| You should refer to the explanation of the qualifications and limitations on forward-looking statements set forth at the beginning of Item 1 of this Report |
| The cancellation or material modification of one or more significant contracts could have a material adverse effect on our ability to realize anticipated sales |
| Sales, directly and indirectly, to the US government and its agencies accounted for approximately 80prca of our total net sales in fiscal 2005 |
| Our contracts typically permit the US government to unilaterally modify or terminate a contract or to discontinue funding for a particular program at any time |
| The cancellation of one or more significant contracts could have a material adverse effect on our ability to realize anticipated sales and profits |
| The cancellation of a contract, if terminated for cause, could also subject us to liability for the excess costs incurred by the US government in procuring undelivered items from another source |
| If terminated for convenience, our recovery of costs would be limited to amounts already incurred or committed, and our profit would be limited to work completed prior to termination |
| Future reductions or changes in US government spending could negatively affect our sales |
| Our primary aerospace and defense customers include the DoD and its agencies, the government prime contractors that supply products to these customers, and NASA As a result, we rely on particular levels of US government spending on propulsion systems for defense and space applications and armament systems for precision tactical weapon systems and munitions applications, and our backlog depends, in a large part, on continued funding by the US government for the programs in which we are involved |
| These spending levels are not generally correlated with any specific economic cycle, but rather follow the cycle of general political support for this type of spending |
| Although the DoD currently forecasts continued defense budget increases through its fiscal year 2010, which is the remainder of the DoD’s detailed forecast period, future levels of defense spending may not increase and could decrease |
| Moreover, although our contracts often contemplate that our services will be performed over a period of several years, Congress usually must approve funds for a given program each government fiscal year and may significantly reduce or eliminate funding for a program |
| A decrease in US military expenditures, or the elimination or curtailment of a material program in which we are involved, could negatively affect our revenues |
| A significant percentage of our net sales are generated from fixed-price contracts |
| If we experience cost overruns on these contracts, we would have to absorb the excess costs and our profitability would be adversely affected |
| Our aerospace and defense contracts generally can be categorized as either “fixed-price” or “cost-reimbursable” contracts |
| Under fixed-price contracts, we agree to perform specified work for a fixed price and realize all of the profit or loss resulting from variations in the costs of performing the contract |
| As a result, all fixed-price contracts involve the inherent risk of unreimbursed cost overruns |
| To the extent we were to incur unanticipated cost overruns on a program or platform subject to a fixed-price contract, our profitability would be adversely affected |
| For example, our Atlas V contract, which was recently renegotiated, was a fixed-price contract that was historically unprofitable, in part, due to cost overruns |
| We are also transitioning a fixed-price fire suppression system for the Ford Crown Victoria police vehicle from development to full rate production |
| Future profitability is subject to risks including the ability of suppliers to deliver components of acceptable quality on schedule and the successful implementation of automated tooling in production processes |
| During fiscal 2005, approximately 60prca of Aerojet’s net sales were achieved on fixed-price contracts and 40prca on cost reimbursable contracts |
| 16 _________________________________________________________________ [73]Table of Contents Our success and growth in the aerospace and defense industry depend on our ability to secure contracts |
| We face significant competition, including from competitors with greater resources than ours, which may adversely affect our market share |
| We encounter intense competition in bidding for contracts |
| Many of our competitors have financial, technical, production, and other resources substantially greater than ours |
| Although the downsizing of the defense industry in the early 1990s has resulted in a reduction in the aggregate number of competitors, the consolidation has also strengthened the capabilities of some of the remaining competitors resulting in an increasingly competitive environment |
| The US government also has its own manufacturing capabilities in some areas |
| We may be unable to compete successfully with our competitors and our inability to do so could result in a decrease in revenues that we historically have generated from these contracts |
| Further, the US government may open to competition programs on which we are currently the sole supplier, which could also adversely affect our sales |
| Our Aerospace and Defense segment is subject to procurement and other related laws and regulations inherent in contracting with the US government, non-compliance with which could have a material adverse effect on our business |
| In the performance of contracts with the US government, we are subject to complex and extensive procurement and other related laws and regulations |
