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Orbital Sciences Corporation (ORB)

Q4 2008 Earnings Call Transcript

February 19, 2009 9:00 am ET

Executives

Dave Thompson – Chairman & CEO

Garrett Pierce – Vice Chairman & CFO

J.R. Thompson – Vice Chairman, President & COO

Analysts

Gary Liebowitz – Wachovia Securities

Patrick McCarthy – FBR

Chris Donaghey – SunTrust Robinson Humphrey

Troy Lahr – Stifel Nicolaus

Michael French – Morgan Joseph

Tyler Hojo – Sidoti & Company

Operator

Good morning. My name is Leslie and I will be your conference operator today. At this time I would like to welcome everyone to the Orbital Sciences Corporation fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions). Thank you, Mr. Thompson. You may begin your conference.

Dave Thompson

Thank you, Leslie. Good morning, everyone. Thank you for joining us for Orbital's fourth quarter and full year 2008 financial results call. I'm Dave Thompson. With me on the phone today are J.R. Thompson and Garrett Pierce.

Before we get underway, I'd like to ask everyone to take special note of the Safe Harbor paragraph that appears at the end of our earnings release. This paragraph emphasizes the major uncertainties and risk in the forward-looking statements that we'll make this morning. So please keep this in mind as we discuss the company's future financial and operational plans and our guidance during today's call.

We will follow our customary outline for the discussion this morning. I'll begin by covering some highlights from the fourth quarter and the full year and then turn it over to Garrett who will discuss our quarterly and annual financial results in greater detail and also update the preliminary guidance for 2009 that we provided last fall. After that, J.R. will recap recent space missions and major system deliveries. He'll also provide us with a preview of upcoming launches, deliveries and other major operational events that we have planned over both the next three months and for 2009 as a whole. Finally I'll address recent new orders and our contract backlog as well as the company's new business outlook for the year ahead. And at that point, we'll be happy to open up the call for your questions.

To set the stage for today's discussion, I'd like to highlight three areas in which the company's fourth quarter and full year performance was particularly noteworthy. We will cover each of these in more depth later in the morning's call.

But let's start with financial performance. A solid financial results in the fourth quarter capped a very good year for the company. Fourth quarter revenue increase d 11% to $311 million, which set a new quarterly record for Orbital.

Our operating income increased marginally to 22.4 million, even though R&D spending, primarily on our Taurus II launch vehicle program was substantially higher than was the case a year ago. And adjusted earnings per share came in at 33 cents compared to 24 cents this time last year, helped by a lower tax rate in the fourth quarter of 2008.

Free cash flow was 14.1 million in the quarter, which boosted full year cash flow to a record $82.3 million, which was slightly better than last year's $81.9 million of free cash flow. For the full year, revenue grew 14% to $1 billion 174 million.

Operating income expanded 11% to $89.9 million on the strength of rapid growth in our advanced program segment and on improved operating margins in our satellite manufacturing unit. These more than offset a large increase in R&D expenditures of last year.

And our adjusted EPS increased 26% to $1.11, excluding investment impairment charges. Garrett will give us the business segment numbers and other financial details and also update our preliminary guidance for 2009 in just a few minutes.

Next though there is our operational highlights from the quarter. Orbital carried out seven space missions in the final quarter of last year, consisting of six rocket launches and one satellite deployment. The company also completed and delivered five additional space systems comprising two satellites and three launch vehicles for future missions.

As J.R. will describe later for 2008 as a whole, the company conducted 17 space missions, all of which achieved complete success and we also delivered nine additional systems for upcoming launches.

Looking ahead, we are preparing for an even busier year in 2009 with over 40 major satellite and rocket launches and system deliveries planned to take place this year. In the first quarter alone, we are scheduled to launch or deliver a total of 10 systems consisting of three satellites and 7 launch vehicles.

And then, finally, let's take an early look at new business activity. New business wins in the fourth quarter totaled a record breaking $2 billion 290 million, propelling our full-year new orders and option exercises to $3 billion 650 million. This total was almost twice the level of new business volume in 2007, which itself was at the time a new record for the company.

The big news in the fourth quarter was NASA's award of the CRS Space Station Cargo Delivery Contract worth just under $1.9 billion over the next seven years, which I'll discuss in a little more detail later. In addition, other orders for launch vehicles and satellites contributed just over $400 million to our new business volume in the final quarter of last year.

As to potential new orders in the first half of 2009, the company currently has about $550 million of proposals that under evaluation by customers and is preparing another $200 million or more worth of bids for submittal before the end of next month. The out come on most of these opportunities, which total over $750 million in potential value should be known by mid-year. I'll cover our contract backlog composition and market outlook for 2009 later on in the call.

Now though I'd like to ask Garrett to take you through the financial results for the fourth quarter and the year and to update our preliminary guidance for 2009 that we first provided last October. Garrett?

Garrett Pierce

Thank you, Dave, and good morning. Before commenting on the financial results, I want to note that during this call we will provide certain non-GAAP financial measures, a reconciliation of these measures to comparable GAAP financial measures can be found in our earnings release or to the extent not addressed there, but discussed in this call will be available as an appendix to the transcript of this call and will be posted under our investor relations heading on our Web site.

Dave summarized the financial results. I will go into more detail. Revenues for the fourth quarter 2008 were $311 million compared to $279 million in the fourth quarter of 2007, an increase of 11%. Advanced space programs increased 43% over the prior year, reflecting the growth in intelligence defense contract activity. Our launch vehicle segment revenues increased 22% driven by the interceptor in space launch vehicles product lines.

