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Alliant Techsystems Inc. (NYSE:ATK)

F3Q09 (Qtr End 12/31/08) Earnings Call

January 29, 2009 10:00 am ET

Executives

Jeff Huebschen - Director, Investor Relations

Dan Murphy - Chairman and CEO

John Shroyer - SVP and CFO

Analysts

Joe Nadol - JPMorgan

Rob Spingarn - Credit Suisse

David Strauss - UBS

Robert Stallard - Macquarie

Carter Copeland - Barclays Capital

Howard Rubel - Jefferies & Company

Gautam Khanna - Cowan & Company

Herb Hardt - Monnes

Operator

Good day, everyone and welcome to this ATK third quarter fiscal year '09 earnings release conference call. Today's call is being recorded. At this time, I would like to turn the call over to the Director of Investor Relations, Mr. Jeff Huebschen. Please go ahead, sir.

Jeff Huebschen

Good morning and thank you for joining us for our third quarter fiscal 2009 earnings call and webcast. With me this morning are Dan Murphy, ATK's Chairman and CEO, and John Shroyer, Senior Vice President and Chief Financial Officer.

During today's call, we will make several forward-looking statements regarding our current projections for future results. These statements are made under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are made based on our best estimates, estimates made based on our understanding of information known to us today and they are subject to the risks and uncertainties that face any business.

Many of those risks and uncertainties are discussed in detail in our SEC filings including our most recent 10-Qs, 10-Ks, and 8-Ks and I would encourage you to review those filings. Actual results of course, could differ materially from the projections that we make today. Certain financial measures we use today will be considered non-GAAP financial measures so we include a reconciliation of those measures to the most comparable GAAP measures on our website, ATK.com, where we will provide other additional background data as well.

Dan will open up the call today with some brief comments on the quarter and ATK's outlook. Then John will discuss some of the financial details of the quarter and our outlook. And at that point, we will open up the phones for questions from our listeners.

With that said, I turn the call over to you, Dan.

Dan Murphy

Thank you, Jeff. Good morning, everyone. Despite the current economic challenges, ATK delivered another strong quarter and we are on track to deliver outstanding performance for the remainder of the year. We have record backlog in excess of $7 billion, strong cash flow and year-over-year EPS growth is approaching 20%.

We continue to execute our long-term growth strategy, which is all the more significant given the recent changes in DoD priorities as described by Secretary Gates in his senate hearings this week. We are capturing new programs in our core businesses as well and we are extending our reach into new markets.

We are expanding our international base. We are executing on key development programs and we are successfully transitioning development into production. Backlog and order flow are strong and a bit pipeline for future business is robust.

We expect well defined opportunities and advanced weapons, military and commercial aircraft structures, military satellites and growing international demand for our armament and ISR Systems will position us for accelerated sales growth in FY 11 and beyond.

We are making significant progress in our move into structures for next-generation commercial aircraft. This area represents sustained growth for ATK. Commercial composite structures leverage our core design and manufacturing capabilities. They are the natural extension of our military aircraft structures business and capitalize on the industry shift from metals to composites for next-generation aircraft and engines. We have already secured contracts with General Electric and Rolls-Royce and anticipate announcing shortly additional contracts.

In total, we expect to receive orders in excess of $1 billion for commercial aircraft structures during this current quarter.

Elsewhere, in Mission Systems we are transitioning the AARGM program into production. We are executing on the PGK, the Precision Guidance Kit and on Excalibur 1b and we are bidding on significant new business opportunities.

Major pursuits include JATAS, Joint Allied Threat Awareness System, which is the next-generation missile warning system, which will be adapted by both the Army and the Marine Corps/Navy approval all rotary wing and non-combat aircraft.

We are also moving quite aggressively into the area of low cost ISR Programs, which we term aircraft missionization. Winning JATAS will establish ATK as the market leader in missile warning systems and provide a robust long-term business.

In aircraft missionization, we are part of Secretary Gates’ Project Liberty Program and we are expanding rapidly domestically and internationally. I visited our Fort Worth facility this week, where we are working 24/7 executing four-month turnarounds of these top priority assets. This week we have 13 aircraft and four hangers being converted.

Armament Systems expansion continues at a brisk pace. We are achieving solid international growth in medium-caliber ammunition, medium-caliber gun systems and law enforcement and military ammunition. Growth over the last three years internationally for armaments has averaged about 20% and we anticipate doubling that in our fiscal year 10.

We are also expanding our gun systems content with new capability for integrated weapon systems, again inline with affordability, which is become so important now. Our Palletized Autonomous Weapons System and our light weight 25 gun system are perfectly suited for the demands of today's military.

In essence, it’s a roll-on/roll-off capability that can be mounted in the bed of a truck or in the back of an aircraft and provide full systems capability including fire control and of course ammunition and gun. These systems provide excellent performance from a much lighter, smaller and much more affordable system.

We are also experiencing outstanding growth in the law enforcement and sporting markets due to our enhanced performance products and strong brands. We continue to grow our new tactical accessories and training lines and early market indicators point to continued strong demand in our commercial products division.

