MOOG INC. (MOG-A) FY 2021 MD&A

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

The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and the related notes appearing elsewhere in this report.

This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those under the heading “Risk Factors” in Item 1A of this report.

OVERVIEW

We are a worldwide designer, manufacturer and systems integrator of high performance precision motion and fluid controls and control systems for a broad range of applications in aerospace and defense and industrial markets.

Within the aerospace and defense market, our products and systems include:

•Defense market - primary and secondary flight controls for military aircraft, stabilization and automatic ammunition loading controls for armored combat vehicles, tactical and strategic missile steering controls and gun aiming controls.

•Commercial aircraft market - primary and secondary flight controls for commercial aircraft.

•Commercial space market - satellite positioning controls and thrust vector controls, as well as integrated space vehicles.

In the industrial market, our products are used in a wide range of applications including:

•Industrial automation market - components and systems for injection and blow molding machinery, heavy industry applications for steel and aluminum production, metal forming presses, flight simulation motion control systems and material and automotive structural and fatigue testing systems.

•Medical market - components and systems for enteral clinical nutrition and infusion therapy pumps, CT scan medical equipment, ultrasonic sensors and surgical handpieces and sleep apnea equipment.

•Energy market - control and safety components for steam and gas power generation turbines and oil and gas exploration components and systems.

We operate under three segments, Aircraft Controls, Space and Defense Controls and Industrial Systems. Our principal manufacturing facilities are located in the United States, Philippines, United Kingdom, Germany, Czech Republic, Italy, Costa Rica, China, Netherlands, Luxembourg, Japan, Canada, India and Lithuania.

Under ASC 606, 63% of revenue was recognized over time for the year ended October 2, 2021, using the cost-to-cost method of accounting. The over-time method of revenue recognition is predominantly used in Aircraft Controls and Space and Defense Controls. We use this method for U.S. Government contracts and repair and overhaul arrangements as we are creating or enhancing assets that the customer controls. In addition, many of our large commercial contracts qualify for over-time accounting as our performance does not create an asset with an alternative use and we have an enforceable right to payment for performance completed to date.

For the year ended October 2, 2021, 37% of revenue was recognized at the point in time control transferred to the customer. This method of revenue recognition is used most frequently in Industrial Systems. We use this method for commercial contracts in which the asset being created has an alternative use. We determine the point in time control transfers to the customer by weighing the five indicators provided by ASC 606. When control has transferred to the customer, profit is generated as cost of sales is recorded and as revenue is recognized.

We concentrate on providing our customers with products designed and manufactured to the highest quality standards. Our technical experts work collaboratively around the world, delivering capabilities for mission-critical solutions. These core operational principles are necessary as our products are applied in demanding applications, "When Performance Really Matters®." By capitalizing on these core foundational strengths, we believe we have achieved a leadership position in the high performance, precision controls market. Additionally, these strengths yield a broad control product portfolio, across a diverse base of customers and end markets.

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By focusing on customer intimacy and commitment to solving our customers' most demanding technical problems, we have been able to expand our control product franchise to multiple markets; organically growing from a high-performance components manufacturer to a high-performance systems designer, manufacturer and systems integrator. In addition, we continue expanding our content positions on our current platforms, seeking to be the market-leading supplier in the niche markets we serve. We also look for innovation in all aspects of our business, employing new technologies to improve productivity and operational performance.

Our fundamental long-term strategies to achieve our goals center around talent, lean and innovation and include:

•a strong leadership team that has positioned the Company for growth,

•utilizing our global capabilities and strong engineering heritage to innovate,

•maintaining our technological excellence by solving our customers’ most demanding technical problems in applications "When Performance Really Matters®,"

•continuing to invest in talent development to strengthen employee performance, and

•maximizing customer value by implementing lean enterprise principles.

These fundamentals will help us achieve our financial objective of increasing shareholder value with sustainable competitive advantages across our segments. In doing so, we expect to maintain a balanced, diversified portfolio in terms of markets served, product applications, customer bases and geographic presence.

We focus on improving shareholder value through strategic revenue growth, both organic and acquired, through improving operating efficiencies and manufacturing initiatives and through utilizing low cost manufacturing facilities without compromising quality. Historically, we have taken a balanced approach to capital deployment in order to maximize shareholder returns over the long-term. Our activities have included strategic acquisitions, share buybacks and dividend payments. As we continue to adapt to the changing COVID-19 environment, we believe we are well positioned to invest in our business and have returned to a balanced capital deployment strategy. We will organically invest in our operations and explore opportunities to make strategic acquisitions and return capital to shareholders.

Acquisitions and Divestitures

All of our acquisitions are accounted for under the purchase method and, accordingly, the operating results for the acquired companies are included in the Consolidated Statements of Earnings from the respective dates of acquisition. Under purchase accounting, we record assets and liabilities at fair value and such amounts are reflected in the respective captions on the Consolidated Balance Sheets. The purchase price described for each acquisition below is net of any cash acquired, includes debt issued or assumed and the fair value of contingent consideration.

Acquisitions

In the first quarter of 2021, we acquired Genesys Aerosystems Group, Inc. ("Genesys"), headquartered in Mineral Wells, Texas for a purchase price of $78 million. Genesys designs and manufactures a full suite of electronic flight instrument systems and autopilot solutions. This operation is included in our Aircraft Controls segment.

In the first quarter of 2020, we acquired Gesellschaft für Antriebstechnik mbH and GAT Inc. ("GAT"), headquartered in Geisenheim, Germany for a purchase price of $54 million. GAT designs and manufactures high-end fluid rotating unions and slip rings. This operation is included in our Industrial Systems segment.

Divestitures

In the fourth quarter of 2021, we sold a non-core business of our Industrial Systems segment for $11 million in net consideration and recorded a loss in other income of $2 million.

