37 - Rockwell Collins...its fair value. Goodwill is potentially impaired if the carrying value of a...

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ROckwell cOllins annual RepORt 2007 37notestoconsolidatedFinancialstatements

1. BUSINESS DESCRIPTION AND BASIS OF PRESENTATION

Rockwellcollins,inc.(thecompanyorRockwellcollins)providesdesign,productionandsupportofcommunicationsandaviationelectronicsformilitaryandcommercialcustom-ersworldwide.

thecompanyoperatesona52/53weekfiscalyearendingontheFridayclosesttoseptember30.Foreaseofpresenta-tion,september30isutilizedconsistentlythroughoutthesefinancialstatementsandnotestorepresentthefiscalyearenddate.alldatereferencescontainedhereinrelatetothecompany’sfiscalyearunlessotherwisestated.

2. SIGNIFICANT ACCOUNTING POLICIES

Consolidationtheconsolidatedfinancialstatementsincludetheaccountsofthecompanyandallmajority-ownedsubsidiaries.thecompany’sinvestmentsinentitiesitdoesnotcontrolbutoverwhichithastheabilitytoexercisesignificantinfluenceareaccountedforundertheequitymethodandareincludedinotherassets.allintercompanytransactionsareeliminated.

Revenue Recognitionthecompanyentersintosalesarrangementsthatmayprovideformultipledeliverablestoacustomer.thecompanyidentifiesallgoodsand/orservicesthataretobedeliveredseparatelyunderasalesarrangementandallocatesrevenuetoeachdeliverablebasedonrelativefairvalues.Fairvaluesaregenerallyestablishedbasedonthepriceschargedwhensoldseparatelybythecompany.ingeneral,revenuesaresepa-ratedbetweenhardware,engineeringservices,maintenanceservices,andinstallationservices.theallocatedrevenueforeachdeliverableisthenrecognizedusingappropriaterevenuerecognitionmethods.

salesrelatedtolong-termcontractsrequiringdevelopmentanddeliveryofproductsoverseveralyearsareaccountedforunderthepercentage-of-completionmethodofaccountingundertheamericaninstituteofcertifiedPublicaccountants’statementofPosition81-1,Accounting for Performance of Construction-Type and Certain Production-Type Contracts.salesandearningsunderthesecontractsarerecordedeitherasproductsareshippedundertheunits-of-deliverymethod(forproductioneffort),orbasedontheratioofactualcostsincurredtototalestimatedcostsexpectedtobeincurredrelatedtothecontractunderthecost-to-costmethod(fordevelopmenteffort).Purchaseoptionsandchangeordersareaccountedforeitherasanintegralpartoftheoriginalcontractorseparatelydependinguponthenatureandvalueoftheitem.salesandcostsrelatedtoprofitablepurchaseoptionsareincludedinestimatesonlywhentheoptions

areexercisedwhilesalesandcostsrelatedtounprofitablepurchaseoptionsareincludedinestimateswhenexerciseisdeterminedtobeprobable.salesrelatedtochangeordersareincludedinestimatesonlyiftheycanbereliablyestimatedandcollectibilityisreasonablyassured.anticipatedlossesoncontractsarerecognizedinfullintheperiodinwhichlossesbecomeprobableandestimable.changesinestimatesofprofitorlossoncontractsareincludedinearningsonacumu-lativebasisintheperiodtheestimateischanged.

salesrelatedtolong-termseparatelypricedproductmainte-nanceorwarrantycontractsareaccountedforbasedonthetermsoftheunderlyingagreements.certaincontractsarefixedpricecontractswithsalesrecognizedratablyoverthecontractuallife,whileothercontractshaveafixedhourlyratewithsalesrecognizedbasedonactuallabororflighthoursincurred.thecostofprovidingtheseservicesisexpensedasincurred.

thecompanyrecognizessalesforallotherproductsorserviceswhenallofthefollowingcriteriaaremet:anagree-mentofsaleexists,productdeliveryandacceptancehasoccurredorserviceshavebeenrendered,pricingisfixedordeterminable,andcollectionisreasonablyassured.

Research and Developmentthecompanyperformsresearchanddevelopmentactivitiesrelatingtothedevelopmentofnewproductsandtheimprovementofexistingproducts.company-fundedresearchanddevelopmentprogramsareexpensedasincurredandincludedincostofsales.customer-fundedresearchanddevelopmentexpendituresareaccountedforascontractcostswithincostofsales,andthereimbursementisaccountedforasasale.

Cash and Cash Equivalentscashandcashequivalentsincludestimedepositsandcertificatesofdepositwithoriginalmaturitydatesofthreemonthsorless.

Allowance for Doubtful Accountsallowancesareestablishedinordertoreportreceivablesatnetrealizablevalueonthecompany’sstatementofFinancialPosition.thedeterminationoftheseallowancesrequiresmanagementofthecompanytomakeestimatesandjudg-mentsastothecollectibilityofcustomeraccountbalances.theseallowancesareestimatedforcustomerswhoareconsideredcreditrisksbyreviewingthecompany’scollectionexperiencewiththosecustomersaswellasevaluatingthecustomers’financialcondition.thecompanyalsoconsidersbothcurrentandprojectedeconomicandmarketconditions.specialattentionisgiventoaccountswithinvoicesthatarepastdue.Pastdueisdefinedasanyinvoiceforwhichpayment

ROckwell cOllins annual RepORt 2007 38notestoconsolidatedFinancialstatements

hasnotbeenreceivedbytheduedatespecifiedonthebillinginvoice.theuncollectibleportionofreceivablesischargedagainsttheallowancefordoubtfulaccountswhencollec-tioneffortshaveceased.Recoveriesofreceivablespreviouslycharged-offarerecordedwhenreceived.

Inventoriesinventoriesarestatedatthelowerofcostormarketusingcostswhichapproximatethefirst-in,first-outmethod,lessrelatedprogresspaymentsreceived.inventoriedcostsincludedirectcostsofmanufacturing,certainengineeringcostsandallocableoverheadcosts.thecompanyregularlycomparesinventoryquantitiesonhandonapartlevelbasistoestimatedforecastsofproductdemandandproductionrequirementsaswellashistoricalusage.Basedonthesecom-parisons,managementestablishesanexcessandobsoleteinventoryreserveonanaggregatebasis.

thecompanydeferscertainpre-productionengineeringcostsaswork-in-processinventoryinconnectionwithlong-termsupplyarrangementsthatcontaincontractualguaranteesforreimbursementfromcustomers.suchcustomerguaran-teesgenerallytaketheformofaminimumorderquantitywithquantifiedreimbursementamountsiftheminimumorderquantityisnottakenbythecustomer.suchcostsaretypicallydeferredtotheextentofthecontractualguaranteesandaregenerallyamortizedoveraperiodof2to6yearsasacomponentofcostofsalesasrevenueisrecognizedontheminimumorderquantity.Deferredpre-productionengineer-ingcostswere$126millionand$96millionatseptember30,2007and2006,respectively.Pre-productionengineeringcostsincurredpursuanttosupplyarrangementsthatdonotcon-taincustomerguaranteesforreimbursementareexpensedasincurred.

Progress PaymentsProgresspaymentsrelatetobothreceivablesandinvento-riesandrepresentcashcollectedfromgovernment-relatedcontractswherebythegovernmentshavealegalrightofoffsetrelatedtothereceivableorlegaltitletothework-in-processinventory.

PropertyPropertyisstatedatacquisitioncost.Depreciationofpropertyisgenerallyprovidedusingacceleratedandstraight-linemethodsoverthefollowingestimatedusefullives:buildingsandimprovements,15–40years;machineryandequipment,6–12years;andinformationsystemssoftwareandhardware,3–10years.Depreciationmethodsandlivesarereviewedperiodicallywithanychangesrecordedonaprospectivebasis.

significantrenewalsandbettermentsarecapitalizedandreplacedunitsarewrittenoff.Maintenanceandrepairs,aswellasrenewalsofminoramounts,arechargedtoexpenseintheperiodincurred.thefairvalueofliabilitiesassociatedwiththeretirementofpropertyisrecordedwhenthereisalegalorcontractualrequirementtoincursuchcostsandthecostsarereasonablyestimable.Upontheinitialrecognitionofacontractualorlegalliabilityforanassetretirementobligation,thecompanycapitalizestheassetretirementcostbyincreas-ingthecarryingamountofthepropertybythesameamountastheliability.thisassetretirementcostisthendepreciatedovertheestimatedusefullifeoftheunderlyingproperty.thecompanyhadnosignificantassetretirementobligationsatseptember30,2007and2006.

Goodwill and Intangible AssetsGoodwillandintangibleassetsgenerallyresultfrombusi-nessacquisitions.Businessacquisitionsareaccountedforunderthepurchasemethodbyassigningthepurchasepricetotangibleandintangibleassetsacquiredandliabilitiesassumed,includingresearchanddevelopmentprojectswhichhavenotyetreachedtechnologicalfeasibilityandhavenoalternativefutureuse(purchasedresearchanddevelopment).assetsacquiredandliabilitiesassumedarerecordedattheirfairvalues;thefairvalueofpurchasedresearchanddevelop-mentisimmediatelychargedtoexpense;andtheexcessofthepurchasepriceovertheamountsassignedisrecordedasgoodwill.assetsacquiredandliabilitiesassumedareallocatedtothecompany’sreportingunitsbasedonthecompany’sintegrationplansandinternalreportingstructure.Purchasedintangibleassetswithfinitelivesareamortizedovertheirestimatedusefullives.Goodwillandintangibleassetswithindefinitelivesarenotamortized,butreviewedatleastannu-allyforimpairment.

Customer IncentivesRockwellcollinsprovidessalesincentivestocertaincommer-cialcustomersinconnectionwithsalescontracts.incentivesconsistingofcashpaymentsorcustomeraccountcreditsarerecognizedasareductionofsalesandincentivesconsistingoffreeproductarerecognizedascostofsales.

incentivesgiventocustomerspriortodeliveringproductsorperformingservicesarerecordedasacustomerrelationshipintangibleassetandamortizedovertheperiodthecompanyhasreceivedacontractuallyenforceablerightrelatedtotheincentive.incentivesincludedinintangibleassetswere$36millionand$13millionatseptember30,2007and2006,respectively.

incentivesearnedbycustomersbasedonpurchasesofcompanyproductsorservicesarerecognizedasaliabilitywhentherelatedsaleisrecorded.theliabilityfortheseincen-tivesisincludedinothercurrentliabilities.

ROckwell cOllins annual RepORt 2007 39notestoconsolidatedFinancialstatements

Impairment of Long-Lived Assetslong-livedassetsarereviewedforimpairmentwhenman-agementplanstodisposeofassetsorwheneventsorcircumstancesindicatethatthecarryingamountofalong-livedassetmaynotberecoverable.assetsheldfordisposalarereportedatthelowerofthecarryingamountorfairvaluelesscosttosell.Managementdeterminesfairvalueusingadiscountedfuturecashflowanalysisorotheracceptedvalu-ationtechniques.long-livedassetsheldforusearereviewedforimpairmentbycomparingthecarryingamountofanassettotheundiscountedfuturecashflowsexpectedtobegener-atedbytheassetoveritsremainingusefullife.ifanassetisconsideredtobeimpaired,theimpairmenttoberecognizedismeasuredastheamountbywhichthecarryingamountoftheassetexceedsitsfairvalue.

Goodwillandindefinite-livedintangibleassetsaretestedannuallyforimpairmentwithmorefrequenttestsperformedifindicationsofimpairmentexist.thecompany’sannualimpairmenttestingdateisinthesecondquarterofeachfiscalyear.impairmentforintangibleassetswithindefinitelivesexistsifthecarryingvalueoftheintangibleassetexceedsitsfairvalue.Goodwillispotentiallyimpairedifthecarryingvalueofareportingunitexceedsitsestimatedfairvalue.Managementdeterminesfairvalueusingadiscountedfuturecashflowanalysisorotheracceptedvaluationtechniques.thecompany’sannualimpairmenttestingperformedinthesecondquarterof2007,2006,and2005yieldednoimpairments.seenote7foradiscussionofthetradenameswrite-offrecordedinthefourthquarterof2005.

Advance Payments from Customersadvancepaymentsfromcustomersrepresentcashcollectedfromcustomersinadvanceofrevenuerecognition.

Environmentalliabilitiesforenvironmentalmattersarerecordedintheperiodinwhichitisprobablethatanobligationhasbeenincurredandthecostcanbereasonablyestimated.atenvironmentalsitesinwhichmorethanonepotentiallyresponsiblepartyhasbeenidentified,thecompanyrecordsaliabilityforitsestimatedallocableshareofcostsrelatedtoitsinvolvementwiththesiteaswellasanestimatedallo-cableshareofcostsrelatedtotheinvolvementofinsolventorunidentifiedparties.atenvironmentalsitesinwhichthecompanyistheonlyresponsibleparty,thecompanyrecordsaliabilityforthetotalestimatedcostsofremediation.costsoffutureexpendituresforenvironmentalremediationobliga-tionsdonotconsiderinflationandarenotdiscountedtopresentvalues.ifrecoveryfrominsurersorotherthirdpartiesisdeterminedtobeprobable,thecompanyrecordsareceiv-ablefortheestimatedrecovery.

Income Taxescurrenttaxliabilitiesandassetsarebaseduponanestimateoftaxespayableorrefundableinthecurrentyearforeachofthejurisdictionsinwhichthecompanytransactsbusiness.aspartofthedeterminationofitstaxliability,managementexercisesconsiderablejudgmentinassessingthepositionstakenbythecompanyinitstaxreturnsandestablishesreservesforprobabletaxexposures.thesereservesrepre-sentthebestestimateofamountsexpectedtobepaidandareadjustedovertimeasmoreinformationregardingtaxauditsbecomesavailable.Deferredtaxassetsandliabilitiesarerecordedfortheestimatedfuturetaxeffectsattributabletotemporarydifferencesbetweenthecarryingamountsofassetsandliabilitiesusedforfinancialreportingpurposesandtheirrespectivecarryingamountsforincometaxpurposes.Deferredtaxassetsarereducedbyavaluationallowancewhen,intheopinionofmanagement,itismorelikelythannotthatsomeportionorallofthedeferredtaxassetswillnotberealized.

