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ORBITAL SCIENCES CORP /DE/ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Certain statements contained in this Item 2 and elsewhere in this Form 10-Q are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements include, but are not limited to, those related to our financial outlook, liquidity, goals, business strategy, projected plans and objectives of management for future operating results, and forecasts of future events. These statements can be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements often include the words "anticipate," "forecast," "expect," "believe," "should," "intend," "plan" and words of similar substance. Such forward-looking statements are subject to risks, trends and uncertainties that could cause the actual results or performance of the company to be materially different from the forward-looking statement. Uncertainty surrounding factors such as continued government support and funding for key space and defense programs, achievement of important performance milestones on significant contracts, new product development programs, product performance and market acceptance of products and technologies, government contract procurement and termination risks, insurance recovery and income tax rates may materially impact Orbital's actual financial and operational results. Other risks, uncertainties and factors are discussed under the caption "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2010. We are under no obligation to, and expressly disclaim any obligation or undertaking to update or alter any forward-looking statement, whether as a result of new information, subsequent events or otherwise, except as required by law. We develop and manufacture small- and medium-class rockets and space systems for commercial, military and civil government customers. Our primary products and services include the following: · Launch Vehicles - Rockets that are used as small- and medium-class space launch vehicles that place satellites into Earth orbit and escape trajectories, interceptor and target vehicles for missile defense systems and suborbital launch vehicles that place payloads into a variety of high-altitude trajectories. · Satellites and Space Systems - Small- and medium-class satellites that are used to enable global and regional communications and broadcasting, conduct space-related scientific research, collect imagery and other remotely-sensed data about the Earth, carry out interplanetary and other deep-space exploration missions and demonstrate new space technologies. · Advanced Space Programs - Human-rated space systems for Earth-orbit and deep-space exploration, and small- and medium-class satellites primarily used for national security space programs and to demonstrate new space technologies. The following discussion should be read along with our 2010 Annual Report on Form 10-K filed with the Securities and Exchange Commission, and with the unaudited condensed consolidated financial statements included in this Form 10-Q. 16-------------------------------------------------------------------------------- Table of Contents Consolidated Results of Operations for the Quarters and Six Months Ended June 30, 2011 and 2010 Revenues - Our consolidated revenues were $350.6 million in the second quarter of 2011, an increase of $12.9 million, or 4%, compared to the second quarter of 2010 primarily due to higher revenues in the launch vehicles segment partially offset by lower revenues in the satellites and space systems and advanced space programs segments. Launch vehicles segment revenues increased $35.7 million, or 37%, due to increased production work on Taurus II launch vehicles for the International Space Station Commercial Resupply Services ("CRS") contract and the Commercial Orbital Transportation Services ("COTS") program and increased activity on target launch vehicles, partially offset by decreased activity on missile defense interceptors. Satellites and space systems segment revenues decreased $1.2 million, or 1%, due to decreased activity on science and remote sensing satellite contracts partially offset by increased activity on space technical services contracts. Advanced space programs segment revenues decreased $17.7 million, or 15%, due to reduced activity on the CRS contract and the Orion Launch Abort System ("LAS") contract, which was terminated in the second quarter of 2010, partly offset by increased activity on national security satellite contracts. Eliminations of intersegment revenues increased to $22.1 million in the second quarter of 2011 as compared to $18.3 million in the second quarter of 2010. Intersegment revenues included $20.3 million and $16.5 million in the second quarter of 2011 and 2010, respectively, pertaining to Taurus II production work in the launch vehicles segment for the COTS program that is being conducted by our advanced space programs segment. Our consolidated revenues were $668.3 million in the first half of 2011, an increase of $34.4 million, or 5%, compared to the first half of 2010 primarily due to higher revenues in the satellites and space systems and launch vehicles segments, partially offset by lower revenues in the advanced space programs segment. Satellites and space systems segment revenues increased $50.9 million, or 21%, due to increased activity on communications satellite contracts, space technical services contracts and science and remote sensing satellite contracts. Launch vehicles segment revenues increased $40.6 million, or 