Our focus on expanding ATK's role, as a world leader in armaments is on track. During the quarter, we won the first of several contracts to supply a wide range of non-US ammunition to the Afghan and Iraqi militaries. Quality and price are key ATK discriminators that positioned us very well for follow-on awards that could exceed $1 billion over the next five years.

In Space Systems, our turn around of the spacecraft component business is on track and we are positioning the group for sustained profitability. The emerging military small satellite market represents a potentially large growth opportunity.

We have already secured significant positions on three key programs including the ORS Sat-1, which stands for Operationally Responsive Space Satellite 1, which is a very ambitious 24-month start to finish with finish being on orbit in service capability of a small satellite in support of an urgent military requirement. This first of its kind small satellite acquisition is likely to define the future of operationally responsive space. We intend to insure its success.

Within NASA, we are performing exceptionally well in support areas Ares I. We are meeting all milestones. Based on recent congressional action, we expect NASA's funding to improve this year enabling at least a partial reversal of last year's Ares I slippage, which it was entirely the consequence of a funding shortfall.

A bit further downstream, we are in the process of bidding on the cargo varied Ares V, where we had substantial composite structure and proportion opportunities. Additionally, we anticipate a key role on the conventional strike missile, which is the US Air Forces’ next-generation long-range conventional attack missile.

The defense-wide umbrella program called Prompt Global Strike will also include a navy missile barrier to be surfaced in submarine launched. We anticipate playing a significant role on this system as well.

The outlook for ATK is one of the expanded market share. Our strategy has been and is now even more so aligned with the top DoD priority of affordable capability. Our ability to develop and produce affordable innovative solutions that leverage current assets and prior investments is a matter of record.

I have listened to several within the industry speak to how they are fine tuning operations to meet the new affordability imperative. We have been there for a number of years and again we have established a record of achievement in this area.

ATK's competitive advantage is the creation and manufacturer of low cost, good enough, rapid to field military capabilities. This is a key ATK differentiator, I cannot overstate that. We offer a better than 75% solution, at a fraction of the traditional cost.

Precision Guidance Kit, Excalibur 1b, Precision Motor, AARGM the AAR-47 sensor and multi-mission ISR aircraft at a $5 million price point are pretty good examples.

We see strong support for our core defense space and aerospace portfolios and growing demand for our low cost solutions and systems. We are strengthening our business fundamentals. We are growing backlog and we are driving operational efficiencies.

In sum, the multiyear investments, we made in affordable innovation coupled with first rate execution of core programs position us very well to meet the nation's needs.

With that, John let me turn it over to you.

John Shroyer

Thanks, Dan and good morning everyone. As Dan mentioned, we are pleased with the quarter. EPS was up 19% to $1.96. Sales are up 5% to $1.1 billion and net income was up 12% to $65 million.

Orders in the quarter were up nearly 100%. We look forward to finishing the year strong and driving for even better results in fiscal year '10. We expect to finish fiscal year 2009, near the upper end of our current EPS guidance range of $7.40 to $7.50 per share.

Sales for the full year are rolling up to $4.5 billion, which is slightly lower than our previous expectations and primarily the result of slight delays in Mission Systems growth programs, including the multi-state supersonic target, which was under protest, but has since been cleared.

Our continued focus on margin improvement is positively affecting bottom line results. For the quarter, our margins improved to 10.8% from 10.5% in the prior year quarter. A real strength in the quarter was a large uptick in orders driven by Rolls-Royce and the non-standard ammunition contract for Afghanistan, which drove a book-to-bill of greater than one.

These orders build on our core business and help give us significant confidence for the long-term. We now expect to finish the fiscal year with orders in excess of $5 billion. Combined with the Ares I order from last year, our total backlog at the end of fiscal '09 should exceed $7 billion, a record for ATK.

For the year, we continue to expect free cash flow of $260 million and CapEx of $120 million. The tax rate for the year should be approximately 37%. We have tightened our share count expectations a bit to $34.2 million. We expect to make a $150 million discretionary investment in our pension fund assets in early fiscal year '10.

This will bring the PPA funded status up into the mid 90% [tail]. The prepayment net of taxes will primarily impact our free cash flow in fiscal year '10 and I will talk more about that in a minute. However, the anticipated FY 10 prepayment also affects our FY ‘09 tax expense, which we estimate will the reduce EPS by eight pennies $0.06 of the impact was recorded in the third quarter.

Now, I would like to give you more information on the performance of the groups in the quarter. Starting with Armament Systems, once again, sales of $438 million were very strong, up 15% year-over-year. Our commercial products business, which includes sport hunting and law enforcement ammunition and our medium-caliber ammunition and gun systems, led the way. While small-caliber ammunition continued to deliver at historically high levels.

Our team just returned from the SHOT Show, the world's largest commercial ammunition show and early reports indicate that we will continue to see strong growth in this segment.

On the last call, we raised our full-year sales growth expectations for the group from the low double-digits to the mid-teens. Given the year-to-date numbers and what we see early in the fourth quarter, we continue to be comfortable with that.

