10-K 1 d281720d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

 

x ANNUAL REPORT ON FORM 10-K PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the year ended December 31, 2011

 

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

For the transition period from              to             

Commission File Number 333-147828

 

 

Hawker Beechcraft Acquisition Company, LLC

Hawker Beechcraft Notes Company

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   71-1018770 20-8650498

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

10511 East Central, Wichita, Kansas 67206

(Address of Principal Executive Offices) (Zip Code)

(316) 676-7111

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

 

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  ¨    No  x

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  ¨    No  x

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  ¨    No  x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Securities Exchange Act of 1934.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x    Smaller reporting company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).    Yes  ¨    No  x

No membership interests in Hawker Beechcraft Acquisition Company, LLC and no common shares of Hawker Beechcraft Notes Company are held by non-affiliates.

 

 

 


Table of Contents

Table of Contents

 

              Page  
Part I        
  Item 1.    Business      4   
  Item 1A.    Risk Factors      10   
  Item 1B.    Unresolved Staff Comments      21   
  Item 2.    Properties      21   
  Item 3.    Legal Proceedings      22   
  Item 4.    Mine Safety Disclosures      23   
Part II        
  Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      23   
  Item 6.    Selected Financial Data      23   
  Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      25   
  Item 7A.    Quantitative and Qualitative Disclosures About Market Risk      42   
  Item 8.    Financial Statements and Supplementary Data      43   
  Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      94   
  Item 9A.    Controls and Procedures      94   
  Item 9B.    Other Information      95   
Part III        
  Item 10.    Directors, Executive Officers, and Corporate Governance      95   
  Item 11.    Executive Compensation      100   
  Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      121   
  Item 13.    Certain Relationships and Related Transactions, and Director Independence      122   
  Item 14.    Principal Accountant Fees and Services      124   
Part IV        
  Item 15.    Exhibits and Financial Statement Schedules      125   
  Signatures      132   
  Schedule II – Valuation and Qualifying Accounts      134   

 

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FORWARD-LOOKING STATEMENTS

All statements that are not reported financial results or other historical information are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. This Annual Report on Form 10-K includes forward-looking statements including, for example, statements about our business outlook, our products, including the timing of new product introductions, and the markets in which we operate, including growth of our various markets and our expectations, beliefs, plans, strategies, objectives, prospects, and assumptions for future events or performance. These forward-looking statements are not guarantees of future performance. Forward-looking statements are based on management’s assumptions and assessments in light of past experience and trends, current conditions, expected future developments and other relevant factors. They are also based on management’s expectations that involve a number of business risks and uncertainties, any of which could cause actual results to differ materially from those expressed in or implied by, the forward-looking statements. Among the factors that could cause actual results to differ materially from those described or implied in the forward-looking statements are the substantial leverage and debt service resulting from our indebtedness; our ability to successfully complete our restructuring activities; disruption in supply from key vendors; work stoppages at our operations facilities; disruptions to our operations due to our computer system upgrade during the three months ended September 30, 2011, and any impact that such upgrade may have had or may continue to have on our internal controls; general business and economic conditions; lack of market acceptance of our products and services; competition in our existing and future markets; loss or retirement of key executives; our ability to attract and retain highly talented professionals; any unfavorable resolution of legal proceedings; and other risks disclosed in our filings with the Securities and Exchange Commission.

In addition to specific factors described in connection with any particular forward-looking statement, factors that could cause actual results to differ materially include, but are not limited to, those discussed under the sections Item 1A, “Risk Factors,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These sections of this Annual Report should be reviewed for a more complete discussion of these risks and other factors that may affect our business.

All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth or referred to above. Except as required by law, we are not obligated to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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PART I

 

Item 1. Business

Basis of Presentation

As used in this annual report, unless the context indicates otherwise:

 

   

The terms “we,” “our,” “us,” the “Company,” “Successor,” “Hawker Beechcraft” and “HBAC” refer to Hawker Beechcraft Acquisition Company, LLC and its subsidiaries.

 

   

“HBI” refers to Hawker Beechcraft, Inc., the direct parent company of HBAC.

 

   

“Raytheon” refers to Raytheon Company. “Raytheon Aircraft” refers to certain subsidiaries of Raytheon which made up essentially the business acquired by HBI. Raytheon Aircraft is also referred to as the “Predecessor” in certain sections of this annual report. Raytheon was the Predecessor’s parent company.

 

   

“HBNC” refers to Hawker Beechcraft Notes Company, a wholly-owned subsidiary of HBAC which was formed to co-issue certain debt obligations. HBNC has no operations, assets or revenues.

Market Data Used in this Report

Certain market and industry data presented in this annual report, including our market position along with the positions of our competitors, are based on management estimates. Although we believe our estimates are reasonably derived, undue reliance should not be placed on them as estimates are inherently uncertain. Other market and industry data are derived from market research firms, including information published by the General Aviation Manufacturers Association (“GAMA”), Forecast International, Inc., the Teal Group and Honeywell Aerospace. While we believe the industry sources used are generally reliable, we have not independently verified data from these sources or obtained third party verification of market share data and do not guarantee the accuracy or completeness of this information. Data regarding our industry is intended to provide general guidance. However, market share data is subject to change and cannot always be verified with certainty due to limits on the availability and reliability of raw data regarding the specific market segments that we serve, the voluntary nature of the data gathering process and other limitations and uncertainties inherent in any statistical survey of market shares. In addition, customer preferences can and do change. As a result, market size, relative positions within industry segments and other similar data set forth herein, and estimates and beliefs based on such data, may not be reliable.

In certain parts of this annual report, we state statistics or market positions of certain “families” of aircraft (e.g., the Hawker 987 family refers to the 900, 800/850 and 750 models). In this context, the family of a particular model includes the current type design, its current derivative products and any previous versions of the aircraft produced using the same type design. In the case of the King Air family, it refers to the current King Air models, their current derivatives and any previous King Air models.

Our Company

Hawker Beechcraft is a leading manufacturer of business, special mission and trainer/attack aircraft; designing, marketing and supporting aviation products and services for businesses, governments and individuals worldwide. We have an extensive global network of more than 100 company-owned and company-authorized service centers in over 30 countries to support an estimated installed fleet of more than 34,000 aircraft.

Our business was formerly owned by Raytheon. On March 26, 2007, HBI purchased Raytheon Aircraft Acquisition Company, LLC (which has been renamed Hawker Beechcraft Acquisition Company, LLC) and substantially all of the assets of Raytheon Aircraft Services Limited from Raytheon and some of its affiliates (the “Acquisition”). Following the Acquisition, HBI contributed to us the equity interest of the entity purchasing the assets of Raytheon Aircraft Services Limited.

Business Segment Information

We conduct our business through three segments: Business and General Aviation, Trainer/Attack Aircraft and Customer Support. Segment financial information can be found in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8 “Financial Statements and Supplementary Data” of this annual report.

Business and General Aviation

Our Business and General Aviation segment designs, develops, manufactures, markets and delivers commercial and specially modified general aviation aircraft. The segment manufactures a broad range of products under the Hawker® and

 

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Beechcraft® brands that enables us to attract and retain a broad range of corporate, fractional and charter operators as well as individual customers worldwide. The Business and General Aviation segment also manufactures and provides aircraft parts to our Trainer/Attack Aircraft and Customer Support segments and sells used general aviation aircraft which may be received as a trade-in during a new aircraft sales transaction.

Under the Hawker brand, our Hawker business jet product line offers the Hawker 4000, Hawker 987 family, and Hawker 400XP. In December 2011, we also slowed the pace of the Hawker 200 certification program until indicators reflect a healthier light jet market. At the same time, the decision was made to temporarily halt production of the Hawker 750 model until market demand improves.

Under the Beechcraft brand, our business jet product line offers the Premier IA, our turboprops product line offers the King Air family, and our piston product line offers the Baron G58 and Bonanza G36. The King Air 250 was introduced in October 2010 and received type certification from the Federal Aviation Administration (“FAA”) in June 2011. Deliveries commenced immediately thereafter.

Our Business and General Aviation segment also markets, produces and supports a range of special mission aircraft for militaries and governments worldwide. Versions of the Beechcraft turboprops, pistons, Hawker 400XP and Hawker 800 family that have been customized for special missions are currently in service worldwide.

We sell our Business and General Aviation aircraft through various distribution channels, including direct retail sales and our authorized dealer network. Business and General Aviation segment sales were 53%, 60% and 71% of total consolidated sales for the years ended December 31, 2011, 2010 and 2009, respectively.

Trainer/Attack Aircraft

Our Trainer/Attack Aircraft segment designs, develops, manufactures, markets and sells military training and light attack aircraft to the U.S. and foreign governments. The segment manufactures our primary military trainer aircraft, the T-6 Texan II (“T-6”). In 1995, Raytheon Aircraft was awarded the U.S. Air Force and the U.S. Navy’s Joint Primary Aircraft Training System (“JPATS”) program. Under this program, we continue to be the sole source provider to the U.S. Air Force and the U.S. Navy of their primary military trainer aircraft. As the JPATS program nears completion, we continue to pursue alternative customers for the T-6 family of aircraft, primarily in foreign markets. The expiration of the contract will likely cause the revenues within this segment to decrease and could cause them to be more unstable on a prospective basis.

The T-6 family is comprised of four variants; the T-6A, T-6B, T-6C and AT-6. Through December 31, 2011, Hawker Beechcraft and Raytheon Aircraft have delivered over 700 trainer aircraft, including over 600 under the JPATS contracts and 130 to international customers. We continued to invest in the AT-6, the light attack aircraft being offered by Hawker Beechcraft during 2011. In November 2011, the U.S. Air Force notified us that the AT-6 was excluded from its Light Air Support bidding process. As discussed in Item 3 “Legal Proceedings” we contested this decision and we received notice on February 28, 2012, that the Air Force set aside the previous contract awarded to a competitor.

In addition, our Trainer/Attack Aircraft segment provides training and logistics support and aftermarket parts and services. We expect the U.S. government to continue to require product support for T-6 trainers through 2050.

We continue to market the T-6 trainer to certain foreign governments and anticipate future additional international awards. International customers made up 31% of the deliveries in 2011. Trainer/Attack Aircraft segment sales were approximately 26%, 24% and 17% of total consolidated sales for the years ended December 31, 2011, 2010 and 2009.

Customer Support

Our Customer Support segment provides parts and maintenance services to our estimated installed fleet of more than 34,000 aircraft. We sell parts from our headquarters in Wichita, Kansas and operate distribution warehouses in Dallas, Texas; London, England; Dubai, United Arab Emirates; and Singapore.

Support services include maintenance, repairs and refurbishment, as well as airframe and avionics modifications and upgrades. Our extensive aircraft service and support network consists of over 100 company-owned and company-authorized third party service centers in over 30 countries. We continue to selectively add company-owned and company-authorized service centers to support our global customer base.

 

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Customer Support segment sales were 21%, 16% and 12% of total consolidated sales for the years ended December 31, 2011, 2010 and 2009.

Customers and Distribution Methods

Our customer base includes corporations, fractional and charter operators, governments and individuals around the world. We currently have a global network of general aviation dealers, regional sales representatives and distributors who market our products. We sell parts through a variety of channels, including our headquarters in Wichita, Kansas, and our company-owned and company-authorized third party service centers. We also sell support services through our company-owned service centers.

We continue to develop our sales resources to address markets outside the U.S. We currently have the largest installed fleet of turboprop and business jet aircraft in Latin America and Africa, and we believe our King Air products are ideally suited for the level of infrastructure available in many developing nations. We continue to market our T-6A trainers and its derivatives to foreign governments. For the year ended December 31, 2011, approximately 41% of our sales were from outside the U.S. For additional information related to our sales derived outside the U.S., see Note 20 to our Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

During 2011, one customer, the U.S. government, represented approximately 31% of our sales, primarily from our Trainer/Attack Aircraft segment. The U.S. government accounts for a substantial portion of our backlog through the JPATS program. A significant reduction in purchases by the U.S. government could have a material adverse effect on our financial position, results of operations and liquidity.

Competition

Competition in the Business and General Aviation segment is based on price, quality, product support, performance, reliability, product innovation and reputation. Competition is driven by the ability to deliver superior performance and features, such as increased cabin size or range, on a cost-effective basis. We have five major competitors in the business and general aviation industry: Cessna Aircraft Company, Bombardier Aerospace, Gulfstream Aerospace Corporation, Dassault Falcon Jet Corp. and Embraer S.A.

The Trainer/Attack Aircraft segment operates in the military aviation business and is the sole source provider of the primary military trainer aircraft, the T-6 and its variants, to the U.S. Air Force and the U.S. Navy. Outside the U.S., we compete for primary military trainer contracts with companies including Pilatus Aircraft Ltd., Embraer S.A., Korea Aerospace Industries Ltd., Alenia Aermacchi, EADS, Grob Aircraft AG and Lockheed Martin Corporation. It is anticipated the light attack aircraft will compete primarily with the Super Tucano offered by Embraer Defense Systems.

Competition in the Customer Support segment is based upon price, quality, performance, innovation and reputation. Direct competition against our parts and maintenance activities comes mostly from a multitude of privately-owned maintenance facilities, repair shops, parts brokers and parts distributors located across the global market. Most of these competitors are regionally focused without any significant concentration of market share by any one competitor. Our Customer Support segment seeks to increase our share of the aftermarket services provided to our customers by continuing to improve our service standards, leveraging our product knowledge, expanding our product offerings and improving distribution capabilities. We seek to reach industry-leading service levels and to improve the profitability of our company-owned service network.

Employees

As of December 31, 2011, we had approximately 7,400 employees.

The following table summarizes our employees represented by collective bargaining agreements:

 

Union

   Approximate
Number of
Employees
Represented
     Percent of Total
Employees
Represented
    Collective
Bargaining
Agreement
Expiration
Date

The International Association of Machinists and Aerospace Workers (“IAM”)

     2,600         35   August 2016

Union of Needletrades, Industrial and Textile Employees

     130         2   March 2012 (a)

 

(a) Although this agreement expired on March 31, 2012, we do not anticipate any work stoppages during the renegotiation process, which is currently ongoing.

 

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Suppliers and Raw Materials

Our key supplies vary from raw materials, such as aluminum, to completed aircraft components and major assemblies, such as engines, avionics, fuselages and wings. We expect that major aircraft systems and structures will continue to comprise a substantial portion of our supply costs. Pricing arrangements with our suppliers generally include multi-year contracts with fixed-price and annual price adjustment clauses based on published economic indices.

A significant portion of components in each of our aircraft designs, such as engines and avionics, is co-developed with our suppliers and, therefore, are often sole-sourced with the supplier of a particular component. The majority of our supplies are custom ordered, engineered into the aircraft design and governed by FAA and other comparable international agencies aircraft certification. Changing an existing supplier’s design is often cost-prohibitive because it requires re-certification.

Approximately 40% of our direct material purchases are from the following four major suppliers: Pratt & Whitney Canada (engines), Honeywell (engines, avionics, environmental control, auxiliary power units and lighting), Rockwell Collins (avionics) and Airbus (certain wings and fuselages). Approximately 18% of our direct material purchases are from Pratt & Whitney Canada. A significant disruption in supply from one or more of these suppliers could have a material adverse effect on our financial position, results of operations and liquidity.

During March and April of 2012, we announced that we were beginning to furlough employees that work in various departments and on various aircraft including the Beechcraft King Air, Piston and Premier IA and the Hawker 4000 and 987 family. These furloughs were a result of difficulty in obtaining adequate materials in order to continue production as well as matching production to demand. The furloughs will be on a rolling basis and are expected to occur for one to two months. Each furlough will last thirty to forty-five days.

Certain key suppliers have indicated that they may cease providing supplies to us on normal credit terms or at all based upon our current financial difficulties and payment terms which we are employing (see Item 1A, “Risk Factors” contained in this Annual Report on Form 10-K).

Working Capital

In recent years, a significant portion of our Business and General Aviation aircraft deliveries have occurred during the fourth quarter of the year. Given the long lead time involved in the production of aircraft, it is necessary to build aircraft throughout the year in support of the higher fourth quarter delivery volume. As a result, our inventory levels typically rise during the first three quarters of the year and are reduced significantly during the fourth quarter when we generate the majority of our cash flow. Any disruptions to our business or delivery schedule during the fourth quarter of the year could have a disproportionate effect on our full-year financial operating results. Business for the Trainer/Attack Aircraft and Customer Support segments is not generally seasonal in nature.

Backlog

The following table summarizes our backlog:

 

     As of December 31, 2011      As of December 31, 2010  
(In millions)    Funded      Unfunded      Total      Funded      Unfunded      Total  

Business and General Aviation

   $ 771.3       $ —         $ 771.3       $ 782.6       $ —         $ 782.6   

Trainer/Attack Aircraft

     306.9         52.5         359.4         584.4         40.8         625.2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,078.2       $ 52.5       $ 1,130.7       $ 1,367.0       $ 40.8       $ 1,407.8   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Orders for aircraft are included in backlog upon receipt of an executed contract. Our backlog includes significant orders with the U.S. government as well as international customers. Unfunded backlog represents U.S. and foreign government contracts for which funding has not yet been appropriated. Due to the nature of the work performed, the Customer Support segment does not have backlog. At December 31, 2011, 22% of our total backlog represents orders that are not expected to be filled in 2012.

 

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Research and Development

Our research and development efforts are focused on developing technologies that will improve our existing products and our manufacturing processes. We believe derivative models refresh our product line and typically generate increased sales volume. Over the past five years, we have successfully introduced 15 new or derivative models. We plan to focus future research and development efforts on derivative models of our existing aircraft.

Our development effort is an ongoing process that helps us increase the value of our products and expand into new markets. We are currently focused on research in areas such as advanced metallic joining, low cost composites, noise attenuation, efficient structures, systems integration, advanced design and analysis methods and new material application. We collaborate with our major suppliers on product upgrades and often share the associated costs.

Research and development expenditures were $94.3 million, $101.1 million and $107.3 million for the years ended December 31, 2011, 2010 and 2009.

Government Contracts

All companies engaged in supplying defense-related equipment and services to U.S. government agencies, either directly or by subcontract, are subject to business risks specific to the defense industry. U.S. government contracts generally contain provisions permitting termination, in whole or in part, without prior notice at the U.S. government’s convenience, as well as termination for default based on lack of performance. Upon termination for convenience, we generally would be entitled to compensation only for work done, supplier costs and termination liability at the time of termination and to receive an allowance for profit on the work performed. A termination arising out of our default could expose us to liability and have a negative impact on our ability to obtain future U.S. government contracts and orders. Furthermore, on U.S. government contracts for which we are a subcontractor and not the prime contractor, the U.S. government could terminate the prime contract for convenience or otherwise, which would likely result in the termination of our subcontract.

Governmental Regulations

Our operations, products and services are subject to oversight by the FAA and its counterpart regulators in jurisdictions outside of the U.S. These regulators routinely evaluate aircraft operational and safety requirements and are responsible for certification of new and modified aircraft. These regulators further oversee other aspects of our operations, including the provision of aircraft maintenance services. Failure to comply with the applicable laws, rules and regulations governing aviation in the U.S. or other jurisdictions may subject us to civil penalties, including fines or the suspension or revocation of certain necessary licenses or certifications. Future action by these regulators, including increased scrutiny or a change from past practices, may adversely affect our financial position, results of operations or liquidity and impair our ability to certify and deliver new products.

Defense contractors are subject to many levels of audit, investigation and claims. Agencies that oversee contract performance include: the Defense Contract Audit Agency (“DCAA”), Defense Contract Management Agency (“DCMA”), the U.S. Department of Defense, the Inspector General, the Government Accountability Office, the U.S. Department of Justice and Congressional committees. These agencies review a contractor’s performance under its contracts, cost structure and compliance with applicable laws, regulations and standards. The DCAA also reviews the adequacy of, and a contractor’s compliance with, its internal control systems and policies. Any costs found to be improperly allocated to a specific contract will not be reimbursed or must be refunded if already reimbursed. If an audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties, including treble damages, and administrative sanctions, which may include termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or prohibition from doing business with the U.S. government.

As a U.S. government contractor, we are subject to specific import and export, procurement and other regulations and requirements. Failure to obtain timely export or import licenses could delay production and adversely affect our sales. Failure to comply with these regulations and requirements could result in reductions of the value of contracts, contract modifications or terminations and the assessment of penalties and fines, and lead to suspension or debarment, for cause, from government contracting or subcontracting for a period of time. Among the causes for debarment are violations of various statutes related to procurement integrity, export control, government security regulations, employment practices, protection of the environment, and accuracy of records and recording of costs. Under many U.S. government contracts, we are required to maintain facility and personnel security clearances complying with U.S. Department of Defense requirements.

 

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Intellectual Property

We rely on a combination of trademarks, trade names, copyrights, patents and trade secrets to establish and protect our intellectual property rights relating to the development and manufacturing of our products. Some of these intellectual property assets are owned jointly with others or are provided to us through licenses. In the ordinary course of business, we have disputes with third parties regarding intellectual property rights which, in some cases, may result in litigation.

Environmental, Health and Safety Matters

Our operations are subject to the requirements of federal, state, local, and foreign environmental and occupational health and safety laws and regulations, the violation of which could result in substantial costs and liabilities, including material civil and criminal fines and penalties. Such requirements include those pertaining to pollution; the protection of human health and the environment; air emissions; wastewater discharges; occupational health and safety; and the generation, handling, treatment, remediation, use, storage, transport, release of and exposure to, hazardous substances and wastes. We have incurred, and will continue to incur, costs and capital expenditures to comply with these environmental requirements and to obtain and maintain all necessary permits. Any failure by us to comply with such laws and regulations could subject us to significant civil or criminal fines and penalties and other liabilities. In addition, if we were convicted of a violation of these laws or regulations (including the Clean Air Act and the Clean Water Act), we, or one of our subsidiaries, could be placed by the Environmental Protection Agency (“EPA”) on the “Excluded Parties List” maintained by the U.S. General Services Administration. The listing would continue until the EPA concluded that the cause of the violation had been cured. Facilities at which the violation occurred cannot be used in performing any U.S. government contract awarded during any period of listing by the EPA, and pre-existing contracts may be terminated by the government once a facility is listed. In addition, this prohibition can also extend to other facilities that are owned or operated by the convicted entity. We are not currently included on the Excluded Parties List.

Under certain statutes, such as the federal Superfund statute, the obligation to investigate and remediate contamination at a facility may be imposed on current and former owners or operators or on persons who may have sent waste to that facility for disposal. Liability under these statutes may be without regard to fault or to the legality of the activities giving rise to the contamination. Contamination has been identified at some of our facilities, and we have incurred, and will continue to incur, costs to investigate and remediate these conditions. In connection with such contamination, we may also be liable for natural resource damages, government penalties and claims by third parties for personal injury and property damage. In addition, we may incur liabilities in connection with any future environmental contamination or any previously unknown but currently existing environmental conditions at our facilities. While the amount of these costs and liabilities could be significant, we do not believe that, based on currently available information, the costs of investigation and remediation and other costs with respect to identified environmental conditions, including conditions at offsite disposal locations with respect to which we have been notified of potential liability, will have a material adverse effect on our business, financial condition, results of operations or liquidity.

In addition, environmental laws and regulations, and interpretation or enforcement thereof, are constantly evolving, and it is impossible to predict accurately the effect that changes in these laws and regulations, or their interpretation or enforcement, may have upon our business, financial condition, results of operations or liquidity. Should environmental laws and regulations, or their interpretation or enforcement, become more stringent, the costs of compliance could increase. If we cannot pass along future costs to our customers, any such increases may have an adverse effect on our business, financial condition, results of operations or liquidity.

Corporate Information

Hawker Beechcraft Acquisition Company, LLC is a limited liability company formed in 2006 under the laws of the state of Delaware. Hawker Beechcraft Notes Company is a corporation formed in 2007 under the laws of the state of Delaware. Our headquarters and principal executive offices are located at 10511 East Central, Wichita, Kansas 67206 and our telephone number is (316) 676-7111. Our website is www.hawkerbeechcraft.com. The information contained on or connected to our website is expressly not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this or any other report filed with the Securities Exchange Commission, (“SEC”). Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and any amendments to those reports, are available free of charge through our website as soon as reasonably practicable after they are filed with, or furnished to, the SEC. These reports may also be obtained at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC.

 

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Item 1A. Risk Factors

You should carefully consider the risk factors set forth below as well as the other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks described below are not the only risks we face. Additional risks not presently known to us or which we currently consider immaterial also may materially adversely affect us. If any of these risks actually occur, our business, financial condition, results of operations and liquidity could be materially adversely affected.

Risks Related to Our Indebtedness and Liquidity

 

   

“Senior Notes” refers to $400.0 million of 8.5% Senior Fixed Rate Notes due April 1, 2015 and $400.0 million of 8.875%/9.625% Senior PIK-Election Notes due April 1, 2015 of HBAC and HBNC that were registered under the Securities Act of 1933 (“Securities Act”), as well as substantially identical notes that were issued in March 2007 and surrendered by the holders in exchange for the registered notes.

 

   

“Notes” refers to the Senior Notes and $300.0 million of 9.75% Senior Subordinated Notes due April 1, 2017 of HBAC and HBNC that were registered under the Securities Act, as well as substantially identical notes that were issued in March 2007 and surrendered by the holders in exchange for the registered notes.

 

   

“Senior Secured Credit Facilities” refers to debt instruments resulting from the execution of our $1,810.0 million Credit Agreement that includes a $1,300.0 million Senior Secured Term Loan, a $400.0 million Revolving Credit Facility and a $110.0 million synthetic letter of credit facility.

There is substantial doubt about our ability to continue as a going concern.

Management has concluded that there is substantial doubt about the Company’s ability to continue as a going concern. This conclusion was reached based on a variety of factors, including those described below. We determined not to pay our interest obligations under the Notes on April 2, 2012 and anticipate an inability to pay interest on the Notes on future interest payment dates. Furthermore, we will be required to repay or refinance our Senior Secured Credit Facilities and the Senior Tranche Advance prior to the repayment of the Notes and we will be required to repay or refinance the Senior Notes prior to the repayment of the Senior Subordinated Notes. The Company has suffered recurring operating losses resulting in a significant net shareholder’s deficit that raises substantial doubt about its ability to continue as a going concern. The Company is operating under a forbearance agreement with its lenders which defers interest payment obligations and provides relief from loan covenants through June 29, 2012. Due to the fact that we have recurring negative cash flows from operations and recurring losses from operations, we will need to seek additional financing. There is substantial doubt that we will be able to obtain additional equity or debt financing on favorable terms, or at all, in order to have sufficient liquidity to meet our cash requirements for the next twelve months.