21%, due to increased production work on Taurus II launch vehicles for the CRS and COTS programs and increased activity on target launch vehicles, partly offset by decreased activity on missile defense interceptors and on certain Minotaur space launch contracts, and the effect of the Taurus XL launch failure discussed below. Advanced space programs segment revenues decreased $32.6 million, or 14%, due to decreased activity on the CRS contract and the Orion LAS contract, which was terminated in the second quarter of 2010, partly offset by increased activity on national security satellite programs. Eliminations of intersegment revenues increased to $55.1 million in the first six months of 2011 as compared to $30.5 million in the first six months of 2010. Intersegment revenues included $51.7 million and $27.0 million in the first six months of 2011 and 2010, respectively, pertaining to Taurus II production work in the launch vehicles segment for the COTS program that is being conducted by our advanced space programs segment. 17-------------------------------------------------------------------------------- Table of Contents The CRS contract accounted for 18% and 20% of consolidated revenues in the second quarter and six months ended June 30, 2011, respectively, and 21% and 20% of consolidated revenues in the second quarter and six months ended June 30, 2010. The launch vehicle portion of the CRS contract is reported in our launch vehicles segment and the remainder of the CRS contract is reported in our advanced space programs segment. CRS contract revenues totaled $64.7 million in the second quarter of 2011, a decrease of $6.9 million, or 10%, due to a particularly high level of subcontractor activity in the second quarter of 2010. CRS contract revenues totaled $132.4 million in the first six months of 2011, an increase of $4.9 million, or 4%, due to increased overall activity. Cost of Revenues - Our cost of revenues was $282.8 million in the second quarter of 2011, an increase of $11.5 million, or 4%, compared to the second quarter of 2010. Cost of revenues includes the costs of personnel, materials, subcontractors and overhead. The increase in our cost of revenues was primarily attributable to the increases in contract activity that drove the growth in revenues described above. Cost of revenues in the launch vehicles segment increased $32.3 million, or 43%, while cost of revenues in the advanced space programs segment decreased $13.3 million, or 14%, and cost of revenues in the satellites and space systems segment decreased $3.8 million, or 3%, in the second quarter of 2011 compared to the second quarter of 2010. Eliminations of intersegment cost of revenues increased $3.8 million attributable to the increase in intersegment revenues discussed above. Our cost of revenues was $553.8 million in the first half of 2011, an increase of $54.6 million, or 11%, compared to the first half of 2010. The increase in our year-to-date cost of revenues was primarily attributable to the increases in contract activity that drove the growth in revenues described above. Cost of revenues in the launch vehicles segment increased $54.7 million, or 37%, and cost of revenues in the satellite and space systems segment increased $43.7 million, or 21%, which were partially offset by a decrease of $19.2 million, or 11%, in the advanced space programs segment in the first half of 2011 compared to the first half of 2010. Eliminations of intersegment cost of revenues increased $24.5 million attributable to the increase in intersegment revenues discussed above. Research and Development Expenses - Our research and development expenses totaled $23.4 million, or 7% of revenues, in the second quarter of 2011, a $6.8 million decrease compared to $30.3 million, or 9% of revenues, in the second quarter of 2010. Our research and development expenses totaled $40.6 million, or 6% of revenues, in the first half of 2011, a $19.9 million decrease compared to $60.4 million, or 10% of revenues, in the first half of 2010. The majority of our research and development expenses in 2011 and 2010 were attributable to the COTS program and our Taurus II launch vehicle development program. 18-------------------------------------------------------------------------------- Table of Contents In connection with the COTS agreement with NASA, we are designing, building and demonstrating a new space transportation system. Under the COTS agreement, as amended, NASA has agreed to pay us $288 million in cash milestone payments, partially funding our program costs which are currently estimated to be approximately $445 million. During the first quarter of 2011, NASA agreed to increase its funding by $98 million under the COTS agreement for a Taurus II test flight in addition to the demonstration flight that was already planned under the program. This additional test flight is intended to provide greater information on the Taurus II rocket's performance. We expect to complete the COTS program in the first quarter of 2012. The COTS program is being accounted for as a best-efforts research and development cost-sharing arrangement. As such, the amounts funded by NASA are recognized proportionally as an offset to our COTS project research and development expenses, including associated general and administrative expenses. As of June 30, 2011, deferred revenue and customer advances on our balance sheet included $49.9 million of cash received from NASA that had not yet been recorded as an offset to research and development expenses. The following