The EBIT rate in the group was 10% versus 9.8% a year ago, and we continue to expect full-year margins in the group of approximately 10%. Sales in the Mission Systems Group grew modestly up 2% from a year ago to $285 million. The push out of MSST and other growth programs impacted the quarter and will impact the full year as well.

We now expect FY ‘09 sales growth of approximately 6% to 7%, down from previous expectations of approximately 10%. However, with a book-to-bill for the year now expected to be more than 2% to 1%, the sales profile will turn sharply upward in the longer-term.

EBIT for Mission Systems was 12.5% on the quarter versus 11% a year ago, reflecting greater operating efficiencies, lower pension costs and the absence of a $2.7 million charge for an uncollectible account in the prior year period. We are raising our full year margin expectations to approximately 12%.

Sales in the Space Systems Group were up slightly to $386 million, compared to $394 million in the prior year quarter. We expect the group to finish the year with sales growth in the low single-digits. EBIT for the Space Systems Group was 11.5% compared to 12.5% in the prior year quarter.

Lower volumes on Minuteman III, a lower profit rate in the spacecraft structures business, and a favorable overhead benefit in the prior year were the primary drivers. For the year, we expect margins to approach 12%.

Turning to FY 10 sales, we see real strength in Armament Systems; the group is moving into adjacent markets, capturing new business like non-standard ammunition, growing its commercial portfolio including accessories, and continuing to win new business in the medium-caliber arena, including more international sales.

Mission System sales will also be strong, led by commercial composite structures, and weapons programs such as MSST. Those increases will be partially offset by decreases in Space Systems, primarily due to the scheduled close out of the Minuteman III program.

Our best look at this point puts sales in a range of $4.55 billion to $4.65 billion. We will continue to identify new opportunities and pursue additional core business. It is early, and we have a robust backlog. We're driving hard on the opportunities set to deliver top line growth and look forward to updating you throughout the year.

We expect fiscal year 10 EPS in a range of $7.40 to $7.60. That on an apples-to-apples basis is a 5% to 9% growth. EPS will benefit from increased revenue, continued margin improvement partially offset by increased pension expense. I'll come back to pension in just a minute.

Our FY 10 EPS guidance includes a $0.35 per share non-cash adjustment related to a change in convertible debt accounting rules. The change is effective on April 1st and beginning for our new fiscal year. We will be required to retrospectively adopt this change for fiscal years 2005 through 2009.

The retrospective change to fiscal '09 is expected to have a $0.42 per share non-cash impact. To clarify, our current EPS guidance for FY '09 of $7.40 to $7.50 would be $6.98 to $7.08 per share, based on the new accounting rules.

We will continue working aggressively to deliver bottom-line performance, starting with margin improvement. We expect our margins to improve slightly in fiscal 10 even as we absorb the hit from pension. We are targeting a $20 million benefit from additional supply chain management savings.

We are focused on reducing indirect expenses and seeing improvements in our spacecraft business, which as you know had a charge this year. Our B&P run rate in fiscal '09 is unusually high because of the significant opportunities we have pursued, most notably commercial composites, MSST and Excalibur 1b.

Obviously, we have been successful in all three and expect P&P to return to more historical norms in fiscal year 10.

In the back half of the year, we should begin realizing benefits from lower commodity prices. We will also benefit from the joint venture we announced last fall with Day & Zimmerman and we will obviously continue to focus on production efficiencies company-wide.

Collectively, these opportunities will help improve our margins in fiscal year 10 and in the longer term give us confidence that we will approach 11% margins by fiscal year 11.

On the last call, we provided a comprehensive look into our pension obligations. Obviously, the broader markets have not helped. We expect fiscal year 10 pension expense to be approximately $95 million, up by approximately $55 million from fiscal '09.

As you know, our measurement date for our pension plans is March 31. So it remains difficult to predict exactly where we will stand but here is what we see as the approximate expense drivers.

A $20 million increase due to asset returns that are down by approximately 18% through the end of the third quarter, and our assumption that they will be down a similar amount at the end of the year. A $20 million increase due to the reduction of our long-term rate of return assumptions to 8% from the current 9%.

A $10 million increase due to adjustments in our mortality rate assumptions. Also a $7 million increase due to our expectations that the discount rate will be down about 30 basis points to approximately 6.5%.

As a reminder, here are current sensitivities. Every 1% deviation of actual performance from our long-term assumptions changes next years pension expense by approximately 700K. On the liability side, every quarter point variance in the discount rate from our assumptions translates into an approximate $6.5 million change to the pension expense.

We remain comfortable with our liquidity and access to capital. As we mentioned last quarter, two of our three convertible debt offerings were contingently convertible. As of December 28th, that was no longer the case.

Less than $1 million of the bonds were converted in the quarter, remaining bonds are no longer convertible. We do have $280 million classified as current debt because the bond holders have the ability, to put to us, in August of 2009. We have the right to call those bonds as well, and anticipate having adequate liquidity to support that, if we so choose.

