MOOG INC. (MOG-A) FY 2022 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, turreted weapon systems, 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.

•Space market - satellite positioning controls and thrust vector controls, as well as integrated space launch vehicles and hypersonic applications.

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, Italy, Costa Rica, China, Netherlands, Luxembourg, Japan, Czech Republic, Canada, India and Lithuania.

Under ASC 606, 64% of revenue was recognized over time for the year ended October 1, 2022, 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 1, 2022, 36% 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. These activities have included strategic acquisitions, share buybacks and dividend payments. Today, we believe we can create long term value for our shareholders by continuing to invest in our business through both capital expenditures, as well as investments in new market opportunities. We will also continue exploring opportunities to make strategic acquisitions and return capital to shareholders.

COVID-19 impacts on our business

Substantially all of our operations and production activities have, to-date, remained operational. However, the residual effects of the COVID-19 pandemic, including constraints and inflated prices within our supply chain, and localized lockdowns in China, impacted our business. While our backlog continues to grow across our end markets, ongoing COVID-19 disruptions continue to challenge our business. As economic activity continues to recover, we will continue to monitor the situation, assessing further possible implications on our operations, supply chain, liquidity, cash flow and customer orders.

Acquisitions, Divestitures and Equity Method Investments

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

On February 21, 2022, we acquired TEAM Accessories Limited ("TEAM") based in Dublin, Ireland for a purchase price, net of acquired cash, of $15 million, consisting of $12 million in cash and contingent consideration with an initial fair value of $3 million. TEAM specializes in Maintenance, Report and Overhaul ("MRO") of engine and airframe components. This operation is included in our Aircraft Controls segment. The purchase price allocation is subject to adjustments as we obtain additional information for our estimates during the measurement period.

On December 18, 2020, we acquired Genesys Aerosystems Group, Inc. ("Genesys"), headquartered in Mineral Wells, Texas for a purchase price of $78 million, net of acquired cash. Genesys designs and manufactures a full suite of electronic flight instrument systems and autopilot solutions. This operation is included in our Aircraft Controls segment.

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Divestitures

On September 30, 2022, we sold a sonar business based in the United Kingdom previously included in our Industrial Systems segment. We received net proceeds of $12 million and recorded a loss of $15 million, net of transaction costs. The loss is subject to adjustments associated with amounts currently held in escrow.

On September 20, 2022, we sold assets of a security business based in Northbrook, Illinois previously included in our Space and Defense Controls segment. We received net proceeds of $10 million and recorded a loss of $4 million, net of transaction costs. The loss is subject to adjustments associated with amounts currently held in escrow.

On December 3, 2021, we sold the assets of our Navigation Aids ("NAVAIDS") business based in Salt Lake City, Utah previously included in our Aircraft Controls segment. We received net proceeds of $36 million and recorded a gain of $16 million, net of transaction costs. The gain is subject to adjustments associated with amounts currently held in escrow.

In the fourth quarter of 2021, we sold a non-core business of our Industrial Systems segment. We received net proceeds of $11 million and recorded a loss of $2 million.

In the first quarter of 2021, we sold a non-core business of our Aircraft Controls segment for $2 million in net consideration and recorded a minimal loss.

Equity Method Investments

On August 31, 2022, we contributed $1 million to Suffolk Technologies Fund 1, L.P., a limited partnership that invests in startups to transform the construction, real estate and property maintenance industries in the U.S. As we are a limited partner in this investment, we are accounting for it using the equity method. We have a remaining on-call capital commitment of up to $7 million. This operation is included in our Industrial Systems segment.

On June 3, 2022, we increased our investment in NOVI LLC ("NOVI") by $1 million and now hold a 42.5% ownership interest. NOVI specializes in applying machine learning algorithms to space situational awareness. We are accounting for this investment using the equity method. This operation is included in our Space and Defense Controls segment.

For further information, refer to Note 3 - Acquisitions, Divestitures and Equity Method Investments, of Item 8, Financial Statements and Supplementary Data, of this report

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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 1, 2022 was 64% 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 1, 2022, we had contract reserves of $47 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 1, 2022, we had net inventories of $588 million, or 33% of current assets. Reserves for inventory were $141 million, or 19% 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 1, 2022, we had $805 million of goodwill, or 23% 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 estimation. 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 2022, we performed a quantitative 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 quantitative assessment indicated that is more likely than not that the fair value of each of the reporting units exceed its carrying value; and therefore, goodwill was not impaired.