table summarizes the COTS program costs incurred and amounts funded by NASA recorded in research and development expenses (in millions): Second Quarter First Six Months Inception 2011 2010 2011 2010 To Date Research and development costs incurred (1) $ 36.5 $ 38.9 $ 78.4 $ 67.2 $ 337.5 Less - amounts funded by NASA 25.2 18.1 59.3 33.1 211.6 Net research and development expenses $ 11.3 $ 20.8 $ 19.1 $ 34.1 $ 125.9 (1) Includes associated general and administrative expenses. Research and development expenses attributable to our Taurus II launch vehicle development program were $8.2 million and $7.8 million in the second quarter of 2011 and 2010, respectively, and were $15.3 million and $23.1 million in the first six months of 2011 and 2010, respectively. We believe that the majority of our research and development expenses are recoverable and billable under our contracts with the U.S. Government. Charging practices relating to research and development and other costs that may be charged directly or indirectly to government contracts are subject to audit by U.S. Government agencies to determine if such costs are reasonable and allowable under government contracting regulations and accounting practices. We believe that the research and development costs incurred in connection with our Taurus II development program are allowable, although the U.S. Government has not yet made a final determination. Since the inception of the Taurus II program through June 30, 2011, we have incurred $134.5 million of such expenses that have been recorded as allowable costs. If such costs were determined to be unallowable, we could be required to record revenue and profit reductions in future periods. In the second quarter and first half of 2010, we recognized $5.1 million and $10.3 million, respectively, of research and development expenses in excess of a self-imposed ceiling on the amount of such expenses that we would recover under our U.S. Government contracts, although we believe that such expenses would otherwise be allowable and recoverable under U.S. 19-------------------------------------------------------------------------------- Table of Contents Government contracting regulations and accounting practices. There were no unrecoverable research and development expenses incurred in 2011. Selling, General and Administrative Expenses - Selling, general and administrative expenses were $21.6 million and $23.9 million, or 6% and 7% of revenues, in the second quarter of 2011 and 2010, respectively. Selling, general and administrative expenses include the costs of our finance, legal, administrative and general management functions, as well as bid, proposal and marketing costs. Selling, general and administrative expenses decreased $2.3 million, or 10%, in the second quarter of 2011 compared to the second quarter of 2010 primarily due to the absence of $1.6 million of transaction expenses incurred in 2010 in connection with a business acquisition, and a decrease in bid, proposal and marketing costs pertaining to new business prospects. Selling, general and administrative expenses were $41.0 million and $44.7 million, or 6% and 7% of revenues, in the first half of 2011 and 2010, respectively. Selling, general and administrative expenses decreased $3.7 million, or 8%, in the first half of 2011 primarily due to a decrease in bid, proposal and marketing costs pertaining to new business prospects and the absence of $1.6 million of transaction expenses incurred in 2010 in connection with a business acquisition. Operating Income - Operating income was $22.8 million in the second quarter of 2011, an increase of $10.6 million, or 87%, compared to the second quarter of 2010 due to operating income increases in all of our business segments. Advanced space programs segment operating income increased $4.6 million primarily due to increased activity on national security satellite contracts and the absence of $3.3 million of unrecovered research and development expenses that were recognized in the second quarter of 2010. Launch vehicles segment operating income increased $3.4 million primarily due to the absence of $1.8 million of unrecovered research and development expenses that were recognized in the second quarter of 2010, in addition to favorable profit adjustments on missile defense interceptor contracts and increased activity on target launch vehicle contracts. Satellites and space systems segment operating income increased $1.0 million due to improved results from communications satellite contracts, partially offset by the reduction in activity on science and remote sensing satellite contracts. Communications satellite operating income increased primarily due to the absence of $2.5 million of costs incurred in the second quarter of 2010 pertaining to the successful resolution of the Galaxy 15 satellite anomaly that occurred in April 2010. Operating income in the second quarter of 2010 also included $1.6 million of transaction expenses attributable to a business acquisition. Operating income was $32.9 million in the first half of 2011, an increase of $3.3 million, or 11%, compared to the first half of 2010 due to operating income increases in our advanced space programs and satellite and space systems segments, partially offset by a decrease in operating income in our launch vehicles segment. Advanced space programs segment operating income increased $4.3 million primarily due to increased activity on national security satellite contracts and the absence of $5.4 million of unrecovered research