UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________
FORM 10-Q
(Mark One)
| þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| | For the quarterly period ended September 30, 2011 |
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| | For the transition period from ______ to ______ |
Commission file number 1-14279
____________________________________
ORBITAL SCIENCES CORPORATION
(Exact name of registrant as specified in charter)
| Delaware | 06-1209561 |
| (State of Incorporation of Registrant) | (I.R.S. Employer Identification No.) |
21839 Atlantic Boulevard
Dulles, Virginia 20166
(Address of principal executive offices)
(703) 406-5000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of October 24, 2011, 58,748,920 shares of the registrant’s Common Stock were outstanding.
ORBITAL SCIENCES CORPORATION
FINANCIAL INFORMATION
| | ORBITAL SCIENCES CORPORATION |
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited, in thousands, except share data)
| | | September 30, | | | December 31, | |
| | | 2011 | | | 2010 | |
| ASSETS | | | | | | |
| Current assets: | | | | | | |
| Cash and cash equivalents | | $ | 303,972 | | | $ | 252,415 | |
| Receivables, net | | | 397,633 | | | | 326,543 | |
| Inventories | | | 54,313 | | | | 56,217 | |
| Deferred income taxes, net | | | 40,796 | | | | 24,348 | |
| Other current assets | | | 14,074 | | | | 18,111 | |
| Total current assets | | | 810,788 | | | | 677,634 | |
| Investments | | | 9,700 | | | | 8,600 | |
| Property, plant and equipment, net | | | 251,583 | | | | 232,706 | |
| Goodwill | | | 75,261 | | | | 74,747 | |
| Deferred income taxes, net | | | 22,277 | | | | 47,806 | |
| Other non-current assets | | | 27,575 | | | | 21,043 | |
| Total assets | | $ | 1,197,184 | | | $ | 1,062,536 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | |
| Current liabilities: | | | | | | | | |
| Accounts payable and accrued expenses | | $ | 267,690 | | | $ | 248,835 | |
| Deferred revenues and customer advances | | | 158,116 | | | | 112,182 | |
| Total current liabilities | | | 425,806 | | | | 361,017 | |
| Long-term obligations | | | 129,745 | | | | 125,535 | |
| Other non-current liabilities | | | 16,969 | | | | 7,367 | |
| Total liabilities | | | 572,520 | | | | 493,919 | |
| Commitments and contingencies | | | | | | | | |
| Stockholders’ equity: | | | | | | | | |
| Preferred Stock, par value $.01; 10,000,000 shares authorized, none outstanding | | | — | | | | — | |
| Common Stock, par value $.01; 200,000,000 shares authorized, 58,747,734 and | | | | | | | | |
| 58,239,875 shares outstanding, respectively | | | 587 | | | | 582 | |
| Additional paid-in capital | | | 564,018 | | | | 558,015 | |
| Accumulated other comprehensive loss | | | (1,996 | ) | | | (2,011 | ) |
| Retained earnings | | | 62,055 | | | | 12,031 | |
| Total stockholders’ equity | | | 624,664 | | | | 568,617 | |
| Total liabilities and stockholders’ equity | | $ | 1,197,184 | | | $ | 1,062,536 | |
See accompanying notes to condensed consolidated financial statements.
ORBITAL SCIENCES CORPORATION
CONDENSED CONSOLIDATED INCOME STATEMENTS (Unaudited, in thousands, except per share data)
| | | Quarters Ended, | | | Nine Months Ended | |
| | | September 30, | | | September 30, | |
| | | 2011 | | | 2010 | | | 2011 | | | 2010 | |
| Revenues | | $ | 342,170 | | | $ | 314,519 | | | $ | 1,010,472 | | | $ | 948,435 | |
| Cost of revenues | | | 267,494 | | | | 237,844 | | | | 821,292 | | | | 737,043 | |
| Research and development expenses | | | 26,681 | | | | 35,367 | | | | 67,248 | | | | 95,798 | |
| Selling, general and administrative expenses | | | 23,327 | | | | 21,952 | | | | 64,340 | | | | 66,645 | |
| Income from operations | | | 24,668 | | | | 19,356 | | | | 57,592 | | | | 48,949 | |
| Interest income and other | | | 369 | | | | 486 | | | | 12,561 | | | | 1,232 | |
| Interest expense | | | (2,880 | ) | | | (2,418 | ) | | | (8,217 | ) | | | (7,120 | ) |
| Income before income taxes | | | 22,157 | | | | 17,424 | | | | 61,936 | | | | 43,061 | |
| Income tax provision | | | (5,684 | ) | | | (6,795 | ) | | | (11,912 | ) | | | (16,819 | ) |
| Net income | | $ | 16,473 | | | $ | 10,629 | | | $ | 50,024 | | | $ | 26,242 | |
| | | | | | | | | | | | | | | | | |
| Basic income per share | | $ | 0.28 | | | $ | 0.18 | | | $ | 0.85 | | | $ | 0.45 | |
| | | | | | | | | | | | | | | | | |
| Diluted income per share | | $ | 0.28 | | | $ | 0.18 | | | $ | 0.84 | | | $ | 0.45 | |
See accompanying notes to condensed consolidated financial statements.
ORBITAL SCIENCES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited, in thousands)
| | | Nine Months Ended September 30, | |
| | | 2011 | | | 2010 | |
| Operating Activities: | | | | | | |
| Net income | | $ | 50,024 | | | $ | 26,242 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | |
| Depreciation and amortization expense | | | 24,464 | | | | 17,727 | |
| Deferred income taxes | | | 9,754 | | | | 15,703 | |
| Stock-based compensation and other | | | 8,338 | | | | 7,240 | |
| Changes in assets and liabilities, net of effect of acquisition | | | 2,047 | | | | (66,142 | ) |
| Net cash provided by operating activities | | | 94,627 | | | | 770 | |
| | | | | | | | | |
| Investing Activities: | | | | | | | | |
| Capital expenditures | | | (43,118 | ) | | | (58,682 | ) |
| Payment for business acquisition | | | — | | | | (55,000 | ) |
| Proceeds from sale of investment | | | — | | | | 4,250 | |
| Net cash used in investing activities | | | (43,118 | ) | | | (109,432 | ) |
| | | | | | | | | |
| Financing Activities: | | | | | | | | |
| Net proceeds from issuances of common stock | | | 1,971 | | | | 10,775 | |
| Debt issuance costs | | | (3,084 | ) | | | — | |
| Tax benefit of stock-based compensation | | | 1,161 | | | | 2,067 | |
| Net cash provided by financing activities | | | 48 | | | | 12,842 | |
| | | | | | | | | |
| Net increase (decrease) in cash and cash equivalents | | | 51,557 | | | | (95,820 | ) |
| Cash and cash equivalents, beginning of period | | | 252,415 | | | | 372,986 | |
| Cash and cash equivalents, end of period | | $ | 303,972 | | | $ | 277,166 | |
See accompanying notes to condensed consolidated financial statements.
ORBITAL SCIENCES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 2011 and 2010
(Unaudited)
(1) Basis of Presentation
Orbital Sciences Corporation (together with its subsidiaries, “Orbital” or the “company”), a Delaware corporation, develops and manufactures small- and medium-class rockets and space systems for commercial, military and civil government customers.
In the opinion of management, the accompanying unaudited interim financial information reflects all adjustments, consisting of normal recurring accruals, necessary for a fair presentation on a going concern basis. Certain information and disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to instructions, rules and regulations prescribed by the U.S. Securities and Exchange Commission. The company believes that the disclosures provided herein are adequate to make the information presented not misleading when these unaudited interim condensed consolidated financial statements are read in conjunction with the audited consolidated financial statements contained in the company’s Annual Report on Form 10-K for the year ended December 31, 2010.
The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions, including estimates of future contract costs and earnings. Such estimates and assumptions affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and earnings during the current reporting period. Management periodically assesses and evaluates the adequacy and/or deficiency of liabilities recorded for various reserves, contract risks and other uncertainties. Actual results could differ from these estimates and assumptions.
All financial amounts are stated in U.S. dollars unless otherwise indicated.
The company has evaluated subsequent events in accordance with U.S. GAAP. Management has evaluated the events and transactions that have occurred through the date the financial statements were issued, and noted no items requiring adjustment or disclosure in the financial statements. Operating results for the quarter ended September 30, 2011 are not necessarily indicative of the results expected for the full year.
(2) Business Acquisition and Goodwill
On April 2, 2010, the company acquired certain assets and liabilities of the spacecraft development and manufacturing business of General Dynamics Advanced Information Systems, a subsidiary of General Dynamics Corporation (the “Seller”), for $55 million in cash, subject to a potential working capital adjustment. The company’s consolidated financial statements reflect
the operations of the acquired business since the date of acquisition. The company and the Seller are each disputing the other party’s claim for a purchase price adjustment based on the calculation of working capital as of the closing date.
The allocation of the purchase price for the tangible and identifiable intangible assets acquired and liabilities assumed was based on their estimated fair values at the date of acquisition using established valuation techniques. The company may recognize changes to the acquired assets or liabilities as a result of a working capital adjustment or if new information is obtained about facts and circumstances that existed as of the acquisition date. In 2011, the company recorded an additional $0.5 million of goodwill related to the update of purchase accounting associated with the acquisition.
(3) Industry Segment Information
Orbital’s products and services are grouped into three reportable business segments: launch vehicles, satellites and space systems and advanced space programs. Reportable segments are generally organized based upon product lines. Corporate office transactions that have not been attributed to a particular segment, as well as consolidating eliminations and adjustments, are reported in corporate and other. The primary products and services from which the company’s reportable segments derive revenues are:
| | • | Launch Vehicles - Rockets that are used as small- and medium-class space launch vehicles that place satellites into Earth orbit and escape trajectories, interceptor and target vehicles for missile defense systems and suborbital launch vehicles that place payloads into a variety of high-altitude trajectories. |
| | • | Satellites and Space Systems - Small- and medium-class satellites that are used to enable global and regional communications and broadcasting, conduct space-related scientific research, collect imagery and other remotely-sensed data about the Earth, carry out interplanetary and other deep-space exploration missions and demonstrate new space technologies. |
| | • | Advanced Space Programs - Human-rated space systems for Earth-orbit and deep-space exploration, and small- and medium-class satellites primarily used for national security space programs and to demonstrate new space technologies. |
Intersegment sales are generally negotiated and accounted for under terms and conditions that are similar to other commercial and government contracts. Substantially all of the company’s assets and operations are located within the United States.
