess of the 2016 benefit associated with similar claims

The increase in operating earnings as a percent of sales was primarily due to higher sales volume and the above mentioned favorable resolution of prior year claims.

General Corporate, Net

General corporate expenses that are not allocated to our operating segments are included in General corporate, net. These costs are included within Cost of sales, SG&A and Other income, net on the Consolidated Statement of Operations. General corporate, net is summarized as follows:

General corporate, net expense decreased $1 million during 2018 as compared to 2017.

General corporate, net expense increased $13 million during 2017 as compared to 2016, primarily due to costs of the acquired B/E Aerospace business and higher employee incentive compensation costs.

Retirement Plans

Net benefit expense (income) for pension benefits and other retirement benefits are as follows:



(in millions)	2018			2017			2016
Pension benefits	$	(29	)	$	(25	)	$	(24	)
Other retirement benefits	13			14			14
Net benefit (income) expense	$	(16	)	$	(11	)	$	(10	)

Pension Benefits

In 2018, five of the Company's eight collective bargaining agreements were negotiated and participation in the Rockwell Collins Pension Plan is now closed to newly hired employees pursuant to those negotiations. The individuals covered by the agreements will instead receive supplemental Company contributions to the existing defined contribution savings plan. The Company previously amended its U.S. qualified and non-qualified defined benefit pension plans to discontinue benefit accruals for salary increases and services rendered after September 30, 2006 for all salaried and hourly employees who were not covered by collective bargaining agreements. Our total cash contributions to defined contribution savings plans were $69 million, $54 million and $46 million for 2018, 2017 and 2016, respectively.

In October 2014, the Society of Actuaries published a new set of mortality tables (RP-2014). For our 2017 year end pension liability valuation, the Company continued to use the RP-2014 tables with an adjustment for plan experience, but utilized the MP-2016 mortality improvement scale adjusted to reflect convergence to an ultimate annual rate of mortality improvement of 0.75 percent by 2032. For the 2018 year end pension liability valuation, the Company continued to use the RP-2014 tables with an adjustment for plan experience, but utilized the MP-2017 mortality improvement scale adjusted to reflect convergence to an

ultimate annual rate of mortality improvement of 0.75 percent by 2033. Both the MP-2016 and MP-2017 mortality improvement scales indicate that U.S. mortality continues to improve, but at a slower average rate. See additional details in the Critical Accounting Policies section in Item 7A below.

A "spot rate approach" has been used to calculate pension interest and service cost. The spot rate approach applies separate discount rates for each projected benefit payment in the calculation of pension interest and service cost.

Defined benefit pension income for the years ended September 30, 2018, 2017 and 2016 was $29 million, $25 million and $24 million, respectively.

The increase in pension income in 2018 compared to 2017 was primarily due to an anticipated increase in return on plan assets as well as a change in the discount rate, impacting interest costs and amortization of net actuarial losses. The increase in pension income in 2017 compared to 2016 was primarily due to a change in the discount rate, impacting interest costs and amortization of net actuarial losses.

During 2018, the funded status of our pension plans went from a deficit of $1.016 billion at September 30, 2017 to a deficit of $356 million at September 30, 2018. The improvement in funded status was primarily due to an increase in contributions by the Company to its pension plans from $68 million during the year ended September 30, 2017 to $467 million during the year ended September 30, 2018, an increase in plan assets due to favorable market returns during 2018, and the favorable impact from an increase in the discount rate used to measure our U.S. pension obligations from 3.53 percent at September 30, 2017 to 4.02 percent at September 30, 2018.

Our objective with respect to the funding of our pension plans is to provide adequate assets for the payment of future benefits. Pursuant to this objective, we will fund our pension plans as required by governmental regulations and may consider discretionary contributions as conditions warrant. We believe our strong financial position continues to provide us the opportunity to make contributions to our pension plans without inhibiting our ability to pursue strategic investments.

There is no minimum statutory funding requirement for 2019. Any additional future contributions necessary to satisfy minimum statutory funding requirements are dependent upon actual plan asset returns, interest rates and other actuarial assumptions.

Other Retirement Benefits

Other retirement benefits expense for the years ended September 30, 2018, 2017 and 2016 was $13 million, $14 million and $14 million, respectively.

FINANCIAL CONDITION AND LIQUIDITY

Cash Flow Summary

Our ability to generate significant cash flow from operating activities coupled with our expected ability to access the credit markets enables us to execute our growth strategies and return value to our shareowners. The timing of our cash inflows is historically heavily weighted towards the second half of our fiscal year, particularly our fourth quarter. We expect this trend to continue in the future.