and development expenses that were recognized in 2010. Satellites and space systems segment operating income increased $3.6 million due to improved results from communications satellite contracts and increased activity on 20-------------------------------------------------------------------------------- Table of Contents science and remote sensing satellite contracts. Communications satellite operating income increased primarily due to the $1.8 million reduction in costs pertaining to the successful resolution of the Galaxy 15 satellite anomaly discussed above. Launch vehicles segment operating income decreased $6.2 million primarily due to an approximately $12.2 million operating income reduction resulting from a Taurus XL launch failure during the first quarter of 2011 discussed below. The effect of the launch failure was partially offset by the absence in 2011 of $4.9 million of unrecovered research and development expenses that were recognized in 2010. Operating income in 2010 also included $1.6 million of transaction expenses attributable to a business acquisition. On March 4, 2011, our Taurus XL rocket, which was carrying the Glory scientific satellite that we had built for NASA, experienced a launch failure. As a result, in the first quarter of 2011, we recorded an $11.3 million adjustment to reduce revenue and operating profit on the Taurus contract pertaining to a mission success incentive that was not earned. The unearned mission success incentive was recovered under an insurance policy. We recorded an $11.3 million insurance recovery accrual reported as "other income" in the first quarter of 2011. Total operating income from the CRS contract was $3.3 million in the second quarter of 2011, a decrease of $0.2 million due to a particularly high level of subcontractor activity in the second quarter of 2010. Total operating income from the CRS contract was $6.7 million in the first half of 2011, an increase of $0.5 million compared to the first half of 2010. Interest Income and Other - Interest income and other was $0.7 million in the second quarter of 2011, compared to $0.4 million in the second quarter of 2010. Interest income and other was $12.2 million in the first half of 2011, compared to $0.7 million in the first half of 2010. Interest income and other in the first half of 2011 included the $11.3 million insurance recovery pertaining to the Taurus XL launch failure discussed above. Interest Expense - Interest expense was $2.8 million and $2.3 million in the second quarter of 2011 and 2010, respectively, and was $5.3 million and $4.7 million in the first half of 2011 and 2010, respectively, primarily attributable to interest on our long-term debt. Income Tax Benefit (Provision) - We recorded an income tax benefit of $0.5 million in the second quarter of 2011, compared to an income tax provision of $4.0 million in the second quarter of 2010. We recorded income tax provisions of $6.2 million and $10.0 million in the first half of 2011 and 2010, respectively. Our effective income tax rate was 15.7% and 39.1% for the first half of 2011 and 2010, respectively. The reduction in income taxes was largely due to a favorable income tax adjustment of $7.7 million recorded in the second quarter of 2011 pertaining to our election to claim extraterritorial income ("ETI") exclusions related to export activities in certain prior years. In addition, income taxes in 2011 reflected federal research and development tax credits as a result of legislation that was re-enacted in the fourth quarter of 2010. 21-------------------------------------------------------------------------------- Table of Contents Net Income - Our net income was $21.2 million, or $0.36 diluted earnings per share, and $6.3 million, or $0.11 diluted earnings per share, in the second quarter of 2011 and 2010, respectively, and was $33.6 million, or $0.56 diluted earnings per share, and $15.6 million, or $0.27 diluted earnings per share, in the first half of 2011 and 2010, respectively. Segment Results for the Quarters and Six Months Ended June 30, 2011 and 2010 Our products and services are grouped into three reportable segments: launch vehicles, satellites and space systems and advanced space programs. Corporate office transactions that have not been attributed to a particular segment, as well as consolidating eliminations and adjustments, are reported in corporate and other. The following tables of financial information and related discussion of the results of operations of our business segments are consistent with the presentation of segment information in Note 3 to the financial statements in this Form 10-Q. Launch Vehicles Launch vehicles segment operating results were as follows: Second Quarter First Six Months ($ in thousands) 2011 2010 % Change 2011 2010 % Change Revenues $ 131,367 $ 95,702 37% $ 236,640 $ 196,044 21% Operating income 6,870 3,469 98% 1,821 8,000 (77% ) Operating margin 5.2% 3.6% 0.8% 4.1% Segment Revenues - Launch vehicles segment revenues increased $35.7 million, or 37%, in the second quarter of 2011 compared to the second quarter of 2010 primarily due to increased activity on space launch vehicles, driven by Taurus II launch vehicles for the CRS contract and the COTS program, and increased activity on target launch vehicles, partially offset by decreased activity on missile defense interceptors. Space launch vehicle revenues grew $23.7 million primarily due to an $18.2 million increase in Taurus II launch vehicle revenues attributable to increased activity. Taurus II launch vehicle revenues were $52.5 million and $34.3 million in the second quarter of 2011 and 2010, respectively, which included $32.2 million and $17.8 million, respectively, related to the CRS contract and $20.3 million and $16.5 million, respectively, related to the COTS program. Target launch vehicle revenues increased $15.8 million, or 74%, primarily due to recently awarded contracts. Interceptor launch vehicle revenues decreased $3.6 million due to decreased activity on our Ground-based Midcourse Defense contract in the second quarter of 2011. 