In the third quarter of 2021, we announced that we entered into a definitive agreement to sell the assets of our Navigation Aids ("Navaids") business to Thales. Navaids is engaged in the business of designing, developing, manufacturing and marketing ground and ship-based radio frequency navigation beacons and related antennas for military and civilian applications. The business is based in Salt Lake City, Utah and is included in our Aircraft Controls segment. The transaction is subject to regulatory review and customary closing conditions.

In the first quarter of 2020, we sold a non-core business of our Industrial Systems segment for $2 million in net consideration and recorded a minimal gain in other income.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our financial statements and accompanying notes are prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires us to make estimates, assumptions and judgments that affect the amounts reported. These estimates, assumptions and judgments are affected by our application of accounting policies, which are discussed in Note 1, Summary of Significant Accounting Policies, of Item 8, Financial Statements and Supplementary Data, of this report. We believe the accounting policies discussed below are the most critical in understanding and evaluating our financial results. These critical accounting policies have been reviewed with the Audit Committee of our Board of Directors.

Revenue Recognition on Over-Time Contracts

We recognize revenue from contracts with customers using the five-step model prescribed in ASC 606. For contracts that qualify for over time treatment, we recognize revenue as control of the promised goods or services is being transferred to the customer. Revenue recognized over time for the year ended October 2, 2021 was 63% of total revenue. The cost-to-cost method of accounting as determined by the ratio of cumulative costs incurred to date to estimated total contract costs at completion, multiplied by the total estimated contract revenue, less cumulative revenue recognized in prior periods. We believe this is an appropriate measure of progress toward satisfaction of performance obligations as this measure most accurately depicts the progress of our work and transfer of control to our customers. Changes in estimates affecting sales, costs and profits are recognized in the period in which the change becomes known using the cumulative catch-up method of accounting. Revenue and cost estimates for substantially all over-time contract performance obligations are reviewed and updated quarterly. For further information, refer to Note 2, Revenue from Contracts with Customers and Note 21,Segments, of Item 8, Financial Statements and Supplementary Data, of this report.

Contract Reserves

At October 2, 2021, we had contract reserves of $59 million. Contract reserves are comprised of contract loss reserves, recall reserves, and contract-related reserves. Contract loss reserves are recorded for open contracts where it is anticipated that contract costs will be greater than contract income and are determined considering all direct and indirect contract costs, exclusive of any selling, general or administrative cost allocations that are treated as period expenses. In accordance with ASC 606, we calculate contract losses at the contract level, versus the performance obligation level. Recall reserves are recorded when additional work is needed on completed products for them to meet contract specifications. Contract-related reserves are recorded for other reasons, such as delivery issues outside of the ordinary scope of the contract. For all three types of reserves, a provision for the entire amount of the loss is charged against income in the period in which the loss becomes known and can be reasonably estimated by management. For further information, refer to Note 2, Revenue from Contracts with Customers, of Item 8, Financial Statements and Supplementary Data, of this report.

Reserves for Inventory Valuation

At October 2, 2021, we had net inventories of $613 million, or 36% of current assets. Reserves for inventory were $156 million, or 20% of gross inventories. Inventories are stated at the lower of cost or net realizable value with cost determined primarily on the first-in, first-out method of valuation.

We record valuation reserves to provide for slow-moving or obsolete inventory by principally using a formula-based method that increases the valuation reserve as the inventory ages. We also take specific circumstances into consideration. We consider overall inventory levels in relation to firm customer backlog in addition to forecasted demand including aftermarket sales. Changes in these and other factors, such as low demand and technological obsolescence, could cause us to increase our reserves for inventory valuation, which would negatively impact our gross margin. As we record provisions within cost of sales to increase inventory valuation reserves, we establish a new, lower cost basis for the inventory.

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Reviews for Impairment of Goodwill

At October 2, 2021, we had $852 million of goodwill, or 25% of total assets. We test goodwill for impairment for each of our reporting units at least annually, during our fourth quarter, and whenever events occur or circumstances change, such as changes in the business climate, poor indicators of operating performance or the sale or disposition of a significant portion of a reporting unit. We also test goodwill for impairment when there is a change in reporting units.

We identify our reporting units by assessing whether the components of our operating segments constitute businesses for which discrete financial information is available and segment management regularly reviews the operating results of those components. We aggregate certain components based upon an evaluation of the facts and circumstances, including the nature of products and services and the extent of shared assets and resources. As a result, we have four reporting units.

Companies may perform a qualitative assessment as the initial step in the annual goodwill impairment testing process for all or selected reporting units. Companies are also allowed to bypass the qualitative analysis and perform a quantitative analysis if desired. Economic uncertainties and the length of time from the calculation of a baseline fair value are factors that we consider in determining whether to perform a quantitative test.

When we evaluate the potential for goodwill impairment using a qualitative assessment, we consider factors including, but not limited to, macroeconomic conditions, industry conditions, the competitive environment, changes in the market for our products and services, regulatory and political developments, entity specific factors such as strategy and changes in key personnel and overall financial performance. If, after completing this assessment, it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying value, we proceed to a quantitative two-step impairment test.

Quantitative testing first requires a comparison of the fair value of each reporting unit to its carrying value. We principally use the discounted cash flow method to estimate the fair value of our reporting units. The discounted cash flow method incorporates various assumptions, the most significant being projected revenue growth rates, operating margins and cash flows, the terminal growth rate and the discount rate. Management projects revenue growth rates, operating margins and cash flows based on each reporting unit's current business, expected developments and operational strategies typically over a five-year period. If the carrying value of the reporting unit exceeds its fair value, goodwill is considered impaired and any loss must be measured.

In measuring the impairment loss, the implied fair value of goodwill is determined by assigning a fair value to all of the reporting unit's assets and liabilities, including any unrecognized intangible assets, as if the reporting unit had been acquired in a business combination at fair value. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss would be recognized in an amount equal to that excess.

