Orbital ATK Announces Preliminary Second Quarter 2016 Financial Results

Orbital ATK reported revenues of $1,052 million for the second quarter of 2016, compared to $1,077 million in the comparable period of 2015. GAAP income from continuing operations, before interest, income taxes and non-controlling interest (which the company refers to as operating income) was $115.7 million, or 11.0% operating margin, in the second quarter of 2016 compared to $96.8 million and 9.0%, respectively, in the comparable period of 2015. The company reported GAAP earnings per diluted share of $1.23 in the second quarter of 2016 compared to $0.92 in the comparable period of 2015. Net cash from operating activities was $143.3 million in the second quarter of 2016.

The company also reported the following non-GAAP adjusted results.* Adjusted operating income and operating margin were $125.2 million and 11.9%, respectively, in the second quarter of 2016, compared to $102.6 million and 9.5%, respectively, in the same period of 2015. Adjusted diluted earnings per share in the quarter were $1.35, compared to $0.98 in the comparable period of 2015.

Free cash flow, defined as net cash from operating activities minus capital expenditures, was $107.2 million in the second quarter of 2016. Adjusted free cash flow, which excludes certain merger-related cash expenses totaling $3.5 million, was $110.7 million in the quarter.

“Orbital ATK’s second quarter was characterized by solid operational performance, excellent new orders, and strong earnings and cash flow,” said David W. Thompson, Orbital ATK’s President and Chief Executive Officer. “While the company experienced revenue softness in certain market areas, especially in our commercial satellite product line, we exceeded our initial profit margin expectations, enabling us to maintain our outlook for 2016 earnings. In addition, we continued to implement a disciplined cash deployment strategy that includes a mix of dividends, share repurchases and investments in long-term growth initiatives that will benefit the company in the years ahead.”

Consolidated Financial Highlights

GAAP Results

Revenues decreased $25 million, or 2.3%, in the second quarter of 2016 compared to revenues in the comparable period in 2015, due to a $21 million decrease in Flight Systems Group (FSG), a $32 million decrease in Space Systems Group (SSG), and a $7 million increase in corporate eliminations partially offset by a $35 million increase in Defense Systems Group (DSG).

Operating income increased $18.9 million, or 19.5%, in the second quarter of 2016 compared to operating income in the same period in 2015, due to a $2.9 million increase in FSG, a $2.4 million increase in SSG and a $4.6 million increase in DSG. There was also a $9.0 million increase in corporate adjustments primarily due to a favorable Financial Accounting Standards (FAS)/Cost Accounting Standards (CAS) pension difference.

Net income and earnings per share reflected an income tax rate of 27.7% for the second quarter of 2016 compared to 32.1% for the same period in 2015. The tax rate in the second quarter of 2016 benefited from the permanent extension of the federal research and development (R&D) tax credit that occurred in late 2015 and other favorable adjustments.

Adjusted Non-GAAP Results

All adjusted financial measures discussed below are non-GAAP adjusted financial results from continuing operations. See the reconciliation tables in the “Disclosure of Non-GAAP Financial Measures” section for details.

Adjusted operating income increased $22.6 million, or 22.0%, in the second quarter of 2016 compared to the same period in 2015, driven by a $2.9 million increase in FSG, a $3.3 million increase in SSG and a $2.0 million increase in DSG. There was also a $14.4 million increase in corporate adjustments due mainly to a favorable FAS/CAS pension difference.

“Orbital ATK’s financial performance in the second quarter reflects solid profit margin and earnings per share results. The company also generated over $110 million in free cash flow in the second quarter,” said Garrett E. Pierce, the company’s Chief Financial Officer. "As we indicated in our Form 8-K filed with the SEC today, management is reviewing the prior accounting for a long-term contract to produce small-caliber ammunition for the U.S. Army that was awarded to Alliant Techsystems Inc. (ATK) in 2012. We currently expect to restate financial results for the fiscal year ended March 31, 2015 and subsequent periods to account for this program as a loss contract," he added.

Recently Announced Restatement

Orbital ATK reported today on SEC Form 8-K that it expects to restate its financial statements for the fiscal year ended March 31, 2015 (“fiscal 2015”), the nine-month transition period ended December 31, 2015 (“2015 transition period”), the quarters in fiscal 2015 and the 2015 transition period, and the quarter ended April 3, 2016 (the “Restated Periods”). The restatement is not expected to have a material impact on the company’s operating cash flow, cash balances or backlog as of and for the Restated Periods.