We have adequate cash on hand and $500 million revolver that will allow us to meet all of the company's anticipated needs, including the prepayment to the pension fund.

Our preliminary look at the fiscal year 10 tax rate is approximately 37%. Free cash will also be affected by the pension contributions. Net of tax, the pension will reduce free cash by approximately $130 million in fiscal 10 giving us a total of approximately $130 million to $150 million free cash flow for the year.

To recap the quarter, EPS was up 19% on solid sales growth of 5% and continued margin improvements. Net income was up 12%, our full-year fiscal '09 orders forecast of $5 billion should give us our largest backlog in history and significant confidence in our long-term growth and stability.

With that, I'll turn it back over to Dan.

Daniel Murphy

Thank you, John. Shawn, let's turn it back over to you; we're ready to begin the Q&A phase.

Question and Answer Session

Operator

All right, excellent. (Operator Instructions) We will go first to Joe Nadol, JPMorgan.

Joe Nadol - JPMorgan

Thanks. Good morning.

Dan Murphy

Hi, Joe.

Joe Nadol - JPMorgan

Dan, first over at Space, just wondering there has been a talk with the transition team of the Obama administration in the last couple of months. Then some speculation that they're looking at a variety of options for the constellation taking a new look at EELV, just your thoughts on that situation?

Dan Murphy

I think when those coming into positions of responsibility, fully understand the facts that it's highly unlikely that there will be a change made to EELV. Simply the Ares I is much more capable than a variant of EELV could be. There is no variant of EELV that is human rated, which is an enormous expense on top of the current systems. Third, no variant of EELV can be made as safe as the Ares I.

The Ares I enables a crew departure under emergency conditions anywhere along the trajectory in the atmosphere. There is no possibility of that given the dynamics of missile systems or correction and Launch Systems that were designed to carry payload, not with humans which is a significant fact. As a matter of fact, whenever our folks visit within NASA or on the hill, this is an overriding concern that there might be a change that would increase the risk to our astronauts.

So all told, there is nothing unusual at all about a new team examining decisions that have been made in the past. In fact we had our Ares I team spend half a day with the transition team in a very collegial and productive meeting, going through how we view the situation. So, I don't see it really Joe as anything more than proper due diligence by the new administration.

Joe Nadol - JPMorgan

Okay. Could you address the leadership change at the Space business during the quarter? Just a little bit about the new leader and what is going on there?

Dan Murphy

We brought Carl Marchetto into the company to run the group that was going to include MacDonald Dettwiler. With his background in the industry; his expertise is in satellite development and manufacturing. When that didn't close, we took a little time to evaluate what the best situation in terms of leadership in the organization might be for our Space Group that didn't have that $600 million business in it.

We mutually made the decision that Carl wanted to get back into the satellite business. We elevated his deputy, Blake Larson, who is our long-term executive within ATK who previously had run the Advanced Propulsion Group for us, and had been the deputy in Mission Systems Group for the last three years. We're flattening that organization, by closing down the headquarters that we had established in Virginia, moving and reconsolidating everything out into Utah, and with that achieving a recurring savings of $7 million.

We are working hard at taking costs out of an operation that has historically been cost plus, and just leaning ourselves out there as we have elsewhere in the company in anticipation of the possibility of shifts in the number of these launch contracts from a cost plus to up to a fixed price contract.

Joe Nadol - JPMorgan

That makes sense. On the orders outlook, it sounds like you're a little bit more bullish maybe today than three months ago on the outlook for the year, and you had a great quarter. Just wondering, you have a $5 billion target for the year; can you remind us where we are year-to-date? What's in the fourth quarter?

Do you have things near probability weighted either big order in there for non-standard ammo? Is there are other stuff that's coming?

John Shroyer

Joe, we're at about $3.1 billion year-to-date, so we have $1.9 billion to go in the fourth quarter. A couple of bigger ones, we do have a international order for our barrier system in the quarter, about a couple of $100 million. Then we have some composite structures, commercial orders that we expect in the fourth quarter to round out the difference other than just our normal activity.

Joe Nadol - JPMorgan

In a non-standard ammo, that we're in as a big opportunity that's out there, that will be incremental or that's beyond the end of March 31st?

John Shroyer

We do have a small Iraqi opportunity that's right around the March timeframe Joe, about $50 million. But the larger IDIQ contract, I think that you're referring to would be out into next year.

Joe Nadol - JPMorgan

Okay. Finally, John on the segments you gave, directionally, where you see things going in FY 10 with Space down, and the other two up. Can you share anymore granularity there or is that as much as you want to give at this point?

John Shroyer

I will give you some initial looks at the ranges here. On the Armament Systems, we expect them to be up in the 6% to 8% range, Mission in the 10% to 12% range. Then Space approximately down 10% driven by the scheduled closure of the Minuteman III that I mentioned.

Joe Nadol - JPMorgan

Okay, very helpful. Thanks very much.

Operator

Your next question comes from Rob Spingarn, Credit Suisse.

Rob Spingarn - Credit Suisse

Good morning.