Derivative Financial Instrumentsthecompanyusesderivativefinancialinstrumentsintheformofforeigncurrencyforwardexchangecontractsandinterestrateswapcontractsforthepurposeofminimiz-ingexposuretochangesinforeigncurrencyexchangeratesonbusinesstransactionsandinterestrates,respectively.thecompany’spolicyistoexecutesuchinstrumentswithcreditworthybanksandnottoenterintoderivativefinancialinstrumentsforspeculativepurposesortomanageexposurefornetinvestmentsinforeignsubsidiaries.thesederivativefinancialinstrumentsdonotsubjectthecompanytoundueriskasgainsandlossesontheseinstrumentsgenerallyoffsetgainsandlossesontheunderlyingassets,liabilities,orantici-patedtransactionsthatarebeinghedged.

allderivativefinancialinstrumentsarerecordedatfairvalueinthestatementofFinancialPosition.Foraderivativethathasnotbeendesignatedasanaccountinghedge,thechangeinthefairvalueisrecognizedimmediatelythroughearnings.Foraderivativethathasbeendesignatedasanaccountinghedgeofanexistingassetorliability(afairvaluehedge),thechangeinthefairvalueofboththederivativeandunderlyingassetorliabilityisrecognizedimmediatelythroughearn-ings.Foraderivativedesignatedasanaccountinghedgeofananticipatedtransaction(acashflowhedge),thechangeinthefairvalueisrecordedonthestatementofFinancialPositioninaccumulatedothercomprehensivelosstotheextentthederivativeiseffectiveinmitigatingtheexposurerelatedtotheanticipatedtransaction.thechangeinthefairvaluerelatedtotheineffectiveportionofthehedge,ifany,isimmediatelyrecognizedinearnings.theamountrecordedwithinaccumulatedothercomprehensivelossisreclassifiedinearningsinthesameperiodduringwhichtheunderlyinghedgedtransactionaffectsearnings.thecompanydoesnotexcludeanyamountsfromthemeasureofeffectivenessforbothfairvalueandcashflowhedges.

ROckwell cOllins annual RepORt 2007 40notestoconsolidatedFinancialstatements

Use of EstimatesthefinancialstatementsofthecompanyhavebeenpreparedinaccordancewithaccountingprinciplesgenerallyacceptedintheUnitedstatesofamerica,whichrequiremanagementtomakeestimatesandassumptionsthataffecttheamountsreportedinthefinancialstatements.actualresultscoulddifferfromthoseestimates.estimatesareusedinaccountingfor,amongotheritems,long-termcontracts,allowancesfordoubtfulaccounts,inventoryobsolescence,productwarrantycostliabilities,customerincentiveliabilities,retirementben-efits,incometaxes,environmentalmatters,recoverabilityoflong-livedassetsandcontingencies.estimatesandassump-tionsarereviewedperiodicallyandtheeffectsofchanges,ifany,arereflectedinthestatementofoperationsintheperiodthattheyaredetermined.

Concentration of Risksthecompany’sproductsandservicesareconcentratedwithintheaerospaceanddefenseindustrieswithcustomersconsistingprimarilyofmilitaryandcommercialaircraftmanu-facturers,commercialairlines,andtheUnitedstatesandinternationalgovernments.asaresultofthisindustryfocus,thecompany’scurrentandfuturefinancialperformanceislargelydependentupontheoveralleconomiccondi-tionswithintheseindustries.inparticular,thecommercialaerospacemarkethasbeenhistoricallycyclicalandsubjecttodownturnsduringperiodsofweakeconomicconditions,whichcouldbepromptedbyorexacerbatedbypoliticalorotherdomesticorinternationalevents.thedefensemarketmaybeaffectedbychangesinbudgetappropriations,pro-curementpolicies,politicaldevelopmentsbothdomesticallyandabroad,andotherfactors.Whilemanagementbelievesthecompany’sproductofferingsarewellpositionedtomeettheneedsofitscustomerbase,anymaterialdeteriorationintheeconomicandenvironmentalfactorsthatimpacttheaerospaceanddefenseindustriescouldhaveamaterialadverseeffectonthecompany’sresultsofoperations,finan-cialpositionorcashflows.

inadditiontotheoverallbusinessrisksassociatedwiththecompany’sconcentrationwithintheaerospaceanddefenseindustries,thecompanyisalsoexposedtoaconcentrationofcollectionriskoncreditextendedtocommercialairlines.accountsreceivableduefromU.s.andinternationalcom-mercialairlinesatseptember30,2007wasapproximately$23millionand$91million,respectively.thecompanyper-formsongoingcreditevaluationsonthefinancialconditionofallofitscommercialairlinecustomersandmaintainsallow-ancesforuncollectibleaccountsreceivablebasedonexpectedcollectibility.althoughmanagementbelievesitsallowancesareadequate,thecompanyisnotabletopredictwithcertaintythechangesinthefinancialstabilityofitscustomers.anymaterialchangeinthefinancialstatusofanyoneorgroupofcustomerscouldhaveamaterialadverseeffectonthecom-pany’sresultsofoperations,financialpositionorcashflows.

asofseptember30,2007,approximately12percentofthecompany’semployeeswererepresentedbycollectivebargainingagreements.collectivebargainingagreementsrepresentingapproximately11percentofthecompany’semployeesexpirewithinoneyear.Failuretoreachnewagree-mentswiththesecollectivebargainingunitscouldresultinworkstoppageswhichcouldadverselyaffectthecompany’sresultsofoperations,financialpositionorcashflows.

Recently Issued Accounting StandardsinFebruary2007,theFinancialaccountingstandardsBoard(FasB)issuedstatementofFinancialaccountingstandards(sFas)no.159,The Fair Value Option for Financial Assets and Financial Liabilities(sFas159).sFas159permitsentitiestochoosetomeasurecertaineligiblefinancialassetsandfinan-cialliabilitiesatfairvalue(thefairvalueoption).sFas159alsoestablishespresentationanddisclosurerequirementsdesignedtofacilitatecomparisonsbetweenentitiesthatchoosedifferentmeasurementattributesforsimilartypesofassetsandliabilities.Unrealizedgainsandlossesonitemsforwhichthefairvalueoptioniselectedwouldbereportedinearnings.sFas159iseffectiveforthecompany’syearendingseptember30,2009.thecompanyiscurrentlyevaluatingwhethertoelectthefairvalueoptionforeligiblefinancialassetsand/orfinancialliabilitiesandtheimpact,ifany,ofsFas159onthecompany’sfinancialstatements.

inseptember2006,theFasBissuedsFasno.158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)(sFas158).UndersFas158,com-paniesmust:a)recognizeanetliabilityorassettoreportthefundedstatusoftheirdefinedbenefitplansontheirstate-mentoffinancialposition,b)measureaplan’sassetsanditsobligationsthatdetermineitsfundedstatusasoftheendoftheemployer’sfiscalyear,andc)recognizechangesinthefundedstatusofadefinedbenefitplanintheyearinwhichthechangesoccurincomprehensiveincome.Duringthefirstquarterof2007,thecompanycompleteditsevaluationofsFas158andelectedtoadoptthemeasurementdateprovi-sionsofsFas158effectiveoctober1,2006.thecompanyadoptedtherecognitionprovisionsofsFas158asoftheendof2007asrequiredbysFas158.seenote11forfurtherinfor-mationregardingthecompany’sadoptionofsFas158.

inseptember2006,theFasBissuedsFasno.157,Fair Value Measurements(sFas157).sFas157definesfairvalue,establishesaframeworkformeasuringfairvalueingener-allyacceptedaccountingprinciples,andexpandsdisclosuresaboutfairvaluemeasurements.sFas157appliesunderotheraccountingpronouncementsthatrequireorpermitfairvaluemeasurements.sFas157indicates,amongotherthings,afairvaluemeasurementassumesthatthetransactiontosellanassetortransferaliabilityoccursintheprincipalmar-ketfortheassetorliabilityor,intheabsenceofaprincipal

ROckwell cOllins annual RepORt 2007 41notestoconsolidatedFinancialstatements

market,themostadvantageousmarketfortheassetorliability.sFas157iseffectiveforthecompany’syearendingseptember30,2009.thecompanyiscurrentlyevaluatingtheimpactofsFas157onthecompany’sfinancialstatements.

inJune2006,theFasBissuedFasBinterpretationno.48,Accounting for Uncertainty in Income Taxes (Fin48).Fin48clarifiestheaccountingforuncertaintyinincometaxesbyestablishingaminimumrecognitionthresholdataxpositionisrequiredtomeetbeforebeingrecognizedinthefinancialstatements.Fin48prescribesacomprehensivemodelforhowacompanyshouldrecognize,derecognize,measure,present,anddiscloseinitsfinancialstatementsuncertaintaxposi-tionsthatacompanyhastakenorexpectstotakeonataxreturn.inaddition,Fin48providesguidanceoninterestandpenalties,accountingininterimperiods,andtransition.thecompanywilladoptFin48effectiveoctober1,2007,withanycumulativeeffectoftheadoptionrecordedasanadjustmenttobeginningretainedearnings.Basedonthecompany’scurrentassessment,theadoptionofFin48isnotexpectedtohaveamaterialeffectonthecompany’sfinancialstatements.

3. ACQUISITIONS

Duringtheyearsendedseptember30,2007,2006and2005,thecompanycompletedfiveacquisitionsthataresumma-rizedasfollows:

intanGiBleassets

WeiGHteD Fiscal casH aveRaGe yeaR PURcHase Finite liFein(dollarsinmillions) acqUiReD PRice GooDWill liveD yeaRs

informationtechnology&

applicationscorporation 2007 $37 $25 $14 7

anzus,inc. 2006 19 12 9 7

iPUnwired,inc. 2006 10 7 3 8

e&ssimulationBusiness 2006 66 33 22 9

telDiXGmbH 2005 19 45 15 11

Information Technology & Applications Corporationonaugust10,2007,thecompanyacquired100percentofthesharesofinformationtechnology&applicationscorporation(itac).itac,locatedinReston,virginia,isaproviderofintel-ligence,surveillance,reconnaissanceandcommunicationssolutionstosupporttheglobalwaronterrorandhomelandsecurity.thetotalcashpurchaseprice,netofcashacquired,was$37million.thecompanyisintheprocessofallocatingthepurchasepriceandobtainingavaluationforacquiredintangibleassets.Basedonthecompany’spreliminaryallocationofthepurchaseprice,$25millionhasbeenallo-catedtogoodwilland$14milliontofinite-livedintangibleassetswithaweightedaveragelifeofapproximately7years.theexcesspurchasepriceovernetassetsacquiredreflectsthecompany’sviewthatthisacquisitionwillenhancethecompany’scommunicationsintelligencecapabilities.noneofthegoodwillresultingfromtheacquisitionistaxdeductible.GoodwillisincludedwithintheassetsoftheGovernmentsystemssegment.

Anzus, Inc.onseptember25,2006,thecompanyacquired100percentofthesharesofanzus,inc.(anzus).anzus,locatedinPoway,california,isadeveloperofsoftwarethatenableshigh-speedtacticaldatalinkprocessingandsensorcorrelationfortheU.s.DepartmentofDefenseaswellasinternationalgovernments.thetotalcashpurchaseprice,netofcashacquired,was$19million.Duringthefourthquarterof2007,thepurchasepriceallocationwasfinalizedwith$12millionofthepurchasepriceallocatedtogoodwilland$9milliontofinite-livedintan-gibleassetswithaweightedaveragelifeofapproximately7years.theexcesspurchasepriceovernetassetsacquiredreflectsthecompany’sviewthatthisacquisitionwillenhancethecompany’stacticaldatalinkintegrationsolutions.noneofthegoodwillresultingfromtheacquisitionistaxdeduct-ible.GoodwillisincludedwithintheassetsoftheGovernmentsystemssegment.

IP Unwired, Inc.onseptember5,2006,thecompanyacquired100percentofthesharesofiPUnwired,inc.(iPUnwired).iPUnwired,locatedinottawa,canada,isaproviderofadvanceddigitalcommunicationsandnetworkingtechnologyforU.s.andinternationalmilitarycustomers.thetotalcashpurchaseprice,netofcashacquired,was$10million.Duringthefourthquarterof2007,thepurchasepriceallocationwasfinalizedwith$7millionofthepurchasepriceallocatedtogoodwilland$3milliontofinite-livedintangibleassetswithaweightedaveragelifeofapproximately8years.theexcesspurchasepriceovernetassetsacquiredreflectsthecompany’sviewthatthisacquisitionwillstrengthenthecompany’snetwork-centricoperationalcapabilities.allgoodwillresultingfromtheacquisitionistaxdeductible.GoodwillisincludedwithintheassetsoftheGovernmentsystemssegment.

E&S Simulation BusinessonMay26,2006,thecompanyacquiredevans&sutherlandcomputercorporation’s(e&s)militaryandcommercialsimulationassetsandcertainliabilities,includingoperationsintheUnitedstatesandUnitedKingdom(thee&ssimulationBusiness).thee&ssimulationBusinessproduceshardwareandsoftwaretocreatevisualimagesforsimulation,training,engineering,andotherapplicationsthroughouttheworld.inconnectionwiththistransaction,thecompanyalsoenteredintoalaserprojectionsystemsagreementwithe&swherebythecompanyhasexclusiveandnon-exclusiverightstolaserprojectorsfortheacquiredbusinessandcertainofthecompany’sotherrelatedbusinesses.

thetotalcashpurchasepricewasapproximately$66mil-lion,whichisnetofa$5millionpost-closingpurchasepriceadjustmentreceivedbythecompanyinMarch2007.Duringthethirdquarterof2007,thepurchasepriceandpurchasepriceallocationwerefinalizedwith$33millionofthepurchasepriceallocatedtogoodwilland$22milliontofinite-livedintangibleassetswithaweightedaveragelifeof

ROckwell cOllins annual RepORt 2007 42notestoconsolidatedFinancialstatements

approximately9years.theexcesspurchasepriceovernetassetsacquiredreflectsthecompany’sviewthatthisacquisi-tionwillfurtherenhancethecompany’ssimulationandtrainingcapabilitiesandprovidemorerobustsolutionsforthecompany’scustomers.allgoodwillresultingfromtheacquisi-tionistaxdeductible.$22millionofgoodwillisincludedintheGovernmentsystemssegmentand$11millionofgood-willisincludedinthecommercialsystemssegment.

