Orbital Sciences (ORB)

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission file number 1-14279

 

 

 

 

ORBITAL SCIENCES CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:
(703) 406-5000

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The aggregate market value of the voting common equity held by non-affiliates of the registrant based on the closing sales price of the registrant’s Common Stock as reported on The New York Stock Exchange on June 30, 2007 was approximately $1,228,700,000. The registrant has no non-voting common equity.

 

As of February 20, 2008, 58,430,363 shares of the registrant’s Common Stock were outstanding.

 

Portions of the registrant’s definitive proxy statement to be filed on or about March 10, 2008 are incorporated by reference in Part III of this report.

 

 

TABLE OF CONTENTS

 

 

 

Pegasus is a registered trademark and service mark of Orbital Sciences Corporation; Taurus is a registered trademark of Orbital Sciences Corporation; Orbital is a trademark of Orbital Sciences Corporation.

 

 

General

 

We develop and manufacture small rockets and space systems for commercial, military and civil government customers, including the U.S. Department of Defense (“DoD”), the National Aeronautics and Space Administration (“NASA”) and other U.S. government agencies.

 

Our primary products and services include the following:

 

 

Our general strategy is to develop and expand a core integrated business of space and launch systems technologies and products, focusing on the design and manufacturing of affordable rockets, small satellites and other space systems in order to establish and expand positions in niche markets that have not typically been emphasized by our larger competitors. Another part of our strategy is to seek customer contracts that will fund the development of enhancements to our existing launch vehicle and space systems product lines. As a result of our capabilities and experience in designing, developing, manufacturing and operating a broad range of small rockets and space systems, we believe we are well positioned to capitalize on the demand for small space-technology systems in missile defense, space-based military and intelligence operations, and commercial satellite communications programs, and to take advantage of government-sponsored initiatives for space-based scientific research and lunar and planetary exploration initiatives.

 

Orbital was incorporated in Delaware in 1987 to consolidate the assets, liabilities and operations of two entities established in 1982 and 1983.

 

Our corporate headquarters are located at 21839 Atlantic Boulevard, Dulles, Virginia 20166 and our telephone number is (703) 406-5000.

 

Available Information

 

We maintain an Internet website at www.orbital.com. In addition to news and other information about our company, we make available on or through the Investor Relations section of our website our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and all amendments to these reports as soon as reasonably practicable after we electronically file this material with, or furnish it to, the U.S. Securities and Exchange Commission.

At the Investor Relations section of our website, we have a Corporate Governance page that includes, among other things, copies of our Code of Business Conduct and Ethics, our Corporate Governance Guidelines and the charters for each standing committee of the Board of Directors, including the Audit and Finance Committee, the Corporate Governance and Nominating Committee and the Human Resources and Compensation Committee.

 

Printed copies of all of the above-referenced reports and documents may be requested by contacting our Investor Relations Department either by mail at our corporate headquarters, by telephone at (703) 406-5543 or by e-mail at investor.relations@orbital.com. All of the above-referenced reports and documents are available from us free of charge.

 

Description of Orbital’s Products and Services

 

Our products and services are grouped into four reportable business segments that are described below: launch vehicles, satellites and space systems, advanced space programs and transportation management systems. Prior to 2007, advanced space programs was aggregated and reported with satellites and space systems. However, we determined to report advanced space programs on a stand-alone basis in 2007 due to significant growth in new programs within the segment. Our business is not seasonal. Customers that accounted for 10% or more of our consolidated revenues in 2007 were DoD, Lockheed Martin Corporation (“Lockheed Martin”), NASA, SES Global S.A. (“SES”) and The Boeing Company (“Boeing”).

 

Launch Vehicles.  Our launch vehicles segment is involved in developing and producing interceptor launch vehicles, target launch vehicles and space launch vehicles.

 

Interceptor Launch Vehicles.  We develop and produce rockets that are used as interceptor launch vehicles for missile defense systems, including interceptor boosters that carry “kill vehicles” designed to defend against ballistic missile attacks. Pursuant to a contract with Boeing, we are the sole supplier of operational and test interceptor boosters for the U.S. Missile Defense Agency’s (“MDA”) Ground-based Midcourse Defense (“GMD”) program, for which our interceptor boost vehicle, a modified version of our Pegasus rocket, is being used as a major operational element in the U.S. national missile defense system. We are also developing a boost vehicle for MDA’s Kinetic Energy Interceptor (“KEI”) program. During 2007, we conducted one successful GMD interceptor flight test and delivered nine GMD boost vehicles.

 

Target Launch Vehicles.  We design and produce target launch vehicles used in the development and testing of missile defense systems. Our target launch vehicles include suborbital rockets and their principal subsystems, as well as payloads carried by such vehicles.

 

Various branches and agencies of the U.S. military, including MDA, use our target launch vehicles as targets for defense-related applications such as ballistic missile interceptor testing and related experiments. These rockets are programmed to simulate incoming enemy missiles, offering an affordable and reliable means to test advanced missile defense systems. Our family of targets extends from long-range ballistic target launch vehicles, which include targets for testing MDA’s GMD system, to medium- and short-range target vehicles designed to simulate threats to U.S. and allied military forces deployed in overseas theaters. We have also developed a short-range supersonic sea-skimming target that flies just above the ocean’s surface and is currently being used by the U.S. Navy. In 2007, we performed a total of 10 target launch missions.

 

Space Launch Vehicles.  We develop and produce small-class launch vehicles that place satellites weighing up to 4,000 lbs. into low-Earth orbit, including the Pegasus, Taurus and Minotaur space launch vehicles that are used by commercial, civil government and military customers. Our Pegasus launch vehicle is launched from our L-1011 carrier aircraft to deploy relatively lightweight satellites into low-

Earth orbit. The Taurus launch vehicle is a ground-launched derivative of the Pegasus vehicle that can carry heavier payloads to orbit. The ground-launched Minotaur launch vehicle family combines Minuteman II and Peacekeeper ballistic missile rocket motors with our Pegasus and Taurus technology. In 2007, we carried out one successful Minotaur mission and one successful Pegasus mission. We did not have any Taurus missions in 2007.

 

Our launch vehicles segment and our advanced space programs segment are jointly engaged in a major new product development program of a medium-capacity rocket called Taurus II that could substantially increase the payload capacity of our space launch vehicle platforms. The launch vehicle is in the preliminary design phase and we are actively marketing it to various U.S. government agencies. We expect the first Taurus II launches to occur in 2010 and 2011.

 

Satellites and Space Systems.  Our satellites and space systems segment is involved in developing and producing communication satellites, science and technology satellites, related subsystems, and space technical services.

 

Communications Satellites.  Small geosynchronous-Earth orbit (“GEO”) satellites that provide cable and direct-to-home television distribution, business data network connectivity, regional mobile telephony and other space-based communications services.

 

Science and Technology Satellites.  Small- and medium-class low-Earth orbit (“LEO”) and other spacecraft that are used to conduct space-related scientific research, to carry out interplanetary and other deep-space exploration missions, to demonstrate new space technologies, to collect imagery and other remotely-sensed data about the Earth and to enable national security applications.

 

Space Technical Services.  Advanced space systems, including satellite command and data handling, attitude control and structural subsystems and a broad range of space-related technical services, including analytical, engineering and production services for space-related science and defense programs.

 

During 2007, we delivered three communications satellites, one scientific satellite and one planetary spacecraft for commercial and government customers.

 

Advanced Space Programs.  Our advanced space programs segment is involved in developing and producing human-rated space systems, advanced launch systems and satellites and related subsystems primarily used for national security space programs.

 

Human Space Systems.  We design and manufacture advanced human-rated systems to be used in Earth orbit, lunar and other space missions. We are a member of the industry team selected by NASA to design and build the Orion crew exploration spacecraft that will succeed the Space Shuttle in transporting humans to space. Our principal role is to design, develop and manufacture the launch abort system to allow the astronaut crew to escape in the event of an in-flight failure of the Orion launch vehicle.

 

Advanced Launch Systems.  We design and produce advanced launch vehicle systems, including launchers used to boost research test vehicles and platforms used to test new space technologies. We have adapted our existing launch vehicle technology for a number of advanced technology demonstrations, including supporting efforts to develop technologies that could be applied to reusable launch vehicles, space maneuvering vehicles, and hypersonic aircraft and missiles. The advanced space programs segment is responsible for leading the early development stage of the medium-class Taurus II launch vehicle discussed above.

 

National Security Space Systems.  We develop and produce small satellites and satellite subsystems used primarily for national security space missions and related technology demonstration programs.

Transportation Management Systems.  Our transportation management systems segment develops and produces fleet management systems that are used primarily by metropolitan mass transit operators in the United States. We combine global positioning satellite vehicle tracking technology with terrestrial wireless communications to help transit agencies manage public bus fleets and public works systems. Major customers for our transportation management systems include the metropolitan mass transit authorities in Los Angeles, Washington, D.C., Philadelphia, Baltimore, Denver, Phoenix, Austin, and a number of other state and municipal transit systems and private vehicle fleet operators. Internationally, we have provided a system to a mass transit service in Singapore.

 

Competition

 

We believe that competition for sales of our products and services is based primarily on performance and technical features, reliability, price, delivery schedule and our ability to customize our products to meet particular customer needs, and we believe that we compete favorably on the basis of these factors. The table below identifies who we believe to be our primary competitors for each major product line.