The determination of our assumptions is subjective and requires significant estimates. Changes in these estimates and assumptions could materially affect the results of our reviews for impairment of goodwill.

For our annual test of goodwill for impairment in 2021, we performed a qualitative assessment for each of our four reporting units.

We evaluated the potential for goodwill impairment by considering macroeconomic conditions, industry and market conditions, cost factors, both current and future expected financial performance, and relevant entity-specific events for each of the reporting units. We also considered our overall market performance discretely as well as in relation to our peers. The results of our qualitative assessment indicated that is more likely than not that the fair value of each of the reporting units exceed its carrying value; and therefore, a quantitative two-step impairment test was not necessary.

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Reviews for Impairment of Long-Lived Assets

Long-lived assets held for use, which primarily includes finite-lived intangible assets, property, plant and equipment and right-of-use assets, are evaluated for impairment whenever events or circumstances indicate that the undiscounted net cash flows to be generated by their use over their expected useful lives and eventual disposition are less than their carrying value. The long-term nature of these assets requires the estimation of their cash inflows and outflows several years into the future and only takes into consideration technological advances known at the time of the impairment test. For further information, refer to Note 6, Property, Plant and Equipment and Note 8, Goodwill and Intangible Assets, of Item 8, Financial Statements and Supplementary Data, of this report.

Pension Assumptions

We maintain various defined benefit pension plans covering employees at certain locations. In 2021, pension expense for all defined benefit plans was $26 million. For further information, refer to Note 14, Employee Benefit Plans, of Item 8, Financial Statements and Supplementary Data, of this report. Pension obligations and the related costs are determined using actuarial valuations that involve several assumptions. The most critical assumptions are the discount rate, the long-term expected return on assets and mortality rates. Other assumptions include salary increases and retirement age.

We use the spot rate approach to estimate the service and interest cost components of the net periodic benefit cost for most of our plans. Under this approach the service cost is determined by applying the discount rates along the yield curve to the specific service cost cash flows to determine the present value. The interest cost component is computed by using each assumed discount rate along the curve. The discount rates used in determining expense for the U.S. Employees’ Retirement Plan, our largest plan, in 2021 were 3.1% for service cost and 2.6% for interest cost, compared to 3.5% and 2.9%, respectively, in 2020. A 50 basis point decrease in the discount rates would decrease our annual pension expense by $1 million. The discount rates are used to state expected future cash flows at present value. Using a higher discount rate typically decreases the present value of pension obligations and decreases pension expense. We use the Aon Hewitt AA Above Median yield curve to determine the discount rate for our U.S. defined benefit plans at year end. We believe that the Aon Hewitt AA Above Median yield curve best mirrors the yields of bonds that would be selected by management if actions were taken to settle our obligation.

Mortality rates are used to estimate the life expectancy of plan participants during which they are expected to receive benefit payments. We use a modified version of the mortality table and projection scale published by the Society of Actuaries, which reflects improvements consistent with the Social Security Administration, as a basis for our mortality assumptions for our U.S. plans. We believe the use of this modified table and projection scale best reflects our demographics and anticipated plan outcomes.

The long-term expected return on assets assumption reflects the average rate of return expected on funds invested or to be invested to provide for the benefits included in the projected benefit obligation. In determining the long-term expected return on assets assumption, we consider our current and target asset allocations. We consider the relative weighting of plan assets, the historical performance of total plan assets and individual asset classes and economic and other indicators of future performance. Asset management objectives include maintaining an adequate level of diversification to reduce interest rate and market risk and to provide adequate liquidity to meet immediate and future benefit payment requirements. In determining the 2021 expense for our largest plan, we used a 5.0% return on assets assumption, compared to 4.5% for 2020. A 25 basis point decrease in the long-term expected return on assets assumption would increase our annual pension expense by $2 million.

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Income Taxes

Our annual tax rate is based on our earnings before tax by jurisdiction, applicable statutory tax rates, the impacts of permanent differences, tax incentives and tax planning opportunities in the various jurisdictions in which we operate.  Significant judgment is required in determining our annual tax rate and in evaluating our tax positions.

An estimated annual effective tax rate is applied to our quarterly ordinary operating results. For certain significant, unusual or infrequent events, we recognize the tax impact in the quarter in which it occurs.

We record reserves against tax benefits when it’s more likely than not that we will not sustain a position if the appropriate taxing jurisdiction had full information and examined our position. We adjust these reserves when facts and circumstances change, such as when progress is made by taxing authorities in their review of our position. There is a considerable amount of judgment in making these assessments. There were no significant reserves taken in 2021.

Valuation allowances associated with deferred tax assets is another area that requires judgment. We record a valuation allowance to reduce deferred tax assets to the amount of future tax benefit that we believe is more likely than not to be realized. We consider recent earnings projections, allowable tax carryforward periods, tax planning strategies and historical earnings performance to determine the amount of the valuation allowance. Changes in these factors could cause us to adjust our valuation allowance, which would impact our income tax expense when we determine that these factors have changed.

At October 2, 2021, we had gross deferred tax assets of $157 million and deferred tax asset valuation allowances of $14 million. The deferred tax assets principally relate to benefit accruals, inventory obsolescence, tax benefit carryforwards, contract reserves and lease liabilities. The deferred tax assets include $15 million related to tax benefit carryforwards associated with net operating losses and tax credits, for which $13 million of deferred tax asset valuation allowances are recorded. For further information, refer to Note 15, Income Taxes, of Item 8, Financial Statements and Supplementary Data, of this report.