TELDIX GmbHonMarch31,2005,thecompanyacquired100percentofthestockoftelDiXGmbH(telDiX),aleadingproviderofmilitaryaviationelectronicsproductsandservices,basedinHeidelberg,Germany.telDiXsuppliesabroadportfolioofcomplexmilitaryaircraftcomputerproducts,advancedmechanicalspacemechanismsandrelatedsupportservicestomajorprimecontractorsthroughouteurope.theacqui-sitionoftelDiXhasbroadenedthecompany’seuropeanpresenceandprovidescomplementaryproductlinesthatshouldallowthecompanytoenhanceitsofferingstocustomersworldwideandshouldprovidenewchannel-to-marketopportunitiesforthecompany’sotherproductsandservices.in2006,telDiXwascombinedwiththecompany’sexistingGermanoperationsandisnowcalledRockwellcollinsDeutschlandGmbH.in2006,thepurchasepriceandpurchasepriceallocationwerefinalized.thecashpurchaseprice,netofcashacquired,was$19millionofwhich$45millionwasallocatedtogoodwilland$15milliontofinitelivedintangibleassetswithaweightedaveragelifeofapproximately11years.theexcesspurchasepriceovernetassetsacquiredreflectsthecompany’sviewthatthereareopportunitiestoexpanditsmarketshareintheeuropeanregion.approximately18percentofthegoodwillresultingfromthisacquisitionistaxdeductible.GoodwillisincludedwithintheassetsoftheGovernmentsystemssegment.

theresultsofoperationsoftheseacquiredbusinessesareincludedinthestatementofoperationssincetheirrespectivedatesofacquisition.Proformafinancialinformationisnotpresentedastheeffectoftheseacquisitionsisnotmaterialtothecompany’sresultsofoperations.

4. RECEIVABLES

Receivablesaresummarizedasfollows: sePteMBeR30

(inmillions) 2007 2006

Billed $715 $665

Unbilled 207 203

lessprogresspayments (30) (35)

total 892 833

lessallowancefordoubtfulaccounts (9) (12)

Receivables $883 $821

thecompanyexpectstobillandcollectallreceivablesout-standingasofseptember30,2007withinthenexttwelve

months.asofseptember30,2006,theportionofreceivablesoutstandingthatwerenotexpectedtobecollectedwithinthenexttwelvemonthswasapproximately$7million.

Unbilledreceivablesprincipallyrepresentsalesrecordedunderthepercentage-of-completionmethodofaccountingthathavenotbeenbilledtocustomersinaccordancewithappli-cablecontractterms.

5. INVENTORIES

inventoriesaresummarizedasfollows: sePteMBeR30

(inmillions) 2007 2006

Finishedgoods $187 $172

Workinprocess 362 318

Rawmaterials,parts,andsupplies 371 329

total 920 819

lessprogresspayments (97) (92)

inventories $823 $727

inaccordancewithindustrypractice,inventoriesincludeamountswhicharenotexpectedtoberealizedwithinoneyear.theseamountsprimarilyrelatetolife-timebuyinventoryandcertainpre-productionengineeringcostsnotexpectedtoberealizedwithinoneyearof$183millionand$146millionatseptember30,2007and2006,respectively.life-timebuyinventoryisinventorythatistypicallynolongerbeingproducedbythecompany’svendorsbutforwhichmultipleyearsofsupplyarepurchasedinordertomeetproductionandservicerequirementsoverthelifespanofaproduct.

6. PROPERTy

Propertyissummarizedasfollows: sePteMBeR30

(inmillions) 2007 2006

land $ 31 $ 30

Buildingsandimprovements 307 281

Machineryandequipment 769 709

informationsystemssoftwareandhardware 276 264

constructioninprogress 72 63

total 1,455 1,347

lessaccumulateddepreciation (848) (795)

Property $ 607 $ 552

Propertyadditionsacquiredbyincurringaccountspayable,whicharereflectedasanon-cashtransactioninthecompany’sconsolidatedstatementofcashFlows,were$29million,$14million,and$14millionatseptember30,2007,2006,and2005,respectively.

ROckwell cOllins annual RepORt 2007 43notestoconsolidatedFinancialstatements

7. GOODWILL AND INTANGIBLE ASSETS

changesinthecarryingamountofgoodwillaresummarizedasfollows: GoveRnMent coMMeRcial(inmillions) systeMs systeMs total

Balanceatseptember30,2005 $278 $180 $458

e&ssimulationBusinessacquisition 20 14 34

iPUnwiredacquisition 7 — 7

anzusacquisition 14 — 14

currencytranslationadjustments 4 — 4

Balanceatseptember30,2006 323 194 517

itacacquisition 25 — 25

Purchasepriceallocationadjustments (1) (3) (4)

currencytranslationadjustments 6 — 6

Balanceatseptember30,2007 $353 $191 $544

intangibleassetsaresummarizedasfollows: sePteMBeR30,2007 sePteMBeR30,2006

(inmillions) GRoss accUMaMoRt net GRoss accUMaMoRt net

intangibleassetswithfinitelives:

Developedtechnologyandpatents $156 $ (72) $ 84 $143 $(58) $ 85

licenseagreements 11 (3) 8 24 (6) 18

customerrelationships 67 (19) 48 41 (14) 27

trademarksandtradenames 12 (7) 5 11 (6) 5

intangibleassetswithindefinitelives:

trademarksandtradenames 2 — 2 2 — 2

intangibleassets $248 $(101) $147 $221 $(84) $137

customersthatitwouldnolongerusecertainindefinitelivedtradenamesrelatedtoKaiseraerospaceandelectronicscorporation(Kaiser),acquiredinDecember2000.asaresult,thecompanyrecordeda$15millionpre-taxwrite-offinthefourthquarterof2005.thetradenameswrite-offwasrecordedincostofsales.

amortizationexpenseforintangibleassetsfortheyearsendedseptember30,2007,2006and2005was$22million,$21million,and$19million,respectively.annualamortiza-tionexpenseforintangibleassetsfor2008,2009,2010,2011,and2012isexpectedtobe$24million,$24million,$26mil-lion,$27million,and$17million,respectively.

thecommercialsystemssegmentpaid$14millionforalicensefeeinprioryearsrelatedtoastrategicagreementwiththeBoeingcompany(Boeing)toprovideaglobalbroad-bandconnectivitysolutionforbusinessaircraftthroughthecompany’scollinseXchange™product.inthefourthquarterof2006,Boeingannouncedtheywouldexitthehigh-speedbroadbandcommunicationsconnectivitymarkets.During2007,thecompanyandBoeingreachedasettlementthatincluded,amongotherthings,repaymentbyBoeingof$14milliontothecompany,representingthecarryingvalueofthelicenseagreement.

inthefourthquarterof2005,thecompanycompletedacompany-widebrandinginitiativeandannouncedtoits

ROckwell cOllins annual RepORt 2007 44notestoconsolidatedFinancialstatements

8. OTHER ASSETS

otherassetsaresummarizedasfollows: sePteMBeR30

(inmillions) 2007 2006

long-termdeferredincometaxes(note16) $ 1 $ 34

long-termreceivables 73 9

investmentsinequityaffiliates 10 13

exchangeandrentalassets,netofaccumulated

depreciationof$95atseptember30,2007

and$91atseptember30,2006 37 37

other 74 52

otherassets $195 $145

Investments in Equity Affiliates investmentsinequityaffiliatesconsistofinvestmentsinjointventures,eachofwhichis50percentownedbythecompanyandaccountedforundertheequitymethod.thecompany’sjointventurescurrentlyconsistofvisionsystemsinternational,llc(vsi),Datalinksolutions,llc(Dls),integratedGuidancesystems,llc(iGs),andquestFlighttraininglimited(quest).

vsiisajointventurewithelbitsystems,ltd.forthejointpursuitofhelmetmountedcueingsystemsfortheworldwidemilitaryfixedwingaircraftmarket.

DlsisajointventurewithBaesystems,plcforthejointpur-suitoftheworldwidemilitarydatalinkmarket.

iGsisajointventurewithHoneywellinternationalinc.establishedinnovemberof2005forthejointpursuitofintegratedprecisionguidancesolutionsforworldwideguidedweaponssystems.

questisajointventurewithquadrantGroupplc(quadrant)thatprovidesaircrewtrainingservicesforprimarilytheUnitedKingdomMinistryofDefense.the50percentinvestmentinquestwasacquiredfromevans&sutherlandinMayof2006.

Rockwellscientificcompany,llc(Rsc)wasajointventurewithRockwellautomation,inc.(Rockwellautomation)thatwasengagedinadvancedresearchanddevelopmentoftechnologiesinelectronics,imagingandoptics,materialandcomputationalsciencesandinformationtechnology.onseptember15,2006,thecompanyandRockwellautomationsoldRsctoteledyneBrownengineering,inc.(teledyne)for$168millionincash,ofwhichthecompanyreceivedapproxi-mately$84million(50percent),excludingexpensesandcertainretainedliabilities.aspartofthesale,thecompanyenteredintoaserviceagreementtocontinuefundingcertainresearchperformedbyRscfor$7million,$7million,and$4millionfor2007,2008,and2009,respectively.inaddition,teledyneagreedtolicensecertainintellectualpropertyofRsc

tothecompany.Priortothesale,Rscperformedresearchanddevelopmenteffortsonbehalfofthecompanyintheamountof$9millionforeachoftheyearsendedseptember30,2006and2005.inthefourthquarterof2006,thecompanyrecordedapre-taxgainof$20million($13millionaftertaxes,or7centspershare)relatedtothesaleofRsc.thispre-taxgainwasrecordedinotherincome,net.

Undertheequitymethodofaccountingforinvestments,thecompany’sproportionateshareoftheearningsorlossesofitsequityaffiliatesareincludedinnetincomeandclassifiedasotherincome,netinthestatementofoperations.Forseg-mentperformancereportingpurposes,Rockwellcollins’shareofearningsorlossesofvsi,Dls,iGs,andquestareincludedintheoperatingresultsoftheGovernmentsystemssegment.Rscwasconsideredacorporate-levelinvestmentpriortoitssalein2006.

inthenormalcourseofbusinessorpursuanttotheunder-lyingjointventureagreements,thecompanymaysellproductsorservicestoequityaffiliates.thecompanydefersaportionoftheprofitgeneratedfromthesesalesequaltoitsownershipinterestintheequityaffiliatesuntiltheunder-lyingproductisultimatelysoldtoanunrelatedthirdparty.salestoequityaffiliateswere$128million,$139million,and$126millionfortheyearsendedseptember30,2007,2006,and2005,respectively.thedeferredportionofprofitgeneratedfromsalestoequityaffiliateswas$6millionand$7millionatseptember30,2007and2006,respectively.

Exchange and Rental Assetsexchangeandrentalassetsconsistofcompanyproductsthatareeitherloanedorrentedtocustomersonashort-termbasisinconnectionwithwarrantyandotherservicerelatedactivitiesorunderoperatingleases.theseassetsarerecordedatacquisitionorproductioncostanddepreciatedusingthestraight-linemethodovertheirestimatedliveswhichrangefrom3-11years.Depreciationmethodsandlivesarereviewedperiodicallywithanychangesrecordedonaprospectivebasis.

9. OTHER CURRENT LIABILITIES

othercurrentliabilitiesaresummarizedasfollows: sePteMBeR30

(inmillions) 2007 2006

customerincentives $117 $125

contractreserves 18 37

other 78 81

othercurrentliabilities $213 $243

ROckwell cOllins annual RepORt 2007 45notestoconsolidatedFinancialstatements

10. DEBT

Revolving Credit FacilitiesinMay2005,thecompanyenteredintoan$850millionfive-yearunsecuredrevolvingcreditfacilitywithvariousbanks.thiscreditfacilityexistsprimarilytosupportthecompany’scommercialpaperprogram,butmaybeusedforothercor-poratepurposesintheeventaccesstothecommercialpapermarketisimpairedoreliminated.thecreditfacilityincludesonefinancialcovenantrequiringthecompanytomaintainaconsolidateddebttototalcapitalizationratioofnotgreaterthan60percent.theratiowas11percentasofseptember30,2007.inaddition,thecreditfacilitycontainscovenantsthatrequirethecompanytosatisfycertainconditionsinordertoincurdebtsecuredbyliens,engageinsale/leasebacktransac-tions,ormergeorconsolidatewithanotherentity.BorrowingsunderthiscreditfacilitybearinterestatthelondoninterbankofferedRate(liBoR)plusavariablemarginbasedonthecompany’sunsecuredlong-termdebtratingor,atthecompany’soption,ratesdeterminedbycompetitivebid.

onMarch7,2007,thecompanyamendedtheRevolvingcreditFacilitytoextendthetermbyapproximatelytwoyears,withoptionstofurtherextendthetermforuptotwoone-yearperiodsand/orincreasetheaggregateprincipalamountupto$1.2billion.theseoptionsaresubjecttotheapprovalofthelenders.theamendmentalsoloweredcertainmarginsapplicabletointerestrates,reducedthefacilityfeerate,andmodifiedthefinancialcovenanttoexcludethesFas158equityimpactrelatedtodefinedbenefitplansfromthecalcu-lationoftheconsolidateddebttototalcapitalizationratio.

inaddition,short-termcreditfacilitiesavailabletoforeignsubsidiarieswere$63millionasofseptember30,2007,ofwhich$24millionwasutilizedtosupportcommitmentsintheformofcommerciallettersofcredit.atseptember30,2007and2006,therewerenosignificantcommitmentfeesorcompensatingbalancerequirementsunderanyofthecompany’screditfacilitiesandtherewerenoborrowingsoutstandingunderanyofthecompany’screditfacilitiesorthecommercialpaperprogram.