Operating Activities



(in millions)	2018			2017		2016
Cash (used for) provided by operating activities from continuing operations	$	(310	)	$	1,264	$	723

The $1.574 billion increase in cash used for operating activities in 2018 compared to 2017 was primarily due to the following:


•	higher payments for production inventory and other operating costs, which increased $2.214 billion to $7.366 billion compared to $5.152 billion in 2017 due to cash payments of the recently acquired B/E Aerospace business and a $234 million increase in cash incentive payments to customers in 2018


•	payments to our pension plan increased $399 million as we made contributions of $467 million in 2018 compared to $68 million in 2017. The incremental contribution was made to achieve a tax deduction at the pre-reform rate and reduce future Pension Benefit Guaranty Corporation premiums

•

payments for employee incentive pay increased $213 million, primarily due to the accelerated payment of 2018 employee incentive compensation, as discussed below. In 2017, $121 million was paid for employee incentive pay costs expensed during 2016. In the first fiscal quarter of 2018, $182 million was paid for employee incentive pay costs expensed during 2017. In addition, $152 million was paid in the fourth fiscal quarter of 2018 for employee incentive pay costs expensed during 2018. Payment of 2018 employee incentive compensation was accelerated, consistent with requirements of the Merger Agreement, given that the UTC Merger was expected to close prior to our 2018 fiscal year end. Incentive pay costs expensed in 2018 and 2017 were higher than in 2016 primarily due the acquisition of B/E Aerospace

•

partially offset by higher cash receipts from customers, which increased by $1.063 billion to $8.010 billion in 2018, compared to $6.947 billion in 2017, primarily due to cash receipts of the recently acquired B/E Aerospace business. The increase in cash receipts from customers was less than the sales volume increase of $1.843 billion primarily due to the timing of sales relative to the collection of receivables from customers as well as a $248 million decrease in cash generated by sales of accounts receivable under factoring arrangements (see Note 5 of the Notes to Consolidated Financial Statements in Item 8 below)


•	also offset by lower cash payments for income taxes, which decreased $202 million to $28 million in 2018 compared to $230 million in 2017. The decrease in cash used for income tax payments was primarily due to a $387 million discretionary pension contribution made in July 2018, a lower federal income tax rate as a result of the Tax Cuts and Jobs Act and the receipt of certain tax refunds

The $541 million increase in cash provided by operating activities in 2017 compared to 2016 was primarily due to the following:


•	higher cash receipts from customers, which increased by $1.867 billion to $6.947 billion in 2017 compared to $5.080 billion in 2016, primarily due to cash receipts of the recently acquired B/E Aerospace business. The increase in cash receipts from customers was more than the sales volume increase of $1.563 billion due to the timing of sales relative to the collection of receivables from customers


•	partially offset by higher payments for production inventory and other operating costs, which increased by $1.135 billion to $5.152 billion in 2017, compared to $4.017 billion in 2016, primarily due to cash payments of the recently acquired B/E Aerospace business

•

also offset by cash payments for income taxes, which increased $100 million to $230 million in 2017, compared to $130 million in 2016. The increase in cash used for income tax payments was primarily due to the retroactive reinstatement of the Federal R&D tax credit as a result of the Protecting Americans from Tax Hikes Act in 2016, as well as pre-tax income associated with the recently acquired B/E Aerospace business


•	further offset by payments for transaction costs associated with the B/E Aerospace acquisition of $114 million in 2017

Investing Activities



(in millions)	2018			2017			2016
Cash (used for) investing activities from continuing operations	$	(256	)	$	(3,674	)	$	(209	)

The $3.418 billion reduction in cash used for investing activities in 2018 compared to 2017 was primarily due to the following:


•	$3.429 billion of cash payments for acquisitions in 2017, primarily related to the acquisition of B/E Aerospace


•	partially offset by a $17 million increase in cash payments for property additions in 2018 compared to the prior year, primarily due to the B/E Aerospace acquisition

The $3.465 billion increase in cash used for investing activities in 2017 compared to 2016 was primarily due to the following:


•	$3.417 billion in cash consideration paid, net of cash acquired, related to the April 2017 acquisition of B/E Aerospace


•	a $47 million increase in cash payments for property additions to $240 million in 2017, primarily driven by the B/E Aerospace acquisition

Financing Activities



(in millions)	2018		2017		2016
Cash provided by (used for) financing activities from continuing operations	$	610	$	2,759	$	(422	)

The $2.149 billion decrease in cash provided by financing activities in 2018 compared to 2017 was primarily due to the following:


•	$3.980 billion of prior year financing activities related to B/E Aerospace acquisition. $6.099 billion in net proceeds from the issuance of long-term debt were principally used to repay $2.119 billion of assumed B/E Aerospace debt, finance the cash portion of the B/E Aerospace purchase price and pay related transaction fees and expenses


•	partially offset by a $1.280 billion increase in net proceeds from short-term commercial paper borrowings


•	further offset by a $541 million decrease in repayments of long-term debt

The $3.181 billion increase in cash provided by financing activities in 2017 compared to 2016 was primarily due to the following:


•	$3.980 billion related to financing of the B/E Aerospace acquisition. $6.099 billion in net proceeds from the issuance of long-term debt were principally used to repay $2.119 billion of assumed B/E Aerospace debt, finance the cash portion of the B/E Aerospace purchase price and pay related transaction fees and expenses


•	cash repurchases of common stock decreased $215 million to $46 million in 2017, compared to $261 million in 2016


•	partially offset by a $930 million increase in repayments of long-term debt and a $102 million decrease in the net proceeds from short-term commercial paper borrowings

Share Repurchase Program

Cash flow from operations provided funds for repurchasing our common stock under our share repurchase program as follows:



(in millions, except per share amounts)	2018		2017		2016
Amount of share repurchases	$	—	$	39	$	255
Number of shares repurchased	—		0.4		2.9
Weighted average price per share	$	—	$	104.32	$	87.30

None of the 2017 or 2016 share repurchases reflected in the table above are included within accounts payable at September 30, 2017 or 2016, respectively.

Dividends

We declared and paid cash dividends of $216 million, $194 million and $172 million in 2018, 2017 and 2016, respectively. Based on our current dividend policy, we expect to pay quarterly cash dividends which, on an annual basis, would equal $1.32 per share. We expect to fund dividends using cash generated from operations. The declaration and payment of future dividends is at the sole discretion of the Board of Directors, subject to certain restrictions in the Merger Agreement.

Financial Condition and Liquidity

We maintain a capital structure that we believe enables us sufficient access to credit markets. When combined with our ability to generate strong levels of cash flow from our operations, this capital structure has provided the strength and flexibility necessary to pursue strategic growth opportunities and to return value to our shareowners.

A comparison of key elements of our financial condition as of September 30, 2018 and 2017 are as follows:



	September 30
(in millions)	2018			2017
Cash and cash equivalents	$	738		$	703

Short-term debt	(2,248		)	(479		)
Long-term debt, net	(5,681		)	(6,676		)
Total Debt	$	(7,929	)	$	(7,155	)
Total equity	$	7,114		$	6,050
Debt to total capitalization ⁽¹⁾	53		%	54		%

⁽¹⁾ Calculated as Total debt divided by the sum of Total debt plus Total equity

On April 13, 2017, we completed our acquisition of B/E Aerospace for $6.5 billion in cash and stock, plus the assumption of $2.0 billion in debt, net of cash acquired. The $6.5 billion purchase price included cash consideration of $3.5 billion and $3.0 billion of common stock issued for B/E Aerospace common stock (31.2 million shares of common stock issued to B/E Aerospace shareholders at the April 13, 2017 closing share price of $96.63). The cash consideration, related transaction fees and expenses and assumed debt were financed through the issuance of $4.35 billion of senior unsecured notes and $1.5 billion borrowed under a 3-year senior unsecured syndicated term loan facility that was entered into on December 16, 2016.

We primarily fund our contractual obligations, capital expenditures, small to medium-sized acquisitions, dividends and share repurchases with cash generated from operating activities. As of September 30, 2018, approximately 60 percent of our cash and cash equivalents reside at non-U.S. locations and may not be readily accessible for use in the U.S. We are studying changes enacted by the Tax Cuts and Jobs Act, costs of repatriation and the current and future cash needs of foreign operations to determine whether there is an opportunity to tax efficiently repatriate additional foreign cash balances in the future.

Due to the fluctuations of cash flows, we supplement our internally-generated cash flow from time to time by issuing short-term commercial paper. Under our commercial paper program, we may sell up to $1.5 billion face amount of unsecured short-term promissory notes in the commercial paper market. The commercial paper notes have maturities of not more than 364 days from the date of issuance. At September 30, 2018, short-term commercial paper borrowings outstanding were $1.5 billion, with a weighted-average annualized interest rate and maturity period of 2.42 percent and 9 days, respectively. At September 30, 2017, short-term commercial paper borrowings outstanding were $330 million, with a weighted-average annualized interest rate and maturity period of 1.45 percent and 18 days, respectively. The maximum amount of short-term commercial paper borrowings outstanding during 2018 was $1.5 billion.