Our substantial level of indebtedness could adversely affect our business, financial condition, results of operations or liquidity and prevent us from fulfilling our obligations under the Notes.

We have substantial indebtedness. As of December 31, 2011, we had $2,334.1 million of total indebtedness which is all classified as current due to our financial difficulties. We also had issued letters of credit totaling $51.2 million of the $75.0 million available under our synthetic letter of credit facility. In addition, on March 27, 2012, we borrowed an additional $124.5 million senior tranche term loan to fund ongoing operations (the “Senior Tranche Advance”).

Our substantial indebtedness could have important consequences, including the following:

 

   

we may not be able to satisfy our obligations with respect to the Notes;

 

   

our ability to obtain additional financing for working capital, debt service requirements, general corporate or other purposes may be impaired;

 

   

we must use a substantial portion of our cash flow to pay interest and principal on the Notes and our other indebtedness, which will reduce the funds available to us for other purposes;

 

   

we may be vulnerable to economic downturns and adverse industry conditions;

 

   

our ability to capitalize on business opportunities and to react to pressures and changes in our industry as compared to our competitors may be compromised due to our high level of indebtedness; and

 

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we may not be able to refinance our indebtedness, including the Notes.

The borrowings under our Senior Secured Credit Facilities bear interest at variable rates and other debt we incur could likewise be variable-rate debt. If market interest rates increase, variable-rate debt will create higher debt service requirements, which could adversely affect our cash flow. While we periodically enter into agreements designed to limit our exposure to higher interest rates, any such agreements do not offer complete protection from this risk.

As of December 31, 2011, we were not in compliance with the covenants under our Senior Secured Credit Facilities and had $0.3 million for additional borrowings under our Revolving Credit Facility. As a result, we must rely on revenues from our business to meet our payment obligations under our indebtedness. We determined not to pay our interest obligations under the Notes on April 2, 2012 and anticipate an inability to pay interest on the Notes on future interest payment dates. Furthermore, we will be required to repay or refinance our Senior Secured Credit Facilities and the Senior Tranche Advance prior to the repayment of the Notes and we will be required to repay or refinance the Senior Notes prior to the repayment of the Senior Subordinated Notes. If we were unable to make payments or refinance our debt or obtain new financing under these circumstances, we would have to consider other options, such as:

 

   

sales of assets;

 

   

sales of equity;

 

   

negotiations with our lenders to restructure the applicable debt; and/or

 

   

seeking protection under chapter 11 of the U.S. Bankruptcy Code.

Our Senior Secured Credit Facilities and the indentures governing the Notes may restrict, or market or business conditions may limit, our ability to avail ourselves of some or all of these options.

Our principal sources of liquidity have consisted of cash generated by operations and borrowings available under our Revolving Credit Facility, which has $0.3 million of availability. Our liquidity requirements are significant, primarily due to debt service obligations. We will rely on the Senior Tranche Advance to fund our ongoing operations while we continue to work with our lenders towards a comprehensive recapitalization plan. Our ability to make payments on and to refinance our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive, legislative, regulatory and other factors that are largely beyond our control.

Despite our current indebtedness level, we and our subsidiaries may still be able to incur substantially more debt, which could exacerbate the risks associated with our substantial indebtedness.

The terms of the indentures governing the Notes permit us to incur substantial additional indebtedness in the future, including secured indebtedness. Any senior debt incurred by us would be senior to the Senior Subordinated Notes and, if secured, effectively senior to the Senior Notes. If we incur any additional indebtedness that ranks equal to either the Senior Notes or the Senior Subordinated Notes, the holders of that debt will be entitled to share ratably with the holders of the applicable notes in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding up of us. If new debt is added to our or our subsidiaries’ current debt levels, the related risks that we now face could intensify.

Our debt instruments, including the indentures governing the Notes and our Senior Secured Credit Facilities, impose significant operating and financial restrictions on us. If we default under any of these debt instruments, we may not be able to make payments on the Notes.

The indentures and our Senior Secured Credit Facilities impose significant operating and financial restrictions on us. These restrictions limit our ability to, among other things:

 

   

incur additional indebtedness or guarantee obligations;

 

   

repay indebtedness (including the Notes) prior to stated maturities;

 

   

pay dividends or make certain other restricted payments;

 

   

make investments or acquisitions;

 

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create liens or other encumbrances;

 

   

transfer or sell certain assets or merge or consolidate with another entity;

 

   

engage in transactions with affiliates; and

 

   

engage in certain business activities.

In addition to the restrictions listed above, our Revolving Credit Facility requires us to meet specified financial covenants as of certain dates. We are required to maintain a specified minimum liquidity and, beginning in fiscal year 2011, we are required to maintain a minimum adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) for specified periods, as described subsequently as part of “Management’s Discussion and Analysis and Results of Operations – Capital Resources.” Any of these provisions could limit our ability to plan for or react to market conditions and could otherwise restrict corporate activities.

As of December 31, 2011, we were not in compliance with the covenants contained in our Senior Secured Credit Facilities and on March 27, 2012, we entered into a comprehensive forbearance agreement with the lenders under which our obligations to make certain interest payments were deferred and we were granted relief from certain of our existing covenants.

Our ability to comply with the covenants in our debt instruments going forward may be affected by events beyond our control, and an adverse development affecting our business could require us to seek waivers or amendments of covenants, alternative or additional sources of financing or reductions in expenditures. We cannot be certain that such waivers, amendments or alternative additional financings could be obtained or, if obtained, would be on terms acceptable to us. In addition, the holders of the Senior Notes will have no control over any waivers or amendments with respect to any debt outstanding other than the debt contained in the indenture governing the Senior Notes, and the holders of the Senior Subordinated Notes will have no control over any waivers or amendments with respect to any debt outstanding other than the debt contained in the indenture governing the Senior Subordinated Notes. Therefore, we cannot be certain that even if the holders of the Senior Notes or Senior Subordinated Notes, as applicable, agree to waive or amend the covenants contained in the respective indenture, the holders of our other debt will agree to do the same with respect to their debt instruments.

A breach of any of the covenants or restrictions contained in any of our existing or future financing agreements could result in a default or an event of default under those agreements. Such a default or event of default could allow the lenders under our financing agreements, if the agreements so provide, to discontinue lending, to accelerate the related debt as well as any other debt to which a cross-acceleration or cross-default provision applies, and to declare all borrowings outstanding thereunder to be due and payable. In addition, the lenders could terminate any commitments they had made to supply us with further funds. If the lenders require immediate repayments, we may not be able to repay them and also repay the Notes in full. In connection with our decision not to make the April 2, 2012 interest payment under the Notes, the respective indentures for the Notes each provide that missed interest payments do not give rise to an Event of Default (as defined in the applicable indenture) until the interest payments have been in default for 30 days or more.

Certain private equity investment funds affiliated with GS Capital Partners VI, L.P. and Onex Partners II LP own a significant majority of our equity, and their interests may not be aligned with our note holders or creditors.

Private equity investment funds affiliated with GS Capital Partners VI, L.P. and Onex Partners II LP own substantially all of our equity. Subject to certain exceptions, these private equity investment funds have the power to direct our affairs and policies. A majority of the members of the HBI Board of Directors have been designated by these private equity investment funds. Through such representation on the HBI Board of Directors, they are able to substantially influence the appointment of management and entry into extraordinary transactions, including mergers and sales of assets. In addition, affiliates of GS Capital Partners VI, L.P. and Onex Partners II LP currently own approximately $159.4 million of our Notes.

The interests of GS Capital Partners VI, L.P. and Onex Partners II LP and their respective affiliates could conflict with the interests of the other note holders or creditors. For example, if we are unable to pay our debts as they mature, the interests of GS Capital Partners VI, L.P. and Onex Partners II LP as equity holders might conflict with the interests of the other note holders or creditors. Affiliates of GS Capital Partners VI, L.P. and Onex Partners II LP may also have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their equity investments, although such transactions might involve risks to the note holders or creditors. In addition, GS Capital Partners VI, L.P. and Onex Partners II LP or their respective affiliates may in the future own businesses that directly or indirectly compete with us, our suppliers or customers of ours. For example, affiliates of Onex Partners II LP currently own a controlling interest in one of our suppliers.

 

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We are a holding company.

We are a holding company, and we conduct substantially all of our operations through our subsidiaries. As a result, our ability to meet our debt obligations substantially depends upon our subsidiaries’ cash flows and payment of funds to us by our subsidiaries as dividends, loans, advances or other payments. In addition, the payment of dividends or the making of loans, advances or other payments to us may be subject to regulatory or contractual restrictions.

Risks Relating to Our Business

Any significant disruption in our supply from key vendors could threaten production and adversely affect our sales.

The FAA prescribes standards and qualification requirements for aerostructures, including virtually all general aviation products, with which our suppliers must comply. We cannot be certain that our suppliers will be able to comply, and failure to do so may cause shortages or delays. We cannot be certain that substitute raw materials or component parts will be available to us or will meet the strict specifications and quality standards that we, our customers and the U.S. government impose. Often, our certification from the FAA relates to a specific part from a specific supplier. If we were required to certify replacement parts from a new vendor, the certification process could materially delay or threaten production and adversely affect our business, financial condition, results of operations and liquidity.

We are highly dependent on the availability of essential materials and purchased components from our suppliers, some of which are available only from a sole source or limited sources, especially major components such as wings, engines and avionics, which are co-developed with our suppliers and, therefore, are often sole-sourced with that supplier. Moreover, we are dependent upon the ability of our suppliers to provide materials and components that meet specifications, quality standards and delivery schedules. Our suppliers’ failure to provide expected raw materials or component parts that meet our technical specifications could materially disrupt production schedules and contract profitability.

In addition, contracts with certain of our suppliers for raw materials and other goods are short-term contracts. We cannot be certain that these suppliers will continue to provide products to us at attractive prices or at all, or that we will be able to obtain such products in the future from these or other providers on the scale and within the time periods we require. Our foreign suppliers must also comply with U.S. import/export control laws. Any failure to comply with such laws may delay or halt supplier production or shipments of goods. If we are not able to obtain key products on a timely basis and at affordable costs, or we experience significant delays or interruptions of supply, we may need to suspend production and our business, financial condition and results of operations could be materially adversely affected.

In addition to the risks described above, our continued supply of materials is subject to a number of other risks including:

 

   

disputes with our suppliers, including disputes over timeliness of payments and associated risks of termination;

 

   

requests by our suppliers for assurances that we will be able to perform under our arrangements with such suppliers and their refusal to be satisfied by such assurances;

 

   

a work stoppage or strike by our suppliers’ employees;

 

   

the failure of essential equipment at our suppliers’ plants;

 

   

the failure, shortage or delays in the delivery of supply of raw materials to our suppliers;

 

   

inability of second tier suppliers to perform as required; and

 

   

the destruction of our suppliers’ facilities or their distribution infrastructure.

 

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We operate in a very competitive business environment.

The general aviation industry is highly competitive and we encounter competition in both domestic and foreign markets. The highly competitive nature of our industry means we are continually subject to the risk of loss of our market share, loss of significant customers, reduction in margins, the inability for us to gain market share or acquire new customers, and difficulty in raising our prices. Many of our competitors in the general aviation market are either part of larger, more diversified companies or may be the beneficiaries of government subsidies. As a result of this, these competitors may have access to more resources than we do. These circumstances may provide our competitors with a lower cost of capital, the ability to sustain a prolonged downturn in the industry or general economy, more funds for investment in development of new products and more resources in general. These competitors may have less debt than we have and may be better able to withstand changes in market conditions within the industry. For these reasons, we may not be able to compete successfully against such competitors or future entrants into the general aviation markets in which we compete, which could have a material adverse effect on our business, financial condition and results of operations.

We incur risks associated with our aircraft programs.

The principal markets in which our businesses operate experience changes due to the introduction of new technologies. To meet our customers’ needs in these businesses, we must continuously design new products, update existing products and services, and invest in and develop new technologies. Making such investments requires available capital which may not be available to us. In addition, new programs with new technologies typically carry risks associated with design responsibility, FAA mandated certification requirements, development of new production tools, hiring and training of qualified personnel, increased capital and funding commitments, delivery schedules and unique contractual requirements, supplier performance and our ability to accurately estimate costs associated with such programs. Our competitors may also develop products that are superior to our products or may adapt more quickly than us to new technologies or evolving customer requirements. Technological advances by our competitors may lead to new manufacturing techniques to manufacture their products and may make it more difficult for us to compete. In addition, any new aircraft program may not generate sufficient demand or may be subject to technological problems or significant delays in the regulatory certification or manufacturing and delivery schedule, and the costs of these new aircraft programs may exceed our expectations. If we were unable to manufacture products at our estimated costs or if a new program in which we had made a significant investment is subject to weak demand, delays or technological problems, or if we lack sufficient capital to make the necessary investments in new programs, our business, financial condition and results of operations could be materially adversely affected.

Our business will suffer if we are unable to recruit and retain highly skilled staff.

The success of our business is highly dependent upon our ability to continue to recruit, train and retain skilled employees, particularly skilled engineers as well as finance and accounting personnel. The market for these personnel resources is highly competitive. We may be unsuccessful in attracting and retaining the employees we need, and, in such event, our business could be materially adversely affected. Our inability to hire new personnel with the requisite skills could impair our ability to provide products to our customers or to manage our business effectively.

Significant changes in discount rates, actual investment return on pension assets and other factors could affect our results of operations, equity and pension contributions in future periods.

Our results of operations are impacted by the amount of income or expense we record for our pension and other postretirement benefit plans. Generally accepted accounting principles in the U.S. (“U.S. GAAP”) require that we calculate income or expense for the plans using actuarial valuations. These valuations reflect assumptions relating to financial market and other economic conditions. The most significant year-end assumptions used to estimate pension or other postretirement income or expense for the following year are the discount rate, the expected long-term rate of return on plan assets and expected rate of inflation for medical costs. In addition, we are required to make an annual measurement of plan assets and liabilities, which may result in a significant change to Other Comprehensive Income, a component of equity. Changes in key economic indicators could cause our assumptions to not be realized and materially impact our results of operations. For a discussion regarding how our financial statements can be affected by pension and other postretirement plan accounting policies, see Item 7, “Management’s Discussion and Analysis – Critical Accounting Estimates” of this Annual Report on Form 10-K. Although U.S. GAAP expense and pension or other postretirement contributions are not directly related, the key economic factors that affect U.S. GAAP expense would also likely affect contributions to the pension or other postretirement plans. Potential pension contributions include both mandatory amounts required under the federal Employee Retirement Income Security Act and discretionary contributions to improve the plans’ funded status. If we are unable to make these contributions, our business, financial condition and results of operations could be materially adversely affected.

 

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

We derive a significant portion of our revenues from sales to customers outside the U.S. For the year ended December 31, 2011, international sales accounted for approximately 41% of our consolidated revenues. We expect that our international sales will continue to account for a significant portion of our revenues for the foreseeable future and are likely to increase over time. As a result, we are subject to risks of doing business internationally, including:

 

   

changes in regulatory requirements;

 

   

domestic and foreign government policies, including requirements to expend a portion of program funds locally and governmental industrial cooperation requirements;

 

   

the necessity and complexity of using foreign employees, representatives and consultants;

 

   

fluctuations in foreign exchange rates;

 

   

lack of intellectual property protection in foreign jurisdictions;

 

   

imposition of tariffs or embargoes, export controls and other trade restrictions;

 

   

the difficulty of management and operation of an enterprise spread over various countries;

 

   

compliance with a variety of foreign laws and taxation policies, as well as U.S. laws affecting the activities of U.S. companies abroad; and

 

   

economic and geo-political developments and conditions, including international hostilities, political instability, acts of terrorism and governmental reactions, inflation, trade relationships and military and political alliances.

While these factors or the impact of these factors are difficult to predict, any one or more of these factors could materially adversely affect our business, financial condition, results of operations and liquidity.

In order to sell many of our products outside of the U.S., we must first obtain licenses and authorizations from various government agencies. For certain sales of defense equipment and services to foreign governments, the U.S. Department of State must notify Congress at least 15 to 30 days, depending on the size and location of the sale, prior to authorizing these sales. During that time, Congress may take action to block the proposed sale. We can give no assurance that we will continue to be successful in obtaining the necessary licenses or authorizations or that Congress will not prevent certain sales. Our inability to sell products outside of the U.S. could materially adversely affect our business, financial condition, results of operations and liquidity.

If we are not able to remedy our weaknesses and other deficiencies in our internal controls, our business reputation could be harmed and noteholders could lose confidence in our financial reporting.

Through our ongoing assessment of our system of internal controls over financial reporting, we identified material weaknesses in our internal control over financial reporting related to our implementation of an upgraded ERP system and difficulties in attracting and retaining appropriately qualified accounting and finance personnel. While we have taken certain remedial actions and are taking future remedial actions, additional controls must be implemented and tested successfully before we can be reasonably assured that our internal controls are effective. Our implementation of changes to our internal controls in connection with our remediation plans are expected to require additional expenditures, could take a significant period of time to complete and could distract our officers and employees from the operation of our business. In light of these material weaknesses and other deficiencies, we may not be able to produce reliable financial statements or to file these financial statements as part of a periodic report in a timely manner with the Securities and Exchange Commission. Our failure to maintain effective internal controls could result in a loss of confidence in the reliability of our financial statements by noteholders, which in turn could harm the value of the notes.

A cybersecurity incident could have a negative impact on the Company.

A cyber-attack that bypasses our information technology (IT) security systems causing an IT security breach, may lead to a material disruption of our IT business systems and/or the loss of business information resulting in an adverse business impact. Risks may include:

 

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future results could be adversely affected due to the theft, destruction, loss, misappropriation or release of confidential data or intellectual property;

 

   

operational or business delays resulting from the disruption of IT systems and subsequent clean-up and mitigation activities; and

 

   

negative publicity resulting in reputation or brand damage with customers, partners or industry peers.

The difficult conditions in the general aviation and other aircraft markets and in the overall economy that continue to materially adversely affect our business, financial condition, results of operations and liquidity may not improve in the near future.

Many of the products we sell are considered discretionary purchases, and are significantly affected by the level of corporate and consumer spending which, in turn, is a function of the general economic environment. In a slowly growing economy, such as many of the markets in which we operate are experiencing, demand for our products may weaken and prospective customers may postpone planned purchases. Accordingly, sales of our products may be adversely affected by a weak economy, increases in consumer debt levels, uncertainties regarding future economic prospects or a decline in consumer confidence.

Moreover, aircraft customers, including sellers of fractional share interests, providers of charter services and dealers have responded, and may continue to respond, to the current weak economic conditions by delaying delivery of orders [or canceling orders as we have experienced since late 2008]. Weakness in the economy may also result in fewer hours being flown on existing aircraft and, consequently, lower demand for spare parts and maintenance services. Weak economic conditions may also cause reduced demand for used business jets. We have experienced reductions in the fair market value of used aircraft accepted as trade-ins while such aircraft were in our inventory. In addition, economic conditions have resulted in an increased supply of used aircraft in the market which to some extent competes with our sales of new aircraft into the market. The continuation of this dynamic may adversely affect sales of our products.

Our operations depend on our ability to maintain continuous, uninterrupted production at our manufacturing facilities. Our production facilities are subject to physical and other risks that could disrupt production.

Our manufacturing facilities could be damaged or disrupted by a natural disaster, war, terrorist activity or sustained mechanical failure. Although we have obtained property damage and business interruption insurance in amounts determined sufficient by management, a major catastrophe, such as a fire, flood, tornado or other natural disaster at any of our sites, war or terrorist activities in any of the areas where we conduct operations or the sustained mechanical failure of a key piece of equipment could result in a prolonged interruption of all or a substantial portion of our business. Production at our manufacturing facilities could be disrupted in connection with our closure of certain of our other facilities and our outsourcing of certain operations. Any disruption resulting from these events could cause significant delays in shipments of products and the loss of sales and customers. We may not have insurance to adequately compensate us for any of these events. A large portion of our operations is conducted in facilities in Wichita, Kansas; Little Rock, Arkansas; Chester, England; and Chihuahua, Mexico, and any significant damage or disruption to these facilities in particular would materially adversely affect our ability to manufacture and deliver aircraft and parts to our customers.

Our results of operations and financial condition could be materially adversely impacted by some of our customers’ inability to obtain financing.

Some of our customers rely on credit markets to obtain financing for new and used aircraft purchases. Uncertainty in with respect to the residual value of aircraft being financed may reduce the number of lenders willing to finance aircraft or cause lenders to impose stricter lending requirements. The inability of a portion of our customers to obtain financing could lead to reduced demand for our products, delayed deliveries or order cancellations, which could adversely affect the number of aircraft deliveries we make or reduce the prices we can charge for our aircraft, either of which could have a material adverse effect on our financial condition and results of operations.

We accept used aircraft as trade-ins from our customers and may be required to accept trade-ins at a financial loss.

In connection with the signing of a purchase contract for new aircraft, we may agree to accept a trade-in aircraft from our customer as partial consideration of the purchase price. We may be required to accept trade-ins at prices that are above the then-market price of the trade-in aircraft, which would result in lower gross margins at the time of the new aircraft sale.

 

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We are at risk of adverse publicity and losses stemming from any accident involving aircraft for which we hold design authority.

Any accident involving one of our manufactured aircraft could create a public perception that our aircraft are not safe or reliable, which could harm our reputation and have a negative impact on our business, financial condition and results of operations. In addition, if one of our manufactured aircraft were to crash or be involved in an accident, we could be exposed to significant liability. We are currently involved in various litigation matters stemming from such incidents. Our insurance coverage may not be adequate to cover all possible losses that may arise in the event of an accident involving one of our manufactured products. In the event that our insurance is not adequate, we may be forced to bear substantial losses.

Accidents and incidents involving one of our manufactured aircraft may prompt the FAA to issue airworthiness directives or other notices regarding the aircraft, and we have received such airworthiness directives previously. Publication of an FAA airworthiness directive or notice could create a public perception that a particular Hawker Beechcraft aircraft is not safe, reliable, or suitable for an operator’s needs. This perception could result in a claim being filed against us or lost future sales, or both. In addition, the FAA could require design modifications causing us to incur significant expenditures altering an aircraft design, altering aircraft in production and altering fielded aircraft. FAA airworthiness directives are typically followed by similar regulatory requirements in other countries where affected aircraft are certified. The publication of an airworthiness directive or notice by the FAA could lead to a decline in revenues and have a negative impact on our business, financial condition and results of operations.

The General Aviation Revitalization Act of 1994 (“GARA”) provides a “statute of repose” which, in the context of aviation litigation, operates to limit the time a lawsuit can be filed against an aircraft manufacturer. GARA bars lawsuits against a manufacturer of aircraft or aircraft components once the product has been in service for eighteen years. Such limitations on liability, however, are dependent upon the facts and circumstances surrounding the incident giving rise to liability. GARA does not, for instance, apply if the aircraft was engaged in a scheduled passenger flight and may not apply in certain air medical services operations. Raytheon Aircraft has manufactured certain aircraft that remain in use in scheduled passenger and other operations, including the King Air 1900, that may not be covered by GARA. In addition, as part of the Acquisition, we retained the type certification for the King Air 1900. As a result, if any of these aircraft were to crash or be involved in an accident, we could be exposed to liability and may not have a defense under GARA.

The outcome of litigation in which we have been named as a defendant is unpredictable and an adverse decision in any such matter could have a material adverse effect on our financial position, results of operations and liquidity.

We are defendants in a number of litigation matters and are subject to various other claims, demands and investigations. These matters may divert financial and management resources that would otherwise be used to benefit our operations. No assurances can be given that the results of these matters will be favorable to us. An adverse resolution or outcome of any of these lawsuits, claims, demands or investigations could have a negative impact on our business, financial condition, results of operations and liquidity.

Increases in labor costs, potential labor disputes and work stoppages at our facilities could materially adversely affect our financial performance.

Our financial performance is affected by the availability of qualified personnel and the cost of labor. Approximately 37% of our workforce at December 31, 2011, was represented by unions and is covered by collective bargaining agreements. Approximately 2,600 of our hourly employees at our Wichita, Kansas facilities are covered by a collective bargaining agreement with the International Association of Machinists and Aerospace Workers that expires in August 2016. Our service facility in Chester, England, had a union contract covering approximately 130 employees that expired on March 31, 2012. Although this agreement expired on March 31, 2012, we do not anticipate any work stoppages during the renegotiation process. If our workers were to engage in a strike, work stoppage or other slowdown, we could experience a significant disruption of our operations that could cause us to be unable to deliver products to our customers on a timely basis and could result in a breach of our sales or supply agreements. This could result in a loss of business and an increase in our operating expenses, which could have a material adverse effect on our business, financial condition, results of operations and liquidity. In addition, our non-unionized labor force may become subject to labor union organizing efforts, which could cause us to incur additional labor costs and increase the related risks that we now face.

Our JPATS contracts expose us to the inherent risks of fixed price contracting, and future contracts under the JPATS program are not guaranteed.

We manufacture aircraft for the U.S. Air Force and the U.S. Navy. We provide some of our products and services to governments through long-term contracts in which the pricing terms are fixed based on certain production volumes. For the year

 

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ended December 31, 2011, approximately 21% of our revenues were derived from the JPATS contract. Government programs such as the JPATS program are generally implemented by the award of multi-year contracts in which the pricing for future years’ procurements by the government is negotiated under fixed price contracts and segregated into individual lots to be exercised on an annual basis. The award of these future lots is subject to future Congressional appropriations. Congress generally appropriates funds on a fiscal year basis even though a program extends for more than one year. Consequently, programs are often only partially funded at any one time, and additional funds are committed only as Congress makes further appropriations. U.S. government contracts under such programs are subject to termination or adjustment if appropriations for the program are not available or change. In addition, U.S. government contracts, including the JPATS contract, generally contain provisions permitting termination, in whole or in part, without prior notice at the U.S. government’s convenience as well as termination for default based on performance. Upon termination for convenience, we are generally entitled to compensation only for work done and commitments outstanding at the time of termination. A termination arising out of our default could expose us to liability and have a negative impact on our ability to obtain future contracts and orders. Furthermore, on contracts for which we are a subcontractor and not the prime contractor, the U.S. government could terminate the prime contract for convenience or otherwise, irrespective of our performance as a subcontractor.