Long-Term DebtinJune2006,thecompanyenteredintoafive-yearunsecuredvariablerateloanfacilityagreementfor20.4millioneuros($25million).theinterestrateisvariableattheeurointer-bankofferedRateplus35basispointsandinterestispayablequarterly.theoutstandingbalanceofthisloanfacilitywas$24millionand$25millionatseptember30,2007and2006,respectively.theinterestratewas5.08percentand3.77percentatseptember30,2007and2006,respectively.thevariablerateloanfacilitycontainscustomaryloancovenants,noneofwhicharefinancialcovenants.Failuretocomplywithcustomarycovenantsortheoccurrenceofcustomaryeventsofdefaultcontainedintheagreementwouldrequiretherepaymentofanyoutstandingborrowingsundertheagreement.

inJune2006,thecompanyenteredintoafive-yearunsecuredvariablerateloanfacilityagreementfor11.5millionBritishpounds($21million).thisloanfacilitywasrepaidin2007.atseptember30,2006theoutstandingbalanceofthisloanfacilitywas$22millionandtheinterestratewas5.42percent.

inaddition,thecompanyhasashelfregistrationstatementfiledwiththesecuritiesandexchangecommissioncoveringupto$750millionindebtsecurities,commonstock,pre-ferredstockorwarrantsthatmaybeofferedinoneormoreofferingsontermstobedeterminedatthetimeofsale.onnovember20,2003,thecompanyissued$200millionof4.75percentfixedrateunsecureddebtundertheshelfregis-trationdueDecember1,2013(thenotes).interestpaymentsonthenotesaredueonJune1andDecember1ofeachyear.thenotescontaincertaincovenantsandeventsofdefault,includingrequirementsthatthecompanysatisfycertaincon-ditionsinordertoincurdebtsecuredbyliens,engageinsale/leasebacktransactions,ormergeorconsolidatewithanotherentity.in2004,thecompanyenteredintointerestrateswapcontractswhicheffectivelyconverted$100millionaggregateprincipalamountofthenotestofloatingratedebtbasedonsix-monthliBoRless7.5basispoints.seenote17foraddi-tionalinformationrelatingtotheinterestrateswapcontracts.atseptember30,2007,$550millionoftheshelfregistrationstatementwasavailableforfutureuse.

long-termdebtandareconciliationtothecarryingamountissummarizedasfollows: sePteMBeR30

(inmillions) 2007 2006

PrincipalamountofnotesdueDecember1,2013 $200 $200

Principalamountofvariablerateloanfacilities

dueJune2011 24 47

Fairvalueswapadjustment(note17) (1) (2)

long-termdebt $223 $245

thecompanywasincompliancewithalldebtcovenantsatseptember30,2007and2006.

interestpaidondebtfortheyearsendedseptember30,2007,2006,and2005was$13million,$11million,and$10million,respectively.

ROckwell cOllins annual RepORt 2007 46notestoconsolidatedFinancialstatements

11. RETIREmENT BENEFITS

thecompanysponsorsdefinedbenefitpension(PensionBenefits)andotherpostretirement(otherRetirementBenefits)planscoveringmostofitsU.s.employeesandcertainemployeesinforeigncountrieswhichprovidemonthlypensionandotherbenefitstoeligibleemployeesuponretirement.

SFAS 158 AdoptionDuringthefirstquarterof2007,thecompanychangeditsmeasurementdatefromJune30toseptember30forallofthecompany’sdefinedbenefitplans.inaccordancewiththemeasurementdatetransitionprovisionsofsFas158,thecompanyremeasuredbenefitobligationsandplanassetsasofthebeginningofthefiscalyear.asaresultofthisremea-surement,retirementbenefitliabilitiesincreased$141millionandaccumulatedothercomprehensivelossincreased$47million,primarilyduetoadeclineinthediscountrateforPensionBenefitsfrom6.5percentto6.1percent.thecompanyalsorecordedachargetoRetainedearningsof$5million,aftertax,whichwasthenetbenefitcostfortheperiodfromJuly1,2006toseptember30,2006.inaddition,theremeasurementdecreasedoverallretirementnetbenefitcostby$1millionforfiscal2007.

effectiveseptember30,2007,thecompanyadoptedtherecognitionprovisionsofsFas158andrecognizedthefundedstatusofthecompany’sretirementbenefitplansonthestatementofFinancialPosition.thecompanyhasrecognizedtheaggregateofalloverfundedplansasaPrepaidPensionassetandtheaggregateofallunderfundedplansasaRetirementBenefitliability.thecurrentportionoftheliabilityistheamountbywhichtheactuarialpresentvalueofbenefitsincludedinthebenefitobligationpayableinthenext12monthsexceedsthefairvalueofplanassetsandisreflectedincompensationandBenefitsinthestatementofFinancialPosition.

atseptember30,2007,thepreviouslyunrecognizeddif-ferencesbetweenactualamountsandestimatesbasedonactuarialassumptionsareincludedinaccumulatedothercomprehensivelossinthestatementofFinancialPositionasrequiredbysFas158.infutureperiods,thedifferencesbetweenactualamountsandestimatesbasedonactuarial

assumptionswillberecognizedincomprehensiveincomeintheperiodinwhichtheyoccur.theadoptionofthesFas158recognitionprovisionshadnoeffectonthecompany’sstatementofoperationsfortheyearendedseptember30,2007,orforanypriorperiodspresented,andwillnotaffectthecompany’sstatementofoperationsinfutureperiods.

theincrementaleffectonindividuallineitemsinthestatementofFinancialPositionofadoptingtherecogni-tionprovisionsofsFas158issummarizedasfollowsasofseptember30,2007: asset(liaBility)

BeFoRe aFteR aDoPtion aDoPtion(inmillions) oFsFas158 aDJUstMents oFsFas158

PrepaidPensionasset $ 541 $(453) $ 88

long-termDeferredincometaxes (236) 193 (43)

compensationandBenefits (311) 6 (305)

RetirementBenefits (284) (75) (359)

accumulatedother

comprehensiveloss 7 329 336

amountsrecognizedinaccumulatedothercomprehensivelossatseptember30,2007areasfollows: otHeR Pension RetiReMent BeneFits BeneFits

Priorservicecost $(135) $(140)

netactuarialloss 636 210

total $ 501 $ 70

Components of Expense (Income)thecomponentsofexpense(income)forPensionBenefitsandotherRetirementBenefitsaresummarizedbelow: otHeR PensionBeneFits RetiReMentBeneFits

(inmillions) 2007 2006 2005 2007 2006 2005

servicecost $ 8 $ 50 $ 36 $ 4 $ 4 $ 3

interestcost 151 140 141 15 15 18

expectedreturnon

planassets (189) (181) (177) (1) (1) (1)

amortization:

Priorservicecost (19) (18) (15) (39) (39) (39)

netactuarialloss 58 79 46 16 19 20

netbenefitexpense

(income) $ 9 $ 70 $ 31 $ (5) $ (2) $ 1

ROckwell cOllins annual RepORt 2007 47notestoconsolidatedFinancialstatements

Funded Status and Net Asset (Liability)thefollowingtablereconcilestheprojectedbenefitobligations(PBo),planassets,fundedstatus,andnetasset(liability)forthecompany’sPensionBenefitsandtheotherRetirementBenefits.the2007columnincludesthetwelve-monthperiodfromoctober1,2006toseptember30,2007.theRemeasurecolumnincludesthethree-monthperiodfromJuly1,2006toseptem-ber30,2006whichreflectsthechangeinmeasurementdatefromJune30toseptember30.the2006columnincludesthetwelve-monthperiodfromJuly1,2005toJune30,2006. PensionBeneFits otHeRRetiReMentBeneFits

(inmillions) 2007 ReMeasURe 2006 2007 ReMeasURe 2006

PBoatbeginningofperiod $2,557 $2,423 $2,742 $ 278 $ 271 $ 301

servicecost 8 9 50 4 4 4

interestcost 151 38 140 15 1 15

Discountratechange (164) 119 (357) (10) 9 —

actuariallosses(gains) 130 1 5 (5) (2) (19)

Planamendments — — (36) (15) — —

Benefitspaid (140) (34) (129) (29) (5) (30)

other 12 1 8 — — —

PBoatendofperiod 2,554 2,557 2,423 238 278 271

Planassetsatbeginningofperiod 2,207 2,148 2,061 15 15 14

actualreturnonplanassets 328 90 143 2 — 2

companycontributions 90 3 71 27 5 30

Benefitspaid (140) (34) (129) (29) (5) (30)

other 5 — 2 — — (1)

Planassetsatendofperiod 2,490 2,207 2,148 15 15 15

Fundedstatusofplans (64) (350) (275) (223) (263) (256)

contributionsaftermeasurementdate — — 1 — — —

Unamortizedamounts:

Priorservicecost — (153) (158) — (164) (173)

netactuarialloss — 866 802 — 245 242

netasset(liability) $ (64) $ 363 $ 370 $(223) $(182) $(187)

netasset(liability)consistsof:

Deferredtaxasset $ — $ 262 $ 234 $ — $ — $ —

Prepaidpensionasset 88 — — — — —

Retirementbenefitsliability (143) (346) (264) (213) (148) (153)

compensationandbenefitsliability (9) — — (10) (34) (34)

accumulatedothercomprehensiveloss — 447 400 — — —

netasset(liability) $ (64) $ 363 $ 370 $(223) $(182) $(187)

ROckwell cOllins annual RepORt 2007 48notestoconsolidatedFinancialstatements

theaccumulatedbenefitobligationforalldefinedben-efitpensionplanswas$2,547million,$2,548million,and$2,404millionatseptember30,2007,october1,2006,andseptember30,2006,respectively.

theestimatedamountsthatwillbeamortizedfromaccumulatedothercomprehensivelossintonetdefined

benefitexpense(income)duringtheyearendingseptember30,2008areasfollows:

otHeR Pension RetiReMent BeneFits BeneFits

Priorservicecost $ (19) $ (33)

netactuarialloss 47 14

total $ 28 $ (19)

Actuarial Assumptionsthefollowingtablepresentsthesignificantassumptionsusedindeterminingthebenefitobligations.the2007columnrelatestothebenefitobligationsatseptember30,2007.theRemeasurecolumnrelatestothebenefitobligationsatoctober1,2006,whichreflectsthechangeinmeasurementdatefromJune30toseptember30.the2006columnrelatestothebenefitobligationatJune30,2006.

PensionBeneFits otHeRRetiReMentBeneFits

2007 ReMeasURe 2006 2007 ReMeasURe 2006

Discountrate 6.60% 6.10% 6.50% 6.50% 6.00% 6.50%

compensationincreaserate 4.50% 4.50% 4.50% — — —

thediscountratesusedtodeterminethebenefitobligationswerebasedonindividualbond-matchingmodelscomprisedofportfoliosofhigh-qualitycorporatebondswithprojectedcashflowsandmaturitydatesreflectingtheexpectedtimehorizonthatbenefitswillbepaid.Bondsincludedinthemodelportfoliosarefromacross-sectionofdifferentissuers,areratedaa-orbetter,arenon-callable,andhaveatleast$25millionoutstandingatthemeasurementdate.

significantassumptionsusedindeterminingthenetbenefitexpense(income)areasfollows: otHeR RetiReMent PensionBeneFits BeneFits

2007 2006 2007 2006

Discountrate 6.10% 5.30% 6.00% 5.30%

expectedlong-termreturnon

planassets 8.75% 8.75% 8.75% 8.75%

compensationincreaserate 4.50% 4.50% — —

Pre-65healthcarecostgross

trendrate* — — 11.00% 11.00%

Post-65healthcarecostgross

trendrate* — — 11.00% 11.00%

Ultimatetrendrate* — — 5.50% 5.50%

yearthattrendreachesultimaterate* — — 2013 2012

*Duetotheeffectofthefixedcompanycontribution,thenetimpactofanychangeintrendrateisnotsignificant.

expectedlong-termreturnonplanassetsforeachyearpresentedisbasedonbothhistoricallong-termactualandexpectedfutureinvestmentreturnsconsideringthecurrentinvestmentmixofplanassets.actuarialgainsandlossesinexcessof10percentofthegreateroftheprojectedbenefitobligationormarket-relatedvalueofassetsareamortized

onastraight-linebasisovertheaverageremainingserviceperiodofactiveparticipants.Priorservicecostsresultingfromplanamendmentsareamortizedinequalannualamountsovertheaverageremainingserviceperiodofaffectedactiveparticipantsorovertheremaininglifeexpectancyofaffectedretiredparticipants.thecompanyusesafive-year,market-relatedvalueassetmethodofamortizingthedifferencebetweenactualandexpectedreturnsonplanassets.

Pension Plan Benefitsthecompanyprovidespensionbenefitstomostofthecompany’sU.s.employeesintheformofnon-contributory,definedbenefitplansthatareconsideredqualifiedplansunderapplicablelaws.thebenefitsprovidedundertheseplansforsalariedemployeesaregenerallybasedonyearsofserviceandaveragecompensation.thebenefitsprovidedundertheseplansforhourlyemployeesaregenerallybasedonspecifiedbenefitamountsandyearsofservice.inaddi-tion,thecompanysponsorsanunfundednon-qualifieddefinedbenefitplanforcertainemployees.thecompanyalsomaintainstwopensionplansinforeigncountries,oneofwhichisunfunded.

inJune2003,thecompany’sU.s.qualifiedandnon-qualifieddefinedbenefitpensionplanswereamendedtodiscontinuebenefitaccrualsforsalaryincreasesandservicesrenderedafterseptember30,2006.thesechangesaffectallofthecompany’sdomesticpensionplansforallsalariedandhourlyemployeesnotcoveredbycollectivebargainingagreements.thecompanysupplementeditsexistingdefinedcontributionsavingsplaneffectiveoctober1,2006toincludeadditionalcompanycontributionswhichwere$28millionin2007.

ROckwell cOllins annual RepORt 2007 49notestoconsolidatedFinancialstatements

in2006,thecompany’sU.s.qualifieddefinedbenefitpen-sionplanwasalsoamendedtodiscontinuepre-retirementandpost-retirementlumpsumancillarydeathbenefits.theamendmentiseffectiveforactiveemployeeswhoareentitledtoadeferredvestedbenefitthatdieonorafteroctober1,2006,andforretireesundertheplanwhodieonorafterJanuary1,2007.theeffectofthisplanamendmentwastobothreducethebenefitobligationandincreasethefundedstatusofthecompany’sU.s.qualifiedpensionplanby$28millionatseptember30,2006.

alsoduring2006,thecompany’sUnitedKingdomdefinedbenefitpensionplanwasamendedtodiscontinuebenefitaccrualsforsalaryincreasesandservicesrenderedafterFebruary28,2009forallparticipants.concurrently,thecompanyenhanceditsexistingdefinedcontributionsavingsplaneffectiveMarch1,2006toincludeadditionalcompanycontributions.newhiresonorafterMarch1,2006participateonlyinthedefinedcontributionplan.existingemployeesmaychoosetomovetotheexpandeddefinedcontributionsavingsplananytimeafterMarch1,2006.theeffectofthisplanamendmentwastobothreducethebenefitobligationandincreasethefundedstatusofthecompany’sUnitedKingdompensionplanby$8millionatseptember30,2006.