Dan Murphy

Hi, Rob.

Rob Spingarn - Credit Suisse

Joe just asked that last question, I was going to focus on that because it looks like Space is really taking you down from what had been a long-term objective of what 8% to 10% annually for a while in sales overall?

Dan Murphy

This is a temporary situation. We've known and have reported externally for three years that this program which has been over $200 million per year in sales and highly profitable was coming to closure. We began several years ago to develop a backfill for that and that is what has now become known as Prompt Global Strike that was an ATK initiative, three years ago.

This is not a nuclear capability, this is a conventional warhead capability, but strategic in the sense that there will be a Navy and an Air Force variant with the launch capability from the United States from port deployed locations and the from the sea. The Congress approved initial budget of about $120 million in this last fiscal year, and we are already very well positioned on the Air Force variant which is the conventional strike missile CSM as I had mentioned.

As this plays out, we have every expectation that the revenue and profit that were generated by Minuteman will be replaced. But it takes a little bit of time and in fact, there is a one-year slippage in funding within the Air Force against the timeline that we had anticipated, and that's led to this sales erosion within Space for FY 10, that may carry over bit into FY 11, but for the long haul, the launch part of Space is returning to a growth situation.

Rob Spingarn - Credit Suisse

Okay. To get a little deeper into it Dan, and maybe this a question for John, but can you give us the specifics? You talked overall by $200 million swing factor here on Minuteman, but what is Minuteman in the fiscal '09? What should it be down to in fiscal 10?

John Shroyer

Yes. In fiscal '09 it will be just around $200 million for the year, and in fiscal 10 just under $50 million. Then that will be the last year as it stands, but as Dan mentioned, we are working in the Sustainment Program of that out into the future in addition to the Prompt Global Strike program.

Daniel Murphy

Actually, John that's a good point. I did fail to mention that. With increased priority on nuclear preparedness, the Air Force now supports a Sustainment Program for the Minuteman III similar to the $100 million year program that the Navy has out at least through 2020, and that was not funded this year. It will be funded next year.

So, we don't know what that total would be. I would imagine somewhere in the $50 million per year range. That’s additive to the Prompt Global Strike that I was referring to.

Rob Spingarn - Credit Suisse

Okay. Could we talk about the, on Ares and Orion, what the current ramp looks like in terms of revenue and what upside and when if you get Ares V?

John Shroyer

Right now this year, we’re going to expecting to do about $750 million to $800 million on the combination of Ares 1 and Shuttle. We do see that continuing at about that rate through next fiscal year. We are starting to bid on the Ares V work right now.

We do see that revenues are ramping up more in our fiscal year 11 timeframe. So, as Dan mentioned, that's what we see that taking off or reaccelerating a bid in the fiscal year 11 timeframe.

Rob Spingarn - Credit Suisse

How might an extension to Shuttle help you or pressure the other program?

John Shroyer

If the new administration goes that route.

Dan Murphy

We are very encouraged by the senate authorization of $1.5 billion in additional funding for NASA for this current fiscal year, with $1 billion of that earmarked for the Constellation Program, the human Space exploration program because the rub is and this is I know the core of your question. If the Space Shuttle program is extended without the additional funding, that is required to support that extension, then the Ares program gets slipped.

There's just no way around it. There is considerable support, universal support on the Hill and my meetings with key senators and representatives on both sides of the isle for closing the gap in our human Space exploration capability. If the funding is there, two additional flights can be accomplished within the preexisting budget. Go beyond that and then we've had former Administrator Griffin said, that will require about an additional $3 billion per year to sustain a program beyond the two additional flights.

We will know, within several months once there's an Administrator in place and he and his new team have had an opportunity to make their decisions and get approval by the President and the Hill as to how this is going to shape up. Should it shape up to the additional money is put in place, to close the gap then that will be a material improvement in our sales frankly beginning probably in the latter part of FY 10.

Rob Spingarn - Credit Suisse

That is key. Last question on A350, just considering the wins you have and then the possibility that you might add some stringers or something in this quarter at what point do you shift, what R&D had, when do you have and for how long and at what point do you going to revenue?

Dan Murphy

We have already expanded the R&D. We have the fully automated production capability, in place, tested out and there will be an announcement from a governor here in a couple of days, as to where that work should it be confirmed shortly, will be performed.

Rob Spingarn - Credit Suisse

Okay. And the timing Dan on A350 work?

Dan Murphy

If we were get it right away.

Rob Spingarn - Credit Suisse

Okay, excellent. Thank you.

Dan Murphy

You’re welcome

Operator

(Operators Instructions)

All right our next question comes from David Strauss, UBS.

David Strauss - UBS

Good morning. Thanks. So, Dan just to go back on [Mark’s] question, I think you had consistently maintain 8% to 10% growth despite the fact the Minuteman was coming down. So, really just to slip in the Prompt Global Strike program that’s really what’s caused this gap here?

Dan Murphy

That in the year slip in the Sustainment Program for the existing Minuteman III. The Sustainment Program is a series of tests for static tests and actual launches during the course of a year that require a continued production at a lower rate certainly than was the case for the refurbishment of the entire Propulsion Stack.

