SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q /X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended December 27, 1998 or / / 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 1-10582 ALLIANT TECHSYSTEMS INC. (Exact name of registrant as specified in its charter) DELAWARE 41-1672694 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 600 SECOND STREET N.E. HOPKINS, MINNESOTA 55343-8384 (Address of principal executive office) (Zip Code) (612) 931-6000 (Registrant's telephone number, including area code) NOT APPLICABLE (Former name, former address and former fiscal year if changed from last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed under 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 /X/ No / / As of January 31, 1999, the number of shares of the registrant's common stock, par value $.01 per share, outstanding was 10,569,625 (excluding 3,293,988 treasury shares). PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Consolidated Income Statements (Unaudited) (In thousands except QUARTERS ENDED NINE MONTHS ENDED per share data) -------------------------- -------------------------- December 27 December 28 December 27 December 28 1998 1997 1998 1997 ----------- ----------- ----------- ----------- Sales $ 274,446 $ 269,217 $ 789,765 $ 787,811 Cost of sales 226,086 221,152 650,740 650,196 --------- --------- --------- --------- Gross margin 48,360 48,065 139,025 137,615 Operating expenses: Research and development 1,971 2,890 5,703 7,564 Selling 5,536 10,085 20,022 29,134 General and administrative 14,885 11,033 38,966 33,304 --------- --------- --------- --------- Total operating expenses 22,392 24,008 64,691 70,002 --------- --------- --------- --------- Income from operations 25,968 24,057 74,334 67,613 Miscellaneous income (expense) (61) 84 (19) 147 --------- --------- --------- --------- Earnings before interest and income taxes 25,907 24,141 74,315 67,760 Interest expense (5,213) (6,943) (16,089) (21,880) Interest income 505 829 1,172 2,725 --------- --------- --------- --------- Income before income taxes and extraordinary loss 21,199 18,027 59,398 48,605 Income tax provision 3,180 -- 8,910 -- --------- --------- --------- --------- Income before extraordinary loss 18,019 18,027 50,488 48,605 Extraordinary loss on early extinguishment of debt, net of income tax benefit (1,661) -- (16,288) -- --------- --------- --------- --------- Net income $ 16,358 $ 18,027 $ 34,200 $ 48,605 ========= ========= ========= ========= Basic earnings per common share: Income before extraordinary loss $ 1.50 $ 1.37 $ 4.06 $ 3.72 Extraordinary loss (.14) -- (1.31) -- --------- --------- --------- --------- Net income $ 1.36 $ 1.37 $ 2.75 $ 3.72 ========= ========= ========= ========= Diluted earnings per common share: Income before extraordinary loss $ 1.45 $ 1.33 $ 3.96 $ 3.62 Extraordinary loss (.13) -- (1.28) -- --------- --------- --------- --------- Net income $ 1.32 $ 1.33 $ 2.68 $ 3.62 ========= ========= ========= ========= Average number of common shares (thousands) 12,047 13,155 12,419 13,067 ========= ========= ========= ========= Average number of common and dilutive shares (thousands) 12,386 13,539 12,740 13,443 ========= ========= ========= ========= See Notes to Consolidated Financial Statements 2 Consolidated Balance Sheets (Unaudited) (In thousands except share data) December 27, 1998 March 31, 1998 ----------------- -------------- Assets Current assets: Cash and cash equivalents $ 37,778 $ 68,960 Receivables 240,470 209,915 Net inventory 39,476 49,072 Deferred income tax asset 38,280 38,280 Other current assets 5,550 6,803 --------- --------- Total current assets 361,554 373,030 Net property, plant, and equipment 329,898 333,538 Goodwill 129,807 131,600 Prepaid and intangible pension assets 71,817 61,667 Other assets and deferred charges 10,588 8,474 --------- --------- Total assets $ 903,664 $ 908,309 ========= ========= Liabilities and Stockholders' Equity Current liabilities: Current portion of debt $ 45,750 $ 17,838 Accounts payable 84,469 80,071 Contract advances and allowances 53,922 64,318 Accrued compensation 26,023 32,275 Accrued income taxes 12,695 8,049 Accrued restructuring and facility consolidation 558 2,637 Other accrued liabilities 59,914 72,214 --------- --------- Total current liabilities 283,331 277,402 Long-term debt 314,443 180,810 Post-retirement and post-employment benefits liability 131,287 136,889 Pension liability 9,596 10,120 Other long-term liabilities 36,239 37,334 --------- --------- Total liabilities $ 774,896 $ 642,555 Contingencies Redeemable common shares (813,000 shares, $.01 par value, redeemable at a prescribed price totaling $44,979 at March 31, 1998. Redeemed quarterly, in equal lots of 271,000 shares each, during calendar 1998.) $ -- $ 44,979 Common stock - $.01 par value Authorized - 20,000,000 shares Issued and outstanding 10,541,865 shares at December 27, 1998 and 12,855,511 at March 31, 1998 124 121 Additional paid-in-capital 243,366 201,728 Retained earnings 106,744 72,544 Unearned compensation (2,089) (1,251) Pension liability adjustment (4,743) (4,743) Common stock in treasury, at cost (3,321,748 shares held at December 27, 1998 and 1,008,102 at March 31, 1998) (214,634) (47,624) --------- --------- Total liabilities and stockholders' equity $ 903,664 $ 908,309 ========= ========= See Notes to Consolidated Financial Statements 3 Consolidated Statements of Cash Flows (Unaudited) (In thousands) NINE MONTHS ENDED ------------------------------------ December 27, 1998 December 28, 1997 ----------------- ----------------- Operating activities Net income $ 34,200 $ 48,605 Adjustments to net income to arrive at cash provided by operations: Depreciation 28,913 31,259 Amortization of intangible assets and unearned compensation 4,407 4,530 Extraordinary loss on early extinguishment of debt 16,288 -- Loss on disposal of property 462 199 Changes in assets and liabilities: Receivables (30,555) 9,685 Inventory 9,596 15,736 Accounts payable 4,398 (24,957) Contract advances and allowances (10,396) (32,428) Accrued compensation (6,252) (5,905) Accrued income taxes 7,521 (2,124) Accrued restructuring and facility consolidation (2,079) (12,294) Accrued environmental liability (524) (1,419) Pension and post-retirement benefits (6,126) (5,837) Other assets and liabilities (20,705) (19,614) --------- --------- Cash provided by operations 29,148 5,436 --------- --------- Investing activities Capital expenditures (27,447) (11,166) Acquisition of business (1,100) (6,194) Proceeds from disposition of property, plant, and equipment 275 1,197 --------- --------- Cash used for investing activities (28,272) (16,163) --------- --------- Financing activities Payments made on bank debt (48,648) (61,768) Payments made to extinguish high yield debt (152,997) -- Proceeds from issuance of long-term debt 350,193 -- Payments made for debt issue costs (8,691) -- Net purchase of treasury shares (175,646) (9,632) Proceeds from exercised stock options 3,731 8,278 Other financing activities, net -- (2,302) --------- --------- Cash used for financing activities (32,058) (65,424) --------- --------- Decrease in cash and cash equivalents (31,182) (76,151) Cash and cash equivalents - beginning of period 68,960 122,491 --------- --------- Cash and cash equivalents - end of period $ 37,778 $ 46,340 ========= ========= See Notes to Consolidated Financial Statements 4 Notes to Consolidated Financial Statements (Unaudited) 1. In connection with the Company's September, 1998 early extinguishment of its Senior Subordinated Notes and the refinancing of its bank borrowings in November, 1998, the Company incurred extraordinary charges for the early extinguishment of debt, totalling $16.3 million, for the nine-month period ending December 27, 1998. The extraordinary charge includes charges associated with the Company's September 16, 1998, completion of the tender offer and consent solicitation relating to its then outstanding $150 million 11.75 percent Senior Subordinated Notes which were due March 1, 2003 (the "Notes"). Under the tender offer (the "Offer"), the Company accepted all validly tendered Notes for payment under the Offer, and accordingly paid approximately $153 million to purchase the Notes from noteholders holding approximately $140 million principal amount of the Notes. In conjunction with the early extinguishment of the Notes, the Company also refinanced its bank borrowings under a new bank credit facility on November 23, 1998. See Note 2 below, for further discussion of the new bank credit facility. In connection with these early extinguishments of debt, the Company recorded a $19.2 million extraordinary charge ($16.3 million, after the tax benefit of $2.9 million), which is comprised of the $13.2 million cash premium paid to acquire the Notes, as well as the write-off of approximately $6.0 million representing the unamortized portion of the debt issuance costs associated with the original borrowings. 2. On November 23, 1998, the Company entered into a new $650 million bank credit facility (the facility). The facility, which refinanced the Company's previously existing bank credit facility, has a six-year term and consists of term-debt credit facilities totalling up to $400 million, and a revolving credit facility of $250 million. Interest charges under the new facility are primarily at the London Inter-Bank Offering Rate (LIBOR), plus 2.25 percent (which totalled 7.3 percent at December 27, 1998), and will be subject to change in the future, as changes occur in market conditions and in the Company's financial performance. Borrowings under the facility are subject to financial leverage covenants, as well as other customary covenants (e.g., restrictions on additional indebtedness and liens, sales of assets, and restricted payments). Fees associated with the refinancing were approximately $9 million. These costs are classified in "Other Assets and Deferred Charges", and are being amortized to interest expense over the six-year term of the new facility. At December 27, 1998, the Company had borrowings of $20.0 million against its $250 million bank revolving credit facility. Additionally, the Company had outstanding letters of credit of $31.4 million, which further reduced amounts available on the revolving facility to $198.6 million at December 27, 1998. Scheduled minimum loan repayments on the Company's outstanding long-term debt are as follows: fiscal 1999, $0; fiscal 2000, $36.5 million; fiscal 2001, $49.5 million; fiscal 2002, $61.0 million; fiscal 2003, $71.2 million; fiscal 2004, $61.0 million, and thereafter, $61.0 million. 