Fortheyearsendedseptember30,2007and2006,thecompanymadecontributionstoitspensionplansasfollows:

(inmillions) 2007 2006

DiscretionarycontributionstoU.s.qualifiedplan $75 $50

contributionstointernationalplans 7 9

contributionstoU.s.non-qualifiedplan 8 7

total $90 $66

thecompany’sobjectivewithrespecttothefundingofitspensionplansistoprovideadequateassetsforthepaymentoffuturebenefits.Pursuanttothisobjective,thecompanywillfunditspensionplansasrequiredbygovernmentalregulationsandmayconsiderdiscretionarycontributionsasconditionswarrant.althoughnotrequiredtomakeanycon-tributionstoitsU.s.qualifiedpensionplanbygovernmentalregulations,thecompanyiscontemplatingmakingadiscre-tionarycontributionofupto$75millionin2008tofurtherimprovethefundedstatusofthisplan.contributionstothecompany’sinternationalplansandtheU.s.non-qualifiedplanareexpectedtototal$14millionin2008.

Other Retirement Benefitsotherretirementbenefitsconsistofretireehealthcareandlifeinsurancebenefitsthatareprovidedtosubstantiallyallofthecompany’sU.s.employeesandcovereddependents.employeesgenerallybecomeeligibletoreceivethesebenefitsiftheyretireafterage55withatleast10yearsofservice.Mostplansarecontributorywithretireecontributionsgenerallybaseduponyearsofserviceandadjustedannuallybythecompany.Retireemedicalplanspayastatedpercent-ageofexpensesreducedbydeductiblesandothercoverage,principallyMedicare.theamountthecompanywillcontrib-utetowardretireemedicalcoverageformostemployeesisfixed.additionalpremiumcontributionswillberequiredfromparticipantsforallcostsinexcessofthecompany’sfixedcontributionamount.asaresult,increasingordecreasingthehealthcarecosttrendratebyonepercentagepointwouldnothaveasignificantimpactonthecompany’scostofprovidingthesebenefits.Retireelifeinsuranceplansprovidecoverageataflatdollaramountorasamultipleofsalary.Withtheexceptionofcertainbargainingunitplans,otherRetirementBenefitsarefundedasexpensesareincurred.

otherRetirementBenefitplanamendmentsreducedthebenefitobligationby$15millionatseptember30,2007.theplanamendmentsprimarilyrelatedtothecompanynolongerprovidingpost-age65prescriptiondrugcoverageeffectiveJanuary1,2008.

Plan AssetstotalplanassetsforPensionBenefitsandotherRetirementBenefitsasofseptember30,2007and2006were$2,505millionand$2,163million,respectively.thecompanyhasestablishedinvestmentobjectivesthatseektopreserveandmaximizetheamountofplanassetsavailabletopayplanbenefits.theseobjectivesareachievedthroughinvestmentguidelinesrequiringdiversificationandallocationstrategiesdesignedtomaximizethelong-termreturnsonplanassetswhilemaintainingaprudentlevelofinvestmentrisk.theseinvestmentstrategiesareimplementedusingactivelyman-agedandindexedassets.targetandactualassetallocationsasofseptember30areasfollows:

taRGetMiX 2007 2006

equities 40%–70% 69% 68%

Fixedincome 25%–60% 30% 28%

alternativeinvestments 0%–15% — —

cash 0%– 5% 1% 4%

alternativeinvestmentsmayincluderealestate,hedgefunds,venturecapital,andprivateequity.therewerenoplanassetsinvestedinthesecuritiesofthecompanyasofseptember30,2007and2006oratanytimeduringtheyearsthenended.targetandactualassetallocationsareperiodicallyrebalancedbetweenassetclassesinordertomitigateinvestmentriskandmaintainassetclasseswithintargetallocations.

ROckwell cOllins annual RepORt 2007 50notestoconsolidatedFinancialstatements

Benefit Paymentsthefollowingtablereflectsestimatedbenefitpaymentstobemadetoeligibleparticipantsforeachofthenextfiveyearsandthefollowingfiveyearsinaggregate:

otHeR Pension RetiReMent(inmillions) BeneFits BeneFits

2008 $141 $25

2009 145 22

2010 150 22

2011 154 21

2012 160 20

2013–2017 907 98

substantiallyallofthePensionBenefitpaymentsrelatetothecompany’squalifiedfundedplanswhicharepaidfromthepensiontrust.

12. SHAREOWNERS’ EQUITy

Common Stockthecompanyisauthorizedtoissueonebillionsharesofcom-monstock,parvalue$0.01pershare,and25millionsharesofpreferredstock,withoutparvalue,ofwhich2.5millionsharesaredesignatedasseriesaJuniorParticipatingPreferredstockforissuanceinconnectionwiththeexerciseofpreferredsharepurchaserights.atseptember30,2007,10.4millionsharesofcommonstockwerereservedforissuanceundervariousemployeeincentiveplans.

Preferred Share Purchase RightseachoutstandingshareofcommonstockprovidestheholderwithonePreferredsharePurchaseRight(Right).theRightswillbecomeexercisableonlyifapersonorgroupacquires,orofferstoacquire,withoutpriorapprovaloftheBoardofDirectors,15percentormoreofthecompany’scommonstock.However,theBoardofDirectorsisauthorizedtoreducethe15percentthresholdfortriggeringtheRightstonotlessthan10percent.Uponexercise,eachRightentitlestheholderto1/100thofashareofseriesaJuniorParticipatingPreferredstockofthecompany(JuniorPreferredstock)atapriceof$125,subjecttoadjustment.

Uponacquisitionofthecompany,eachRight(otherthanRightsheldbytheacquirer)willgenerallybeexercisablefor$250worthofeithercommonstockofthecompanyorcommonstockoftheacquirerfor$125.incertaincircumstances,eachRightmaybeexchangedbythecompanyforoneshareofcom-monstockor1/100thofashareofJuniorPreferredstock.theRightswillexpireonJune30,2011,unlessearlierexchangedorredeemedat$0.01perRight.theRightshavetheeffectofsubstantiallyincreasingthecostofacquiringthecompanyinatransactionnotapprovedbytheBoardofDirectors.

Treasury Stockthecompanyrepurchasedsharesofitscommonstockasfollows:

(inmillions) 2007 2006 2005

amountofsharerepurchases $333 $492 $498

numberofsharesrepurchased 4.6 9.3 10.6

asdiscussedinnote18,thecompanypaid$19millionin2007relatedtothesettlementofanacceleratedsharerepurchaseagreementexecutedin2006,whichisreflectedinthetableabove.atseptember30,2007,thecompanywasauthorizedtorepurchaseanadditional$240millionofoutstandingstockunderthecompany’ssharerepurchaseprogram.inoctober2007(subsequenttoyear-end),thecompanyenteredintoanacceleratedsharerepurchaseagree-mentwithaninvestmentbankunderwhichthecompanyrepurchased3millionsharesofoutstandingstockforaninitialpriceof$224million.thisacceleratedsharerepurchasereducedtheamountofadditionalsharesthecompanyisauthorizedtorepurchaseunderthecurrentBoardofDirectorsauthorizationto$16million.inaddition,thecompanycanelecttosharesettleorcashsettletheacceleratedsharerepurchaseagreement.

Accumulated Other Comprehensive Lossaccumulatedothercomprehensivelossconsistsofthefollowing: sePteMBeR30

(inmillions) 2007 2006 2005

Unamortizedpensionandother

retirementbenefits,netoftaxes

of$211for2007 $(360) $ — $ —

Minimumpensionliabilityadjustment,

netoftaxesof$234for2006and

$351for2005 — (400) (599)

Foreigncurrencytranslationadjustment 27 8 (3)

Foreigncurrencycashflow

hedgeadjustment (3) (1) (2)

accumulatedothercomprehensiveloss $(336) $(393) $(604)

ROckwell cOllins annual RepORt 2007 51notestoconsolidatedFinancialstatements

13. STOCK-BASED COmPENSATION

Stock-Based Compensation ExpensePriortooctober1,2005,thecompanyaccountedforemployeestock-basedcompensationusingtheintrinsicvaluemethod.Undertheintrinsicvaluemethod,compensationexpenseisrecordedfortheexcessofthestock’squotedmar-ketpriceatthetimeofgrantovertheamountanemployeehadtopaytoacquirethestock.asthecompany’svariousincentiveplansrequirestockoptionstobegrantedatpricesequaltoorabovethefairmarketvalueofthecompany’scommonstockonthegrantdates,nocompensationexpensewasrecordedpriortooctober1,2005undertheintrinsicvaluemethod.

thecompanyadoptedsFasno.123(revised2004),Share-Based Payment(sFas123R)usingthemodifiedprospectivemethodasofoctober1,2005.Underthismethod,stock-basedcompensationexpensefor2007and2006includestherequisiteserviceperiodportionofthegrantdatefairvalueof:(a)allawardsofequityinstrumentsgrantedpriorto,butnotyetvestedasof,september30,2005;and(b)allawardsofequityinstrumentsgrantedsubsequenttoseptember30,2005.

stock-basedcompensationexpenseisrecognizedonastraight-linebasisovertherequisiteserviceperiod.totalstock-basedcompensationexpenseincludedwithintheconsolidatedstatementofoperationsfor2007and2006isasfollows:

(inmillions,exceptpershareamounts) 2007 2006

stock-basedcompensationexpenseincludedin:

Productcostofsales $ 4 $ 4

servicecostofsales 1 1

selling,generalandadministrativeexpenses 12 13

incomebeforeincometaxes $ 17 $ 18

netincome $ 11 $ 12

Basicanddilutedearningspershare $0.07 $0.07

inaccordancewiththemodifiedprospectiveadoptionmethodofsFas123R,financialresultsforthepriorperiodshavenotbeenrestated.

Stock-Based Compensation Program DescriptionUnderthecompany’s2001long-termincentivesPlanandDirectorsstockPlan,upto14.3millionsharesofcommonstockmaybeissuedbythecompanyasnon-qualifiedoptions,incentivestockoptions,performanceunits,performanceshares,stockappreciationrights,andrestrictedstock.sharesavailableforfuturegrantorpaymentundertheseplanswere0.5millionatseptember30,2007.

Underthecompany’s2006long-termincentivesPlan,upto11.0millionsharesofcommonstockmaybeissuedbythecompanyasnon-qualifiedoptions,incentivestockoptions,performanceunits,performanceshares,stockapprecia-tionrights,restrictedstock,restrictedstockunits,dividendequivalentrights,andotherawards.eachshareissuedpursuanttoanawardofrestrictedstock,restrictedstock

units,performanceshares,andperformanceunitscountsasthreesharesagainsttheauthorizedlimit.sharesavailableforfuturegrantorpaymentunderthisplanwere9.9millionatseptember30,2007.

optionstopurchasecommonstockofthecompanyhavebeengrantedundervariousincentiveplanstodirectors,officers,andotherkeyemployees.allofthecompany’sstock-basedincentiveplansrequireoptionstobegrantedatpricesequaltoorabovethefairmarketvalueofthecommonstockonthedatestheoptionsaregranted.theplansprovidethattheoptionpriceforcertainoptionsgrantedundertheplansmaybepaidbytheemployeeincash,sharesofcom-monstock,oracombinationthereof.certainoptionawardsprovideforacceleratedvestingifthereisachangeincontrol.stockoptionsgenerallyexpiretenyearsfromthedatetheyaregrantedandgenerallyvestratablyoverthreeyears.thecompanyhasanongoingsharerepurchaseplanandexpectstosatisfyshareoptionexercisesfromtreasurystock.

Historicallythecompanyhasutilizedstockoptionsasthepri-marycomponentofstock-basedcompensationawardsunderitslong-termincentiveplansforofficersandotherkeyemploy-ees.in2006,thecompanybeganusingfewerstockoptionsaspartoftheseawardsandintroducedmulti-yearperformancesharesandrestrictedstock.Boththeperformancesharesandrestrictedstockcliffvestattheendofthreeyears.thenumberofperformancesharesthatwillultimatelybeissuedisbasedonachievementofperformancetargetsoverathree-yearperiodthatconsiderscumulativesalesgrowthandreturnonsaleswithanadditionalpotentialadjustmentupordowndependingonthecompany’stotalreturntoshareownerscomparedtoagroupofpeercompanies.thecompany’sstock-basedcompensationawardsaredesignedtoalignmanagement’sinterestswiththoseofthecompany’sshare-ownersandtorewardoutstandingcompanyperformance.thecompany’sstock-basedcompensationawardsserveasanimportantretentiontoolbecausetheawardsgenerallyvestoverathree-yearperiodorcliffvestattheendofthreeyears.

Pro Forma Information for the Period Prior to Fiscal 2006thefollowingtableillustratestheeffectonnetincomeandearningspershareifthecompanyhadaccountedforitsstock-basedcompensationplansusingthefairvaluemethodfortheyearendedseptember30,2005:

(inmillions,exceptpershareamounts) 2005

netincome,asreported $396

stock-basedemployeecompensationexpenseincludedin

reportednetincome,netoftax —

stock-basedemployeecompensationexpensedetermined

underthefairvaluebasedmethod,netoftax (13)

Proformanetincome $383

earningspershare:

Basic–asreported $2.24

Basic–proforma $2.16

Diluted–asreported $2.20

Diluted–proforma $2.13

ROckwell cOllins annual RepORt 2007 52notestoconsolidatedFinancialstatements

General Option Informationthefollowingsummarizestheactivityofthecompany’sstockoptionsfor2007,2006,and2005:

2007 2006 2005

WeiGHteD WeiGHteD WeiGHteD aveRaGe aveRaGe aveRaGe(sharesinthousands) sHaRes eXeRcisePRice sHaRes eXeRcisePRice sHaRes eXeRcisePRice

numberofsharesunderoption:

outstandingatbeginningofyear 8,091 $28.16 10,428 $26.52 13,311 $24.37

Granted 456 58.36 590 45.22 1,337 36.88

exercised (2,388) 26.44 (2,848) 25.52 (4,172) 22.96

Forfeitedorexpired (29) 45.01 (79) 34.49 (48) 28.14

outstandingatendofyear 6,130 30.99 8,091 28.16 10,428 26.52

exercisableatendofyear 4,886 26.89 5,979 25.26 7,146 23.78

2007 2006 2005

Weighted-averagefairvalueperoptionofoptionsgranted $16.70 $13.46 $10.06

intrinsicvalueofoptionsexercised $94million $75million $88million

taxdeductionresultingfromintrinsicvalueofoptionsexercised $34million $27million $33million

theintrinsicvalueofoptionsoutstandingandoptionsexercisableatseptember30,2007was$258millionand$225million,respectively.

thefollowingtablesummarizesthestatusofthecompany’sstockoptionsoutstandingatseptember30,2007:

oPtionsoUtstanDinG oPtionseXeRcisaBle

WeiGHteDaveRaGe WeiGHteDaveRaGe

ReMaininG eXeRcise ReMaininG eXeRcise(sharesinthousands,remaininglifeinyears) sHaRes liFe PRice sHaRes liFe PRice

RangeofexercisePrices

$15.30to$29.13 3,512 $23.24 3,512 $23.24

$29.14to$37.78 1,594 35.23 1,187 34.77

$37.79to$52.20 560 45.02 181 45.13

$52.21to$70.64 464 58.26 6 55.49

total 6,130 5.4 30.99 4,886 4.7 26.89

thefollowingsummarizestheactivityofthecompany’sstockoptionsthathavenotvestedfortheyearsendedseptember30,2007,2006,and2005:

2007 2006 2005

WeiGHteD WeiGHteD WeiGHteD aveRaGe aveRaGe aveRaGe(sharesinthousands) sHaRes eXeRcisePRice sHaRes eXeRcisePRice sHaRes eXeRcisePRice

nonvestedatbeginningofyear 2,112 $36.39 3,282 $32.49 3,297 $27.51

Granted 456 58.36 590 45.22 1,337 36.88

vested (1,295) 33.61 (1,703) 34.35 (1,311) 26.35

Forfeitedorexpired (29) 45.01 (57) 36.12 (41) 29.21

nonvestedatendofyear 1,244 47.13 2,112 36.39 3,282 32.49

thetotalfairvalueofoptionsvestedwas$13million,$17million,and$11millionduringtheyearsendedseptember30,2007,2006,and2005,respectively.totalunrecognizedcompensationexpenseforoptionsthathavenotvestedasofseptember30,2007is$6millionandwillberecognizedoveraweightedaverageperiodof0.6years.