 

 

Many of our competitors are larger and have substantially greater resources than we do. Furthermore, it is possible that other domestic or foreign companies or governments, some with greater experience in the space and defense industry and many with greater financial resources than we possess, will seek to provide products or services that compete with our products or services. Any such foreign competitor could benefit from subsidies from, or other protective measures by, its home country.

 

Research and Development

 

We invest in product-related research and development to conceive and develop new products and to enhance existing products. Our research and development expenses totaled approximately $18.7 million, $9.6 million and $6.3 million for the years ended December 31, 2007, 2006 and 2005, respectively.

 

Patents and Proprietary Rights

 

We rely, in part, on patents, trade secrets and know-how to develop and maintain our competitive position and technological advantage, particularly with respect to our launch vehicle and satellite products. While our intellectual property rights in the aggregate are important to the operation of our business, we do not believe that any existing patent or other intellectual property right is of such importance that its loss or termination would have a material adverse effect on our business, taken as a whole.

 

Components and Raw Materials

 

We purchase a significant percentage of our product components, structural assemblies and certain key satellite components and instruments from third parties. We also obtain from the U.S. government parts and equipment that are used in the production of our products or in the provision of our services. Generally, we have not experienced material difficulty in obtaining product components or necessary parts and equipment and we believe that alternatives to our existing sources of supply are available, although increased costs and possible delays could be incurred in securing alternative sources of supply. We rely upon sole source suppliers for rocket motors used on most of our launch vehicles. While we believe that alternative sources for rocket motors would be available, the inability of our current suppliers to provide us with motors could result in significant program delays, expenses and loss of revenues.

 

U.S. Government Contracts

 

During 2007, 2006 and 2005, approximately 65%, 63% and 77%, respectively, of our total annual revenues were derived from contracts with the U.S. government and its agencies or from subcontracts with other U.S. government prime contractors. Most of our U.S. government contracts are funded incrementally on a year-to-year basis.

Our major contracts with the U.S. government primarily fall into two categories: cost-reimbursable contracts and fixed-price contracts. Approximately 88% and 12% of our revenues from U.S. government contracts in 2007 were derived from cost-reimbursable contracts and fixed-price contracts, respectively. Under a cost-reimbursable contract, we recover our actual allowable costs incurred, allocable overhead costs and a fee consisting of (i) a base amount that is fixed at the inception of the contract and/or (ii) an award amount that is based on the customer’s evaluation of our performance in terms of the criteria stated in the contract. Our fixed-price contracts include firm fixed-price and fixed-price incentive fee contracts. Under firm fixed-price contracts, work performed and products shipped are paid for at a fixed price without adjustment for actual costs incurred in connection with the contract. Therefore, we bear the risk of loss if costs increase, although some of this risk may be passed on to subcontractors. Fixed-price incentive fee contracts provide for sharing by us and the customer of unexpected costs incurred or savings realized within specified limits, and may provide for adjustments in price depending on actual contract performance other than costs. Costs in excess of the negotiated maximum (ceiling) price and the risk of loss by reason of such excess costs are borne by us, although some of this risk may be passed on to subcontractors.

 

We derive a significant portion of our revenues from U.S. government contracts, which are dependent on continued political support and funding. All our U.S. government contracts and, in general, our subcontracts with other U.S. government prime contractors provide that such contracts may be terminated for convenience at any time by the U.S. government or the prime contractor, respectively. Furthermore, any of these contracts may become subject to a government-issued stop work order under which we would be required to suspend production. In the event of a termination for convenience, contractors generally are entitled to receive the purchase price for delivered items, reimbursement for allowable costs for work in process and an allowance for reasonable profit thereon or adjustment for loss if completion of performance would have resulted in a loss. For a more detailed description of risks relating to the U.S. government contract industry, see “Item 1A — Risk Factors.”

 

A portion of our business is classified for national security purposes by the U.S. government and cannot be specifically described. The operating results of these classified programs are included in our consolidated financial statements. The business risks associated with classified programs, as a general matter, do not differ materially from those of our other U.S. government programs.

 

Regulation

 

Our ability to pursue our business activities is regulated by various agencies and departments of the U.S. government and, in certain circumstances, the governments of other countries. Commercial space launches require licenses from the U.S. Department of Transportation (“DoT”) and operation of our L-1011 aircraft requires licenses from certain agencies of the DoT, including the Federal Aviation Administration. Our classified programs require that we and certain of our employees maintain appropriate security clearances. We also require licenses from the U.S. Department of State (“DoS”) and the U.S. Department of Commerce (“DoC”) with respect to work we do for foreign customers or with foreign subcontractors.

 

Contract Backlog

 

Our firm backlog was approximately $2.06 billion at December 31, 2007 and approximately $1.79 billion at December 31, 2006. While there can be no assurance, we expect to convert approximately $950 million of the 2007 year-end firm backlog into revenues during 2008.

 

Our firm backlog as of December 31, 2007 included approximately $1.68 billion of contracts with the U.S. government and its agencies or from subcontracts with prime contractors of the U.S. government. Most of our government contracts are funded incrementally on a year-to-year basis. Firm backlog from

government contracts at December 31, 2007 included total funded orders of about $270 million and orders not yet funded of about $1.42 billion. Changes in government policies, priorities or funding levels through agency or program budget reductions by the U.S. Congress or executive agencies could materially adversely affect our financial condition and results of operations. Furthermore, contracts with the U.S. government may be terminated or suspended by the U.S. government at any time, with or without cause, which could result in a reduction in backlog.

 

Total backlog was approximately $3.90 billion at December 31, 2007. Total backlog includes firm backlog in addition to unexercised options, indefinite-quantity contracts and undefinitized orders and contract award selections.

 

Employees

 

As of February 11, 2008, Orbital had approximately 3,100 permanent employees. None of our employees is subject to collective bargaining agreements. We believe our employee relations are good.

 

* * *

 

Financial information about our products and services, business segments, domestic and foreign operations and export sales is included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the notes to our consolidated financial statements, and is incorporated herein by reference.

 

Special Note Regarding Forward-Looking Statements

 

All statements other than those of historical facts included in this Form 10-K, including those related to our financial outlook, liquidity, goals, business strategy, projected plans and objectives of management for future operating results, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are subject to numerous assumptions, risks and uncertainties, including the risks set forth below, and are based on our current expectations and projections about future events. Our actual results, performance or achievements could be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Although we believe the expectations reflected in these forward-looking statements are based on reasonable assumptions, there is a risk that these expectations will not be attained and that any deviations will be material. We disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained in this Form 10-K to reflect any changes in our expectations or any change in events, conditions or circumstances on which any statement is based.

 

 

Investors should carefully consider, among other factors, the risks listed below.

 

We derive a significant portion of our revenues from U.S. government contracts, which are dependent on continued political support and funding and are subject to termination by the U.S. government at any time.

 

The majority of our total annual revenues and our firm backlog at December 31, 2007 was derived from U.S. government contracts. Most of our U.S. government contracts are funded incrementally on a year-to-year basis and are subject to uncertain future funding levels. Furthermore, our direct and indirect contracts with the U.S. government may be terminated or suspended by the U.S. government or its prime contractors at any time, with or without cause. There can be no assurance that government contracts will not be terminated or suspended in the future, or that contract suspensions or terminations

will not result in unreimbursable expenses or charges or other adverse effects on our financial condition. A decline in U.S. government support and funding for key missile defense and space programs could materially adversely affect our financial condition and results of operations.

 

We are subject to a number of domestic and international laws, regulations and restrictions, the non-compliance with which may expose us to adverse consequences.

 

As a government contractor, we are subject to extensive and complex U.S. government procurement laws and regulations, including the Procurement Integrity Act and the False Claims Act. Failure to comply with these laws and regulations could result in contract termination, price or fee reductions, civil or criminal penalties, injunctions and/or administrative sanctions such as suspension or debarment from contracting with the U.S. government.

 

In addition, our international business subjects us to numerous U.S. and foreign laws and regulations, including the Foreign Corrupt Practices Act and regulations relating to import-export control. Our failure to comply with these laws and regulations could result in administrative, civil, or criminal liabilities, and could result in suspension or debarment from contracting with the U.S. government or suspension of our export privileges.

 

Our business could be adversely affected by a negative audit by the U.S. government.

 

U.S. government agencies, including the Defense Contract Audit Agency (“DCAA”) and various agency Inspectors General, routinely audit and investigate government contractors. These agencies review a contractor’s performance under its contracts, cost structure and compliance with applicable laws, regulations and standards. These agencies also review the adequacy of, and a contractor’s compliance with, its internal control systems and policies, including the contractor’s purchasing, property, estimating, compensation, accounting and information systems. Responding to governmental audits, inquiries or investigations may involve significant expense and divert management attention. Any costs found to be misclassified may not be reimbursed, and such costs already reimbursed may be subject to repayment. Also, if an audit or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or prohibition from doing business with the U.S. government. In addition, we could suffer serious reputational harm if allegations of impropriety were made against us.

 

Termination of our backlog of orders could negatively impact our revenues.

 

All of our direct and indirect contracts with the U.S. government or its prime contractors may be terminated or suspended at any time, with or without cause, for the convenience of the government. From time to time, certain of our commercial contracts have also given the customer the right to unilaterally terminate the contracts. For these reasons, we cannot assure you that our backlog will ultimately result in revenues.

 

We use estimates in accounting for many contracts. Changes in our estimates could adversely affect our future financial results.