3. The major categories of other current and long-term accrued liabilities are as follows (in thousands): Period Ending ---------------------------------- December 27, 1998 March 31, 1998 -------------------------------------------------------------------------------- Employee benefits and insurance 26,385 29,196 Legal accruals 11,502 21,495 Other accruals 22,027 21,523 -------------------------------------------------------------------------------- Other accrued liabilities-current 59,914 72,214 ================================================================================ Environmental remediation liability 16,740 17,264 Deferred tax liability 19,499 19,499 Other long-term -- 571 -------------------------------------------------------------------------------- Other long-term liabilities 36,239 37,334 ================================================================================ 5 The decrease in legal accruals since March 31, 1998 is reflective of payments made during the nine-month period ended December 27, 1998, for legal settlements agreed to (and reserved for) in previous periods, including the $4.5 million installment paid in April 1998 in connection with the Accudyne "qui-tam" settlement (reached in June 1995) and payments totaling $6.5 million in satisfaction of the liabilities associated with two other qui-tam issues previously settled. See Note 6 for further discussion of legal settlements. 4. Alternative minimum taxes of $1.4 and $2.1 million were paid during the nine-month period ended December 27, 1998 and December 28, 1997, respectively. The effective income tax rate of 15 percent on continuing operations in the current nine-month period reflects recognition and utilization of $8.0 million of available federal and state loss carryforwards (net) for tax purposes. 5. On December 15, 1998, the Company completed the repurchase of 1.7 million shares of its common stock at a price of $77 per share, or approximately $130 million in total. The repurchase occurred via the terms and conditions of a modified "Dutch auction" tender offer (Dutch auction), and was financed under the Company's new bank credit facility. In connection with the completion of the Dutch auction, the Company's Board of Directors authorized the Company to repurchase up to an additional 1.1 million shares of its common stock. Any repurchases made under this repurchase plan would be subject to market conditions and the Company's compliance with its debt covenants. As of December 27, 1998, the Company's debt covenants permit the Company to expend up to $90 million specifically in connection with future share repurchases. Additionally, the Company may make "restricted payments" (as defined in the Company's debt covenants) of up to an additional $50 million, which among other items, would allow payments for further stock repurchases (over and above the aforementioned $90 million). While it is currently the Company's intention to make stock repurchases under this program, there can be no assurance that the Company will purchase all or any portion of the remaining shares, or as to the timing or terms thereof. As of December 27, 1998, minor repurchases have been made under the plan, aggregating less than $.2 million. On October 24, 1997, the Company entered into an agreement with Hercules Incorporated (Hercules) providing for the disposition of the 3.86 million shares of Alliant common stock then held by Hercules. The shares represented the stock issued by the Company in connection with the March 15, 1995 acquisition of the Hercules Aerospace Company operations from Hercules (Aerospace acquisition). Under the agreement with Hercules (the "Hercules repurchase"), during the quarter ended December 28, 1997 the Company registered for public offering approximately 2.78 million shares (previously unregistered) held by Hercules. The offering was completed on November 21, 1997. No new shares were issued in the offering nor did the Company receive any proceeds from the offering. The remaining 1.1 million shares held by Hercules became subject to a put/call arrangement under which Hercules could require the Company to purchase the shares in four equal installments of 271,000 shares during each of the four calendar quarters of 1998. The Company could likewise require Hercules to sell the shares to the Company in four equal installments during each of the four calendar quarters of 1998. The price for shares purchased under the put/call arrangement was equal to the per-share net proceeds realized by Hercules in the secondary public offering, $55.32. In late fiscal 1998, the Company did repurchase the first installment of 271,000 shares, for approximately $15 million. In May, August, and November of 1998, respectively, the Company repurchased the remaining installments of 271,000 shares, each for approximately $15 million. During early fiscal 1998, the Company completed a $50 million stock repurchase program started in fiscal 1996. In connection with that program, the Company made repurchases in the nine-months ended December 28, 1997 of approximately 140,000 shares, for approximately $6.0 million. 6 6. Contingencies: As a U.S. Government contractor, the Company is subject to defective pricing and cost accounting standards non-compliance claims by the Government. Additionally, the Company has substantial Government contracts and subcontracts, the prices of which are subject to adjustment. The Company believes that resolution of such claims and price adjustments made or to be made by the Government for open fiscal years (1987 through 1998) will not materially exceed the amount provided in the accompanying balance sheets. The Company is a defendant in numerous lawsuits that arise out of, and are incidental to, the conduct of its business. Such matters arise out of the normal course of business and relate to product liability, intellectual property, government regulations, including environmental issues, and other issues. Certain of the lawsuits and claims seek damages in large amounts. In these proceedings, no director, officer, or affiliate is a party or a named defendant. Under the terms of the agreements relating to the Aerospace acquisition, all litigation and legal disputes arising in the ordinary course of the acquired operations will be assumed by the Company except for a few specific lawsuits and disputes including two specific qui-tam lawsuits. Under terms of the purchase agreement with Hercules, the Company's maximum combined settlement liability for both of these qui tam matters was approximately $4 million, which the Company had fully reserved. On May 15, 1998, Hercules announced that it had agreed to a settlement in the first qui tam lawsuit which has since been approved by the court. Therefore, in July, 1998 the Company paid $4 million in full satisfaction of its liability related to these matters. In March, 1997 the Company received a partially unsealed complaint, in a qui tam action by four former employees (the "Relators") alleging labor mischarging to the Intermediate Nuclear Force (INF) contract, and other contracts. Damages are not specified in this civil suit. The Company and Hercules have agreed to share equally the external attorney's fees and investigative fees and related costs and expenses of this action until such time as a determination is made as to the applicability of the indemnification provisions of the Aerospace acquisition purchase agreement. In March 1998, the Company and Hercules settled with the Department of Justice on the portion of the complaint alleging labor mischarging to the INF contract and agreed to pay $2.25 million each, together with Relators' attorney's fees of $150 thousand each, which was paid in April 1998. The Department of Justice declined to intervene in the remaining portion of the complaint. On October 16, 1998 the Company and Hercules settled with the Relators all remaining issues in this action by agreeing to each pay $575 thousand, subject to court approval. On January 21, 1999, the court approved the settlement and entered judgment dismissing the case, subject to the right of the Department of Justice to appeal such approval and dismissal. The Company has also been served with a complaint in a civil action alleging violation of the False Claims Act and the Truth in Negotiations Act. The complaint alleges defective pricing on a government contract. Based upon documents provided to the Company in connection with the action, the Company believes that the U.S. Government may seek damages and penalties of approximately $5 million. The Company is a defendant in a patent infringement case brought by Cordant Technologies (formerly Thiokol Corporation), which the Company believes is without merit. The complaint does not quantify the amount of damages sought. Through its analysis of an October 27, 1997, court filing, the Company now believes that, based on an economist's expert testimony, Cordant Technologies may seek lost profits, interest and costs of approximately $240 million. Even if the Company is found liable, it believes that damages should be based upon a reasonable royalty of less than $5 