| Possible consequences of a failure to comply, even inadvertently, with these laws and regulations include civil and criminal fines and penalties, in some cases, double or triple damages, and suspension or debarment from future government contracts and exporting of goods for a specified period of time |
| These laws and regulations provide for ongoing audits and reviews of incurred costs as well as contract procurement, performance and administration |
| The US government may, if appropriate, conduct an investigation into possible illegal or unethical activity in connection with these contracts |
| Investigations of this nature are common in the aerospace and defense industry, and lawsuits may result |
| In addition, the US government and its principal prime contractors periodically investigate the financial viability of its contractors and subcontractors as part of its risk assessment process associated with the award of new contracts |
| If the US government or one or more prime contractors were to determine that we were not financially viable, our ability to continue to act as a government contractor or subcontractor would be impaired |
| Our inability to adapt to rapid technological changes could impair our ability to remain competitive |
| The aerospace and defense industry has undergone rapid and significant technological development over the last few years |
| Our competitors may implement new technologies before we are able to, allowing them to provide more effective products at more competitive prices |
| Future technological developments could: • adversely impact our competitive position if we are unable to react to these developments in a timely or efficient manner; • require us to write-down obsolete facilities, equipment and technology; • require us to discontinue production of obsolete products before we can recover any or all of our related research, development and commercialization expenses; or • require significant capital expenditures for research, development and launch of new products or processes |
| We may experience product failures, schedule delays or other problems with existing or new products and systems, all of which could result in increased costs and loss of sales |
| Many of the products we develop and manufacture are technologically advanced systems that must function under demanding operating conditions |
| Even though we believe that we employ sophisticated and 17 _________________________________________________________________ [74]Table of Contents rigorous design, manufacturing and testing processes and practices, we may not be able to successfully launch or manufacture our products on schedule or our products may not perform as intended |
| Some of our contracts require us to forfeit a portion of our expected profit, receive reduced payments, provide a replacement product or service or reduce the price of subsequent sales to the same customer if our products fail to perform adequately |
| Performance penalties also may be imposed should we fail to meet delivery schedules or other measures of contract performance |
| We do not generally insure against potential costs resulting from any required remedial actions or costs or loss of sales due to postponement or cancellation of scheduled operations or product deliveries |
| Future reductions in airbag propellant volume could adversely affect our profitability |
| One of our plants produces large volumes of propellants used in automobile airbags sold to a single customer |
| These products are subject to extreme cost competition from other potential domestic and foreign suppliers |
| The loss of significant volume could affect fixed cost absorption in the plant and negatively impact profitability on other products |
| Our operations and properties are currently the subject of significant environmental claims, and the numerous environmental and other government regulations to which we are subject may become more stringent in the future and may reduce our profitability |
| We are subject to federal, state, and local laws and regulations that, among other things, require us to obtain permits to operate and install pollution control equipment and regulate the generation, storage, handling, transportation, treatment and disposal of hazardous and solid wastes |
| We may also be subject to fines and penalties relating to the operation of our existing and formerly owned businesses, and are subject to toxic tort and asbestos suits as well as other third-party lawsuits, due to either our past or present use of hazardous substances or the alleged on-site or off-site contamination of the environment through past or present operations |
| We may incur material costs in defending these proceedings or claims |
| Any unexpected adverse judgment or cash outlay could reduce our profitability and leave us with less cash available to service our debt |
| For additional discussion of environmental and legal matters, please see the environmental discussion in Note 14 to Consolidated Financial Statements |
| Although some of our environmental costs may be recoverable and we have established reserves, given the many uncertainties involved in assessing liability for environmental claims, our reserves may not be sufficient |
| Under an agreement with the US government, the US government recognizes as allowable for government contract cost purposes up to 88prca of environmental expenses at our Sacramento and former Azusa sites |
| Aerojet’s mix of contracts can affect the actual reimbursement made by the US government |
| Because these costs are recovered through forward pricing arrangements, our ability to continue recovering these costs from the US government depends on Aerojet’s sustained business volume under US government contracts and programs and the relative size of Aerojet’s commercial business |