The following table presents operating information and identifiable assets by reportable segment (in thousands):
| | Quarters Ended September 30, | | Nine Months Ended September 30, | |
| | 2011 | | | 2010 | | 2011 | | | 2010 | |
| Launch Vehicles: | | | | | | | | | | |
Revenues(1) | $116,538 | | | $105,828 | | $353,178 | | | $301,872 | |
| Operating income | 5,242 | | | 4,988 | | 7,063 | | | 12,988 | |
| Identifiable assets | 209,216 | | | 212,360 | (2) | 209,216 | | | 212,360 | (2) |
| Capital expenditures | 2,516 | | | 15,472 | | 23,212 | | | 37,897 | |
| Depreciation and amortization | 3,497 | | | 1,865 | | 10,769 | | | 5,479 | |
Satellites and Space Systems: | | | | | | | | | | |
Revenues(1) | $141,130 | | | $121,844 | | $431,963 | | | $361,788 | |
| Operating income | 11,460 | | | 7,441 | | 30,244 | | | 22,660 | |
| Identifiable assets | 293,394 | | | 268,804 | (2) | 293,394 | | | 268,804 | (2) |
| Capital expenditures | 3,531 | | | 4,210 | | 7,376 | | | 7,537 | |
| Depreciation and amortization | 1,651 | | | 1,670 | (3) | 5,102 | | | 4,226 | (3) |
| Advanced Space Programs: | | | | | | | | | | |
Revenues(1) | $112,214 | | | $103,204 | | $308,112 | | | $331,673 | |
| Operating income | 7,966 | | | 7,835 | | 20,285 | | | 15,829 | |
| Identifiable assets | 259,345 | | | 188,184 | (2) | 259,345 | | | 188,184 | (2) |
| Capital expenditures | 3,098 | | | 4,867 | | 10,294 | | | 11,049 | |
| Depreciation and amortization | 1,276 | | | 1,088 | (3) | 3,576 | | | 3,431 | (3) |
| Corporate and Other: | | | | | | | | | | |
Revenues(1) | $(27,712) | | | $(16,357) | | $(82,781) | | | $(46,898) | |
| Operating loss | — | | | (908) | (4) | — | | | (2,528) | (4) |
| Identifiable assets | 435,229 | | | 393,188 | (2) | 435,229 | | | 393,188 | (2) |
| Capital expenditures | 1,199 | | | 542 | | 2,236 | | | 2,199 | |
| Depreciation and amortization | 1,564 | | | 1,711 | | 5,017 | | | 4,591 | |
| Consolidated: | | | | | | | | | | |
| Revenues | $342,170 | | | $314,519 | | $1,010,472 | | | $948,435 | |
| Operating income | 24,668 | | | 19,356 | | 57,592 | | | 48,949 | |
| Identifiable assets | 1,197,184 | | | 1,062,536 | (2) | 1,197,184 | | | 1,062,536 | (2) |
| Capital expenditures | 10,344 | | | 25,091 | | 43,118 | | | 58,682 | |
| Depreciation and amortization | 7,988 | | | 6,334 | | 24,464 | | | 17,727 | |
| (1) | Corporate and other revenues are comprised solely of the elimination of intersegment revenues summarized as follows (in millions): |
| | | Quarters Ended September 30, | | | Nine Months Ended September 30, | |
| | | 2011 | | | 2010 | | | 2011 | | | 2010 | |
| Launch Vehicles | | $ | 26.1 | | | $ | 14.4 | | | $ | 77.8 | | | $ | 41.4 | |
| Satellites and Space Systems | | | 1.5 | | | | 1.7 | | | | 3.9 | | | | 4.5 | |
| Advanced Space Programs | | | 0.1 | | | | 0.3 | | | | 1.1 | | | | 1.0 | |
| Total intersegment revenues | | $ | 27.7 | | | $ | 16.4 | | | $ | 82.8 | | | $ | 46.9 | |
(2) As of December 31, 2010.
(3) Prior period amounts have been reclassified to conform to the current period presentation.
| | (4) | The corporate and other operating loss in 2010 is comprised of unallocated corporate-level costs and includes $1.6 million of transaction expenses incurred in connection with a business acquisition. |
The computation of basic and diluted earnings per share (“EPS”) is as follows (in thousands, except per share amounts):
| | | | Quarters Ended | | | Nine Months Ended | |
| | | | September 30, | | | September 30, | |
| Numerator | | 2011 | | | 2010 | | | 2011 | | | 2010 | |
| | Net income | | $ | 16,473 | | | $ | 10,629 | | | $ | 50,024 | | | $ | 26,242 | |
| | Percentage allocated to shareholders (1) | | | 99.2% | | | | 98.9% | | | | 99.0% | | | | 99.1% | |
| | Numerator for basic and diluted earnings per share | | $ | 16,341 | | | $ | 10,512 | | | $ | 49,524 | | | $ | 26,005 | |
| | | | | | | | | | | | | | | | | | |
| Denominator | | | | | | | | | | | | | | | | |
| | Denominator for basic earnings per share - | | | | | | | | | | | | | | | | |
| | weighted-average shares outstanding | | | 58,598 | | | | 57,899 | | | | 58,441 | | | | 57,550 | |
| | Dilutive effect of stock options | | | 389 | | | | 583 | | | | 445 | | | | 676 | |
| | Dilutive effect of restricted stock units | | | — | | | | — | | | | 99 | | | | — | |
| | Denominator for diluted earnings per share | | | 58,987 | | | | 58,482 | | | | 58,985 | | | | 58,226 | |
| | | | | | | | | | | | | | | | | | |
| Per share income | | | | | | | | | | | | | | | | |
| | Basic | | $ | 0.28 | | | $ | 0.18 | | | $ | 0.85 | | | $ | 0.45 | |
| | Diluted | | | 0.28 | | | | 0.18 | | | | 0.84 | | | | 0.45 | |
| _________________________ | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| (1) | Basic weighted-average shares outstanding | | | 58,598 | | | | 57,899 | | | | 58,441 | | | | 57,550 | |
| | Basic weighted-average shares outstanding and | | | | | | | | | | | | | | | | |
| | unvested restricted share units expected to vest | | | 59,062 | | | | 58,514 | | | | 59,047 | | | | 58,071 | |
| | Percentage allocated to shareholders | | | 99.2% | | | | 98.9% | | | | 99.0% | | | | 99.1% | |
The calculation of EPS shown above excludes the income attributable to certain of the company’s unvested restricted stock units from the numerator and excludes the impact of those units from the denominator. Diluted weighted-average shares for all periods exclude the effect of the company’s convertible senior subordinated notes that were anti-dilutive.
(5) Receivables
Receivables consisted of the following (in thousands):
| | | September 30, | | | December 31, | |
| | | 2011 | | | 2010 | |
| Billed | | $ | 106,548 | | | $ | 56,035 | |
| Unbilled | | | 291,085 | | | | 270,508 | |
| Total | | $ | 397,633 | | | $ | 326,543 | |
As of September 30, 2011 and December 31, 2010, unbilled receivables included $13.7 million and $14.9 million, respectively, of incentive fees on certain completed satellite contracts that become due incrementally over periods of up to 15 years, subject to the achievement of performance criteria. In addition, certain satellite contracts require the company to refund cash to the customer if performance criteria, which cover periods of up to 15 years, are not satisfied. As of September 30, 2011, the company could be required to refund up to approximately $16.7 million to customers if certain completed satellites were to fail to satisfy performance criteria. Orbital generally procures insurance policies that the company believes would indemnify the company for satellite incentive fees that are not earned and for performance refund obligations.
(6) Inventories
Total inventories were $54.3 million at September 30, 2011 and $56.2 million at December 31, 2010. Substantially all of the company’s inventory consisted of component parts, raw materials and milestone payments for future delivery of component parts. The company had no significant allowances for obsolete inventory as of September 30, 2011 and December 31, 2010.
(7) Investments
As of September 30, 2011, the company held investments consisting of three auction-rate debt securities (life insurance company capital reserve funds), an auction-rate equity security (financial guarantee company capital reserve fund) and two preferred stock investments. These investments are classified as available for sale securities and as non-current assets on the company’s balance sheet. Contractual maturities for the debt securities are 14 years or greater and the remaining securities have no fixed maturity. The amortized cost and fair value of these investments were as follows (in thousands):
| | | September 30, 2011 | | | December 31, 2010 | |
| | | Cost or Amortized Cost | | | Net Unrealized Gain (Loss) | | | Fair Value | | | Cost or Amortized Cost | | | Net Unrealized Gain (Loss) | | | Fair Value | |
| Debt | | $ | 7,150 | | | $ | 50 | | | $ | 7,200 | | | $ | 7,150 | | | $ | (450 | ) | | $ | 6,700 | |
Equity(1) | | | 2,000 | | | | 500 | | | | 2,500 | | | | 2,000 | | | | (100 | ) | | | 1,900 | |
| Total | | $ | 9,150 | | | $ | 550 | | | $ | 9,700 | | | $ | 9,150 | | | $ | (550 | ) | | $ | 8,600 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
(1) As of September 30, 2011 and December 31, 2010, cost and fair value of the two preferred stock investments were $0.