The misstatements which the company has identified relate primarily to its $2.3 billion long-term contract (the “Contract”) with the U.S. Army to manufacture and supply small caliber ammunition at the U.S. Army’s Lake City Army Ammunition Plant. The Contract is managed by the Small Caliber Systems Division within the Defense Systems Group.

After considering the misstatements described below, the company believes that the Contract will result in a net loss over its 10-year term. Under generally accepted accounting principles, the company is required to record the entire anticipated forward loss provision for a contract in the period in which the loss becomes evident. The company believes that a forward loss provision should have been recorded for the Contract in fiscal 2015, which was the first year of large-scale production under the Contract.

The company estimates that this forward loss provision will reduce previously reported pre-tax operating income by approximately $400 million to $450 million, after-tax net income by approximately $250 million to $280 million, and the applicable balance sheet accounts including retained earnings by approximately $250 million to $280 million. These adjustments represent the company’s current estimate of the entire anticipated forward loss for the full 10-year term of the Contract. The misstatements also resulted in revenues being overstated by $100 million to $150 million, primarily in fiscal 2015. Based on the information currently available, management believes that the primary impact of the restatement is in fiscal 2015, but there are also related changes necessary in periods subsequent to fiscal 2015. The company’s evaluation of the misstatements is ongoing and, accordingly, the determination as to which fiscal period the forward loss provision and related effects should have been recorded is preliminary and could change. The company continues to evaluate whether periods prior to fiscal 2015 are materially misstated and whether a portion of the loss should be treated as a change in estimate in the quarterly period ended July 3, 2016.

Please refer to the tables at the end of this release which present the preliminary estimated restated income statement for the second quarter of 2015.

As a result of the restatement and the ongoing review, all adjustments and amounts and time periods presented in this press release are preliminary and subject to revision.

Segment Results

Orbital ATK conducts its operations in three business segments: Flight Systems Group, Defense Systems Group and Space Systems Group. Each of these groups in turn consists of several product-line divisions. Segment operating results include pension expense recoverable under U.S. Government contracts as determined in accordance with government Cost Accounting Standards. The difference between pension expense recorded in accordance with GAAP Financial Accounting Standards and pension costs recorded in accordance with CAS is reported at the corporate level. The amortization of intangible assets recorded in connection with the merger of Orbital and ATK is also reported at the corporate level.

Flight Systems Group:

GAAP Results

FSG revenues for the second quarter of 2016 decreased $21 million, or 5.4%. Operating income increased $2.9 million, or 5.6%. The changes were due mainly to lower revenues and higher margins in the Launch Vehicles Division.

Adjusted Non-GAAP Results

FSG adjusted operating income increased $2.9 million, or 5.6%. The changes were due mainly to higher margins in the Launch Vehicles Division.

Defense Systems Group:

GAAP Results

DSG revenues for the second quarter of 2016 increased $35 million, or 8.6%, while operating income increased $4.6 million, or 14.9%, mainly due to higher revenues in the Defense Electronics Division and Missile Products Division, partially offset by lower Small Caliber Systems Division revenues and margins.

Adjusted Non-GAAP Results

DSG adjusted operating income increased $2.0 million, or 5.5%, mainly due to higher revenues in the Defense Electronics Division and Missile Products Division, partially offset by lower Small Caliber Systems Division revenues and margins.

Space Systems Group:

GAAP Results

SSG revenues for the second quarter of 2016 decreased $32 million, or 10.8% mainly due to lower revenues in the Satellite Systems Division, while operating income increased $2.4 million, or 8.1%, primarily due to higher margins in the Advanced Programs Division.

Adjusted Non-GAAP Results

SSG adjusted operating income increased $3.1 million, or 10.4%, mainly due to higher

margins in the Advanced Programs Division.

Operating Cash Flow, Free Cash Flow and Capital Allocation Activities

Cash generated by operating activities totaled $143.3 million, while capital expenditures totaled $36.1 million in the quarter. Free cash flow in the second quarter of 2016 was $107.2 million. Adjusted free cash flow was $110.7 million which excluded $3.5 million of cash payments associated with merger-related activities (see non-GAAP reconciliation table below for details).