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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 2022, pension expense for all defined benefit plans was $30 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 2022 were 3.3% for service cost and 2.7% for interest cost, compared to 3.1% and 2.6%, respectively, in 2021. 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 2022 expense for our largest plan, we used a 5.0% return on assets assumption, which was the same for 2021. A 25 basis point decrease in the long-term expected return on assets assumption would increase our annual pension expense by $1 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 2022.

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 1, 2022, we had gross deferred tax assets of $151 million and deferred tax asset valuation allowances of $9 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 $11 million related to tax benefit carryforwards associated with net operating losses and tax credits, for which $9 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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CONSOLIDATED RESULTS OF OPERATIONS

The following is a discussion of our results of operations in 2022 compared to 2021. A discussion of our 2021 results of operations compared to 2020 results can be found within Part II, Item 7. Management's Discussion and Analysis within our 2021 Annual Report on Form 10-K, filed with the Securities and Exchange Commission on November 15, 2021.

Net sales increased in 2022 compared to 2021 across all of our segments, particularly in our commercial aircraft programs and our defense programs. Also in 2022, weaker foreign currencies, primarily the Euro, the British Pound and the Japanese Yen relative to the U.S. Dollar, decreased sales $44 million compared to 2021.

Gross margin decreased slightly in 2022 compared to 2021. The additional costs associated with our constrained supply chain and $4 million of inventory write-down charges together offset the incremental margin from higher sales volumes across all three segments.

Research and development expenses decreased in 2022 compared to 2021. Aircraft Controls reduced research and development spend by $11 million primarily due to the redeployment of engineering activity to funded development programs. Industrial Systems also reduced research and development spend by $3 million.

Selling, general and administrative expense as a percentage of sales increased in 2022 compared to 2021. Across all of our segments, we had higher expenses to support customer interactions as we emerged from COVID-19 lockdowns, as well as increased investments in operations.

Interest expense increased in 2022 compared to 2021 due to higher interest rates on our outstanding debt throughout the year.

In 2022, we incurred charges for asset impairments and restructuring in all of our segments as we continued our business resizing and portfolio shaping activities, primarily in the second quarter of 2022. The benefits associated with these activities have averaged, and are expected to average, $4 million per quarter. Also, the first quarter of 2022 included a $16 million gain from the sale of our NAVAIDS business, and the fourth quarter of 2022 included a $9 million gain on the sale of a building. However, these gains were offset by losses associated with two business sales in Industrial Systems and in Space and Defense Controls in the fourth quarter of 2022, totaling $19 million.

Other in 2021 included a $6 million pension curtailment gain associated with the termination of a foreign pension plan, which did not repeat in 2022.

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The effective tax rate in 2022 increased modestly compared to the tax rate in 2021. The effective tax rate in 2022 included the benefit of favorable adjustments for tax credits associated with last year's tax return. The effective tax rate in 2021 included charges associated with the revaluation of deferred tax liabilities in the U.K., mostly offset by adjustments to the previous year's provision in the U.S.

The twelve-month backlog at October 1, 2022 increased as compared with the twelve-month backlog at October 2, 2021. The twelve-month backlog increased in Industrial Systems due to recovering demand for our flight simulation products and from orders for our new construction products. Also, backlog increased within Space and Defense Controls driven by our RIwP turret program. Backlog was unchanged within Aircraft Controls, as higher commercial OEM and aftermarket orders were offset by declines across various military programs.

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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 increased in 2022 compared to 2021, driven primarily by recoveries from the COVID-19 pandemic in our commercial OEM and aftermarket aircraft programs.

In 2022 compared to 2021, sales increased $70 million in our commercial OEM programs. We benefited from higher sales volumes across our main programs, increasing sales $26 million for our business jets programs, $21 million for our Boeing programs and $16 million for our Airbus programs. Additionally, in 2022 compared to 2021, sales increased $62 million in our commercial aftermarket programs. Higher spares volumes and repair demand, reflecting recovering flight-hour levels, increased sales a combined $30 million across our 787 and A350 programs. Also, sales increased an additional $18 million on our 787 aftermarket program due to one-time, retrofit sales.

Partially offsetting these sales increases in 2022 compared to 2021, was a $34 million sales decrease in our military OEM programs. The timing of orders and delayed material receipts on the F-35 program decreased sales $29 million, lower volumes for foreign military programs decreased sales $19 million and the sales associated with our divested NAVAIDS business decreased sales $17 million. Partially offsetting these reductions were $16 million of higher sales across our helicopter programs, $5 million of Genesys sales and $4 million of increased activity on funded development programs. Additionally in 2022 compared to 2021, sales decreased $2 million for our military aftermarket programs. Lower orders for the F-18 program and supply chain constraints affecting other legacy aircraft programs was mostly offset by higher spares and repair activity on the V-22 and the F-15 programs.