22-------------------------------------------------------------------------------- Table of Contents Launch vehicles segment revenues increased $40.6 million, or 21%, in the first half of 2011 compared to the first half of 2010 principally due to the same factors that impacted our second quarter results, namely increased activity on space launch vehicles, driven by Taurus II launch vehicles, and increased activity on target launch vehicles, partially offset by decreased activity on missile defense interceptors. Space launch vehicle revenues increased $37.5 million in the first half of 2011 primarily due to increased production work on Taurus II launch vehicles partially offset by decreased activity on Minotaur space launch vehicles and the effect of the March 2011 Taurus XL launch failure discussed above. Taurus II launch vehicle revenues were $102.0 million and $60.5 million in the first half of 2011 and 2010, respectively, which included $50.3 million and $33.5 million, respectively, related to the CRS contract and $51.7 million and $27.0 million, respectively, related to the COTS program. Target launch vehicle revenues increased $13.2 million primarily due to certain new contracts awarded in the first quarter of 2011. Interceptor launch vehicle revenues decreased $7.2 million due to decreased activity on the Ground-based Midcourse Defense contract. Segment Operating Income - Operating income in the launch vehicles segment increased $3.4 million, or 98%, in the second quarter of 2011 compared to the second quarter of 2010 primarily due to the absence of $1.8 million of unrecovered research and development expenses that were recognized in the second quarter of 2010 and due to higher operating income from missile defense interceptor and target launch vehicles. Operating income from missile defense interceptors increased to $3.5 million compared to $2.0 million in the second quarter of 2010, primarily due to favorable profit adjustments, including a $0.7 million favorable adjustment in connection with the close-out of the Kinetic Energy Interceptor ("KEI") contract that had been terminated for convenience in 2009. Operating income from Taurus II launch vehicles for the CRS contract was $1.6 million and $0.9 million in the second quarter of 2011 and 2010, respectively. This segment does not recognize any profit pertaining to the intersegment Taurus II launch vehicle revenues associated with the COTS program, which is conducted by and reported as a research and development program in our advanced space programs segment. These increases in operating income were partially offset by a $1.0 million reduction in operating results from Taurus launch vehicles due to costs incurred in the second quarter of 2011 associated with the investigation of the Taurus XL launch failure discussed above. Operating income in the launch vehicles segment decreased $6.2 million, or 77%, in the first half of 2011 compared to the first half of 2010 primarily due to a $12.2 million reduction in operating income resulting from the March 2011 Taurus XL launch failure discussed above, partially offset by the same factors that drove the improvement in our second quarter results. The operating results for the first half of 2010 were lowered by $4.9 million of unrecovered research and development expenditures, whereas there were no unrecovered research and development expenses in the first half of 2011. Operating income from missile defense interceptor contracts increased to $6.2 million compared to $4.3 million in the first half of 2010, primarily due to the favorable profit adjustments noted above. Operating income from Taurus II launch vehicle production work for the CRS contract was $2.6 million and $1.7 million in the first half of 2011 and 2010, respectively. This segment does not recognize any profit pertaining to the intersegment Taurus II launch vehicle revenues associated with the COTS program, which is 23-------------------------------------------------------------------------------- Table of Contents conducted by and reported as a research and development program in our advanced space programs segment. Segment operating margin (as a percentage of revenues) increased to 5.2% in the second quarter of 2011 compared to 3.6% in the second quarter of 2010 primarily due to the favorable profit adjustments on missile defense interceptor contracts and the absence of unrecovered research and development expenditures in 2011. Segment operating margin decreased in the first half of 2011 primarily due to the Taurus XL launch failure, partially offset by the absence of unrecovered research and development expenditures in 2011. Satellites and Space Systems Satellites and space systems segment operating results were as follows: Second Quarter First Six Months ($ in thousands) 2011 2010 % Change 2011 2010 % Change Revenues $ 138,174 $ 139,423 (1% ) $ 290,833 $ 239,944 21% Operating income 8,474 7,512 13% 18,784 15,219 23% Operating margin 6.1% 5.4% 6.5% 6.3% Segment Revenues - Satellites and space systems segment revenues decreased $1.2 million in the second quarter of 2011 compared to the second quarter of 2010 due to decreased activity on science and remote sensing satellite contracts, offset by increased activity on space technical services contracts and marginally higher communications satellite revenues. Science and remote sensing satellite revenues decreased $7.3 million, or 26%, due to decreased contract activity. Space technical services revenues increased $5.8 million, or 36%, primarily due to production work on a contract awarded in the third quarter of 2010. Communications satellite revenues accounted for 68% and 67% of total segment revenues in the second quarter of 2011 and 2010, respectively. Satellites and space systems segment revenues increased $50.9 million, or 21%, in the first half of 2011 compared to the first half of 2010 primarily due to increased activity on communications satellite contracts, space technical services contracts and science and remote sensing satellite contracts, including contracts acquired in our 2010 acquisition. Communications satellite revenues increased $25.7 million, or 15%, principally attributable to activity on new communications satellite contracts awarded in the fourth quarter of 2010 and the first half of 2011. Communications satellite revenues accounted for 67% and 71% of total segment revenues in the first half of 2011 and 2010, respectively. Space technical services revenues increased $13.4 million, or 43%, primarily due to production work on a contract awarded in the third quarter of 2010. Science and remote sensing satellite revenues increased $12.1 million, or 34%, primarily due to the addition of contracts acquired in our 2010 business acquisition. Segment Operating Income - Operating income in the satellites and space systems segment increased $1.0 million in the second quarter of 2011 compared to the second quarter of 2010, primarily due to improved results from communications satellite contracts, partially offset by the 24-------------------------------------------------------------------------------- Table of Contents reduction in activity on science and remote sensing satellite contracts. Communications satellite operating income increased $2.2 million, or 66%, primarily due to the absence of $2.5 million of costs incurred in the second quarter of 2010 pertaining to the successful resolution of the Galaxy 15 satellite anomaly that occurred in April 2010. Communications satellite results accounted for 64% and 44% of total segment operating income in the second quarter of 2011 and 2010, respectively. Science and remote sensing satellite operating income decreased $0.8 million, or 27%, consistent with the revenue reduction described above. Operating income in the satellites and space systems segment increased $3.6 million in the first half of 2011 compared to the first half of 2010 primarily due to increased activity on communications satellite contracts and science and remote sensing satellite contracts, including contracts acquired in our 2010 acquisition. Communications satellite operating income increased $2.8 million, or 31%, principally attributable to activity on new communications satellite contracts awarded in the fourth quarter of 2010 and first half of 2011, and a $1.8 million reduction in costs pertaining to the successful resolution of the Galaxy 15 satellite anomaly discussed above. Communications satellite contracts accounted for 62% and 58% of total segment operating income in the first half of 2011 and 2010, respectively. Science and remote sensing satellite operating income increased $1.5 million, or 40%, primarily due to the addition of contracts acquired in our 2010 acquisition. Segment operating margin (as a percentage of revenues) increased to 6.1% in the second quarter of 2011 from 5.4% in the second quarter of 2010, and to 6.5% in the first half of 2011 compared to 6.3% in the first half of 2010, due to improved margins on communications satellite contracts and science and remote sensing satellite contracts, in addition to lower costs pertaining to the successful resolution of the Galaxy 15 satellite anomaly discussed above. Advanced Space Programs Advanced space programs segment operating results were as follows: Second Quarter First Six Months ($ in thousands) 2011 2010 % Change 2011 2010 % Change Revenues $ 103,188 $ 120,926 (15% ) $ 195,898 $ 228,469 (14% ) Operating income 7,463 2,867 160% 12,319 7,994 54% Operating margin 7.2% 2.4% 6.3% 3.5% Segment Revenues - Advanced space programs segment revenues decreased $17.7 million, or 15%, in the second quarter of 2011 compared to the second quarter of 2010 primarily due to a $21.2 million decrease in revenues on the CRS contract, which resulted from a particularly high level of subcontract activity in the second quarter of 2010. The CRS contract accounted for 32% and 44% of total segment revenues in the second quarter of 2011 and 2010, respectively. Segment revenues also decreased due to a $13.9 million reduction in revenues on the Orion LAS contract that was terminated for convenience by the customer in the second quarter of 2010. These revenue reductions were partially offset by a $17.1 million increase in activity on national security satellite contracts. 