 

Contract accounting requires judgments relative to assessing risks, estimating contract revenues and costs and making assumptions for schedule and technical issues. Due to the size and nature of many of our contracts, the estimation of total revenues and costs at completion is complicated and subject to many variables. For example, assumptions have to be made regarding the length of time to complete the contract because costs also include expected increases in wages and prices for materials. Incentives or

penalties related to performance on contracts are considered in estimating revenue and profit rates, and are recorded when there is sufficient information for us to assess anticipated performance.

 

Because of the significance of the judgments and estimation processes described above, it is possible that materially different amounts could be obtained if different assumptions were used or if the underlying circumstances were to change. Changes in underlying assumptions, circumstances or estimates may have a material adverse effect upon future period financial performance.

 

We may not receive full payment for our satellites or launch services and we could incur penalties in the event of failure, malfunction or if our satellites are not delivered or our rockets are not launched on schedule.

 

Some of our satellite contracts provide for performance-based payments to be made to us after the satellite is in-orbit over periods that may be as long as 15 years. Additionally, some satellite contracts require us to refund cash to the customer if performance criteria, which cover periods of up to 15 years, are not satisfied. Certain launch contracts have payments contingent upon a successful launch. While our practice is generally to procure insurance policies that we believe would indemnify us for satellite incentive fees that are not earned and for performance refund obligations, insurance may not continue to be available on economical terms, if at all. Further, we may elect not to procure insurance. In addition, some of our satellite and launch contracts require us to pay penalties in the event that satellites are not delivered, or the launch does not occur, on a timely basis, or to refund all cash receipts if a contract is terminated for default prior to launch. Our failure to receive incentive payments, or a requirement that we refund amounts previously received or that we pay delay penalties, could adversely affect our results of operations, profitability and liquidity.

 

Contract cost overruns could subject us to losses and impair our liquidity.

 

We provide our products and services primarily through fixed-price and cost-reimbursable contracts. Cost overruns may result in losses and, if significant, could adversely impact our financial results and our liquidity:

 

 

Our success depends on our ability to penetrate and retain markets for our existing products and to continue to conceive, design, manufacture and market new products on a cost-effective and timely basis.

 

We anticipate that we will continue to incur expenses to design and develop new products. There can be no assurance that we will be able to achieve the technological advances necessary to remain

competitive and profitable, that new products will be developed and manufactured on schedule or on a cost-effective basis or that our existing products will not become technologically obsolete. Our failure to predict accurately the needs of our customers and prospective customers, and to develop products or product enhancements that address those needs, may result in the loss of current customers or the inability to secure new customers. The development of new or enhanced products is a complex and uncertain process that requires the accurate anticipation of technological and market trends and can take a significant amount of time and expense to complete. We may experience design, manufacturing, marketing and other difficulties that could delay or prevent the development, introduction or acceptance of new products and enhancements.

 

There can be no assurance that our products will be successfully developed or manufactured or that they will perform as intended.

 

Most of the products we develop and manufacture are technologically advanced and sometimes include novel systems that must function under highly demanding operating conditions and are subject to significant technological change and innovation. From time to time, we experience product failures, cost overruns in developing and manufacturing our products, delays in delivery and other operational problems. We may experience some product and service failures, schedule delays and other problems in connection with our launch vehicles, satellites, advanced space systems, transportation management systems and other products in the future. Some of our satellite and launch services contracts impose monetary penalties on us for delays and for performance failures, which penalties could be significant. In addition to any costs resulting from product warranties or required remedial action, product failures or significant delays may result in increased costs or loss of revenues due to postponement or cancellation of subsequently scheduled operations or product deliveries and claims against performance bonds. Negative publicity from product failures may also impair our ability to win new contracts.

 

If our key suppliers fail to perform as expected, we may experience delays and cost increases, and our operating results may be impacted adversely.

 

We purchase a significant percentage of our product components, structural assemblies and some key satellite components and instruments from third parties. We also obtain from the U.S. government parts and equipment used in the production of our products or the provision of our services. In addition, we have a sole source for the rocket motors we use on most of our launch vehicles. If our subcontractors fail to perform as expected or encounter financial difficulties, we may have difficulty replacing them in a timely or cost effective manner. As a result, we may experience delays that could result in additional costs, a customer terminating our contract for default, or damage to our customer relationships, causing our revenues, profitability and cash flow to decline. In addition, negative publicity from any failure of one of our products as a result of a failure by a key supplier could damage our reputation and prevent us from winning new contracts.

 

Our international business is subject to risks that may have a material adverse effect on our operating results.

 

We sell certain of our communications satellites and other products to non-U.S. customers. International contracts are subject to numerous risks that may have a material adverse effect on our operating results, including:

 

 

 

We operate in a regulated industry, and our inability to secure or maintain the licenses, clearances or approvals necessary to operate our business could have a material adverse effect on our financial condition and results of operations.

 

Our ability to pursue our business activities is regulated by various agencies and departments of the U.S. government and, in certain circumstances, the governments of other countries. Commercial space launches require licenses from the DoT, and operation of our L-1011 aircraft requires licenses from certain agencies of the DoT, including the Federal Aviation Administration. Our classified programs require that we and certain of our employees maintain appropriate security clearances. There can be no assurance that we will be successful in our future efforts to secure and maintain necessary licenses, clearances or regulatory approvals. Exports of our products, services and technical information generally require licenses from the DoS or from the DoC. We have a number of international customers and subcontractors. Our inability to secure or maintain any necessary licenses or approvals or significant delays in obtaining such licenses or approvals could negatively impact our ability to compete successfully in international markets, and could result in an event of default under certain of our international contracts.

 

We face significant competition in each of our lines of business and many of our competitors possess significantly more resources than we do.

 

Many of our competitors are larger and have substantially greater resources than we do. Furthermore, it is possible that other domestic or foreign companies or governments, some with greater experience in the space industry and many with greater financial resources than we possess, could seek to produce products or services that compete with our products or services, including new launch vehicles using new technology which could render our launch vehicles less competitively viable. Some of our foreign competitors currently benefit from, and others may benefit in the future from, subsidies from or other protective measures by their home countries.

 

Our financial covenants may restrict our operating activities.

 

Our credit facility contains certain financial and operating covenants, including, among other things, certain coverage ratios, as well as limitations on our ability to incur debt, make dividend payments, make investments, sell all or substantially all of our assets and engage in mergers and consolidations and certain acquisitions. These covenants may restrict our ability to pursue certain business initiatives or certain acquisition transactions. In addition, failure to meet any of the financial covenants in our credit facility could cause an event of default under and/or accelerate some or all of our indebtedness, which would have a material adverse effect on us.

The loss of executive officers and our inability to retain other key personnel could adversely affect our operations.

 

Our inability to retain our executive officers and other key employees, including personnel with security clearances required for classified work and highly skilled engineers and scientists, could have a material adverse effect on our operations.

 

The anticipated benefits of future acquisitions may not be realized.

 

From time to time we may evaluate potential acquisitions that we believe would enhance our business. Were we to complete any acquisition transaction, the anticipated benefits may not be fully realized if we are unable to successfully integrate the acquired operations, technologies and personnel into our organization.

 

We are subject to environmental regulations.

 

We are subject to various federal, state and local environmental laws and regulations relating to the operation of our business, including those governing pollution, the handling, storage and disposal of hazardous substances and the ownership and operation of real property. Such laws may result in significant liabilities and costs. There can be no assurance that compliance with or liability under such laws and regulations will not have a material adverse effect on us in the future.

 

Our restated certificate of incorporation, our amended and restated bylaws, our stockholder rights plan and Delaware law contain anti-takeover provisions that may adversely affect the rights of our stockholders.

 

Our Board of Directors has the authority to issue up to 10 million shares of our preferred stock, $0.01 par value per share, and to determine the price, rights, preferences and privileges of those shares without any further vote or action by the stockholders. The rights of the holders of our common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock.

 

In addition to our ability to issue preferred stock without stockholder approval, our charter documents contain other provisions which could have an anti-takeover effect, including:

 

 

In 1998, we adopted a stockholder rights plan which is intended to deter coercive or unfair takeover tactics. Under the rights plan, a preferred share purchase right, which is attached to each share of our common stock, generally will be triggered upon the acquisition, or actions that would result in the acquisition, of 15% or more of our common stock by any person or group. If triggered, these rights would entitle our stockholders (other than the acquirer) to purchase, for the exercise price, shares of

Orbital’s common stock having a market value of two times the exercise price. The exercise price, which is subject to certain adjustments, is $210 per right. The stock purchase rights would cause substantial dilution to a person or group that attempts to acquire us on terms not approved by our Board of Directors.

 

In addition, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which restrict the ability of current stockholders holding more than 15% of our voting shares to acquire us without the approval of 662/3% of the other stockholders. These provisions could discourage potential acquisition proposals and could delay or prevent a change in control transaction. They could also have the effect of discouraging others from making tender offers for our common stock. As a result, these provisions may prevent our stock price from increasing substantially in response to actual or rumored takeover attempts. These provisions may also prevent changes in our management.

 

The repurchase rights in our 2.4375% convertible senior subordinated notes triggered by a fundamental change could discourage a potential acquirer.

 

The repurchase rights in our 2.4375% convertible senior subordinated notes triggered by a fundamental change of our company could discourage a potential acquirer. The term “fundamental change” is limited to specified transactions and may not include other events that might adversely affect our financial condition or business operations.

 

Conversion of our 2.4375% convertible senior subordinated notes may dilute the ownership interests of existing stockholders.