Satellites and Space Systems segment revenues were down by 11% due to the substantial completion of certain Geo and science and technology satellites since the fourth quarter of 2007. This decrease reflects the timing of contract execution between the comparable quarters. Our satellite backlog continues to be strong.

Revenues for the full year 2008 were $1 billion 174 million versus $1 billion 34 million, in 2007, an increase of 14% year over year. Our operating income was $22.4 million or 7.2% operating margin in the fourth quarter 2008 as compared to $22.2 million or 8% operating margin in 2007. It should be noted that the fourth quarter 2008 operating income includes $1.5 million of research and development expenditures that are not recoverable under government contracts.

Operating income for the full year 2008 was $89.9 million versus $81.2 million in 2007, an increase of 11% year over year. Research and development expenses not recoverable under government contracts reduced our full year 2008 operating income by $8.5 million, lowering the operating margin about 70 basis points and reducing earnings per share about 9 cents.

We continue to believe that our research and development investment in the Taurus II product line will significantly expand our space launch vehicle market and provide substantial revenue growth in future periods.

I will now highlight certain factors in each of our three operating segments. Fourth quarter 2008 revenues in our Launch Vehicle segment were up $23.2 million over last year's fourth quarter due to a $19.2 million growth in the interceptor product line and a $9.9 million increase in space launch vehicle while the sub-orbital product line was down $5.8 million.

Launch Vehicle segment operating income decreased $800,000 in the fourth quarter of 2008 compared to the fourth quarter of 2007, primarily due to a $1.5 million unrecoverable research and development costs related to the Taurus II program.

For the full year, the Launch Vehicle segment results included $8.5 million of unrecoverable research and development costs. Excluding these R&D expenses, this segment's operating income was $11.3 million for the quarter and $47.7 million for the full year.

The fourth quarter operating margin for the Launch Vehicle segment excluding the unrecoverable R&D costs was 8.8% compared to 10.1% last year. The margin reduction is primarily due to a $1.3 million cost that was recorded in the fourth quarter of 2008 related to possible launch delays of certain space launch programs.

The fourth quarter revenues in our Satellites and Space Systems segment were down $13.4 million year-over-year due to decreases in the Geo satellite and science and technology product lines, which were down by about $9.2 million and $4 million respectively, reflecting the timing of completion of certain satellite contracts since the fourth quarter 2007.

Operating income was $8.7 million for the quarter, which is a 3% increase over the fourth quarter of 2007. The operating margin in the Satellites and Space Systems segment increased 8% in the fourth quarter of 2008 as compared to 6.9% in the fourth quarter 2007.

This margin improvement is due to the Geo product line margin increasing from 7.1% to 7.6% and the satellite and technology product line increasing from 7.1% to 11.2%. Fourth quarter revenues in our Advanced Space Programs segment were up $23 million or 43%, driven by our intelligence and defense programs.

Operating income was 3.9 million for the quarter, an increase of 400,000 or 11% over the prior year. The operating margin in the Advanced Space Programs segment was 5.2% in the fourth quarter of 2008 as compared to 6.5% in the fourth quarter 2007. The large decline is attributable to lower margins in certain national security programs due to an unfavorable contract value adjustment recorded in the fourth quarter of 2008.

The effective tax rate for the fourth quarter of 2008 was 20.4%. The fourth quarter was impacted by various favorable tax adjustments recognized on the completion of an IRS audit. As of year end 2008 we had NOL carry forwards and other tax shields totaling $243 million. We estimate that our NOLs will substantially reduce cash taxes until sometime in 2011.

During the fourth quarter, Orbital purchased 1.6 million shares of its outstanding common stock for $27.9 million. This is the largest quarterly purchase under our stock buyback program. For the full year, we repurchased 2.5 million shares or $49.5 million. Since the end of 2008, through yesterday, under our current 10D5 filing, we have purchased 358,000 shares for $6.1 million. We had $6.2 million in our April 2000 authorization of $50 million left.

From the inception of our buyback program in 2004, we have purchased approximately 12 million shares at a total cost of $197 million at an average price of $16.45. The repurchase program since the inception of 2004 has reduced outstanding shares by approximately 20%.

Free cash flow for the fourth quarter was strong, $14.1 million primarily driven by cash flows in our Launch System segment. Capital expenditures included in cash flows totaled 7.7 million in the quarter. Year-to-date free cash flow was $82.3 million, including $26.6 million of capital expenditures. Free cash flow in 2007 was $81.9 million, including $18.5 million of capital expenditures.

Our liquidity is very strong. At the end of the quarter, we had two $328 million in cash. We also had a $100 million revolving credit facility in place through 2012.

Last year, we had net interest income of $2.7 million, reflecting a 2.475% interest expense on our $144 million convertible notes payable and interest income at an average rate of about 2% on average invested cash balances of about $300 million.

Given the current economic environment and our conservative investment policy, we currently expect the interest rates on our invested cash balances in 2009 will be less than 50 basis points. As discussed in prior quarters we hold investments and auction rate securities with a total par value of $34.5 million.

Based on our ongoing monitoring and assessment of the value of these securities, we recorded a $6.2 million non-cash impairment charge in the P&L in the fourth quarter. Throughout 2008, we have recorded a total of $17.8 million of non-cash impairment charges in the P&L.

This accounting reflects the application of financial accounting standards 157, level 3 estimates of fair value. The magnitude of these impairment charges reflect the unprecedented turbulence in the credit markets throughout 2008. These securities are classified as non-current investments on our balance sheet. We have ample liquidity to hold these investments for an extended period of time. Our current effective yield on auction rate securities is approximately 3.3%.