We have a $1.5 billion five-year senior unsecured revolving credit agreement with various banks that expires in December 2021. At September 30, 2018 and September 30, 2017, there were no outstanding borrowings under the Company's revolving credit facility.

In December 2016, we entered into a $4.35 billion 364-day senior unsecured bridge term loan credit agreement and a $1.5 billion three-year senior unsecured term loan credit agreement. The bridge facility terminated upon receipt of proceeds from the notes issued to finance a portion of the B/E Aerospace acquisition. Proceeds from borrowings under the term loan facility were used to finance a portion of the B/E Aerospace acquisition and to pay related transaction fees and expenses. At September 30, 2018, the outstanding principal balance of the term loan credit agreement was $481 million.

The revolving credit agreement and term loan credit agreement include one financial covenant requiring us to maintain a consolidated debt to total capitalization ratio of not greater than 65 percent (excluding the equity impact of accumulated other comprehensive loss related to defined benefit retirement plans). The ratio was 48 percent at September 30, 2018.

In addition, alternative sources of liquidity could include funds available from the issuance of equity securities, debt securities and potential asset securitization strategies.

Credit ratings are a significant factor in determining our ability to access short-term and long-term financing, as well as the cost of such financing. Our strong credit ratings have enabled continued access to both short- and long-term credit markets. The following is a summary of our credit ratings as of September 30, 2018:



Credit Rating Agency	Short-Term Rating	Long-Term Rating	Outlook
Fitch Ratings	F2	BBB	Positive
Moody’s Investors Service	P-2	Baa2	Stable
Standard & Poor’s	A-2	BBB	Positive

We were in compliance with all debt covenants at September 30, 2018 and September 30, 2017.

Factoring Arrangements

We sell certain accounts receivable on a non-recourse basis to unrelated financial institutions under factoring agreements arranged by certain customers. Under the terms of the agreements, we retain no rights or interest and have no obligations with respect to the sold receivables. We account for these transactions as sales of receivables and record cash proceeds when received as cash provided by operating activities in the Consolidated Statement of Cash Flows. The unfavorable impact on cash used for operating activities during 2018 was $154 million. The favorable impact on cash provided by operating activities during 2017 was $94 million. The cost of participating in these programs was immaterial to our results.

Off-balance Sheet Arrangements

As of September 30, 2018, other than operating leases, we had no material off-balance sheet arrangements, including guarantees, retained or contingent interests in assets transferred to unconsolidated entities, derivative instruments indexed to our stock and classified in shareowners' equity on our Consolidated Statement of Financial Position or variable interests in entities that provide financing, liquidity, market risk or credit risk support to our Company.

Contractual Obligations

The following table summarizes certain of our contractual obligations as of September 30, 2018, as well as when these obligations are expected to be satisfied.



	Payments Due by Period
(in millions)	Total		Less than 1 Year		1 - 3 Years		4 - 5 Years		Thereafter
Long-term debt	$	6,481	$	750	$	331	$	1,350	$	4,050
Interest on long-term debt	2,549		231		392		326		1,600
Non-cancelable operating leases	506		89		134		87		196
Non-cancelable capital leases, including interest	65		6		11		12		36
Purchase obligations:
Purchase orders	2,432		1,842		405		176		9
Purchase contracts	133		35		58		20		20
Total	$	12,166	$	2,953	$	1,331	$	1,971	$	5,911

Interest payments under long-term debt obligations exclude the potential effects of the related interest rate swap contracts. See Note 9 of the Notes to Consolidated Financial Statements in Item 8 below.

We lease certain office and manufacturing facilities as well as certain machinery and equipment under various lease contracts. Our commitments under operating leases, in the form of non-cancelable future lease payments, are not reflected as a liability on

our Consolidated Statement of Financial Position. The principal portion of capital lease obligations is reflected within Other Liabilities on our Consolidated Statement of Financial Position.

Purchase obligations include purchase orders and purchase contracts. Purchase orders are executed in the normal course of business and may or may not be cancelable. Purchase contracts include agreements with suppliers under which there is a commitment to buy a minimum amount of products or pay a specified amount regardless of actual need. Generally, items represented in purchase obligations are not reflected as liabilities on our Consolidated Statement of Financial Position.

The table excludes obligations with respect to pension and other post-retirement benefit plans (see Note 10 of the Notes to Consolidated Financial Statements in Item 8 below). There is no minimum statutory funding requirement for 2019 and the Company does not currently expect to make any discretionary contributions during 2019 to these plans. Any additional future contributions necessary to satisfy minimum statutory funding requirements are dependent upon actual plan asset returns, interest rates and actuarial assumptions. With the exception of certain bargaining unit plans, payments due under other post-retirement benefit plans are funded as the expenses are incurred.