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COVID-19 IMPACTS ON OUR BUSINESS

The spread of the COVID-19 outbreak has disrupted businesses on a global scale. On March 11, 2020, the World Health Organization classified the outbreak as a pandemic. As we entered this crisis, the Company established two clear priorities: first and foremost the health and safety of our employees and their families, and second, continuing to meet the needs of our customers and secure the financial well-being of the Company. Substantially all of our operations and production activities have, to-date, remained operational. In response to the COVID-19 crisis, we implemented changes in our work practices to maintain a safe working environment for production employees at our facilities, while enabling other employees to productively work from home. As we commence bringing employees back to the workplace and return to in-person meetings with customers and suppliers, we have adopted a flexible work approach. These actions will allow for a smooth transition from COVID-19 conditions to a future that better meets the needs of the business and the interests of our employees. Additionally, we will fully comply with the U.S. Government's Safer Federal Workforce Task Force's guidelines on vaccination requirements for employees of the federal government and their contractors and subcontractors. As economic activity recovers, we will continue to monitor the situation, assessing further possible implications on our operations, supply chain, liquidity, cash flow and customer orders. We believe that our existing financial arrangements are sufficient to meet our operating needs, and have adequate borrowings under short and long-term arrangements that could provide additional relief if necessary.

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CONSOLIDATED RESULTS OF OPERATIONS

The following is a discussion of our results of operations in 2021 compared to 2020. A discussion of our 2020 results of operations compared to 2019 results can be found within Part II, Item 7. Management's Discussion and Analysis within our 2020 Annual Report on Form 10-K, filed with the Securities and Exchange Commission on November 17, 2020.

Net sales for the 2021 year are down marginally in comparison to 2020, due to the timing of the recovery from the COVID-19 pandemic. In 2021, sales were impacted by a full year of COVID-19 related pressure, as compared to 2020 where only the second half of the year was impacted. Sales growth in Space and Defense was offset by decreases within Industrial Systems and Aircraft Controls, the segments most impacted by this pandemic. Stronger foreign currencies, primarily the Euro relative to the U.S. Dollar, increased sales $34 million in the year in comparison to 2020, offsetting the real sales decrease. Additionally, the acquisition of Genesys contributed $44 million of incremental sales compared to 2020.

Gross margin increased in 2021 compared to 2020 due to the absence of last year's $23 million COVID-19 related inventory write-down. Excluding last year's COVID-19 related charges, gross margin increased marginally due to favorable sales mixes within Aircraft Controls and Industrial Systems. Also, higher sales volume within Space and Defense contributed to the increase. Partially offsetting these increases was lower sales volumes within Aircraft Controls and Industrial Systems.

Research and development expenses increased across Aircraft Controls and Industrial Systems in 2021 as compared to the prior year. The incorporation of the Genesys acquisition and higher activity across military development programs within Aircraft Controls increased research and development expenses $10 million. Research and development expenses also increased in Industrial Systems by $4 million for the year, due to higher innovation spend.

For 2021, selling, general and administrative expenses were slightly higher as a percentage of sales than the prior year, reflecting increased investments after several quarters of depressed spending throughout 2020 due to the COVID-19 pandemic.

Interest expense for fiscal 2021 decreased compared to 2020 due to lower interest rates on outstanding debt.

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In 2021, we recorded $2 million of impairment charges in our Space and Defense Controls segment as we exited certain product and contract arrangements. Additionally, we incurred $4 million of portfolio refinement and other charges in Industrial Systems and Space and Defense Controls. In 2020, we incurred impairment and restructuring expenses related to the impact that the COVID-19 pandemic had on our business. Throughout 2020, we incurred $38 million of long-lived asset impairments, $23 million of inventory write-downs and $11 million of restructuring expense. Of the total expense, the charges consist of $29 million of non-cash charges for the impairment of property, plant and equipment, $23 million of non-cash inventory reserves, $10 million for severance and $9 million of non-cash charges for the impairment of intangible assets.

In the fourth quarter of 2020, we purchased a single premium non-participating group annuity contract for our retirees who are receiving benefits of our U.S. defined benefit plan, which were then transferred to an insurance company. As a result of this transaction, we incurred a $121 million non-cash pension settlement charge as we accelerated unrecognized losses held in equity into our earnings.

Other expense in 2021 included a $6 million pension curtailment gain associated with the termination of a foreign pension plan, partially offset by $2 million of losses on the sale of non-core businesses within our Industrial Systems and Aircraft Controls segments. Other expense in 2020 included $15 million of non-service pension expense, as well as a $4 million call premium, as we redeemed our $300 million aggregate principal 5.25% senior notes.

In 2021, the effective tax rate increased when compared to 2020. In 2021, we revalued our deferred tax liabilities due to an increase in the U.K. tax rate that will become effective in 2023. During 2020, the effective tax rate was low due to foreign tax credit utilization associated with a prior year tax return filing, the pension settlement in the fourth quarter and due to the lower earnings before income tax.

The change in twelve-month backlog at October 2, 2021 as compared with the twelve-month backlog at October 3, 2020 was driven by increases across all markets. Backlog increased in Aircraft Controls due to the timing of commercial aircraft orders, F-35 and additional military development programs. Backlog also increased in Space and Defense Controls driven by increases in space satellite programs and higher orders for defense control products. The Industrial Systems backlog increased due to recovering demand for core industrial and industrial components products.

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SEGMENT RESULTS OF OPERATIONS

Operating profit, as presented below, is net sales less cost of sales and other operating expenses, excluding interest expense, equity-based compensation expense, non-service pension expense and other corporate expenses. Cost of sales and other operating expenses are directly identifiable to the respective segment or allocated on the basis of sales, manpower or profit. Operating profit is reconciled to earnings before income taxes in Note 21, Segments, of Item 8, Financial Statements and Supplementary Data of this report.

Aircraft Controls

Aircraft Controls' net sales decreased in 2021 as compared to 2020 due to the continued impacts of the global COVID-19 pandemic adversely affecting commercial OEM and aftermarket programs.