Beginning of the first quarter of 2009, we'll be required to adopt a new accounting rule pertaining to certain net convertible debt instruments, including our convertible notes payable. This rule must be applied retrospectively, meaning that beginning in 2009, our 2008 and prior year financial statements will be change to reflect the new accounting. The new rule requires us to separately account for the liability in equity components of the convertible debt. This will result in an imputed debt discount that will be amortized as non-cash interest expense.

Although we have not completed our analysis, we believe the adoption of this rule will increase non-cash interest expense by about $5 million or 5 cents per share in both 2008 and 2009. Free cash flow and average shares used to calculate diluted EPS are unaffected by the new standard. I want to emphasize that this accounting change will not have any impact on the company's earning power or future economics. It is a non-cash charge.

We are updating our estimates of 2009 revenues in the range of 1 billion 150 million to 1 billion 175 million. However, we are maintaining our operating margin in the range of 6 to 6.25 and lowering diluted EPS to reflect lower revenues and interest income in a range of 80 cents to 85 cents per share.

The range moves to 75 cents to 82 cents per share including the non-cash charge of 5 cents per share for the new accounting treatment. The operating results include approximately $25 million or 25 cents per share of unrecoverable research and development expenses. Average diluted shares are estimated at 59 million.

The tax provision for 2009 is estimated at approximately 32% and reflects the favorable impact of research and experimentation tax credits related to the increase in research and development expenditures for Taurus II and COTS. However, more important, the tax rate is expected to continue to be about 2% to 3%, and the research and development experimental tax credits add to our NOL shield dollar to dollar as a tax credit.

Finally, free cash flow is targeted to be in the range of 65 million to 75 million in 2009. Due to higher Taurus II expenditures in the first half, we expect cash flows for the first half of this year to be lower than the second half of 2009. Now back to Dave.

Dave Thompson

Okay. Thanks, Garrett. I would now like to invite J.R. to update you on the company's major operational events from the fourth quarter and to preview what's ahead in 2009. J.R.?

J.R. Thompson

Thanks, Dave, and good morning. Operational results in the fourth quarter were very strong and concluded a solid year of execution while highlighting outstanding reliability in both our satellite and launch vehicle products.

Major system deliveries during the quarter included a NASA scientific satellite, the orbiting carbon observatory, the recently launched Geo communications satellite, NSS-9, a Minotaur Rocket, a GMV interceptor, and a Supersonic Sea-Skimming Target. Seven missions were conducted during the quarter, all successful.

The launch and check out of NASA's IBEX satellite carried to space aboard the 40th Pegasus air launch rocket and five successful launches involving intercepts, the six flight tests of a GMD OBV interceptor, a medium range target and three Supersonic Sea-Skimming Targets.

The score card for 2008 full year operations would include the successful launch of nine rockets with six more delivered, the successful launch on the orbit check out of three satellites, with a total of six delivered, four Geo communications satellites, there were five AMC 21, NSS-9 and MEO set satellites and two NASA scientific satellites, IBEX and OCO.

Five space payloads were deployed and 16 sounding rockets launched. 2009 is shaping up to be our busiest year in interceptor work since we entered that market almost ten years ago, with three flight tests planned. The first two stage interceptor tests planned in early July, the first KEI flight test scheduled in August, and the 7th three stage interceptor flight tests later in the year.

We expect to deliver ten interceptors during the year, eight mid course and two boost phase interceptors. Approximately 50% of our staff in Arizona is now allocated to this area of our business, where mission reliability and 100% success have been the key to our success.

This year we will see a major ramp up in the Minotaur program with a Minotaur I launch later this month followed by as many as five Minotaur four launches throughout the year. Three space launches carrying DOD payloads and two sub-orbital launches carrying hypersonic test experiments.

Significant progress has been made on the launch of board system for NASA's Orion spacecraft. A critical development firing of the control motor has been successfully completed and we anticipate delivery of the Jettison abort and control motors for white sand over the next two months.

Our satellite manufacturing facility remains busy, with nine Geo communication satellites and one scientific satellite in integration and test flow. With a change in administration, we expect a significant upturn of interest in earth science satellites by both NASA and Nova. The Geo communications business is expected to remain relatively strong. We are now well along in the development of the two basic elements of the space station cargo resupply system.

The Taurus II launch vehicle and the Cigna space station rendezvous space craft it will carry to orbit. All design reviews for the Taurus II vehicle will be completed by this spring. Construction work will soon begin at Wallops Island launch site. Facility modifications are progressing at NASA's Stennis Space Center, with new testing scheduled to begin this fall.

Delivery of the cryogenic first stage from the Ukraine is only 15 months away. And although the schedule is tight, we are still targeting the initial Taurus launch by the end of 2010. The final design review for the Cigna space craft will be completed in August. Long lead procurement of systems has begun and we are targeting to begin spacecraft and the integration and tests one year from now.

Hiring of new staff continues to be a priority, with just over 600 new employees joining us in 2008, including 135 in the fourth quarter. We ended the year with a total staff of just over 3,600 employees. To accommodate both this growth and our projected needs for the immediate future, Orbital completed and occupied new facilities in Virginia, Arizona and California. Last year – and began construction on one more building in Arizona that will be ready to occupy this fall. We currently expect to add another 350 new employees to 400 new employees in 2009.

Major system deliveries for the first quarter include two Geo communications satellites and SS-9, Optus D3, four Supersonic Sea-Skimming Targets, the Taurus launch vehicle for next week's NASA's earth science OCO mission, two GMDM interceptors, a medium range target, a Minotaur IV for the SBS space based surveillance system mission and the Jettison and abort motor deliveries for the mid year pat abort test at white sands missile range.

Missions scheduled during the quarter include last week's successful launch and deployment of the NSS-9 Geo communications satellite that is now in Geo stationary orbit. And by the way, Orbital’s 16 Geo satellite in orbit.