In January 2011, the Secretary of Defense publicized his efforts to freeze the military budget as part of the U.S. government’s efforts to decrease the deficit. Circumstances such as these may increase the risk that Congress may limit its appropriations in the future. The termination of one or more large contracts, whether due to lack of funding, for convenience, or otherwise, or the occurrence of delays, cost overruns and product failures in connection with one or more government contracts, could materially adversely impact our results of operations and financial condition. Furthermore, we can give no assurance that we would be able to procure new U.S. government contracts to offset the revenues lost as a result of any termination of our current U.S. government contracts. The majority of our Trainer/Attack Aircraft segment sales are from our JPATS contract. A termination of the JPATS contract would substantially reduce future sales in this segment.

The JPATS contracts are generally fixed-price in nature. As a result, we will bear the risk that increased or unexpected costs may reduce our profit margins or cause us to sustain losses on the contract. We must fully absorb cost overruns, notwithstanding the difficulty of estimating all of the costs we will incur in performing this contract and in projecting the ultimate level of sales that we may achieve. Our failure to anticipate technical problems, estimate delivery reductions, estimate costs accurately, or control costs during performance of a fixed price contract may reduce the profitability of a contract or cause a loss.

Our business could be adversely affected by a negative audit by the U.S. government.

As a government contractor we are subject to routine audits and investigations by U.S. government agencies such as the DCAA. These agencies review a contractor’s performance under its contracts, cost structure and compliance with applicable laws, regulations and standards. The DCAA also reviews the adequacy of, and a contractor’s compliance with, its internal control systems and policies. Any costs found to be improperly allocated to a specific contract will not be reimbursed or must be refunded if already reimbursed. Moreover, private individuals may bring qui tam, or “whistle blower” suits, under the False Claims Act, which permits a private individual to bring a claim on behalf of the U.S. government to recover payments made as a result of a false claim. Such individuals may receive a portion of amounts recovered on behalf of the U.S. government. If an audit, alleged whistle blower or other activity results in discovery of improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, which may include: termination of contracts; forfeiture of profits; suspension of payments; fines; and suspension or prohibition from doing business with the U.S. government. In addition, we could suffer serious reputational harm if allegations of impropriety were made against us.

We are subject to government regulation, and our business may be materially adversely affected if we lose our government, regulatory or industry approvals, if more stringent government regulations are enacted or if industry oversight is increased.

The FAA prescribes standards and qualification requirements for aerostructures, including virtually all general aviation products. The FAA further regulates virtually all aviation services, such as maintenance, training, and the operation of aircraft. Comparable agencies, including but not limited to the European Aviation Safety Agency (“EASA”), in Europe, regulate these matters in other countries. In addition, the FAA, the EASA or other comparable agencies occasionally propose new regulations or changes to existing regulations. These regulations, if adopted, could cause us to incur significant additional costs to achieve compliance. If we fail to qualify for or obtain a required license for one of our products or services or lose a qualification or license previously granted, the sale of the subject product or service would be prohibited by law until such license is obtained or renewed and our business, financial condition, results of operations and liquidity could be materially adversely affected. In addition, designing new products to meet existing regulatory requirements and retrofitting existing products to comply with new regulatory requirements can be expensive and time consuming.

Further, our business could be materially adversely affected if the U.S. government enacts new regulation in the form of user fees or other tax regulation on our products or their use. Our products are generally considered discretionary goods and are

 

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not currently subject to user fees or other excess taxation. If the U.S. government were to institute new taxes on the operation or use of our products, the attractiveness of general aviation as an alternative to commercial airfare could be affected and demand for our products may decrease, which could have a material adverse effect on our business, financial condition, results of operations and liquidity.

The Department of Homeland Security and the Transportation Security Administration, along with other governmental regulatory agencies regularly review the level of security associated with general aviation flight operations to minimize the vulnerability of general aviation aircraft being used as a weapon or to deliver illicit materials or to transport dangerous individuals. Any changes to the current regulations which decrease the efficiencies associated with the use of general aviation aircraft may make the utilization of general aviation as an alternative to commercial air travel less attractive and could therefore lower demand for our products which could have a material adverse effect on our business, financial condition, results of operation and liquidity.

Certain contracts, primarily related to our special mission business, are classified contracts. Because one of our principal shareholders is a Canadian entity, we have agreed to, and have implemented, a Security Control Agreement with the Defense Security Service as a suitable Foreign Ownership, Control or Influence (“FOCI”) mitigation arrangement under the National Industrial Security Program Operating Manual. A FOCI arrangement is necessary for us to continue to maintain the requisite security clearances to complete performance under these contracts. Failure to reach and/or maintain an appropriate agreement with the Defense Security Service regarding the appropriate FOCI mitigation arrangement could result in invalidation or termination of the security clearances, which in turn would mean that we would not be able to enter into future classified contracts, and may result in the loss of our ability to complete our existing classified contracts.

We are subject to regulation of our technical data and goods under U.S. export control laws.

We are regulated by the International Traffic in Arms Regulations administered by the U.S. Department of State, and the Export Administration Regulations administered by the U.S. Department of Commerce. Collaborative agreements that we may have with foreign persons, including manufacturers and suppliers, are also subject to U.S. export control laws. In addition, we are subject to trade sanctions against embargoed countries, administered by the Office of Foreign Assets Control within the U.S. Department of the Treasury.

A determination that we have failed to comply with one or more of these export controls or trade sanctions could result in civil or criminal penalties, including the imposition of fines and the denial of export privileges and debarment from participation in U.S. government contracts. Delays or disapproval of export or import licenses or agreements could delay production and adversely affect our financial condition. Additionally, restrictions may be placed on the export of technical data and goods in the future as a result of changing geo-political conditions. Any one or more of such sanctions could have a material adverse effect on our business, financial condition and results of operations.

We are subject to strict environmental laws and regulations that may lead to significant, unforeseen expenses.

Our operations are subject to the requirements of federal, state, local, European and other foreign environmental and occupational health and safety laws and regulations, the violation of which can result in substantial costs and liabilities, including material civil and criminal fines and penalties. Such requirements include those pertaining to pollution; the protection of human health and the environment; air emissions; wastewater discharges; occupational safety and health; and the generation, handling, treatment, remediation, use, storage, transport, release of and exposure to, hazardous substances and wastes. We have incurred and will continue to incur costs and capital expenditures to comply with these environmental requirements and to obtain and maintain all necessary permits. Any failure by us to comply with such laws and regulations could subject us to significant civil or criminal fines and penalties and other liabilities. In addition, if we were convicted of a violation of certain of these laws or regulations (including the Clean Air Act and the Clean Water Act), we, or one of our subsidiaries, could be placed by the U. S. Environmental Protection Agency (the “EPA”) on the “Excluded Parties List” maintained by the U.S. General Services Administration. The listing would continue until the EPA concluded that the cause of the violation had been cured. Facilities at which the violation occurred cannot be used in performing any U.S. Government contract awarded during any period of listing by the EPA, and pre-existing contracts may be terminated by the government once a facility is listed. In addition, this prohibition can also extend to other facilities that are owned or operated by a convicted entity.

Under certain of these laws and regulations, such as the federal Superfund statute, the obligation to investigate and remediate contamination at a facility may be imposed on current and former owners or operators or on persons who may have sent waste to that facility for disposal. Liability under these laws and regulations may be without regard to fault or to the legality of the activities giving rise to the contamination. Contamination has been identified at some of our facilities, and we have incurred, and will continue to incur, costs to investigate and remediate these conditions. In connection with such contamination, we may also be liable for natural resource damages, government penalties and claims by third parties for personal injury and property damage. In addition, we may incur liabilities in connection with any future environmental contamination or any

 

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previously unknown but currently existing environmental conditions at our facilities. The costs of investigation, remediation and other costs with respect to identified environmental conditions, including conditions at offsite disposal locations with respect to which we have been notified of potential liability, could be significant.

In addition, environmental laws and regulations, and the interpretation or enforcement of these laws and regulations, are constantly evolving and it is impossible to predict accurately the effect that changes in these laws and regulations, or their interpretation or enforcement, may have upon our business, financial condition, results of operations or liquidity. Should environmental laws and regulations, or their interpretation or enforcement, become more stringent, the costs of compliance could increase. If we cannot pass along future cost increases to our customers, any such increases may have an adverse effect on our business, financial condition, results of operations or liquidity.

We are subject to fluctuations in the rate of exchange between U.S. dollars and foreign currencies, particularly U.K. pound sterling.

The majority of our sales are generated in U.S. dollars; however, a significant component of our aircraft production cost on certain models is contracted with suppliers in U.K. pound sterling. We may enter into foreign currency forward contracts with commercial banks to fix the dollar value of a portion of our commitments to these suppliers; however, these foreign currency forward contracts may not cover the total value of foreign currency payments we are obligated, or may become obligated, to make. Therefore, we could be adversely affected by a weakening of the U.S. dollar relative to foreign currencies, particularly the U.K. pound sterling. Conversely, declining production volumes could cause foreign currency forward contracts to be in excess of required foreign currency commitments causing us to be exposed to mark-to-market gains or losses for the ineffective portion of foreign currency forward contracts or contracts not designated in a cash flow hedging relationship.

We must assess the value of used aircraft and aircraft materials and parts, which requires significant judgment, and changes in the value of such items could adversely affect our future financial results.

There is significant judgment used to determine the value of used aircraft that we acquire. We assess the realizable value of the aircraft on a continual basis. During this assessment, we evaluate many factors, including current and future market conditions, the age and condition of the aircraft and availability levels of the aircraft in the market. In addition, the valuation of aircraft materials and parts that support our worldwide fleet requires significant judgment. We assess the realizable value of the parts on a continual basis. During this assessment, we evaluate many factors, including the expected useful life of the aircraft, some of which have remained in service for several decades. Furthermore, we assume an orderly disposition of both used aircraft and aircraft materials and parts in connection with our assessments of realizable value. Changes in market or economic conditions and changes in products or competitive products may adversely impact the future valuation of used aircraft and aircraft materials and parts and such changes in valuation could materially adversely affect our business, financial condition, results of operations or liquidity.

We use estimates in accounting for certain contracts and changes in our estimates could adversely affect our financial results.

Revenue recognition for certain of our contracts requires judgment relative to estimating total sales and costs at completion. Due to the size and nature of these contracts, the estimating process is complicated. Because of the significance of the judgments and estimation processes, it is likely that materially different amounts could be recorded if we used different assumptions. Changes in underlying assumptions, circumstances or estimates may materially adversely affect our business, financial condition and results of operations.

Our business operations could be negatively impacted if we fail to adequately protect our intellectual property rights or if third parties claim that we are in violation of their intellectual property rights.

We rely on a combination of trademarks, trade names, copyrights, patents, non-patented proprietary know-how, trade secrets and other proprietary information. We employ various methods to protect our proprietary information, including confidentiality agreements, invention assignment agreements and proprietary information agreements with vendors, employees, contractors, distributors, consultants and others. However, these agreements may be breached. In addition, we hold U.S. and foreign trademarks and patents relating to a number of our products and have additional trademark and patent applications pending. We also apply for patents in the ordinary course of our business, as we deem appropriate. However, these precautions offer only limited protection, and our proprietary information may become known to, or be independently developed by, competitors, patent or trademark applications might not be issued or our proprietary rights in intellectual property may be challenged, any of which could have a material adverse effect on our business, financial condition and results of operations. Additionally, our existing or future patents, if any, may not afford us significant competitive advantages, and we cannot be certain that any patent application will result in an issued patent or that our patents will not be circumvented, invalidated or declared unenforceable.

 

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Our results of operations, financial condition and liquidity could be adversely affected if we become involved in intellectual property litigation. If we were to lose any such litigation, a court or a similar foreign governing body could invalidate or render unenforceable our owned or licensed patents, require us to pay significant damages, cause us to seek licenses and/or pay royalties to third parties, require us to redesign our products, or prevent us from manufacturing, using or selling our products. Any of those events could have a material adverse effect on our financial condition, results of operations and liquidity. The defense and prosecution of intellectual property suits and proceedings before the U.S. Patent and Trademark Office, or its foreign equivalents, are costly and time consuming. Intellectual property litigation relating to our products could cause our customers or potential customers to defer or limit their purchase or use of the affected products until resolution of the litigation.

Inclement weather conditions during the last quarter of the calendar year, when we typically have our peak deliveries, could adversely affect our financial results.

Historically, our peak deliveries have occurred during the last quarter of the calendar year. Inclement weather conditions during that time of year may limit our ability to conduct necessary pre-delivery flight tests, which may delay our deliveries and adversely affect our financial results.

If we fail to maintain a minimum number of employees in Kansas, we will be required to repay a portion of the funds we have received from the State of Kansas, which could materially adversely affect our business, financial condition, results of operations or liquidity.

In December 2010, we reached an agreement with the State of Kansas pursuant to which we received $10.0 million in 2011, and we will receive an additional $5.0 million each year for the next four years. These funds may be used for expenses such as the purchase or relocation of equipment, product development, labor recruitment or building costs. The State’s incentive package requires us to maintain our current product lines in Wichita and retain at least 4,000 jobs in Kansas over the next 10 years. If we do not, we will be subject to certain repayment obligations which could materially adversely affect our business, financial condition, results of operations or liquidity.

Any future business combinations, acquisitions, mergers or joint ventures will expose us to risks, including the risk that we may not be able to successfully integrate these businesses or achieve expected operating synergies.

We actively consider strategic transactions from time to time. We evaluate acquisitions, joint ventures, alliances or co-production programs as opportunities arise, and we may be engaged in varying levels of negotiations with potential competitors at any time. We may not be able to effect transactions with strategic alliance, acquisition or co-production program candidates on commercially reasonable terms or at all. The integration of companies that have previously been operated separately involves a number of risks; as such, if we enter into these transactions, we also may not realize the benefits we anticipate and we may subject ourselves to unforeseen contingent liabilities. Consummating any acquisitions, joint ventures, alliances or co-production programs could result in the incurrence of additional debt and related interest expense. In addition, we may not be able to obtain additional financing for these transactions.

 

Item 1B. Unresolved Staff Comments

Not applicable.

 

Item 2. Properties

Our facilities consist of manufacturing, corporate office and hangar space, as well as our network of company-owned service centers.

Our principal executive offices and headquarters are located in Wichita, Kansas. Our principal manufacturing facilities are in Wichita, Kansas; Little Rock, Arkansas; and Chihuahua, Mexico. Our primary distribution facilities are located in Wichita, Kansas; Dallas, Texas; London, England; Dubai, United Arab Emirates; and Singapore.

 

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The following table summarizes our properties as of December 31, 2011:

 

Segment

  

Location

  

Activities

  

Owned/
Leased

  

Square
Footage

Corporate Headquarters (a)

   Wichita, Kansas    Parts processing, engine buildup, major and sub assembly, aircraft painting and interior installation and flight testing    Owned    3.9 million

Business and General Aviation

   Salina, Kansas (b)    Sub-assembly for all business and general aviation Beechcraft models and the Hawker 400XP    Leased    0.4 million
   Little Rock, Arkansas    Final specialty interior installation for the Hawker 900XP family and the Hawker 4000 and painting for the Hawker 900XP family    Leased    0.4 million
   Chihuahua, Mexico    Sheet metal processing, fabrication of parts and sub-assemblies for general aviation aircraft    Leased    0.4 million

Customer Support

   Dallas, Texas    Retail aftermarket parts distribution warehouse    Leased    0.2 million

 

(a) Our Corporate Headquarters are located in Wichita, Kansas. All three of our business segments, Business and General Aviation, Trainer/Attack Aircraft and Customer Support, have operations located at our Corporate Headquarters. All operations for our Trainer/Attack Aircraft segment are in Wichita, Kansas.
(b) These operations have been transitioned to other facilities. This lease expired in February 2012.

At December 31, 2011, our Customer Support segment operated 10 company-owned service centers in the following locations: Wichita, Kansas; Houston, Texas; Atlanta, Georgia; Mesa, Arizona; Indianapolis, Indiana; Little Rock, Arkansas; Tampa, Florida; San Antonio, Texas; Toluca, Mexico; and Chester, England. We also have new company-owned service centers scheduled to open in the first half of 2012 in Wilmington, Delaware, and Monterrey, Mexico. These centers are supplemented by approximately 100 company-authorized third party service centers. Service centers typically provide maintenance, repairs, overhaul, refurbishment and product upgrade services.

Management continually evaluates our facilities to ensure they are adequate to meet current business needs. Adjustments are made to the various holdings as business conditions change.

 

Item 3. Legal Proceedings

We are from time to time subject to, and are presently involved in, litigation or other legal proceedings arising in the ordinary course of business. We are a defendant in a number of product liability lawsuits with respect to accidents involving our aircraft that allege personal injury and property damage and seek substantial recoveries, including, in some cases, punitive and exemplary damages. We maintain partial insurance coverage against such claims at a level determined by management to be prudent (see Note 19 to the Consolidated Financial Statements). In addition, Raytheon retained all product liability claims arising from incidents occurring after April 1, 2001 until closing the Acquisition on March 25, 2007. We cannot predict the outcome of these matters or whether Raytheon will uphold its indemnity obligations. We are at risk of losses and adverse publicity stemming from any accident involving aircraft for which we hold design authority. The outcome of litigation in which we have been named as a defendant is unpredictable and an adverse decision in any such matter could have a material adverse effect on our financial condition, results of operations or liquidity.

Similar to other companies in our industry, we receive requests for information from government agencies in connection with their regulatory or investigational authority in the ordinary course of business. Such requests can include subpoenas or demand letters for documents to assist the government in audits or investigations. We review such requests and notices and take appropriate action.

Qui Tam Matter

In April 2009, HBAC received a complaint naming it as a defendant in a qui tam lawsuit in the U.S. District Court for the District of Kansas. The complaint alleged violations of the civil False Claims Act (“FCA”) arising from alleged supplier non-conformance with specifications and HBAC’s alleged inadequate quality control over the supplier’s manufacturing process on certain T-6 and King Air aircraft delivered to the government. The lawsuit, United States ex rel. Minge, et al. v. Turbine Engine Components Technologies Corporation, et al., No. 07-1212-MLB (D. Kan.), alleged FCA causes of action against HBAC (and its predecessor, Raytheon Aircraft Company) and FCA causes of action, retaliation causes of action, and a tort cause of action against TECT Aerospace Wellington, Inc. (“TECT”), an HBAC supplier, and various affiliates of TECT. On February 3, 2010, the District of Kansas court granted HBAC’s motion for summary judgment in the qui tam case. The Court permitted the FCA retaliation cause of action to proceed against TECT. On June 1, 2010, the plaintiffs filed a motion to reconsider the order granting summary judgment and a motion to amend the complaint. On August 2, 2010, the Court denied plaintiffs’ motion to reconsider the order but granted plaintiffs’ leave to file an amended complaint. On September 29, 2010, HBAC filed an Answer and

 

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Affirmative Defenses. Per the Third Scheduling Order (dated November 10, 2011) and an April 3, 2012 Order denying plaintiffs’ motion to extend the fact discovery deadline, fact discovery on the limited issues before the Court concluded on March 1, 2012. The Court has suspended the deadlines for expert disclosures and dispositive motions and will re-set those deadlines at a hearing to be held following the Court’s issuance of rulings on a number of pending discovery motions. No accruals have been recorded for this matter as of December 31, 2011.

Airbus Arbitration

On March 29, 2012, HBAC filed a Request for Arbitration with the International Court of Arbitration of the International Chamber of Commerce (“ICC”) in Paris, initiating proceedings against Airbus Operations Limited (“Airbus”). HBAC alleges that Airbus breached the Airframe Purchase and Support Agreement, dated August 19, 1998 between Airbus and HBAC. Airbus’s Answer and nomination of a co-arbitrator are due within 30 days from the receipt of the Request for Arbitration from the ICC.

Bid Protest

On October 29, 2010, the Air Force issued a solicitation for light air support aircraft (the “Solicitation”). Only two offerors submitted proposals in response to this Solicitation – Hawker Beechcraft Defense Company (“HBDC”) and the Sierra Nevada Corporation. HBDC proposed the AT-6C, a derivative of HBDC’s trainer aircraft (the “T-6”) widely used by the Air Force. After months of discussion, the Air Force excluded HBDC from the competitive range and, on December 22, 2011, awarded the contract to the Sierra Nevada Corporation.

On December 27, 2011, HBDC filed a bid protest action in the Court of Federal Claims, seeking a declaratory judgment and a permanent injunction requiring the Air Force to (i) set aside the award to the Sierra Nevada Corporation, (ii) reinstate HBDC to the competitive range under the procurement, (iii) conduct meaningful discussions with HBDC, (iv) request new final proposal revisions, and (v) reevaluate the proposals in accordance with the terms of the Solicitation.

On February 14, 2012, HBDC filed a Motion for Judgment on the Administrative Record and, in response, on February 28, 2012, the Air Force filed a Notice of Corrective Action stating that the Air Force intended to take corrective action with respect to the award at issue in the protest. The Air Force stated that it would (i) set aside the award to Sierra Nevada Corporation, (ii) reinstate HBDC to the competitive range under the procurement, (iii) accept new proposals from the parties, based upon the existing solicitation in its original form, or as amended, (iv) conduct meaningful discussions with the parties, and (v) reevaluate proposals in accordance with the terms of the Solicitation. The Air Force also reserved the right to conduct a whole new competition.

Based on its corrective action, the Air Force, on March 5, 2012, filed a motion to dismiss the protest on mootness grounds. That motion is currently pending before the Court of Federal Claims.

 

Item 4. Mine Safety Disclosures

Not applicable.

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

All of the issued and outstanding capital stock of HBNC is owned by HBAC, and all of the limited liability company interests of HBAC are owned by HBI. Accordingly, there is no established public trading market for HBAC’s equity securities.

 

Item 6. Selected Financial Data

The following table presents selected historical financial information and other data. For the years ended December 31, 2011, 2010, 2009 and 2008 and the nine months ended December 31, 2007, the financial information and other data is for HBAC (the “Successor”) and is derived from our audited consolidated financial statements included elsewhere in this and our prior Annual Reports on Form 10-K. The financial information and other data for the three months ended March 25, 2007, is for Raytheon Aircraft (the “Predecessor”) and is derived from the audited consolidated financial statements and accompanying notes thereto of the Predecessor and included in our prior Annual Reports on Form 10-K. The following information should be read in conjunction with the consolidated financial statements and related notes, as well as Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K.

 

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     Successor         Predecessor  
     Year Ended December 31,     Nine Months
Ended
December 31,
        Three Months
Ended
March 25,
 
(In millions)    2011     2010     2009     2008     2007         2007  

Statements of Operations Data:

              

Net sales

   $ 2,435.1      $ 2,804.7      $ 3,198.5      $ 3,546.5      $ 2,793.4        $ 670.8   

Long-lived asset impairment

     226.6        12.6        74.5        —          —            —     

Goodwill and indefinite-lived intangible asset impairment

     66.0        13.0        448.3        —          —            —     

Operating (loss) income

     (481.8     (173.9     (712.0     140.3        148.3        $ 31.4   

Net (loss) income attributable to parent company

   $ (632.8   $ (304.9   $ (451.6   $ (158.6   $ 0.1        $ 10.0   
 
Statements of Financial Position Data:    Successor         Predecessor  
     As of December 31,     Nine Months
Ended
December 31,
        Three Months
Ended
March 25,
 
(In millions)    2011     2010     2009     2008     2007         2007  

Cash and cash equivalents

   $ 248.9      $ 422.8      $ 568.8      $ 377.6      $ 569.5       

Working capital(a)

     225.9        327.7        375.8        553.9        326.1       

Total assets

     2,778.3        3,211.8        3,747.8        4,687.6        4,675.2       

Total debt(b)

     2,334.1        2,129.7        2,364.2        2,490.8        2,446.9       
 

Other Data:

              

Aircraft deliveries

     291        318        418        477        367          88   

Backlog

   $ 1,130.7      $ 1,407.8      $ 3,359.2      $ 7,606.6      $ 6,290.8       

Capital expenditures

   $ 54.1      $ 41.7      $ 54.5      $ 74.9      $ 66.4        $ 27.3   

 

(a) Working capital is defined as current assets (excluding cash and cash equivalents) less current liabilities (excluding current portion of long-term debt). Certain balances in prior periods have been conformed to the current presentation.
(b) Total debt as of December 31, 2011, includes $1,397.6 million in outstanding principal on our Senior Secured Credit Facilities net of unamortized original issue discount, $630.6 million of outstanding Notes and $305.9 million of short-term notes payable and outstanding borrowings under our Revolving Credit Facility.

 

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

The following discussion and analysis of financial condition and results of operations for the years ended December 31, 2011, 2010 and 2009 reflects the business of HBAC.

The following discussion and analysis should be read in conjunction with the consolidated financial statements and accompanying notes thereto included elsewhere in this Annual Report on Form 10-K. In addition, this discussion may contain forward-looking statements, which are subject to risks and uncertainties. See “Forward-Looking Statements” for more information about these risks and uncertainties.

Business Overview

We are a leading designer and manufacturer of business jet, turboprop and piston aircraft. We are also the sole source provider of the primary military trainer aircraft to the U.S. Air Force and the U.S. Navy and provide military trainer aircraft to other governments. We deliver our products to a diverse customer base, including corporations, fractional and charter operators, governments and individuals throughout the world. We provide parts, maintenance and flight support services through an extensive network of more than 100 company-owned and company-authorized service centers in over 30 countries to an estimated installed fleet of more than 34,000 aircraft.

Our consolidated financial statements have been prepared on a going concern basis of accounting which contemplates continuity of operations, realization of assets, liabilities and commitments in the normal course of business. There are substantial doubts that we will be able to continue as a going concern and, therefore, may be unable to realize our assets and discharge our liabilities in the normal course of business. The financial statements do not reflect any adjustments relating to the recoverability and classification of recorded asset amounts or to the amounts and classification of liabilities that may be necessary should we be unable to continue as a going concern.