The changes in fair value of the investments were recorded as follows (in thousands):
| | | Quarters Ended | | | Nine Months Ended | |
| | | September 30, | | | September 30, | |
| | | 2011 | | | 2010 | | | 2011 | | | 2010 | |
| Debt Securities | | | | | | | | | | | | |
| Fair value at beginning of period | | $ | 6,900 | | | $ | 10,500 | | | $ | 6,700 | | | $ | 10,900 | |
| Temporary impairment credits (charges), net | | | 300 | | | | 250 | | | | 500 | | | | (150 | ) |
| Other-than-temporary impairment charges | | | — | | | | (850 | ) | | | — | | | | (850 | ) |
| Sale of security | | | — | | | | (3,400 | ) | | | — | | | | (3,400 | ) |
| Net change in fair value | | | 300 | | | | (4,000 | ) | | | 500 | | | | (4,400 | ) |
| Fair value at end of period | | $ | 7,200 | | | $ | 6,500 | | | $ | 7,200 | | | $ | 6,500 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Equity Securities | | | | | | | | | | | | | | | | |
| Fair value at beginning of period | | $ | 2,800 | | | $ | 2,100 | | | $ | 1,900 | | | $ | 2,200 | |
| Temporary impairment credits (charges), net | | | (300 | ) | | | — | | | | 600 | | | | (100 | ) |
| Net change in fair value | | | (300 | ) | | | — | | | | 600 | | | | (100 | ) |
| Fair value at end of period | | $ | 2,500 | | | $ | 2,100 | | | $ | 2,500 | | | $ | 2,100 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Total | | | | | | | | | | | | | | | | |
| Fair value at beginning of period | | $ | 9,700 | | | $ | 12,600 | | | $ | 8,600 | | | $ | 13,100 | |
| Temporary impairment credits (charges), net | | | — | | | | 250 | | | | 1,100 | | | | (250 | ) |
| Other-than-temporary impairment charges | | | — | | | | (850 | ) | | | — | | | | (850 | ) |
| Sale of security | | | — | | | | (3,400 | ) | | | — | | | | (3,400 | ) |
| Net change in fair value | | | — | | | | (4,000 | ) | | | 1,100 | | | | (4,500 | ) |
| Fair value at end of period | | $ | 9,700 | | | $ | 8,600 | | | $ | 9,700 | | | $ | 8,600 | |
There was no sale, purchase, issuance, settlement or transfer activity related to these investments during 2011. In the third quarter of 2010, the company sold one of its debt auction-rate securities for $4.3 million resulting in a $0.9 million gain.
Auction-rate securities are intended to be structured to provide liquidity through an auction process that resets the applicable interest rate at predetermined calendar intervals. This mechanism allows existing investors either to roll over or liquidate their holdings by selling such securities at par. Since the third quarter of 2007 and through September 30, 2011, the auctions, which occur approximately every 28 days for the auction-rate securities held by the company, have not had sufficient buyers to cover investors’ sell orders, resulting in unsuccessful auctions. These unsuccessful auctions result in a resetting of the interest rate paid on the securities until the next auction date, at which time the process is repeated.
The company has estimated the fair value of these securities based on an income approach using a discounted cash flow analysis which considered the following key inputs: (i) the underlying structure of each security; (ii) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions and the relevant risk associated with each security; and (iii) the time horizon until each security will be sold. The discount rates used in the present value calculations are based on yields on U.S. Treasury securities with similar time horizons plus interest rate risk premiums that are intended to
compensate for general market risk and the risk specific to each security. The risk premiums are based upon current credit default swap pricing market data for similar or related securities or credit spreads for corporate bonds with similar credit ratings and similar maturities. The discounted cash flow analysis is a Level 3 valuation.
The company records other-than-temporary impairment charges with respect to equity securities based on the company’s assessment that it is likely that the fair value of the investment will not fully recover in the foreseeable future given the duration, severity and continuing declining trend of the fair value of the security, as well as the uncertain financial condition and near-term prospects of the issuer. The company determines other-than-temporary impairment charges for its debt securities based on credit losses.
At this time it is uncertain if or when the liquidity issues relating to these investments will improve, and there can be no assurance that the market for auction-rate securities will stabilize. The fair value of the auction-rate securities could change significantly in the future and the company may be required to record additional temporary or other-than-temporary impairment charges if there are further reductions in fair value in future periods.
(8) Debt
Convertible Notes
On December 13, 2006, the company issued $143.8 million of 2.4375% convertible senior subordinated notes due 2027 with interest payable semi-annually each January 15 and July 15. As of September 30, 2011 and December 31, 2010, the net carrying amount of the convertible notes was $129.7 million and $125.5 million, respectively, and the related unamortized debt discount was $14.1 million and $18.3 million, respectively.
Under certain circumstances, the convertible notes are convertible into cash, or a combination of cash and common stock at the company’s election, based on an initial conversion rate of 40.8513 shares of the company’s common stock per $1,000 in principal amount of the convertible notes (equivalent to an initial conversion price of approximately $24.48 per share). At any time on or after January 21, 2014, the convertible notes are subject to redemption at the option of the company, in whole or in part, for cash equal to 100% of the principal amount of the convertible notes, plus unpaid interest, if any, accrued to the redemption date. Holders of the convertible notes may require the company to repurchase the convertible notes, in whole or in part, on January 15, 2014, January 15, 2017 or January 15, 2022, or, if a “fundamental change” (as such term is defined in the indenture governing the convertible notes) occurs, for cash equal to 100% of the principal amount of the convertible notes, plus any unpaid interest, if any, accrued to the redemption date.
The fair value of the company’s convertible notes at September 30, 2011 and December 31, 2010 was estimated at $143.3 million and $150.2 million, respectively. The fair value was determined based on market prices quoted by a broker-dealer.
Credit Facility
In June 2011, the company entered into a five-year $300 million revolving secured credit facility (the “Credit Facility”), which replaced the company’s $100 million revolving credit facility that was established in 2007. All letters of credit outstanding under the terminated credit facility were transferred to the Credit Facility. The Credit Facility has a scheduled maturity date of June 7, 2016. The company’s obligations under the Credit Facility are secured by substantially all of the company’s assets except for real property.
The Credit Facility provides capacity for up to $300 million of revolving loans and permits the company to utilize up to $125 million of such capacity for the issuance of standby letters of credit. The company has the option to increase the amount of the Credit Facility by up to $150 million to the extent that any one or more lenders, whether or not currently party to the Credit Facility, commits to be a lender for such amount. Loans under the Credit Facility bear interest at LIBOR plus an applicable margin ranging from 1.75% to 2.50%, with the applicable margin varying according to the company’s total leverage ratio, or, at the election of the company, at a prime base rate plus 0.75% to 1.50%. Letters of credit issued under the Credit Facility accrue fees at a rate equal to the applicable margin for LIBOR loans. In addition, the company is required to pay a quarterly commitment fee for the unused portion of the Credit Facility, if any, at a rate ranging from 0.30% to 0.50%.
As of September 30, 2011, there were no borrowings under the Credit Facility, although $17.7 million of letters of credit were issued under the Credit Facility. Accordingly, as of September 30, 2011, $282.3 million of the Credit Facility was available for borrowings.
Debt Covenants
Orbital’s Credit Facility contains covenants limiting its ability to, among other things, pay cash dividends, incur debt or liens, redeem or repurchase company stock, enter into transactions with affiliates, make investments, merge or consolidate with others or dispose of assets. In addition, the Credit Facility contains financial covenants with respect to leverage and interest coverage.
(9) Comprehensive Income
Comprehensive income consisted of the following (in thousands):
| | | Quarters Ended | | | Nine Months Ended | |
| | | September 30, | | | September 30, | |
| | | 2011 | | | 2010 | | | 2011 | | | 2010 | |
| Net income | | $ | 16,473 | | | $ | 10,629 | | | $ | 50,024 | | | $ | 26,242 | |
| Unrealized gain (loss) on investments | | | — | | | | 250 | | | | 1,100 | | | | (250 | ) |
| Defined benefit plans, net of tax | | | (958 | ) | | | 412 | | | | (1,085 | ) | | | 131 | |
| Total comprehensive income | | $ | 15,515 | | | $ | 11,291 | | | $ | 50,039 | | | $ | 26,123 | |
(10) Stock-Based Compensation
The following tables summarize information related to the company’s stock-based compensation:
| | | Restricted Stock Units | | Stock Options |
| | | | | Weighted Average | | | | | | Weighted Average |
| | | Number of | | Measurement | | Number of | | | | Exercise |
| | | Units | | Date Fair Value | | Options | | | | Price |
| Outstanding at December 31, 2010 | | | 684,674 | | | $ | 16.38 | | | | 1,226,582 | | | | $ | 6.46 | |
Granted (1) | | | 438,110 | | | | 17.41 | | | | — | | | | | — | |
| Exercised | | | — | | | | — | | | | (197,492 | ) | | | | 4.49 | |
| Vested | | | (326,271 | ) | | | 18.48 | | | | — | | | | | — | |
| Forfeited | | | (12,450 | ) | | | 16.67 | | | | — | | | | | — | |
| Expired | | | — | | | | — | | | | (5,648 | ) | | | | 4.14 | |
| Outstanding at September 30, 2011 | | | 784,063 | | | $ | 16.08 | | | | 1,023,442 | (2) | | | $ | 6.85 | |
| (1) | The fair value of restricted stock unit grants is determined based on the closing market price of Orbital’s common stock on the date of grant. Such value is recognized as expense over the service period, net of estimated forfeitures. |
| (2) | The weighted average remaining contractual term is 1.66 years. |
| | | Quarters Ended September 30, |
| (in millions) | | 2011 | | 2010 |
| Stock-based compensation expense | | $ | 1.8 | | | $ | 1.7 | |
| Income tax benefit related to stock-based compensation expense | | | 0.6 | | | | 0.7 | |
| Intrinsic value of options exercised computed as the market | | | | | | | | |
| price on the exercise date less the price paid to exercise the options | | | 0.7 | | | | 1.2 | |
| Cash received from exercise of options | | | 0.3 | | | | 2.2 | |
| Tax benefit recorded as credits to additional paid-in capital related | | | | | | | | |
| to stock-based compensation transactions | | | 0.3 | | | | 0.4 | |
| | | | | | | | | |
| | | Nine Months Ended September 30, |
| (in millions) | | 2011 | | 2010 |
| Stock-based compensation expense | | $ | 4.7 | | | $ | 3.5 | |
| Income tax benefit related to stock-based compensation expense | | | 1.5 | | | | 1.4 | |
| Intrinsic value of options exercised computed as the market | | | | | | | | |
| price on the exercise date less the price paid to exercise the options | | | 2.5 | | | | 5.4 | |
| Cash received from exercise of options | | | 0.9 | | | | 9.7 | |
| Tax benefit recorded as credits to additional paid-in capital related | | | | | | | | |
| to stock-based compensation transactions | | | 1.0 | | | | 2.0 | |
| | | As of | |
| (in millions) | | September 30, 2011 | |
| Shares of common stock available for grant under stock-based incentive plans | | | 0.8 | |
| Aggregate intrinsic value of restricted stock units that are expected to vest | | $ | 10.0 | |
| Unrecognized compensation expense related to non-vested restricted stock units, expected to | | | | |
| be recognized over a weighted-average period of 2.38 years | | | 11.4 | |
| Aggregate intrinsic value of stock options outstanding, all fully vested | | | 6.1 | |
(11) Research and Development
In the first quarter of 2008, the company entered into an agreement with the National Aeronautics and Space Administration (“NASA”) to design, build and demonstrate a new space transportation system under a program called Commercial Orbital Transportation Services (“COTS”) for delivering cargo and supplies to the International Space Station. Under the agreement, as amended, NASA has agreed to pay the company $288 million in cash milestone payments, partially funding Orbital’s project costs which are currently estimated to be approximately $458 million. The company expects to complete this project in the second quarter of 2012.