The Navy I wanted to say does about six real life tests every year. We have replaced 12 on an annual basis of the D5 Propulsion stack. In the Air Force we will implement a similar program. I believe that would have been implemented in this fiscal year, but it wasn’t so we’ve got a one year slip there.

David Strauss - UBS

Okay. Could you just give some color on what exactly you’re seeing on the civil side of your ammo business, obviously you are continuing to do well there, despite the economic environment. Can you give some color and then also, the impact of lower copper prices, how that might be helping you today, and what’s assumed in your guidance going forward for copper?

Dan Murphy

The month of December was our strongest orders month in history for commercial ammunition. We anticipate seeing, quite a bit of strength, some of that is, is speculated to be, those who are maybe stock piling some ammunition with concern that there may be a higher taxes or regulations or something of that sort.

But frankly there has been different speculation as to why these orders have stayed very strong for the last three years and we are experiencing what John; I think a 15% year-over-year growth in commercial this year.

John Shroyer

That's correct.

Dan Murphy

That is expected to be sustained through the end of the year. That’s largely a part of not so much market expansion though as it is market share expansion. The innovation, the R&D that we put into new products has made us the number one commercial ammunition provider in the world. We continue to make those well reasoned investments that keep us on top. I forgot what your second question was?

David Strauss - UBS

Lower Copper prices is the benefit you’re seeing now and what’s assumed for going forward?

Dan Murphy

What we are hedged through about the middle of the calendar year at the main price of, I think it is close to--

John Shroyer

It is about 280 a pound.

Dan Murphy

About 280, so once we work through that, again in the late summer timeframe, then we expect to experience the benefit of the little lower copper prices.

As you know, it was a Herculean feat over the last several years to retain profitability on our Army contracts, as well as commercial, in the face of a 400% increase in the price of copper, lead and zinc. Now we are on the backside of that, so that's upside.

David Strauss - UBS

Okay. Last questions. The increase in pension John, how does that flow through the segments, maybe some color on what we're looking at for margins by the segments next year? Then the convertible debt that is callable, in your guidance have you assumed that you will be calling that?

John Shroyer

First on the pension by segment, I don't have the detail there. Obviously, the Space Group is more cost type, so it will flow through. But on a net-net company wide basis that $55 million increase in expense, we expect to collect about 20ish million of that throughout the year from our customers. We have a net bottom-line increase of about $33 million or just over a $0.50 per share impact to that increase in pension.

And then as we firm up the details here over the quarter here, we'll give you the more detail out by group in the May call. And what was, I forgot the second question.

David Strauss - UBS

The convertible debt that's callable, in your guidance have you assumed that you will be calling it?

John Shroyer

We of course keep your capital deployment options open as you know and maintain that flexibility. As I mentioned in the script, that's certainly a option that we have available if we choose to use it.

David Strauss - UBS

Okay. Thanks, John.

Operator

Our next question comes from Robert Stallard, Macquarie.

Robert Stallard - Macquarie

Good morning.

Dan Murphy

Good morning.

Robert Stallard - Macquarie

Dan, first of all let me I could ask you about the acquisition landscape. In the past, you've been fairly active on acquisitions. We haven't seen anything on this front for about 12 months. I was wondering if you could see any prospects out there in terms of acquisitions?

Dan Murphy

We do have a number of prospects active. The freeze up in lending that the world has experienced has made any large acquisitions somewhat more remote for the immediate future anyway. But our very strong cash and the credit that we have on hand which approaches $500 million available to us provides us plenty of dry powder to make acquisitions that are in the less than $100 million range. Growth through organic and acquired sales is key to our success thus far, and we are not walking away from it.

Robert Stallard - Macquarie

Secondly, on the Space front, just to get this right, once you got Space down in fiscal 10 and recovering in 2011. If there’s no change to the current Shuttle and Ares plan, is it expected to dip again then in 2012 as Shuttle comes to an end?

Dan Murphy

It won't dip, no, but we probably expect to see growth closer to 3%, 4% than getting back up into the upper single-digits, which is where we would be if the star is all aligned in our favor.

John Shroyer

That’s also, where we expect the Ares V work to start to kick in on top of the Ares 1 and Shuttle decline that you mentioned.

Robert Stallard - Macquarie

So it’s kind of down up slow, it is what we can see for the next three years.

John Shroyer

Correct.

Robert Stallard - Macquarie

In terms of operating margin in Space, do you expect the margin to follow the similar sort of profile of dipping next year then recovering and then staying fairly static?

John Shroyer

I think there are a couple of things. One, of course, as we have talked about all along, the Shuttle is fairly large margin program with a lot of award fees, very mature. So obviously towards the end of that and as the Ares I ramps up over time, it gets into production, we would assume similar award fees, which will drive our margins up from where they are currently running about 11% on that program.

But then also, spacecraft business as you know, this year we took the charge and as Dan mentioned, we are on track to returning to that profitability and so we expect to see some more of that benefit toward the back half of next year, which will start to improve the margins in that area too. So overall, I still expect that group to be a very profitable segment of the company.