million. The court has bifurcated the trial, with the liability issue being tried first, and if liability is found, the damages issue being tried second. The liability issue was tried in January 1998, after which the court 7 requested, and the parties submitted, post-trial briefs. A decision on the liability issue is not expected until several months after submission of the parties' post-trial briefs. In the judgment of management, the case will not have a material adverse effect upon the Company's future financial condition or results of operations. However, there can be no assurance that the outcome of the case will not have a material adverse effect on the Company. During fiscal 1998, the Company substantially completed the requirements of the M117 Bomb reclamation contract. The contract contained a priced option, having approximate contract value less than $5 million, whereby the customer could require the reclamation of additional quantities, given that such option be exercised within the terms and conditions of the contract. On August 4, 1997, the customer informed the Company that it was exercising the option. The Company, based on advice from its counsel, maintains that the option exercise was invalid and has therefore not performed on the option. The Company is currently appealing the validity of the option to the United States Court of Appeals, based on the Company's continued belief that such exercise was invalid. In late December 1997, the Company was informed by the customer that the Company was being terminated for default on the contract option. The Company expects the appeals process to conclude in calendar 1999. Depending on the outcome of the appeal, which will drive the outcome of the termination for default, management currently estimates that the range of possible adverse impact to the Company's future operating earnings is from $0-$4 million, in total. During fiscal 1998, the Company identified potential technical and safety issues on its Explosive "D" contracts that, depending on the outcome of the continuing evaluation of these risks and the potentially mitigating solutions, could add cost growth to the program. These potential technical and safety issues have caused the Company to delay contract performance until the issues are resolved to the satisfaction of the Company. As a result, the Government customer has provided the Company notification that it has been terminated for default on the contracts. The Company is currently working closely with the customer to resolve these matters. Based on information known at this time, management's estimated range of reasonably possible additional cost growth that could occur as a result of the potential technical and safety issues on the Explosive "D" program is currently $0-$7 million, on which ultimate outcome is dependent on the extent to which the Company is able to mitigate these potential risks and ultimately resolve the contractual performance issues on a mutually agreeable basis. The Company does not believe that the above contract terminations will have a material adverse impact on the Company's results of operations, its liquidity, or its financial position. The Company is subject to various local and national laws relating to protection of the environment and is in various stages of investigation or remediation of potential, alleged, or acknowledged contamination. At December 27, 1998, the accrued liability for environmental remediation of $31.3 million represents management's best estimate of the present value of the probable and reasonably estimable costs related to the Company's known remediation obligations. It is expected that a significant portion of the Company's environmental costs will be reimbursed to the Company. As collection of those reimbursements is estimated to be probable, the Company has recorded a receivable of $9.6 million, representing the present value of those reimbursements at December 27, 1998. Such receivable primarily represents the expected reimbursement of costs associated with the Aerospace operations, acquired from Hercules in March, 1995, whereby the Company generally assumed responsibility for environmental compliance at Aerospace facilities. It is expected that much of the compliance and remediation costs associated with these facilities will be reimbursable under U.S. government contracts, and that those environmental remediation costs not covered through such contracts will be covered by Hercules under various indemnification agreements, subject to the Company having appropriately notified Hercules of issues identified, prior to the expiration of the stipulated notification periods (March 2000 or March 2005, depending on site ownership). The Company's accrual for environmental remediation liabilities and the associated receivable for reimbursement thereof, have been discounted to reflect the present value of the expected future cash 8 flows, using a discount rate, net of estimated inflation, of 4.5 percent. The following is a summary of the Company's amounts recorded for environmental remediation at December 27, 1998 (in millions): Accrued Environmental Environmental Costs - Liability Reimbursement Receivable ------------------------------------------------------------------------------------------------ Amounts (Payable)/Receivable $ (40.4) $ 12.4 Unamortized Discount 9.1 (2.8) ------------------------------------------------------------------------------------------------ Present Value Amounts (Payable)/Receivable $ (31.3) $ 9.6 ================================================================================================ At December 27, 1998, the estimated discounted range of reasonably possible costs of environmental remediation is between $31 and $49 million. The Company does not anticipate that resolution of the environmental contingencies in excess of amounts accrued, net of recoveries, will materially affect future operating results. In future periods, new laws or regulations, advances in technologies, outcomes of negotiations/litigations with regulatory authorities and other parties, additional information about the ultimate remedy selected at new and existing sites, the Company's share of the cost of such remedies, changes in the extent and type of site utilization, the number of parties found liable at each site, and their ability to pay are all factors that could significantly change the Company`s estimates. It is reasonably possible that management's current estimates of liabilities for the above contingencies could change in the near term, as more definitive information becomes available. 7. Interest paid during the nine-month periods ended December 27, 1998 and December 28, 1997 totalled $14.3 and $16.3 million, respectively. In late fiscal 1998, the Company entered into treasury rate-lock agreements to hedge against increases in market interest rates on the anticipated refinancing of its debt. In connection with completing the refinancing of its debt (see footnotes 1 and 2) during the third quarter of fiscal 1999, these treasury rate-locks have been converted into interest rate swaps having a total notional amount of $200 million. Of this total, swaps having a $100 million notional amount have 6 year terms and swap interest rates of between 6.32 and 6.55 percent (6.43% average). The remaining swap has a $100 million notional amount, a swap interest rate of 6.1 percent, and is effective for 10 years, with a bank cancellation option at 5 years. 8. In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share", which requires companies to present basic earnings per share (EPS) and diluted EPS, instead of the primary and fully diluted EPS that were previously required. The Company adopted the provisions of SFAS 128 during fiscal 1998, as required under the Statement. Accordingly, the financial statements have been reported consistent with the requirements of SFAS 128. Basic EPS is computed based upon the weighted average number of common shares outstanding for each period presented. Diluted EPS is computed based on the weighted average number of common shares and common equivalent shares. Common equivalent shares represent the effect of redeemable common stock (see Note 5) and stock options outstanding during each period presented, which, if exercised, would have a dilutive effect on EPS. The diluted EPS calculation results in the same EPS that the Company has historically reported as fully diluted. 9 In computing EPS for the three and nine month periods ended December 27, 1998 and December 28, 1997, net income as reported for each respective period, is divided by: Three-Months Ended Nine-Months Ended ---------------------------------- ------------------------------------- Dec. 27, 1998 Dec. 28, 1997 Dec. 27, 1998 Dec. 28, 1997 ----------------------------------------------------------------------------------------------------------------------- Basic EPS: - Average Shares Outstanding 12,047 13,155 12,419 13,067 ======================================================================================================================= Diluted EPS: - Average Shares Outstanding 12,047 13,155 12,419 13,067 - Dilutive effect of options and 339 384 321 376 redeemable common shares ----------------------------------------------------------------------------------------------------------------------- Diluted EPS Shares Outstanding 12,386 13,539 12,740 13,443 ======================================================================================================================= For the three-month period ended December 28, 1997, 1,084,000 common shares, which were subject to the put/call agreement with Hercules (see Note 5) were not included in the calculation of diluted EPS, as inclusion of those redeemable shares would have been anti-dilutive. There were no anti-dilutive securities for the three or nine month periods ended December 27, 1998, or for the nine-month period ended December 28, 1997. 