The COTS agreement is being accounted for as a best-efforts research and development cost-sharing arrangement. As such, the amounts funded by NASA are recognized proportionally as an offset to the company’s COTS project research and development expenses, including associated general and administrative expenses. As of September 30, 2011 and December 31, 2010, deferred revenue and customer advances on the accompanying balance sheet included $26.9 million and $25.2 million, respectively, of cash received from NASA that had not yet been recorded as an offset to research and development expenses. The following table summarizes the COTS project research and development expenses incurred and amounts funded by NASA (in millions):
| | | Third Quarter | | | First Nine Months | | | Inception | |
| | | 2011 | | | 2010 | | | 2011 | | | 2010 | | | To Date | |
Research and development costs incurred (1) | | $ | 36.8 | | | $ | 39.9 | | | $ | 115.1 | | | $ | 107.0 | | | $ | 374.3 | |
| Less - amounts funded by NASA | | | 23.0 | | | | 19.0 | | | | 82.3 | | | | 52.1 | | | | 234.6 | |
| Net research and development expenses | | $ | 13.8 | | | $ | 20.9 | | | $ | 32.8 | | | $ | 54.9 | | | $ | 139.7 | |
(1) Includes associated general and administrative expenses.
The company is engaged in a major product development program of a medium-capacity rocket named Taurus II. Approximately $9.0 million and $12.3 million of the company’s research and development expenses in the third quarter of 2011 and 2010, respectively, and $24.2 million and $35.4 million in the first nine months of 2011 and 2010, respectively, were attributable to the Taurus II program.
(12) Income Taxes
The company’s effective tax rates were 19.2% and 39.1% for the nine months ended September 30, 2011 and 2010, respectively. The lower tax rate in 2011 primarily resulted from a favorable income tax adjustment of $7.7 million recorded in the second quarter of 2011 pertaining to the company’s election to claim extraterritorial income exclusions related to prior-year export activity. The tax rate in 2011 also includes the effect of the federal research and development tax credit that was reinstated in December 2010.
(13) Commitments and Contingencies
U.S. Government Contracts
The accuracy and appropriateness of costs charged to U.S. Government contracts are subject to regulation, audit and possible disallowance by the Defense Contract Audit Agency or other government agencies. Accordingly, costs billed or billable to U.S. Government customers are subject to potential adjustment upon audit by such agencies.
Most of the company’s U.S. Government contracts are funded incrementally on a year-to-year basis. Changes in government policies, priorities or funding levels through agency or program budget reductions by the U.S. Congress or executive agencies could materially adversely affect the company’s financial condition or results of operations. Furthermore, contracts with the U.S. Government may be terminated or suspended by the U.S. Government at any time, with or without cause. Such contract suspensions or terminations could result in
unreimbursable expenses or charges or otherwise adversely affect the company’s financial condition and/or results of operations.
Research and Development Expenses
The company believes that a majority of the company’s research and development expenses are recoverable and billable under contracts with the U.S. Government, from which the majority of the company’s revenues are derived. Charging practices relating to research and development and other costs that may be charged directly or indirectly to government contracts are subject to audit by U.S. Government agencies to determine if such costs are reasonable and allowable under government contracting regulations and accounting practices. The company believes that research and development costs incurred in connection with the company’s Taurus II development program (see Note 11) are allowable, although the U.S. Government has not yet made a final determination. If such costs were determined to be unallowable, the company could be required to record revenue and profit reductions in future periods.
Terminated Contracts
In 2010, the Orion Launch Abort System contract was terminated for convenience by the customer. The company has recognized its best estimates of the revenues and profit that will ultimately be realized in the final termination settlement. However, because of the inherent judgments associated with termination costs and profit assessments, it is possible that the company could recognize material adjustments to earnings upon resolution of this matter.
In April 2011, subject to U.S. Government ratification, the company negotiated a settlement with its customer with respect to fees earned on the Kinetic Energy Interceptor contract that had been terminated in 2009. The resolution of this matter did not have a material impact on the company’s financial statements.
Litigation
From time to time the company is party to certain litigation or other legal proceedings arising in the ordinary course of business. Because of the uncertainties inherent in litigation, the company cannot predict the outcome of such litigation or other legal proceedings; however, we believe that none of these matters will have a material adverse effect on the company’s results of operations or financial condition.
(14) Recent Accounting Pronouncements
In September 2011, the FASB issued ASU No. 2011-08, “Testing Goodwill for Impairment.” This ASU provides an option for companies to use a qualitative approach to test goodwill for impairment if certain conditions are met. After assessment of certain qualitative factors, if it is determined to be more likely than not that the fair value of a reporting unit is less than its carrying amount, entities must perform the quantitative analysis of the goodwill impairment test. Otherwise, the quantitative test becomes optional. The provisions of this ASU are effective for
interim and annual periods beginning after December 15, 2011. The company does not expect that adoption of this ASU will have a material impact on its financial statements.
In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income.” This ASU intends to enhance comparability and transparency of other comprehensive income components. The guidance provides an option to present total comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of stockholders’ equity. The provisions of this ASU will be applied retrospectively for interim and annual periods beginning after December 15, 2011. There will be no impact to the consolidated financial results as this ASU relates only to changes in financial statement presentation.
In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (Topic 820)—Fair Value Measurement.” This ASU clarifies certain concepts related to the fair value measurement of financial instruments and related disclosures. The provisions of this ASU are effective prospectively for interim and annual periods beginning on or after December 15, 2011. The company is currently evaluating the impact of the pending adoption of this ASU on its financial statements.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements contained in this Item 2 and elsewhere in this Form 10-Q are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements include, but are not limited to, those related to our financial outlook, liquidity, goals, business strategy, projected plans and objectives of management for future operating results, and forecasts of future events. These statements can be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements often include the words “anticipate,” “forecast,” “expect,” “believe,” “should,” “intend,” “plan” and words of similar substance. Such forward-looking statements are subject to risks, trends and uncertainties that could cause the actual results or performance of the company to be materially different from the forward-looking statement. Uncertainty surrounding factors such as continued government support and funding for key space and defense programs, achievement of important performance milestones on significant contracts, new product development programs, product performance and market acceptance of products and technologies, government contract procurement and termination risks, insurance recovery and income tax rates may materially impact Orbital’s actual financial and operational results. Other risks, uncertainties and factors are discussed under the caption “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010. We are under no obligation to, and expressly disclaim any obligation or undertaking to update or alter any forward-looking statement, whether as a result of new information, subsequent events or otherwise, except as required by law.
We develop and manufacture small- and medium-class rockets and space systems for commercial, military and civil government customers. Our primary products and services include the following:
| · | Launch Vehicles - Rockets that are used as small- and medium-class space launch vehicles that place satellites into Earth orbit and escape trajectories, interceptor and target vehicles for missile defense systems and suborbital launch vehicles that place payloads into a variety of high-altitude trajectories. |
| · | Satellites and Space Systems - Small- and medium-class satellites that are used to enable global and regional communications and broadcasting, conduct space-related scientific research, collect imagery and other remotely-sensed data about the Earth, carry out interplanetary and other deep-space exploration missions and demonstrate new space technologies. |
| · | Advanced Space Programs - Human-rated space systems for Earth-orbit and deep-space exploration, and small- and medium-class satellites primarily used for national security space programs and to demonstrate new space technologies. |
The following discussion should be read along with our 2010 Annual Report on Form 10-K filed with the Securities and Exchange Commission, and with the unaudited condensed consolidated financial statements included in this Form 10-Q.
Consolidated Results of Operations for the Quarters and Nine Months Ended September 30, 2011 and 2010
Revenues - Our consolidated revenues were $342.2 million in the third quarter of 2011, an increase of $27.7 million, or 9%, compared to the third quarter of 2010 primarily due to higher revenues in all business segments. Satellites and space systems segment revenues increased $19.3 million, or 16%, due to increased activity on communications satellite contracts and space technical services contracts, partially offset by decreased activity on science and remote sensing satellite contracts. Launch vehicles segment revenues increased $10.7 million, or 10%, due to increased production work on target launch vehicles and Taurus II launch vehicles, partially offset by decreased activity on other space launch vehicles and missile defense interceptors. Advanced space programs segment revenues increased $9.0 million, or 9%, due to increased activity on the national security satellite contracts, partially offset by lower activity on the International Space Station Commercial Resupply Services (“CRS”) contract and the Orion Launch Abort System (“LAS”) contract, which was terminated in the second quarter of 2010.