| As of November 30, 2005, we had established reserves of dlra268 million, which we believe to be sufficient to cover our estimated share of the environmental remediation costs at that time |
| However, given the many uncertainties involved in assessing liability for environmental claims, our reserves may prove to be insufficient |
| We continually evaluate the adequacy of those reserves, and they could change |
| In addition, the reserves are based only on known sites and the known contamination at those sites |
| It is possible that additional remediation sites will be identified in the future or that unknown contamination at previously identified sites will be discovered |
| This could lead us to have additional expenditures for environmental remediation in the future and given the many uncertainties involved in assessing liability for environmental claims, our reserves may prove to be insufficient |
| 18 _________________________________________________________________ [75]Table of Contents For additional discussion of environmental matters, please see the environmental discussion in Note 14 to Consolidated Financial Statements |
| The release or explosion of dangerous materials used in our business could disrupt our operations and cause us to incur additional costs and liability |
| The operations of our business involve the handling and production of potentially explosive materials and other dangerous chemicals, including materials used in rocket propulsion and explosive devices |
| Despite our use of specialized facilities to handle dangerous materials and intensive employee training programs, the handling and production of hazardous materials could result in incidents that temporarily shut down or otherwise disrupt our manufacturing operations and could cause production delays |
| It is possible that a release of these chemicals or an explosion could result in death or significant injuries to employees and others |
| Material property damage to us and third parties could also occur |
| The use of these products in applications by our customers could also result in liability if an explosion or fire were to occur |
| Any release or explosion could expose us to adverse publicity or liability for damages or cause production delays, any of which could have a material adverse effect on our reputation and profitability |
| Disruptions in the supply of key raw materials and difficulties in the supplier qualification process, as well as increases in prices of raw materials, could adversely impact our operations |
| We closely monitor sources of supply to assure that adequate raw materials and other supplies needed in our manufacturing processes are available |
| As a US government contractor, we are frequently limited to procuring materials and components from sources of supply that meet rigorous customer and/or government specifications |
| In addition, as business conditions, DoD budgets, and Congressional allocations change, suppliers of specialty chemicals and materials sometimes consider dropping low-volume items from their product lines, which may require us to qualify new suppliers for raw materials on key programs |
| Current suppliers of some insulation materials used in rocket motors have announced plans to close manufacturing plants and discontinue certain product lines |
| These materials, which include a neoprene compound and silica phenolic used as an insulator, are used industry-wide in the production of rocket motors and, therefore, are key to many of our solid booster/ motor programs |
| We have qualified new suppliers and materials for this insulation and we expect that such new materials can be available in time to meet our future production needs |
| Another supplier has announced it will stop production of a primary binder compound (R45) used industry-wide in all solid propellants |
| The US Government and companies operating in the propulsion industry worked together to resolve the availability issue of the R45 primary binder material |
| In our case, Aerojet entered into a new supply contract which includes a “surcharge” as a price adjustment |
| We were able accomplish this with the assistance of our customers through similar price adjustment clauses on many of our existing contracts |
| The supply of ammonium perchlorate, a principal raw material used in solid propellant, is limited to a single source that supplies the entire domestic solid propellant industry |
| This single source, however, maintains two separate manufacturing lines a reasonable distance apart which mitigates the likelihood of a fire, explosion, or other problem impacting production |
| The industry also currently relies on one primary supplier for graphite fiber, which is used in the production of composite materials |
| This supplier has multiple manufacturing lines for such material |
| Although other sources of graphite fiber exist, the addition of a new supplier would require us to qualify the new source for use |
| As of year end 2005, neither of these key materials has had any indication that their availability is in jeopardy |
| We are also impacted, as is the rest of the industry, by increases in the prices and lead-times of raw materials used in production on various fixed-price contracts |
| Most recently, we have seen an increase in the price and lead-times of commodity metals, primarily steel, titanium and aluminum |
| Aerojet monitors the price and supply of these materials and works closely with suppliers to schedule purchases far enough in advance and in the most economical means possible to reduce program impact |