In addition, the table excludes liabilities for unrecognized tax benefits, which totaled $214 million at September 30, 2018, as we cannot reasonably estimate the ultimate timing of cash settlements to the respective taxing authorities (see Note 13 of the Notes to Consolidated Financial Statements in Item 8 below).

The following table reflects certain of our commercial commitments as of September 30, 2018:



	Amount of Commitment Expiration by Period
(in millions)	Total Amount Committed		Less than 1 Year		1 - 3 Years		4 - 5 Years		Thereafter
Letters of credit ⁽¹⁾	$	364	$	172	$	111	$	69	$	12

⁽¹⁾ See Note 16 of the Notes to Consolidated Financial Statements in Item 8 below for a discussion of letters of credit.

In addition to the obligations disclosed above, we occasionally enter into offset agreements, required by certain customers in some non-U.S. countries, as a condition to obtaining contract awards for our products and services. These agreements, which generally extend over several years, are customary in our industry and are designed to enhance the social and economic environment of the country in which our customers operate. These commitments may be satisfied through activities that do not require us to use cash, including transfer of technology, providing manufacturing and other consulting support to in-country projects, strategic alliances and transactions conducted by third parties (e.g., our vendors). These agreements may also be satisfied through our use of cash for activities such as placement of direct work or vendor orders for supplies and/or services, building or leasing facilities for in-country operations, in-country employment of a non-U.S. country's citizens and other forms of assistance in the applicable country. The offset rules and regulations, as well as the underlying contracts, may differ from one country to another.

We typically do not commit to offset agreements until contract awards for our products or services are definitive. Should we be unable to meet the offset obligations we may be subject to contractual penalties, and our chances of receiving additional business from the applicable customers could be reduced or, in certain cases, eliminated. We historically have not been required to pay material penalties related to offset obligations and are currently in compliance with our offset commitments.

At September 30, 2018, we had outstanding offset obligations totaling approximately $374 million that extend through 2036. The amounts ultimately applied against our offset requirements are based on negotiations with the customer and the cost to fulfill the obligation is typically only a fraction of the original obligation.

RECENTLY ISSUED ACCOUNTING STANDARDS

For information related to recently issued accounting standards, see Note 2 of the Notes to Consolidated Financial Statements in Item 8 below.

ENVIRONMENTAL

For information related to environmental claims, remediation efforts and related matters, see Note 18 of the Notes to Consolidated Financial Statements in Item 8 below.

CRITICAL ACCOUNTING POLICIES

The preparation of our financial statements in accordance with accounting principles generally accepted in the United States of America requires us to make estimates, judgments and assumptions that affect our financial condition and results of operations that are reported in the accompanying consolidated financial statements, as well as the related disclosure of assets and liabilities, contingent upon future events.

Understanding the critical accounting policies discussed below and related risks is important in evaluating our financial condition and results of operations. We believe the following accounting policies used in the preparation of the consolidated financial statements are critical to our financial condition and results of operations as they involve a significant use of management judgment on matters that are inherently uncertain. If actual results differ significantly from management's estimates, there could be a material effect on our financial condition, results of operations and cash flows. Management regularly discusses the identification and development of these critical accounting policies with the Audit Committee of the Board of Directors.

Accounting for Long-Term Contracts

A substantial portion of our sales to government customers and certain of our sales to commercial customers are made pursuant to long-term contracts requiring development and delivery of products over several years and often contain fixed-price purchase options for additional products. Certain of these contracts are accounted for under the percentage-of-completion method of accounting. Sales and earnings under the percentage-of-completion method are recorded either as products are shipped under the units-of-delivery method, or based on the ratio of actual costs incurred to total estimated costs expected to be incurred related to the contract under the cost-to-cost method. Approximately 16 percent of our sales are accounted for under the percentage-of-completion method of accounting.

The percentage-of-completion method of accounting requires management to estimate the profit margin for each individual contract and to apply that profit margin on a uniform basis as sales are recorded under the contract. The estimation of profit margins requires management to make projections of the total sales to be generated and the total costs that will be incurred under a contract. These projections require management to make numerous assumptions and estimates relating to items such as the complexity of design and related development costs, performance of subcontractors, availability and cost of materials, labor productivity and cost, overhead and capital costs and manufacturing efficiency. These contracts often include purchase options for additional quantities and customer change orders for additional or revised product functionality. Sales and costs related to profitable purchase options are included in our estimates only when the options are exercised while sales and costs related to unprofitable purchase options are included in our estimates when exercise is determined to be probable. Sales related to change orders are included in profit estimates only if they can be reliably estimated and collectability is reasonably assured. Purchase options and change orders are accounted for either as an integral part of the original contract or separately, depending upon the nature and value of the item. Anticipated losses on contracts are recognized in full in the period in which losses become probable and estimable.