Across our commercial aircraft programs, the COVID-19 pandemic greatly reduced airline traffic and orders for new aircraft. Our airframe customers refined their production forecasts and worked down their inventory levels during the second half of 2020. During the second half of 2021, U.S. domestic commercial air traffic began to recover; however, international travel has remained muted and wide-body production rates have remained pressured. In 2021 compared to 2020, commercial OEM sales declined $97 million and commercial aftermarket sales declined $8 million as the impacts of the COVID-19 pandemic affected all of our programs. Partially offsetting the declines was a $61 million sales increase across our military programs, driven by higher activity on funded development programs, higher quantities for the F-35 program and acquired sales from Genesys.

Operating margin increased in 2021 compared to 2020 due to the absence of last year's $57 million in COVID-19 related impairment and restructuring charges. Excluding these charges, adjusted operating margin in 2020 was 7.6%. In 2021 operating margin was higher than the adjusted operating margin in 2020 due to a more favorable sales mix from higher levels of military OEM sales, including foreign military, and the addition of Genesys. In addition, 2021 included an increase of $10 million in research and development expenses from continued investment in military programs and the newly acquired Genesys, which partially offset the margin increase.

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Space and Defense Controls

Net sales within Space and Defense Controls in 2021 increased compared to 2020, driven by growth in our space markets.

Across our space programs, we continue benefiting from increased government spending on military applications and civil missions. Sales in our space market increased $39 million in 2021 when compared to 2020 due to increases in integrated space vehicles programs and satellite avionics programs. Partially offsetting the increase was a $10 million sales decline within our defense market. Within the defense market, sales declined $15 million in missile systems due to the timing of orders for development and production missiles. Additionally, defense sales declined $13 million in our security programs due to lower bookings. Increased orders for defense component programs and naval programs partially offset the sales declines.

Operating margin decreased in 2021 as compared to 2020 primarily due to higher costs on firm fixed price development contracts across our space and defense markets. As a result of the COVID-19 pandemic, we experienced supply chain challenges and direct labor inefficiencies. Additionally, in 2021 we recorded $2 million of impairment charges and $1 million in other charges as we exited certain product and contract arrangements.

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Industrial Systems

Net sales in Industrial Systems declined in 2021 as compared to 2020, as the recent industrial automation recoveries were more than offset by a decline across our other industrial markets. Stronger foreign currencies, primarily the Euro relative to the U.S. Dollar, increased sales $23 million in the year in comparison to 2020, partially offsetting the real sales decrease.

The COVID-19 pandemic, and the associated macroeconomic slowdown and reduced capital investments by our customers, created productivity and demand challenges. Additionally, the decline of the global airline market weakened demand for flight simulation products. These factors started in the second half of 2020 and continued through much of fiscal 2021, leading to a sales decline of $17 million year over year. Sales decreased $18 million within our medical market, as the prior year's surge in demand related to the COVID-19 pandemic moderated. The COVID-19 pandemic also affected sales within our simulation and test markets and energy markets, resulting in $13 million and $8 million declines, respectively. Partially offsetting these declines was a $22 million sales increase in our industrial automation market, as companies began to build capacity to meet recovering demand late in the year.

Both 2021 and 2020 operating margins include COVID-19 charges. In 2021, there was $4 million of COVID-19 related charges and impairments, while in 2020 there was $14 million charges related to the COVID-19 pandemic. Excluding these charges, adjusted operating margin for 2021 and 2020 were relatively unchanged at 10.1% and 10.3%, respectively. Research and development expenses increased by $4 million, which when combined with the sales decrease and portfolio refinement charges, resulted in a slightly reduced adjusted operating margin.

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SEGMENT OUTLOOK

2022 Outlook – We expect higher sales and general recovery across all segments to drive an increase in net sales in 2022. This growth is anticipated to be led by a recovery of legacy and recently acquired programs within commercial aircraft. We also expect increased Space and Defense sales, due mostly to higher amounts of activity in advanced space missions and satellites. In addition, we expect a modest sales recovery in Industrial Systems. We expect operating margin will increase due to operational improvements within all segments, combined with the absence of restructuring and impairment charges from 2021. Net earnings in 2022 are expected to benefit from the incremental operating margin, while holding our non-operating expense levels as a percentage of sales in line with 2021. We expect diluted earnings per share will range between $5.30 and $5.70, with a midpoint of $5.50, reflecting the continued uncertainty from the COVID-19 environment.

2022 Outlook for Aircraft Controls – In 2022, within commercial aircraft programs, we anticipate an increase in sales in our legacy OEM programs, a full year of the Genesys acquisition, combined with general recoveries within business jets and commercial aftermarket programs. We also expect military sales will increase driven by both OEM and aftermarket programs, spread across helicopters, funded development programs, Genesys and F-35 aftermarket, which will offset expected declines in F-35 OEM sales. We expect operating margin will increase in 2022 due to increased sales volumes and the continuation of a more favorable sales mix driven by military OEM and aftermarket programs.

2022 Outlook for Space and Defense Controls – We expect 2022 sales in Space and Defense Controls will increase in both of our markets. Within our defense market, we expect higher sales across both U.S. and foreign programs, primarily from our new turret program, and growth in defense component sales. We expect sales in our space market to increase as well, driven by higher sales from advanced missions and satellites, partially offset by the wind down of some of our launch program sales. We expect operating margin will increase in 2022 resulting from the incremental margin from higher sales volume, in addition to the absence of charges from portfolio refinement and product line sales from 2021.