| Additionally, we have negotiated 19 _________________________________________________________________ [76]Table of Contents economic and/or price adjustment clauses tied to commodity indices, whenever possible with our customers |
| Our past success in negotiating these terms is no indication of our ability to continue to do so |
| Prolonged disruptions in the supply of any of our key raw materials, difficulty qualifying new sources of supply, implementing use of replacement materials or new sources of supply, and/or a continuing increase in the prices of raw materials could have an adverse effect on our operating results, financial condition and/or our cash flows |
| Substantially all of our real estate is located in Sacramento County, California making us vulnerable to changes in economic and other conditions in that particular market |
| As a result of the geographic concentration of our properties, our long-term performance and the value of our properties will depend upon conditions in the Sacramento region, including: • the sustainability and growth of industries located in the Sacramento region; • the financial strength and spending of the State of California; • local real estate market conditions; • changes in neighborhood characteristics; and • real estate tax rates |
| There can be no assurance that the Sacramento market will continue to grow or that conditions will remain favorable |
| If unfavorable economic or other conditions occur in the region, our business plan could be adversely affected |
| We have limited experience in real estate activities |
| While we have owned our Sacramento real estate for over 50 years, we have no significant real estate business experience |
| Therefore, we do not have any real estate history from which you can draw conclusions about our ability to execute our real estate business plans |
| The real estate business is inherently risky |
| Our real estate activities may subject us to the following risks: • we may be unable to obtain, or suffer delays in obtaining, necessary re-zoning, land use, building, occupancy and other required governmental permits and authorizations, which could result in increased costs or our abandonment of these projects; • we may be unable to complete environmental remediation or to lift state and federal environmental restrictions on our real estate, which could cause a delay or abandonment of these projects; • we may be unable to obtain sufficient water sources to service our projects, which may prevent us from executing our plan; • our real estate activities require significant capital expenditures and we may not be able to obtain financing on favorable terms, which may render us unable to proceed with our plan; • economic and political uncertainties could have adverse effects on consumer buying habits, construction costs, availability of labor and materials and other factors affecting us and the real estate industry in general; • our property is subject to federal, state and local regulations and restrictions that may impose significant limitations on our plans |
| Much of our property is raw land located in areas where the natural habitats of various endangered or protected wildlife species; and • if our land use plans are approved by the appropriate governmental authorities, we may face potential lawsuits from those who oppose such plans |
| Such lawsuits and the costs associated with such opposition 20 _________________________________________________________________ [77]Table of Contents could be material and have an adverse effect on our ability to sell properties or realize income from our projects |
| Additionally, the time frame required for approval of our plans means that we may have to wait years for a significant cash return |
| The value of our real estate assets could be adversely affected by an increase in interest rates |
| For the past three years, interest rates in the US have been at historically low levels, which has facilitated the financing and purchase of homes |
| Historical evidence has shown that significant increases in interest rates have a negative impact on housing demand |
| Since June 30, 2004, the federal funds rate has increased from 1prca to 4dtta25prca |
| If interest rates continue to increase, and the ability or willingness of prospective buyers to finance home purchases is diminished, the value of our real estate assets may decrease |
| We have a substantial amount of debt, and the cost of servicing that debt could adversely affect our ability to take actions or our liquidity or financial condition |
| Subject to the limits contained in some of the agreements governing our outstanding debt, we may incur additional debt in the future |
| Our level of debt places significant demands on our cash resources, which could: • make it more difficult for us to satisfy our outstanding debt obligations; • require us to dedicate a substantial portion of our cash for payments on our debt, reducing the amount of our cash flow available for working capital, capital expenditures, acquisitions, entitle our real estate assets, and other general corporate purposes; • limit our flexibility in planning for, or reacting to, changes in the industries in which we compete; • place us at a competitive disadvantage compared to our competitors, some of which have lower debt service obligations and greater financial resources than we do; • limit our ability to borrow additional funds; or • increase our vulnerability to general adverse economic and industry conditions |
| If we are unable to generate sufficient cash flow to service our debt and fund our operating costs, our liquidity may be adversely affected |