Robert Stallard - Macquarie

That's great. Thanks so much.

Operator

Our next question comes from Carter Copeland, Barclays Capital.

Carter Copeland - Barclays Capital

Good morning, guys.

Dan Murphy

Good morning.

John Shroyer

Good morning.

Carter Copeland - Barclays Capital

Dan, I wondered if we can talk briefly about aero-structures and about how you are speaking about the business and that opportunity longer term. Either the capability is what is derived from military capabilities, and they would seem that the contract mix is a different animal when you think about commercial opportunities. How is it that, as you think about chasing these opportunities, you insure that the profitability on that business is going to be consistent with your expectations and how do you think about the risk in it? It seems like there's a lot of growth here but in terms of profitability, how are you thinking about it?

Dan Murphy

Carter, that is a little bit of history. We’ve been the leader in automated composite structure manufacturing since the 1980s. For a full 20 years, that product set was all contained within Space launch vehicles in support of Lockheed Martin and Boeing specifically.

What we did six, seven years ago was move into military aircraft on the F-22 with the most highly stressed part on the aircraft, which is called the Pivot Shaft, which is the workhorse of the horizontal stabilator for that aircraft.

We were able to leverage our performance there with Lockheed into a relatively small position on the Joint Strike Fighter, which again through performance now, we have grown to what’s approaching $2 million dollars in content per aircraft. We do the wings, we with do the strap over the top. We do a number of structural parts there, and that’s where we really cut out teeth in the broader set of aircraft structures, when you think of frames and wings.

We have been pursuing the commercial aircraft market now for three years, and the pursuit falls in three buckets. One is in frames and stringers, I think of the internal skeleton of an aircraft and our great advantage there, is that we have developed a process fully automated manufacturing of an entire plane set of those and can be delivered as a single set. That's not possible elsewhere in the industry.

Secondly, for business jets and regional jets, we have developed the manufacturing capability through fiber placement machines, which we invented again in the early 1980s to build an entire fuselage on one mantel, again not possible anywhere else in the industry.

Thirdly, we’re using both our composite in our ceramics technologies, which are also historically proven. We have been successful in moving into jet engine components of both General Electric and Rolls-Royce, and we anticipate further growth, with further expansion of these advanced materials in the future jet engines.

There is always some risk, when you go from prototype to full rate production, but we have that very well planned out and again we have the experience behind us. So, we know what the pitfalls are. I do not see the risk is high, and I see the profitability as being a greater than what we experienced in our military aircraft structures.

Carter Copeland - Barclays Capital

Great. Is it when you think longer term about the opportunities; is it something you think will be reached entirely organically through, cost advantages or technological advantages or whatever it is, that you see on each opportunity? Or is it something that you would imagine augmenting with acquisition over time or what’s your thoughts there?

Dan Murphy

We certainly looked at rest of the industry, as it relates to aircraft structures, and there are a handful of very well established companies that have significant sales on an annual basis. What we do is different for the most part from what they do. What we do is different than that our Spirit AeroSystems or GKN for example.

We through automation design and manufacture very highly performing components, and then through that same automation are able on a smaller variant to manufacture that I mentioned entire fuselage. So, my sense is that, we will continue organically with this growth, because there is a lot of organic growth here and we may want to partner with another company to go at greater content in support of a Boeing or an Airbus for example one of the regional jet providers.

But I would not anticipate a significant acquisition in the near-term, here because we’ve got plenty to do with the business that we have acquired. As John mentioned, it’s over $1 billion, it’s over $1.2 billion in fact and that’s up from zero two years ago. So, we’re quite pleased with what we’ve been able to do. Now our focus is on performing.

Carter Copeland - Barclays Capital

Great, thanks a lot, Dan.

Operator

Our next question comes from Howard Rubel, Jefferies & Company.

Howard Rubel - Jefferies & Company

Thank you very much. First I want to go back to the convert, John. Could you give us a little bit of a range of scenarios or what your thinking is, as to why you wouldn't want to retire the convert?

John Shroyer

You know certainly where our stock price is right now, Howard. We’re going to look take a very hard look at retiring that convert. We do have high expectations that the holders of those will probably want to put those to us as well. So, I think that certainly at the forefront of our mind right now. But again as we look at all of our options and capital deployment, we still have flexibility and as we go through the year, we will take a look at that further.

Howard Rubel - Jefferies & Company

I mean it would seem to me that you also have to look and see, whether you can refinance part of that in the debt market at a reasonable price in order to replace some of the capital, because just to have it go away is a bit of a challenge.

John Shroyer

Yes, keep in mind, we are generating strong free cash flow this year. We have as well as last year, Howard. Again we expect even net of the pension contribution additional cash next year. So, we have plenty of flexibility if we choose to retire that and have flexibility for other options as well.

Howard Rubel - Jefferies & Company

So, you would probably then be limited in your share repurchases from here, if you decided to pursue an acquisition?