25-------------------------------------------------------------------------------- Table of Contents Advanced space programs segment revenues decreased $32.6 million, or 14%, in the first half of 2011 compared to the first half of 2010 primarily due to a $32.3 million revenue reduction on the Orion LAS contract that was terminated in 2010 and an $11.9 million decrease in activity on the CRS contract. These revenue reductions were partially offset by an $11.6 million increase in activity on national security satellite contracts. In the first half of 2011 and 2010, the CRS contract accounted for 42% and 41%, respectively, of total segment revenues. Segment Operating Income - Operating income in the advanced space programs segment increased $4.6 million, or 160%, in the second quarter of 2011 compared to the second quarter of 2010 primarily due to the absence of $3.3 million of unrecovered research and development expenses that were recognized in the second quarter of 2010 and a $1.2 million increase in operating results from national security satellite contracts. Segment operating income also improved due to the absence of an unfavorable profit adjustment recognized in the second quarter of 2010 resulting from the termination of the Orion LAS contract. These operating income improvements were partially offset by a $1.0 million decrease in operating results from the CRS contract associated with the reduction in revenues discussed above. Operating income in the advanced space programs segment increased $4.3 million, or 54%, in the first half of 2011 compared to the first half of 2010, despite the decrease in revenues primarily due to the absence of unrecovered research and development expenses of $5.4 million and the unfavorable Orion LAS contract adjustment that was recognized in 2010. This segment's operating margin (as a percentage of revenues) increased to 7.2% in the second quarter of 2011 from 2.4% in the second quarter of 2010, and to 6.3% in the first half of 2011 from 3.5% in the first half of 2010, largely due to the absence of unrecovered research and development expenses and the 2010 Orion LAS contract adjustment discussed above. Corporate and Other Corporate and other revenues were comprised solely of the elimination of intersegment revenues of $22.1 million and $18.3 million in the second quarter of 2011 and 2010, respectively, and $55.1 million and $30.5 million in the first half of 2011 and 2010, respectively. Intersegment revenues are comprised primarily of Taurus II launch vehicle revenues recorded in the launch vehicles segment in connection with the COTS program that is conducted by and reported as a research and development program in our advanced space programs segment. Taurus II revenues for the COTS program were $20.3 million and $16.5 million in the second quarter of 2011 and 2010, respectively, and $51.7 million and $27.0 million in the first half of 2011 and 2010, respectively. We reported an operating loss in "Corporate and Other" of $1.6 million in the second quarter and first half of 2010 that consisted solely of transaction expenses incurred in connection with our second quarter 2010 business acquisition. There was no corporate and other operating income or loss in the second quarter and first half of 2011. 26-------------------------------------------------------------------------------- Table of Contents Backlog Our firm backlog was approximately $2.1 billion and $2.0 billion at June 30, 2011 and December 31, 2010, respectively. While there can be no assurance, we expect to convert approximately $660 million of the June 30, 2011 firm backlog into revenue during the remainder of 2011. Firm backlog consists of aggregate contract values for firm product orders, excluding the portion previously included in revenues, and including government contract orders not yet funded and our estimate of potential award fees. Total backlog was approximately $5.3 billion at June 30, 2011 and $4.6 billion at December 31, 2010. Total backlog includes firm backlog in addition to unexercised options, indefinite-quantity contracts and undefinitized orders and contract award selections. Liquidity and Capital Resources Cash Flow from Operating Activities Cash flow from operating activities in the first half of 2011 was $68.0 million, as compared to cash used in operating activities of $53.2 million in the first half of 2010. The increase in operating cash flow resulted primarily from an increase in the net effect of changes in working capital and certain other assets and liabilities, in addition to the effect of increased net income in the first six months of 2011. During the first half of 2011, net changes in working capital and certain other assets and liabilities provided $6.8 million of cash, compared to a $93.6 million use of cash in the first half of 2010. The changes in working capital in the first half of 2011 included a $71.8 million increase in deferred revenues and customer advances primarily due to new communications satellite contract awards and increased accounts payable and accrued expenses of $51.1 million primarily due to timing of certain cash disbursements. These sources of cash were partially offset by a $120.9 million increase in receivables, primarily pertaining to the CRS contract. Under the terms of the CRS contract, a substantial percentage of the customer cash receipts are billable and collectible only upon the successful completion of certain key milestones, including the launch of each vehicle, the first of which is scheduled to occur in 2012. Cash Flow from Investing Activities Cash used in investing activities in the first half of 2011 was $32.8 million, as compared to $88.6 million in the first half of 2010. In the second quarter of 2010, we spent $55 million in connection with a business acquisition (see Note 2 to the accompanying financial statements). We spent $32.8 million for capital expenditures in the first half of 2011 as compared to $33.6 million in the first half of 2010. 