| We are obligated to comply with financial and other covenants in our debt that could restrict our operating activities, and the failure to comply could result in defaults that accelerate the payment of our debt |
| These covenants include, among others, provisions restricting our ability to: • incur additional debt; • make certain distributions, investments and other restricted payments; • limit the ability of restricted subsidiaries to make payments to us; • enter into transactions with affiliates; • create certain liens; • sell assets and if sold, use of proceeds; and • consolidate, merge or sell all or substantially all of our assets |
| 21 _________________________________________________________________ [78]Table of Contents Our secured debt also contains other customary covenants, including, among others, provisions: • relating to the maintenance of the property securing the debt, and • restricting our ability to pledge assets or create other liens |
| In addition, certain covenants in our bank facilities require us and our subsidiaries to maintain certain financial ratios |
| Any of the covenants described in this risk factor may restrict our operations and our ability to pursue potentially advantageous business opportunities |
| Our failure to comply with these covenants could also result in an event of default that, if not cured or waived, could result in the acceleration of all or a substantial portion of our debt |
| If our operating subsidiaries do not generate sufficient cash flow or if they are not able to pay dividends or otherwise distribute their cash to us, or if we have insufficient funds on hand, we may not be able to service our debt |
| All of the operations of our Aerospace and Defense and Real Estate businesses are conducted through subsidiaries |
| Consequently, our cash flow and ability to service our debt obligations will be largely dependent upon the earnings of our operating subsidiaries and the distribution of those earnings to us, or upon loans, advances or other payments made by these subsidiaries to us |
| The ability of our subsidiaries to pay dividends or make other payments or advances to us will depend upon their operating results and will be subject to applicable laws and any contractual restrictions contained in the agreements governing their debt, if any |
| We may expand our operations through acquisitions, which may divert management’s attention and expose us to unanticipated liabilities and costs |
| We may experience difficulties integrating any acquired operations, and we may incur costs relating to acquisitions that are never consummated |
| Our business strategy may include continued expansion of our Aerospace and Defense operations through future acquisitions that make both strategic and economic sense |
| However, our ability to consummate and integrate effectively any future acquisitions on terms that are favorable to us may be limited by the number of attractive acquisition targets, internal demands on our resources and our ability to obtain financing |
| Our success in integrating newly acquired businesses will depend upon our ability to retain key personnel, avoid diversion of management’s attention from operational matters, integrate general and administrative services and key information processing systems and, where necessary, requalify our customer programs |
| In addition, future acquisitions could result in the incurrence of additional debt, costs and contingent liabilities |
| We may also incur costs and divert management attention to acquisitions that are never consummated |
| Integration of acquired operations may take longer, or be more costly or disruptive to our business, than originally anticipated |
| It is also possible that expected synergies from future acquisitions may not materialize |
| Although we undertake a diligence investigation of each business that we acquire, there may be liabilities of the acquired companies that we fail to or are unable to discover during the diligence investigation and for which we, as a successor owner, may be responsible |
| In connection with acquisitions, we generally seek to minimize the impact of these types of potential liabilities through indemnities and warranties from the seller, which may in some instances be supported by deferring payment of a portion of the purchase price |
| However, these indemnities and warranties, if obtained, may not fully cover the liabilities due to limitations in scope, amount or duration, financial limitations of the indemnitor or warrantor or other reasons |
| We have recently focused our operations through divestitures |
| We may incur additional costs related to these divestitures, which may negatively impact our profitability |
| In connection with our recent divestitures of the Fine Chemicals and GDX businesses, we may incur additional costs, including costs related to the closure of a manufacturing facility in Chartres, France |
| This closure in France requires us to comply with certain procedures and processes that are defined under local law and labor regulations |
| These procedures may require additional cash expenditures, thereby reducing our profitability and our liquidity |
| 22 _________________________________________________________________ [79]Table of Contents A strike or other work stoppage, or our inability to renew collective bargaining agreements on favorable terms, could have a material adverse effect on our cost structure and ability to run our facilities and produce our products |
| As of November 30, 2005, 17prca of our 3cmam101 employees were covered by collective bargaining or similar agreements all of which are due to expire within two years |