 

Upon conversion of our 2.4375% convertible senior subordinated notes, we will deliver in respect of each $1,000 principal amount of notes tendered for conversion (1) an amount in cash (“principal return”) equal to the lesser of (a) the principal amount of the converted notes and (b) the conversion value (such value equal to the conversion rate multiplied by the average price of our common shares over a 10 consecutive-day trading period) and (2) if the conversion value is greater than the principal return, an amount in cash or common stock, or a combination thereof (at our option) with a value equal to the difference between the conversion value and the principal return. Any common stock issued upon conversion of the notes will dilute the ownership interests of existing stockholders. Any sales in the public market of the common stock issuable upon such conversion could adversely affect prevailing market prices of our common stock. In addition, the existence of the notes may encourage short selling by market participants because the conversion of the notes could depress the price of our common stock.

 

 

Not applicable.

 

 

We lease approximately 1,000,000 square feet of office, engineering and manufacturing space in various locations in the United States, as summarized in the table below:

 

We own a 135,000 square foot state-of-the-art space systems manufacturing facility that primarily houses our satellite manufacturing, assembly and testing activities in Dulles, Virginia.

 

While we believe that our existing facilities are adequate for our immediate requirements, we are currently seeking to lease additional office space which we believe will be available at commercially reasonable rates to accommodate expected growth. In addition, we plan to enter into a long-term lease for a new 42,000 square foot office building adjacent to our corporate headquarters in Dulles, Virginia, the construction of which is expected to be completed in late 2008 or early 2009.

 

 

In 2007, we were advised by the Civil Division of the Department of Justice (“DoJ”) that we had been named as a defendant in a lawsuit brought by a former employee and filed under seal on February 23, 2005, in the United States District Court for the District of Arizona, under the qui tam provisions of the civil False Claims Act, which permit an individual to bring suit in the name of the United States and share in any recovery. The Court subsequently unsealed the matter, which is captioned United States of America ex rel. W. Austin Sallade v. Orbital Sciences Corporation.

 

The complaint alleges that our Launch Systems Group submitted false and fraudulent claims for payment to the U.S. government allegedly by misclassifying and mischarging costs and by engaging in defective pricing. The complaint asserts that as a result of the allegedly wrongful conduct, the United States suffered damages and that we are liable to the United States for three times the amount of the alleged damages, plus civil penalties of up to $10,000 for each false claim and punitive damages. We have devoted significant time and resources to investigate the issues raised by the complaint and, while we cannot predict the outcome of any litigation, we believe we have strong substantive defenses to all of the claims. We are vigorously defending this lawsuit.

 

The above-described lawsuit relates to matters underlying an investigation by the DoJ that we learned of in 2005 involving suspected civil and criminal violations of government contracting laws and regulations in connection with certain U.S. government launch vehicle programs. While the Civil Division of the DoJ has declined to intervene in such lawsuit, in the future it could seek to intervene with permission from the Court. To our knowledge, the criminal investigation remains open. We have cooperated fully with the U.S. government authorities in connection with their investigation. We cannot predict whether the government ultimately will conclude that there have been any violations by us of any federal contracting laws, policies or procedures, or any other applicable laws, or whether the former employee plaintiff will prevail in the lawsuit. The outcome of the government investigation could subject us to criminal, civil and/or administrative penalties and up to treble damages depending on the nature of such violations, which could have a material adverse effect on our results of operations or financial condition.

 

In addition, from time to time we are party to certain litigation or other legal proceedings arising in the ordinary course of business. Because of the uncertainties inherent in litigation, we cannot predict whether the outcome of such litigation or other legal proceedings will have a material adverse effect on our results of operations or financial condition.

 

 

There was no matter submitted to a vote of our security holders during the fourth quarter of 2007.

 

The following table sets forth the name, age and position of each of the executive officers of Orbital as of February 11, 2008. All executive officers are appointed annually and serve at the discretion of the Board of Directors.

 

 

David W. Thompson is a co-founder of Orbital and has been Chairman of the Board and Chief Executive Officer of Orbital since 1982. From 1982 until October 1999, he also served as our President. Prior to founding Orbital, Mr. Thompson was employed by Hughes Electronics Corporation as special assistant to the President of its Missile Systems Group and by NASA at the Marshall Space Flight Center as a project manager and engineer, and also worked on the Space Shuttle’s autopilot design at the Charles Stark Draper Laboratory. Mr. Thompson is a Fellow of the American Institute of Aeronautics and Astronautics, the American Astronautical Society and the Royal Aeronautical Society, and is a member of the U.S. National Academy of Engineering.

 

James R. Thompson (who is not related to David W. Thompson), has been Vice Chairman, President and Chief Operating Officer since April 2002, and was President and Chief Operating Officer since October 1999. He has been a director of the Company since 1992. From 1993 until October 1999, Mr. Thompson served as Executive Vice President and General Manager, Launch Systems Group. Mr. Thompson was Executive Vice President and Chief Technical Officer of Orbital from 1991 to 1993. He was Deputy Administrator of NASA from 1989 to 1991. From 1986 until 1989, Mr. Thompson was Director of the Marshall Space Flight Center at NASA. Mr. Thompson was Deputy Director for Technical Operations at Princeton University’s Plasma Physics Laboratory from 1983 through 1986. Before that, he had a 20-year career with NASA at the Marshall Space Flight Center.

 

Garrett E. Pierce has been Vice Chairman and Chief Financial Officer since April 2002, and was Executive Vice President and Chief Financial Officer since August 2000. He has been a director of the Company since August 2000. From 1996 until August 2000, he was Executive Vice President and Chief Financial Officer of Sensormatic Electronics Corp., a supplier of electronic security systems, where he was also named Chief Administrative Officer in July 1998. Prior to joining Sensormatic, Mr. Pierce was the Executive Vice President and Chief Financial Officer of California Microwave, Inc., a supplier of microwave, radio frequency and satellite systems and products for communications and wireless networks. From 1980 to 1993, Mr. Pierce was with Materials Research Corporation, a provider of thin film equipment and high purity materials to the semiconductor, telecommunications and media storage industries, where he progressed from Chief Financial Officer to President and Chief Executive Officer.

Materials Research Corporation was acquired by Sony Corporation as a wholly owned subsidiary in 1989. From 1972 to 1980, Mr. Pierce held various management positions with The Signal Companies. Mr. Pierce is a director of Kulicke and Soffa Industries, Inc.

 

Ronald J. Grabe has been Executive Vice President and General Manager, Launch Systems Group since 1999. From 1996 to 1999, he was Senior Vice President and Assistant General Manager of the Launch Systems Group, and Senior Vice President of the Launch Systems Group since 1995. From 1994 to 1995, Mr. Grabe served as Vice President for Business Development in the Launch Systems Group. From 1980 to 1993, Mr. Grabe was a NASA astronaut during which time he flew four Space Shuttle missions and was lead astronaut for development of the International Space Station.

 

Michael E. Larkin has been Executive Vice President and General Manager, Space Systems Group since February 2008 and Senior Vice President and Deputy General Manager of the Space Systems Group since 2006. From 2004 to 2006, he served as Senior Vice President of Finance of the Space Systems Group. From 1996 to 2004, he was Vice President of the Space Systems Group, and was Director of Finance of the Space Systems Group from 1994 to 1996. Prior to that, he held a variety of program and financial management positions at Fairchild Space and Defense Corporation, a space and military electronics company, until its acquisition by Orbital in 1994.

 

Antonio L. Elias has been Executive Vice President and General Manager, Advanced Programs Group since October 2001, and was Senior Vice President and General Manager, Advanced Programs Group since August 1997. From January 1996 until August 1997, Dr. Elias served as Senior Vice President and Chief Technical Officer of Orbital. From May 1993 through December 1995, he was Senior Vice President for Advanced Projects, and was Senior Vice President, Space Systems Division from 1990 to April 1993. He was Vice President, Engineering of Orbital from 1989 to 1990 and was Chief Engineer from 1986 to 1989. From 1980 to 1986, Dr. Elias was an Assistant Professor of Aeronautics and Astronautics at Massachusetts Institute of Technology. He was elected to the National Academy of Engineering in 2001.

 

Susan Herlick has been Senior Vice President, General Counsel and Corporate Secretary since January 2006 and served as Vice President and Deputy General Counsel from 2003 to 2005. From 1997 to 2002, she was Vice President and Assistant General Counsel. She joined Orbital as Assistant General Counsel in 1995. Prior to that, she was an attorney at the law firm of Hogan & Hartson LLP.

PART II

 

 

On February 11, 2008, there were 2,336 Orbital common stockholders of record.

 

Our common stock trades on the New York Stock Exchange (“NYSE”) under the symbol ORB. The range of high and low sales prices of Orbital common stock, as reported on the NYSE, was as follows:

 

 

 

We have never paid any cash dividends on our common stock, nor do we anticipate paying cash dividends on our common stock at any time in the foreseeable future. Moreover, our credit facility contains covenants limiting our ability to pay cash dividends. For a discussion of these limitations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

 

The transfer agent for our common stock is:

 

Computershare Trust Company, N.A.

P.O. Box 43010

Providence, RI 02940

Telephone: (800) 730-4001

www.computershare.com

 

The following table sets forth information regarding our repurchase of common stock during, and as of, the quarter ended December 31, 2007.

 

 

The following graph compares the yearly cumulative total return on the company’s common stock against the cumulative total return on the S&P 500 Index and the Dow-Jones Aerospace/Defense Index for the five-year period commencing on December 31, 2002 and ending on December 31, 2007.