Our operations are divided into three segments: Business and General Aviation, Trainer/Attack Aircraft and Customer Support. The Business and General Aviation segment designs, develops, manufactures, markets and delivers commercial and specially-modified general aviation aircraft, as well as manufactures and provides aircraft parts to our Trainer/Attack Aircraft and Customer Support segments. The Business and General Aviation segment also sells used general aviation aircraft which may be received as a trade-in during a new aircraft sales transaction. The Trainer/Attack Aircraft segment designs, develops, manufactures, markets and sells military training aircraft and provides training and logistics support and aftermarket parts and services. We expect the U.S. government to continue to require product support for T-6 trainers through 2050. The Customer Support segment provides aftermarket parts and maintenance services as well as refurbishments and upgrade services for our installed fleet of aircraft worldwide.

We operate in the global business and general aviation industry, which continues to experience depressed demand primarily as a result of uncertainty in the global economy. The business and general aviation industry has historically been cyclical and has been impacted by many factors, including the condition of the U.S. and global economies, the exchange rate of the U.S. dollar compared to other currencies, corporate profits and geo-political events. Additionally, the business and general aviation industry has historically lagged behind changes in general economic conditions and corporate profit trends. We believe that the business and general aviation industry as a whole will continue to experience depressed demand during 2012.

Our Trainer/Attack Aircraft segment is less susceptible to changes in general economic conditions and provides us with a more stable and recurring source of revenue. Sales in this segment are principally generated by U.S. and foreign government defense spending. Decreases or reprioritization of such spending could materially affect the financial performance of this segment. As the JPATS program nears completion, we continue to pursue alternative customers for the T-6 family of aircraft, primarily in foreign markets. The expiration of the contract will likely cause the revenues within this segment to decrease and could cause them to be more unstable on a prospective basis.

Our Customer Support segment is also impacted by the general economic environment that has affected the business and general aviation industry. The impact on this segment of our business has not been as significant as the impact on our Business and General Aviation segment. In addition to general market conditions, our Customer Support business is influenced by the size and age of the installed fleet of aircraft, our customers’ aircraft usage patterns and the overall maintenance requirements for our aircraft.

Recent Developments

On October 29, 2010, the Air Force issued a solicitation for light air support aircraft (the “Solicitation”). Only two offerors submitted proposals in response to this Solicitation – HBDC and the Sierra Nevada Corporation. HBDC proposed the

 

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AT-6C, a derivative of HBDC’s trainer aircraft (the “T-6”) widely used by the Air Force. After months of discussion, the Air Force excluded HBDC from the competitive range and, on December 22, 2011, awarded the contract to the Sierra Nevada Corporation.

On December 27, 2011, HBDC filed a bid protest action in the Court of Federal Claims, seeking a declaratory judgment and a permanent injunction requiring the Air Force to (i) set aside the award to the Sierra Nevada Corporation, (ii) reinstate HBDC to the competitive range under the procurement, (iii) conduct meaningful discussions with HBDC, (iv) request new final proposal revisions, and (v) reevaluate the proposals in accordance with the terms of the Solicitation.

On February 14, 2012, HBDC filed a Motion for Judgment on the Administrative Record and, in response, on February 28, 2012 the Air Force filed a Notice of Corrective Action stating that the Air Force intended to take corrective action with respect to the award at issue in the protest. The Air Force stated that it would (i) set aside the award to Sierra Nevada Corporation, (ii) reinstate HBDC to the competitive range under the procurement, (iii) accept new proposals from the parties, based upon the existing solicitation in its original form, or as amended, (iv) conduct meaningful discussions with the parties, and (v) reevaluate proposals in accordance with the terms of the Solicitation. The Air Force also reserved the right to conduct a whole new competition. Based on its corrective action, the Air Force, on March 5, 2012, filed a motion to dismiss the protest on mootness grounds. That motion is currently pending before the Court of Federal Claims.

On March 15, 2012, we announced that we will not cease operations in our Plant I facility that we had previously announced would be closing.

On March 27, 2012, we entered into a forbearance agreement and a Third Amendment to the Credit Agreement (the “Third Amendment”) implementing a new $124.5 million senior tranche term loan (the “Senior Tranche Advance”), the proceeds of which will be used by us to fund our ongoing operations. Pursuant to the terms of the Third Amendment, we borrowed the full amount of the Senior Tranche Advance on March 27, 2012. The Senior Tranche Advance matures on June 29, 2012 and interest on such amount is payable, at our election, at the Credit Agreement’s base rate plus 11.00% or the Eurocurrency rate plus 12.00% (with the Eurocurrency rate subject to a 2.00% floor).

A portion of the Senior Tranche Advance equal to $16.0 million will be made available to us solely to cash collateralize letters of credit we may request be issued during the period prior to the maturity date of the Senior Tranche Advance.

The Senior Tranche Advance is secured by the assets of the Loan Parties (as defined in the Credit Agreement) and certain of our affiliates in accordance with the terms of, and subject to the priorities set forth in, the U.S. Pledge and Security Agreement and the Senior Aircraft Security Agreement. We agreed to cause certain additional subsidiaries to become obligated under the Credit Agreement and grant security interests in their assets to secure their obligations owed under the Credit Agreement.

As part of the Third Amendment, we agreed to operate in compliance with a net cash flow budget subject to variances, tested periodically.

In connection with entry into the Agreement, the Lenders agreed also to waive compliance with certain obligations under the Credit Agreement and to forbear from exercising remedies with respect to certain known or anticipated events. Lenders currently holding more than 70% of our outstanding indebtedness under the Credit Agreement (as amended) have agreed to defer, until June 29, 2012 (the “Forbearance Period”), our obligation to make certain interest payments on our senior secured revolving and term loans under the Credit Agreement when due and have granted us relief from certain existing loan covenants under the Credit Agreement during the Forbearance Period.

Also during the Forbearance Period, the Lenders agreed to standstill with respect to listed events that have occurred or may occur during the Forbearance Period, including our failure to satisfy the financial covenants set forth in the Credit Agreement as of December 31, 2011, obtain an audit for the fiscal year ended December 31, 2011 without a going concern modification and certain other events.

The Forbearance Period is subject to our continuing compliance with the terms of the Credit Agreement (as amended by the Third Amendment and subject to the waivers granted pursuant to the Third Amendment) and satisfaction of milestones including (i) delivery of a 2012 business plan on or prior to March 31, 2012 and (ii) delivery of a restructuring term sheet and financing term sheet on terms acceptable to the Lenders on or prior to April 30, 2012 (which date automatically extends to May 15, 2012 if holders of more than a majority of the 8.500% Senior Fixed Rate Notes due 2015 and the 8.875%/ 9.625% Senior PIK Election Notes due 2015 of HBAC and Hawker Beechcraft Notes Company have agreed to forbear from exercising remedies under the related indenture).

 

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As part of the Agreement, HBAC paid the Lenders a fee in the aggregate amount of 5.00% of the Senior Tranche Advance and the Agent a transaction fee in the amount of $450,000.

During March and April of 2012, we announced that we were beginning to furlough employees that work in various departments and on various aircraft including the Beechcraft King Air, Piston and Premier IA and the Hawker 4000 and 987 family. These furloughs were a result of difficulty in obtaining adequate composite materials in order to continue production as well as matching production to demand. The furloughs will be on a rolling basis and are expected to occur for one to two months. Each furlough will last thirty to forty-five days.

Results of Operations

 

     Year Ended December 31,  
(In millions)    2011     2010     2009  

Sales

   $ 2,435.1      $ 2,804.7      $ 3,198.5   

Cost of sales

     2,247.2        2,579.5        3,036.6   
  

 

 

   

 

 

   

 

 

 

Gross margin

     187.9        225.2        161.9   

Restructuring, net

     12.3        14.9        34.1   

Long-lived asset impairment

     226.6        12.6        74.5   

Goodwill and indefinite-lived intangible asset impairment

     66.0        13.0        448.3   

Selling, general and administrative expenses

     270.5        257.5        209.7   

Research and development expenses

     94.3        101.1        107.3   
  

 

 

   

 

 

   

 

 

 

Operating loss

     (481.8     (173.9     (712.0
  

 

 

   

 

 

   

 

 

 

Interest expense

     135.6        131.8        154.6   

Interest income

     (0.3     (0.1     (1.2

Gain on debt repurchase, net

     —          —          (352.1

Other income, net

     (1.7     (2.2     (1.3
  

 

 

   

 

 

   

 

 

 

Nonoperating expense (income), net

     133.6        129.5        (200.0
  

 

 

   

 

 

   

 

 

 

Loss before taxes

     (615.4     (303.4     (512.0

Provision for (benefit from) income taxes

     16.5        0.9        (60.7
  

 

 

   

 

 

   

 

 

 

Net loss

     (631.9     (304.3     (451.3

Net income attributable to noncontrolling interest

     0.9        0.6        0.3   
  

 

 

   

 

 

   

 

 

 

Net loss attributable to parent company

   $ (632.8   $ (304.9   $ (451.6
  

 

 

   

 

 

   

 

 

 

Sales

Sales decreased $369.6 million or 13.2% for the year ended December 31, 2011, when compared to the year ended December 31, 2010. The decrease was driven by lower aircraft deliveries in the Business and General Aviation and Trainer/Attack Aircraft segments due to decreased demand as well as supply disruptions. The decrease was partially offset by increased volume in the Customer Support segment.

Sales decreased by $393.8 million for the year ended December 31, 2010 as compared to the year ended December 31, 2009. The decrease was driven by lower aircraft deliveries in the Business and General Aviation segment, partially offset by increased volume in the Trainer/Attack Aircraft and Customer Support segments.

 

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The following table summarizes our sales by segment which are described subsequently:

 

     Year Ended December 31,  
(In millions)    2011     2010     2009  

Sales:

      

Business and General Aviation

   $ 1,359.5      $ 1,735.0      $ 2,310.6   

Trainer/Attack Aircraft

     649.4        681.1        531.3   

Customer Support

     562.2        544.6        438.3   

Eliminations

     (136.0     (156.0     (81.7
  

 

 

   

 

 

   

 

 

 

Total

   $ 2,435.1      $ 2,804.7      $ 3,198.5   
  

 

 

   

 

 

   

 

 

 

Business and General Aviation

Sales decreased by $375.5 million or 21.6% for the year ended December 31, 2011, when compared to the year ended December 31, 2010. The decrease was largely attributable to lower commercial aircraft deliveries and sales prices as a result of depressed demand across the general aviation market and supply disruptions. The Hawker 4000 had a software related supply disruption which was resolved during the third quarter. The Hawker 4000 was not certified by the European Aviation Safety Agency (“EASA”) until December of 2011 which prevented sales of the aircraft to European customers during the current year. These two factors had an impact on the deliveries of that aircraft during the year. The King Air product line also had decreased sales in the current year as a result of supply disruptions which were generally resolved during the fourth quarter of 2011. Additionally, we experienced reduced deliveries related to the Hawker 400XP as a result of our announced production suspension of this aircraft until such time when market demand improves. The lower aggregate sales price in the current year is in part the result of the sale of fewer Hawker jets which was due to decreased product demand and supply disruptions.

Sales for the year ended December 31, 2010 decreased by $575.6 million as compared to the year ended December 31, 2009. The decrease was largely attributable to lower commercial aircraft deliveries as a result of depressed demand across the general aviation market and lower special mission aircraft deliveries. The year ended December 31, 2009 included sales of 29 units of special mission King Air aircraft to the U.S. government under Project Liberty Phase I that were not repeated in 2010.

The following table summarizes our Business and General Aviation new aircraft deliveries:

 

     Year Ended December 31,  
     2011      2010      2009  

Hawker 4000

     10         16         20   

Hawker 900XP

     22         28         35   

Hawker 800XP/850XP

     1         1         3   

Hawker 750

     7         5         13   

Hawker 400XP

     1         12         11   

Premier

     11         11         16   

King Air

     107         114         155   

Pistons

     54         51         56   
  

 

 

    

 

 

    

 

 

 

Total

     213         238         309   
  

 

 

    

 

 

    

 

 

 

Trainer/Attack Aircraft

Sales decreased by $31.7 million or 4.7% for the year ended December 31, 2011, when compared to the year ended December 31, 2010. During the year ended December 31, 2011, the Trainer/Attack Aircraft segment delivered 78 T-6 aircraft compared to 80 in the comparable period of 2010. Revenue is recognized on nearly all contracts in the Trainer/Attack Aircraft segment using a percentage-of-completion method to measure progress towards completion. Percentage of completion volume has declined with decreases in production along with total sales leading to the decreased sales during the year. This was partially offset by revenues derived other than from the sale of aircraft.

Sales for the year ended December 31, 2010 increased by $149.8 million as compared to the year ended December 31, 2009 due to higher volume on both the JPATS contract as well as international trainer contracts awarded in late 2009. A significant portion of the higher volume related to the Ground Based Training Systems and Contractor Logistics Support elements of the JPATS and international contracts. During the year ended December 31, 2010, the Trainer/Attack Aircraft segment delivered 80

 

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T-6 aircraft compared to 109 in the comparable period of 2009. The year ended December 31, 2009 included 36 units that were built in 2008 but were not delivered until 2009 due to a delivery suspension related to quality issues with a supplier’s component.

Customer Support

Sales increased by $17.6 million or 3.2% for the year ended December 31, 2011, when compared to the year ended December 31, 2010. The increase was primarily driven by the continued strength of strategic pricing and market capture initiatives that were put in place in prior years. In addition, this marketplace continues to expand, leading to increases in demand for our products and services. The increase was partially offset by a loss of revenue as a result of temporary business disruptions. Customer Support segment sales are principally comprised of the sale of spare parts and maintenance services to existing aircraft operators.

Sales for the year ended December 31, 2010 increased by $106.3 million as compared to the year ended December 31, 2009. The increase was primarily driven by the improved effectiveness of our strategic pricing and market capture initiatives across our parts and maintenance service business as well as general market strength.

Cost of Sales

Cost of sales decreased $332.3 million or 12.9% for the year ended December 31, 2011, when compared to the year ended December 31, 2010. The decrease was driven by lower aircraft deliveries in the Business and General Aviation and Trainer/Attack Aircraft segments due to decreased demand as well as supply disruptions. In addition, inventory impairments in the current year contributed to the decrease. The decrease was partially offset by increased volume in the Customer Support segment.

Cost of sales decreased by $457.1 million or 15.1% for the year ended December 31, 2010 as compared to the year ended December 31, 2009. The decrease was driven by lower aircraft deliveries in the Business and General Aviation segment, partially offset by increased volume in the Trainer/Attack Aircraft and Customer Support segments.

Business and General Aviation

Cost of sales decreased by $316.6 million or 17.6% for the year ended December 31, 2011, when compared to the year ended December 31, 2010. The decrease was largely attributable to lower commercial aircraft deliveries, inventory impairments, and increased spending on expenditures related to factory operations cost-reduction initiatives. The inventory impairments in this segment of $32.9 million were the result of an evaluation of the usefulness of the inventory. There was an increase in spending on expenditures related to factory operations cost-reduction initiatives when compared to the prior year of $20.8 million. The remainder of the difference was due to lower aircraft deliveries and product mix.

Cost of sales for the year ended December 31, 2010 decreased by $575.0 million as compared to the year ended December 31, 2009. The decrease was largely attributable to lower commercial aircraft deliveries as a result of depressed demand across the general aviation market and lower special mission aircraft deliveries. The year ended December 31, 2009 included sales of 29 units of special mission King Air aircraft to the U.S. government under Project Liberty Phase I that were not repeated in 2010.

Trainer/Attack Aircraft

Cost of sales decreased by $42.7 million or 8.0% for the year ended December 31, 2011, when compared to the year ended December 31, 2010. During the year ended December 31, 2011, the Trainer/Attack Aircraft segment delivered 78 T-6 aircraft compared to 80 in the comparable period of 2010. Percentage of completion volume has declined with line rate adjustments along with total sales leading to the decreased cost of sales during the year.

Cost of sales for the year ended December 31, 2010 increased by $98.0 million as compared to the year ended December 31, 2009 due to higher volume on both the JPATS contract as well as international trainer contracts awarded in late 2009. A significant portion of the higher volume related to the Ground Based Training Systems and Contractor Logistics Support elements of the JPATS and international contracts. During the year ended December 31, 2010, the Trainer/Attack Aircraft segment delivered 80 T-6 aircraft compared to 109 in the comparable period of 2009. The year ended December 31, 2009 included 36 units that were built in 2008 but were not delivered until 2009 due to a delivery suspension related to quality issues with a supplier’s component.

Customer Support

Cost of sales increased by $27.0 million or 6.7% for the year ended December 31, 2011, when compared to the year ended December 31, 2010. The increase was primarily the result of higher sales during the year ended December 31, 2011.

 

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Cost of sales for the year ended December 31, 2010 increased by $19.9 million as compared to the year ended December 31, 2009. The increase was primarily the result of higher sales during the year ended December 31, 2010. The gross margin improved as the Company began to adjust its pricing upwards on its parts business.

Restructuring

We recorded pre-tax charges of $12.3 million related to restructuring during the year ended December 31, 2011 as compared to $14.9 million and $34.1 million for the years ended December 31, 2010 and 2009. We continued restructuring actions that were announced during previous years as well as initiated new activities. These actions were undertaken as part of our on-going cost reduction initiatives and in response to lower aircraft production rates that resulted from depressed demand in the general aviation industry.

See additional disclosure of our restructuring activity in Note 8 to our Consolidated Financial Statements. 

Long-lived Asset Impairment

Long-lived asset impairments were $226.6 million in the current year as compared to $12.6 million and $74.5 million for the years ended December 31, 2010 and 2009. The 2011 impairments were recorded to reduce the value of the Hawker business jet technology and tooling related to the Hawker business jet family. The impairment was caused by a decrease in the expected cash flows from the underlying Hawker business jet products as a result of the depressed business and general aviation market and resulting reduced production volumes and downward pricing pressure.

The tests were performed during the fourth quarter due to poor operating performance during the quarter, decreases in future projections, and decisions by the Company to slow-down or cease production of certain aircraft during the quarter. These items, when taken together, caused management to determine that impairment testing was required during the fourth quarter.

Goodwill and Indefinite-lived Asset Impairment

Goodwill impairments were $66.0 million in the current year as compared to $13.0 million and $443.8 million for the years ended December 31, 2010 and 2009. The primary cause of the goodwill impairment was the overall decline in the market value of the Trainer/Attack segment as a result of the adverse global economic conditions, uncertainty surrounding the Light Air Support (LAS) contract, and expected decreased production as a result of the JPATS contract nearing its conclusion.

Selling, General and Administrative Expense

Selling, general and administrative expense totaled $270.5 million, or 11.1% of sales, for the year ended December 31, 2011, as compared to $257.5 million, or 9.2% of sales, for the year ended December 31, 2010. This was primarily due to an increase of selling expenses of $18.8 million associated with our expanded focus on international sales combined with an increase in our information technology expenses of $14.8 million related to the implementation of an upgraded enterprise resource planning application. This was offset by a decrease of $19.3 million associated with consulting and other services related to factory operations cost reduction activities as well as a decrease in personnel costs related to benefits and performance pay of $3.3 million.

Selling, general and administrative expense totaled $257.5 million, or 9.2% of sales, for the year ended December 31, 2010 as compared to $209.7 million, or 6.6% of sales, for the year ended December 31, 2009. This increase was primarily due to higher selling expenses of $33.7 million associated with our increased focus on international sales and higher costs associated with consulting and other services related to factory operations cost reduction activities of $13.4 million.

Research and Development Expense

Research and development expense was $94.3 million for the year ended December 31, 2011, as compared to $101.1 million for the year ended December 31, 2010. Although we continue to invest in development activities in the Business and General Aviation segment our expenditures in that segment were lower in 2011 as compared to 2010 as we continue in our efforts to time new product introduction with anticipated market demand. This decrease was partially offset by an increase in research and development costs in the Trainer/Attack segment as a result of increased spending on the AT-6 aircraft.

Research and development expense was $101.1 million for the year ended December 31, 2010 as compared to $107.3 million for the year ended December 31, 2009, a decrease of $6.2 million. Although we continued to invest in development activities in the Business and General Aviation segment, our expenditures in that segment were lower in 2010 as compared to

 

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2009, as we attempted to time new product introduction with anticipated market demand.

Operating Loss

Operating loss increased $307.9 million or 177.1% for the year ended December 31, 2011, when compared to the year ended December 31, 2010. The increase in the loss was primarily the result of asset impairment charges of $292.6 million in the current year as compared to asset impairment charges of $25.6 million recorded during the year ended December 31, 2010. $226.6 million of the charges were related to the BG&A segment as a result of a decrease in the expected cash flows from Hawker jet products as a result of the depressed business and general aviation market and resulting reduced production volumes and downward pricing pressure. In addition, there was an impairment of $66.0 million in the Trainer/Attack Aircraft segment related to decreased cash flows as a result of an anticipated decrease in sales. The remainder of the decrease was due to the lower sales in the current year discussed previously.

Operating loss decreased $538.1 million or 75% for the year ended December 31, 2010, when compared to the year ended December 31, 2009. Improved operating performance was primarily due to charges of $25.6 million related to asset impairments recorded during the year ended December 31, 2010 as compared to charges of $522.8 million that had been recorded during the year ended December 31, 2009. A majority of the charges in 2009 were recorded in the Business and General Aviation segment. The decrease in aircraft delivery volume in the Business and General Aviation segment during the year ended December 31, 2010 as compared to the year ended December 31, 2009, partially offset the improvement in operating income.

The following table summarizes our Operating (Loss) Income by business segment; which are described in more detail below:

 

     Year Ended December 31,  
(In millions)    2011     2010     2009  

Operating (Loss) Income:

      

Business and General Aviation

   $ (602.0   $ (367.0   $ (801.7

Trainer/Attack Aircraft

     25.3        95.7        45.5   

Customer Support

     95.3        97.5        44.1   

Eliminations

     (0.4     (0.1     0.1   
  

 

 

   

 

 

   

 

 

 

Total

   $ (481.8   $ (173.9   $ (712.0
  

 

 

   

 

 

   

 

 

 

Business and General Aviation

Operating loss increased $235.0 million or 64.0% for the year ended December 31, 2011, when compared to the year ended December 31, 2010. The increase in the loss was primarily driven by the impairments recorded in the current year of $226.6 million as compared to impairments of $25.6 million in the prior year. In addition, there were $32.9 million of inventory impairments in this segment as a result of an evaluation of the usefulness of the inventory.

The operating loss was $367.0 million for the year ended December 31, 2010 as compared to an operating loss of $801.7 million for the year ended December 31, 2009. The improvement of $434.7 million primarily resulted from lower impairment and loss-making aircraft charges, which were partially offset by decreases in sales volume, higher selling expenses associated with our expansion of our international sales force, and consulting and other expenditures related to factory operations cost-reduction initiatives.

During 2010, we recorded a charge of $13.0 million to reflect impairments of indefinite-lived assets and a charge of $12.6 million for long-lived asset impairments. In the third quarter of 2009, we recorded charges of $340.1 million to reduce the carrying value of the Business and General Aviation segment goodwill to $0, $181.2 million to impair other intangible assets and $60.2 million to impair tangible assets and inventories.

We recorded charges to reserves for loss-making aircraft of $89.4 million during 2010 and $137.1 million during 2009, a majority of which was related to the Hawker 4000. Operating income was impacted significantly by the mix of aircraft delivered during each year. Of particular significance were the Project Liberty Phase I aircraft deliveries in 2009 that were not repeated in 2010.

Trainer/Attack Aircraft

Operating income decreased $70.4 million or 73.6% for the year ended December 31, 2011, when compared to the year

 

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ended December 31, 2010. The primary cause of this decrease was the $66.0 million impairment to the Trainer/Attack segment goodwill that is discussed above. The remainder of the decrease is largely due to increased research and development spend when compared to the prior year as a result of the investments in the AT-6 platform.

Operating income increased by $50.2 million for the year ended December 31, 2010 as compared to the year ended December 31, 2009 due primarily to the increased volumes discussed previously as well as improved estimated contract profitability during the current year resulting from lower than expected contract service costs. The use of a percentage-of-completion method of revenue recognition causes gross margin to be recognized based on management’s estimate of total contract revenue and total contract cost at completion. As estimates were updated, any impact on revenue and gross margin as a result of the change in estimate was reflected in current earnings on a cumulative catch-up basis. Favorable cumulative catch-up adjustments of $25.3 million were recorded during the year ended December 31, 2010 as compared to $6.0 million during the year ended December 31, 2009. In addition, the year ended December 31, 2009 included amortization expense of $3.1 million related to intangible assets arising with the Acquisition. The underlying assets became fully amortized at March 29, 2009; therefore, there was not a similar expense during the year ended December 31, 2010.

Customer Support

Operating income decreased by $2.2 million or 2.3% for the year ended December 31, 2011, when compared to the year ended December 31, 2010. This decrease is primarily the result of a temporary disruption in our business related to the implementation of our computer system upgrade.

Operating income increased by $53.4 million for the year ended December 31, 2010 as compared to the year ended December 31, 2009 due primarily to an inventory impairment charge of $31.5 million recorded in 2009 that did not recur in 2010. The remaining increase was primarily driven by the improved effectiveness of our strategic pricing and market capture initiatives across our parts and maintenance service business and our cost productivity initiatives.

Nonoperating Income/Expense, net

For the year ended December 31, 2011, net nonoperating expense was $133.6 million, primarily related to interest expense, versus net nonoperating expense of $129.5 million for the year ended December 31, 2010, an increase of $4.1 million in expense. The primary reason for the increase in the nonoperating expense versus the year ended December 31, 2010 was an increase in interest expense due to the Company’s borrowing on its Revolving Credit Facility.

Net nonoperating expense was $129.5 million for the year ended December 31, 2010, primarily related to interest expense, versus net nonoperating income of $200.0 million for the year ended December 31, 2009. This net expense increase of $329.5 million was primarily the result of the nonrecurring gain of the $352.1 million we recorded in 2009 in connection with the purchase of our own debt securities. Partially offsetting this increase was a $22.8 million decrease in interest expense for the year ended December 31, 2010 as compared to the year ended December 31, 2009.