And SST, stream rate operation with the U.S. navy, a Minotaur I launch for the TacSat-3 mission and the previously mentioned Taurus launch in OCO satellite. For the 2009 full year, we expect to execute 30 missions or project events, 21 rocket launches, five communication satellites, two science satellites, five payload deployments, a pat abort test for the Orion program, two Taurus two system test milestones, 15 additional major system deliverables and another 20 to 25 sounding rocket launches.

We expect this year to be the most productive in the company's history while laying the foundation for a new launch vehicle and cargo resupply system for NASA’s space station.

And now I'll turn the discussion back to Dave.

Dave Thompson

Thank you, J.R. I'll now report on our fourth quarter and full year 2008 new business and contract backlog figures and then I'll also comment on our overall market outlook for 2009 as we see it today. Of Orbital's $2 billion 295 million in total new business volume in the December quarter, about 165 million was in the form of new firm orders, a billion 890 million was in the form of new option orders and 240 million was in option exercises under existing contracts.

Our Advanced Space Programs segment received a lion share of the fourth quarter's new business, with a total of $2 billion 65 million, powered by the almost $1.9 billion CRS contract. This was followed by our Launch Vehicle segment, with $125 million in new business volume and our Satellite and Space Systems segment with $105 million in new business.

For the full year, the three segment contributions to new business volumes were as follows

Launch Vehicles came in at 655 million, roughly 18% of the company total, Satellites and Space Systems added $640 million, also about 18% of the total, and Advanced Space Programs won $2 billion 355 million of new business, some 64% of our total for the year.

The most notable fourth quarter order was our selection by NASA for the space station Commercial Resupply Services or CRS contract. As currently structured, the CRS contract involves eight launches of our Taurus II rocket and Cigna's maneuvering spacecraft carrying a total of about 20 metric tons or some 44,000 pounds of net cargo to the international space station.

These launches are scheduled to take place over a four-year period from 2011 through 2015 following the COTS demonstration mission of our Taurus II and Cigna system set for late next year. As you probably know, NASA's contract decision on CRS was protested to the government accountability office by a losing bidder. We believe NASA made a good and proper decision in the CRS procurement and expect the protests to be resolved by April.

Beyond this large order, other substantial contracts in the fourth quarter included an addition of six more orbital boost vehicle interceptors in our GMD program with Boeing, the order for our fourth Geosynchronous communication satellite of 2008 by Intelsat and an increase in the value of our Orion launch escape system contract with Lockheed Martin.

Reflecting the year's record setting new business results, the company's firm contract backlog as of the end of December increased about 3% to $2.11 billion and our total backlog jumped about 50% to approximately $5.86 billion. Both of these compared to the respective backlog figures a year earlier.

By reporting segment, Launch Vehicles accounted for about 52% of firm backlog and 36% of total backlog. Satellites and Space Systems contributed 21% of firm and 17% of total backlog and Advanced Space Programs added 27% of firm and 47% of total backlog. As we began this year, the company had approximately 85% of our projected 2009 revenue and about 50% of our 2010 projected revenue in these backlog figures.

Looking ahead to the first half of 2009, Orbital currently has approximately $550 million worth of new business proposals that are under evaluation by customers and we are also preparing another $250 million more for submittal before the end of March. All of these are expected to be decided on by customers during the first half of this year.

Some of our best near-term prospects are for potential new orders and option exercises for several space launch vehicles, one of which we announced earlier this week. For additional missile defense interceptor rockets and target vehicles and for several military and scientific satellite programs. Together, these account for about $500 million of our first half new business opportunities.

Later on in the spring or early summer, potential new business in commercial and national security satellites in the first mission exercise under the CRS contract could contribute sizable amounts to second quarter and third quarter backlog growth as well.

I'd be happy to discuss our view points on each of these market areas during the Q&A period in just a few minutes.

To add to what J.R. has already reported on the Taurus II and COTS programs, both the new Taurus II Launch Vehicle and the Cigna's maneuvering spacecraft remain on track for their demonstration mission under the COTS program late next year.

However, as J.R. pointed out, our schedules are tight and there are many important events coming up over the next six months. These include the final engineering design reviews on Taurus II in later this month and March and for the Cigna's and its cargo modules in the late summer. Along with the Taurus II propulsion testing this summer and fall and the first unit production starts on both the Taurus II rocket and the Cigna's spacecraft before the end of the year.

The Taurus II R&D and CapEx spending through the end of last year put us at just under 25% of our total planned investment level. But with expenditures ramping up to their maximum monthly rate in the first four months or five months of this year, we expect to be around 55% complete on the Taurus II investments by mid-year and about 75% complete by the end of 2009.

The Cigna spacecraft and its cargo module were less than 15% complete based on costs incurred through last December, but they also are now progressing rapidly. We anticipate being about 35% complete by the end of June and around 55% complete by the end of December on the Cigna's system.

I want to caution everyone that our work on both Taurus II and Cigna's represent major development efforts with plenty of chances still ahead for things to be delayed or for costs to come in at greater levels than planned.

As we see it now, however, the first half of this year is expected to be the time of strongest P&L and cash flow headwinds due to these R&D and capital investments. For instance, about 60% to 65% of this year's EPS reduction due to these investments is expected to occur during the first and second quarters.

Finally, regarding the preliminary design and early customer marketing of the potential expansion of our current communications satellite product line, design work has continued, but it is still premature to say if Orbital will proceed with the full development of this larger spacecraft.

Since last fall, we have completed most of the technical tray studies and are close to having an integrated final design that as of now looks promising. But additional market testing is going to be required over the next three months to six months before we will have enough information to make a go or no go decision about the full development of this new higher power communications satellite.