Estimates of profit margins for contracts are typically reviewed by management on a quarterly basis. Assuming the initial estimates of sales and costs under a contract are accurate, the percentage-of-completion method results in the profit margin being recorded evenly as revenue is recognized under the contract. Changes in these underlying estimates due to revisions in sales and cost estimates, the combining of contracts or the exercise of contract options may result in profit margins being recognized unevenly over a contract as such changes are accounted for on a cumulative basis in the period estimates are revised. Cumulative catch-up adjustments resulting from changes in estimates did not have a material effect on our results of operations during the years ended September 30, 2018, 2017 or 2016.

Program Investments

We defer certain pre-production engineering costs in Inventories, net and record up-front sales incentives in Intangible Assets (collectively referred to as Program Investments). These Program Investments are amortized over their estimated useful lives, up to a maximum of 15 years. Estimated useful lives are limited to the amount of time we are virtually assured to earn revenues through a contractually enforceable right included in long-term supply arrangements with our customers. This provides the best matching of expense over the related period of benefit. The following provides an overview of the Program Investments:



	September 30
(in millions)	2018		2017
Pre-production engineering costs	$	1,166	$	1,175
Up-front sales incentives	578		243
Total Program Investments	$	1,744	$	1,418

We defer the cost of certain pre-production engineering costs incurred during the development phase of a program in connection with long-term supply arrangements that contain contractual guarantees for reimbursement from customers. These customer guarantees generally take the form of a minimum order quantity with quantified reimbursement amounts if the minimum order quantity is not taken by the customer. These costs are deferred in inventory to the extent of the contractual guarantees and are amortized over their estimated useful lives using a units-of-delivery method, up to 15 years. This amortization expense is included in customer funded R&D as a component of cost of sales. Amortization is based on our expectation of delivery rates on a program-by-program basis and begins when we start recognizing revenue as we deliver equipment for the program. Pre-production engineering costs in excess of the contractual guarantee, and costs incurred pursuant to supply arrangements that do not contain customer guarantees for reimbursement, are expensed as incurred.

We also provide up-front sales incentives prior to delivering products or performing services to certain commercial customers in connection with sales contracts. Up-front sales incentives are recorded as a customer relationship intangible asset and are amortized using a units-of-delivery method over the period we have received a contractually enforceable right related to the incentives, up to 15 years after entry into service. Amortization is based on our expectation of delivery rates on a program-by-program basis. Amortization begins when we start recognizing revenue as we deliver equipment for the program. Up-front sales incentives consisting of cash payments or customer account credits are amortized as a reduction of sales, whereas incentives consisting of free products are amortized as cost of sales.

Risks inherent in recovering the value of our Program Investments include, but are not limited to, the following:


•	changes in market conditions may affect product sales under a program. In particular, the commercial aerospace market has been historically cyclical and subject to downturns during periods of weak economic conditions, which could be prompted or exacerbated by political or other U.S. or international events


•	bankruptcy or other significant financial difficulties of our customers


•	our ability to produce products could be impacted by the performance of subcontractors, the availability of specialized materials and other production risks

We evaluate the carrying amount of Program Investments for recovery at least annually or when potential indicators of impairment exist, such as a change in the estimated number of products to be delivered under a program. No significant impairment charges related to Program Investments were recorded in 2018, 2017 or 2016. While we believe our Program Investments are recoverable over time, the cancellation of a program by a customer coupled with bankruptcy or other financial difficulties, would represent the most significant impairment factor related to Program Investments. We also evaluate our amortization of Program Investments quarterly based on our expectation of delivery rates on a program-by-program basis. The impact of changes in expected delivery rates on the Program Investments' amortization is adjusted as needed on a prospective basis.

Amortization expense for pre-production engineering and up-front sales incentives for 2018, 2017 and 2016 was as follows:



(in millions)	2018		2017		2016
Amortization of pre-production engineering	$	87	$	59	$	49
Amortization of up-front sales incentives	21		13		18
Total amortization of Program Investments	$	108	$	72	$	67

As disclosed in Note 3 of the Notes to Consolidated Financial Statements in Item 8 below, the weighted-average amortization period for up-front sales incentives is approximately 12 years. Anticipated amortization expense for the up-front sales incentives at September 30, 2018, for 2019 and beyond is summarized below:



(in millions)	2019	2020	2021	2022	2023	Thereafter
Anticipated amortization expense for up-front sales incentives	24	26	26	26	25	451

As discussed in Note 2 of the Notes to Consolidated Financial Statements in Item 8 below, adoption of the new revenue recognition standard on October 1, 2018, resulted in elimination of the $1.166 billion pre-production engineering balance and approximately $120 million of customer relationship intangible assets. Therefore, $120 million of amortization expense associated with customer relationship intangible assets as contemplated in the table above will be avoided.