Provision for Income Taxes

The effective tax rate was negative 2.7% and negative 0.3% for the years ended December 31, 2011 and December 31, 2010. The primary difference between the effective tax rate and statutory tax rate in the jurisdictions in which we operate is a result of the valuation allowance against our net deferred tax assets.

Liquidity and Capital Resources

Our liquidity requirements are significant, primarily due to debt service obligations. We will rely on the Senior Tranche Advance to fund our ongoing operations while we continue to work with our lenders towards a comprehensive recapitalization plan. Our ability to make payments on and to refinance our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive, legislative, regulatory and other factors that are largely beyond our control. If we are not able to refinance our indebtedness or reach a restructuring agreement with our lenders, we may need to seek protection under chapter 11 of the U.S. Bankruptcy Code.

Our principal sources of liquidity have consisted of cash generated by operations and borrowings available under our Revolving Credit Facility. On March 27, 2012, pursuant to the Third Amendment, we borrowed the Senior Tranche Advance to fund ongoing operations while we continue to work with our lenders towards a comprehensive recapitalization plan. As discussed previously, we entered in to a forbearance arrangement in connection with the Third Amendment with certain of our lenders. The forbearance period will expire on June 29, 2012. Our ability to make payments on and to refinance our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future, which is subject to general economic,

 

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financial, competitive, legislative, regulatory and other factors that are largely beyond our control. Our business operations required the use of substantial cash in 2011. During 2010 and 2011, we undertook several actions in order to reduce our cash needs and liquidity risks; however, we continue to have significant cash requirements and risks as a result of our continuing operations.

As of December 31, 2011, we had $248.9 million of cash and cash equivalents. We utilized $239.0 million and had issued $1.0 million in letters of credit of our $240.3 million capacity under our Revolving Credit Facility in order to maintain a prudent amount of cash on hand. We continue to evaluate our short-term and long-term balance sheet management plans. We have hired a variety of professional advisers to assist us on many different projects, including seeking to refinance our indebtedness and develop a comprehensive recapitalization plan.

We have taken, and continue to take, various actions to preserve our liquidity and cash position, including reduced production levels to better meet expected demand; use of furloughs and work force reductions consistent with the lower production levels; and other cost reduction efforts including sharply reduced discretionary spending and deferrals of certain product development activity. Our ability to pay principal and interest on our debt, fund working capital and make capital expenditures depends on our future performance and our ability to successfully restructure our balance sheet.

All outstanding debt was reclassified to short-term liabilities as of December 31, 2011. This reclassification was necessary due to our violation of our debt covenants on our outstanding borrowings as of December 31, 2011 and consideration of our forbearance agreement period expires on June 29, 2012.

Due to the fact that we have recurring negative cash flows from operations and recurring losses from operations, we will need to seek additional financing. As a result, there is substantial doubt that we will be able to obtain additional equity or debt financing on favorable terms, or at all, in order to have sufficient liquidity to meet our cash requirements for the next twelve months.

Cash Flow Analysis

The following table summarizes our sources and uses of funds:

 

     Year Ended December 31,  
(In millions)    2011     2010     2009  

Net cash (used in) provided by operating activities

   $ (163.8   $ 297.8      $ 177.1   

Net cash (used in) investing activities

     (53.7     (35.2     (53.3

Net cash provided by (used in) financing activities

     43.6        (408.6     67.4   
  

 

 

   

 

 

   

 

 

 

Net decrease in cash and cash equivalents

   $ (173.9   $ (146.0   $ 191.2   
  

 

 

   

 

 

   

 

 

 

Operating Activities

Net cash used in operating activities during 2011 was $163.8 million. The decrease when compared to prior years was primarily the result of lower sales and overall operating performance during 2011. In addition, there was a decrease in advanced payments outstanding at December 31, 2011 along with an increase in inventory which contributed to the decrease in cash flow. This was partially offset by an increase in accounts payable.

Despite lower sales in 2010, our operating activities provided positive net cash performance primarily as a result of better management of our inventories, partially offset by a reduction in advanced payments from customers.

The positive net cash provided by operating activities during 2009 was a result of sharply reduced inventory levels reflecting an increase in Hawker 4000 deliveries, lower material receipts compared to aircraft deliveries, lower levels of used aircraft inventory on-hand and better overall inventory management. Partially offsetting the inventory improvement was the operating loss for the year as well as decreased accounts payable balances as amounts due vendors associated with higher activity in late 2008 were paid early in 2009. In addition, customer deposits were reduced as a result of the decline in new orders.

Investing Activities

Net cash used in investing activities during 2011 of $53.7 million related primarily to capital expenditures for property, plant and equipment (“PP&E”), a computer system upgrade and software. The PP&E increase was primarily related to the continued production of tooling in our Business and General Aviation segment and Trainer/Attack Aircraft segment.

 

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Net cash used in investing activities during 2010 related primarily to capital expenditures for tooling in our Business and General Aviation segment and the AT-6 program and associated tooling in our Trainer/Attack Aircraft segment.

Net cash used in investing activities during 2009 related primarily to capital expenditures for tooling in our Business and General Aviation segment and facilities improvements in our Customer Support segment.

Financing Activities

Net cash provided by financing activities during 2011 of $43.6 million represents the repayment of approximately $44.5 million on our long-term borrowings and payments of $150.9 million on notes used to finance engine purchases which were offset by additional borrowings on the Revolving Credit Facility of $239.0 million.

Net cash used in financing activities during 2010 represents the repayment of the previously outstanding $235.0 million on the Revolving Credit Facility as well as payments on notes payable used to finance certain aircraft engine purchases.

Net cash from financing activities during 2009 included $235.0 million in net borrowings from our Revolving Credit Facility as well as $188.0 million in net proceeds from the additional debt issuance in the fourth quarter of 2009. Offsetting these inflows was $136.7 million used to purchase our debt securities in the first half of 2009 and payments on notes payable used to finance engine purchases.

Capital Resources

The following table summarizes our capital structure as of the dates indicated:

 

     Year Ended December 31,  
(In millions)    2011     2010     2009  

Cash and cash equivalents

   $ 248.9      $ 422.8      $ 568.8   

Total debt

     2,334.1        2,129.7        2,364.2   

Net debt (total debt less cash and cash equivalents)

     2,085.2        1,706.9        1,795.4   

Total (deficit) equity

     (956.9     (214.4     118.3   

Total capitalization (debt plus equity)

     1,377.2        1,915.3        2,482.5   

Net capitalization (debt plus equity less cash and cash equivalents)

     1,128.3        1,492.5        1,913.7   

Debt to total capitalization

     169     111     95

Net debt to net capitalization

     185     114     94

Our total indebtedness at December 31, 2011 included $66.9 million of short-term obligations payable to a third party under a financing arrangement and $239.0 million drawn on our Revolving Credit Facility. We also had issued letters of credit totaling $51.2 million of the $75.0 million available under our synthetic letter of credit facility. Our Senior PIK-Election Notes permitted us to pay interest by increasing the principal amount thereunder (“PIK Interest”) rather than paying cash interest through April 1, 2011. On September 30, 2010, we notified our noteholders that we had elected to pay the April 2011 semi-annual interest payment on our Senior PIK-Election Notes in cash. As the PIK Interest option is no longer available, all subsequent interest payments are currently required to be paid in cash. On March 27, 2012, pursuant to the Third Amendment, we borrowed an additional $124.5 million under the Senior Tranche Advance. We determined not to pay our interest obligations under the Notes on April 2, 2012 and anticipate an inability to pay interest on the Notes on future interest payment dates.

Our pension plan assets, which are broadly diversified, were relatively flat when compared to the prior year, however, the liability continued to increase. As measured under U.S. GAAP, our pension benefit plans were $492.9 million underfunded at December 31, 2011 as compared to being $351.1 million underfunded at December 31, 2010. We recognize the funded status of our defined benefit pension and other postretirement benefits plans in our Consolidated Statements of Financial Position, with a corresponding after-tax adjustment to Accumulated other comprehensive loss. The 2011 annual remeasurement of our pension and other postretirement plans resulted in a net $137.6 million decrease in total equity, which was primarily driven by poor performance of the underlying investments. We currently estimate that required pension plan cash contributions will be $45.2 million in 2012. We also expect to contribute approximately $0.8 million for our unfunded other postretirement benefits plans in 2012. However, absent a recovery of pension plan asset values or higher interest rates, we will be required to make higher contributions in future years. See Note 14 to our Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for additional information about our pension and other postretirement benefits plans.

 

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Notes:

In connection with the Acquisition, we issued $1,100.0 million of Notes that included $400.0 million of 8.5% Senior Fixed Rate Notes due April 1, 2015, $400.0 million of 8.875%/9.625% Senior PIK-Election Notes due April 1, 2015 and $300.0 million of 9.75% Senior Subordinated Notes due April 1, 2017. In February 2008, we exchanged these Notes for new notes with identical terms, except that the new notes have been registered under the Securities Act and do not bear restrictions on transferability mandated by the Securities Act or certain penalties for failure to file a registration statement relating to the exchange.

The Notes are unsecured obligations and are guaranteed by certain current and future wholly-owned subsidiaries that guarantee our obligations under the Senior Secured Credit Facilities. Interest on the Senior Fixed Rate Notes accrues at the rate of 8.50% per annum and interest on the Senior Subordinated Notes accrues at the rate of 9.75% per annum. Cash interest on the Senior PIK-Election Notes accrues at the rate of 8.875% per annum and the PIK Interest accrues at the cash interest rate per annum plus 0.75%. Interest is payable in cash, except as discussed above with respect to our ability to elect to pay PIK Interest, rather than cash interest.

On June 2, 2009, we completed a cash tender offer to purchase a portion of our outstanding Senior Fixed Rate Notes, Senior PIK-Election Notes and Senior Subordinated Notes. The tender offer, along with open market purchases executed in the first quarter of 2009, resulted in an aggregate purchase of $496.6 million aggregate principal amount of our debt securities, allowing us to realize a net gain of $352.1 million.

Senior Secured Credit Facilities:

In March 2007, in connection with the Acquisition, we executed a $1,810.0 million Credit Agreement that included a $1,300.0 million Senior Secured Term Loan that was drawn at the close of the Acquisition, a $400.0 million secured Revolving Credit Facility that was reduced by the Second Amendment that is described subsequently, and a $110.0 million synthetic letter of credit facility (collectively the “Senior Secured Credit Facilities”). In March 2008, we reduced the synthetic letter of credit facility to $75.0 million based on our expected needs in the future. At December 31, 2011, we had issued letters of credit totaling $51.2 million under the synthetic facility.

On September 15, 2008, Lehman Brothers filed for bankruptcy. One of Lehman Brothers’ subsidiaries, Lehman Brothers Commercial Bank, had a $35.0 million commitment in our Revolving Credit Facility. We do not expect Lehman Brothers Commercial Bank to fulfill its funding obligations under our Revolving Credit Facility.

In December 2008, we amended the Credit Agreement to allow us to prepay, up to a maximum of $300.0 million, the Senior Secured Term Loan at a discount price to par to be determined pursuant to certain auction procedures.

On November 6, 2009, we further amended our Credit Agreement (the “Second Amendment”). The Second Amendment provides that compliance with the maximum consolidated secured debt ratio test under the Credit Agreement is waived. The continuing effectiveness of this waiver is subject to the condition that we shall not have made a restricted payment pursuant to certain available restricted payment baskets under the Credit Agreement. If this condition fails to be satisfied, then the waiver of the maximum consolidated secured debt ratio covenant will be revoked and we will be required to comply (and, if revoked, compliance with the consolidated secured debt ratio will be required for the two most recently completed fiscal quarters) with the maximum consolidated secured debt ratio test in the Credit Agreement.

The Second Amendment added a new minimum liquidity covenant which requires our unrestricted cash plus available commitments under our Revolving Credit Facility, determined in each case as of the last day of such fiscal quarter, to be at least $162.5 million.

In addition, the Second Amendment added a new Adjusted EBITDA covenant requiring that, to the extent the consolidated secured debt ratio covenant is waived as described above, for any fiscal quarter beginning with the second quarter of 2011 for which any revolving facility commitment is outstanding on the last day of such fiscal quarter, we maintain a minimum Adjusted EBITDA as specified in the Second Amendment. This Adjusted EBITDA covenant is now in effect.

The initial effectiveness of the Second Amendment was conditioned upon, among other items, the repayment of $125.0 million of our outstanding borrowings under the Revolving Credit Facility and the permanent reduction of facility commitments by $137.0 million (which included a $12.3 million portion of the $35.0 million originally committed by Lehman Brothers).

The remaining $22.7 million portion of Lehman Brothers’ revolving commitment is not considered available as they have been unable to honor this commitment as a result of their bankruptcy. As a result of the Second Amendment and the Lehman

 

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Brothers bankruptcy, the total reduction in available commitments was $159.7 million. Following these reductions, the capacity under the Revolving Credit Facility is now $240.3 million. At December 31, 2011, we had borrowings of $239.0 million and issued letters of credit of $1.0 million outstanding under the Revolving Credit Facility.

On November 25, 2009, we entered into an Incremental Facility Supplement Agreement. Pursuant to the terms of the agreement, we were provided $200.0 million of new term loans (the “Incremental Secured Term Loans”) under the incremental facilities provisions of the Credit Agreement. We paid a fee to the lenders on closing, in the form of an Original Issue Discount, equal to 6.0% of the agreement principal amount of the Incremental Secured Term Loans.

The Incremental Secured Term Loans have a final maturity date of March 26, 2014 (the same as the existing Senior Secured Term Loans under the Credit Agreement) and will amortize in quarterly principal installments totaling 1% annually beginning with the quarter ended December 31, 2009. The interest rates applicable to the Incremental Secured Term Loans are equal to either a base rate or an adjusted Eurocurrency bank deposit rate plus, in each case, an applicable margin. For base rate loans, the applicable margin is 7.5% and for Eurocurrency loans, the applicable margin is 8.5%. The base rate has a floor of 3.0% and the Eurocurrency bank deposit rate has a floor of 2.0%. Voluntary prepayments of the Incremental Secured Term Loans are permitted, in whole or in part, at the U.S. Borrower’s option, without premium or penalty. Voluntary prepayments of the Incremental Secured Term Loans will be applied to remaining scheduled amortization installments in an order to be determined at our option. The terms of the Incremental Secured Term Loans are otherwise governed by and subject to the Credit Agreement. After fees and the original issue discount, net proceeds to us were $180.4 million with the proceeds to be used for general corporate purposes.

On March 27, 2012, we entered into the Third Amendment and borrowed the Senior Tranche Advance to fund our ongoing operations. Pursuant to the terms of the Third Amendment, we borrowed the full amount of the Senior Tranche Advance on March 27, 2012. The Senior Tranche Advance matures on June 29, 2012 and interest on such amount is payable, at our election, at the Credit Agreement’s base rate plus 11.00% or the Eurocurrency rate plus 12.00% (with the Eurocurrency rate subject to a 2.00% floor).

A portion of the Senior Tranche Advance equal to $16.0 million will be made available to us solely to cash collateralize letters of credit we may request be issued during the period prior to the maturity date of the Senior Tranche Advance.

The Senior Tranche Advance is secured by the assets of the Loan Parties (as defined in the Credit Agreement) and certain of our affiliates in accordance with the terms of, and subject to the priorities set forth in, the U.S. Pledge and Security Agreement and the Senior Aircraft Security Agreement. We agreed to cause certain additional subsidiaries to become obligated under the Credit Agreement and grant security interests in their assets to secure their obligations owed under the Credit Agreement.

As part of the Agreement, we agreed to operate in compliance with a net cash flow budget subject to variances, tested periodically.

Debt Covenants:

The indentures governing the Notes and the Credit Agreement governing our Senior Secured Credit Facilities include usual and customary covenants for notes and credits of this type. These covenants include, but are not limited to, limiting debt, investments, dividends, transactions with affiliates, liens, mergers, asset sales, and material changes in our business or our subsidiaries.

Our excess cash flow, as defined under the Credit Agreement, and our year-end consolidated secured debt ratio determines the annual amount of mandatory term loan prepayment due under our Credit Agreement, if any. The consolidated secured debt ratio is the ratio of our consolidated secured debt less cash on hand at the end of each period divided by a rolling 12-month calculation of our debt covenant defined EBITDA (“DC EBITDA”). DC EBITDA is calculated based on our net income adjusted for (i) interest, taxes, depreciation and amortization expense; (ii) nonrecurring transition costs as a result of the Acquisition; (iii) nonrecurring inventory step-up costs and other nonrecurring purchase accounting impacts; (iv) noncash compensation expense; (v) project start up, ramp up and launch costs including the development of new aircraft; (vi) management fees paid to our principal external shareholders; (vii) minority interest adjustments; and (viii) miscellaneous other adjustments. Based on our 2010 excess cash flow and the consolidated secured debt ratio, as defined under the Credit Agreement, we were required to make a mandatory term loan principal prepayment. We paid $44.5 million of principal in March 2011 that we elected to apply against our principal repayment schedules. This election eliminates required principal payments set forth in our repayment schedules until near maturity of these debt instruments. As discussed above, the Second Amendment provides that compliance with the maximum consolidated secured debt ratio covenant is waived under certain conditions and our new EBITDA covenant is in effect.

As of December 31, 2011, we were not in compliance with the covenants contained in the debt agreement. As discussed

 

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above, we entered into a forbearance agreement with our lenders in which they agreed to delay all potential remedies, including the ability to call the debt on demand, available to them until June 29, 2012.

Industrial Revenue Bonds:

One of our subsidiaries uses Industrial Revenue Bonds (“IRBs”) issued by Sedgwick County, Kansas to finance the purchase and/or development of certain real and personal property. Tax benefits associated with the IRBs include a provision for a 10-year ad valorem property tax abatement and retail sales tax exemption on the property financed with the proceeds of the IRBs. Sedgwick County holds legal title to the bond financed assets and leases them to us subject to an option to purchase for a nominal consideration, which we may exercise at any time.

At the time of the acquisition, Raytheon held IRBs with an aggregate principal amount of $454.2 million. Raytheon assigned its IRBs to us as part of the Acquisition, and, therefore, we are the bondholder as well as the borrower/lessee of the property purchased with IRBs proceeds. We record the property on our Consolidated Statements of Financial Position, along with a capital lease obligation to repay the proceeds of the IRBs. Moreover, as holder of the bonds, we have the right to offset the amounts due by our subsidiary with the amounts due to us; accordingly, no net debt associated with the IRBs is reflected in our Consolidated Statements of Financial Position. Upon maturity or redemption of the bonds, title to the leased property reverts to our subsidiary. At December 31, 2011 and 2010, we held IRBs with an aggregate principal amount of $230.6 million and $286.8 million.

Contractual Obligations

The following table summarizes known contractual obligations as of December 31, 2011, and estimates of when these obligations are expected to be satisfied:

 

(In millions)    Total      2012      2013      2014      2015      2016      Thereafter  

Long-term debt obligations

   $ 2,034.9       $ 2,034.9       $ —         $ —         $ —         $ —         $ —     

Interest on long-term debt

     108.8         108.8         —           —           —           —           —     

Operating lease obligations

     79.4         6.7         6.1         5.9         5.5         5.0         50.2   

Purchase obligations

     1,329.0         1,058.4         202.9         21.2         21.7         4.1         20.7   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,552.1       $ 3,208.8       $ 209.0       $ 27.1       $ 27.2       $ 9.1       $ 70.9   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The table above excludes $0.6 million of tax liabilities for uncertain tax positions for which we cannot reasonably estimate the timing of payment. The table above further excludes required pension and other postretirement contributions. We are required to make pension and other postretirement contributions of $46.1 million in 2012. Amounts beyond 2012 for required pension and other postretirement contributions depend upon actuarial assumptions, actual plan asset performance and other factors described under pension costs in Critical Accounting Estimates. However, based solely on our current assumptions, we anticipate our funding requirements to be approximately $82.0 and $68.0 million in 2013 and 2014 and remaining relatively stable thereafter.

All outstanding debt was presented as being due during 2012 in the table above. This presentation is consistent with our classification of all outstanding debt as short-term liabilities due to our violation of our debt covenants on our outstanding borrowings as of December 31, 2011. If the debt remains outstanding, interest payments of $108.6 million, $68.7 million, $24.7 million, $14.1 million would be due in 2013-2016, respectively and $3.5 million of interest payments would be due thereafter.

Purchase obligations in the table above represent agreements to purchase goods or services that are enforceable and legally binding on us and that specify all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the purchase. We enter into contracts with some customers, primarily the U.S. government, which entitle us to full recourse for costs incurred, including purchase obligations, in the event the contract is terminated by the customer for convenience. These purchase obligations are included above notwithstanding the amount for which we are entitled to full recourse from our customers.

Off-Balance Sheet Arrangements

We use customary off-balance sheet arrangements, such as operating leases and letters of credit, in the normal course of our business. We may, from time to time, instruct banks to issue letters of credit on our behalf to support cash deposits and to guarantee the performance of our contractual obligations. None of these arrangements has or is likely to have a material effect on

 

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our financial position or results of operations. See Note 19 to our Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for additional information about off-balance sheet arrangements.

Inflation

Since the primary elements of our operating costs are purchased components and raw materials, annual escalation in commodity and materials pricing could have a significant impact on our product cost. We have long-term agreements with many of our major suppliers to minimize potential price volatility. In some cases, our supply arrangements contain inflationary adjustment provisions based on accepted industry indices, and we typically include an inflation component in estimating our supply costs.

Critical Accounting Estimates

The preparation of our financial statements in accordance with U.S. GAAP requires us to make estimates, judgments and assumptions that affect our financial position 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 estimates used in implementing our accounting policies discussed below and the related risks are important in evaluating our financial position and results of operations. We believe the following accounting estimates used in the preparation of the consolidated financial statements are critical to our financial position and results of operations as they involve the significant use judgment on matters that are inherently uncertain. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. If actual results differ significantly from management’s estimates, there could be a material effect on our financial position, results of operations and cash flows.

Revenue Recognition

For the majority of our aircraft sales, revenue is recognized when title to an airworthy aircraft is transferred to the customer. Actual sales and cost values for the unit being delivered are used as the basis for recording revenue and its associated margin.

We use a percentage of completion method to measure progress towards completion for longer term contracts with substantial contract-specific development or engineering cost. The ratio of costs incurred-to-date compared to total estimated costs at the completion of the contract are used to derive the estimated revenues to record. Management must apply judgment to determine the estimated contract revenue and costs at completion. Total contract revenue estimates are based on negotiated contract prices and quantities. Estimated amounts for contract changes and claims are included in contract sales only when realization is estimated to be probable. Total contract cost projections require management to make numerous assumptions and estimates relating to items such as the complexity of design, availability and cost of materials, labor productivity and cost, overhead and capital costs and operational efficiency. Contract estimates are reviewed periodically to determine whether revisions to contract values or estimated costs at completion are necessary. The effects of changes in estimates resulting from any such revisions are reflected in the period the estimates are revised using a cumulative catch-up adjustment. Claims are included in revenue estimates only when it is probable that a reliably estimated increase in contract value will be realized. To the extent estimated total costs on a contract exceed the total estimate of revenue to be earned from the contract, the full value of the estimated loss is recorded in the period the loss is identified.

We recognize revenue on aircraft parts and services as the part is shipped or as the service is rendered.

Income Taxes

Deferred income tax assets and liabilities are recognized for future income tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is recorded to reduce deferred income tax assets to an amount that, in the opinion of management, will more likely than not be realized. During the fourth quarter of 2008, we recorded a valuation allowance against net deferred tax assets. This decision was based on our cumulative pre-tax losses and the need to generate significant amounts of taxable income in future periods in order to utilize existing deferred tax assets. The valuation allowance was $511.2 million at December 31, 2010. Our valuation allowance increased $294.5 million during the twelve months ending December 31, 2011 to $805.7 million. The increase in valuation allowance was a result of an increase in our U.S. deferred tax assets, primarily related to U.S. federal and state net operating losses.

We record an income tax expense or benefit based on the net income earned or net loss incurred in each tax jurisdiction and the tax rate applicable to that income or loss. In the ordinary course of business, there are transactions for which the ultimate tax

 

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outcome is uncertain. These uncertainties are accounted for in accordance with applicable literature. The final tax outcome of these matters may be different than the estimates originally made by management in determining the income tax provision. A change to these estimates could impact the effective tax rate and, subsequently, net income or net loss. The effect of changes in tax rates is recognized during the period in which the rate change occurs.

HBAC is included in the U.S. consolidated federal income tax return of HBI. Under the terms of an informal tax sharing agreement between HBAC and HBI, the amount of the cumulative tax liability of each member shall not exceed the total tax liability as computed on a separate return basis. Refer to Note 13 for additional information about our income taxes.

Pension Benefits

We have defined benefit pension and retirement plans covering the majority of our non-union employees hired prior to January 1, 2007 in addition to all of our union employees. Accounting standards require the cost of providing these pension plans be measured on an actuarial basis. These accounting standards will generally reduce, but not eliminate, the volatility of the reported pension obligation and related 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 on the future rate of return on pension plan assets.

The following table summarizes the net periodic benefit cost assumptions for our defined benefit pension plans:

 

     Year Ended December 31,  
     2011     2010     2009  

Discount rate

     5.40     6.00     6.25

Expected rate of return on plan assets

     8.00     8.00     8.00

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 this 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. Changes in the discount rate could have a material effect on our reported pension obligations and related pension expense.

The expected rate of return on plan assets 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, which is shown in the table below. Differences between the actual and expected rate of return on plan assets can impact our expense for pension benefits.

The following table summarizes our actual and target investment asset allocations:

 

     As of December 31,     Target  
     2011     2010     Allocation  

Equity securities

     48.4     50.7     50.0

Debt securities

     42.6     40.4     40.0

Other

     9.0     8.9     10.0
  

 

 

   

 

 

   

 

 

 
     100.0     100.0     100.0
  

 

 

   

 

 

   

 

 

 

Other variables that can impact the pension funded status and expense include demographic experience, such as the rates of salary increase, retirement, turnover and mortality. Assumptions for these variables are set based on actual and projected plan experience.