The company repurchased approximately $18 million of its common stock and also paid dividends of approximately $17 million during the second quarter of 2016, returning a total of about $35 million to shareholders in the period. The company reduced outstanding debt by $85 million in the quarter as well. For the first six months of 2016, Orbital ATK repurchased about $45 million of its shares and paid dividends of $35 million, returning a total of $80 million to shareholders.

Operational Highlights

Orbital ATK’s strong operational execution led to the achievement of numerous milestones in the quarter. These included the following important events:

In the Flight Systems Group, the company completed two major ground tests of launch vehicle propulsion systems and launched several missile defense targets during the second quarter. In May, Orbital ATK successfully completed a 30-second on-pad “hot-fire” of the Antares rocket that tested the vehicle’s modified first stage core and two liquid-fuel RD-181 engines. In June, at the company’s Promontory, Utah facilities, Orbital ATK successfully completed the final ground test of the world’s largest solid rocket booster that will be used with NASA’s Space Launch System. Also in the quarter, Orbital ATK launched a medium-range target rocket in support of a missile defense test and three short-range Coyote target missiles for the U.S. Navy. The company also supported two United Launch Alliance missions with propulsion systems and composite structures and reached a long-term production milestone by completing its 500^th large-scale launch vehicle composite structure during the quarter.

In the Defense Systems Group, the company delivered about 6,000 tactical rocket motors and warheads during the quarter and produced approximately 375 million rounds of small-, medium- and large-caliber ammunition for domestic and international customers. Orbital ATK also supported two successful flight tests for the Missile Defense Agency’s Standard Missile-3 using the company’s enhanced third stage rocket motor. In addition, the company achieved production milestones on several important weapons programs, including the transition to full-rate production of approximately 10,000 annual units for its Precision Guidance Kit and the first deliveries of the alternate warhead for the U.S. Army’s Guided Multiple Launch Rocket System.

In the Space Systems Group, second quarter operations were highlighted by the successful completion in June of the OA-6 cargo logistics mission for NASA, which delivered a record amount of pressurized cargo to the space station and completed post-departure scientific experiments. Earlier in the quarter, Orbital ATK deployed, checked-out and completed handover of the Thaicom 8 commercial communications satellite to the customer. The company also launched two suborbital research rockets, completed two high altitude scientific balloon missions, and delivered numerous satellite components for Orbital ATK spacecraft and other external customers. Finally, the company-built Dawn spacecraft completed its historic nine-year mission to the main asteroid belt during which it returned never-before-seen images and other data about two near-planet sized bodies, Ceres and Vesta.

“In the second quarter, Orbital ATK successfully carried out a number of high-profile operational events, including critical tests of our Antares rocket and NASA’s Space Launch System, as well as the deployment of a new communications satellite, three successful missile defense launches, and production step-ups on several defense programs,” said Chief Operating Officer Blake E. Larson. “Our operational execution on key programs across all three business groups remains strong as a result of the hard work and attention to detail by our program and technical teams.”

New Business Summary

In the second quarter of 2016, Orbital ATK recorded approximately $1,590 million in new firm and option contract bookings. In addition, the company received approximately $255 million in option exercises under existing contracts. As of July 3, 2016, the company’s firm backlog was approximately $8.48 billion, up 1% compared to a year ago, and its total backlog (including options, indefinite quantity contracts and undefinitized orders) was approximately $15.17 billion, 25% higher than this time last year.

2016 Financial Guidance

The company lowered its annual revenue guidance to $4,450-$4,500 million, increased its guidance for adjusted operating profit margins to 11.5% to 12.0%, and increased the lower end of its guidance for adjusted diluted earnings per share. The company also updated the range of its free cash flow guidance to $225-$275 million. Please see the reconciliation table in the “Disclosure of Non-GAAP Financial Measures” section below for details concerning adjustments to the corresponding GAAP items.

Orbital ATK currently expects an effective tax rate of approximately 28% for the year and interest expense of approximately $70 million, which includes approximately $8 million due to non-cash interest related to certain adjustments required in purchase accounting. Pension funding is expected to be approximately $40 million and capital expenditures are projected to be approximately $200 million for the year. Diluted weighted average shares outstanding are expected to be approximately 58 million on the basis of continued repurchase activity in 2016. The FAS/CAS favorable pension adjustment is expected to be approximately $80 million for the year.