To wrap up, 2008 was an outstanding year among the very best in Orbital's quarter century history. Our financial results exceeded targets and set new records for revenue, EPS, cash flow and year-end backlog. Our operational performance was fast paced, consistent and ultimately very successful and our new business activity also set an all time record for the company.

Looking ahead to 2009, we will certainly continue to face the normal strategic and operational challenges that characterize our business. This year, these regular challenges are likely to be amplified somewhat by shifting growth prospects in several of our markets and by considerable investment headwinds due to our Taurus II and COTS development work.

However, even though the year ahead will be particularly challenging, I am convinced that our long-term strategy for building shareholder value is very sound. On the basis of the investments we're making now, I'm confident that the company is on track for a return to double-digit revenue growth, a substantial profit margin rebound and strong EPS gains in 2010 and for years beyond. Thank you for your attention. I think we're now ready to open up the call for your questions.

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from the line of Gary Liebowitz of Wachovia Securities. Your line is open.

Gary Liebowitz – Wachovia Securities

Thank you. Good morning, gentlemen.

Dave Thompson

Good morning, Gary.

Gary Liebowitz – Wachovia Securities

Dave, can you comment a little bit on the stimulus plan? It looks like NASA got about a billion dollar mark. Have you had a chance to look at that and any sort of details as to what types of opportunities would be available for orbital?

Dave Thompson

Yes, we've taken a preliminary look at what – the information that's available on that and that does represent a potential upside for us over the next year or 18 months. As you say, Gary, NASA received about a billion dollar unexpected funding increase in the economic stimulus package and that includes about $400 million for an accelerated program of earth science satellites and also about $400 million that can be applied to the Orion and AIRES system. NASA is due to report back to Congress within a little less than two months in terms of the details of how they would – how they would put that money to work over the next 18 months to 24 months, and so all of the program level information is still being formulated by the space agency. We'll be watching that carefully and we do view that as an area of some upside potential for us.

I might also mention, in this connection, that as J.R. mentioned, in addition to this increase for NASA, within the Department of Commerce, the National Oceanic and Atmospheric Administration, which is a companion agency to NASA in the area of weather satellites and earth science, spacecraft also received a substantial contribution from the stimulus package. Again, the details on that are not immediately available, but we'll be tracking that closely over the next couple of months as well and the potential there is at least in the earth science area is roughly comparable to the $400 million increase that NASA has been allocated. So those do look like both short-term and I think longer-term growth areas for the company. We'll also be watching closely when the fiscal year of 2010 budget comes out in April for potential additional increases beyond just the stimulus investments that would apply over the next year and a half or two years, but for the longer term as well.

Gary Liebowitz – Wachovia Securities

Thanks. And then just on the quarter, could you just comment on the strong revenues? It looks like maybe Orion sales rebounded more than we might have expected and also the OBV line? Where was the upside?

Dave Thompson

It was in those two areas plus – both of which were a little stronger than we expected and there was a third area that also contributed higher than anticipated revenue. That is in the Advanced Space Programs segment, but more specifically in our military and intelligence satellite programs. Those are – those have been growing quite rapidly over the last year or two and are expected to continue to be significant contributors to growth relative to what they did last year both in 2009 and years beyond.

Gary Liebowitz – Wachovia Securities

But Orion is still expected to peak in 2008 and face a tough comps this year.

Dave Thompson

That's correct.

Gary Liebowitz – Wachovia Securities

Okay. Thank you very much.

Operator

Thank you. Our next question comes from the line of Patrick McCarthy of FBR. Your line is open.

Patrick McCarthy – FBR

Hi, good morning. Thanks for taking my call.

Dave Thompson

Yes. Good morning, Pat.

Patrick McCarthy – FBR

Just two quick questions. One is when you look at the '09 guidance – and I apologize if you had mentioned this at the beginning of the call, but could you just talk about some of the puts and takes in the guidance change, maybe how much is from the quarter beating in the fourth quarter and then how much maybe for the protest in CRS and other things?

Dave Thompson

Yes. Sure. I'm not sure I can quite quantify the breakdown, but at least qualitatively, I would say that $25 million at least for the time being been reduced from our preliminary numbers largely attributed to the delay in starting up on CRS. That by the way also translates into a couple of pennies in terms of EPS. In addition, as Garrett alluded to earlier, even in the last couple of months with the interest rate environment continuing to evolve, we've reduced our expected interest rate on our cash balances to something like a half a percentage point for the year ahead and that also took two cents or three cents out of the EPS range that we had anticipated as recently as October. The kind of fourth quarter surge probably also had an effect.

So putting all those together, we thought at this point, the right thing to do was to take a little more cautious approach on the outlook for this year. There's some other puts and takes that probably net out right now to roughly a neutral effect and we'll be watching both potential opportunities and threats over the next couple of months pretty carefully as the opportunities that I mentioned in response to Gary's question come into better focus and also as we get better insight into the fiscal year 2010 defense spending outlook, which also is something that we'll start to become clear in April. I don't think we'll have the full story there until probably late summer, early fall, once Congress has reviewed it. But this is a period of unusually high uncertainty with both the change in administrations and the general economic situation, and so we're going to take a little more guarded approach than we might have under more normal circumstances.

Patrick McCarthy – FBR

Okay. Thank you. And then maybe on Taurus II, just thinking about the supply chain a little bit, how is that going right now? Are there any issues there that you're monitoring and is it just coming along well?