 

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Based on our assumptions, we expect 2012 pension expense to be approximately $45.3 million. The following table summarizes the estimated sensitivity of 2012 pension expense to changes in key assumptions:

 

    

Change in Assumption

Assumptions:

  

25 Basis Point Increase

  

25 Basis Point Decrease

Discount Rate

   $4.3 pension expense decrease    $4.4 pension expense increase

Expected rate of return on plan assets

   $1.9 pension expense decrease    $1.9 pension expense increase

At December 31, 2011 we had $389.6 million of deferred losses resulting primarily from differences between actual and assumed asset returns, changes in discount rates and differences between actual and assumed demographic experience. To the extent we continue to have fluctuations in these items, we will experience increases or decreases in our funded status and related accrued retiree benefit obligation.

Goodwill and Intangible Assets

Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired businesses. Intangible assets are recorded at cost or, when acquired as part of a business combination, at estimated fair value. Intangible assets with definite lives consist of certain trade names and trademarks, order backlog, customer relationships, technological knowledge and computer software and are amortized on a straight-line basis over their estimated useful life. The following table summarizes the weighted average amortization periods assigned to long-lived intangible assets:

 

     Estimated  
     Useful Life  

Technological knowledge

     15 years   

Customer relationships

     17 years   

Computer software

     8 years   

Order backlog

     3 years   

Trademarks and tradenames - definite lives

     10 years   

Goodwill and intangible assets with indefinite lives, which includes certain trademarks and trade names, are not amortized but are instead reviewed for impairment on an annual basis during the fourth quarter or upon the occurrence of events that may indicate possible impairment. We conduct our review for impairment on a reporting unit basis.

The assumptions, inputs and judgments used in performing the valuation analysis are inherently subjective and reflect estimates based on known facts and circumstances at the time we perform the valuation. These estimates and assumptions primarily include, but are not limited to, the discount rate; terminal growth rate; EBITDA and capital expenditures forecasts. The use of different assumptions, inputs and judgments, or changes in circumstances, could materially affect the results of the valuation. Due to the inherent uncertainty involved in making these estimates, actual results could differ from our estimates. The following is a description of the primary valuation methodologies used to derive the fair value of the reporting units:

 

   

Income Approach: We determine fair value by discounting the expected cash flows of the reporting units. We rely upon internally generated five-year forecasts for sales and operating profits, including capital expenditures, when estimating future cash flows, and an assumed long-term annual growth rate of cash flows for periods after the five-year forecast for both the Trainer/Attack and Customer Support segments. Discount rates are determined by weighting the required returns on interest-bearing debt and paid-in capital in proportion to their estimated percentages in an expected industry capital structure.

 

   

Market-Comparable Approach: We make use of market price data of stocks of companies engaged in the same or similar line of businesses as that of the reporting unit. Specifically, we calculated multiples of total enterprise value to EBITDA for comparable companies using data for the latest twelve months (“LTM”) ended September 2011, and for the 2012 projected year. In determining the concluded range of trailing and forward multiples, we compared the historical and expected performance of the comparable companies to those of the reporting units. The selected range of multiples were then multiplied by the LTM and projected 2012 EBITDA of these reporting units to determine fair value.

 

   

Market Transaction Approach: We assessed EBITDA multiples realized in actual purchase transactions of comparable companies. After we adjusted these multiples to account for the current economic climate, versus the period during

 

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which the transactions occurred, they were applied to the LTM EBITDA of the reporting units to determine fair value.

Equal weightings were assigned to the aforementioned model results to arrive at a final fair value estimate of the reporting unit.

The necessity for, and the amount of, any goodwill impairment is determined using a two-step process. The first step is to identify if a potential impairment is indicated by comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, the goodwill of the reporting unit is not considered to be impaired and the second step of the impairment test is not necessary. However, if the carrying amount of a reporting unit exceeds its fair value, the second step is performed for that reporting unit to determine if goodwill is impaired and to measure the amount of impairment loss that should be recognized, if any.

The second step, if necessary, compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that reporting unit’s goodwill. The process of determining such implied fair value of goodwill involves allocating the reporting unit’s fair value as determined in step one to all of the reporting unit’s assets and liabilities. If the implied fair value of goodwill exceeds the carrying amount, then goodwill is not considered impaired. However, if the carrying amount of goodwill exceeds the implied fair value, an impairment loss is recognized in an amount equal to that excess.

Impairments of indefinite-lived intangible assets are recognized when events or changes in circumstances indicate that the carrying amount of the asset, or related groups of assets, may not be recoverable, and our estimate of discounted cash flows over the assets’ remaining useful lives is less than the carrying value of the assets. The fair value of these intangibles is measured using the relief-from-royalty method. This method is used to estimate the cost savings that accrue to the owner of an intangible asset who would otherwise have to pay royalties or license fees on revenues earned through the use of the asset. The royalty rate based on an analysis of empirical, market-derived royalty rates for comparable companies and an analysis of the profitability of the underlying businesses utilizing the name and related marks. The market-derived royalty rate is then applied to estimate the royalty savings. The net after-tax royalty savings are discounted using the weighted average cost of capital of our Business and General Aviation segment. Any excess carrying value over the fair value represents the amount of impairment.

There were no impairments recognized on our indefinite-lived assets in the current year as the fair value exceeded the carrying value. The fair value of the tradenames exceeded the carrying value by approximately $75 million or 22% in the aggregate. This includes the Hawker tradename which had a fair value that exceeded the carrying value by approximately $9 million or 5%.

See additional disclosure of these analyses in Note 6 to our Consolidated Financial Statements including the impairment charges recorded during the years ended December 31, 2011, 2010 and 2009.

Impairment of Long-lived Assets

Management determines whether long-lived assets are to be held-for-use or held-for-disposal. Upon indication of possible impairment, management evaluates the recoverability of held-for-use long-lived assets by measuring the carrying amount of the assets against the related estimated undiscounted future cash flows. When an evaluation indicates that the future undiscounted cash flows are not sufficient to recover the carrying value of the asset, the asset is written down to its estimated fair value. In order for long-lived assets to be considered held-for-disposal, management must have committed to a plan to dispose of the assets. Once deemed held-for-disposal, the assets are stated at the lower of carrying amount or net realizable value.

See additional disclosure of these analyses in Notes 5 and 6 to our Consolidated Financial Statements including the impairment charges recorded during the years ended December 31, 2011, 2010 and 2009.

Product Warranty

Warranty provisions related to commercial aircraft and parts sales are determined based upon an estimate of costs that may be incurred for warranty services over the period of coverage from one to five years with limited additional coverage up to 10 years on the Hawker 4000. We estimate our warranty costs based on historical warranty claim experience. The warranty accrual is reviewed quarterly to verify that it appropriately reflects the estimated remaining obligation based on the anticipated expenditures over the balance of the obligation period. Adjustments are made when actual warranty claim experience causes management to revise its estimates. The effects of changes in estimates are reflected in the period the estimates are revised. Warranty provisions related to aircraft deliveries on contracts accounted for using a percentage-of-completion method to measure progress towards completion are recorded as contract costs as the work is performed. The estimation of these costs is an integral part of the revenue recognition process for these contracts.

 

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Warranty provisions related to aircraft deliveries on contracts accounted for using a percentage-of-completion method to measure progress towards completion are recorded as contract costs as the warranty work is performed. The estimation of these costs is an integral part of the revenue recognition process for these contracts.

Fair Value

We estimate the fair value of our derivatives using an income valuation approach. The fair value of our foreign currency forward contracts is calculated as the present value of the forward rate less the contract rate multiplied by the notional amount. The fair value of interest rate swaps is derived from a discounted cash flow analysis based on the terms of the contract and the interest rate yield curve. Our fair value measurements also incorporate credit risk. For derivatives in a liability position, we incorporate our own credit risk, and, for derivatives in an asset position, we incorporate our counterparty’s credit risk. To measure credit risk, we modify our discount rate to include the applicable credit spread, which is calculated as the difference between the relevant entity’s yield curve (or average yield curve for similarly rated companies, if the specific entity’s yield curve is not available) and LIBOR, for the derivative. Significant inputs to these valuation models include forward rates, interest rates and yield curves, which are obtained from third-party pricing services. These inputs are derived principally from or corroborated by other observable market data and are therefore considered to be Level 2 inputs. We test the validity of our valuations by comparing them to the valuations we receive from our counterparties.

Recent Accounting Pronouncements

In August 2011, the FASB approved a revised accounting standard update intended to simplify how an entity tests goodwill for impairment. The amendment will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity no longer will be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This accounting standard update will be effective for us beginning in the first quarter of fiscal 2012 and early adoption is permitted. We do not believe that the adoption of this standard will have a material impact on our financial statements

In June 2011, the FASB issued new accounting guidance, which eliminates the current option to report other comprehensive income and its components in the statement of stockholders’ equity. Instead, an entity will be required to present items of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. The standard is effective for fiscal years beginning after December 15, 2011. We will adopt this standard in the first quarter of fiscal 2012. We are currently evaluating the impact of this accounting standard update on our consolidated financial statements.

In May 2011, the FASB issued a new accounting standard update, which amends the fair value measurement guidance and includes some enhanced disclosure requirements. The most significant change in disclosures is an expansion of the information required for Level 3 measurements based on unobservable inputs. The standard is effective for fiscal years beginning after December 15, 2011. We will adopt this standard in the first quarter of fiscal 2012. We do not believe that the adoption of this standard will have a material impact on our financial statements.

Other new pronouncements issued but not effective until after December 31, 2011 are not expected to have a material effect on our cash flows.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Foreign Currency Exchange Rate Risk

We are subject to foreign currency exchange rate risk on payments made to foreign suppliers in foreign currencies. We may use foreign currency forward contracts to hedge our exposure to foreign currency exchange rate fluctuations for firm commitments and forecasted purchases from foreign suppliers. The objective of these foreign currency forward contracts is to minimize the impact of foreign currency exchange rate movements on the results of our operations and cash flows. All previous foreign currency forward contracts have been executed with creditworthy banks and were denominated in U.K. pound sterling. The duration of foreign currency forward contracts generally has been two years or less. We do not use foreign currency forward contracts for speculative or trading purposes. We account for the foreign currency forward contracts as cash flow hedges when they qualify for such treatment. We had no foreign currency forward contracts outstanding at December 31, 2011.

For more information about our foreign currency forward contracts, see Note 7 to our Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

 

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Interest Rate Risk

We have substantial indebtedness, including both fixed and variable rate debt obligations, and are subject to interest rate risk on our variable rate debt obligations, which primarily relate to amounts outstanding under our Senior Secured Credit Facilities. The following table summarizes our outstanding debt obligations at December 31, 2011:

 

            Weighted-  
     Amount      Average  
(Dollars in millions)    Outstanding      Interest Rate  

Fixed-rate debt

   $ 630.6         8.97

Variable-rate debt

     1,703.5         3.75
  

 

 

    

Total debt

   $ 2,334.1      
  

 

 

    

We entered into an interest rate swap agreement in April 2007 to hedge our exposure to changes in interest rates on a portion of our variable rate debt obligations and to attain an appropriate balance between fixed and variable rate debt. Our counterparty syndicated 40% of our April 2007 swap agreement by entering into risk participation agreements with a subsidiary of Lehman Brothers and another financial institution. On September 15, 2008, Lehman Brothers filed for Chapter 11 bankruptcy, which triggered termination of its risk participation agreement with our counterparty. As agreed with our counterparty, the swap was amended to increase the fixed rate by four basis points to 4.95% to compensate our counterparty for assuming the additional credit risk. This interest rate swap had a notional amount of $150.0 million and it matured on December 30, 2011.

We entered into an additional interest rate swap agreement in June 2009. The additional swap had a notional amount of $300.0 million and it matured on June 30, 2011.

Assuming the debt levels that existed on December 31, 2011, a hypothetical 100 basis point increase in the interest rate of each of our variable-rate debt obligations would increase our 2012 projected interest expense by $17.0 million.

For more information about our outstanding debt obligations and interest rate swap, see Notes 10 and 7, to our Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

Credit Risk

We are exposed to the risk that third parties that owe us money, securities or other assets will not perform their obligations. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. Generally, our primary credit risk exposure results from our use of derivative financial instruments. As of December 31, 2011, we had no derivative financial instruments.

 

Item 8. Financial Statements and Supplementary Data

COMPANY RESPONSIBILITY FOR FINANCIAL STATEMENTS

The financial statements and related information contained in this Annual Report on Form 10-K have been prepared by and are the responsibility of our management. Our financial statements have been prepared in conformity with accounting principles generally accepted in the U.S. and reflect judgments and estimates as to the expected effects of transactions and events currently being reported. Our management is responsible for the integrity and objectivity of the financial statements and other financial information included in this Annual Report on Form 10-K.

PricewaterhouseCoopers LLP, an independent registered public accounting firm, was appointed by our Audit Committee to audit our financial statements, and their report follows.

 

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Hawker Beechcraft Acquisition Company, LLC

Index to Consolidated Financial Statements

 

     Page  

Consolidated Financial Statements of Hawker Beechcraft Acquisition Company, LLC

  

Report of Independent Registered Public Accounting Firm

     45   

Consolidated Statements of Financial Position

     46   

Consolidated Statements of Operations

     47   

Consolidated Statements of Equity and Comprehensive Loss

     48   

Consolidated Statements of Cash Flows

     49   

Notes to Consolidated Financial Statements

     50-93   

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors of

Hawker Beechcraft Acquisition Company, LLC

In our opinion, the consolidated financial statements listed in the accompanying index, present fairly, in all material respects, the financial position of Hawker Beechcraft Acquisition Company, LLC (“the Company”) and its subsidiaries at December 31, 2011 and 2010 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring operating losses resulting in a significant net shareholder’s deficit that raises substantial doubt about its ability to continue as a going concern. As further discussed in Note 1, as of the date of this report, the Company is operating under a forbearance agreement with its lenders which defers interest payment obligations and provides relief from loan covenants through June 29, 2012. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty

 

/s/ PricewaterhouseCoopers LLP

St. Louis, Missouri
April 10, 2012

 

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Hawker Beechcraft Acquisition Company, LLC

Consolidated Statements of Financial Position

(In millions)

 

     As of December 31,  
     2011     2010  

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 248.9      $ 422.8   

Accounts and notes receivable, net

     115.7        121.0   

Unbilled revenue

     50.1        34.4   

Inventories

     1,168.0        1,059.9   

Prepaid expenses and other current assets

     19.7        30.7   
  

 

 

   

 

 

 

Total current assets

     1,602.4        1,668.8   

Property, plant and equipment, net

     340.2        482.2   

Goodwill

     193.5        259.5   

Intangible assets, net

     609.9        759.1   

Other assets, net

     32.3        42.2   
  

 

 

   

 

 

 

Total assets

   $ 2,778.3      $ 3,211.8   
  

 

 

   

 

 

 

Liabilities and Equity

    

Current liabilities:

    

Notes payable, revolver, and current portion of long-term debt

   $ 2,334.1      $ 74.6   

Advance payments and billings in excess of costs incurred

     229.7        266.0   

Accounts payable

     317.3        221.1   

Other accrued expenses

     274.7        371.3   
  

 

 

   

 

 

 

Total current liabilities

     3,155.8        933.0   

Long-term debt

     —          2,055.1   

Accrued pension benefits

     490.9        349.4   

Other long-term liabilities

     78.9        75.1   

Noncurrent deferred income tax liability, net

     9.6        13.6   
  

 

 

   

 

 

 

Total liabilities

     3,735.2        3,426.2   
  

 

 

   

 

 

 

Equity

    

Paid-in capital

     1,007.3        1,004.5   

Accumulated other comprehensive loss

     (423.8     (310.4

Retained deficit

     (1,544.8     (912.0
  

 

 

   

 

 

 

Total deficit attributable to parent company

     (961.3     (217.9

Noncontrolling interest

     4.4        3.5   
  

 

 

   

 

 

 

Total deficit

     (956.9     (214.4
  

 

 

   

 

 

 

Total liabilities and equity

   $ 2,778.3      $ 3,211.8   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Hawker Beechcraft Acquisition Company, LLC

Consolidated Statements of Operations

(In millions)

 

     Year Ended December 31,  
     2011     2010     2009  

Sales:

      

Aircraft and parts

   $ 2,254.8      $ 2,643.2      $ 3,034.3   

Services

     180.3        161.5        164.2   
  

 

 

   

 

 

   

 

 

 

Total sales

     2,435.1        2,804.7        3,198.5   
  

 

 

   

 

 

   

 

 

 

Cost of sales:

      

Aircraft and parts

     2,087.6        2,442.2        2,894.3   

Services

     159.6        137.3        142.3   
  

 

 

   

 

 

   

 

 

 

Total cost of sales

     2,247.2        2,579.5        3,036.6   
  

 

 

   

 

 

   

 

 

 

Gross profit

     187.9        225.2        161.9   
  

 

 

   

 

 

   

 

 

 

Restructuring

     12.3        14.9        34.1   

Long-lived asset impairment

     226.6        12.6        74.5   

Goodwill and indefinite-lived intangible asset impairment

     66.0        13.0        448.3   

Selling, general and administrative expenses

     270.5        257.5        209.7   

Research and development expenses

     94.3        101.1        107.3   
  

 

 

   

 

 

   

 

 

 

Operating loss

     (481.8     (173.9     (712.0
  

 

 

   

 

 

   

 

 

 

Interest expense

     135.6        131.8        154.6   

Interest income

     (0.3     (0.1     (1.2

Gain on debt repurchase, net

     —          —          (352.1

Other income, net

     (1.7     (2.2     (1.3
  

 

 

   

 

 

   

 

 

 

Nonoperating expense (income), net

     133.6        129.5        (200.0
  

 

 

   

 

 

   

 

 

 

Loss before taxes

     (615.4     (303.4     (512.0

Provision for (benefit from) income taxes

     16.5        0.9        (60.7
  

 

 

   

 

 

   

 

 

 

Net loss

     (631.9     (304.3     (451.3

Net income attributable to noncontrolling interest

     0.9        0.6        0.3   
  

 

 

   

 

 

   

 

 

 

Net loss attributable to parent company

   $ (632.8   $ (304.9   $ (451.6
  

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Hawker Beechcraft Acquisition Company, LLC

Consolidated Statements of Equity and Comprehensive Loss

(In millions)

For the Period January 1, 2009 – December 31, 2011

 

     Paid-in
Capital
     Retained
Earnings
(Deficit)
    Accumulated
Other
Comprehensive
Income (Loss)
    Noncontrolling
Interest
    Total
Equity
          Total
Comprehensive
Income (Loss)
Attributable to
HBAC
    Total
Comprehensive
Income
Attributable
Noncontrolling
Interest
 

Balance at January 1, 2009

   $ 996.8       $ (156.4   $ (409.3   $ 4.2      $ 435.3            

Stock-based compensation

     3.3               3.3            

Noncontrolling interest activity

        0.3          (0.6     (0.3         

Net (loss) income

        (451.6       0.3        (451.3        $ (451.6   $ 0.3   

Other comprehensive income (loss), net of tax:

                    

Realized prior service cost due to curtailment

          5.5          5.5             5.5     

Net gain on pension and other benefits, net of tax of $(14.6)

          38.8          38.8             38.8     

Unrealized gain on cash flow hedges, net of tax of $(14.5)

          21.4          21.4             21.4     

Realized losses due to de-designation

          39.1          39.1             39.1     

Reclassifications of unrealized losses due to maturities, net of tax of $(1.0)

          29.7          29.7             29.7     

Foreign currency translation adjustments, net of tax of $(0.6)

          0.7          0.7             0.7     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

        

 

 

   

 

 

 

Balance at December 31, 2009

     1,000.1         (607.7     (274.1     3.9        122.2           $ (316.4   $ 0.3   
                  

 

 

   

 

 

 

Stock-based compensation

     4.4               4.4            

Noncontrolling interest activity

        0.6          (1.0     (0.4         

Net (loss) income

        (304.9       0.6        (304.3        $ (304.9   $ 0.6   

Other comprehensive income (loss), net of tax:

                    

Net loss on pension and other benefits, net of tax of $0

          (50.5       (50.5          (50.5  

Unrealized loss on cash flow hedges, net of tax of $0

          (7.3       (7.3          (7.3  

Reclassification of unrealized losses due to maturities, net of tax of $0

          22.1          22.1             22.1     

Foreign currency translation adjustments, net of tax of $0

          (0.6       (0.6          (0.6  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

        

 

 

   

 

 

 

Balance at December 31, 2010

     1,004.5         (912.0     (310.4     3.5        (214.4        $ (341.2   $ 0.6   
                  

 

 

   

 

 

 

Stock-based compensation

     2.8               2.8            

Net (loss) income

        (632.8       0.9        (631.9        $ (632.8   $ 0.9   

Adjustment for amortization of net actuarial loss and prior service cost

                    

Other comprehensive income (loss), net of tax:

                    

Net loss on pension and other benefits, net of tax of ($1.5)

          (137.6       (137.6          (137.6  

Realized net curtailment loss, net of tax of $0

          3.6          3.6             3.6     

Unrealized gain on cash flow hedges, net of tax of $6.2

          0.8          0.8             0.8     

Reclassification of unrealized losses due to maturities, net of tax of ($14.7)

          20.5          20.5             20.5     

Foreign currency translation adjustments, net of tax of $0.5

          (0.7       (0.7          (0.7  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

        

 

 

   

 

 

 

Balance at December 31, 2011

   $ 1,007.3       $ (1,544.8   $ (423.8   $ 4.4      $ (956.9        $ (746.2   $ 0.9   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

        

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Hawker Beechcraft Acquisition Company, LLC

Consolidated Statements of Cash Flows

(In millions)

 

     Year Ended December 31,  
     2011     2010     2009  

Cash flows from operating activities:

      

Net loss

   $ (631.9   $ (304.3   $ (451.3

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

      

Depreciation

     89.0        90.6        91.0   

Amortization of intangible assets

     38.7        43.8        62.2   

Amortization of debt issuance costs

     8.6        9.3        12.6   

Amortization of original issue discount

     2.5        2.2        0.5   

Amortization of deferred compensation

     —          —          0.3   

Stock-based compensation

     2.8        4.6        3.3   

Change in current and deferred income taxes

     4.2        (0.9     (34.0

Gain on sale of property, plant and equipment

     0.4        (1.4     —     

Gain on repurchase of long-term debt, net of debt issuance costs write-off

     —          —          (352.1

Inventory impairments

     32.9        —          70.7   

Long-lived asset impairment

     226.6        12.6        95.9   

Goodwill and other indefinite-lived intangible impairment charges

     66.0        13.0        448.3   

Pension and other curtailment

     3.6        —          5.5   

Noncash interest expense

     —          6.9        20.2   

Changes in assets and liabilities:

      

Accounts receivable, net

     5.3        8.3        (23.4

Unbilled revenue, advanced payments and billings in excess of costs incurred

     (52.0     (60.9     (181.9

Inventories, net

     9.3        389.1        583.0   

Prepaid expenses and other current assets

     4.9        (4.9     10.5   

Accounts payable

     96.2        15.2        (189.1

Other accrued expenses

     (100.7     87.2        (63.5

Pension and other changes, net

     29.9        (11.6     67.9   

Income taxes payable

     (0.1     (1.0     0.5   
  

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by operating activities

     (163.8     297.8        177.1   
  

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

      

Purchases of capital expenditures

     (38.4     (32.0     (51.0

Additions to computer software

     (15.7     (9.7     (3.5

Proceeds from sale of property, plant and equipment

     0.4        6.5        1.2   
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (53.7     (35.2     (53.3
  

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

      

Payment of notes payable

     (150.9     (158.7     (202.2

Payment of term loans

     (44.5     (15.0     (13.5

Issuance of long-term debt

     —          —          188.0   

Utilization of Revolving Credit Facility

     239.0        —          235.0   

Payment of Revolving Credit Facility

     —          (235.0     (7.6

Proceeds from Industrial Revenue Bond funding

     —          0.1        4.4   

Debt repurchase

     —          —          (136.7
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     43.6        (408.6     67.4   
  

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (173.9     (146.0     191.2   

Cash and cash equivalents at beginning of period

     422.8        568.8        377.6   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 248.9      $ 422.8      $ 568.8   
  

 

 

   

 

 

   

 

 

 

Supplemental Disclosures:

      

Cash paid for interest

   $ 121.5      $ 119.0      $ 133.8   

Cash paid (received) for income taxes

     1.5        2.0        (0.5

Net noncash transfers to (from) property, plant and equipment (to) from inventory

     7.9        8.0        (21.5

Net noncash transfers from property, plant and equipment to prepaid expenses and other current assets

     —          (3.0     —     

Inventories acquired through issuance of notes

     158.2        158.1        148.9   

The accompanying notes are an integral part of these consolidated financial statements.

 

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Hawker Beechcraft Acquisition Company, LLC

Notes to Consolidated Financial Statements

 

1. Background and Basis of Presentation

Background

Hawker Beechcraft, Inc. (“HBI”) was formed in late 2006 by GS Capital Partners VI, L.P., an affiliate of The Goldman Sachs Group, Inc., and Onex Partners II LP, an affiliate of Onex Corporation, for the purpose of purchasing the Raytheon Aircraft business (“Raytheon Aircraft” or “Predecessor”) from Raytheon Company (“Raytheon”) (the “Acquisition”). The Acquisition was completed on March 26, 2007. HBI acquired all of the outstanding membership interests of Raytheon Aircraft Acquisition Company, LLC, which was renamed Hawker Beechcraft Acquisition Company, LLC (“HBAC”), and substantially all of the assets of Raytheon Aircraft Services Limited. Hawker Beechcraft Notes Company (“HBNC”) is a wholly-owned subsidiary of HBAC which was formed to co-issue certain debt obligations. HBNC has had no activity since its formation. Following the Acquisition, HBI contributed the equity interest of the entity purchasing the assets of Raytheon Aircraft Services Limited to HBAC. HBAC is engaged in the design, development, manufacturing, marketing, selling and servicing of business and general aviation, training and special mission aircraft. The terms “we,” “our,” “us,” the “Company,” “Successor” and “Hawker Beechcraft” refer to HBAC and its subsidiaries.

Principles of Consolidation

Our consolidated financial statements include our accounts and those of our wholly-owned and majority-owned subsidiaries. All material intercompany transactions have been eliminated in consolidation.