9. Goodwill represents the excess of the cost of purchased businesses over the fair value of their net assets at date of acquisition and is being amortized on a straight-line basis over periods of 25 to 40 years. The recoverability of the carrying value of goodwill is periodically evaluated by comparison of the carrying value of the underlying assets which gave rise to the goodwill (including the carrying value of the goodwill itself) with the estimated future undiscounted cash flows from the related operations. An impairment loss would be measured as the amount by which the carrying value of the asset exceeds the fair value of the asset based on discounted estimated future cash flows. To date, management has determined that no impairment exists. 10. Certain reclassifications have been made to the fiscal 1998 financial statements, as previously reported, to conform to the current classification. These reclassifications did not affect the net income from operations, as previously reported. 11. The figures set forth in this quarterly report are unaudited but, in the opinion of the Company, include all adjustments necessary for a fair presentation of the results of operations for the three and nine month periods ended December 27, 1998, and December 28, 1997. The Company's accounting policies are described in the notes to financial statements in its fiscal 1998 Annual Report on Form 10-K. 12. In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income," which requires businesses to disclose comprehensive income and its components in the Company's general-purpose financial statements. Effective April 1, 1998, the Company adopted SFAS No. 130. The Company's net income (as reported) is identical to its "comprehensive income", as defined by SFAS 130, for the three and nine month periods ended December 27, 1998, and December 28, 1997, respectively. In June 1997, the FASB issued SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information," which requires additional disclosure only, and as such, is expected to have no financial impact to the Company. The statement is effective for the Company's fiscal year ending March 31, 1999. 10 In March 1998, the AICPA issued Statement of Position (SOP) 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The SOP provides guidance on when costs incurred for internal use computer software are to be capitalized. The SOP is currently not expected to have a material impact to the Company's results of operations or its financial position. The SOP is effective for the Company's fiscal year beginning April 1, 1999. 11 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS Sales Sales for the quarter ended December 27, 1998 totaled $274.4 million, an increase of $5.2 million compared to $269.2 million for the comparable quarter in the prior year. Conventional Munitions Group sales were $110.0 million for the current year quarter, compared to $111.8 million in the comparable quarter of the prior year. Space and Strategic Systems Group sales were $97.8 million for the current year quarter, an increase of $4.9 million, or 5.3 percent, compared to $92.9 million in the comparable quarter of the prior year. The increase is attributable to higher propulsion sales, up $12.1 million compared to the comparable quarter of the prior year, primarily on the Titan and Delta space propulsion programs. These propulsion sales increases were partially offset by an $8.1 million decrease in composite structures sales on the substantial completion of the X-33 contract for the development and sub-assembly of liquid hydrogen fuel tanks for the next-generation Space Shuttle. Defense Systems Group sales were $69.4 million for the current year quarter, an increase of $4.6 million, or 7.1 percent, compared to $64.8 million in the comparable quarter of the prior year. The increase was primarily attributable to the timing of deliveries on anti-tank munition programs. Sales for the nine-month period ended December 27, 1998 totaled $789.8 million, compared to $787.8 million for the comparable period of the prior year. Conventional Munitions Group sales for the nine-month period ended December 27, 1998 were $349.6 million, an increase of $4.6 million, or 1.3 percent, compared to $345.0 million for the comparable period of the prior year. Space and Strategic Systems Group sales for the nine-month period ended December 27, 1998 were $292.0 million, an increase of $25.1 million, or 9.4 percent, compared to $266.9 million for the comparable period of the prior year. The increase is attributable to higher propulsion sales, up $52.1 million compared to the comparable period of the prior year, primarily on the Titan and Delta space propulsion programs. These propulsion sales increases were partially offset by a $27.1 million decrease in composite structures sales due to the substantial completion of the X-33 development contract. Defense Systems Group sales for the nine-month period ended December 27, 1998 were $152.5 million, a decrease of $19.0 million, or 11.1 percent, compared to $171.5 million for the comparable period of the prior year. The decrease is primarily attributable to the substantial completion of the Outrider (TM) Unmanned Aerial Vehicle development program. Company sales for fiscal 1999 are expected to be approximately $1.1 billion. Gross Margin The Company's gross margin in the quarter ended December 27, 1998, was $48.4 million or 17.6 percent of sales, compared to $48.1 million, or 17.9 percent of sales for the comparable quarter of the prior year. The slight decrease in margin for the current quarter was due to a combination of sales mix and timing. Gross margin for the nine-month period ended December 27, 1998, totaled $139.0 million, or 17.6 percent of sales, compared to $137.6 million, or 17.5 percent of sales for the comparable period of the prior year. Gross margin in the current year nine-month period 12 improved slightly, as a percent of sales, due to higher award fees on space propulsion systems programs. Fiscal 1999 gross margin, as a percent of sales, is expected to be in the 17.5 - 18.0 percent range. Operating Expenses The Company's operating expenses for the quarter ended December 27, 1998, totaled $22.4 million, or 8.2 percent of sales, compared to $24.0 million, or 8.9 percent of sales for the comparable quarter of the prior year. The decrease in current year operating expenses is due primarily to decreases in selling and research and development expenses incurred, compared to the comparable quarter of the prior year, due to timing of expenses in the prior year on program pursuits, including the Company's pursuit of the Intercontinental Ballistic Missile (ICBM) Prime Integration Program. These cost decreases were partially offset by increased legal expenses in the current year (see discussion of ongoing legal matters in Contingencies, below). Operating expenses for the nine-month period ended December 27, 1998 totaled $64.7 million, or 8.2 percent of sales, compared to $70.0 million, or 8.9 percent of sales for the comparable period of the prior year. The decrease in current year expenses is due to decreases in selling and research and development expenses, primarily driven by the absence of approximately $6.9 million of selling expenses incurred on the ICBM pursuit in the comparable period of the prior year, offset partially by higher legal expenses incurred in the current year period. Fiscal 1999 operating expenses, as a percent of sales, are expected to be approximately 8.5 percent. Interest Expense The Company's interest expense for the quarter ended December 27, 1998 was $5.2 million, a decrease of $1.7 million compared to $6.9 million for the comparable quarter in the prior year. Interest expense for the nine-month period ended December 27, 1998 was $16.1 million, a decrease of $5.8 million compared to interest expense of $21.9 million for the comparable period of the prior year. The large decrease in the current year expense was driven by significantly reduced average level of borrowings outstanding in the current year periods, as well as lower interest rates, as compared to the comparable periods of the prior year. Interest Income Interest income for the quarter ended December 27, 1998, was $.5 million, compared to $.8 million for the comparable quarter of the prior year, a decrease of $.3 million. Interest income for the nine-month period ended December 27, 1998 was $1.2 million, a decrease of $1.5 million, compared to $2.7 million for the comparable period of the prior year. The decrease in interest income in the current year periods is driven by the absence of interest income earned on higher average cash balances in the comparable periods of the prior year. Cash balances during the prior year periods included approximately $40.0 million in proceeds from the Company's February, 1997 sale of its former Marine Systems Group. These proceeds were used late in fiscal 1998 to pre-pay a portion of the Company's outstanding long-term debt. Income Taxes 13 The three and nine-month periods ended December 27, 1998, reflect an effective income tax rate of 15 percent. The three and nine month periods ended December 28, 1997, reflect an effective income tax rate of 0 percent. These tax rates differ from statutory tax rates due to the partial recognition of available tax-loss carryforwards. Recognition of such carryforwards is expected to continue to reduce future tax expense. It is currently expected that required payments for taxes in fiscal 1999 will also be reduced due to the aforementioned tax-loss carryforwards. However, the Company may be subject to the provisions of the Alternative Minimum Tax (AMT), in which case tax payments could be required. To the extent that AMT is required to be paid currently, the resulting deferred tax asset can be carried