2022 Outlook for Industrial Systems – We expect a similar level of sales in 2022 as compared to 2021. In 2022, we anticipate strong sales within our medical components business, led by increased orders for sleep therapy products, as compared to 2021. We expect a modest sales increase in the simulation and test markets as they continue to recover from the effects of COVID-19. Additionally, we expect sales to be relatively unchanged in our industrial automation programs as global capital investment activity stabilizes. We expect operating margin will remain relatively unchanged in 2022 as compared to 2021, due to ongoing footprint rationalization activities and new product investments.

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FINANCIAL CONDITION AND LIQUIDITY

Our available borrowing capacity and our cash flow from operations provide us with the financial resources needed to run our operations, reinvest in our business and make strategic acquisitions.

At October 2, 2021, our cash balances were $101 million which was primarily held outside of the U.S. Cash flow from our U.S. operations, together with borrowings on our credit facility, fund on-going activities, debt service requirements and future growth investments.

Operating activities

Net cash provided by operating activities increased in 2021 compared to 2020, driven by working capital improvements. In 2021, cash from inventories increased approximately $120 million when compared to 2020, primarily in our Aircraft Controls and Space and Defense Controls segments. Also, accounts payable used $105 million less cash than a year ago, based on the timing of vendor payments. These working capital benefits were partially offset by accounts receivable, which provided $185 million less cash than a year ago, as a result of strong year end collections in 2020. In addition, 2021 pension contributions decreased $21 million from the prior year.

We expect cash from operations in 2022 to be approximately $340 million, driven primarily by cash from the amended securitization facility, partially offset by less cash from new customer advances, as we work down existing project milestones. See Note 24, Subsequent Events, of Item 8, Financial Statements and Supplementary Data of this report for further discussion of our amended and restated receivables purchase agreement.

Investing activities

Net cash used by investing activities in 2021 included $78 million for our acquisition of Genesys and $129 million for capital expenditures. We increased our investments in capital expenditures in 2021 once the level of uncertainty from the pandemic subsided. Net cash used by investing activities in 2020 included $54 million for our acquisition of GAT and $88 million for capital expenditures.

We expect capital expenditures in 2022 to be $160 million, as we invest in facilities and infrastructure to support future growth and operational improvements.

Financing activities

Net cash used by financing activities in 2021 included $32 million of cash dividends, $30 million for our Board of Directors authorized share repurchase programs and $28 million of net repayments on our credit facilities.

Net cash used by financing activities in 2020 included the net proceeds of issuing our $500 million aggregate principal 4.25% senior notes, which were used to repay a portion of our outstanding borrowings. Additionally, financing activities in 2020 included $215 million related to repurchasing approximately 3 million shares, $95 million of net payments on long-term debt and $25 million of cash dividends.

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CAPITAL STRUCTURE AND RESOURCES

We maintain bank credit facilities to fund our short and long-term capital requirements, including acquisitions. From time to time, we also sell debt and equity securities to fund acquisitions or take advantage of favorable market conditions.

On October 15, 2019, we amended and restated our U.S. revolving credit facility, which matures on October 15, 2024. Our U.S. revolving credit facility has a capacity of $1.1 billion and also provides an expansion option, which permits us to request an increase of up to $400 million to the credit facility upon satisfaction of certain conditions. The U.S. revolving credit facility had an outstanding balance of $322 million at October 2, 2021. The weighted-average interest rate on the majority of the outstanding credit facility borrowings was 1.59% and is principally based on LIBOR plus the applicable margin, which was 1.5% at October 2, 2021. The credit facility is secured by substantially all of our U.S. assets.

The U.S. revolving credit facility contains various covenants. The minimum for the interest coverage ratio, defined as the ratio of EBITDA to interest expense for the most recent four quarters, is 3.0. The maximum for the leverage ratio, defined as the ratio of net debt to EBITDA for the most recent four quarters, is 4.0. We are in compliance with all covenants. EBITDA is defined in the loan agreement as (i) the sum of net income, interest expense, income taxes, depreciation expense, amortization expense, other non-cash items reducing consolidated net income and non-cash equity-based compensation expenses minus (ii) other non-cash items increasing consolidated net income.

We are generally not required to obtain the consent of lenders of the U.S. revolving credit facility before raising significant additional debt financing; however, certain limitations and conditions may apply that would require consent to be obtained. In recent years, we have demonstrated our ability to secure consents to access debt markets. We have also been successful in accessing equity markets from time to time. We believe that we will be able to obtain additional debt or equity financing as needed.

The SECT has a revolving credit facility with a borrowing capacity of $35 million, maturing on July 26, 2024. Interest was 2.21% as of October 2, 2021 and is based on LIBOR plus a margin of 2.13%. As of October 2, 2021, there were $7 million of outstanding borrowings.

On December 13, 2019, we completed the sale of $500 million aggregate principal amount of 4.25% senior notes due December 15, 2027 with interest paid semiannually on June 15 and December 15 of each year, which commenced on June 15, 2020. The senior notes are unsecured obligations, guaranteed on a senior unsecured basis by certain subsidiaries and contain normal incurrence-based covenants and limitations such as the ability to incur additional indebtedness, pay dividends, make other restricted payments and investments, create liens and certain corporate acts such as mergers and consolidations. The aggregate net proceeds of $492 million were used to repay indebtedness under our U.S. revolving credit facility, thereby increasing the unused portion of our U.S. revolving credit facility. The effective interest rate for these notes after considering the amortization of deferred debt issuance costs is 4.60%.

On December 13, 2019, we issued a notice of redemption to the holders of our 5.25% senior notes due on December 1, 2022, to redeem and retire all of the outstanding notes. The notes were redeemed on January 13, 2020 at 101.313% pursuant to an early redemption right. We redeemed the aggregate principal amount of $300 million using proceeds drawn from our U.S. revolving credit facility. The associated loss on redemption includes $4 million of call premium paid to external bondholders.