ROckwell cOllins annual RepORt 2007 53notestoconsolidatedFinancialstatements

Performance Shares, Restricted Shares, and Restricted Stock Units Informationthefollowingsummarizestheperformanceshares,restrictedshares,andrestrictedstockunitsasofseptember30,2007and2006:

PeRFoRMancesHaRes RestRicteDsHaRes RestRicteDstocKUnits

(inmillions,exceptsharesandpershareamounts, remaininglifeinyears) 2007 2006 2007 2006 2007 2006

outstandingatbeginningofyear 77,229 — 61,475 — 18,523 —

Granted 64,377 79,127 42,520 62,875 21,323 18,523

Restrictionsreleased — — (886) — (1,516) —

Forfeited (7,756) (1,898) (1,760) (1,400) — —

outstandingatendofyear 133,850 77,229 101,349 61,475 38,330 18,523

totalunrecognizedcompensationcosts $ 7 $ 5 $ 3 $ 2 $ — $ —

Weightedaveragefairvaluepershareofawardsgranted $58.36 $45.18 $58.69 $46.37 $65.32 $52.40

Weightedaverageliferemaining 1.6 2.1 1.7 1.9 — —

Stock Option Fair Value Informationthecompany’sdeterminationoffairvalueofoptionawardsonthedateofgrantusinganoption-pricingmodelisaffectedbythecompany’sstockpriceaswellasassumptionsregard-inganumberofsubjectivevariables.theseassumptionsinclude,butarenotlimitedto:thecompany’sexpectedstockpricevolatilityoverthetermoftheawards,theprojectedemployeestockoptionexerciseterm,theexpecteddivi-dendyield,andtherisk-freeinterestrate.changesintheseassumptionscanmateriallyaffecttheestimatedvalueofthestockoptions.

thefairvalueofeachoptiongrantedbythecompanywasestimatedusingabinomiallatticepricingmodelandthefol-lowingweightedaverageassumptions:

2007 2006 2005 GRants GRants GRants

Risk-freeinterestrate 4.55% 4.40% 3.55%

expecteddividendyield 1.09% 1.08% 1.50%

expectedvolatility 0.28 0.30 0.30

expectedlife 5years 5years 5years

theexpectedlifeofemployeestockoptionsrepresentstheweighted-averageperiodthestockoptionsareexpectedtoremainoutstanding.thebinomiallatticemodelassumesthatemployees’exercisebehaviorisafunctionoftheoption’sremainingexpectedlifeandtheextenttowhichtheoptionisin-the-money.thebinomiallatticemodelestimatestheprob-abilityofexerciseasafunctionofthesetwovariablesbasedontheentirehistoryofexercisesandforfeituresonallpastoptiongrantsmadebythecompany.

themaximumnumberofperformancesharesgrantedin2007thatcanbeissuedbasedontheachievementofperformancetargetsforfiscalyears2007through2009is149,789.themaximumnumberofperformancesharesgrantedin2006thatcanbeissuedbasedontheachievementofperformancetargetsforfiscalyears2006through2008is171,451.

Diluted Share EquivalentsDilutivestockoptionsoutstandingresultedinanincreaseinaverageoutstandingdilutedsharesof2.4million,2.5mil-lion,and3.2millionfor2007,2006,and2005,respectively.theaverageoutstandingdilutedsharescalculationexcludesoptionswithanexercisepricethatexceedstheaveragemar-ketpriceofsharesduringtheyear.lessthan0.1millionstockoptionswereexcludedfromtheaverageoutstandingdilutedsharescalculationin2007,2006and2005.Dilutiveperfor-manceshares,restrictedshares,andrestrictedstockunitsresultedinanincreaseinaverageoutstandingdilutivesharesof0.2millionin2007andlessthan0.1millionin2006.

Employee Benefits Paid in Company StockthecompanyoffersanemployeestockPurchasePlan(esPP)whichallowsemployeestohavetheirbasecompensationwithheldtopurchasethecompany’scommonstock.

PriortoJune1,2005,sharesofthecompany’scommonstockcouldbepurchasedundertheesPPatsix-monthintervalsat85percentofthelowerofthefairmarketvalueonthefirstorthelastdayoftheofferingperiod.thereweretwoofferingperiodsduringtheyear,eachlastingsixmonths,beginningonDecember1andJune1.

effectiveJune1,2005,theesPPwasamendedwherebysharesofthecompany’scommonstockarepurchasedeachmonthbyparticipantsat95percentofthefairmarketvalueonthelastdayofthemonth.

thecompanyisauthorizedtoissue9.0millionsharesundertheesPP,ofwhich4.5millionsharesareavailableforfuturegrantatseptember30,2007.theesPPisconsideredanon-compensatoryplanandaccordinglynocompensationexpenseisrecordedinconnectionwiththisbenefit.

ROckwell cOllins annual RepORt 2007 54notestoconsolidatedFinancialstatements

thecompanyalsosponsorsdefinedcontributionsavingsplansthatareavailabletothemajorityofitsemployees.theplansallowemployeestocontributeaportionoftheircompensationonapre-taxand/orafter-taxbasisinaccor-dancewithspecifiedguidelines.thecompanymatchesapercentageofemployeecontributionsusingcommonstockofthecompanyuptocertainlimits.employeesmaytrans-feratanytimealloraportionoftheirbalanceincompanycommonstocktoanyoftheotherinvestmentoptionsofferedwithintheplans.inaddition,effectiveoctober1,2006,thedefinedcontributionsavingsplanwasamendedtoincludeanadditionalcashcontributionbasedonanemployee’sageandservice.thecompany’sexpenserelatedtothesavingsplanswas$75million,$39million,and$35millionfor2007,2006and2005,respectively.

During2007,2006,and2005,0.9million,1.0million,and1.9millionshares,respectively,ofcompanycommonstockwereissuedtoemployeesunderthecompany’semployeestockpurchaseanddefinedcontributionsavingsplansatavalueof$58million,$50million,and$69millionfortherespectiveperiods.

14. RESEARCH AND DEVELOPmENT

Researchanddevelopmentexpenseconsistsofthefollowing:

(inmillions) 2007 2006 2005

customer-funded $480 $443 $348

company-funded 347 279 243

totalresearchanddevelopment $827 $722 $591

15. OTHER INCOmE, NET

otherincome,netconsistsofthefollowing:

(inmillions) 2007 2006 2005

Gainonsaleofequityaffiliatea $ — $(20) $ —

earningsfromequityaffiliates (8) (8) (11)

interestincome (4) (5) (5)

Royaltyincome (6) (5) (3)

other,net 3 6 2

otherincome,net $(15) $(32) $(17)

a seenote8foradiscussionofthegainonsaleofRockwellscientificcompany,llc.

16. INCOmE TAXES

thecomponentsofincometaxexpenseareasfollows:

(inmillions) 2007 2006 2005

current:

Unitedstatesfederal $189 $161 $104

non-Unitedstates 12 12 11

Unitedstatesstateandlocal 14 6 5

totalcurrent 215 179 120

Deferred:

Unitedstatesfederal 41 27 25

non-Unitedstates (1) 3 —

Unitedstatesstateandlocal 3 3 6

totaldeferred 43 33 31

incometaxexpense $258 $212 $151

netcurrentdeferredincometaxbenefitsconsistofthetaxeffectsoftemporarydifferencesrelatedtothefollowing: sePteMBeR30

(inmillions) 2007 2006

inventory $ 4 $ 8

Productwarrantycosts 73 67

customerincentives 31 28

contractreserves 12 10

compensationandbenefits 34 31

other,net 22 24

currentdeferredincometaxes $176 $168

netlong-termdeferredincometaxbenefits(liabilities)consistofthetaxeffectsoftemporarydifferencesrelatedtothefollowing: sePteMBeR30

(inmillions) 2007 2006

Retirementbenefits $ 55 $119

intangibles (8) (4)

Property (62) (68)

stock-basedcompensation 11 6

other,net (39) (19)

long-termdeferredincometaxes $(43) $ 34

long-termdeferredincometaxassetsandliabilitiesareincludedintheconsolidatedstatementofFinancialPositionasfollows: sePteMBeR30

(inmillions) 2007 2006

otherassets $ 1 $34

otherliabilities (44) —

long-termdeferredincometaxes $(43) $34

Managementbelievesitismorelikelythannotthatthecurrentandlong-termdeferredtaxassetswillberealizedthroughthereductionoffuturetaxableincome.significantfactorsconsideredbymanagementinitsdeterminationoftheprobabilityoftherealizationofthedeferredtaxassetsinclude:(a)thehistoricaloperatingresultsofRockwellcollins($1,408millionofUnitedstatestaxableincomeoverthepastthreeyears),(b)expectationsoffutureearnings,and(c)the

ROckwell cOllins annual RepORt 2007 55notestoconsolidatedFinancialstatements

extendedperiodoftimeoverwhichtheretirementbenefitliabilitieswillbepaid.

theeffectiveincometaxratedifferedfromtheUnitedstatesstatutorytaxrateforthereasonssetforthbelow:

2007 2006 2005

statutorytaxrate 35.0% 35.0% 35.0%

Researchanddevelopmentcredit (4.0) (0.8) (3.9)

extraterritorialincomeexclusion (0.5) (3.0) (2.9)

Domesticmanufacturingdeduction (0.7) (0.4) —

stateandlocalincometaxes 1.1 0.5 1.4

Resolutionofpre-spindeferredtaxmatters — — (1.9)

other (0.3) (0.5) (0.1)

effectiveincometaxrate 30.6% 30.8% 27.6%

incometaxexpensewascalculatedbasedonthefollowingcomponentsofincomebeforeincometaxes:

(inmillions) 2007 2006 2005

Unitedstatesincome $802 $642 $512

non-Unitedstatesincome 41 47 35

total $843 $689 $547

thefederalResearchandDevelopmenttaxcreditexpiredDecember31,2005.onDecember20,2006,thetaxReliefandHealthcareactof2006wasenacted,whichretroactivelyreinstatedandextendedtheResearchandDevelopmenttaxcreditfromJanuary1,2006toDecember31,2007.theretroactivebenefitforthepreviouslyexpiredperiodfromJanuary1,2006toseptember30,2006wasrecognizedandloweredthecompany’seffectivetaxratebyabout1.5per-centagepointsfortheyearendedseptember30,2007.

thephase-outperiodforthefederalextraterritorialincomeexclusion(eti)taxbenefitendedonDecember31,2006.theenactedfederalreplacementtaxbenefitforeti,theDomesticManufacturingDeduction(DMD),willapplytothefull2007year.For2007,theavailableDMDtaxbenefitisone-thirdofthefullbenefitthatwillbeavailablein2011.theamountofDMDtaxbenefitavailablein2008,2009and2010willbetwo-thirdsofthefullbenefit.

theinternalRevenueservice(iRs)iscurrentlyauditingthecompany’staxreturnsfortheyearsendedseptember30,2004and2005aswellascertainclaimsthecompanyfiledforprioryearsrelatedtotheeti.thecompanyhasreceivedpro-posedauditadjustmentsfromtheiRs.thecompanybelievesthatithasadequatelyprovidedforanytaxadjustmentsthatmayresultfromtheiRsincometaxexamination.

During2006,thecompanysettledaniRstaxreturnauditfortheyearsendedseptember30,2002and2003forallitemsotherthantheeti.theresultsoftheauditweresettledwith-outamaterialimpactonthecompany’sfinancialstatements.

During2005,thecompanysettledaniRstaxreturnauditfortheshortperiodreturnfiledforthethreemonthsendedseptember30,2001.thecompletionoftheiRs’sauditofthecompany’staxreturnsforthethree-monthshort-periodendedseptember30,2001enabledthecompanytoresolveestimatesinvolvingcertaindeferredtaxmattersexistingatthetimeofthespin-off.theresolutionofthesepre-spindeferredtaxmattersduring2005resultedina$10milliondecreasetothecompany’s2005incometaxexpense.

theamericanJobscreationactof2004(theact)providedforaspecialone-timedeductionof85percentofcertainforeignearningsrepatriatedintotheU.s.fromnon-U.s.subsidiar-iesthroughseptember30,2006.During2006,thecompanyrepatriated$91millionincashfromnon-U.s.subsidiariesintotheU.s.undertheprovisionsoftheact.therepatriationdidnotimpactthecompany’seffectiveincometaxratefortheyearendedseptember30,2006asa$2milliontaxliabilitywasestablishedduring2005whenthedecisionwasmadetorepatriatetheforeignearnings.

noprovisionhasbeenmadeasofseptember30,2007forUnitedstatesfederalorstate,oradditionalforeignincometaxesrelatedtoapproximately$79millionofundistributedearningsofforeignsubsidiarieswhichhavebeenorareintendedtobepermanentlyreinvested.thecompanyesti-matestheamountoftheunrecognizeddeferredtaxliabilitytobeapproximately$15millionatseptember30,2007.

thecompanypaidincometaxes,netofrefunds,of$212mil-lion,$164million,and$60million,in2007,2006,and2005,respectively.