Eliminations of intersegment revenues increased to $27.7 million in the third quarter of 2011 as compared to $16.4 million in the third quarter of 2010. Intersegment revenues included $26.1 million and $14.4 million in the third quarter of 2011 and 2010, respectively, pertaining to Taurus II production work performed in our launch vehicles segment as part of the Commercial Orbital Transportation Services (“COTS”) program that is being conducted by our advanced space programs segment.
Our consolidated revenues were $1,010.5 million in the first nine months of 2011, an increase of $62.0 million, or 7%, compared to the first nine months of 2010 primarily due to higher revenues in the satellites and space systems and launch vehicles segments, partially offset by lower revenues in the advanced space programs segment. Satellites and space systems segment revenues increased $70.2 million, or 19%, due to increased activity on communications satellite contracts, space technical services contracts and science and remote sensing satellite contracts. Launch vehicles segment revenues increased $51.3 million, or 17%, due to increased production work on Taurus II launch vehicles for the CRS and COTS programs and increased activity on target launch vehicles, partly offset by decreased activity on missile defense interceptors and on certain space launch vehicle contracts, and the effect of the Taurus XL launch failure discussed below. Advanced space programs segment revenues decreased $23.6 million, or 7%, due to decreased activity on the CRS contract and the Orion LAS contract, which was terminated in the second quarter of 2010, partly offset by increased activity on national security satellite programs.
Eliminations of intersegment revenues increased to $82.8 million in the first nine months of 2011 as compared to $46.9 million in the first nine months of 2010. Intersegment revenues included $77.8 million and $41.4 million in the first nine months of 2011 and 2010, respectively, pertaining to Taurus II production work performed in our launch vehicles segment as part of the COTS program that is being conducted by our advanced space programs segment.
The CRS contract accounted for 14% and 21% of consolidated revenues in the third quarter of 2011 and 2010, respectively, and 18% and 20% of consolidated revenues in the first nine months of 2011 and 2010, respectively. The launch vehicle portion of the CRS contract is reported in our launch vehicles segment and the remainder of the CRS contract is reported in our advanced space programs segment. CRS contract revenues totaled $46.7 million in the third quarter of 2011, a decrease of $19.0 million, or 29%, due to a higher level of subcontractor activity in the third quarter of 2010. CRS contract revenues totaled $179.1 million in the first nine months of 2011, a decrease of $14.1 million, or 7%, due to higher subcontractor activity in the first nine months of 2010.
Cost of Revenues - Our cost of revenues was $267.5 million in the third quarter of 2011, an increase of $29.7 million, or 13%, compared to the third quarter of 2010. Cost of revenues includes the costs of personnel, materials, subcontractors and overhead. The increase in our cost of revenues was primarily attributable to the increases in contract activity that drove the growth in revenues described above. Cost of revenues increased $14.8 million in the satellites and space systems segment, $14.5 million in the launch vehicles segment and $11.8 million in the advanced space programs segment. Eliminations of intersegment cost of revenues increased $11.4 million attributable to the increase in intersegment revenues discussed above.
Our cost of revenues was $821.3 million in the first nine months of 2011, an increase of $84.2 million, or 11%, compared to the first nine months of 2010. The increase in our year-to-date cost of revenues was primarily attributable to the increases in contract activity that drove the growth in revenues described above. Cost of revenues in the launch vehicles segment increased $69.1 million and cost of revenues in the satellites and space systems segment increased $58.4 million. These increases were partially offset by a decrease of $7.4 million in the advanced space programs segment. Eliminations of intersegment cost of revenues increased $35.9 million attributable to the increase in intersegment revenues discussed above.
Research and Development Expenses - Our research and development expenses totaled $26.7 million, or 8% of revenues, in the third quarter of 2011, a $8.7 million decrease compared to $35.4 million, or 11% of revenues, in the third quarter of 2010. Our research and development expenses totaled $67.3 million, or 7% of revenues, in the first nine months of 2011, a $28.6 million decrease compared to $95.8 million, or 10% of revenues, in the first nine months of 2010. The majority of our research and development expenses in 2011 and 2010 were attributable to the COTS program and our Taurus II launch vehicle development program.
In connection with the COTS agreement with NASA, we are designing, building and demonstrating a new space transportation system. Under the COTS agreement, as amended, NASA has agreed to pay us $288 million in cash milestone payments, partially funding our program costs which are currently estimated to be approximately $458 million. During the first quarter of 2011, NASA agreed to increase its funding by $98 million under the COTS agreement for a Taurus II test flight in addition to the demonstration flight that was already planned under the program. This additional test flight is intended to provide greater information on the Taurus II rocket’s performance. We expect to complete the COTS program in the second quarter of 2012.
The COTS program is being accounted for as a best-efforts research and development cost-sharing arrangement. As such, the amounts funded by NASA are recognized proportionally as an offset to our COTS project research and development expenses, including associated general and administrative expenses. As of September 30, 2011, deferred revenue and customer advances on our balance sheet included $26.9 million of cash received from NASA that had not yet been recorded as an offset to research and development expenses. The following table summarizes the COTS program costs incurred and amounts funded by NASA recorded in research and development expenses (in millions):
| | | Third Quarter | | | First Nine Months | | | Inception | |
| | | 2011 | | | 2010 | | | 2011 | | | 2010 | | | To Date | |
Research and development costs incurred (1) | | $ | 36.8 | | | $ | 39.9 | | | $ | 115.1 | | | $ | 107.0 | | | $ | 374.3 | |
| Less - amounts funded by NASA | | | 23.0 | | | | 19.0 | | | | 82.3 | | | | 52.1 | | | | 234.6 | |
| Net research and development expenses | | $ | 13.8 | | | $ | 20.9 | | | $ | 32.8 | | | $ | 54.9 | | | $ | 139.7 | |
(1) Includes associated general and administrative expenses.
Research and development expenses attributable to our Taurus II launch vehicle development program were $9.0 million and $12.3 million in the third quarter of 2011 and 2010, respectively, and were $24.2 million and $35.4 million in the first nine months of 2011 and 2010, respectively.
We believe that the majority of our research and development expenses are recoverable and billable under our contracts with the U.S. Government. Charging practices relating to research and development and other costs that may be charged directly or indirectly to government contracts are subject to audit by U.S. Government agencies to determine if such costs are reasonable and allowable under government contracting regulations and accounting practices. We believe that the research and development costs incurred in connection with our Taurus II development program are allowable, although the U.S. Government has not yet made a final determination. Since the inception of the Taurus II program through September 30, 2011, we have incurred $143.4 million of such expenses that have been recorded as allowable costs. If such costs were determined to be unallowable, we could be required to record revenue and profit reductions in future periods.
In the third quarter and first nine months of 2010, we recognized $1.6 million and $6.5 million, respectively, of research and development expenses in excess of a self-imposed ceiling on the amount of such expenses that we would recover under our U.S. Government contracts, although we believe that such expenses otherwise would have been allowable and recoverable under U.S. Government contracting regulations and accounting practices. There were no unrecoverable research and development expenses incurred in 2011.
Selling, General and Administrative Expenses - Selling, general and administrative expenses were $23.3 million and $22.0 million, or 7% of revenues, in the third quarter of 2011 and 2010, respectively. Selling, general and administrative expenses include the costs of our finance, legal, administrative and general management functions, as well as bid, proposal and marketing costs. Selling, general and administrative expenses increased $1.3 million, or 6%, in the third quarter of 2011 compared to the third quarter of 2010 primarily due to certain legal and other general and
administrative expenses, partially offset by lower bid, proposal and marketing costs in the satellites and space systems and the advanced space programs segments.
Selling, general and administrative expenses were $64.3 million and $66.7 million, or 6% and 7% of revenues, in the first nine months of 2011 and 2010, respectively. Selling, general and administrative expenses decreased $2.3 million, or 3%, in the first nine months of 2011 primarily due to a decrease in bid, proposal and marketing costs in all of our business segments and the absence of $1.6 million of transaction expenses incurred in 2010 in connection with a business acquisition.
Operating Income - Operating income was $24.7 million in the third quarter of 2011, an increase of $5.3 million, or 27%, compared to the third quarter of 2010 due to operating income increases in all of our business segments. Satellites and space systems segment operating income increased $4.0 million due to increased contract activity and improved profit margins on communications satellite contracts. Operating income from communications satellite contracts reflected the absence of $1.0 million of costs incurred in the third quarter of 2010 pertaining to the successful resolution of a satellite anomaly that occurred in April 2010. Launch vehicles segment operating income increased $0.3 million primarily due to the absence of $1.6 million of unrecovered research and development expenses that were recognized in the third quarter of 2010, in addition to increased activity on target launch vehicle contracts, partially offset by decreased activity on certain space launch vehicles and missile defense interceptors. Advanced space programs segment operating income increased $0.1 million primarily due to increased activity on national security satellite contracts and the absence of an unfavorable profit reduction of $2.8 million in the third quarter of 2010 attributable to the termination of the Orion LAS contract offset by a $5.4 million profit improvement in the third quarter of 2010 related to a research and development expense rate adjustment. Operating income in the third quarter of 2010 also included $0.9 million of unallocated corporate-level costs.