Dave Thompson

Well, it's a big challenge and we are spending a lot of senior management time on it. And so far things seem to be going along pretty well. There are some significant challenges to us that we haven't encountered in the past, particularly on the first stage, which is powered by liquid rocket engines that are being provided to us by Air Jet, and that's probably the – that's certainly not the only area we have to pay a lot of attention to, but that's number one on my list of things to stay focused on, particularly this year as J.R. indicated, heading towards main engine testing late this summer, early in the fall and the first flight vehicle deliveries to the launch site just over – a little over a year from now in the spring of next year. So we'll be updating you on that. You can count on our paying a lot of attention to that everyday between here and there.

Patrick McCarthy – FBR

Okay. And then on the military and Intel satellites, could you just talk whether you're doing the buses or the payloads or both and then whether you're a prime or a sub? Thank you.

Dave Thompson

Sure, Pat. It's kind of both – the answer is both to each of those questions. Although primarily our business is one characterized by building the buses and integrating payloads even that we buy or that are supplied from our government customers, we also, on occasion, will build buses for other system integrators and in a couple of specific areas, we've developed some real state of the art payload capabilities that we use both on our spacecraft and provide to other prime contractors. So we are active in kind of all four elements of that two by two matrix, but the primary activity is in the prime contract and spacecraft bus and system level or area.

Operator

Thank you. Our next question comes from the line of Chris Donaghey of SunTrust Robinson Humphrey. Your line is open.

Chris Donaghey – SunTrust Robinson Humphrey

Hi. Good morning, Dave.

Dave Thompson

Hi, Chris.

Chris Donaghey – SunTrust Robinson Humphrey

First of all, I guess, on the Taurus II program, you said it's costing you about 25 cents in 2009, which has margins done to the 6.25%. Can you at least help us with the box or the range of expectations that we should be thinking about for 2010? Do we see margins come back to 2008 levels to 2007 levels? Just kind of help us get that range set for next year.

Dave Thompson

Yes. Let me try to get you in the ballpark, but stop short of proposing any real guidance for next year at this stage. As I mentioned earlier, this year and particularly the first half of this year is expected to be the time when the P&L and cash flow headwinds are going to be strongest on the Taurus II program. We began the year on a cost basis at about 25% incurred. Most of that was incurred in 2008; I'd say 20% of the 25% was incurred last year, with 5% or maybe even less than 5% having been incurred in 2007 when we really ramped the program up. By the end of this year, that 25% will have gone to about 75%. So what's left after that in the final year is about equal to what we spent last year. And so to the extent that's the only factor involved and hopefully we'll do a little better than that with further margin increases in our main line businesses then we ought to be in the neighborhood, maybe a little better than 2008 operating margins in 2010.

Chris Donaghey – SunTrust Robinson Humphrey

Okay, great. And as you think about this medium class satellite program is there going to need to be a customer decision that serves as the catalyst for proceeding with full scale development of that satellite?

Dave Thompson

That's – yes. That's the way – the way we're structuring it now, Chris.

Chris Donaghey – SunTrust Robinson Humphrey

Okay. And then last I know we're still waiting to get the details from the administration, but there has been talks about missile defense budget being cut by 20%. Have you had any kind of visibility into where you think that those different programs are that could see pressure in terms of the different elements of missile defense?

Dave Thompson

That's probably the area of greatest interest to me, but also fairly considerable uncertainty right now. Let me tell you what I know and then I'll speculate a little bit beyond that. First of all, missile defense agency ended up doing reasonably well in the fiscal year 2009 budget that was approved last fall. Overall, MDA received about a 5% increase over the prior year and is operating with an FY '09 budget of about $9 billion. That excludes a handful of missile defense programs that fall under the general umbrella of the missile defense integrated system, but are managed and funded by the Air Force or the Navy or the Army. But first order, about $9 billion plus is being spent this year. That includes about $2 billion for the GMD program, which is our flagship, and another almost 400 million for KEI, and about 650 million for targets, also both those latter areas being important for us, and both those latter areas being up compared to the prior year. We won't really know – we probably won't really know what the fiscal 2010 numbers are going to be until the early fall.

We'll certainly have a good head start on next year when the fiscal year 2010 budget is released in April, and I wouldn't be surprised to see at least a 10% cut to MDA at that time. That first 900 or billion dollar reduction from our standpoint is while not desirable, it doesn't have much of an impact on our business. It's likely to fall on some of the longer term systems that may slow down or otherwise impact things like airborne laser and miniature kill vehicle and space based systems that are undoubtedly valuable, but which we're not particularly involved in. If the cut went deeper than that, then we would be more concerned about impacts on KEI and GMD. But the – whatever comes out in April is probably not going to be definitive.

There are several major defense related reviews that are underway now that we'll be producing their results between – it's sort of too late to affect the April budget, but during the period from – I guess late March through July or August. We've got not only the quadrennial defense review, but two other reviews, the strategic posture and nuclear posture reviews that will undoubtedly fold into the way Congress reacts to the administration's budget. So I think it's going to be well through the summer and into the fall before we have the definitive answer in terms of what 2010 is going to look like. We have planned for some time as part of the overall long-term five year GMD outlook for – at the GMD program level, about a 15% drop in fiscal year 2010 funding relative to fiscal 2009. I think the questions could – and that's all built into our outlook. The question is will it be – will it be larger than that? And we just don't know at this stage. I would point out though this is a pretty complicated problem. The official position stated recently as a week or so ago by the vice president, the official position of the Obama administration is that it will deploy missile defense systems including GMD if they are demonstrated to work and if they're cost effective.

So the best thing we can do to help ourselves this year is to carry out those tests that J.R. referred to, to further build confidence that we have that we need to make sure others that are in positions of authority also share that the system really does work. And so that's what we're going to stay focused on and try to find ways to allow the pace of testing to increase to further improve the capabilities of our system and to build confidence among national decision makers that this is a technology that's – it will work in militarily useful ways.