17. FINANCIAL INSTRUmENTS

Fair Value of Financial Instrumentsthecarryingamountsandfairvaluesofthecompany’sfinan-cialinstrumentsareasfollows: asset(liaBility)

sePteMBeR30,2007 sePteMBeR30,2006

caRRyinG FaiR caRRyinG FaiR(inmillions) aMoUnt valUe aMoUnt valUe

cashandcashequivalents $ 231 $ 231 $ 144 $ 144

Deferredcompensationplan

investments 39 39 30 30

long-termdebt (223) (216) (245) (240)

interestrateswaps (1) (1) (2) (2)

Foreigncurrencyforward

exchangecontracts (5) (5) (3) (3)

acceleratedsharerepurchase

agreement(note18) — — — 2

thefairvalueofcashandcashequivalentsapproximatetheircarryingvalueduetotheshort-termnatureoftheinstru-ments.Fairvaluefordeferredcompensationplaninvestmentsisbasedonquotedmarketpricesandisrecordedatfairvaluewithinotherassets.Fairvalueinformationforlong-termdebtandinterestrateswapsisobtainedfromthirdparties

ROckwell cOllins annual RepORt 2007 56notestoconsolidatedFinancialstatements

andisbasedoncurrentmarketinterestratesandestimatesofcurrentmarketconditionsforinstrumentswithsimilarterms,maturities,anddegreeofrisk.thefairvalueofforeigncurrencyforwardexchangecontractsisestimatedbasedonquotedmarketpricesforcontractswithsimilarmaturities.thefairvalueoftheacceleratedsharerepurchaseagreementisbasedontheestimatedsettlementamountundertheagreementasdiscussedinnote18.thesefairvalueestimatesdonotnecessarilyreflecttheamountsthecompanywouldrealizeinacurrentmarketexchange.

Interest Rate Swapsthecompanymanagesitsexposuretointerestrateriskbymaintaininganappropriatemixoffixedandvariableratedebt,whichovertimeshouldmoderatethecostsofdebtfinancing.Whenconsiderednecessary,thecompanymayusefinancialinstrumentsintheformofinterestrateswapstohelpmeetthisobjective.onnovember20,2003,thecompanyenteredintotwointerestrateswapcontracts(theswaps)whichexpireonDecember1,2013andeffectivelyconvert$100millionofthe4.75percentfixedratelong-termnotestofloatingratedebtbasedonsix-monthliBoRless7.5basispoints.thecompanyhasdesignatedtheswapsasfairvaluehedgesandusesthe“short-cut”methodforassess-ingeffectiveness.accordingly,changesinthefairvalueoftheswapsareassumedtobeentirelyoffsetbychangesinthefairvalueoftheunderlyingdebtthatisbeinghedgedwithnonetgainorlossrecognizedinearnings.atseptember30,2007and2006,theswapsarerecordedatafairvalueof$1millionand$2million,respectively,withinotherliabilities,offsetbyafairvalueadjustmenttolong-termDebt(note10)of$1mil-lionand$2million,respectively.cashpaymentsorreceiptsbetweenthecompanyandthecounterpartiestotheswapsarerecordedasanadjustmenttointerestexpense.

Foreign Currency Forward Exchange Contractsthecompanytransactsbusinessinvariousforeigncurren-cieswhichsubjectsthecompany’scashflowsandearningstoexposurerelatedtochangesinforeigncurrencyexchangerates.theseexposuresariseprimarilyfrompurchasesorsalesofproductsandservicesfromthirdpartiesandintercompanytransactions.thecompanyhasestablishedaprogramthatutilizesforeigncurrencyforwardexchangecontracts(foreigncurrencycontracts)andattemptstominimizeitsexposure

tofluctuationsinforeigncurrencyexchangeratesrelatingtothesetransactions.Foreigncurrencycontractsprovidefortheexchangeofcurrenciesatspecifiedfuturepricesanddatesandreduceexposuretocurrencyfluctuationsbygenerat-inggainsandlossesthatareintendedtooffsetgainsandlossesontheunderlyingtransactions.Principalcurrenciesthatarehedgedincludetheeuropeaneuro,Britishpound,andJapaneseyen.thedurationofforeigncurrencycontractsisgenerallytwoyearsorless.themaximumdurationofaforeigncurrencycontractatseptember30,2007was154months.themajorityofthecompany’snon-functionalcur-rencyfirmandanticipatedreceivablesandpayablesthataredenominatedinmajorcurrenciesthatcanbetradedonopenmarketsarehedgedusingforeigncurrencycontracts.thecompanydoesnotmanageexposuretonetinvestmentsinforeignsubsidiaries.

notionalamountsofoutstandingforeigncurrencyforwardexchangecontractswere$205millionand$190millionatseptember30,2007and2006,respectively.notionalamountsarestatedinU.s.dollarequivalentsatspotexchangeratesattherespectivedates.thenetfairvalueoftheseforeigncurrencycontractsatseptember30,2007and2006werenetliabilitiesof$5millionand$3million,respectively.netlossesof$3millionand$1millionweredeferredwithinaccumulatedothercomprehensivelossrelatingtocashflowhedgesatseptember30,2007and2006,respectively.thecompanyexpectstore-classifyapproximately$3millionofthesenetlossesintoearningsoverthenext12months.therewasnosignificantimpacttothecompany’searningsrelatedtotheineffectiveportionofanyhedginginstrumentsduringthethreeyearsendedseptember30,2007.Gainsandlossesrelatedtoallforeigncurrencycontractsarerecordedincostofsales.

18. GUARANTEES AND INDEmNIFICATIONS

Product Warranty Costsaccruedliabilitiesarerecordedtoreflectthecompany’scontractualobligationsrelatingtowarrantycommitmentstocustomers.Warrantycoverageofvariouslengthsandtermsisprovidedtocustomersdependingonstandardofferingsandnegotiatedcontractualagreements.anestimateforwarrantyexpenseisrecordedatthetimeofsalebasedonthelengthofthewarrantyandhistoricalwarrantyreturnratesandrepaircosts.

ROckwell cOllins annual RepORt 2007 57notestoconsolidatedFinancialstatements

changesinthecarryingamountofaccruedproductwarrantycostsaresummarizedasfollows: sePteMBeR30

(inmillions) 2007 2006

Balanceatbeginningofyear $189 $172

Warrantycostsincurred (54) (52)

Productwarrantyaccrual 71 69

Reclassification 7 —

acquisitions — 1

Pre-existingwarrantyadjustments — (1)

Balanceatseptember30 $213 $189

Guaranteesinconnectionwiththeacquisitionofquestfromevans&sutherland,thecompanyenteredintoaparentcompanyguaranteerelatedtovariousobligationsofquest.thecompanyhasguaranteed,jointlyandseverallywithquadrant(theotherjointventurepartner),theperformanceofquestinrelationtoitscontractwiththeUnitedKingdomMinistryofDefense(whichexpiresin2030)andtheperformanceofcertainquestsubcontractors(upto$2million).inaddition,thecompanyhasalsopledgedequitysharesinquesttoguaranteepaymentbyquestofaloanagreementexecutedbyquest.intheeventofdefaultonthisloanagreement,thelendinginstitutioncanrequestthatthetrusteeholdingsuchequitysharessurrenderthemtothelendinginstitutioninordertosatisfyallamountsthenoutstandingundertheloanagreement.asofseptember30,2007,theoutstandingloanbalancewasapproximately$9million.quadranthasmadeanidenticalpledgetoguaranteethisobligationofquest.

shouldquestfailtomeetitsobligationsundertheseagreements,theseguaranteesmaybecomealiabilityofthecompanyandquadrant.asofseptember30,2007,thequestguaranteesarenotreflectedonthecompany’sconsolidatedstatementofFinancialPositionbecausethecompanybelievesthatquestwillmeetallofitsperformanceandfinancialobligationsinrelationtoitscontractwiththeUnitedKingdomMinistryofDefenseandtheloanagreement.

Letters of Creditthecompanyhascontingentcommitmentsintheformofcommerciallettersofcredit.outstandinglettersofcreditareissuedbybanksonthecompany’sbehalftosupportcertaincontractualobligationstoitscustomers.ifthecompanyfailstomeetthesecontractualobligations,theselettersofcreditmaybecomeliabilitiesofthecompany.totaloutstandinglet-tersofcreditatseptember30,2007were$118million.thesecommitmentsarenotreflectedasliabilitiesonthecompany’sstatementofFinancialPosition.

Accelerated Share Repurchasesinoctober2007(subsequenttoyear-end),thecompanyexecutedanacceleratedsharerepurchaseagreementwithaninvestmentbankunderwhich3millionsharesofthecompany’soutstandingcommonshareswererepurchasedforaninitialpriceof$224millionor$74.77pershare.theinitialpricewillbesubjecttoapurchasepriceadjustmentbasedonthevolume-weightedaveragepriceofthecompany’sshares,lessadiscount,overasubsequentperiodoftimethatendsnolaterthanDecember14,2007.

inseptember2006,thecompanyenteredintoanacceleratedsharerepurchaseagreementwithaninvestmentbankunderwhichthecompanyrepurchased4.7millionsharesofitsoutstandingcommonsharesataninitialpriceof$54.63pershare,representingtheseptember28,2006closingpriceofthecompany’scommonshares.initialconsiderationpaidtorepurchasethesharesof$257millionwasrecordedasatrea-surystockrepurchasein2006,whichresultedinareductionofshareowners’equity.theagreementcontainedaforwardsalecontractwherebythe4.7millionborrowedsharesheldbytheinvestmentbankthatweresoldtothecompanywerecoveredbysharepurchasesbytheinvestmentbankintheopenmarketoverasubsequentperiodoftimethatendedinDecember2006.theinitialpurchasepricewassubjecttoapurchasepriceadjustmentbasedonthevolume-weightedaveragepriceofthecompany’ssharespurchasedbytheinvestmentbankduringtheperiodlessadiscountasdefinedintheagreement.inDecember2006,thecompany,whichhadtheoptiontosharesettleorcashsettletheagreement,electedtopay$19millionincashtotheinvestmentbankinfullsettlementoftheagreementandrecordedthetransactionasareductionofshareowners’equity.the$19millionwaspaidtotheinvestmentbankinJanuary2007.

inaugust2005,thecompanyenteredintoacceleratedsharerepurchaseagreementswithaninvestmentbankunderwhichthecompanyrepurchased4millionsharesofitsoutstandingcommonsharesataninitialpriceof$196million,or$49.10pershare.theinitialpurchasepricewassubjecttoapurchasepriceadjustmentbasedonthevolume-weightedaveragepriceofthecompany’ssharesduringtheperiodfromaugust2005throughDecember2005,lessadiscount.thepurchasepriceadjustmentcouldhavebeensettled,atthecompany’soption,incashorinsharesofitscommonstock.inDecember2005,thecompany,atitsoption,received$8million(netofrelatedsettlementfeesandexpenses)insharesofitscom-monstockfromtheinvestmentbankinfullsettlementoftheagreements(0.2millionshares).

ROckwell cOllins annual RepORt 2007 58notestoconsolidatedFinancialstatements

19. CONTRACTUAL OBLIGATIONS AND OTHER COmmITmENTS

thefollowingtablereflectscertainofthecompany’snon-cancelablecontractualcommitmentsasofseptember30,2007: PayMentsDUeByPeRioD

(inmillions) 2008 2009 2010 2011 2012 tHeReaFteR total

non-cancelableoperatingleases $41 $36 $31 $18 $15 $ 37 $178

Purchasecontracts 19 13 8 1 — — 41

long-termdebt — — — 24 — 200 224

interestonlong-termdebt 11 11 11 10 10 12 65

total $ 71 $60 $50 $53 $25 $249 $508

Non-cancelable Operating Leasesthecompanyleasescertainofficeandmanufacturingfacilitiesaswellascertainmachineryandequipmentundervariousleasecontractswithtermsthatmeettheaccountingdefinitionofoperatingleases.someleasesincluderenewaloptions,whichpermitextensionsoftheexpirationdatesatratesapproximatingfairmarketrentalrates.Rentexpensefortheyearsendedseptember30,2007,2006,and2005was$29million,$27million,and$25million,respectively.thecompany’scommitmentsundertheseoperatingleases,intheformofnon-cancelablefutureleasepayments,arenotreflectedasaliabilityonitsstatementofFinancialPosition.

Purchase Contractsthecompanymayenterintopurchasecontractswithsuppli-ersunderwhichthereisacommitmenttobuyaminimumamountofproductsorpayaspecifiedamount.thesecom-mitmentsarenotreflectedasaliabilityonthecompany’sstatementofFinancialPosition.

Interest on Long-term Debtinterestpaymentsunderlong-termdebtobligationsexcludethepotentialeffectsoftherelatedinterestrateswapcontracts.

Indemnificationsthecompanyentersintoindemnificationswithlenders,coun-terpartiesintransactionssuchasadministrationofemployeebenefitplans,andothercustomaryindemnificationswiththirdpartiesinthenormalcourseofbusiness.thefollowingareotherthancustomaryindemnificationsbasedonthejudg-mentofmanagement.

thecompanybecameanindependent,publiclyheldcompanyonJune29,2001,whenRockwellinternationalcorporation(Rockwell),renamedRockwellautomationinc.,spunoffitsformeravionicsandcommunicationsbusinessandcertainotherassetsandliabilitiesofRockwellbymeansofadistri-butionofallthecompany’soutstandingsharesofcommonstocktotheshareownersofRockwellinatax-freespin-off(thespin-off).inconnectionwiththespin-off,thecompanymayberequiredtoindemnifycertaininsurersagainstclaimsmadebythirdpartiesinconnectionwiththecompany’slegacyinsurancepolicies.

inconnectionwithagreementsforthesaleofportionsofitsbusiness,thecompanyattimesretainstheliabilitiesofabusinessofvaryingamountswhichrelatetoeventsoccurringpriortoitssale,suchastax,environmental,litigationandemploymentmatters.thecompanyattimesindemnifiesthepurchaserofaRockwellcollinsbusinessintheeventthatathirdpartyassertsaclaimthatrelatestoaliabilityretainedbythecompany.

thecompanyalsoprovidesindemnificationsofvaryingscopeandamountstocertaincustomersagainstclaimsofproductliabilityorintellectualpropertyinfringementmadebythirdpartiesarisingfromtheuseofcompanyorcustomerproductsorintellectualproperty.theseindemnificationsgenerallyrequirethecompanytocompensatetheotherpartyforcertaindamagesandcostsincurredasaresultofthirdpartyproductliabilityorintellectualpropertyclaimsarisingfromthesetransactions.

theamountthecompanycouldberequiredtopayunderitsindemnificationagreementsisgenerallylimitedbasedonamountsspecifiedintheunderlyingagreements,orinthecaseofsomeagreements,themaximumpotentialamountoffuturepaymentsthatcouldberequiredisnotlimited.Whenapotentialclaimisassertedundertheseagreements,thecompanyconsiderssuchfactorsasthedegreeofprobabilityofanunfavorableoutcomeandtheabilitytomakeareason-ableestimateoftheamountofloss.aliabilityisrecordedwhenapotentialclaimisbothprobableandestimable.thenatureoftheseagreementspreventsthecompanyfrommak-ingareasonableestimateofthemaximumpotentialamountitcouldberequiredtopayshouldcounterpartiestotheseagreementsassertaclaim;however,thecompanycurrentlyhasnomaterialclaimspendingrelatedtosuchagreements.