 

 

 

Selected Consolidated Financial Data

 

The selected consolidated financial data presented below for the years ended December 31, 2007, 2006, 2005, 2004 and 2003 are derived from our audited consolidated financial statements, with the years 2006 and prior adjusted to give effect to the adoption of a new accounting pronouncement as further described in Note 2 to the consolidated financial statements included in this Form 10-K. The selected consolidated financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the related notes included elsewhere in this Form 10-K.

 

 

 

 

Overview

 

With the exception of historical information, the matters discussed within this Item 7 and elsewhere in this Form 10-K include forward-looking statements that involve risks and uncertainties, many of which are beyond our control. Readers should be cautioned that a number of important factors, including those identified above in “Item 1 — Special Note Regarding Forward-Looking Statements” and “Item 1A — Risk Factors” may affect actual results and may cause actual results to differ materially from those anticipated or expected in any forward-looking statement. Historical results of operations may not be indicative of future operating results.

 

We develop and manufacture small rockets and space systems for commercial, military and civil government customers. Our primary products and services include the following:

 

 

Critical Accounting Policies and Significant Estimates

 

The preparation of consolidated financial statements requires management to make judgments based upon estimates and assumptions that are inherently uncertain. Such judgments affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Management continuously evaluates its estimates and assumptions, including those related to long-term contracts and incentives, inventories, long-lived assets, warranty obligations, income taxes, contingencies and litigation, and the carrying values of assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, and such differences may be material.

 

The following is a summary of the most critical accounting policies used in the preparation of our consolidated financial statements.

 

 

Certain contracts include provisions for increased or decreased revenue and profit based on performance against established targets. Incentive and award fees are included in estimated contract revenue at the time the amounts can be reasonably determined and are reasonably assured based upon historical experience and other objective criteria. If performance under such contracts were to differ from previous assumptions, current period revenues and profits would be adjusted and could therefore fluctuate significantly.

 

As of December 31, 2007 and December 31, 2006, unbilled receivables included $15.5 million and $16.4 million, respectively, of incentive fees on certain satellite contracts that become due incrementally over periods of up to 15 years, subject to the achievement of performance criteria.

 

Certain satellite contracts require us to refund cash to the customer if performance criteria, which cover periods of up to 15 years, are not satisfied. Through December 31, 2007, we have recognized approximately $43 million of revenues under such contracts, a portion or all of which could be reversed in future periods if satellite performance criteria are not met. We generally procure insurance policies that we believe would indemnify us for satellite incentive fees that are not earned and for performance refund obligations.

 

Through December 31, 2007, we have recognized approximately $9 million of estimated award fees on a contract that is subject to a final assessment at the conclusion of the contract, projected to occur in 2013. If the final award fee assessment is lower than the interim assessments, we would be required to record an unfavorable revenue and profit adjustment.

 

date of the grant. We also followed the disclosure requirements of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation.”

 

As of January 1, 2006, we adopted SFAS No. 123R, “Share-Based Payment,” using (1) the modified prospective method, which requires measurement of compensation cost for all stock awards at fair value on the date of grant and recognition of compensation expense over the service period for awards expected to vest, and (2) the short-cut method to determine the pool of windfall tax benefits. We use the tax law ordering method as our policy for intra-period tax allocation related to the tax attributes of stock-based compensation. The adoption of SFAS No. 123R did not have a material impact on our consolidated financial statements.

 

The fair value of our restricted stock unit grants is determined based on the closing price of our common stock on the date of grant, and the fair value of stock options is determined using the Black-Scholes valuation model, which is consistent with our valuation techniques previously utilized for options in footnote disclosures required under SFAS No. 123. Such value is recognized as expense over the service period, net of estimated forfeitures. The estimation of stock awards that will ultimately vest requires significant judgment. We consider many factors when estimating expected forfeitures, including types of awards, employee class and historical experience. Actual results, and future changes in estimates, may differ substantially from current estimates.

 

Consolidated Results of Operations for the Years Ended December 31, 2007, 2006 and 2005

 

Prior Period Adjustment For Adoption of New Accounting Standard — As discussed in Note 2 to the accompanying consolidated financial statements, our financial statements have been adjusted as required by a new accounting standard pertaining to our L-1011 aircraft which is used in our Pegasus launch vehicle program. The effect of adopting the new accounting standard was not material to our financial statements.

 

2007 Compared With 2006

 

Revenues — Our consolidated revenues were $1,084 million in 2007, up 35% compared to 2006 due to increased revenues in all business segments. Revenues in the advanced space programs segment, which prior to 2007 was aggregated and reported with the satellites and space systems segment, increased $124.1 million, or 243%, driven by contract activity on the Orion crew exploration spacecraft program which began in late 2006. Launch vehicles segment revenues increased $84.8 million, or 27%, principally due to higher target and interceptor vehicle revenues driven by increased contract activity on target vehicle and missile defense programs. Satellites and space systems segment revenues increased $58.9 million, or 14%, driven by growth in the communications satellites product line mainly due to activity on recently awarded contracts. Transportation management systems segment revenues increased $12.4 million, or 33%, primarily due to an increase in product sales supporting existing public fleet management systems in addition to activity on recently awarded contracts.

 

Gross Profit — Our consolidated gross profit was $187.2 million in 2007, an 18% increase compared to $158.7 million in 2006. Gross profit is affected by a number of factors, including the mix of contract types and costs incurred thereon in relation to revenues recognized. Such costs include the costs of personnel, materials, subcontracts and overhead.

 

The gross profit increase in 2007 as compared to 2006 was due to a $13.6 million, or 110%, increase in our advanced space programs segment, a $7.1 million, or 10%, increase in our launch vehicles segment, a $3.9 million, or 6%, increase in our satellites and space systems segment and a $3.9 million, or 45%, increase in our transportation management systems segment. The increase in gross profit in our

advanced space programs segment was principally due to increased contract activity in 2007 on the Orion program and the related profit contributed by this program. The increase in launch vehicles segment gross profit was primarily due to increased activity on target vehicle and interceptor vehicle programs. The increase in gross profit in our satellites and space systems segment was principally due to contract activity in 2007 on new communications satellite programs. The increase in our transportation management systems segment was largely attributable to the increase in product sales mentioned above.

 

Research and Development Expenses — Research and development expenses are comprised of our self-funded product research and development activities and exclude direct customer-funded development activities. Research and development expenses were $18.7 million, or 2% of revenues, and $9.6 million, or 1% of revenues, in 2007 and 2006, respectively. These expenses related primarily to the development of enhanced launch vehicles and satellites, as well as improved product development initiatives in our transportation management systems segment. We are engaged in a major new product development program to create a medium-capacity rocket called Taurus II. Approximately $5.5 million of the increase in research and development expenses was related to the Taurus II development program.

 

Selling, General and Administrative Expenses — Selling, general and administrative expenses were $82.1 million, or 8% of revenues, and $80.8 million, or 10% of revenues, in 2007 and 2006, respectively. Selling, general and administrative expenses include the costs of our finance, legal, administrative and general management functions, as well as bid, proposal and marketing costs.

 

Selling, general and administrative expenses increased only slightly in 2007 compared to 2006, while revenues increased significantly during these periods. In 2007, selling, general and administrative expenses included higher business segment general and administrative expenses and higher personnel costs compared to 2006, partially offset by a reduction in professional fees. Bid, proposal and marketing expenses remained relatively constant in 2007 and 2006, largely due to certain major contract proposal activities in both years.

 

In 2007, our stock-based compensation expense was $7.7 million, compared to $8.0 million in 2006, primarily related to restricted stock units granted in 2005, 2006 and 2007. The majority of these costs are reported in selling, general and administrative expenses and the remainder are reported in cost of goods sold.

 

Interest Income and Other — Interest income and other was $13.0 million in 2007, compared to $13.8 million in 2006, consisting primarily of interest income of $12.8 million and $11.7 million in 2007 and 2006, respectively, on short-term invested cash balances. Other income in 2006 included a $1.6 million gain from the liquidation of an investment written off in 1999.

 

Interest Expense — Interest expense for 2007 decreased to $4.7 million, compared to $12.3 million in 2006. The reduction in interest expense is due to the lower interest rate on our long-term debt as a result of Orbital’s December 2006 refinancing transaction, which is discussed below in “Liquidity and Capital Resources.”

 

Debt Extinguishment Expense — During 2006, we recorded $10.4 million of debt extinguishment expenses associated with the repurchase of substantially all of our 9% senior notes as further described in “Liquidity and Capital Resources.” The debt extinguishment expenses consisted of $2.5 million in accelerated amortization of debt issuance costs and $7.9 million in prepayment premiums and other expenses.

 

Income Taxes — We recorded income tax expense of $38.0 million and $24.3 million in 2007 and 2006, respectively. The effective income tax rate was 40.1% and 40.9% in 2007 and 2006, respectively. The decrease in the effective tax rate is largely due to lower effective state tax rates in 2007. Our cash income tax payments, which primarily relate to alternative minimum tax (“AMT”), were approximately

3% and 2% of pretax income in 2007 and 2006, respectively, primarily due to the utilization of net operating loss carryforwards that substantially offset taxable income.

 

On January 1, 2007, we adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”). As discussed in Note 6 to the accompanying financial statements, there was no material effect on our consolidated financial statements associated with the adoption of FIN 48.

 

Net Income — Our net income for 2007 was $56.7 million, compared to $35.1 million in 2006, or $0.93 and $0.56 diluted net income per share, in 2007 and 2006, respectively. The increase in net income in 2007 was due to a $35.4 million increase in pretax income, partially offset by a $13.7 million increase in our income tax provision.