Operating margin increased in 2022 compared to 2021. Included in this increase was the $16 million gain associated with the divestiture of our NAVAIDS business. This gain was offset by $15 million of impairment and $4 million of restructuring expenses, in our second quarter of 2022, as we resized our business and continued our portfolio shaping activities. The benefits from these actions have averaged, and are expected to average, $3 million per quarter. Excluding both the gain and charges, adjusted operating margin in 2022 was 10.1%. The adjusted margin increase as compared to 2021 was driven by a favorable sales mix in commercial aftermarket, $11 million of reduced research and development spend and incremental margin from higher commercial sales volumes.

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Space and Defense Controls

Space and Defense Controls' net sales increased in 2022 compared to 2021, driven by continued growth within both our defense and space markets.

In 2022 compared to 2021, sales increased $68 million in our defense market. The main driver was the production ramp on our RIwP turret program, which increased sales $69 million. Also, sales for our defense components programs increased $11 million; however, this was offset by $6 million of lower international defense vehicle sales due to continued supply chain constraints and by $5 million of lower naval system sales due to the wind-down of development projects.

Additionally in 2022 compared to 2021, sales increased $5 million in our space market. Higher activity on our integrated space vehicle and advanced mission programs, and on our satellite avionics programs increased sales $24 million and $13 million, respectively. These increases were mostly offset by the wind-down of hypersonic development activity and by lower legacy launch vehicle sales.

Operating margin decreased in 2022 compared to 2021. Throughout 2022, we incurred $4 million of restructuring and inventory write-down charges as we continued our portfolio refinement activities and resized our business. We also incurred a $4 million loss associated with the divestiture of a security business. In the last quarter of 2021, we incurred $3 million of similar portfolio refinement charges. Excluding these charges in both years, the adjusted operating margins were 10.9% in 2022 and 11.4% in 2021. The resulting decline in adjusted operating margin was due to additional costs associated with our constrained supply chain and due to the COVID-19 related direct labor inefficiencies we experienced in the first half of 2022.

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Industrial Systems

Industrial Systems' net sales increased in 2022 compared to 2021 despite the adverse impacts of foreign currencies. Weaker foreign currencies, primarily the Euro and the Japanese Yen relative to the U.S. Dollar, decreased sales $33 million in 2022 when compared to 2021. Excluding the impact of foreign currencies, sales increased in all of our markets except for medical.

In 2022 compared to 2021 net sales increased $10 million in our simulation and test market driven mostly by increased demand for flight training simulators. Sales also increased $8 million in our industrial automation market driven by higher demand for factory automation equipment, particularly in Europe, and sales increased $5 million in our energy market. These increases were partially offset by $8 million of lower sales for medical devices due both to supply chain constraints and as the post COVID-19 demand surge winds-down for our medical pumps and sets.

Operating margin decreased in 2022 compared to 2021. Throughout 2022, we incurred $8 million of restructuring, inventory write-downs and asset impairment charges. These charges were a result of our continued portfolio refinement activities as we resized our business, and from assets associated with Russian actions in Ukraine. In our fourth quarter of 2022, we also incurred a $15 million loss associated with the divestiture of a sonar business, which was partially offset by a $9 million gain on the sale of a building. In the last quarter of 2021, we incurred $4 million of similar portfolio refinement charges. Excluding these charges in both years, the adjusted operating margins were 9.5% in 2022 and 10.1% in 2021. The resulting decline in adjusted operating margin was due to additional costs and inflated pressures associated with our constrained supply chain.

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SEGMENT OUTLOOK

2023 Outlook – We expect higher sales in 2023, driven by continued market recoveries in commercial OEM and industrial programs and by investments in new products across our segments. However, expected weaker foreign currencies and the lost sales associated with our divestitures in 2022 will moderate our sales growth. We expect operating margin will increase due to operational improvements within all segments, combined with the absence of charges related to restructuring, impairments and losses associated with the sales of businesses in 2022. Excluding these charges, we also expect adjusted operating margin will increase. Net earnings in 2023 are expected to benefit from the incremental operating margin, which we expect to be partially offset by higher interest expenses due to the expected higher interest rates on our outstanding debt balances. We expect diluted earnings per share will range between $5.50 and $5.90, with a midpoint of $5.70.

2023 Outlook for Aircraft Controls – In 2023, we anticipate sales increases across all of our commercial OEM programs as the commercial aircraft market recoveries continue and as our customers match the increasing demand with increased orders. We also anticipate a slight sales increase across our military programs as higher activity on funded development programs, the F-35 program and foreign military sales are mostly offset by lower legacy programs. We expect operating margin in 2023 will increase slightly as improved factory utilization from the higher sales volume is partially offset by the absence of 2022's favorable sales mix in commercial aftermarket.