Use of Estimates

Our consolidated financial statements are prepared in conformity with generally accepted accounting principles in the U.S., which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates are used when accounting for certain contracts, including estimates of the extent of progress towards completion, contract revenue and contract completion costs, as well as warranty cost, contingencies, pension, fair value of financial instruments, impairment tests and customer and vendor claims. Actual results could differ from those estimates.

Going Concern Considerations

As of December 31, 2011, Management has concluded that there is substantial doubt about the Company’s ability to continue as a going concern. This conclusion was reached based on a variety of factors, including those described below. We determined not to pay our interest obligations under the Notes on April 2, 2012 and anticipate an inability to pay interest on the Notes on future interest payment dates. Furthermore, we will be required to repay or refinance our Senior Secured Credit Facilities and the Senior Tranche Advance prior to the repayment of the Notes and we will be required to repay or refinance the Senior Notes prior to the repayment of the Senior Subordinated Notes. The Company has suffered recurring operating losses resulting in a significant net shareholder’s deficit that raises substantial doubt about its ability to continue as a going concern. The Company is operating under a forbearance agreement with its lenders which defers interest payment obligations and provides relief from loan covenants through June 29, 2012. Due to the fact that we have recurring negative cash flows from operations and recurring losses from operations, we will need to seek additional financing. There is substantial doubt that we will be able to obtain additional equity or debt financing on favorable terms, or at all, in order to have sufficient liquidity to meet our cash requirements for the next twelve months.

We have taken, and continue to take, various actions to preserve our liquidity and cash position, including reduced production levels to better meet expected demand; use of furloughs and work force reductions consistent with the lower production levels; and other cost reduction efforts including sharply reduced discretionary spending and deferrals of certain product development activity. Our ability to pay principal and interest on our debt, fund working capital and make capital expenditures depends on our future performance and our ability to successfully restructure our balance sheet.

As of December 31, 2011, we were not in compliance with the covenants under our Senior Secured Credit Facilities and had $0.3 million for additional borrowings under our Revolving Credit Facility. We determined not to pay our interest obligations under the Notes on April 2, 2012 and anticipate an inability to pay interest on the Notes on future interest payment

 

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dates. Furthermore, we will be required to repay or refinance our Senior Secured Credit Facilities and the Senior Tranche Advance prior to the repayment of the Notes and we will be required to repay or refinance the Senior Notes prior to the repayment of the Senior Subordinated Notes. If we were unable to make payments or refinance our debt or obtain new financing under these circumstances, we would have to consider other options, including but not limited to the sale of assets, sale of equity, negotiations with our lenders to restructure the applicable debt and/or seeking protection under Chapter 11 of the U.S. Bankruptcy Code.

Comparative Data

Certain reclassifications have been made to prior periods to conform to our current period presentation.

 

2. Summary of Significant Accounting Policies

Revenue Recognition

For the majority of our aircraft sales, revenue is recognized when title to an airworthy aircraft is transferred to the customer. Actual sales and cost values for the unit being delivered are used as the basis for recording revenue and its associated margin.

We use a percentage-of-completion method to measure progress towards completion for longer term contracts with substantial contract-specific development or engineering cost. The ratio of costs incurred-to-date compared to total estimated costs at the completion of the contract are used to derive the estimated revenues to record. Management must apply judgment to determine the estimated contract revenue and costs at completion. Total contract revenue estimates are based on negotiated contract prices and quantities. Estimated amounts for contract changes and claims are included in contract sales only when realization is estimated to be probable. Total contract cost projections require management to make numerous assumptions and estimates relating to items such as the complexity of design, availability and cost of materials, labor productivity and cost, overhead and capital costs and operational efficiency. Contract estimates are reviewed periodically to determine whether revisions to contract values or estimated costs at completion are necessary. The effects of changes in estimates resulting from any such revisions are reflected in the period the estimates are revised using a cumulative catch-up adjustment. Claims are included in revenue estimates only when it is probable that a reliably estimated increase in contract value will be realized. To the extent estimated total costs on a contract exceed the total estimate of revenue to be earned from the contract, the full value of the estimated loss is recorded in the period the loss is identified.

We recognize revenue on aircraft parts and services when the part is shipped or when the service is rendered.

Shipping and Handling Costs

Shipping and handling costs are recorded in Cost of sales.

Advertising Expenses

Advertising costs are expensed as incurred.

Research and Development

Our research and development efforts are focused on developing technologies that will improve our existing products and manufacturing processes. Expenditures for research and development projects that we sponsor are expensed as incurred. Reimbursement of research and development costs under cost-sharing arrangements with vendors is recorded as a reduction to expense.

Income Taxes

Deferred income tax assets and liabilities are recognized for future income tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is recorded to reduce deferred income tax assets to an amount that we believe will more likely than not be realized.

We record an income tax expense or benefit based on the net income earned or net loss incurred in each tax jurisdiction and the tax rate applicable to that income or loss. In the ordinary course of business, there are transactions for which the ultimate tax outcome is uncertain. The final tax outcome of these matters may be different than our original estimates used in determining the

 

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income tax provision. A change to these estimates could impact the effective tax rate and subsequent net income or net loss. The effect of changes in tax rates is recognized during the period in which the rate change occurs.

HBAC is included in the U.S. consolidated federal income tax return of HBI. Under the terms of an informal tax sharing agreement between HBAC and HBI, the amount of the cumulative tax liability of each member shall not exceed the total tax liability as computed on a separate return basis. Refer to Note 13 for additional information about our income taxes.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash and short-term, highly liquid investments with original maturities of 90 days or less. We aggregate our cash balances by bank and reclassify any book overdrafts to accounts payable.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts to provide for the estimated amount of accounts receivable that will not be collected. The allowance is based upon the age of outstanding receivables, an assessment of customer credit-worthiness, historical payment experience and any applicable collateral.

The following table summarizes our allowance for doubtful accounts:

 

     Year Ended December 31,  
(In millions)    2011      2010  

Allowance for doubtful accounts

   $ 4.4       $ 5.5   

Unbilled Revenue

Unbilled revenue is stated at cost plus estimated margin, but not in excess of realizable value. As costs incurred are on other than a straight-line basis, this revenue is recognized over contracted periods in proportion to total costs using historical evidence. We expect to collect this revenue during 2012.

Inventories

Inventories are stated at cost (first-in, first-out or average cost), but not in excess of realizable value. Inventoried costs include direct engineering, production labor and material, as well as applicable overhead. HBAC records pre-owned aircraft acquired in connection with the sale of new aircraft at the lower of the trade-in value or estimated net realizable value. Refer to Note 4 for additional information about our inventories.

Property, Plant and Equipment

Property, plant and equipment obtained in the Acquisition were recorded at fair value and subsequent additions are included at cost. Major improvements are capitalized while expenditures for maintenance, repairs and minor improvements are charged to expense as incurred. Aircraft tooling placed into service prior to January 1, 2011, is accounted for as a group while tooling placed into service subsequent to January 1, 2011, is accounted for as individual discrete assets. When assets, other than aircraft tooling that are accounted for as a group, are retired or otherwise disposed of, the recorded costs of the assets and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in income. When aircraft tooling assets accounted for as a group are retired or replaced in the ordinary course of business, the recorded cost is charged to accumulated depreciation, regardless of the age of the asset, and no gain or loss is recognized.

 

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Provisions for depreciation are computed using the straight-line method. Depreciation provisions are based on the following estimated useful lives:

 

     Estimated  
     Useful Life  

Buildings

     25 - 45 years   

Aircraft and autos

     4 - 10 years   

Furniture, fixtures and office equipment

     8 - 10 years   

Tooling

     2 - 20 years   

Machinery and equipment

     10 years   

Property, plant and equipment obtained in the Acquisition are depreciated over the remaining lives of the assets determined at the date of the Acquisition. For tools placed into service prior to January 1, 2011, aircraft tooling is depreciated using a composite depreciation rate that reflects the blended estimates of the lives of major tooling asset components. In January 2011, we implemented a prospective change in accounting estimate related to the method of depreciation for our aircraft tooling. For tools placed in service on or after January 1, 2011, aircraft tooling is depreciated over the useful life as determined at the date of purchase. This change in accounting estimate did not have a material impact on the financial statements. Leasehold improvements are amortized over the lesser of the remaining life of the lease or the estimated useful life of the improvement. Refer to Note 5 for additional information about our property, plant and equipment.

Impairments of property, plant, and equipment are recognized when events or changes in circumstances indicate that the carrying amount of the asset, or related groups of assets, may not be recoverable, and our estimate of undiscounted cash flows over the assets’ remaining useful lives is less than the carrying value of the assets. Any excess carrying value over the fair value represents the amount of impairment.

Goodwill and Intangible Assets

Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired businesses. Intangible assets are recorded at cost or, when acquired as part of a business combination, at estimated fair value. Intangible assets with definite lives consist of certain trade names and trademarks, order backlog, customer relationships, technological knowledge and computer software and are amortized on a straight-line basis over their estimated useful lives. The following table summarizes the weighted-average amortization periods assigned to long-lived intangible assets:

 

     Estimated  
     Useful Life  

Technological knowledge

     15 years   

Customer relationships

     17 years   

Computer software

     8 years   

Order backlog

     3 years   

Trademarks and tradenames - definite lives

     10 years   

Goodwill and intangible assets with indefinite lives are not amortized but are instead reviewed for impairment on an annual basis during the fourth quarter or upon the occurrence of events that may indicate possible impairment. We conduct our review for impairment on a reporting unit basis.

The assumptions, inputs and judgments used in performing the valuation analysis are inherently subjective and reflect estimates based on known facts and circumstances at the time we perform the valuation. These estimates and assumptions primarily include, but are not limited to, the discount rate; terminal growth rate; earnings before interest, taxes, depreciation and amortization (“EBITDA”) and capital expenditures forecasts. The use of different assumptions, inputs and judgments, or changes in circumstances could materially affect the results of the valuation. Due to the inherent uncertainty involved in making these estimates, actual results could differ from our estimates. The following information describes the primary valuation methodologies used to derive the fair value of the reporting units:

 

   

Income Approach: We determine fair value by discounting the expected cash flows of the reporting units. We rely upon internally generated five-year forecasts for sales and operating profits, including capital expenditures, when estimating future cash flows, and an assumed long-term annual growth rate of cash flows for periods after the five-year forecast for both the Trainer/Attack and Customer Support segments. Discount rates are determined by weighting the required returns on interest-bearing debt and paid-in capital in proportion to their estimated percentages in an expected industry

 

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capital structure.

 

   

Market-Comparable Approach: We use market price data of stocks of companies engaged in the same or similar line of businesses as that of the reporting unit when preparing this valuation methodology. Specifically, we calculate multiples of total enterprise value to EBITDA for comparable companies using data for the latest twelve months (“LTM”) ended September of the current year, and for the following projected year. We then compare the historical and expected performance of the comparable companies to those of the reporting units to determine the range of trailing and forward multiples. The selected range of multiples are then multiplied by the LTM and projected following year EBITDA of these reporting units to determine fair value.

 

   

Market Transaction Approach: We assess EBITDA multiples realized in actual purchase transactions of comparable companies when preparing this valuation methodology. After adjusting these multiples to account for the current economic climate versus the period during which the transactions occurred, they are applied to the LTM EBITDA of the reporting units to determine fair value.

Equal weightings are assigned to the aforementioned model results to arrive at a final fair value estimate of the reporting unit.

The goodwill impairment analysis uses a two-step process. The first step is to identify if a potential impairment is indicated by comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, the goodwill of the reporting unit is not considered to be impaired and the second step of the impairment test is not necessary. However, if the carrying amount of a reporting unit exceeds its fair value, the second step is performed for that reporting unit to determine if goodwill is impaired and to measure the amount of impairment loss that should be recognized, if any.

The second step, if necessary, compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that reporting unit’s goodwill. The process of determining such implied fair value of goodwill involves allocating the reporting unit’s fair value as determined in step one to all of the reporting unit’s assets and liabilities. If the implied fair value of goodwill exceeds the carrying amount, then goodwill is not considered impaired. However, if the carrying amount of goodwill exceeds the implied fair value, an impairment loss is recognized in an amount equal to that excess.

Impairments of indefinite-lived intangible assets are recognized when events or changes in circumstances indicate that the carrying amount of the asset, or related groups of assets, may not be recoverable, and our estimate of discounted cash flows over the assets’ remaining useful lives is less than the carrying value of the assets. The fair value of these intangibles is measured using the relief-from-royalty method. This method is used to estimate the cost savings that accrue to the owner of an intangible asset who would otherwise have to pay royalties or license fees on revenues earned through the use of the asset. The royalty rate based on an analysis of empirical, market-derived royalty rates for comparable companies and an analysis of the profitability of the underlying businesses utilizing the name and related marks. The market-derived royalty rate is then applied to estimate the royalty savings. The net after-tax royalty savings are discounted using the weighted-average cost of capital of our Business and General Aviation segment. Any excess carrying value over the fair value represents the amount of impairment.

See additional disclosure of these analyses in Note 6 to our Consolidated Financial Statements including the impairment charges recorded during the years ended December 31, 2011, 2010 and 2009.

Impairment of Long-lived Assets

Upon indication of possible impairment, we evaluate the recoverability of held for use long-lived assets by measuring the carrying amount of the assets against the related estimated undiscounted future cash flows. When an evaluation indicates that the future undiscounted cash flows are not sufficient to recover the carrying value of the asset, the asset is written down to its estimated fair value. In order for long-lived assets to be considered held-for-disposal, management must have committed to a plan to dispose of the assets. Once deemed held-for-disposal, the assets are stated at the lower of carrying amount or net realizable value.

See additional disclosure of these analyses in Notes 5 and 6 to our Consolidated Financial Statements including the impairment charges recorded during the years ended December 31, 2011, 2010 and 2009.

Notes Payable, Revolver and Current Portion of Long-Term Debt

Notes payable, revolver and current portion of long-term debt consist of the balances due on promissory notes related to a third party financing arrangement and the portion of our debt due within twelve months of the balance sheet date. Refer to Note 10 for additional information about our notes payable, revolver and the current portion of long-term debt.

 

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Advance Payments and Billings in Excess of Costs Incurred

Advance payments and billings in excess of costs incurred represents cash collected from customers in advance of revenue recognition and consists of deposits on commercial aircraft contracts, advances and performance-based payments from government or special mission customers in excess of recorded cost and recognized margin.

Fair Value of Financial Instruments

A three-level valuation hierarchy based upon observable and unobservable inputs is used for fair value measurements. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions based on the best evidence available. These two types of inputs create the following fair value hierarchy:

Level 1 Inputs – Quoted prices for identical assets and liabilities in active markets.

Level 2 Inputs – Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; observable inputs other than quoted prices; and inputs that are derived principally from or corroborated by other observable market data. Our derivative instruments are classified as level 2 investments.

Level 3 Inputs – Unobservable inputs reflecting the entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability.

Refer to Note 12 for additional information about the fair value of our financial instruments.

Derivative Instruments

We use derivative instruments in the form of foreign currency forward contracts and interest rate swap agreements to hedge our economic exposure to changes in the variability of future cash flows attributable to changes in foreign exchange rates and interest rates. Foreign currency forward contracts are used to hedge forecasted vendor payments in foreign currency, and interest rate swaps are used to hedge forecasted interest payments and the risk associated with changing interest rates of our variable rate debt. Our derivative instruments are executed with creditworthy institutions, and we do not hold or issue derivative instruments for trading or speculative purposes.

When appropriate, we designate our derivative instruments as cash flow hedges. At inception, we document the hedging relationship, as well as our risk-management objective and strategy for undertaking the hedging transaction. We assess whether the derivative instrument is highly effective in offsetting changes in the hedged item at hedge inception and on an ongoing basis. Derivative instruments are recognized on the balance sheet at fair value. For derivative instruments designated as cash flow hedges, the effective portion of the change in fair value of the derivative instruments is recorded in Accumulated other comprehensive loss, and any ineffective portion is recorded in earnings. At maturity, amounts in Accumulated other comprehensive loss are reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. We may occasionally hold foreign currency forward contracts for economic purposes that are not designated for hedge accounting treatment. Changes in fair value of these derivative instruments are recorded in earnings immediately.

For all derivative instruments, the gain or loss for foreign currency forward contracts is recorded in Cost of sales and the gain or loss for interest rate swaps is recorded in Interest expense. The cash flows related to all derivative instruments are reported as operating activities in our Consolidated Statements of Cash Flows. Refer to Note 7 for additional information about our derivative instruments and hedging activities.

Share-Based Compensation

Our primary types of share-based compensation include employee stock options and restricted stock. Share-based compensation expense is measured at the grant date based on the calculated fair value of the award. The expense is recognized over the requisite service period, which is generally the vesting period of the award. We use the graded vesting method to amortize compensation expense for awards with a service condition. Compensation expense for awards with a performance condition is recognized in the period in which the performance condition is being measured. The related excess tax benefit received upon exercise of stock options or vesting of restricted stock, if any, to be reflected in our Consolidated Statements of Cash Flows as a financing activity rather than as an operating activity. Refer to Note 15 for additional information about our

 

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employee share-based compensation.

Product Warranty

Warranty provisions related to commercial aircraft and parts sales are determined based upon an estimate of costs that may be incurred for warranty services over the period of coverage from one to five years with limited additional coverage up to 10 years on the Hawker 4000. We estimate our warranty costs based on historical warranty claim experience. The warranty accrual is reviewed quarterly to verify that it appropriately reflects the estimated remaining obligation based on the anticipated expenditures over the balance of the obligation period. Adjustments are made when actual warranty claim experience causes us to revise our estimates. The effects of changes in estimates are reflected in the period the estimates are revised.

Warranty provisions related to aircraft deliveries on contracts accounted for using a percentage-of-completion method to measure progress towards completion are recorded as contract costs as the warranty work is performed. The estimation of these costs is an integral part of the revenue recognition process for these contracts.

Pension and Other Postretirement Benefits

We maintain various defined benefit pension and postretirement plans for our employees. These plans include significant pension and postretirement benefit obligations, which are calculated based on actuarial valuations. Key assumptions used in determining these obligations and related expenses include expected long-term rates of return on plan assets, discount rates and projected healthcare costs. We also make assumptions regarding employee demographic factors such as retirement patterns, mortality, turnover and the rate of compensation increases. We evaluate and update these assumptions annually.

We recognize the overfunded or underfunded status of our defined benefit pension and postretirement benefits plans on our Consolidated Statements of Financial Position with a corresponding adjustment to Accumulated other comprehensive loss. Actuarial gains and losses that are not immediately recognized as a net periodic benefit cost are recognized as a component of Accumulated other comprehensive loss and amortized into net periodic benefit cost in future periods. Refer to Note 14 for additional information about our pension and other postretirement benefits.

Foreign Currency Translation

The functional currency of our foreign subsidiaries is the applicable local currency. The translation from the applicable foreign currencies to U.S. dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted-average exchange rate during the period.

 

3. Recent Accounting Pronouncements

In August 2011, the FASB approved a revised accounting standard update intended to simplify how an entity tests goodwill for impairment. The amendment will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity no longer will be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This accounting standard update will be effective beginning in the first quarter of fiscal 2012 and early adoption is permitted. We do not believe that the adoption of this standard will have a material impact on our financial statements.

In June 2011, the FASB issued new accounting guidance, which eliminates the current option to report other comprehensive income and its components in the statement of stockholders’ equity. Instead, an entity will be required to present items of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. The standard is effective for fiscal years beginning after December 15, 2011. We will adopt this standard in the first quarter of fiscal 2012. We do not believe that the adoption of this standard will have a material impact on our financial statements.

In May 2011, the FASB issued a new accounting standard update, which amends the fair value measurement guidance and includes some enhanced disclosure requirements. The most significant change in disclosures is an expansion of the information required for Level 3 measurements based on unobservable inputs. The standard is effective for fiscal years beginning after December 15, 2011. We will adopt this standard in the first quarter of fiscal 2012. We do not believe that the adoption of this standard will have a material impact on our financial statements.

 

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4. Inventories

The following table summarizes the components of Inventories:

 

     As of December 31,  
(In millions)    2011      2010  

Finished goods

   $ 212.0       $ 165.3   

Work in process

     737.3         663.5   

Materials and purchased parts

     218.7         231.1   
  

 

 

    

 

 

 

Total

   $ 1,168.0       $ 1,059.9   
  

 

 

    

 

 

 

Net noncash transfers of $7.9 million for the year ended December 31, 2011, and $8.0 million for the year ended December 31, 2010, for aircraft physically transferred from inventory to property, plant and equipment were excluded from changes in inventories in our Consolidated Statements of Cash Flows.

In response to the challenging market, in December 2011, we slowed the pace of the Hawker 200 certification program until indicators reflect a healthier light jet market. At the same time, the decision was made to temporarily halt production of the Hawker 750 until market demand improves.

As a result of these decisions, we reviewed the inventory on hand related to each of these product lines. It was determined that the inventory related to these products was impaired and a charge of $32.9 million was recorded during the fourth quarter of 2011.

 

5. Property, Plant and Equipment, net

The following table summarizes the components of Property, plant and equipment (“PP&E”), net:

 

     As of December 31,  
(In millions)    2011      2010  

Land

   $ 27.0       $ 27.0   

Buildings and leasehold improvements

     161.3         160.8   

Aircraft and autos

     68.4         59.5   

Furniture, fixtures and office equipment

     7.9         7.8   

Tooling

     175.8         411.3   

Machinery and equipment

     110.1         106.5   

Construction in process

     38.2         18.0   
  

 

 

    

 

 

 
     588.7         790.9   

Less accumulated depreciation

     248.5         308.7   
  

 

 

    

 

 

 

Property, plant and equipment, net

   $ 340.2       $ 482.2   
  

 

 

    

 

 

 

Depreciation expense was $89.0 million, $90.6 million and $91.0 million for the years ended December 31, 2011, 2010 and 2009.

In conjunction with the impairment testing of our goodwill and indefinite-lived intangible assets discussed subsequently, we also performed an analysis of the potential impairment and re-assessed the remaining asset lives of other identifiable equipment, particularly the Hawker Jet tooling. The analysis and re-assessment resulted in an impairment charge of $98.5 million due to a decrease in expected cash flows from the products underlying the recorded asset values due to reduced production volume and downward pricing pressures. The impairment tests were performed during the fourth quarter due to poor operating performance during the quarter, decreases in future projections, and decisions by us to slow-down or cease production of certain aircraft during the quarter. These items, when taken together, caused management to determine that impairment testing was required during the fourth quarter.

For the year ended December 31, 2010, we analyzed our PP&E for potential impairment and re-assessed the remaining asset lives. The testing resulted in an impairment charge of $9.0 million related to tooling assets due to a decrease in expected cash flows attributable to the Hawker 400XP product line as a result of reduced production plans. The testing also indicated a

 

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need to reduce the lives of certain operating plants to have a remaining useful life of one year based on our decision to relocate certain operating activities.

 

6. Goodwill and Intangibles

Goodwill

Our goodwill balance of $193.5 million resides in the Trainer/Attack Aircraft and Customer Support segments. We test goodwill for impairment at least annually during the fourth quarter of each calendar year. However, certain factors may result in the need to perform an impairment test more frequently. There were no impairment “triggers” identified prior to the annual testing during 2011. Therefore, we performed the annual testing of the goodwill for impairment during the fourth quarter. As a result of that testing, we concluded that it was more likely than not that the fair value of one of our business segments had been reduced below its carrying value

The assumptions, inputs and judgments used in performing the valuation analysis are inherently subjective and reflect estimates based on known facts and circumstances at the time we perform the valuation. These estimates and assumptions primarily include, but are not limited to, the discount rate, terminal growth rate, earnings before interest, taxes, depreciation and amortization, or EBITDA, and capital expenditures forecasts. The use of different assumptions, inputs and judgments, or changes in circumstances, could materially affect the results of the valuation. Due to the inherent uncertainty involved in making these estimates, actual results could differ from our estimates. The following is a description of the valuation methodologies we used to derive the fair value of the reporting units:

 

   

Income Approach: To determine fair value, we discounted the expected cash flows of the reporting units. We calculated expected cash flows using annual revenue growth rates based on management projections. For each of the tests performed during the year, we used a three percent annual growth rate. We used a discount rate that approximates the estimated weighted average cost of capital, which reflects the overall level of inherent risk involved in the respective operations and the rate of return an outside investor would expect to earn. This rate was 14.5% for the Customer Support segment and 10% for the Trainer/Attack Aircraft segment. To estimate cash flows beyond the final year of our model, we used a terminal value and incorporated the present value of the resulting terminal value into our estimate of fair value.

 

   

Market-Based Approach: We used the guideline company method, which focuses on comparing our risk profile and growth prospects, to select reasonably similar/guideline publicly traded companies. Using the guideline company method, we selected revenue multiples below the median for our comparable companies.

 

   

Transaction-Based Approach: We assessed EBITDA multiples realized in actual purchase transactions of comparable companies and applied multiples to the low end of the range of comparable transactions.

Equal weightings were assigned to each of the aforementioned model results, judgmentally allocated based on the observability and reliability of the inputs, to arrive at a final fair value estimate of the reporting unit. The first step of our impairment analysis indicated that the fair value the Company’s Customer Support reporting unit exceeded its carrying value. The Company’s Trainer/Attack Aircraft reporting unit, however, had a fair value less than its carrying value. Accordingly, we performed the second step analysis as described in our summary of significant accounting policies footnote.

As a result of our analysis, we concluded that the implied fair value of the goodwill of our Trainer/Attack Aircraft segment was $156.0 million. Accordingly, we recorded an impairment charge of $66.0 million during the year ended December 31, 2011 to reduce the carrying value to the implied fair value. The primary cause of the goodwill impairment was the overall decline in the market value of the segment as a result of the adverse global economic conditions and expected decreased production as a result of the JPATS contract nearing its conclusion.

During the year ended December 31, 2009, the Company concluded that it was more likely than not that the fair value of one of its Business and General Aviation segment had been reduced below its carrying value. Accordingly, the Company performed an interim review of the value of its goodwill and indefinite-lived intangible assets during the third quarter of 2009. Based on this analysis, the Company concluded the implied fair value of the goodwill of its Business and General Aviation segment was zero. This resulted in the Company recording an impairment charge of $340.1 million during the year ended December 31, 2009. The primary cause of the goodwill impairment was the overall decline in the market value of the segment resulting from adverse global economic conditions and the Company’s expectations as to the timing of a recovery in the general aviation market.