 

2006 Compared With 2005

 

Revenues — Our consolidated revenues were $802.9 million in 2006, a 14% increase compared to $702.9 million in 2005. This increase was driven primarily by $127.3 million revenue growth in our satellites and space systems segment and $11.2 million growth in our transportation management systems segment, offset partially by a $24.2 million decrease in our launch vehicles segment and a $17.1 million decrease in our advanced space programs segment. The satellites and space systems segment growth was driven by significantly higher revenues in the communications satellites product line related to progress on several satellite contracts awarded in 2005. The transportation management systems segment growth was largely driven by work on several new contracts started in 2005 and early 2006. Launch vehicles segment revenues decreased due to lower revenues from the interceptor launch vehicles and the target launch vehicles product lines, partially offset by higher revenues from the space launch vehicles product line. Advanced space programs segment revenues decreased due to a reduction in contract activity on a satellite that was launched in the second quarter of 2006.

 

Gross Profit — Our consolidated gross profit was $158.7 million in 2006, a 26% increase compared to $125.5 million in 2005. Gross profit is affected by a number of factors, including the mix of contract types and costs incurred thereon in relation to revenues recognized. Such costs include the costs of personnel, materials, subcontracts and overhead.

 

The gross profit increase in 2006 as compared to 2005 was due to a $28.0 million, or 70%, increase in our satellites and space systems segment, a $2.4 million, or 25%, increase in our advanced space programs systems segment, a $2.4 million, or 39%, increase in our transportation management systems segment and a $0.4 million, or 1%, increase in our launch vehicles segment.

 

The increase in gross profit in our satellites and space systems segment was principally due to higher revenues, driven by an increased level of contract activity in 2006, and significantly improved contract profitability in the communications satellites product line resulting from net cost reductions and favorable contract adjustments. Gross profit in our advanced space programs segment increased despite lower revenues largely due to a favorable contract adjustment related to a satellite that was launched in the second quarter of 2006. The increase in our transportation management systems segment was largely attributable to the increase in revenues driven by growth in contract activity levels. Although launch vehicles revenues decreased, the segment’s gross profit increased marginally due to the segment’s overall operating margin improvement and cost growth on certain contracts in 2005 that did not recur in 2006.

 

Research and Development Expenses — Research and development expenses are comprised of our self-funded product research and development activities and exclude direct customer-funded development activities. Our research and development expenses relate primarily to the development of improved launch vehicles and satellites.

Research and development expenses were $9.6 million, or 1% of revenues, in 2006 compared to $6.3 million, or 1% of revenues, in 2005. The increase in research and development expenses primarily related to communications satellites and launch vehicle control systems.

 

Selling, General and Administrative Expenses — Selling, general and administrative expenses were $80.8 million, or 10% of revenues, and $65.9 million, or 9% of revenues, in 2006 and 2005, 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. The increase in selling, general and administrative expenses was primarily due to increased stock-based compensation expenses that were recorded in 2006, as discussed below, along with increased bid, proposal and marketing expenses and higher professional fees. Bid, proposal and marketing expenses increased $5.0 million primarily due to our pursuit of new programs in the satellites and space systems segment. The increase in professional expenses was primarily due to $2.6 million of fees incurred in connection with a review of stock-based compensation grants and procedures that was completed in 2006.

 

In 2006, our stock-based compensation expense increased to $8.0 million, compared to $2.2 million in 2005, due to restricted stock units granted in 2005 and 2006. The majority of these costs are reported in selling, general and administrative expenses and the remainder are reported in cost of goods sold.

 

Interest Income and Other — Interest income and other was $13.8 million and $4.6 million in 2006 and 2005, respectively, consisting primarily of interest income of $11.7 million and $5.1 million in 2006 and 2005, respectively. Interest income increased primarily as a result of higher interest rates and higher short-term invested cash balances. Other income in 2006 included a $1.6 million gain from the liquidation of an investment written off in 1999.

 

Interest Expense — Interest expense was $12.3 million and $11.7 million in 2006 and 2005, respectively. Interest expense in 2006 remained relatively consistent with interest expense in 2005 primarily as a result of our unchanged fixed-rate debt balance during the majority of 2006.

 

Debt Extinguishment Expense — During 2006, we recorded $10.4 million of debt extinguishment expenses associated with the repurchase of substantially all of our 9% senior notes as further described in “Liquidity and Capital Resources.” The debt extinguishment expenses consisted of $2.5 million in accelerated amortization of debt issuance costs and $7.9 million in prepayment premiums and other expenses.

 

Income Taxes — We recorded $24.3 million and $17.7 million of income tax expense in 2006 and 2005, respectively, reflecting an annualized effective income tax rate of 40.9% and 38.5%, respectively. The increase in our effective income tax rate was primarily related to higher state income tax expense. Our cash income tax payments, which primarily relate to AMT, were approximately 2% of pretax income in 2006 and 2005 primarily due to the utilization of net operating loss carryforwards that substantially offset taxable income.

 

Net Income — Our consolidated net income was $35.1 million and $28.3 million, or $0.56 and $0.45 diluted net income per share, in 2006 and 2005, respectively. The increase in net income in 2006 was due to a $13.3 million increase in pretax income, partially offset by a $6.5 million increase in our income tax provision.

 

Segment Results

 

Our products and services are grouped into four reportable business segments: (i) launch vehicles; (ii) satellites and space systems; (iii) advanced space programs; and (iv) transportation management systems. Prior to 2007, advanced space programs was aggregated and reported with satellites and space systems. However, we determined to report advanced space programs on a stand-alone basis in 2007 due

to significant growth in new programs within the segment. The segment information for 2006 and 2005 has been restated to conform to the 2007 presentation. 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 table summarizes revenues and income from operations for our reportable business segments and corporate and other (in thousands):

 

 

 

2007 Compared With 2006

 

Launch Vehicles — Launch vehicles segment revenues increased 27% due to revenue increases in all three of the segment’s product lines. In our interceptor launch vehicles product line, which accounted for 52% and 58% of total launch vehicles segment revenues in 2007 and 2006, respectively, we are developing and manufacturing the midcourse-phase Orbital Boost Vehicle (“OBV”), directed by the U.S. Missile Defense Agency (“MDA”) and designed to defend the United States against long-range ballistic missile attacks. During 2007, we conducted one OBV interceptor launch as part of an MDA flight test exercise and we delivered nine additional OBV interceptors for deployment and continued test flights. We are also developing the boost vehicle for the Kinetic Energy Interceptor (“KEI”) program, the next generation missile defense interceptor, under direction by MDA. Revenues from the interceptor launch vehicles product line increased $27.4 million primarily due to a ramp-up of the development efforts on a demonstration vehicle test scheduled for late 2008 on the KEI program, complemented by a marginal increase in OBV program activity. Revenues increased $56.5 million in the target launch vehicles product line resulting primarily from increased design and production activity on our ballistic missile target programs that support missile defense systems testing and on our Coyote supersonic ramjet vehicle program for the U.S. Navy. Space launch vehicle product line revenues increased marginally due to higher levels of activity on Taurus programs, partially offset by a reduction in Pegasus and Minotaur program activity.

Operating income in the launch vehicles segment increased 16%, due to operating profit increases in the interceptor and target launch vehicles product lines, partially offset by a decrease in the space launch vehicles product line operating profit. Interceptor launch vehicles operating income increased primarily due to the increase in the KEI program due to increased program activity. Operating income from interceptor launch vehicles continued to be the largest contributor to this segment’s operating income, with 63% and 61% of total segment operating income in 2007 and 2006, respectively. Operating income from our target launch vehicles product line increased significantly in line with the revenue growth from our ballistic missile target programs and our Coyote supersonic ramjet vehicle program. Operating income from space launch vehicles decreased primarily due to lower Pegasus program activity and an unfavorable profit adjustment on a Pegasus contract due to cost growth in 2007, partially offset by higher Taurus income consistent with higher program activity.

 

This segment’s operating margin (as a percentage of revenues) was 10.0% in 2007, compared to 11.0% in 2006. The margin decline was due to growth in the target launch vehicles product line, which had a lower-than-average margin for the segment, and due to lower margins in the space launch vehicles product line resulting from the unfavorable profit adjustment mentioned above.

 

Satellites and Space Systems — Satellites and space systems segment revenues increased 14% principally due to significant growth in communications satellites revenues partially offset by a reduction in science and technology satellite revenues. Communications satellites revenues accounted for 69% and 60% of total segment revenues in 2007 and 2006, respectively. There were twelve commercial communications satellites in various stages of completion throughout 2007 as compared to eight in various stages of completion throughout 2006. Revenues from the science and technology satellites product line declined largely due to certain programs completed or nearing completion in 2007.

 

Operating income in the satellites and space systems segment increased 11%, primarily due to the growth in the communications satellites product line contract activity in 2007. This increase was partially offset by lower operating income from the science and technology satellites product line driven by the decline in program activity mentioned above in addition to an unfavorable profit adjustment resulting from cost growth on a contract. Communications satellites operating income accounted for 64% and 44% of total segment operating income in 2007 and 2006, respectively. The increase in communications satellites operating income was driven by the substantial growth in program activity as well as an improvement in this product line’s profit margin in 2007.

 

This segment’s operating margin (as a percentage of revenues) was 6.6% in 2007, compared to 6.8% in 2006. This margin decrease is due primarily to a lower operating margin in our science and technology satellites product line that included the unfavorable profit adjustment discussed previously, offset partially by an improved operating margin in 2007 in our communications satellites product line.