2023 Outlook for Space and Defense Controls – In 2023, we anticipate sales increases in our space programs from the continued higher activity for integrated space vehicles programs and for our launch vehicle programs. Excluding the impact of lost sales associated with our security business divestiture, we expect sales increases across our defense programs, primarily driven by the continued production ramp of our RIwP program and by defense components programs. We expect operating margin will increase in 2023 resulting from the incremental margin from higher sales volume, in addition to the absences of charges from portfolio refinements, our business sale and our incremental costs associated with our constrained supply chain.

2023 Outlook for Industrial Systems – In 2023, we anticipate sales increases across our markets, excluding an expected negative impact from continued weaker foreign currencies relative to the U.S. Dollar, and excluding the lost sales associated with our sonar business divestiture. The underlying organic sales growth is expected primarily in our flight simulation products, driven by the continued demand for flight training simulators, and in our medical device products. We expect operating margin will increase in 2023 resulting from the higher sales volumes and due to the absence of charges from our portfolio refinements, impairments and business sale.

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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 1, 2022, our cash balances were $119 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 decreased in 2022 compared to 2021. In 2022, accounts receivable generated $13 million less cash than the previous year, driven in part by the 787 program, where we maintained steady production levels that were higher than the rate at which Boeing took deliveries. This was mostly offset by a $100 million benefit from our Receivables Purchase Agreement ("RPA") program. Also in 2022, supply chain constraints, particularly in Industrial Systems, contributed to inventory using $48 million more in cash. Partially offsetting the increased uses of cash was a $23 million benefit from accounts payable, due to timing of payments.

We expect cash from operations in 2023 to be $280 million, an increase compared to 2022, driven primarily due to improved cash generation from net working capital.

Investing activities

Net cash used by investing activities in 2022 included $139 million of capital expenditures, as we increased investments in facilities to support growth and provide next generation manufacturing capabilities. Also 2022 included $12 million for the acquisition of TEAM Accessories. These cash outflows were partially offset by $71 million of proceeds from the sales of two businesses and a building in 2022.

Net cash used by investing activities in 2021 included $78 million for our acquisition of Genesys and $129 million for capital expenditures.

We expect capital expenditures in 2023 to be $150 million, as we continue to invest in facilities and infrastructure to support future growth and operational improvements.

Financing activities

Net cash used by financing activities in 2022 included $68 million of net payments on our credit facilities. Additionally, financing activities included $33 million of share repurchases and $33 million of cash dividends.

Net cash used by financing activities in 2021 included $32 million of cash dividends, $30 million for share repurchases and $28 million of net payments on our credit facilities.

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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.

Our U.S. revolving credit facility, which matures on October 15, 2024, 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 $321 million at October 1, 2022. The weighted-average interest rate on the majority of the outstanding credit facility borrowings was 4.16% and is principally based on LIBOR plus the applicable margin, which was 1.5% at October 1, 2022. The credit facility is secured by substantially all of our U.S. assets. See Note 24 - Subsequent Events, for information related to the amended and restated U.S. revolving credit facility.

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 5.16% as of October 1, 2022 and is based on LIBOR plus a margin of 2.13%. As of October 1, 2022, there were $20 million of outstanding borrowings.

We have $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. We are in compliance with all covenants. The aggregate net proceeds were used to repay indebtedness under our U.S. bank facility, thereby increasing the unused portion of our U.S. revolving credit facility.

On November 4, 2021, we amended and restated our Receivables Purchase Agreement, which matures on November 4, 2024, allowing the Receivables Subsidiary to sell receivables to the Purchasers in amounts up to a $100 million limit so long as certain conditions are satisfied. The receivables are sold to the Purchasers in consideration for the Purchasers making payments of cash. As of October 1, 2022, the amount sold to the Purchasers and derecognized was $100 million. Each Purchaser’s share of capital accrues yield at a variable rate plus an applicable margin, which totaled 4.04% as of October 1, 2022.

Previously, we securitized certain trade receivables that were accounted for as secured borrowings (the "Securitization Program"). The Securitization Program was extended on October 29, 2021 and matured on December 29, 2021, providing up to $80 million of borrowing capacity and lowered our cost to borrow funds as compared to the U.S. revolving credit facility. Under the Securitization Program, we sold certain trade receivables and related rights to an affiliate, which in turn sold 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. The Securitization Program had a minimum borrowing requirement equal to the lesser of either 80% of our borrowing capacity or 100% of our borrowing base, which was a subset of the trade receivables sold under this agreement. Interest on the secured borrowings under the Securitization Program was based on 30-day LIBOR plus an applicable margin.