Pre-production engineering costs comprise 44 percent of our total Inventory balance at September 30, 2018, compared to 48 percent at September 30, 2017. Pre-production engineering costs decreased $9 million from September 30, 2017 to September 30, 2018. The majority of this decrease was attributable to increased amortization of pre-production engineering. Additionally, up-front sales incentives to Commercial Systems customers increased $335 million from September 30, 2017 to September 30, 2018, primarily due to the extension of certain long-term sales contracts.

Growth in our Program Investments continues to be driven by the expanded market share our Company successfully captured over the past several years. Commercial Systems has secured positions on several key platforms in the air transport market, including the Boeing 737 MAX and Airbus A350. In the business and regional jet market, our Pro Line Fusion avionics system has been selected by customers around the globe, including Bombardier, Embraer and Gulfstream.

We believe our Program Investments are recoverable based upon our contractually enforceable rights under long-term supply arrangements and the expected revenues and profits associated with our positions on these aircraft platforms.

Income Taxes

At the end of each quarterly reporting period, we estimate an effective income tax rate that is expected to be applicable for the full fiscal year. The estimate of our effective income tax rate involves significant judgments resulting from uncertainties in the application of complex tax laws and regulations across many jurisdictions, implementation of tax planning strategies and estimates as to the jurisdictions where income is expected to be earned. These estimates may be further complicated by new laws, new interpretations of existing laws and rulings by taxing authorities. For example, in 2018 the United States Government enacted the Tax Cuts and Jobs Act (the Act), which contains significant changes to the U.S. tax system. Due to the subjectivity and complex nature of these underlying issues, our actual effective income tax rate and related tax liabilities may differ from our initial estimates. Differences between our estimated and actual effective income tax rates and related liabilities are recorded in the period they become known or as our estimates are revised based on additional information. The resulting adjustment to our income tax expense could have a material effect on our results of operations in the period the adjustment is recorded. A one percentage point change in our effective income tax rate would change our annual income from continuing operations by approximately $11 million.

Deferred tax assets and liabilities are recorded for tax carryforwards and the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. The future realization of our deferred tax assets ultimately depends on our ability to generate sufficient taxable income of the appropriate character (for example, ordinary income or capital gains) within the carryback and carryforward periods available under the tax law and our ability to execute successful tax planning strategies. Management believes it is more likely than not that the long-term deferred tax assets will be realized through the reduction of future taxable income. A change in the ability of our operations to continue to generate future taxable income, or our ability to implement tax planning strategies, could affect our ability to realize the future tax deductions underlying our net deferred tax assets, and require us to record a valuation allowance against our net

deferred tax assets. The recognition of a valuation allowance would result in a reduction to net income and if significant, could have a material impact on our effective tax rate, results of operations and financial position in any given period.

As part of the determination of our tax liability, management exercises considerable judgment in evaluating tax positions taken by us in determining the income tax provision and establishes reserves for tax contingencies in accordance with the Income Taxes topic of the FASB Accounting Standards Codification. See Note 13 of the Notes to Consolidated Financial Statements in Item 8 below for further detail regarding the impacts of the Act, unrecognized tax benefits, deferred taxes and the factors considered in evaluating deferred tax asset realization.

Goodwill

As of September 30, 2018, we had $9.107 billion of goodwill related to various business acquisitions. We perform goodwill impairment tests on an annual basis during the fourth quarter of each fiscal year, or on an interim basis if events or circumstances indicate that it is more likely than not that impairment has occurred.

Goodwill is potentially impaired if the carrying value of the reporting unit that contains the goodwill exceeds its estimated fair value. The fair values of our reporting units are generally determined using a combination of an income approach, which estimates fair value based upon future discounted cash flows, and a market approach, which estimates fair value using market multiples, ratios and valuations of a set of comparable public companies within our industry. We completed our annual goodwill impairment test in the fourth quarter of 2018 and concluded no impairment of goodwill exists, as all goodwill reporting units had a calculated fair value in excess of carrying value of greater than 20 percent. Although goodwill is not currently impaired, there can be no assurance that future impairments will not occur. Significant negative industry or economic trends, disruptions to our business, failure to achieve synergies from recent acquisitions, or other unexpected significant changes in the use of certain assets could all have a negative effect on fair values in the future.