 

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The following table summarizes changes in the net carrying value of goodwill:

 

     Business and     Trainer/               
     General     Attack     Customer         
(In millions)    Aviation     Aircraft     Support      Total  

Balance at January 1, 2009

   $ 340.1      $ 222.0      $ 37.5       $ 599.6   

Impairment losses

     (340.1     —          —           (340.1

Accumulated impairment losses

     (340.1     —          —           (340.1
  

 

 

   

 

 

   

 

 

    

 

 

 

Balance at December 31, 2009

     —          222.0        37.5         259.5   

Impairment losses

     —          —          —           —     

Accumulated impairment losses

     (340.1     —          —           (340.1
  

 

 

   

 

 

   

 

 

    

 

 

 

Balance at December 31, 2010

     —          222.0        37.5         259.5   

Impairment losses

     —          (66.0     —           (66.0

Accumulated impairment losses

     (340.1     (66.0     —           (406.1
  

 

 

   

 

 

   

 

 

    

 

 

 

Balance at December 31, 2011

   $ —        $ 156.0      $ 37.5       $ 193.5   
  

 

 

   

 

 

   

 

 

    

 

 

 

Indefinite-Lived Intangible Assets

Our indefinite-lived intangible assets reside in the Business and General Aviation segment. During the fourth quarter of 2011, we performed an assessment of the fair value of our indefinite-lived intangible assets noting that the projected future discounted cash flows exceeded the carrying value of the tradename assets recorded on the balance sheet. Thus, there were no impairments recorded in 2011.

During the fourth quarter of 2010, we recorded an impairment charge of $13.0 million to reduce the carrying value of our Beechcraft trade name. This decrease in value was attributable primarily to our decision in the fourth quarter of 2010 to rebrand the Premier 1A, currently a Beechcraft model line, as a Hawker 200 in 2012.

The following table summarizes changes in the net carrying amount of indefinite-lived intangible assets:

 

     Business and  
     General  
(In millions)    Aviation  

Balance at January 1, 2010

   $ 352.8   

Intangibles acquired during the year

     0.2   

Impairment losses recognized during the period

     (13.0
  

 

 

 

Balance at December 31, 2010

     340.0   

Intangibles acquired during the year

     —     

Impairment losses recognized during the period

     —     
  

 

 

 

Balance at December 31, 2011

   $ 340.0   
  

 

 

 

 

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Long-lived Intangible Assets

The following table summarizes the changes in the net carrying amount of long-lived intangible assets for the year ended December 31, 2011:

 

(In millions)    Definite Lived
Intangibles, gross
January 1, 2011
     Accumulated
Amortization
January 1, 2011
    Intangibles
Acquired
During the
Year
     Impairment
Losses
During the
Year
    Amortization
During the
Year
    Definite-Lived
Intangibles, Net
December 31, 2011
     Accumulated
Impairment
Losses
 

Technological knowledge

   $ 308.3       $ (90.3   $ —         $ (125.2   $ (19.9   $ 72.9       $ (196.6

Customer relationships

     228.0         (54.0     —           —          (14.4     159.6         —     

Computer software

     53.7         (26.6     15.7         (1.0     (4.4     37.4         (1.0

Order backlog

     61.0         (61.0     —           —          —          —           (1.0

Trademarks/tradenames - definite lives

     2.1         (2.1     —           —          —          —           (4.2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 653.1       $ (234.0   $ 15.7       $ (126.2   $ (38.7   $ 269.9       $ (202.8
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

During the fourth quarter of 2011, we performed an assessment of the fair value of our long-lived intangible assets noting that the carrying value of certain intangibles exceeded the fair value. The technological knowledge associated with the Hawker Jets was found to be fully impaired. This impairment was caused by a decrease in the expected cash flows from the underlying Hawker Jet products as a result of the depressed business and general aviation market and resulting reduced production volumes and downward pricing pressure. The tests were performed during the fourth quarter due to poor operating performance during the quarter, decreases in future projections, and decisions by us to slow-down or cease production of certain aircraft during the quarter. These items, when taken together, caused management to determine that impairment testing was required during the fourth quarter.

During the fourth quarter of 2010, we announced decisions to rebrand the Beechcraft Premier 1A as the Hawker 200 and to suspend Hawker 400 production temporarily to realign supply with demand. In response to these impairment indicators, we performed an analysis of undiscounted cash flows attributable to their long-lived intangible assets. Based on this analysis, we recorded a $2.9 million charge to fully impair the value of the Premier trade name and a $0.7 million charge to impair jet technology related to the Hawker 400.

The following table summarizes the changes in the net carrying amount of long-lived intangible assets for the year ended December 31, 2010:

 

(In millions)    Definite Lived
Intangibles, gross
January 1, 2010
     Accumulated
Amortization
January 1, 2010
    Intangibles
Acquired
During the
Year
     Impairment
Losses
During the
Year
    Amortization
During the
Year
    Definite-Lived
Intangibles, net
December 31, 2010
     Accumulated
Impairment
Losses
 

Technological knowledge

   $ 309.0       $ (70.3   $ —         $ (0.7   $ (20.0   $ 218.0       $ (71.4

Customer relationships

     228.0         (39.6     —           —          (14.4     174.0         —     

Computer software

     44.0         (20.3     9.7         —          (6.3     27.1         —     

Order backlog

     61.0         (58.4     —           —          (2.6     —           (1.0

Trademarks/tradenames - definite lives

     5.0         (1.6     —           (2.9     (0.5     —           (4.2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 647.0       $ (190.2   $ 9.7       $ (3.6   $ (43.8   $ 419.1       $ (76.6
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

The following table summarizes the amortization expense related to our long-lived intangible assets:

 

     Year Ended December 31,  
(In millions)    2011      2010      2009  

Amortization expense

   $ 38.7       $ 43.8       $ 62.2   
  

 

 

    

 

 

    

 

 

 

 

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The following table summarizes estimated amortization expense related to our long-lived intangible assets in each of the next five years:

 

(In millions)    Estimated
Amortization
Expense
 

2012

   $ 25.3   

2013

   $ 24.6   

2014

   $ 24.3   

2015

   $ 24.2   

2016

   $ 23.0   

 

7. Derivatives and Hedging Activities

Interest Rate Swap

We entered into an interest rate swap agreement in April 2007 to effectively convert a portion of our variable rate debt to fixed rate debt. The notional amount of the swap was $150.0 million and it matured on December 31, 2011.

Our counterparty syndicated 40% of the April 2007 swap agreement by entering into risk participation agreements with a subsidiary of Lehman Brothers Holding, Inc. (“Lehman Brothers”) and another financial institution. On September 15, 2008, Lehman Brothers filed for Chapter 11 bankruptcy, which triggered termination of its risk participation agreement with our counterparty. As agreed with our counterparty, the swap was amended to increase the fixed rate by four basis points to 4.95% to compensate the counterparty for assuming the additional credit risk. We de-designated the cash flow hedging relationship under the original terms of the swap and re-designated the amended swap in a new cash flow hedging relationship. The deferred loss associated with the de-designated hedge was amortized over the life of the debt.

We entered into an additional interest rate swap agreement in June 2009 to effectively convert an additional portion of our variable rate debt to fixed rate debt. The notional amount of the swap was $300.0 million and it matured on June 30, 2011.

Foreign Currency Forward Contracts

We use foreign currency forward contracts to hedge forecasted United Kingdom pound sterling inventory purchases. We reduced production rates and related purchase volumes as a result of depressed demand in the business and general aviation market, including purchases of previously forecasted United Kingdom pound sterling inventory. As a result, we discontinued cash flow hedge accounting for foreign currency forward contracts when the underlying inventory purchase transactions were no longer probable.

We had no foreign currency forward contracts outstanding at December 31, 2011. The notional amount outstanding at December 31, 2010, based on contract rates, was $0.3 million, which matured in January 2011. We entered into additional foreign currency forward contracts in June 2011 with notional values totaling $59.5 million and maturity dates extending through December 2011. We elected to not designate these forward contracts as cash flow hedges. As of December 31, 2011, we had no net unrealized losses on contracts designated and effective as cash flow hedges recorded in Accumulated other comprehensive loss to be reclassified into earnings.

 

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Notional Amounts and Fair Values

The following table summarizes the effects derivative instruments had on our Consolidated Statements of Financial Position:

 

    Notional amounts     Other accrued expenses  
(In millions)   December 31,
2011
    December 31,
2010
    December 31,
2011
    December 31,
2010
 

Derivatives designated as hedging instruments:

       

Interest rate contracts, current

  $ —        $ 450.0      $ —        $ 8.3   
 

 

 

   

 

 

   

 

 

   

 

 

 

Derivatives not designated as hedging instruments:

       

Interest rate contracts, current

    —          —          —          0.3   

Foreign currency forward contracts, current

    —          0.3        —          —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total derivatives not designated as hedging instruments

    —          0.3        —          0.3   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total derivatives

  $ —        $ 450.3      $ —        $ 8.6   
 

 

 

   

 

 

   

 

 

   

 

 

 

Derivatives not in Cash Flow Hedging Relationships

The following table summarizes the losses recorded in income from derivative instruments that were not designated in cash flow hedging relationships:

 

     Year Ended
December 31,
 
(In millions)    2011     2010     2009  

Interest rate contracts (a)

   $ (0.3   $ (2.7   $ (5.6

Foreign currency forward contracts (b)

     (0.3     (5.3     (26.5
  

 

 

   

 

 

   

 

 

 

Total

   $ (0.6   $ (8.0   $ (32.1
  

 

 

   

 

 

   

 

 

 

 

(a) Amounts are included in Interest expense related to the de-designation of the original hedging relationship
(b) Amounts are included in Cost of sales

We have no unrealized losses related to the de-designation of the original hedging relationship to be reclassified from Accumulated other comprehensive loss into Interest expense over the next twelve months as the underlying transactions have matured and the hedged items are reflected fully in earnings.

Derivatives in Cash Flow Hedging Relationships

The following table summarizes the gains (losses) recorded in Accumulated other comprehensive loss from the effective portion of derivative instruments designated in cash flow hedging relationships:

 

     Year Ended
December 31,
 
(In millions)    2011      2010     2009  

Interest rate contracts (a)

   $ —         $ (2.8   $ 9.5   

Foreign currency forward contracts

     —           (4.5     26.8   
  

 

 

    

 

 

   

 

 

 

Total

   $ —         $ (7.3   $ 36.3   
  

 

 

    

 

 

   

 

 

 

 

(a) In 2011, we had losses of $7.0 million recorded in Accumulated other comprehensive loss which were reclassified into interest expense as a result of the interest rate swaps maturing.

The following table summarizes the losses reclassified from Accumulated other comprehensive loss into income for the effective portion of derivative instruments designated in cash flow hedging relationships:

 

     Year Ended
December 31,
 
(In millions)    2011     2010     2009  

Foreign currency forward contracts (a)

   $ (5.5   $ (19.4   $ 29.7   

 

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(a) Amounts are included in Cost of sales

We have no unrealized losses on foreign currency forward contracts designated and effective as cash flow hedges to be reclassified from Accumulated other comprehensive loss into Cost of sales over the next twelve months as the underlying transactions have matured and the hedged items are reflected fully in earnings.

The following table summarizes the gains recorded in income from the ineffective portion and amount excluded from effectiveness testing of derivative instruments designated in cash flow hedging relationships:

 

     Year Ended
December 31,
 
(In millions)    2011      2010      2009  

Interest rate contracts (a)

   $ 2.1       $ 15.0       $ —     

 

(a) Amounts are included in Interest expense

 

8. Restructuring

During 2011, we continued restructuring actions announced in 2009 and 2010 that were taken as part of our on-going cost reduction initiatives and in response to lower aircraft production rates resulting from depressed demand in the general aviation industry as well as entering into new actions. In August 2011, our union work force ratified a new collective bargaining agreement that included additional incentives to be paid as part of these ongoing restructuring actions. These restructuring actions included the following activities:

 

   

Workforce Reduction: Charges of $12.2 million for the year ended December 31, 2011, $14.0 million for the year ended December 31, 2010, and $29.0 million for the year ended December 31, 2009 related to our decision to reduce staffing; and

 

   

Exit and Other Consolidation Activities: Charges of $0.1 million for the year ended December 31, 2011, $0.9 million for the year ended December 31, 2010, and $3.8 million were recorded related to the exit from a leased facility. In 2009, we had additional charges of $1.3 million related to other consolidation activities.

The following table summarizes our pre-tax charges by business segment:

 

     Year Ended
December 31,
 
(In millions)    2011      2010      2009  

Business and General Aviation

   $ 11.4       $ 14.0       $ 32.3   

Trainer/Attack Aircraft

     0.7         0.8         1.0   

Customer Support

     0.2         0.1         0.8   
  

 

 

    

 

 

    

 

 

 

Total

   $ 12.3       $ 14.9       $ 34.1   
  

 

 

    

 

 

    

 

 

 

The following table summarizes the changes in our restructuring and other reserve balances, which are recorded on the Consolidated Statements of Financial Position as Other accrued expenses:

 

(In millions)    Facilities and
Other
Consolidation
Costs
    Severance and
Related Costs
    Total  

Balance at January 1, 2010

   $ 0.9      $ 1.8      $ 2.7   

Accruals

     0.9        14.0        14.9   

Payments

     (0.7     (11.6     (12.3
  

 

 

   

 

 

   

 

 

 

Balance at December 31, 2010

     1.1        4.2        5.3   

Accruals

     0.1        12.2        12.3   

Payments

     (0.5     (9.7     (10.2
  

 

 

   

 

 

   

 

 

 

Balance at December 31, 2011

   $ 0.7      $ 6.7      $ 7.4   
  

 

 

   

 

 

   

 

 

 

We currently anticipate these restructuring actions will be completed by the end of 2012.

 

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9. Other Accrued Expenses

The following table summarizes the components of Other accrued expenses:

 

     As of December 31,  
(In millions)    2011      2010  

Accrued salaries and wages

   $ 43.8       $ 65.0   

Development advances received

     42.2         29.6   

Post-delivery commitments

     30.7         56.8   

Supplier claims

     26.2         50.5   

Non-warranty repair reserve

     30.4         32.8   

Product warranty, current

     5.1         21.0   

Accrued interest payable

     15.1         14.7   

Other accrued expenses

     81.2         100.9   
  

 

 

    

 

 

 

Total

   $ 274.7       $ 371.3   
  

 

 

    

 

 

 

 

10. Debt and Notes Payable

The following table summarizes the components of our debt and notes payable:

 

     As of December 31,  
(In millions)    2011      2010  

Short-term debt:

     

Revolving credit facility

   $ 239.0       $ —     

Notes payable

     66.9         59.6   

Current portion of long-term debt

     

Senior secured term loan due 2014

     1,212.8         13.0   

Incremental secured term loan due 2014

     184.8         2.0   

Senior fixed rate notes due 2015

     182.9         —     

Senior PIK-election notes due 2015

     302.6         —     

Senior subordinated notes due 2017

     145.1         —     
  

 

 

    

 

 

 

Total short-term debt

     2,334.1         74.6   
  

 

 

    

 

 

 

Senior secured term loan due 2014, net of current portion

     —           1,238.3   

Incremental secured term loan due 2014, net of current portion

     —           186.2   

Senior fixed rate notes due 2015

     —           182.9   

Senior PIK-election notes due 2015

     —           302.6   

Senior subordinated notes due 2017

     —           145.1   
  

 

 

    

 

 

 

Total long-term debt

     —           2,055.1   
  

 

 

    

 

 

 

Total debt and notes payable

   $ 2,334.1       $ 2,129.7   
  

 

 

    

 

 

 

All outstanding debt was reclassified to short-term liabilities for the year ended December 31, 2011. This reclassification was necessary due to us violating our debt covenants on our outstanding borrowings as of December 31, 2011. See Note 22 for additional details.

Notes payable represents a deferred payment obligation to a supplier under which the supplier is paid by the lender upon our receipt of goods. We pay the lender within 120 days under the terms of the underlying short-term promissory notes, with interest determined at the four month LIBOR plus 5.00%. The weighted average interest rate on our outstanding notes payable was 5.49% at December 31, 2011, and 5.40% at December 31, 2010. During the years ended December 31, 2011 and 2010, $158.2 million and $158.1 million of notes were issued. The issuance of these notes was treated as a noncash financing transaction.

During the year ended December 31, 2011, we made payments of $1.2 million of interest related to our Revolving credit facility. The weighted average interest rate was 3.00%.

 

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In March 2007, in connection with the Acquisition, we executed a $1,810.0 million Credit Agreement that included a $1,300.0 million Senior Secured Term Loan, a $400.0 million secured Revolving Credit Facility and a $110.0 million synthetic letter of credit facility. In March 2008, we reduced the synthetic letter of credit facility to $75.0 million. We had issued letters of credit totaling $51.2 million under the synthetic facility at December 31, 2011.

In accordance with our credit agreement, we were required to make a prepayment of principal toward our senior secured and incremental term loans as a result of our excess cash flow for the year 2010. We paid $44.5 million of principal on March 2, 2011, which we elected to apply against our principal repayment schedules. This election eliminates required principal payments set forth in our repayment schedules until near maturity of these debt instruments. The weighted average floating interest rate on the Senior Secured Term Loan was 3.66% at December 31, 2011, and 3.39% at December 31, 2010.

In December 2008, we amended the Credit Agreement to allow us to prepay up to a maximum of $300.0 million of the Senior Secured Term Loan at a discount price to par to be determined pursuant to certain auction procedures.

Also in March 2007, in connection with the Acquisition, we issued $1,100.0 million of notes, including $400.0 million of Senior Fixed Rate Notes due April 2015, $400.0 million of Senior PIK-Election Notes due April 2015 and $300.0 million of Senior Subordinated Notes due April 2017 (collectively referred to as the “Notes”). In February 2008, we exchanged these Notes for new notes with identical terms, except that the new notes have been registered under the Securities Act of 1933 and do not bear restrictions on transferability mandated by the Securities Act of 1933 or certain penalties for failure to file a registration statement relating to the exchange. The Notes are unsecured obligations and are guaranteed by certain current and future wholly-owned subsidiaries that guarantee our obligations under the Senior Secured Credit Facilities.

Interest on the Notes is paid semi-annually on April 1 and October 1. The interest rate for the Senior Fixed Rate Notes and Senior Subordinated Notes is 8.50% and 9.75%, respectively, and is payable in cash. Up through and including April 2011, we have been able to elect to pay interest on the Senior PIK-Election Notes, at our option: entirely in cash, entirely by increasing the principal amount of the Senior PIK-Election Notes (“PIK Interest”), or 50% cash interest and 50% PIK Interest. Cash interest will accrue at a rate of 8.875% per annum and PIK Interest will accrue at a rate of 9.625% per annum. We have been able to elect the form of interest payment with respect to each interest period prior to the beginning of the applicable interest period. We elected to make the April 1, 2010 interest payment by issuing additional PIK Interest rather than by paying in cash. We made the October 1, 2010, and the April 1, 2011, interest payments in cash. As the PIK Interest option is no longer available, all subsequent interest payments are currently required to be paid in cash.

On June 2, 2009, we completed a cash tender offer to purchase a portion of our outstanding Senior Fixed Rate Notes, Senior PIK-Election Notes and Senior Subordinated Notes. The tender offer resulted in the purchase of $274.5 million aggregate principal amount of our debt securities for $96.1 million in cash, realizing a net gain of $175.0 million after considering transaction fees, a $3.8 million charge to reduce the carrying value of deferred debt issuance cost for the portion of the notes purchased and an allocation of a portion of the cash settlement amount to the accrued but unpaid PIK-Election; which would have increased the principal balance of the Senior PIK-Election Notes had the underlying notes not been purchased. During the first quarter of 2009, we purchased $222.1 million of our outstanding Notes for $41.0 million in cash, realizing a net gain of $177.1 million after considering a $4.0 million charge to reduce the carrying value of deferred debt issuance cost for the portion related to the Notes purchased. We also paid $2.6 million in accrued but previously unpaid interest on the Senior Fixed Rate Notes and Senior Subordinated Notes purchased. The tender offer, along with open market purchases executed in the first quarter of 2009, resulted in an aggregate purchase of $496.6 million of our debt securities, realizing a net cumulative gain of $352.1 million during the year ended December 31, 2009.

On November 6, 2009, we further amended our Credit Agreement (the “Second Amendment”). The Second Amendment provides that compliance with the maximum consolidated secured debt ratio test under the Credit Agreement is waived. The continuing effectiveness of this waiver is subject to the condition that we shall not have made a restricted payment pursuant to certain available restricted payment baskets under the Credit Agreement. If this condition fails to be satisfied, then the waiver of the consolidated secured debt ratio covenant will be revoked and we will be required to comply (and, if revoked, compliance with the consolidated secured debt ratio will be required for the two most recently completed fiscal quarters) with the maximum consolidated secured debt ratio test in the Credit Agreement.

The Second Amendment added a new minimum liquidity covenant which requires unrestricted cash plus available commitments under the Revolving Credit Facility, determined in each case as of the last day of such fiscal quarter, to be not less than $162.5 million.

In addition, the Second Amendment added a new Adjusted EBITDA covenant requiring that, to the extent the consolidated secured debt ratio covenant is waived as described above, for any fiscal quarter beginning with the second quarter of 2011 for which any revolving facility commitment is outstanding on the last day of such fiscal quarter we must maintain a certain minimum Adjusted EBITDA as specified in the Second Amendment. This Adjusted EBITDA covenant is in effect.

 

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The initial effectiveness of the Second Amendment was conditioned upon, among other items, the repayment of $125.0 million of our outstanding borrowings under the Revolving Credit Facility and a permanent reduction of the facility commitments by $137.0 million (which included a $12.3 million portion of the $35.0 million originally committed by Lehman Brothers).

The remaining $22.7 million portion of Lehman Brothers’ revolving commitment is not considered available as they have been unable to honor this commitment as a result of their bankruptcy. As a result of the second Amendment and the Lehman Brothers bankruptcy, the total reduction in available commitments was $159.7 million. Following these reductions, the total amount of available revolving commitments under the Revolving Credit Facility is now $240.3 million.

On November 25, 2009, we entered into an Incremental Facility Supplement Agreement. Pursuant to the terms of the agreement, we were provided $200.0 million of new term loans (the “Incremental Secured Term Loans”) under the incremental facilities provisions of the Credit Agreement. We paid a fee to the lenders on closing, in the form of an Original Issue Discount, equal to 6.0% of the agreement principal amount of the Incremental Secured Term Loans. Capitalized deferred financing costs and original issue discount are being amortized over the term of the related debt using the effective interest method.

Our financing arrangements contain a number of customary covenants and restrictions. We were in violation of those covenants as of December 31, 2011. See Note 22 for additional details.

The following table summarizes the minimum principal repayment requirements on debt, excluding the current Notes payable and Revolving credit facility of $305.9 million:

 

(In millions)       

2012

   $ 2,034.9   

2013

     —     

2014

     —     

2015

     —     

2016

     —     

Thereafter

     —     
  

 

 

 

Total debt outstanding

     2,034.9   

Original issue discount

     (6.7
  

 

 

 

Total debt, net

   $ 2,028.2   
  

 

 

 

All outstanding debt was reclassified to due in 2012 in the schedule above for the year ended December 31, 2011. This reclassification was necessary due to us violating our debt covenants on our outstanding borrowings as of December 31, 2011. See Note 22 for further details.

 

11. Product Warranty

The following table summarizes the activity related to commercial aircraft and parts warranty provisions, the majority of which is recorded in Other long-term liabilities on our Consolidated Statements of Financial Position:

 

     Year Ended
December  31,
 
(In millions)    2011     2010  

Beginning balance

   $ 62.0      $ 67.9   

Accrual for aircraft and part deliveries

     15.3        21.5   

Reversals related to prior period deliveries

     0.5        (0.6

Warranty services provided

     (37.3     (26.8
  

 

 

   

 

 

 

Ending balance

   $ 40.5      $ 62.0   
  

 

 

   

 

 

 

 

12. Fair Value Measurements

We use derivatives to manage foreign currency risk and interest rate risk for non-trading purposes. The fair values are classified as long-term or short-term based on anticipated settlement date. Any change in fair value is included in income or Accumulated other comprehensible income, depending upon the designation of the derivative as a cash flow hedge. We had a Level 2 input derivative liability measured at fair value on a recurring basis of $8.6 million outstanding at December 31, 2010. This liability was related to interest rate swaps and was recorded in Other accrued expenses-current in our Consolidated Statements of Financial Position. There were no derivatives outstanding as of December 31, 2011 as all outstanding positions

 

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matured during the year.

Derivative financial instruments are valued using an income valuation approach. The fair value of the foreign currency forward contracts is calculated as the present value of the forward rate less the contract rate multiplied by the notional amount. The fair value of the interest rate swaps is derived from discounted cash flow analyses based on the terms of the contract and the interest rate yield curve. The fair value measurements also incorporate credit risk. For derivatives in a liability position, we incorporated our own credit risk, and, for derivatives in an asset position, the counterparty’s credit risk is incorporated. To measure credit risk, we modify our discount rate to include the applicable credit spread, which is calculated as the difference between the relevant entity’s yield curve (or average yield curve for similarly rated companies, if the specific entity’s yield curve is not available) and LIBOR, for the derivative. Significant inputs to these valuation models include forward rates, interest rates and yield curves, which are obtained from third-party pricing services. These inputs are derived principally from, or corroborated by, other observable market data and are therefore considered to be Level 2 inputs. Our valuations do not include any significant Level 3, or unobservable, inputs.

The fair value of long-term debt is estimated based on prices provided by quoted markets and third-party brokers. The following table summarizes the carrying amount and estimated fair value of our long-term debt:

 

     As of December 31, 2011      As of December 31, 2010  
(In millions)    Carrying
Amount
     Fair
Value
     Carrying
Amount
     Fair
Value
 

Senior secured term loan

   $ 1,212.8       $ 915.7       $ 1,251.3       $ 1,091.7   

Incremental secured term loan due 2014

     184.8         145.0         188.2         186.4   

Senior fixed rate notes