At October 1, 2022, we had $788 million of unused capacity, including $762 million from the U.S. revolving credit facility after considering standby letters of credit and other limitations. Our leverage ratio covenant limits our unused borrowing capacity to $664 million as of October 1, 2022.

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Net debt to capitalization was 33% at October 1, 2022 and 36% at October 2, 2021. The decrease in net debt to capitalization is primarily due to our net earnings, which has increased the total capitalization.

We declared and paid cash dividends of $1.03 per share on our Class A and Class B common stock in 2022.

The Board of Directors authorized a share repurchase program that authorizes repurchases for 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 have purchased approximately 730,000 shares for $55 million.

Today we believe we can create long term value for our shareholders by continuing to invest in our business through both capital expenditures as well as investments in new market opportunities. We will also continue exploring 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 1, 2022, 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 $89 million, respectively. Interest on variable-rate long-term debt, assuming the rate and outstanding balances do not change from those at October 1, 2022, would be approximately $17 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 2023, we have no minimum funding requirements. However, we anticipate making contributions to defined benefit pension plans of $12 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 $936 million and $178 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 are facing varying levels of supply chain and production level pressures from the residual impacts of the COVID-19 pandemic.

Our aerospace and defense businesses represented 70% of our 2022 sales. Within the defense market, our programs are directly affected by funding levels, which have remained relatively stable. Our commercial aircraft market, which represented 18% of our 2022 sales, is still recovering from the initial, dramatic, reductions in air travel at the onset of the COVID-19 pandemic. While domestic travel has recovered, global international travel remains below pre-pandemic levels.

Within our industrial markets, which represented 30% of our 2022 sales, our programs benefited from increased order demand within industrial automation, simulation and test and energy markets. However, as customer demand increases across these markets, we are now experiencing supply chain pressures.

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. 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 predictable capacity needs and future revenues. We maintain positions on numerous high priority programs, including the Lockheed Martin F-35 Lightning II 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 approval, and could increase in the near-term given the current global tensions.

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 led to large production backlogs for Boeing and Airbus. While domestic air travel has recovered from the impact of the COVID-19 pandemic, international travel utilizing wide-body aircraft will take longer to fully recover. Furthermore, as companies and employees become accustomed to working remotely, business travel and the associated flight hours may not fully reach the pre-pandemic levels. As such, we believe Boeing and Airbus will continue to directionally match their wide-body aircraft production rates with the reduced, albeit recovering, air traffic volume, which has lowered their demand for our flight control systems. We believe the commercial OEM market's recovery is heavily dependent on the return to pre-COVID-19 global international air traffic activity levels, and therefore will face pressures for a prolonged period of time.

The commercial aftermarket is driven by usage and the age of the existing aircraft fleet for passenger and cargo aircraft, which drives the need for maintenance and repairs. While there were initial dramatic reductions in flight hours at the onset of the COVID-19 pandemic, we have seen a recovery in the demand volume for our maintenance services and spare parts.

The space market is comprised of four customer markets: the civil market, the U.S. 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 U.S. Department of Defense market is driven by governmental-authorized levels of defense spending, including funding for hypersonic defense technologies. Levels of U.S. defense spending could increase as there is growing emphasis on space as the next frontier of potential future conflicts. 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 smaller satellites at reduced cost.

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Industrial

Within industrial, we serve two end markets: industrial and medical. The industrial market consists of industrial automation products, simulation and test products and energy generation and exploration products. The medical market consists of medical devices and medical components products.

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, technology upgrades and the subsequent effects of the COVID-19 pandemic. As our industrial market continues to recover, ongoing supply chain constraints continue to impact our operations, as will potential future economic recessions.

Our simulation and test products operate in markets that were largely affected by the same factors and investment challenges stemming from the COVID-19 pandemic. However, we have seen stronger order demand for flight simulation systems as the airline training market recovers.

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. Recently, we have seen oil prices rise above pre-pandemic levels due, in part, to global disruptions; but future energy crises could increase the market’s uncertainty.

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. When the COVID-19 pandemic altered the way hospitals provided care by asking non-critical patients to recuperate at home, our medical devices products saw an increase in orders. This surge in demand has waned, as our customers have resized 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 2022 sales were denominated in foreign currencies. During 2022, average foreign currency rates generally weakened against the U.S. dollar compared to 2021. The translation of the results of our foreign subsidiaries into U.S. dollars decreased sales by $44 million compared to one year ago. 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 2021 sales by $34 million compared to 2020.

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").

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