Chris Donaghey – SunTrust Robinson Humphrey

Okay. Great, Dave.

Dave Thompson

Okay.

Operator

Thank you. Our next question comes from the line of Troy Lahr of Stifel Nicolaus. Your line is open.

Troy Lahr – Stifel Nicolaus

Thanks. Wondering if you guys can talk a little bit about the commercial market for satellite, see how that's holding up and maybe what your expectations are for the market in 2009 and then also what you expect awards to be for your wins?

Dave Thompson

Okay. Good morning, Troy. The major operators, Intelsat, SES GLOBAL, Udelsat and so on are the top five or ten that dominate the business and account for the lion share of new satellites being purchased, continue to maintain a pretty optimistic outlook on their businesses this year and in the future. Part of that I think reflects the very high level of current capacity utilization that these operators are enjoying, which ranges from low 80% to in some cases the mid to upper 90% range, which is a historical high for this industry looking back over the last 20 years or so years.

So capital spending budgets and so on are – at least publicly, nobody is backing off from that. Our views are little more guarded. And in comparison to last year, where there were 25 new orders and the prior year when there were 23 new commercial satellite orders, we could see a reduction this year in our view down to something in the range of 17 orders to 20 orders. Now I think the first place that we're going to see that reduction is likely to be among the start-up operators that over the last couple of years have contributed to two orders or three orders 10% or so to the total. I just don't see that likely being replicated this year due to a lack of access to capital. We also saw, particularly, last year, unusually large number of government sponsored operators ordering satellites. That's probably not going to – it will probably be reduced a bit this year.

So among the established operators where our business is focused we could see – we could see the same level or slightly reduced level compared to the average of the last couple of years. Last year, the established operators bought 18 satellites of the 25 new satellites, and the year before they bought 17 satellites of the 23 satellites. So that's why we're – it sounds – it seems like that part of the market is hold together really well. But some of the incremental orders from start-ups and so on are probably going to drop to near zero. At the level of our addressable market for the smaller class of satellites, we expect there will be six orders to eight orders. That would be similar to the six orders in 2007. We had an unusually large number of industry wide small orders last year depending on how you count it, either 11 orders or 12 orders. We don't see it being at that pace this year.

So we're looking for addressable opportunities of six orders to eight orders, and they are targeting three orders with probably a plus or minus one order variability on that three unit target this year. I do think here is another area where we're inclined to be a little more cautious at this stage than perhaps in the past due to uncertainty in the general economic environment, although for the time being, the large customers are not – are not reflecting that in their plans.

Troy Lahr – Stifel Nicolaus

Of those three orders that you're targeting, are those options being exercised or how do you break that down?

Dave Thompson

Two orders – if it turned out to be three orders, then the most likely composition would be two new orders, at least one of those from a repeat customer, but not an option exercised and the third orders would be option exercised under an existing contract.

Troy Lahr – Stifel Nicolaus

Okay. And then I think on the last call, you talked a little bit about 2009 at the segment level just from the sales and directionally from a margin standpoint. Can you maybe walk us through update us a little bit how you're thinking about 2009 from a segment standpoint?

Dave Thompson

Sure. Right now we see growth, although at modest levels in percentage terms in our Launch Vehicles and satellites and Space Systems segment, but offset by a drop-off in revenue in our Advanced Programs segment. The primary reason for that revenue drop-off is as, I think, Garrett mentioned or maybe Patrick did earlier, this past year was the peak year on the Orion program and while CRS and Taurus II and military satellites are all expected to grow quite substantially in 2010, we don't anticipate at this point that their growth will more than offset the drop-off in the Orion work. So advanced space programs is expected to be down, the other two segments up on a revenue basis.

From a margin standpoint – let me start with good news. I think as we saw last year, the Satellite Space Systems segment had a – has significant improvement in operating margins driven by almost a 100 basis point expansion of margins in the commercial satellite division. We expect to see additional margin improvements in that segment this year. The Launch Vehicle segment will be most adversely affected this year at the segment level by the headwinds I talked about earlier coming from the Taurus II investments and so it will be down for the year and particularly for the first half of the year. And the Advanced Space Programs segment I'm not sure I have – I think it will be down a bit, but not as significantly as what we would expect in the Launch Vehicle segment.

Troy Lahr – Stifel Nicolaus

Okay. So it sounds like really no major changes to your 2009 based on what you provide in the third quarter.

Dave Thompson

That's right. I think the margin picture is holding. The revenue picture is driven largely by the delay in ramping up CRS and probably a little bit of the unexpectedly strong fourth quarter revenue that had been anticipated this year and the EPS picture is a little bit related to the revenue and a little related to the lower interest income that we expect in the current interest rate environment.

Troy Lahr – Stifel Nicolaus

Okay. Thanks. And just one point of clarification, I think it was Garrett mentioned there was cost growth due to launch delays. What specifically was that?

Dave Thompson

We have two launches planned this year of our regular Taurus rocket, not the Taurus II, but the regular Taurus rocket. One of those is currently scheduled for next week. That's in good shape and on course. However, the second of those had been scheduled for – originally for June due to scientific instrument delays on satellite it's carrying to orbit. It was pushed back once a few months back to September and then further delayed to November. We thought it would be prudent to take a little more conservative position on the cost if the launch is delayed and if we max out on our ability to recover delay costs from NASA, which is the customer on that mission. And so we – we've adjusted our cost estimates to reflect the latest thinking on the launch schedule, which puts it in the fourth quarter and a conservative approach to how much of the delay cost we might be able to recover through reimbursement.

Troy Lahr – Stifel Nicolaus

Okay. Great. Thanks, guys.