 

Advanced Space Programs — Advanced space programs segment revenues increased 243% primarily due to increased contract activity on the Orion human spacecraft program for NASA which began in late 2006. We are designing, developing and building the Launch Abort System (“LAS”) for the Orion vehicle that will pull the spacecraft and its crew to safety in the event of an emergency on the launch pad or at any time during ascent. The increase in Orion program revenue was partially offset by a reduction in revenue due to the completion of an advanced satellite contract early in 2007.

 

Operating income in the advanced space programs segment increased 191% primarily due to the substantial increase in contract activity on the Orion program. This segment’s operating margin (as a percentage of revenues) was 7.1% in 2007, compared to 8.4% in 2006. This decrease in operating margin was primarily due to contract cost adjustments and a revised profit assessment in 2007 on the Orion program.

Transportation Management Systems — Transportation management systems segment revenues increased 33% primarily due to an increase in product sales supporting existing public transit fleet management systems in addition to activity on recently awarded contracts. Operating income also increased primarily due to income contributed by higher product sales and increased program activity, offset partially by charges in 2007 to record the estimated costs to close out a contract that is expected to be completed in 2008. This segment’s operating margin (as a percentage of revenues) increased to 7.7% in 2007, as compared to 6.7% in 2006, primarily due to higher profit margin on the product sales mentioned above.

 

Corporate and Other — Corporate and other revenues were comprised solely of the elimination of intercompany revenues.

 

2006 Compared With 2005

 

Launch Vehicles — Launch vehicles segment revenues decreased 7% primarily due to a $13.5 million revenue decrease in our interceptor launch vehicles product line and a $19.3 million revenue decrease in our target launch vehicles product line, partially offset by a $6.4 million revenue increase in our space launch vehicles product line. Revenues from the interceptor launch vehicles product line decreased primarily due to a customer-directed reduction in activity on our OBV program, offset partially by increased activity on our KEI program due to ramp up of the development efforts on a demonstration vehicle test scheduled for late 2008. Interceptor launch vehicles accounted for 58% and 57% of total launch vehicles segment revenues in 2006 and 2005, respectively. Target launch vehicle revenues decreased in 2006 as compared to 2005 primarily due to a reduction in activity on certain target launch vehicle programs in 2006, partially offset by higher revenue on the Coyote supersonic ramjet vehicle program for the U.S. Navy due to transition from development into low rate initial production. Space launch vehicle revenues increased primarily due to higher levels of activity on Taurus and Minotaur programs offset by a reduction in Pegasus program activity. The Taurus program ramped up in 2006 in anticipation of future launches, and in the second quarter of 2006, we received and began work on an order for two Minotaur vehicles. Pegasus program activity declined primarily due to customer-directed delays in launch schedules.

 

Operating income in the launch vehicles segment decreased 6% for 2006. Operating income from interceptor launch vehicles continued to be the largest contributor to this segment’s operating income, with $20.6 million and $24.3 million of operating profit in 2006 and 2005, respectively, or 61% and 69%, respectively, of total operating income in this segment. The decrease in interceptor launch vehicle operating income was due to the previously mentioned reduction in revenues and program activity in this product line and to slightly lower contract fee accrual estimates in 2006. Operating income from space launch vehicles increased consistent with the product line’s revenue increase and improved cost performance on contracts. Operating income from our target launch vehicles product line increased marginally despite lower product line revenues, primarily due to cost growth that impacted several contracts in 2005. The launch vehicles segment’s operating margin (as a percentage of revenues) improved to 11.0% in 2006, compared to 10.8% in 2005. This margin increase was due to improved space launch vehicles and target launch vehicles margins due to improved program performance resulting from higher incentive fees, cost control initiatives and continued implementation of lean manufacturing techniques.

 

Satellites and Space Systems — Satellites and space systems segment revenues increased 45% primarily as a result of a $119.0 million increase in communications satellites product line revenues related to substantial progress on several new satellite contracts awarded in 2005. Communications satellites revenues accounted for 60% and 44% of total segment revenues in 2006 and 2005, respectively. In

addition, science and technology satellites product line revenues increased largely due to higher revenues on two science missions for NASA.

 

Operating income in the satellites and space systems segment increased 139% primarily due to the significant growth in revenues and contract activity in our communications satellites product line in addition to net cost reductions and favorable contract adjustments in 2006. In addition, operating income in our science and technology satellites product line increased largely due to higher contract activity on the NASA scientific missions. This segment’s operating margin (as a percentage of revenues) improved to 6.8% in 2006, compared to 4.1% in 2005. This margin increase was primarily due to cost reductions and related operating performance improvements in the communications satellites product line.

 

Advanced Space Programs — Advanced space programs segment revenues decreased 25% primarily due to a reduction in contract activity on a satellite that was launched in the second quarter of 2006, offset partially by a revenue increase on the Orion program for NASA that began in late 2006.

 

Operating income in the advanced space programs segment decreased 4% primarily due to lower overall revenues in the segment, partially offset by a favorable contract adjustment related to a satellite that was launched in the second quarter of 2006. This segment’s operating margin (as a percentage of revenues) was 8.4% in 2006, compared to 6.5% in 2005, largely due to the favorable contract adjustment mentioned.

 

Transportation Management Systems — Transportation management systems segment revenues increased 42% in 2006 compared to 2005 largely driven by work on several new contracts started in 2005 and early 2006. Three projects accounted for approximately $15.8 million of revenue growth. These increases were partially offset by a $4.4 million reduction in revenues recognized on a project in Singapore due to a reduction in activity as the contract was substantially completed at the end of 2006.

 

Operating income increased 69% in 2006 compared to 2005 primarily due to the new contracts discussed above. This segment’s operating margin (as a percentage of revenues) improved to 6.7% in 2006, compared to 5.6% in 2005 due to improved operating performance on contracts started in 2005 and early 2006.

 

Corporate and Other — Corporate and other revenues are comprised solely of the elimination of intercompany revenues. Corporate and other loss from operations is comprised solely of transactions that have not been attributed to a particular segment.

 

Liquidity and Capital Resources

 

Cash Flow from Operating Activities

 

Cash flow from operating activities in 2007 was $100.4 million, as compared to $100.5 million and $74.7 million in 2006 and 2005, respectively. Despite the increase in 2007 revenue and net income, cash flow from operating activities remained constant compared to 2006, primarily due to the increase in deferred revenues in 2006, as described below, that did not recur in 2007. Cash from operations in 2007 included an $8.3 million net reduction due to changes in assets and liabilities, primarily due to an $18.3 million increase in receivables, partially offset by an $8.8 million increase in accounts payable and accrued expenses. The increase in receivables and payables was driven by the growth in contract activity and related revenues and costs in 2007.

 

The increase in 2006 as compared to 2005 was primarily due to cash flows resulting from changes in assets and liabilities. Cash from operations in 2006 included a $14.8 million favorable net change in assets and liabilities, primarily due to a $51.4 million increase in deferred revenues, partially offset by a $34.6 million increase in receivables. The increase in deferred revenues was primarily due to cash

received in advance of contract performance on certain communications satellite programs. The increase in receivables was consistent with revenue growth in 2006.

 

Cash Flow from Investing Activities

 

In 2007, we spent $18.5 million for capital expenditures, as compared to $22.0 million in 2006, and we made net purchases of $34.5 million of investments. The nature and status of these investments are further discussed below in the section “Uncertainties in the Credit Markets.”

 

In 2006, we spent $22.0 million for capital expenditures, as compared to $15.6 million in 2005. The increase in capital expenditures was primarily related to additional integration and test equipment and an expansion of our satellite manufacturing facility.

 

Cash Flow from Financing Activities

 

In 2007, we repurchased and retired a total of 1.6 million shares of our common stock at a cost of $33.4 million. In 2006, we repurchased and retired a total of 3.7 million shares of our common stock at a cost of $66.2 million, including 2.7 million shares repurchased in connection with the refinancing transaction discussed below. In 2005, we repurchased and retired 3.2 million shares of our common stock at a cost of $34.6 million.

 

During 2007, 2006 and 2005, we received $11.9 million, $16.4 million and $7.0 million, respectively, from the issuance of common stock in connection with stock option exercises and employee stock plan purchases, and warrant exercises in 2006 and 2005.

 

In December 2006 we issued $143.8 million of convertible notes payable as discussed in more detail below. We used the net proceeds from the issuance of these notes, together with available cash, to repurchase $125.9 million of our 9% senior notes due 2011 for $133.8 million and to repurchase and retire 2.7 million outstanding shares of our common stock for $50.0 million. Debt issuance costs incurred in connection with the convertible notes were $3.4 million, which is being amortized to interest expense over seven years.

 

Convertible Notes — On December 13, 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 August 2007, we entered into a five-year $100 million revolving secured credit facility (the “Credit Facility”), with the option to increase the amount of the Credit Facility up to $175 million to the extent that any one or more lenders commit to be a lender for such additional amount. The Credit Facility replaced our former $50 million credit agreement, which was terminated in August 2007. Loans under the Credit Facility bear interest at LIBOR plus a margin ranging from 0.75%

to 1.25%, with the applicable margin varying according to our total leverage ratio, or at our election, at a prime rate. The Credit Facility is secured by substantially all of our assets. Up to $75 million of the Credit Facility may be reserved for letters of credit. As of December 31, 2007, there were no borrowings under the Credit Facility, although $18.8 million of letters of credit were issued under the Credit Facility. Accordingly, as of December 31, 2007, $81.2 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 December 31, 2007, we were in compliance with all of these covenants.