Operating income was $57.6 million in the first nine months of 2011, an increase of $8.6 million, or 18%, compared to the first nine months of 2010 due to operating income increases in our satellites and space systems and advanced space programs segments, partially offset by a decrease in operating income in our launch vehicles segment. Satellites and space systems segment operating income increased $7.6 million primarily due to increased activity and improved profit margins on communications satellite contracts. Communications satellite operating income reflected the absence of $3.5 million of costs incurred in the first nine months of 2010 pertaining to the successful resolution of the satellite anomaly discussed above. Advanced space programs segment operating income increased $4.5 million primarily due to increased activity on national security satellite contracts and the absence of an unfavorable profit reduction of $2.8 million in the third quarter of 2010 attributable to the termination of the Orion LAS contract. Launch vehicles segment operating income decreased $5.9 million primarily due to an approximately $12.1 million operating income reduction resulting from a Taurus XL launch failure during the first quarter of 2011 discussed below. The effect of the launch failure was partially offset by the absence in 2011 of $6.5 million of unrecovered research and development expenses that were recognized in 2010. Operating income in 2010 also included $2.5 million of
transaction expenses attributable to a business acquisition as well as other unallocated corporate-level costs.
On March 4, 2011, our Taurus XL rocket, which was carrying the Glory scientific satellite that we had built for NASA, experienced a launch failure. As a result, in the first quarter of 2011, we recorded an $11.3 million adjustment to reduce revenue and operating profit on the Taurus contract pertaining to a mission success incentive that was not earned. The unearned mission success incentive was recovered under an insurance policy. We recorded an $11.3 million insurance recovery accrual reported as “other income” in the first quarter of 2011.
Total operating income from the CRS contract was $2.3 million in the third quarter of 2011, a decrease of $0.9 million due to a higher level of subcontract activity in the third quarter of 2010. Total operating income from the CRS contract was $9.0 million in the first nine months of 2011, a decrease of $0.4 million compared to the first nine months of 2010.
Interest Income and Other - Interest income and other was $0.4 million in the third quarter of 2011, compared to $0.5 million in the third quarter of 2010. Interest income and other was $12.6 million in the first nine months of 2011, compared to $1.2 million in the first nine months of 2010. Interest income and other in the first nine months of 2011 included the $11.3 million insurance recovery pertaining to the Taurus XL launch failure discussed above.
Interest Expense - Interest expense was $2.9 million and $2.4 million in the third quarter of 2011 and 2010, respectively, and was $8.2 million and $7.1 million in the first nine months of 2011 and 2010, respectively, primarily attributable to interest on our long-term debt.
Income Tax Provision - We recorded an income tax provision of $5.7 million and $6.8 million in the third quarter of 2011 and 2010, respectively. We recorded income tax provisions of $11.9 million and $16.8 million in the first nine months of 2011 and 2010, respectively. Our effective income tax rate was 19.2% and 39.1% for the first nine months of 2011 and 2010, respectively. The reduction in income taxes was largely due to a favorable income tax adjustment of $7.7 million recorded in the second quarter of 2011 pertaining to our election to claim extraterritorial income exclusions related to export activities in certain prior years. In addition, income taxes in 2011 reflected federal research and development tax credits as a result of legislation that was re-enacted in the fourth quarter of 2010.
Net Income - Our net income was $16.5 million, or $0.28 diluted earnings per share, and $10.6 million, or $0.18 diluted earnings per share, in the third quarter of 2011 and 2010, respectively, and was $50.0 million, or $0.84 diluted earnings per share, and $26.2 million, or $0.45 diluted earnings per share, in the first nine months of 2011 and 2010, respectively.
Segment Results for the Quarters and Nine Months Ended September 30, 2011 and 2010
Our products and services are grouped into three reportable segments: launch vehicles, satellites and space systems and advanced space programs. Corporate office transactions that
have not been attributed to a particular segment, as well as consolidating eliminations and adjustments, are reported in corporate and other.
The following tables of financial information and related discussion of the results of operations of our business segments are consistent with the presentation of segment information in Note 3 to the accompanying financial statements in this Form 10-Q.
Launch Vehicles
Launch vehicles segment operating results were as follows:
| | | Third Quarter | | | First Nine Months | |
| ($ in thousands) | | 2011 | | | 2010 | | | % Change | | | 2011 | | | 2010 | | | % Change | |
| Revenues | | $ | 116,538 | | | $ | 105,828 | | | | 10% | | | $ | 353,178 | | | $ | 301,872 | | | | 17% | |
| Operating income | | | 5,242 | | | | 4,988 | | | | 5% | | | | 7,063 | | | | 12,988 | | | | (46% | ) |
| Operating margin | | | 4.5% | | | | 4.7% | | | | | | | | 2.0% | | | | 4.3% | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Segment Revenues - Launch vehicles segment revenues increased $10.7 million, or 10%, in the third quarter of 2011 compared to the third quarter of 2010 primarily due to increased production work on target launch vehicles and Taurus II launch vehicles, partially offset by decreased activity on other space launch vehicles and missile defense interceptors. Target launch vehicle revenues grew $19.3 million, or 93%, primarily due to recently awarded contracts. Taurus II launch vehicle revenues increased $4.7 million while other space launch vehicle revenues declined $9.3 million, primarily due to decreased activity on Minotaur space launch vehicles. Taurus II launch vehicle revenues were $40.1 million and $35.4 million in the third quarter of 2011 and 2010, respectively, which included $26.1 million and $14.4 million, respectively, related to the COTS program and $14.0 million and $21.0 million, respectively, related to the CRS contract. Missile defense interceptor revenues decreased $4.0 million, or 15%, due to decreased activity on our Ground-based Midcourse Defense contract in the third quarter of 2011.
Launch vehicles segment revenues increased $51.3 million, or 17%, in the first nine months of 2011 compared to the first nine months of 2010 principally due to increased production work on target launch vehicles and Taurus II launch vehicles, partially offset by decreased activity on other space launch vehicles and missile defense interceptors. Taurus II launch vehicle revenues increased $46.3 million while other space launch vehicle revenues decreased $13.3 million due to decreased activity on Minotaur space launch vehicles and the effect of the March 2011 Taurus XL launch failure discussed above. Taurus II launch vehicle revenues were $142.1 million and $95.8 million in the first nine months of 2011 and 2010, respectively, which included $77.8 million and $41.4 million, respectively, related to the COTS program and $64.3 million and $54.4 million, respectively, related to the CRS contract. Target launch vehicle revenues increased $32.4 million, or 49%, primarily due to certain new contracts awarded in the first quarter of 2011. Missile defense interceptor revenues decreased $11.2 million, or 14%, due to decreased activity on our Ground-based Midcourse Defense contract.
Segment Operating Income - Operating income in the launch vehicles segment increased $0.3 million, or 5%, in the third quarter of 2011 compared to the third quarter of 2010 primarily due to increased activity on target vehicles and the absence of $1.6 million of unrecovered research and development expenses that were recognized in the third quarter of 2010. These factors were partially offset by decreased activity on missile defense interceptors and certain space launch vehicles and profit margin reductions on certain space launch vehicles. Operating income from target vehicles increased $1.2 million, or 37%, in the third quarter of 2010, primarily due to increased activity on recently awarded contracts. Operating income from missile defense interceptors decreased $0.7 million, or 22%, in the third quarter of 2010, primarily due to decreased activity. Operating income from space launch vehicles decreased $1.8 million primarily due to decreased activity on Minotaur space launch vehicles and certain Pegasus launch vehicles. Operating income from Taurus II launch vehicles for the CRS contract was $0.7 million and $0.9 million in the third quarter of 2011 and 2010, respectively. This segment does not recognize any profit pertaining to the intersegment Taurus II launch vehicle revenues associated with the COTS program, which is conducted by and reported as a research and development program in our advanced space programs segment.
Operating income in the launch vehicles segment decreased $5.9 million, or 46%, in the first nine months of 2011 compared to the first nine months of 2010 primarily due to a $12.1 million reduction in operating income resulting from the March 2011 Taurus XL launch failure discussed above, partially offset by a favorable adjustment in connection with the Kinetic Energy Interceptor contract that had been terminated for convenience in 2009 and the absence of unrecovered research and development expenses of $6.5 million that were recognized in 2010. Operating income from missile defense interceptor contracts increased $1.3 million, or 17%, in the first nine months of 2011, primarily due to the favorable profit adjustments noted above. Operating income from Taurus II launch vehicle production work for the CRS contract was $3.3 million and $2.6 million in the first nine months of 2011 and 2010, respectively.
Segment operating margin (as a percentage of revenues) decreased to 4.5% in the third quarter of 2011 compared to 4.7% in the third quarter of 2010 primarily due to profit margin reductions on certain space launch vehicle contracts and higher intersegment Taurus II launch vehicle revenues (which do not generate profit) associated with the COTS program, partially offset by the absence of unrecovered research and development expenditures that were recognized in 2010. Segment operating margin decreased in the first nine months of 2011 primarily due to the same factors that drove operating income results in the first nine months as discussed above.
Satellites and Space Systems
Satellites and space systems segment operating results were as follows:
| | | Third Quarter | | | First Nine Months | |
| ($ in thousands) | | 2011 | | | 2010 | | | % Change | | | 2011 | | | 2010 | | | % Change | |
| Revenues | | $ | 141,130 | | | $ | 121,844 | | | | 16% | | | $ | 431,963 | | | $ | 361,788 | | | | 19% | |
| Operating income | | | 11,460 | | | | 7,441 | | | | 54% | | | | 30,244 | | | | 22,660 | | | | 33% | |
| Operating margin | | | 8.1% | | | | 6.1% | | | | | | | | 7.0% | | | | 6.3% | | | | | |
Segment Revenues - Satellites and space systems segment revenues increased $19.3 million, or 16%, in the third quarter of 2011 compared to the third quarter of 2010 due to increased activity on communications satellite contracts and space technical services contracts partially offset by decreased activity on science and remote sensing satellite contracts. Communications satellite revenues increased $19.8 million, or 26%, principally attributable to activity on new commercial satellite contracts awarded in the fourth quarter of 2010 and in 2011. Communications satellite revenues accounted for 68% and 63% of total segment revenues in the third quarter of 2011 and 2010, respectively. Space technical services revenues increased $9.7 million, or 66%, primarily due to production work on a contract awarded in the third quarter of 2010. Science and remote sensing satellite revenues decreased $10.1 million, or 35%, due to decreased contract activity.