forward indefinitely, and can be recovered via reductions in tax payments on future taxable income. Extraordinary Loss In connection with the Company's September, 1998 early extinguishment of its Senior Subordinated Notes and the refinancing of its bank borrowings in November, 1998, the Company incurred extraordinary charges for the early extinguishment of debt, totalling $16.3 million, for the nine-month period ending December 27, 1998. The extraordinary charge includes charges associated with the Company's September 16, 1998, completion of the tender offer and consent solicitation relating to its then outstanding $150 million 11.75 percent Senior Subordinated Notes which were due March 1, 2003 (the "Notes"). Under the tender offer (the "Offer"), the Company accepted all validly tendered Notes for payment under the Offer, and accordingly paid approximately $153 million to purchase the Notes from noteholders holding approximately $140 million principal amount of the Notes. In conjunction with the early extinguishment of the Notes, the Company also refinanced its bank borrowings under a new bank credit facility on November 23, 1998. See "Liquidity, Capital Resources and Financial Condition" below, for further discussion of the new bank credit facility. In connection with these early extinguishments of debt, the Company recorded a $19.2 million extraordinary charge ($16.3 million, after the tax benefit of $2.9 million), which is comprised of the $13.2 million cash premium paid to acquire the Notes, as well as the write-off of approximately $6.0 million representing the unamortized portion of the debt issuance costs associated with the original borrowings. Net Income Net income reported for the quarter ended December 27, 1998, was $16.4 million, a decrease of $1.7 million, compared to net income of $18.0 million for the comparable quarter of the prior year. The decrease was driven by the $1.7 million extraordinary loss on the early extinguishment of debt, and by $3.2 million of higher tax expense in the quarter, offset partially by lower operating expenses and interest expenses in the current year period. Net income for the nine-month period ended December 27, 1998 was $34.2 million, a decrease of $14.4 million, compared to net income of $48.6 million for the prior year period. The decrease was driven by the $16.3 million extraordinary loss on the early extinguishment of debt, and $8.9 million of higher tax expense in the current year period, offset partially by reduced operating and interest expenses in the current year. LIQUIDITY, CAPITAL RESOURCES, AND FINANCIAL CONDITION Cash provided by operations totaled $29.1 million for the nine months ended December 27, 1998, an increase in cash provided of $23.7 million, when compared with cash provided by operations of 14 $5.4 million in the comparable period of the prior year. The increased level of cash provided by operations in the current year period resulted from a combination of factors, the most significant of which included lower spending on restructuring and facility consolidation activities, as these activities are now substantially complete, and improved profitability (before the extraordinary loss on early extinguishment of debt) for the nine-months ended December 27, 1998, as compared to the comparable period of the prior year. Cash usage for the nine months ended December 27, 1998, also included approximately $13 million in payments for legal settlements settled and accrued in prior years. See "Contingencies" below. Cash used by investing activities for the nine-month period ended December 27, 1998, was $28.3 million, a $12.1 million increase in cash used, compared to cash used by investing activities of $16.2 million in the comparable period of the prior year. This difference primarily represented increased capital expenditures in the current year. The Company currently expects capital expenditures to be approximately $40 million for fiscal 1999. This represents a significant increase in capital spending relative to fiscal 1998. The increased planned expenditures are primarily the result of facilitization costs required to prepare for significant expected growth in the space propulsion business. This business increase is primarily associated with orders received from Boeing in fiscal 1999, totaling approximately $750 million ($1.7 billion if additional options exercised), for the production related to solid rocket boosters and composite structures for the Delta Space Launch Vehicle family. Planned expenditures also include facilitization spending associated with moving the Company's Joliet, Illinois operations to the Radford Army Ammunition Plant in Virginia, and capital spending relating to an electronic fuze business acquired in fiscal 1998. On November 23, 1998, the Company entered into a new $650 million bank credit facility (the facility). The facility, which refinanced the Company's previously existing bank credit facility, has a six-year term and consists of term-debt credit facilities totalling up to $400 million, and a revolving credit facility of $250 million. Interest charges under the new facility are primarily at the London Inter-Bank Offering Rate (LIBOR), plus 2.25 percent (which totalled 7.3 percent at December 27, 1998), and will be subject to change in the future, as changes occur in market conditions and in the Company's financial performance. Borrowings under the facility are subject to financial leverage covenants, as well as other customary covenants (e.g., restrictions on additional indebtedness and liens, sales of assets, and restricted payments). Fees associated with the refinancing were approximately $9 million. These costs are classified in "Other Assets and Deferred Charges", and are being amortized to interest expense over the six-year term of the facility. At December 27, 1998, the Company had borrowings of $20.0 million against its $250 million bank revolving credit facility. Additionally, the Company had outstanding letters of credit of $31.4 million, which further reduced amounts available on the revolving facility to $198.6 million at December 27, 1998. Scheduled minimum loan repayments on the Company's outstanding long-term debt are as follows: fiscal 1999, $0; fiscal 2000, $36.5 million; fiscal 2001, $49.5 million; fiscal 2002, $61.0 million; fiscal 2003, $71.2 million; fiscal 2004, $61.0 million, and thereafter, $61.0 million. The Company's total debt (current portion of debt and long-term debt) as a percentage of total capitalization increased to 74 percent on December 27, 1998, from 43 percent on March 31, 1998. This increase reflects higher total debt, up $161.5 million, which primarily reflects the borrowings required to fund the Company's purchases of its common stock in fiscal 1999. 15 During the nine months ended December 27, 1998, the Company repurchased a total of 2.3 million shares, at a cost of $175.6 million. These repurchases were primarily made under terms of the Company's "Dutch auction" and the completion of the Hercules repurchase, as described below. On December 15, 1998, the Company completed the repurchase of 1.7 million shares of its common stock at a price of $77 per share, or approximately $130 million in total. The repurchase occurred via the terms and conditions of a modified "Dutch auction" tender offer (Dutch auction), and was financed under the Company's new bank credit facility. In connection with the completion of the Dutch auction, the Company's Board of Directors authorized the Company to repurchase up to an additional 1.1 million shares of its common stock. Any repurchases made under this plan would be subject to market conditions and the Company's compliance with its debt covenants. As of December 27, 1998, the Company's debt covenants permit the Company to expend up to $90 million specifically in connection with future share repurchases. Additionally, the Company may make "restricted payments" (as defined in the Company's debt covenants) of up to an additional $50 million, which among other items, would allow payments for further stock repurchases (over and above the aforementioned $90 million). While it is currently the Company's intention to make stock repurchases under this program, there can be no assurance that the Company will purchase all or any portion of the remaining shares, or as to the timing or terms thereof. As of December 27, 1998, minor repurchases have been made under the program, aggregating less than $.2 million. On October 24, 1997, the Company entered into an agreement with Hercules Incorporated (Hercules) providing for the disposition of the 3.86 million shares of Alliant common stock then held by Hercules. The shares represented the stock issued by the Company in connection with the March 15, 1995 acquisition of the Hercules Aerospace Company operations from Hercules (Aerospace acquisition). Under the agreement with Hercules (the "Hercules repurchase"), during the quarter ended December 28, 1997 the Company registered for public offering approximately 2.78 million shares (previously unregistered) held by Hercules. The offering was completed on November 21, 1997. No new shares were issued in the offering nor did the Company receive any proceeds from the offering. The remaining 1.1 million shares held by Hercules became subject to a put/call arrangement under which Hercules could require the Company to purchase the shares in four equal installments of 271,000 shares during each of the four calendar quarters of 1998. The Company could likewise require Hercules to sell the shares to the Company in four equal installments during each of the four calendar quarters of 1998. The price for shares purchased under the put/call arrangement was equal to the per-share net proceeds realized by Hercules in the secondary public offering, $55.32. In late fiscal 1998, the Company did repurchase the first