 

Long-term Obligations — The following table sets forth our long-term obligations, excluding capital lease obligations (in thousands):

 

 

The fair value of our 2.4375% convertible notes at December 31, 2007 was estimated at approximately $174.6 million, based on market trading activity.

 

Uncertainties in the Credit Markets

 

As of December 31, 2007, we had investments in auction-rate securities with a total cost basis of $34.5 million. These investments are highly rated debt and preferred stock securities with nominal maturities of 18 years or greater and are classified as available-for-sale securities under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Auction-rate securities are normally structured to provide liquidity through an auction process that resets the applicable interest rate at predetermined calendar intervals, generally every 28 days. This mechanism allows existing investors either to roll over their holdings, whereby they will continue to own their respective securities, or liquidate their holdings by selling such securities at par. Since the third quarter of 2007, these auctions have not had sufficient buyers to cover investors’ sell orders, resulting in unsuccessful auctions. When an auction is unsuccessful, the interest rate paid on the investment is re-set to a level predetermined by the security and remains in effect until the next auction date, at which time the process repeats. As of December 31, 2007, our investments in auction-rate securities were subject to auctions that have been unsuccessful. While these investments are currently highly rated securities, it is uncertain if or when the liquidity issues relating to these investments will improve, and there is no assurance that the market for auction-rate securities will stabilize.

 

As of December 31, 2007, our auction-rate securities were written down from their cost of $34.5 million to their estimated fair value of $28.0 million, based on our analysis which included market information provided by the broker-dealer of these securities and discounted cash flow analyses. We recognized a temporary impairment charge of $6.5 million in the fourth quarter of 2007 that was

recorded in other comprehensive income within stockholders’ equity, in conformity with SFAS No. 115. In addition, we classified the auction-rate securities as non-current investments on our balance sheet. We concluded that the impairment that occurred in 2007 was temporary because (i) we believe that the decline in market value that occurred in 2007 is due to general market conditions, (ii) the auction-rate securities continue to be of high credit quality and interest is paid as due and (iii) we have the intent and ability to hold the auction-rate securities until a recovery in market value occurs. The fair value of these securities could change significantly in the future and we may be required to record additional temporary or other-than-temporary impairment charges if there are further reductions in fair value in future periods.

 

Taurus II Development Program

 

We are engaged in a major new product development program to create a medium-capacity rocket called Taurus II. We believe that this new rocket could substantially expand our space launch vehicle market. However, the Taurus II program entails a major development effort. We currently anticipate that this effort will consume $40 million to $45 million of cash during 2008 before giving effect to cash receipts from any potential customer orders.

 

Available Cash and Future Funding

 

At December 31, 2007, we had $235.8 million of unrestricted cash and cash equivalents. Management currently believes that available cash, cash expected to be generated from operations and borrowing capacity under our Credit Facility will be sufficient to fund our operating and capital expenditure requirements in the foreseeable future. However, there can be no assurance that this will be the case. Our ability to borrow additional funds is limited by the terms of our Credit Facility. 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.

 

In May 2007, we announced that our Board of Directors authorized the purchase of up to $50 million of our outstanding common stock over a 12-month period. We repurchased 1.6 million shares of our common stock for $33.4 million during 2007. We may purchase up to an additional $16.6 million of our common stock pursuant to this repurchase program through May 2008.

 

Aggregate Contractual Obligations

 

The following summarizes our contractual obligations at December 31, 2007, and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in millions):

 

 

 

Occasionally, certain contracts require us to post letters of credit supporting our performance obligations under the contracts. We had $18.8 million of letters of credit outstanding at December 31, 2007, all of which were issued under the Credit Facility.

 

Off-Balance Sheet Arrangements

 

We issued convertible notes in 2006 with conversion features discussed above in “Liquidity and Capital Resources.” We do not have any material off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

Recent Accounting Pronouncements

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”) and expands disclosures about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS No. 157 does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with earlier adoption permitted, although FASB Staff Position FAS 157-2 delayed by one year the effective date of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The provisions of SFAS No. 157 should be applied prospectively as of the beginning of the fiscal year in which it is initially applied, with limited exceptions. We are currently evaluating the potential impact of SFAS No. 157 on our financial position and results of operations.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value and is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the potential impact of SFAS No. 159 on our financial position and results of operations.

 

In December 2007, the FASB issued SFAS No. 141R, “Business Combinations.” SFAS No. 141R significantly changes the accounting for business combinations in a number of areas including the treatment of contingent consideration, pre-acquisition contingencies, transaction costs, restructuring costs and income taxes. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the fiscal year beginning after December 15, 2008. We are currently evaluating the potential impact of SFAS No. 141R on our financial position and results of operations.

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51.” SFAS No. 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. SFAS No. 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, SFAS No. 160 requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. SFAS No. 160 is effective

for fiscal years beginning after December 15, 2008. We are currently evaluating the potential impact of SFAS 160 on our financial position and results of operations.

 

 

We believe that our market risk exposure is primarily related to changes in foreign currency exchange rates, interest rate risk and the market value of certain investments that we hold as of December 31, 2007. We manage these market risks through our normal financing and operating activities and, when appropriate, through the use of derivative financial instruments. We do not enter into derivatives for trading or other speculative purposes, nor do we use leveraged financial instruments.

 

Uncertainties in the Credit Markets

 

As of December 31, 2007, we had investments in auction-rate securities with a total cost basis of $34.5 million. These investments are highly rated debt and preferred stock securities with nominal maturities of 18 years or greater and are classified as available-for-sale securities under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Auction-rate securities are normally structured to provide liquidity through an auction process that resets the applicable interest rate at predetermined calendar intervals, generally every 28 days. This mechanism allows existing investors either to roll over their holdings, whereby they will continue to own their respective securities, or liquidate their holdings by selling such securities at par. Since the third quarter of 2007, these auctions have not had sufficient buyers to cover investors’ sell orders, resulting in unsuccessful auctions. When an auction is unsuccessful, the interest rate paid on the investment is re-set to a level predetermined by the security and remains in effect until the next auction date, at which time the process repeats. As of December 31, 2007, our investments in auction-rate securities were subject to auctions that have been unsuccessful. While these investments are currently highly rated securities, it is uncertain if or when the liquidity issues relating to these investments will improve, and there can be no assurance that the market for auction-rate securities will stabilize.

 

As of December 31, 2007, our auction-rate securities were written down from their cost of $34.5 million to their estimated fair value of $28.0 million, based on our analysis which included market information provided by the broker-dealer of these securities and discounted cash flow analyses. We recognized a temporary impairment charge of $6.5 million in the fourth quarter of 2007 that was recorded in other comprehensive income within stockholders’ equity, in conformity with SFAS No. 115. In addition, we classified the auction-rate securities as non-current investments on our balance sheet. We concluded that the impairment that occurred in 2007 was temporary because (i) we believe that the decline in market value that occurred in 2007 is due to general market conditions, (ii) the auction-rate securities continue to be of high credit quality and interest is paid as due and (iii) we have the intent and ability to hold the auction-rate securities until a recovery in market value occurs. The fair value of these securities could change significantly in the future and we may be required to record additional temporary or other-than-temporary impairment charges if there are further reductions in fair value in future periods.

 

Foreign Currency Exchange Rate Risk

 

We believe that the potential change in foreign currency exchange rates is not a substantial risk to us because the large majority of our business transactions are denominated in U.S. dollars. At December 31, 2007, we had $2.8 million of receivables denominated in Japanese yen and $0.5 million denominated in Singapore dollars.

From time to time, we enter into forward exchange contracts to hedge against foreign currency fluctuations on receivables or expected payments denominated in foreign currency. At December 31, 2007, we had no foreign currency forward exchange contracts.

 

Interest Rate Risk

 

We are exposed to changes in interest rates in the normal course of our business operations as a result of our ongoing investing and financing activities, which include debt as well as cash and cash equivalents. As of December 31, 2007, we had $143.8 million of convertible senior subordinated notes with a fixed interest rate of 2.4375%. Generally, the fair market value of our fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. In addition, the fair value of our convertible notes is affected by our stock price. The total estimated fair value of our convertible debt at December 31, 2007 was $174.6 million. Fair values were determined from available market prices, using current interest rates and terms to maturity.

 

Our exposure to market risk related to interest rate fluctuations for our cash and cash equivalents is not significant. A hypothetical 100 basis point change in interest rates would result in an annual change of approximately $2 million in interest income earned.

 

We assess our interest rate risks on a regular basis and do not currently use financial instruments to mitigate these risks.

 

Deferred Compensation Plan

 

We have an unfunded deferred compensation plan for senior managers and executive officers with a total liability balance of $7.0 million at December 31, 2007. This liability is subject to fluctuation based upon the market value of the investment options selected by participants.

 

INDEX TO FINANCIAL STATEMENTS AND SCHEDULE

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Stockholders of

Orbital Sciences Corporation:

 

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Orbital Sciences Corporation and its subsidiaries at December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for stock-based compensation effective January 1, 2006.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

 

McLean, Virginia

February 22, 2008

ORBITAL SCIENCES CORPORATION

 

CONSOLIDATED INCOME STATEMENTS

 

 

See accompanying notes to consolidated financial statements.

ORBITAL SCIENCES CORPORATION

 

CONSOLIDATED BALANCE SHEETS

 

 

See accompanying notes to consolidated financial statements.

ORBITAL SCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands)

 

 

See accompanying notes to consolidated financial statements.

ORBITAL SCIENCES CORPORATION

 

CONSOLIDATED STATEMENTS OF CASH FLOWS