We have a trade receivables securitization facility (the "Securitization Program") that matures on October 29, 2021. The Securitization Program provides up to $80 million of borrowing capacity and lowers our cost to borrow funds as compared to the U.S. revolving credit facility. Under the Securitization Program, we sell certain trade receivables and related rights to an affiliate, which in turn sells an undivided variable percentage ownership interest in the trade receivables to a financial institution, while maintaining a subordinated interest in a portion of the pool of trade receivables. We had an outstanding balance of $80 million at October 2, 2021. The Securitization Program has a minimum borrowing requirement, which was $64 million at October 2, 2021. Interest on the secured borrowings under the Securitization Program was 0.95% at October 2, 2021 and is based on 30-day LIBOR plus an applicable margin.

At October 2, 2021, we had $786 million of unused capacity, including $746 million from the U.S. revolving credit facility after considering standby letters of credit. Our leverage ratio covenant limits our unused borrowing capacity to $609 million as of October 2, 2021.

Net debt to capitalization was 36% at October 2, 2021 and 40% at October 3, 2020. The decrease in net debt to capitalization is primarily due to our net earnings, which has increased the total capitalization.

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We declared and paid cash dividends of $0.25 per share on our Class A and Class B common stock in each quarter of 2021.

On November 20, 2020, the Board of Directors authorized a new share repurchase program to replace the previously existing share repurchase program. This program authorizes repurchases that includes both Class A and Class B common stock, and allows us to buy up to an aggregate 3 million common shares. Under this program, since inception we purchased approximately 243,000 shares for $19 million.

Previously, the Board of Directors authorized a share repurchase program that was amended from time to time to authorize additional repurchases that includes both Class A and Class B common stock, and allowed us to buy up to an aggregate 13 million common shares. Under this program, we purchased approximately 13 million shares for $899 million.

As we continue to adapt to the changing COVID-19 environment, we believe we are well positioned to invest in our business and have returned to a balanced capital deployment strategy. We expect to organically invest in our operations and explore opportunities to make strategic acquisitions and return capital to shareholders.

Off Balance Sheet Arrangements

We do not have any material off balance sheet arrangements that have or are reasonably likely to have a material future effect on our financial condition, results of operations or cash flows.

Contractual Obligations and Commercial Commitments

For further information on our contractual obligations and commitments as of October 2, 2021, see the notes referenced below, of Item 8, Financial Statements and Supplementary Data, of this report.

Right-of-use lease liabilities - See Note 7, Leases, for details on obligations and timing of expected future payments, including a five-year maturity schedule.

Debt Obligations and Interest Payments - See Note 9, Indebtedness, for details of our debt and timing of expected future principal and interest payments. Our current and long-term interest obligation on fixed-rate debt is $21 million and $111 million, respectively. Interest on variable-rate long-term debt, assuming the rate and outstanding balances do not change from those at October 2, 2021, would be approximately $8 million annually.

Employee Benefit Plans - See Note 14, Employee Benefit Plans, for details on our obligations and timing of expected future payments under these plans. In 2022, we have no minimum funding requirements. However, we anticipate making contributions to defined benefit pension plans of $13 million, of which approximately $5 million is for a non-qualified U.S. plan. We are unable to determine minimum funding requirements beyond 2022. We have made no discretionary incremental contributions to our defined benefit plans in excess of minimum funding requirements. We do not plan to make additional contributions for the foreseeable future.

Income Taxes - We are unable to determine if and when any unrecognized tax benefits, which are not material, will be settled, nor can we estimate any potential changes to the unrecognized tax benefits. See Note 15, Income Taxes, for additional details of tax obligations.

Commitments - Our current and long-term obligations for non-cancelable purchase commitments are $489 million and $106 million, respectively. See Note 23, Commitments and Contingencies, for additional details.

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ECONOMIC CONDITIONS AND MARKET TRENDS

We operate within the aerospace and defense and industrial markets. Our businesses continue to face varying levels of pressure from the COVID-19 pandemic.

Our defense and aerospace businesses represented 69% of our 2021 sales. These businesses have faced, and will continue to face, modest supply chain and production level risks as a result of the COVID-19 pandemic. Conversely, they are more directly affected by program funding levels, which have remained relatively stable. Our commercial aircraft market, which represented less than 15% of our 2021 sales, continues to face the greatest pressure due to dramatic reductions in air travel throughout the past year and a half. While domestic travel has recently started to show signs of recovery, international travel remains muted.

Within our industrial markets, which represented 31% of our 2021 sales, we have seen recent signs of recovery within industrial automation; however, as the demand is starting to rebuild, we are now experiencing pressure within our material supply chains and direct labor inefficiencies. Additionally, our simulation and test and energy markets continue to face demand challenges from the macroeconomic slowdown and reduced capital investments. Our medical business, which represented less than 10% of our 2021 sales, experienced a surge in demand for our medical applications essential in the fight against the pandemic. As this surge in demand wanes, we expect a return to normal growth rates in the future.

A common factor throughout our markets is the continuing demand for technologically advanced products.

Aerospace and Defense

Within aerospace and defense, we serve three end markets: defense, commercial aircraft and space.

The defense market is dependent on military spending for development and production programs, which to-date, have not been impacted by the COVID-19 pandemic. We have a growing development program order book for future generation aircraft and hypersonic missiles, and we strive to embed our technologies within these high-performance military programs of the future. Aircraft production programs are typically long-term in nature, offering predicable capacity needs and future revenues. We maintain positions on numerous high priority programs, including the Lockheed Martin F-35 Lightning II, FA-18E/F Super Hornet and V-22 Osprey. The large installed base of our products leads to attractive aftermarket sales and service opportunities. The tactical and strategic missile, missile defense and defense controls markets are dependent on many of the same market conditions as military aircraft, including overall military spending and program funding levels. At times when there are perceived threats to national security, U.S. Defense spending can increase; at other times, defense spending can decrease. Future levels of defense spending are uncertain, subject to presidential and congressional debate and could be reduced to offset the various COVID-19 pandemic relief payments.