Satellites and space systems segment revenues increased $70.2 million, or 19%, in the first nine months of 2011 compared to the first nine months of 2010 primarily due to increased activity on communications satellite contracts, space technical services contracts and science and remote sensing satellite contracts, including contracts acquired in our 2010 acquisition. Communications satellite revenues increased $45.5 million, or 18%, principally attributable to activity on new communications satellite contracts awarded in the fourth quarter of 2010 and in 2011. Communications satellite revenues accounted for 68% of total segment revenues in the first nine months of 2011 and 2010, respectively. Space technical services revenues increased $23.2 million, or 51%, primarily due to production work on a contract awarded in the third quarter of 2010. Science and remote sensing satellite revenues increased $2.0 million, or 3%, primarily due to increased activity.
Segment Operating Income - Operating income in the satellites and space systems segment increased $4.0 million, or 54%, in the third quarter of 2011 compared to the third quarter of 2010 primarily due to improved results from communications satellite and space technical services contracts partially offset by the reduction in activity on science and remote sensing satellite contracts. Communications satellite operating income increased $4.9 million, or 140%, primarily due to activity on new commercial satellite contracts awarded in the fourth quarter of 2010 and in 2011, profit improvements on certain communications satellite contracts and the absence of $1.0 million of costs incurred in the third quarter of 2010 pertaining to the successful resolution of a satellite anomaly that occurred in April 2010. Communications satellite results accounted for 73% and 47% of total segment operating income in the third quarter of 2011 and 2010, respectively. Space technical services contracts operating income increased $1.0 million, or 193%, primarily due to production work on a contract awarded in the third quarter of 2010.
Science and remote sensing satellite operating income decreased $1.5 million, or 42%, consistent with the revenue reduction described above.
Operating income in the satellites and space systems segment increased $7.6 million, or 33%, in the first nine months of 2011 compared to the first nine months of 2010 primarily due to increased activity and improved profit margins on communications satellite contracts. Communications satellite operating income increased $7.6 million, or 62%, principally attributable to activity on new communications satellite contracts awarded in the fourth quarter of 2010 and early 2011, and a $3.5 million reduction in costs pertaining to the successful resolution of the satellite anomaly discussed above. Communications satellite contracts accounted for 66% and 54% of total segment operating income in the first nine months of 2011 and 2010, respectively.
Segment operating margin (as a percentage of revenues) increased to 8.1% in the third quarter of 2011 from 6.1% in the third quarter of 2010, and to 7.0% in the first nine months of 2011 compared to 6.3% in the first nine months of 2010, due to profit margin improvements on communications satellite contracts in addition to lower costs pertaining to the satellite anomaly discussed above.
Advanced Space Programs
Advanced space programs segment operating results were as follows:
| | | Third Quarter | | | First Nine Months | |
| ($ in thousands) | | 2011 | | | 2010 | | | % Change | | | 2011 | | | 2010 | | | % Change | |
| Revenues | | $ | 112,214 | | | $ | 103,204 | | | | 9% | | | $ | 308,112 | | | $ | 331,673 | | | | (7% | ) |
| Operating income | | | 7,966 | | | | 7,835 | | | | 2% | | | | 20,285 | | | | 15,829 | | | | 28% | |
| Operating margin | | | 7.1% | | | | 7.6% | | | | | | | | 6.6% | | | | 4.8% | | | | | |
Segment Revenues - Advanced space programs segment revenues increased $9.0 million, or 9%, in the third quarter of 2011 compared to the third quarter of 2010 primarily due to increased activity on national security satellite contracts partially offset by decreased activity on the CRS contract and the Orion LAS contract. National security satellite revenues increased $24.4 million, or 45%. Revenues from the CRS contract decreased $12.1 million, or 27%, resulting from a higher level of subcontract activity in the third quarter of 2010. The CRS program accounted for 29% and 43% of total segment revenues in the third quarter of 2011 and 2010, respectively. Orion LAS contract revenues decreased $3.2 million because this contract was terminated for convenience by the customer in the second quarter of 2010.
Advanced space programs segment revenues decreased $23.6 million, or 7%, in the first nine months of 2011 compared to the first nine months of 2010 primarily due to a $35.6 million revenue reduction on the Orion LAS contract that was terminated in 2010 and a $24.0 million revenue reduction due to a decrease in activity on the CRS contract. These revenue reductions were partially offset by a $36.0 million, or 24%, increase in revenues from national security satellite contracts. In the first nine months of 2011 and 2010, the CRS contract accounted for 37% and 42%, respectively, of total segment revenues.
Segment Operating Income - Operating income in the advanced space programs segment increased $0.1 million, or 2%, in the third quarter of 2011 compared to the third quarter of 2010 primarily due to increased activity and profit margin improvements on national security satellite contracts and the absence of an unfavorable profit adjustment recorded in the third quarter of 2010 attributable to the termination of the Orion LAS contract. These factors were offset by lower CRS operating income due to lower activity and the absence of a $5.4 million profit improvement in the third quarter of 2010 related to a research and development expense rate adjustment.
Operating income in the advanced space programs segment increased $4.5 million, or 28%, in the first nine months of 2011 compared to the first nine months of 2010 primarily due to increased activity and profit margin improvements on national security satellite contracts and the absence of unfavorable profit adjustments incurred in 2010 on the Orion LAS contract that was terminated. These factors were partially offset by lower CRS operating income due to decreased activity.
This segment’s operating margin (as a percentage of revenues) decreased to 7.1% in the third quarter of 2011 from 7.6% in the third quarter of 2010 largely due to the absence of a profit improvement in the third quarter of 2010 related to the research and development expense rate adjustment discussed above that reduced segment operating margin, partially offset by increased margins on national security satellite contracts and the impact of the Orion LAS profit adjustments recorded in 2010. Operating margin increased to 6.6% in the first nine months of 2011 from 4.8% in the first nine months of 2010 primarily due to increased margins on national security satellite contracts and the impact of the Orion LAS profit adjustments recorded in 2010.
Corporate and Other
Corporate and other revenues were comprised solely of the elimination of intersegment revenues of $27.7 million and $16.4 million in the third quarter of 2011 and 2010, respectively, and $82.8 million and $46.9 million in the first nine months of 2011 and 2010, respectively. Intersegment revenues were comprised primarily of Taurus II launch vehicle revenues recorded in the launch vehicles segment in connection with the COTS program that is conducted by and reported as a research and development program in our advanced space programs segment. Taurus II revenues for the COTS program were $26.1 million and $14.4 million in the third quarter of 2011 and 2010, respectively, and $77.8 million and $41.4 million in the first nine months of 2011 and 2010, respectively.
There was no corporate and other operating income or loss in the third quarter and first nine months of 2011. The operating loss in “Corporate and Other” in the third quarter and first nine months of 2010 was comprised of unallocated corporate-level costs and included $1.6 million of transaction expenses incurred during the second quarter of 2010 in connection with an acquisition.
Backlog
Our firm backlog was approximately $2.2 billion and $2.0 billion at September 30, 2011 and December 31, 2010, respectively. While there can be no assurance, we expect to convert approximately $360 million of the September 30, 2011 firm backlog into revenue during the remainder of 2011. Firm backlog consists of aggregate contract values for firm product orders, excluding the portion previously included in revenues, and including government contract orders not yet funded and our estimate of potential award fees.
Total backlog was approximately $4.9 billion at September 30, 2011 and $4.6 billion at December 31, 2010. Total backlog includes firm backlog in addition to unexercised options, indefinite-quantity contracts and undefinitized orders and contract award selections.
Liquidity and Capital Resources
Cash Flow from Operating Activities
Cash flow from operating activities in the first nine months of 2011 was $94.6 million, as compared to $0.8 million in the first nine months of 2010. The increase in operating cash flow resulted primarily from a $68.2 million increase in cash provided by favorable changes in working capital and certain other assets and liabilities, in addition to a $23.8 million increase in net income. During the first nine months of 2011, net changes in working capital and certain other assets and liabilities provided $2.0 million of cash, compared to a $66.1 million use of cash in the first nine months of 2010. The changes in working capital in the first nine months of 2011 included a $45.9 million increase in deferred revenues and customer advances (primarily pertaining to recent communications satellite contract awards) and increased accounts payable and accrued expenses of $18.1 million primarily due to timing of certain cash disbursements. These favorable cash flow factors were offset by a $71.1 million increase in receivables pertaining primarily to the CRS contract. Under the terms of the CRS contract, a substantial percentage of the customer cash receipts are billable and collectible only upon the satisfaction of certain key milestones, including the successful completion of each mission. The first CRS mission is scheduled to occur in 2012.
Cash Flow from Investing Activities
Cash used in investing activities in the first nine months of 2011 was $43.1 million, as compared to $109.4 million in the first nine months of 2010. We spent $43.1 million for capital expenditures in the first nine months of 2011 as compared to $58.7 million in the first nine months of 2010. In 2010, we spent $55 million in connection with a business acquisition (see Note 2 to the accompanying financial statements), and we sold an auction-rate debt security for $4.3 million.
Cash Flow from Financing Activities
Cash flow from financing activities in the first nine months of 2011 was $0.1 million, as compared to $12.8 million in the first nine months of 2010. In 2011, we paid $3.1 million of financing fees associated with establishing a new credit facility, as discussed below. During the first nine months of 2011 and 2010, we received $2.0 million and $10.8 million, respectively, from the issuance of common stock in connection with stock option exercises and employee stock plan purchases.
Convertible Notes - In December 2006, we issued $143.8 million of 2.4375% convertible senior subordinated notes due 2027 with interest payable semi-annually each January 15 and July 15. The convertible notes are convertible into cash, or a combination of cash and common stock at our election, based on an initial conversion rate of 40.8513 shares of our common stock per $1,000 in principal amount of the convertible notes (equivalent to an initial conversion price of approximately $24.48 per share) under certain circumstances.