27-------------------------------------------------------------------------------- Table of Contents Cash Flow from Financing Activities Cash flow used in financing activities in the first half of 2011 was $0.9 million, as compared to cash provided by financing activities of $12.3 million in the first half of 2010. In the second quarter of 2011, we paid $2.9 million of financing fees associated with establishing a new credit facility, as discussed below. During the first half of 2011 and 2010, we received $1.4 million and $10.3 million, respectively, from the issuance of common stock in connection with stock option exercises and employee stock plan purchases. Convertible Notes - In December 2006, we issued $143.8 million of 2.4375% convertible senior subordinated notes due 2027 with interest payable semi-annually each January 15 and July 15. The convertible notes are convertible into cash, or a combination of cash and common stock at our election, based on an initial conversion rate of 40.8513 shares of our common stock per $1,000 in principal amount of the convertible notes (equivalent to an initial conversion price of approximately $24.48 per share) under certain circumstances. At any time on or after January 21, 2014, the convertible notes are subject to redemption at our option, in whole or in part, for cash equal to 100% of the principal amount of the convertible notes, plus unpaid interest, if any, accrued to the redemption date. Holders of the convertible notes may require us to repurchase the convertible notes, in whole or in part, on January 15, 2014, January 15, 2017 or January 15, 2022, or, if a "fundamental change" (as such term is defined in the indenture governing the convertible notes) occurs, for cash equal to 100% of the principal amount of the convertible notes, plus any unpaid interest, if any, accrued to the redemption date. Credit Facility - In June 2011, we entered into a five-year $300 million revolving secured credit facility ("Credit Facility"), which replaced our $100 million revolving credit facility that was established in 2007. The new Credit Facility includes the option to increase the amount of the Credit Facility by up to $150 million to the extent that any one or more lenders commit to be a lender for such additional amount. Loans under the Credit Facility bear interest at LIBOR plus an applicable margin ranging from 1.75% to 2.50%, with the applicable margin varying according to our total leverage ratio, or, at our election, at a prime base rate plus 0.75% to 1.50%. The Credit Facility expires in 2016 and is secured by substantially all of our personal property assets. Up to $125 million of the Credit Facility may be reserved for letters of credit. As of June 30, 2011, there were no borrowings under the Credit Facility, although $17.7 million of letters of credit were issued under the Credit Facility. Accordingly, as of June 30, 2011, $282.3 million of the Credit Facility was available for borrowings. Debt Covenants - Our Credit Facility contains covenants limiting our ability to, among other things, pay cash dividends, incur debt or liens, redeem or repurchase company stock, enter into transactions with affiliates, make investments, merge or consolidate with others or dispose of assets. In addition, the Credit Facility contains financial covenants with respect to leverage and interest coverage. As of June 30, 2011, we were in compliance with all of these covenants. 28-------------------------------------------------------------------------------- Table of Contents Available Cash and Future Funding At June 30, 2011, we had $286.7 million of unrestricted cash and cash equivalents. Management believes that available cash, cash expected to be generated from operations and the borrowing capacity under our Credit Facility will be sufficient to fund our operating and capital expenditure requirements, including research and development expenditures, over the next 12 months and for the foreseeable future. However, there can be no assurance that this will be the case. We believe that we will continue to incur significant costs during the remainder of 2011 related to the Taurus II and COTS research and development programs. Additionally, significant unforeseen events such as termination of major orders or late delivery or failure of launch vehicle or satellite products could adversely affect our liquidity and results of operations. If market opportunities exist, we may choose to undertake financing actions to further enhance our liquidity, which could include raising funds through capital market transactions; however, our ability to borrow additional funds is limited by the terms of our Credit Facility. As discussed in Note 7 to the accompanying financial statements, we currently hold investments in auction rate securities and preferred stock that have experienced a decline in fair value. Given the sufficiency of our available cash and other funding sources as discussed above, we believe that we will not need, nor do we intend, to liquidate these investments in the foreseeable future. Accordingly, we do not believe that any fluctuations in the fair values of these securities will have a significant impact on our liquidity. Off-Balance Sheet Arrangements We do not have any material off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. |