installment of 271,000 shares, for approximately $15 million. In May, August, and November of 1998, respectively, the Company repurchased the remaining installments of 271,000 shares, each for approximately $15 million. During early fiscal 1998, the Company completed a $50 million stock repurchase program started in fiscal 1996. In connection with that program, the Company made repurchases in the nine-months ended December 28, 1997 of approximately 140,000 shares, for approximately $6.0 million. Based on the financial condition of the Company at December 27, 1998, the Company believes that future operating cash flows, combined with existing cash balances and the availability of 16 funding under its bank revolving credit facility, will be adequate to fund the future growth of the Company, as well as to service its long-term debt obligations. CONTINGENCIES As a U.S. Government contractor, the Company is subject to defective pricing and cost accounting standards non-compliance claims by the Government. Additionally, the Company has substantial Government contracts and subcontracts, the prices of which are subject to adjustment. The Company believes that resolution of such claims and price adjustments made or to be made by the Government for open fiscal years (1987 through 1998) will not materially exceed the amount provided in the accompanying balance sheets. The Company is a defendant in numerous lawsuits that arise out of, and are incidental to, the conduct of its business. Such matters arise out of the normal course of business and relate to product liability, intellectual property, government regulations, including environmental issues, and other issues. Certain of the lawsuits and claims seek damages in large amounts. In these proceedings, no director, officer, or affiliate is a party or a named defendant. In June 1995, the Company and claimants reached an agreement to settle the Accudyne "qui tam" lawsuit. Terms of the agreement include payments to be made by the Company over three years, totaling $12.0 million. The final payment of $4.5 million was paid in June, 1998. Under the terms of the agreements relating to the Aerospace acquisition, all litigation and legal disputes arising in the ordinary course of the acquired operations will be assumed by the Company except for a few specific lawsuits and disputes including two specific qui-tam lawsuits. Under terms of the purchase agreement with Hercules, the Company's maximum combined settlement liability for both of these qui tam matters was approximately $4 million, which the Company had fully reserved. On May 15, 1998, Hercules announced that it had agreed to a settlement in the first qui tam lawsuit which has since been approved by the court. Therefore, in July, 1998 the Company paid $4 million in full satisfaction of its liability related to these matters. In March, 1997 the Company received a partially unsealed complaint, in a qui tam action by four former employees (the "Relators") alleging labor mischarging to the Intermediate Nuclear Force (INF) contract, and other contracts. Damages are not specified in this civil suit. The Company and Hercules have agreed to share equally the external attorney's fees and investigative fees and related costs and expenses of this action until such time as a determination is made as to the applicability of the indemnification provisions of the Aerospace acquisition purchase agreement. In March 1998, the Company and Hercules settled with the Department of Justice on the portion of the complaint alleging labor mischarging to the INF contract and agreed to pay $2.25 million each, together with Relators' attorney's fees of $150 thousand each, which was paid in April 1998. The Department of Justice declined to intervene in the remaining portion of the complaint. On October 16, 1998 the Company and Hercules settled with the Relators all remaining issues in this action by agreeing to each pay $575 thousand, subject to court approval. On January 21, 1999, the court approved the settlement and entered judgment dismissing the case, subject to the right of the Department of Justice to appeal such approval and dismissal. The Company has also been served with a complaint in a civil action alleging violation of the False Claims Act and the Truth in Negotiations Act. The complaint alleges defective pricing on a government contract. Based upon documents provided to the Company in connection with the 17 action, the Company believes that the U.S. Government may seek damages and penalties of approximately $5 million. The Company is a defendant in a patent infringement case brought by Cordant Technologies (formerly Thiokol Corporation), which the Company believes is without merit. The complaint does not quantify the amount of damages sought. Through its analysis of an October 27, 1997, court filing, the Company now believes that, based on an economist's expert testimony, Cordant Technologies may seek lost profits, interest and costs of approximately $240 million. Even if the Company is found liable, it believes that damages should be based upon a reasonable royalty of less than $5 million. The court has bifurcated the trial, with the liability issue being tried first, and if liability is found, the damages issue being tried second. The liability issue was tried in January 1998, after which the court requested, and the parties submitted, post-trial briefs. A decision on the liability issue is not expected until several months after submission of the parties' post-trial briefs. In the judgment of management, the case will not have a material adverse effect upon the Company's future financial condition or results of operations. However, there can be no assurance that the outcome of the case will not have a material adverse effect on the Company. During fiscal 1998, the Company substantially completed the requirements of the M117 Bomb reclamation contract. The contract contained a priced option, having approximate contract value less than $5 million, whereby the customer could require the reclamation of additional quantities, given that such option be exercised within the terms and conditions of the contract. On August 4, 1997, the customer informed the Company that it was exercising the option. The Company, based on advice from its counsel, maintains that the option exercise was invalid and has therefore not performed on the option. The Company is currently appealing the validity of the option to the United States Court of Appeals, based on the Company's continued belief that such exercise was invalid. In late December 1997, the Company was informed by the customer that the Company was being terminated for default on the contract option. The Company expects the appeals process to conclude in calendar 1999. Depending on the outcome of the appeal, which will drive the outcome of the termination for default, management currently estimates that the range of possible adverse impact to the Company's future operating earnings is from $0-$4 million, in total. During fiscal 1998, the Company identified potential technical and safety issues on its Explosive "D" contracts that, depending on the outcome of the continuing evaluation of these risks and the potentially mitigating solutions, could add cost growth to the program. These potential technical and safety issues have caused the Company to delay contract performance until the issues are resolved to the satisfaction of the Company. As a result, the Government customer has provided the Company notification that it has been terminated for default on the contracts. The Company is currently working closely with the customer to resolve these matters. Based on information known at this time, management's estimated range of reasonably possible additional cost growth that could occur as a result of the potential technical and safety issues on the Explosive "D" program is currently $0-$7 million, on which ultimate outcome is dependent on the extent to which the Company is able to mitigate these potential risks and ultimately resolve the contractual performance issues on a mutually agreeable basis. The Company does not believe that the above contract terminations will have a material adverse impact on the Company's results of operations, its liquidity, or its financial position. 18 The Company is subject to various local and national laws relating to protection of the environment and is in various stages of investigation or remediation of potential, alleged, or acknowledged contamination. At December 27, 1998, the accrued liability for environmental remediation of $31.3 million represents management's best estimate of the present value of the probable and reasonably estimable costs related to the Company's known remediation obligations. It is expected that a significant portion of the Company's environmental costs will be reimbursed to the Company. As collection of those reimbursements is estimated to be probable, the Company has recorded a receivable of $9.6 million, representing the present value of those reimbursements at December 27, 1998. Such receivable primarily represents the expected reimbursement of costs associated with the Aerospace operations, acquired from Hercules in March, 1995, whereby the Company generally assumed responsibility for environmental compliance at Aerospace facilities. It is expected that much of the compliance and remediation costs associated with these facilities will be reimbursable under U.S. government contracts, and that those environmental remediation costs not covered through such contracts will be covered by Hercules under various indemnification agreements, subject to the Company having appropriately notified Hercules of issues identified, prior to the expiration of the stipulated notification periods (March 2000 or March 2005, depending on site ownership). The Company's accrual for environmental