| If we are unable to negotiate acceptable new agreements with the unions representing our employees upon expiration of the existing contracts, we could experience strikes or work stoppages |
| Even if we are successful in negotiating new agreements, the new agreements could call for higher wages or benefits paid to union members, which would increase our operating costs and could adversely affect our profitability |
| If our unionized workers were to engage in a strike or other work stoppage, or other non-unionized operations were to become unionized, we could experience a significant disruption of operations at our facilities or higher ongoing labor costs |
| A strike or other work stoppage in the facilities of any of our major customers could also have similar effects on us |
| A loss of key personnel or highly skilled employees could disrupt our operations |
| Our executive officers are critical to the management and direction of our businesses |
| Our future success depends, in large part, on our ability to retain these officers and other capable management personnel |
| In general, we do not enter into employment agreements with our executive officers |
| We have entered into severance agreements with our executive officers that allow those officers to terminate their employment under particular circumstances, such as a change of control affecting us |
| Although we believe that we will be able to attract and retain talented personnel and replace key personnel should the need arise, our inability to do so could disrupt the operations of the segment affected or our overall operations |
| In addition, because of the complex nature of many of our products and programs, we are generally dependent on an educated and highly-skilled engineering staff and workforce |
| Our operations could be disrupted by a shortage of available skilled employees |
| Due to the nature of our business, our sales levels may fluctuate causing our quarterly operating results to fluctuate |
| Changes in our operating results from quarter to quarter could result in volatility in our common stock price |
| Our quarterly and annual sales are affected by a variety of factors that could lead to significant variability in our operating results: • In our Aerospace and Defense business, sales earned under long-term contracts are recognized either on a cost basis, when deliveries are made, or when contractually defined performance milestones are achieved |
| The timing of deliveries or milestones may fluctuate from quarter to quarter |
| • In our Real Estate business, sales of property will be made from time to time, which will result in variability in our operating results |
| If we are unable to effectively and efficiently implement the necessary initiatives to eliminate the material weakness identified in our internal controls and procedures, there could be an adverse effect on our operations or financial results |
| We identified a material weakness in the Information and Communication component of internal control due to: (i) insufficient processes and controls to identify, capture and accurately communicate information in sufficient detail concerning complex, non-routine transactions in a timely manner to appropriate members of our finance and accounting organization that possess the necessary skills, knowledge and authority to determine that such transactions are properly accounted for in accordance with US generally accepted accounting principles, and (ii) the lack of specificity in the existing processes regarding the degree and extent of procedures that should be performed by key finance and accounting personnel in their review of accounting for complex, non-routine transactions to determine that the objective of the review has been achieved |
| As a result of this material weakness, errors occurred in several significant accounts in fiscal 2005 interim consolidated financial statements that were not detected |
| The areas most affected by this deficiency include revenue recognition and foreign currency translation |
| This material weakness impacts our ability to properly 23 _________________________________________________________________ [80]Table of Contents account for complex, non-routine transactions in the financial statements |
| Due to this material weakness, management believes that as of November 30, 2005, our internal control over financial reporting was not effective based on the Committee of Sponsoring Organizations of the Treadway Commission criteria |
| We have and continue to implement various initiatives in fiscal 2006 to improve our internal controls over financial reporting and address the matters discussed in Management’s Report on Internal Control over Financial Reporting |
| The implementation of the initiatives and the consideration of additional necessary improvements are among our highest priorities |
| The Board of Directors, under the direction of the Audit Committee, will continually assess the progress of the initiatives and the improvements, and take further actions as deemed necessary |
| Until the identified material weakness is eliminated, there is a risk of an adverse effect on our operations or financial results |
| Investment returns on pension plan assets and the discount rate used to determine pension liabilities may have a material affect on our shareholders’ deficit |
| In the event pension liabilities (based on the accumulated benefit obligation) exceed pension assets on the annual measurement date as a result of the investment returns on such assets and/or the discount rate used to measure pension liabilities, we would record a material charge which will cause an increase to our shareholders’ deficit |