John Shroyer

Again, Howard, we keep looking at all three levers and of course that's one of them in the acquisition, as Dan mentioned. So, we will balance all of that, as we have done in the past.

Howard Rubel - Jefferies & Company

You have to, I mean I appreciate that. I’m just trying to understand the scenarios. The second on Project Liberty, you've gone from zero to 60 pretty darn fast on that. Does this, how do you see the program playing out and clearly, the Secretary of Defense has talked about the capability that this program and others similar to it offer, both in terms of turnaround and in terms of capability. Have you, are there other opportunities for you to pursue, Dan?

Dan Murphy

Yes. We are converting the first seven and we support L3, which received the Directed Award here. So, consider us as a junior partner on this program to L3. This is one of only half a dozen or more programs that we are executing right now. I mentioned 13 aircraft in the four hangers down there, of which seven are Project Liberty, the other six are not related.

We have one order for a similar type of aircraft for Iraq. We have delivered the first Armed Caravan, where we outfitted an ISR collector that we had developed with the capability to fire one health fire from each of the two wings. We were 100% successful in testing and that first aircraft has been delivered.

We are converting a general service for the Government of Columbia for better evac purposes. We are in discussions with several foreign governments for different variants. We believe strongly this is a sweet spot. This is not a (Inaudible) for $100 million. This is a very good capability and communications, radar, signals intelligence and electro-optical for roughly somewhere in the $2 million to $10 million range including the price of the aircraft.

As we look again at the newly focused priority in this administration, on assisting foreign governments and their militaries as partners rather than as the force that comes in, I think interoperability, none of what the United States Military uses is affordable.

So, our focus over the years including in ISR here on terrific off the shelf capability integrated by our engineers and then stuffed into an airplane and delivered complete with ground support is going to be very, very attractive internationally and I think will be enthusiastically supported by the US Department of Defense.

Howard Rubel - Jefferies & Company

Last, I want to go back to NASA. We have had this $1.5 billion to $2 billion number that is hanging out there is a possibility that it could happen. We are almost halfway through the fiscal year or approaching it. I know Congress is focused on the stimulus bill first.

But where do you think this is in the agenda, and what milestones are you looking for to see that it goes forward, so that you will be able to receive some of this on a timely basis?

Dan Murphy

What was interesting in our discussions with the NASA transition team was the recurring theme of jobs preservation. It very important to them to know the number of jobs that we have related to the program, the number that would be a lost should increased funding not be available.

I believe that given the nature of jobs within ATK, within Boeing, within Lockheed, within the United Space Alliance, very high quality engineering and program management and technician positions. This is an area that will get support on that basis alone, even if the additional funding is not contained within the stimulus bill itself, but that we will see added funding in order to protect these positions.

Howard Rubel - Jefferies & Company

So, you don't have an indication of timing on this and if I’m correct you really not factored into your 2010 numbers?

Dan Murphy

No, it’s not factored because it’s still is opaque. We don't have enough to work with.

Howard Rubel - Jefferies & Company

Thank you, Dan.

Dan Murphy

You're welcome.

Operator

Our next question comes from Gautam Khanna, Cowan & Company.

Gautam Khanna - Cowan & Company

Just to frame the segment margins in fiscal 10. Is it fair to assume that you’ll see compression at Armament and Mission offset by the pickup in Space given the lack of a charge is that how we should think of it directionally?

John Shroyer

At this point again, we’re going to really focus on margin improvement across the company in all areas certainly pension will impact armament more than others, but just generally I’d expect margins to be essentially similar to what they are this year by group at this point in the year.

Gautam Khanna - Cowan & Company

Okay. You talked about the high organic growth at Mission in 10. Can you give us some specifics as to how you think composites are going to grow in fiscal 10? The ISR conversion business, overall weapons systems, and what the percentage or absolute level of growth will be, to get you to the 10% to 12%?

John Shroyer

I think what we would like to do there, we're going to be finishing up our fiscal year here focused on that. I will give you some more details on all of those programmatic as we head into our May call for the beginning of our next fiscal year.

Gautam Khanna - Cowan & Company

All right. Thanks, guys.

Operator

Last question comes from Herb Hardt, Monnes.

Herb Hardt - Monnes

Good morning.

Dan Murphy

Good morning.

Herb Hardt - Monnes

I didn't notice any comments regarding the buyback in this quarter, whether any shares repurchased?

John Shroyer

We did not buyback any in the third quarter. We did buyback approximately 300,000 in the second quarter, and as you recall with our contingent convertible debt hanging over us there we had to insure we had plenty of liquidity should those have been put to us during the quarter.

Herb Hardt - Monnes

Thank you very much.

Operator

And we have no further questions on the phone at this time.

Dan Murphy

We will thank you then Shawn for your support through the call and for all who have been on the call we very much appreciate your interest in the company. Thank you, bye.

Operator

You are very welcome. And ladies and gentlemen, this does conclude today's conference. Thank you for your participation.

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Source: Alliant Techsystems Inc. F3Q09 (Qtr End 12/31/08) Earnings Call Transcript
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