At any time on or after January 21, 2014, the convertible notes are subject to redemption at our option, in whole or in part, for cash equal to 100% of the principal amount of the convertible notes, plus unpaid interest, if any, accrued to the redemption date.
Holders of the convertible notes may require us to repurchase the convertible notes, in whole or in part, on January 15, 2014, January 15, 2017 or January 15, 2022, or, if a “fundamental change” (as such term is defined in the indenture governing the convertible notes) occurs, for cash equal to 100% of the principal amount of the convertible notes, plus any unpaid interest, if any, accrued to the redemption date.
Credit Facility - In June 2011, we entered into a five-year $300 million revolving secured credit facility (the “Credit Facility”), which replaced our $100 million revolving credit facility that was established in 2007. The new Credit Facility includes the option to increase the amount of the Credit Facility by up to $150 million to the extent that any one or more lenders commit to be a lender for such additional amount. Loans under the Credit Facility bear interest at LIBOR plus an applicable margin ranging from 1.75% to 2.50%, with the applicable margin varying according to our total leverage ratio, or, at our election, at a prime base rate plus 0.75% to 1.50%. The Credit Facility expires in 2016 and is secured by substantially all of the company’s assets except for real property. Up to $125 million of the Credit Facility may be reserved for letters of credit. As of September 30, 2011, there were no borrowings under the Credit Facility, although $17.7 million of letters of credit were issued under the Credit Facility. Accordingly, as of September 30, 2011, $282.3 million of the Credit Facility was available for borrowings.
Debt Covenants - Our Credit Facility contains covenants limiting our ability to, among other things, pay cash dividends, incur debt or liens, redeem or repurchase company stock, enter into transactions with affiliates, make investments, merge or consolidate with others or dispose of assets. In addition, the Credit Facility contains financial covenants with respect to leverage and interest coverage. As of September 30, 2011, we were in compliance with all of these covenants.
Available Cash and Future Funding
At September 30, 2011, we had $304.0 million of unrestricted cash and cash equivalents. Management believes that available cash, cash expected to be generated from operations and the borrowing capacity under our Credit Facility will be sufficient to fund our operating and capital expenditure requirements, including research and development expenditures, over the next 12 months and for the foreseeable future. However, there can be no assurance that this will be the case. We believe that we will continue to incur significant costs during the remainder of 2011 and in 2012 related to the Taurus II and COTS research and development programs. Additionally, significant unforeseen events such as termination of major orders, late deliveries or failure of launch vehicle or satellite products could adversely affect our liquidity and results of operations. If market opportunities exist, we may choose to undertake financing actions to further enhance our liquidity, which could include raising funds through capital market transactions; however, our ability to borrow additional funds is limited by the terms of our Credit Facility.
As discussed in Note 7 to the accompanying financial statements, we currently hold investments in auction rate securities and preferred stock that have experienced a decline in fair value. Given the sufficiency of our available cash and other funding sources as discussed above, we believe that we will not need, nor do we intend, to liquidate these investments in the foreseeable future. Accordingly, we do not believe that any fluctuations in the fair values of these securities will have a significant impact on our liquidity.
Off-Balance Sheet Arrangements
We do not have any material off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Recent Accounting Pronouncements
In September 2011, the FASB issued ASU No. 2011-08, “Testing Goodwill for Impairment.” This ASU provides an option for companies to use a qualitative approach to test goodwill for impairment if certain conditions are met. After assessment of certain qualitative factors, if it is determined to be more likely than not that the fair value of a reporting unit is less than its carrying amount, entities must perform the quantitative analysis of the goodwill impairment test. Otherwise, the quantitative test becomes optional. The provisions of this ASU are effective for interim and annual periods beginning after December 15, 2011. We do not expect that adoption of this ASU will have a material impact on our financial statements.
In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income.” This ASU intends to enhance comparability and transparency of other comprehensive income components. The guidance provides an option to present total comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive
statements. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of stockholders’ equity. The provisions of this ASU will be applied retrospectively for interim and annual periods beginning after December 15, 2011. There will be no impact to the consolidated financial results as this ASU relates only to changes in financial statement presentation.
In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (Topic 820)—Fair Value Measurement.” This ASU clarifies certain concepts related to the fair value measurement of financial instruments and related disclosures. The provisions of this ASU are effective prospectively for interim and annual periods beginning on or after December 15, 2011. We are currently evaluating the impact of the pending adoption of this ASU on our financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We believe that our market risk exposure is primarily related to the market value of certain investments that we hold as of September 30, 2011, changes in foreign currency exchange rates and interest rate risk. We manage these market risks through our normal financing and operating activities and, when appropriate, through the use of derivative financial instruments. We do not enter into derivatives for trading or other speculative purposes, nor do we use leveraged financial instruments.
Investments
As discussed in Note 7 to the accompanying financial statements, we currently hold investments in auction-rate securities and preferred stock that have experienced a significant decline in fair value resulting in our recording certain other-than-temporary impairment charges. As a result of ongoing liquidity issues impacting these securities, we may be required to record additional impairment charges if there are further reductions in the fair value of these investments in future periods.
Foreign Currency Exchange Rate Risk
We believe that the potential change in foreign currency exchange rates is not a substantial risk to us because the large majority of our business transactions are denominated in U.S. dollars. At September 30, 2011, we had $1.9 million of receivables denominated in Japanese yen.
From time to time, we enter into forward exchange contracts to hedge against foreign currency fluctuations on receivables or expected payments denominated in foreign currency. At September 30, 2011, we had no foreign currency forward exchange contracts.
Interest Rate Risk
We are exposed to changes in interest rates in the normal course of our business operations as a result of our ongoing investing and financing activities, which include debt as well as cash and cash equivalents. As of September 30, 2011, we had $143.8 million of convertible senior subordinated notes with a fixed interest rate of 2.4375%. Generally, the fair market value of our fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. In addition, the fair value of our convertible notes is affected by our stock price. The total estimated fair value of our convertible debt at September 30, 2011 was $143.3 million. The fair value was determined based on market prices quoted by a broker-dealer.
We believe that exposure to market risk related to interest rate fluctuations for cash and cash equivalents are not significant. As of September 30, 2011, a hypothetical 100 basis point change in interest rates would result in an annual change of approximately $2.8 million in interest income earned.
We assess our interest rate risks on a regular basis and do not currently use financial instruments to mitigate these risks.
Deferred Compensation Plan
We have an unfunded deferred compensation plan for senior managers and executive officers with a total liability balance of $9.8 million at September 30, 2011. This liability is subject to fluctuation based upon the market value of the investment options selected by participants.
Evaluation of Disclosure Controls and Procedures
An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures were effective.
Changes in Internal Controls Over Financial Reporting
There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
OTHER INFORMATION
From time to time we are party to certain litigation or other legal proceedings arising in the ordinary course of business. Because of the uncertainties inherent in litigation, we cannot predict the outcome of such litigation or other legal proceedings; however, we believe that none of these matters will have a material adverse effect on our results of operations or financial condition.
There are no material changes to the risk factors disclosed in the company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
| | (a) | None. |
| | (b) | None. |
| | (c) | None. |
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
Not applicable.
(a) Exhibits – A complete listing of exhibits required is given in the Exhibit Index. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | ORBITAL SCIENCES CORPORATION |
| | | |
| | | |
| DATED: October 27, 2011 | By: | /s/ David W. Thompson |
| | | David W. Thompson |
| | | Chairman, President and Chief Executive Officer |
| | | |
| | | |
| DATED: October 27, 2011 | By: | /s/ Garrett E. Pierce |
| | | Garrett E. Pierce |
| | | Vice Chairman and Chief Financial Officer |
EXHIBIT INDEX
The following exhibits are filed with this report unless otherwise indicated.
| Exhibit No. | Description |
| 3.1 | Restated Certificate of Incorporation (incorporated by reference to Exhibit 4.1 to the company’s Registration Statement on Form S-3 (File Number 333-08769) filed and effective on July 25, 1996). |
| 3.2 | Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to the company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005). |
| 3.3 | Certificate of Amendment to Restated Certificate of Incorporation, dated April 29, 1997 (incorporated by reference to Exhibit 3.3 to the company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998). |
| 3.4 | Certificate of Amendment to Restated Certificate of Incorporation, dated April 30, 2003 (incorporated by reference to Exhibit 3.4 to the company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003). |
| 4.1 | Form of Certificate of Common Stock (incorporated by reference to Exhibit 4.1 to the company’s Registration Statement on Form S-1 (File Number 33-33453) filed on February 9, 1990 and effective on April 24, 1990). |
| 4.2 | Indenture dated as of December 13, 2006, by and between Orbital Sciences Corporation and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.1 to the company’s Current Report on Form 8-K filed on December 13, 2006). |
| 4.3 | Form of 2.4375% Convertible Senior Subordinated Note due 2027 (incorporated by reference to Exhibit 4.2 to the company’s Current Report on Form 8-K filed on December 13, 2006). |
| 31.1 | Certification of Chairman, President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) (transmitted herewith). |
| 31.2 | Certification of Vice Chairman and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) (transmitted herewith). |
| 32.1 | Written Statement of Chairman, President and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) (transmitted herewith). |
| 32.2 | Written Statement of Vice Chairman and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) (transmitted herewith). |
| 101.INS* | XBRL Instance Document |
| 101.SCH* | XBRL Taxonomy Extension Schema |
| 101.CAL* | XBRL Taxonomy Extension Calculation Linkbase |
| 101.LAB* | XBRL Taxonomy Extension Labels Linkbase |
| 101.PRE* | XBRL Taxonomy Extension Presentation Linkbase |
| 101.DEF* | XBRL Taxonomy Extension Definition Linkbase |
| | |
*Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files in Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