Pension Benefits

In 2018, five of our eight collective bargaining agreements were negotiated and participation in the Rockwell Collins Pension Plan is now closed to newly hired employees pursuant to those negotiations. The individuals covered by the agreements will instead receive supplemental Company contributions to the existing defined contribution savings plan. We previously amended our U.S. qualified and non-qualified defined benefit pension plans to discontinue benefit accruals for salary increases and services rendered after September 30, 2006 for all salaried and hourly employees who were not covered by collective bargaining agreements. Accounting standards require these plans to be measured on an actuarial basis. These accounting standards will generally reduce, but not eliminate, the volatility of pension expense as actuarial gains and losses resulting from both normal year-to-year changes in valuation assumptions and the differences from actual experience are deferred and amortized. The application of these accounting standards requires management to make numerous assumptions and judgments that can significantly affect these measurements. Critical assumptions made by management in performing these actuarial valuations include the selection of discount rates and expectations regarding the future rate of return on pension plan assets.

In October 2014, the Society of Actuaries published a new set of mortality tables (RP-2014). While accounting standards do not prescribe the use of a specific set of mortality tables in the measurement of pension obligations, mortality is a key assumption in developing actuarial estimates. For our 2017 year end pension liability valuation, we used the RP-2014 tables with an adjustment for plan experience, and utilized the MP-2016 mortality improvement scale adjusted to reflect convergence to an ultimate annual rate of mortality improvement of 0.75 percent by 2032. For the 2018 year end pension liability valuation, we continued to use the RP-2014 tables with an adjustment for plan experience, but utilized the MP-2017 mortality improvement scale adjusted to reflect convergence to an ultimate annual rate of mortality improvement of 0.75 percent by 2033. Both the MP-2016 and MP-2017 mortality improvement scales indicate that U.S. mortality continues to improve, but at a slower average rate. These changes resulted in a decrease to the 2018 projected pension benefit obligation of $18 million.

Discount rates are used to determine the present value of our pension obligations and also affect the amount of pension expense recorded in any given period. We estimate the discount rate based on the rates of return of high quality, fixed-income investments with maturity dates that reflect the expected time horizon over which benefits will be paid (see Note 10 of the Notes to Consolidated Financial Statements in Item 8 below). Changes to the discount rate could have a material effect on our reported pension obligations and would also impact the related pension expense.

A "spot rate approach" has been used to calculate pension and other retirement benefits interest and service costs. The spot rate approach applies separate discount rates for each projected benefit payment in the calculation of pension interest and service cost.

The expected rate of return is our estimate of the long-term earnings rate on our pension plan assets and is based upon both historical long-term actual and expected future investment returns considering the current investment mix of plan assets. Differences between the actual and expected rate of return on plan assets can impact our expense for pension benefits.

Holding all other factors constant, the estimated impact on 2018 pension expense and pension benefit obligation for our U.S. plans caused by hypothetical changes to key assumptions is as follows:



	Change in Assumption (in millions)
Assumption	25 Basis Point Increase	25 Basis Point Decrease
Pension obligation discount rate	$97 pension projected benefit obligation decrease	$102 pension projected benefit obligation increase
Pension obligation discount rate	$1 pension expense increase	$1 pension expense decrease
Expected long-term rate of return on plan assets	$7 pension expense decrease	$7 pension expense increase


Item 7A.	Quantitative and Qualitative Disclosures about Market Risk.

Interest Rate Risk

In addition to using cash provided by normal operating activities, we utilize a combination of short-term and long-term debt to finance operations and make acquisitions. Our operating results and cash flows are exposed to changes in interest rates that could adversely affect the amount of interest expense incurred and paid on debt obligations in any given period. In addition, changes in interest rates can affect the fair value of our debt obligations. Such changes in fair value are only relevant to the extent these debt obligations are settled prior to maturity. We manage our exposure to interest rate risk by maintaining an appropriate mix of fixed and variable rate debt and may employ financial instruments in the form of interest rate swaps to help meet this objective.

At September 30, 2018, we had the following unsecured notes outstanding:



	September 30, 2018
(in millions, except interest rate figures)	Interest Rate		Carrying Value		Fair Value
Fixed-rate notes due:
July 2019	1.95%		$	300	$	298
July 2019	5.25%		300		305
November 2021	3.10%		250		246
March 2022	2.80%		1,100		1,070
December 2023	3.70%		400		397
March 2024	3.20%		950		917
March 2027	3.50%		1,300		1,235
December 2043	4.80%		400		406
April 2047	4.35%		1,000		957
Variable-rate term loan due:
April 2020	1 month LIBOR + 1.25% ⁽¹⁾	&nbs

(in millions)

Other income, net