remediation liabilities and the associated receivable for reimbursement thereof, have been discounted to reflect the present value of the expected future cash flows, using a discount rate, net of estimated inflation, of 4.5 percent. The following is a summary of the Company's amounts recorded for environmental remediation at December 27, 1998 (in millions): Accrued Environmental Environmental Costs - Liability Reimbursement Receivable --------------------------------------------------------------------------------------- Amounts (Payable)/Receivable $(40.4) $12.4 Unamortized Discount 9.1 (2.8) --------------------------------------------------------------------------------------- Present Value Amounts (Payable)/Receivable $(31.3) $9.6 ======================================================================================= At December 27, 1998, the estimated discounted range of reasonably possible costs of environmental remediation is between $31 and $49 million. The Company does not anticipate that resolution of the environmental contingencies in excess of amounts accrued, net of recoveries, will materially affect future operating results. In future periods, new laws or regulations, advances in technologies, outcomes of negotiations/litigations with regulatory authorities and other parties, additional information about the ultimate remedy selected at new and existing sites, the Company's share of the cost of such remedies, changes in the extent and type of site utilization, the number of parties found liable at each site, and their ability to pay are all factors that could significantly change the Company`s estimates. It is reasonably possible that management's current estimates of liabilities for the above contingencies could change in the near term, as more definitive information becomes available. The Company does not generate a significant amount of revenues or costs, nor does it maintain significant assets or liabilities in European Union (EU) countries or in European currencies. 19 Therefore, the Company does not expect that the EU's conversion to the Euro will have a material impact to the Company's financial position or its results of operations. YEAR 2000 Background The Company utilizes a significant amount of information technology ("IT"), such as computer hardware and software, and operating systems ("IT systems"), and non-IT systems, such as applications used in manufacturing, product development, financial business systems and various administrative functions ("non-IT systems"). To the extent that these IT systems and non-IT systems contain source code that is unable to distinguish the upcoming calendar year 2000 from the calendar year 1900 (the "Year 2000 Issue"), some level of modification or replacement of such systems will be necessary. The Company has established a Year 2000 Project Management Plan ("Year 2000 Plan") to identify and address systems requiring such modification or replacement. The Year 2000 Plan also involves assessing the extent to which the Company's suppliers and customers are addressing the Year 2000 Issue. Company management has identified certain business systems, suppliers, and customers as critical to its ongoing business needs ("business critical"). Failure of these business critical systems, suppliers, or customers to become Year 2000 compliant in a timely manner could have a material adverse impact to the Company. State of Readiness The Year 2000 Plan, which encompasses both IT and non-IT systems, involves the following five-phase approach to the Year 2000 Issue, with the indicated timetable for completion of business critical items: Timetable Phase Activity for Completion Status ----- -------- -------------- ------ 1 Ensure Company-wide awareness of the Year 2000 Issue............................................................... September 30, 1997 Completed 2 Assess the impact of the Year 2000 Issue on the Company, and conduct inventories, analyze systems, prioritize modification or replacement, and develop contingency plans....................................... January 31, 1998 Completed 3 Begin modification, replacement or elimination of selected platforms, applications, databases and utilities, and modify interfaces, as appropriate ........................................................ August 31, 1998 Completed 4 Complete work begun in Phase 3, and test, verify and validate all systems............................................................. Early 1999 Substantially Completed 5 Implement modified or replaced platforms, applications, databases and utilities....................................................... March 31, 1999 In-process The Company is not aware of any problems reasonably likely to occur as a result of third party failures to address the Year 2000 Issue. Phase 3 activity involved a significant effort to identify 20 supplier Year 2000 Issues, whereby all suppliers were prioritized and rated, and suppliers were requested to provide a Year 2000 Issue status on their products, operating systems, suppliers and facilities. Phase 4 activity encompasses supplier visits and phone interviews, final testing, and preparation for complete system implementation. Questionnaires continue to be utilized to secure additional information from suppliers on specific Year 2000 Issues. Phase 4 activities are substantially complete, except for specific items where validating actions have been rescheduled into mid-1999 to accommodate business requirements. Phase 5 activities are also underway. Critical actions and completion dates have been identified to ensure that no business critical system will pass its respective time-horizon-to-failure date. The Company has utilized the services of two independent industry consultants to assist it in assessing the reliability of its risk and cost estimates. Costs The Company currently estimates that costs associated with modifying or replacing systems affected by the Year 2000 Issue, including the amounts expended in connection with the Company's ongoing, normal course-of-business efforts to upgrade or replace business critical systems and software applications as necessary, will be approximately $13 million, compared to the Company's normal, annual IT operating budget of approximately $30 million. These costs are being funded through cash flows from operations. Costs associated with incremental personnel costs, consulting, and hardware and software modification are being expensed as incurred. The costs of newly purchased hardware and software are being capitalized in accordance with normal policy. The majority of cost is expected to be incurred during fiscal year 1999, and approximately $8 million has been expended through December 27, 1998. Approximately 37% of the total amount ultimately expended is expected to be for systems modification, and the balance for systems replacement. There are no IT projects which the Company has had to delay due to the Year 2000 Issues that would have a material impact on the Company's results of operations or financial position. The Company continues to review its contractual obligations relative to the Year 2000 Issue, and currently believes that there are no such obligations that would have material impact to the Company's results of operations or its financial position. Risks The failure to resolve a material Year 2000 Issue could result in an interruption in, or a failure of, certain normal business activities or operations. Such failures could materially and adversely affect the Company's results of operations, liquidity and financial position. Due to the general uncertainty inherent in the Year 2000 Issue, resulting in part from the uncertainty of the Year 2000 Issue readiness of third-party suppliers and customers, the Company is unable to determine at this time whether the consequences of failures resulting from the Year 2000 Issue will have a material impact on the Company's results of operations, liquidity or financial position. The Year 2000 Plan is expected to significantly reduce the Company's level of uncertainty about the Year 2000 Issue and, in particular, about the Year 2000 Issue compliance and readiness of its business critical systems, suppliers, and customers. The most significant risk to the Company is the potential impact of circumstances beyond its control, such as the failure of its business critical suppliers and/or customers (particularly the U.S. Government) to resolve their Year 2000 Issues, with a resulting inability of such suppliers to supply critical goods and services to the Company, or of such customers to pay for their 21 purchases from the Company. A related significant risk to the Company is that an inability of its business critical suppliers to resolve their Year 2000 Issues could result in the Company not being able to meet its contractual obligations. Another significant risk to the Company could be the significant loss of critical personnel on its Year 2000 Plan team. The Company currently believes that there is minimal risk that its Year 2000 Plan will be not be successfully implemented in a timely manner. In the event that the Company is ultimately unable to implement its Year 2000 Plan in a timely manner, the Company believes that its contingency plans, described below, adequately accommodate its business critical systems in a way that would not result in a material adverse impact to the Company's results of operations, its liquidity, or its financial position. However, there can be no assurance that the Company and/or relevant third parties will successfully resolve all of their Year 2000 Issues or that the Company's contingency plans will be entirely successful in mitigating those issues. Any such failure could have a material adverse effect on the Company's operations, liquidity, or its financial position. Contingency Plans It is the Company's understanding that the U.S. Government