ROckwell cOllins annual RepORt 2007 59notestoconsolidatedFinancialstatements

20. ENVIRONmENTAL mATTERS

thecompanyissubjecttofederal,stateandlocalregulationsrelatingtothedischargeofsubstancesintotheenviron-ment,thedisposalofhazardouswastes,andotheractivitiesaffectingtheenvironmentthathavehadandwillcontinuetohaveanimpactonthecompany’smanufacturingoperations.theseenvironmentalprotectionregulationsmayrequiretheinvestigationandremediationofenvironmentalimpairmentsatcurrentandpreviouslyownedorleasedproperties.inaddi-tion,lawsuits,claimsandproceedingshavebeenassertedonoccasionagainstthecompanyallegingviolationsofenvi-ronmentalprotectionregulations,orseekingremediationofallegedenvironmentalimpairments,principallyatpreviouslyownedorleasedproperties.asofseptember30,2007,thecompanyisinvolvedintheinvestigationorremediationofsevensitesundertheseregulationsorpursuanttolawsuitsassertedbythirdparties.Managementestimatesthatthetotalreasonablypossiblefuturecoststhecompanycouldincurforsixofthesesitesisnotsignificant.Managementestimatesthatthetotalreasonablypossiblefuturecoststhecompanycouldincurfromoneofthesesitestobeapproxi-mately$9million.thecompanyhasrecordedenvironmentalreservesforthissiteof$2millionasofseptember30,2007,whichrepresentsmanagement’sbestestimateoftheprob-ablefuturecostforthissite.

inaddition,thecompanyiscurrentlyinvolvedininvestigationorremediationofthreesitesrelatedtopropertiespurchasedinconnectionwiththecompany’sacquisitionofKaiseraerospace&electronicscorporation(Kaiser).Rockwellcollinshascertainrightstoindemnificationfromescrowfundssetasideatthetimeofacquisitionthatmanagementbelievesaresufficienttoaddressthecompany’spotentialliabilityfortheKaiserrelatedenvironmentalmatters.

todate,compliancewithenvironmentalregulationsandresolutionofenvironmentalclaimshasbeenaccomplishedwithoutmaterialeffectonthecompany’sliquidityandcapitalresources,competitivepositionorfinancialcondition.Managementbelievesthatexpendituresforenvironmentalcapitalinvestmentandremediationnecessarytocomplywithpresentregulationsgoverningenvironmentalprotectionandotherexpendituresfortheresolutionofenvironmentalclaimswillnothaveamaterialadverseeffectonthecompany’sbusi-nessorfinancialposition,butcouldpossiblybematerialtotheresultsofoperationsorcashflowsofanyonequarter.

21. LITIGATION

thecompanyissubjecttovariouslawsuits,claimsandproceedingsthathavebeenormaybeinstitutedorassertedagainstthecompanyrelatingtotheconductofthecompany’sbusiness,includingthosepertainingtoproductliability,intel-lectualproperty,safetyandhealth,exportingandimporting,contract,employmentandregulatorymatters.althoughtheoutcomeofthesematterscannotbepredictedwithcertaintyandsomelawsuits,claimsorproceedingsmaybedisposedofunfavorablytothecompany,managementbelievesthedispositionofmattersthatarependingorassertedwillnothaveamaterialadverseeffectonthecompany’sbusinessorfinancialposition,butcouldpossiblybematerialtotheresultsofoperationsorcashflowsofanyonequarter.

22. 2006 RESTRUCTURING CHARGE

theseptember2006restructuringchargewasrelatedtodecisionstoimplementcertainbusinessrealignmentandfacilityrationalizationactions.asaresultofthesedecisions,thecompanyrecordedchargesof$14millioninthefourthquarterof2006whichwascomprisedof$11millionofemployeeseparationcostsand$3millionoffacilityexitcosts.During2007,thecompanyadjustedtherestructuringreserveby$5millionprimarilyduetolowerthanexpectedemployeeseparationcosts.

changeintherestructuringreserveduring2007isasfollows: eMPloyee Facility sePaRation eXit(inmillions) costs costs total

Balanceatseptember30,2006 $11 $ 3 $14

Reserveadjustment (5) — (5)

cashpayments (6) (3) (9)

Balanceatseptember30,2007 $— $— $—

23. BUSINESS SEGmENT INFORmATION

Rockwellcollinsprovidesdesign,productionandsupportofcommunicationsandaviationelectronicsformilitaryandcommercialcustomersworldwide.thecompanyhastwooperatingsegmentsconsistingoftheGovernmentsystemsandcommercialsystemsbusinesses.

Governmentsystemssuppliesdefensecommunicationsanddefenseelectronicssystems,products,andservices,whichincludesubsystems,displays,navigationequipmentandsimulationsystems,totheU.s.DepartmentofDefense,othergovernmentagencies,civilagencies,defensecontractorsandforeignministriesofdefense.

commercialsystemsisasupplierofaviationelectronicssys-tems,products,andservicestocustomerslocatedthroughouttheworld.thecustomerbaseiscomprisedoforiginalequip-mentmanufacturers(oeMs)ofcommercialairtransport,businessandregionalaircraft,commercialairlines,fractionalandotherbusinessaircraftoperators.

ROckwell cOllins annual RepORt 2007 60notestoconsolidatedFinancialstatements

salesmadetotheUnitedstatesGovernmentwere36percent,39percent,and41percentoftotalsalesfortheyearsendedseptember30,2007,2006,and2005,respectively.

thefollowingtablereflectsthesalesandoperatingresultsforeachofthecompany’soperatingsegments:

(inmillions) 2007 2006 2005

sales:

Governmentsystems $2,231 $2,043 $1,810

commercialsystems 2,184 1,820 1,635

totalsales $4,415 $3,863 $3,445

segmentoperatingearnings:

Governmentsystems $ 441 $ 402 $ 328

commercialsystems 485 370 296

totalsegmentoperatingearnings 926 772 624

interestexpense (13) (13) (11)

earningsfromcorporate-levelequity

affiliate — 2 4

stock-basedcompensation (17) (18) —

Gainonsaleofequityaffiliate — 20 —

Restructuringandtradenames

write-off 5 (14) (15)

Generalcorporate,net (58) (60) (55)

incomebeforeincometaxes $ 843 $ 689 $ 547

thecompanyevaluatesperformanceandallocatesresourcesbasedupon,amongotherconsiderations,segmentoperat-ingearnings.thecompany’sdefinitionofsegmentoperatingearningsexcludesincometaxes,stock-basedcompensation,unallocatedgeneralcorporateexpenses,interestexpense,gainsandlossesfromthedispositionofbusinesses,non-recurringchargesresultingfrompurchaseaccountingsuchaspurchasedresearchanddevelopmentcharges,earningsandlossesfromcorporate-levelequityaffiliates,assetimpairmentcharges,andotherspecialitemsasidentifiedbymanagementfromtimetotime.intersegmentsalesarenotmaterialandhavebeeneliminated.theaccountingpoliciesusedinprepar-ingthesegmentinformationareconsistentwiththepoliciesdescribedinnote2.

theseptember2006restructuringchargeisrelatedtodeci-sionstoimplementcertainbusinessrealignmentandfacilityrationalizationactionsrelatedtotheoperatingsegmentsasfollows:Governmentsystems,$6million,andcommercialsystems,$8million.the2007adjustmenttotherestructur-ingchargeisrelatedtotheoperatingsegmentsasfollows:Governmentsystems,$3million,andcommercialsystems,$2million.

the2005tradenameswrite-offrelatedtothewrite-offofcertainindefinite-livedKaisertradenamesrelatedtotheoper-atingsegmentsasfollows:Governmentsystems,$9million,andcommercialsystems,$6million.

thefollowingtablessummarizetheidentifiableassetsandinvestmentsinequityaffiliatesatseptember30,aswellastheprovisionfordepreciationandamortization,theamountofcapitalexpendituresforproperty,andearnings(losses)fromequityaffiliatesforeachofthethreeyears

endedseptember30,foreachoftheoperatingsegmentsandcorporate:

(inmillions) 2007 2006 2005

identifiableassets:

Governmentsystems $1,472 $1,361 $1,169

commercialsystems 1,711 1,528 1,402

corporate 567 389 577

totalidentifiableassets $3,750 $3,278 $3,148

investmentsinequityaffiliates:

Governmentsystems $ 10 $ 13 $ 12

commercialsystems — — —

corporate — — 59

totalinvestmentsinequityaffiliates $ 10 $ 13 $ 71

Depreciationandamortization:

Governmentsystems $ 55 $ 48 $ 43

commercialsystems 63 58 61

totaldepreciationandamortization $ 118 $ 106 $ 104

capitalexpendituresforproperty:

Governmentsystems $ 65 $ 75 $ 48

commercialsystems 60 69 63

totalcapitalexpendituresforproperty $ 125 $ 144 $ 111

earnings(losses)fromequityaffiliates:

Governmentsystems $ 8 $ 6 $ 8

commercialsystems — — (1)

corporate — 2 4

totalearningsfromequityaffiliates $ 8 $ 8 $ 11

themajorityofthecompany’sbusinessesarecentrallylocatedandsharemanycommonresources,infrastructuresandassetsinthenormalcourseofbusiness.certainassetshavebeenallocatedbetweentheoperatingsegmentsprimar-ilybasedonoccupancyorusage,principallyproperty,plantandequipment.identifiableassetsatcorporateconsistprincipallyofcashandnetdeferredincometaxassetsforallyearspresented,theprepaidpensionassetfortheyearendedseptember30,2007,andtheinvestmentinRockwellscientificcompany,llcfortheyearendedseptember30,2005.

thefollowingtablesummarizessalesbyproductcategoryfortheyearsendedseptember30:

(inmillions) 2007 2006 2005

Defenseelectronics $1,510 $1,413 $1,232

Defensecommunications 721 630 578

airtransportaviationelectronics 1,175 968 881

Businessandregionalaviationelectronics 1,009 852 754

total $4,415 $3,863 $3,445

Productcategorydisclosuresfordefense-relatedproductsaredelineatedbasedupontheirunderlyingtechnologieswhiletheairtransportandbusinessandregionalaviationelectronicsproductcategoriesaredelineatedbaseduponthedifferenceinunderlyingcustomerbase,sizeofaircraft,andmarketsserved.2005and2006salesfortheairtrans-portaviationelectronicsandbusinessandregionalaviationelectronicsproductcategorysaleshavebeenreclassifiedtoconformtothecurrentyearpresentation.

ROckwell cOllins annual RepORt 2007 61notestoconsolidatedFinancialstatements

thefollowingtablereflectssalesfortheyearsendedseptember30andpropertyatseptember30bygeographicregion:

sales PRoPeRty

(inmillions) 2007 2006 2005 2007 2006 2005

Unitedstates $2,987 $2,616 $2,312 $559 $505 $428

europe 840 674 612 42 39 36

asia-Pacific 252 234 231 4 5 6

canada 218 223 208 — — —

africa/Middleeast 79 74 55 — — —

latinamerica 39 42 27 2 3 3

total $4,415 $3,863 $3,445 $607 $552 $473

salesareattributedtothegeographicregionsbasedonthecountryofdestination.

earningspershareamountsarecomputedindependentlyeachquarter.asaresult,thesumofeachquarter’spershareamountmaynotequalthetotalpershareamountfortherespectiveyear.

netincomeinthefirstquarterof2007includesadiscreteitemrelatedtotheretroactivereinstatementandextensionoftheResearchandDevelopmenttaxcredit,whichloweredthecompany’seffectivetaxratebyabout7percentagepoints.

netincomeinthefourthquarterof2006includes$13mil-lion($20millionbeforetaxes),or7centspershare,relatedtothegainonsaleofRockwellscientificcompany,llc.netincomeinthefourthquarterof2006alsoincludes$9million($14millionbeforetaxes),or5centspershare,forarestruc-turingchargerelatedtodecisionstoimplementcertainbusinessrealignmentandfacilityrationalizationactions.Grossprofitincludes$11millionrelatedtotherestructuringchargeinthefourthquarterof2006.

24. QUARTERLy FINANCIAL INFORmATION (UNAUDITED)

quarterlyfinancialinformationfortheyearsendedseptember30,2007and2006issummarizedasfollows:

2007qUaRteRs

(inmillions,except pershareamounts) FiRst seconD tHiRD FoURtH total

sales $ 993 $1,083 $1,113 $1,226 $4,415

Grossprofit(totalsalesless

productandservicecost

ofsales) 303 327 333 360 1,323

netincome 143 140 146 156 585

earningspershare:

Basic $0.85 $ 0.83 $ 0.87 $ 0.94 $ 3.50

Diluted $0.84 $ 0.82 $ 0.86 $ 0.93 $ 3.45

2006qUaRteRs

(inmillions,except pershareamounts) FiRst seconD tHiRD FoURtH total

sales $ 881 $ 957 $ 964 $1,061 $3,863

Grossprofit(totalsalesless

productandservicecost

ofsales) 251 276 288 296 1,111

netincome 104 114 121 138 477

earningspershare:

Basic $0.60 $0.66 $0.71 $ 0.80 $ 2.77

Diluted $0.59 $0.65 $0.70 $ 0.79 $ 2.73