The commercial OEM aircraft market has depended on a number of factors, including both the last decade's increasing global demand for air travel and increasing fuel prices. Both factors contributed to the demand for new, more fuel-efficient aircraft with lower operating costs that lead to large production backlogs for Boeing and Airbus. However, the impact of the COVID-19 pandemic has drastically reduced air traffic as travel restrictions and social distancing measures were implemented to help control the spread of the virus. The reduced air traffic has applied financial pressures on airlines, and in order to preserve cash and liquidity, have dramatically reduced flight hours and delayed the purchases of new aircraft. Although U.S. domestic air travel has recently increased during the second half of 2021, international travel has not yet begun to recover. Given the uncertain length of this pandemic and associated restrictions to travel long distances, the commercial market may shift away from wide-body aircraft. Furthermore, as companies and employees become accustomed to working remotely, business travel and the associated flight hours may not reach the pre-crisis levels. As such, we believe Boeing and Airbus will continue to directionally match their wide-body aircraft production rates with the reduced air traffic volume, which has lowered their demand for our flight control systems. We believe the commercial OEM market's recovery will be heavily dependent on the return to pre-COVID-19 air traffic activity levels and therefore will face pressures for a prolonged period of time.

The commercial aftermarket is driven by usage and age of the existing aircraft fleet for passenger and cargo aircraft, which drives the need for maintenance and repairs. Given the dramatic reductions in flight hours and the airlines' cash preservation measures due to the impacts of COVID-19, we believe the demand volume for our maintenance services and spare parts will be reduced. Also, with fewer expected new aircraft deliveries, we would see lower future initial provisioning and spares sales. However, as domestic and eventually international travel begin to recover, we expect a faster recovery in this market as compared to the commercial OEM market.

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The space market is comprised of four customer markets: the civil market, the department of defense market, the commercial space market and the new space market. The civil market, namely NASA, is driven by investment for commercial and exploration activities, including NASA's return to the moon. The department of defense market is driven by governmental-authorized levels of funding for satellite communications, as well as funding for hypersonic defense technologies. The commercial space market is comprised of large satellite customers, which traditionally sell to communications companies. Trends for this market, as well as for commercial launch vehicles, follow demand for increased capacity. This, in turn tends to track with underlying demand for increased consumption of telecommunication services, satellite replacements and global navigation needs. The new space market is driven by investments to increase the speed and access to space through integrated space vehicles and smaller satellites at reduced cost. Similar to the defense market, funding for these four markets have not been impacted by the COVID-19 pandemic to-date.

Industrial

Within industrial, we serve two end markets: industrial, consisting of industrial automation products, simulation and test products and energy generation and exploration products; and medical.

The industrial market we serve with our industrial automation products is influenced by several factors including capital investment levels, the pace of product innovation, economic conditions, cost-reduction efforts and technology upgrades. As governments around the world implemented measures to help control the spread of the COVID-19 virus, the subsequent economic downturn constrained capital investment and slowed spending for product innovation and upgrades. During the second half of 2021, we started to see a modest recovery in these markets; however concerns regarding supply chain constraints still exist.

Our simulation and test products operate in markets that are largely affected by these same factors and investment challenges stemming from the COVID-19 pandemic. Reduced air travel and the subsequent reduction in new commercial aircraft have reduced the demand for flight simulator training, for which we supply motion control products. Similarly, the recent lower capital spend has reduced the demand for our automotive and material testing applications.

Our energy generation and exploration products operate in a market that is influenced by changing oil and natural gas prices, global urbanization and the resulting change in supply and demand for global energy. Historically, drivers for global growth include investments in power generation infrastructure and exploration of new oil and gas resources. However, the COVID-19 pandemic led to reduced oil prices, reducing the economic feasibility for these investments and explorations, which to-date, have not returned to the pre-pandemic levels.

The medical market we serve, in general, is influenced by economic conditions, regulatory environments, hospital and outpatient clinic spending on equipment, population demographics, medical advances, patient demands and the need for precision control components and systems. The outbreak of the COVID-19 virus created unprecedented demand for medical equipment and has shifted the way hospitals optimize their capacity. Our medical components products are critical motion control components for life saving medical equipment, including ventilators, oxygen concentrators and continuous positive airway pressure (CPAP) machines, among others. The COVID-19 pandemic increased the demand for ventilators, of which our products are a key component of that industry's supply chain. Additionally, our medical devices products, including infusion and enteral feeding pumps and their corresponding disposable sets, are used primarily in the home healthcare environment. Since the COVID-19 pandemic has altered the way hospitals provide care by asking non-critical patients to recuperate at home, our medical devices products saw an increase in orders. As this level of demand was directly related to pandemic, we have already moved beyond the initial surge in demand as our customers resize their inventory levels.

Foreign Currencies

We are affected by the movement of foreign currencies compared to the U.S. dollar, particularly in Aircraft Controls and Industrial Systems. About one-fifth of our 2021 sales were denominated in foreign currencies. During 2021, average foreign currency rates generally strengthened against the U.S. dollar compared to 2020. The translation of the results of our foreign subsidiaries into U.S. dollars increased sales by $34 million compared to one year ago. During 2020, average foreign currency rates generally weakened against the U.S. dollar compared to 2019. The translation of the results of our foreign subsidiaries into U.S. dollars decreased 2020 sales by $4 million compared to 2019.

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RECENT ACCOUNTING PRONOUNCEMENTS

See Note 1, Summary of Significant Accounting Policies, included in Item 8, Financial Statements and Supplementary Data of this report for further information regarding Financial Accounting Standards Board issued Accounting Standards Updates ("ASU").