anticipates resolving the Year 2000 Issues affecting its payment system by March 1999, which will allow about 9 months for testing of the payment system. The Company is working with the Government payment office on a contingency plan that will accommodate a manual billing and payment process in the event the Year 2000 Issues affecting the Government payment system are not successfully resolved in a timely manner. A contingency plan has been established for all business critical Company systems identified as Year 2000 Issues as of August 31, 1998, and contingency plans have also been developed for certain critical suppliers, including identification of back-up supply sources, and consideration of the need to purchase additional critical supplies. Additionally, the Company will develop plans addressing the operation of its facilities during and immediately after the beginning of calendar 2000, to prepare for the possibility of major infrastructure failure (i.e., power system failure). All contingency plans will be subjected to further review following completion of Phase 4 of the Year 2000 Plan. Cautionary Statement The costs of the Year 2000 Plan and the timing in which the Company believes it will implement the Year 2000 Plan are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources and other factors. However, there can be no assurance that these estimates will be achieved, and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the success of the Company in identifying systems and programs having Year 2000 Issues, the nature and amount of programming required to upgrade or replace the affected programs, the availability and cost of personnel trained in this area, and the extent to which the Company might be adversely impacted by the failure of third parties (i.e., suppliers, customers, etc.) to remediate their own Year 2000 issues. Failure by the Company and/or its suppliers and customers (in particular, the U.S. Government, on which the Company is materially dependent) to complete Year 2000 Issue compliance work in a timely manner could have a material adverse effect on the Company's operations, its liquidity, and/or its financial position. 22 INFLATION In the opinion of management, inflation has not had a significant impact upon the results of the Company's operations. The selling prices under contracts, the majority of which are long term, generally include estimated cost to be incurred in future periods. These cost projections can generally be negotiated into new buys under fixed-price government contracts, while actual cost increases are recoverable on cost-type contracts. RISK FACTORS Certain of the statements made and information contained in this report, excluding historical information, are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements include those relating to fiscal 1999 sales, gross margin, operating expenses, tax payments and capital expenditures. Also included are statements relating to the realization of net deferred tax benefits, the repurchase of Company common stock, the funding of future growth, long-term debt repayment, environmental remediation costs and reimbursement prospects, the financial and operating impact of the resolution of environmental and litigation contingencies in general, resolution of the Cordant Technologies matter, the M117 and Explosive "D" contract terminations for default in particular, and the ultimate cost and impact of the Company's Year 2000 Issue compliance effort. Such forward-looking statements involve risks and uncertainties that could cause actual results or outcomes to differ materially. Some of these risks and uncertainties are set forth in connection with the applicable statements. Additional risks and uncertainties include, but are not limited to, changes in government spending and budgetary policies, governmental laws and other rules and regulations surrounding various matters such as environmental remediation, contract pricing, changing economic and political conditions in the United States and in other countries, international trading restrictions, outcome of union negotiations, customer product acceptance, the Company's success in program pursuits, program performance, continued access to technical and capital resources, supply and availability of raw materials and components, timely compliance with the technical requirements of the Year 2000 Issue, including timely compliance by the Company's vendors and customers, and merger and acquisition activity within the industry. All forecasts and projections in this report are "forward-looking statements", and are based on management's current expectations of the Company's near-term results, based on current information available pertaining to the Company, including the aforementioned risk factors. Actual results could differ materially. 23 PART II -- OTHER INFORMATION ITEM 2. LEGAL PROCEEDINGS The registrant has previously reported that, in March 1997 the registrant received a partially unsealed complaint, filed on an unknown date, in a qui tam action by four former employees ("Relators") alleging violations of the False Claims Act. The action has since been identified as United States of America ex rel. P. Robert Pratt and P. Robert Pratt, individually vs. Alliant Techsystems Inc. and Hercules Incorporated, which was filed in the United States District Court, Central District of California. The action alleges labor mischarging to the Intermediate Nuclear Force ("INF") contract and other contracts at the registrant's Bacchus Works facility in Magna, Utah, which was acquired as part of its acquisition of Hercules Aerospace Company ("HAC") from Hercules Incorporated ("Hercules"). Damages are not specified. The registrant and Hercules have agreed to share equally the external attorney's fees and investigative fees and related costs and expenses of this action until such time as a determination is made as to the applicability of the indemnification provisions of the HAC Purchase Agreement. In March 1998, the registrant and Hercules settled with the Department of Justice on the portion of the complaint alleging labor mischarging to the INF contract and agreed to pay $2.25 million each, together with Relators' attorney's fees of $150,000 each, which amounts were paid in April 1998. The Department of Justice has declined to intervene in the remaining portion of the complaint. On October 16, 1998, the registrant and Hercules settled with the Relators and agreed to pay $500,000 each, together with Relators' attorney's fees of $75,000 each, subject to Court approval. On January 21, 1999, the court approved the settlement and entered judgment dismissing the case, subject to the right of the Department of Justice to appeal such approval and dismissal. Incorporated herein by reference is note 6 of Notes to Financial Statements included in Item 1 of Part I of this report. ITEM 5. OTHER INFORMATION Attached to this report as Exhibit 99 is a list of the registrant's directors and executive officers, as of the date of this report, which reflects the following changes since November 5, 1998: Deletion: Richard Schwartz, Director and Chairman of the Board. Addition: Paul David Miller, Director, Chairman of the Board and Chief Executive Officer. New titles: Peter A. Bukowick, Director, President and Chief Operating Officer; Charles H. Gauck, Vice President and Secretary; and Paul A. Ross, Senior Group Vice President - Space and Strategic Systems. 24 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. Exhibit No. Description of Exhibit ----------- ---------------------- 4.1 Form of Amended and Restated Credit Agreement, dated as of November 23, 1998 between the registrant and The Chase Manhattan Bank 4.2 Form of Credit Agreement, dated as of November 23, 1998, between the registrant and The Chase Manhattan Bank 10.1 Compensation arrangement between the registrant and Paul David Miller 10.2 Form of Restricted Stock Agreement 27 Financial Data Schedule 99 Alliant Techsystems Inc. Directors and Executive Officers (b) Reports on Form 8-K. During the quarterly period ended December 27, 1998, the registrant filed the following report on Form 8-K: Date of Report Items Reported -------------- -------------- November 24, 1998 Item 5. Other Events Item 7(c). Exhibits 25 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. ALLIANT TECHSYSTEMS INC. Date: February 5, 1999 By: /s/ Charles H. Gauck Name: Charles H. Gauck Title: Secretary (On behalf of the registrant) Date: February 5, 1999 By: /s/ Scott S. Meyers Name: Scott S. Meyers Title: Vice President, Treasurer and Chief Financial Officer (Principal Financial Officer) 26 ALLIANT TECHSYSTEMS INC. FORM 10-Q EXHIBIT INDEX The following exhibits are filed herewith electronically or incorporated herein by reference. The applicable Securities and Exchange Commission File Number is 1-10582. Exhibit Number Description of Exhibit Method of Filing ------ ---------------------- ---------------- 4.1 Form of Amended and Restated Credit Agreement, dated as of November 23, 1998, between the registrant and The Chase Manhattan Bank.............. Incorporated by reference from Exhibit 9.(b)(2) to registrant's Schedule 13E-4 dated November 30, 1998 4.2 Form of Credit Agreement, dated as of November 23, 1998, between the registrant and The Chase Manhattan Bank................................ Incorporated by reference from Exhibit 9.(b)(3) to registrant's Schedule 13E-4 dated November 30, 1998 10.1 Compensation arrangement between the registrant and Paul David Miller.. Filed herewith electronically 10.2 Form of Restricted Stock Agreement..................................... Filed herewith electronically 27 Financial Data Schedule................................................ Filed herewith electronically 99 Alliant Techsystems Inc. Directors and Executive Officers.............. Filed herewith electronically