Dave Thompson

You bet. Thank you.

Operator

Thank you. Our next question comes from the line of Michael French of Morgan Joseph.

Michael French – Morgan Joseph

Good morning, gentlemen.

Dave Thompson

Morning, Mike.

Michael French – Morgan Joseph

I have a follow-up to a question you answered earlier about the '09 guidance. You mentioned the 25 million reduction for the time being related partly to CRS being delayed. My question is, if the protest isn't resolved in April will that result in further reductions, and if so, how much?

Dave Thompson

Yes, it could. If a favorable resolution of the protest is not forthcoming in April and we do expect that there will be a favorable outcome; but if that were not happen, then we'd have to once again take a look at the outlook for the year. The magnitude of that of any adjustment would depend on our estimate at that time as to how long some additional delay might be, I guess, in the extreme case, the program just didn't happen at all this year, didn't ramp up at all this year, we could be looking at something in the range of $50 million. We don't think that's very likely, but I think that would down the possible – the range of the possible.

Michael French – Morgan Joseph

Okay. Thanks. That's helpful. Another question that's kind of a follow-up to it, you were just discussing on the commercial satellite side and so the margins there were pretty strong at 8%. And question is, in the pricing environment, you mentioned that the order environment looks like, but does the pricing environment today enable you to continue to expand the margins past '09?

Dave Thompson

I think pricing will continue to be a helpful contributor, but probably more important to our business than pricing is the payoff of work we did a couple of years ago in improving the efficiency and timeliness of our design and manufacturing flow for those spacecraft. We – as J.R. mentioned, the launch of our most recent commercial communications satellite last Thursday, NEW SKIES nine spacecraft was the 16th commercial satellite that we had launched into orbit. Fifteen of those have occurred just over the last – the last six or six and a half years. And so we've gotten better and better at building these satellites and maintaining our schedules. In fact, the last two that we delivered, NEW SKIES nine and Optus D3 were both built ahead of schedule – delivered ahead of schedule and that avoids any extra cost that we had incurred on occasion in years past when programs took a little longer than expected. Both of those two recent satellites were designed, built and delivered in 23 months from the time the order was placed. And as we get better at – as added I'm confident we will over the next couple of years, together with perhaps some pricing flexibility, we should be able to further improve margins. The hundred or so basis point improvement we saw in 2008 it was not something that we can replicate indefinitely, but we are looking for sizable improvements in margins this year and next year in that business.

Michael French – Morgan Joseph

Okay. Thank you. And lastly, there's been a lot in the news lately about the Iridium situation the Russian satellite creating a (inaudible) 350 mile orbit and just wanted to see from your perspective whether there's any concern from customers, whether the commercial folks who have operations channel over to whether they will see insurance rates go up or whether this might be more business because more satellites need to be replaced. Is that issue a factor at all in your business?

Dave Thompson

Mike, so far, we haven't seen it rise to the level where having any business impact. As you pointed out there are a number of commercial operators both in the communications and in the imaging markets that own and operate low orbit satellites, although the majority – strong majority of the commercial satellite market is at a Geosynchronous altitude, which is unaffected by any debris from this collision. But so far, no, we haven't – we haven't seen really any impacts, and hopefully we won't, because worst thing for the industry would be if that – if the debris from that collision triggered other collisions and it would very quickly cascade throughout certain orbital bands, although, again, I don't think that would affect the Geosynchronous market, which is our bread and butter commercial satellite market, it would certainly be a bad development for a variety of government satellites, both civil and military, and it would also be negative for insurance rates and other business factors in our sectors.

So hopefully it took a little over 50 years since the first satellites were launched for this initial collision between two spacecrafts to occur. Hopefully, it will be a long time before we see another one. I think this is raising the general level both in the U.S. and internationally of the importance of space situational awareness, something that approximates what is done both domestically and globally and air traffic control, and that which is a function primarily carried out by the military today could generate some future opportunities.

For instance, the launch coming up here in a few months of our first Minotaur IV rocket is carrying a satellite, J.R. mentioned the air force has based a surveillance system satellite which is designed to – from space map not only satellites but smaller objects, debris and so on, much more accurately than we've been able to do in the past, and if things go well there, that could be the first of a small fleet of such space traffic control platforms that we might see coming along over the next four years, five years that might represent opportunities both in our satellite business and in our launch business. But that's pretty speculative at this time.

Michael French – Morgan Joseph

Okay. Well, thank you, David.

Dave Thompson

Okay. Thanks Mike.

Operator

Thank you. And our final question comes from the line of Tyler Hojo of Sidoti & Company. Your line is open.

Tyler Hojo – Sidoti & Company

Hey, good morning. Just a couple of quick items here. What is the aggregate R&D spend rate that's within your guidance? I understand the D2 portion, but just outside of that just a total spend rate for 2009?

Thompson

Hold on just a second on that one, Tyler, we'll try to get you an answer. I'll tell you the Taurus II is the lion share of it, but let me see if we can give you something that's a little more precise than that.

Garrett Pierce

As we're looking let me give you a little backdrop. The R&D rate ex-Taurus II in 2007 and 2008 is fairly constant. So the movement you see the big jump in research and development year-to-date is a function of principally of Taurus II. So the 25 million that we talked about that's the unrecovered Taurus II expenditures.

Dave Thompson

Yes, the base level of R&D, which covers normal product upgrades and enhancements has historically at least over the last five years for us, run between 1% and 2% of revenue. We deviated for the first time last year from that ratio because of Taurus II, and unless we can come up with the number here in real time we'll have to call you back on it but I would think that would probably be a pretty good guide.

Tyler Hojo – Sidoti & Company

Yes. That's fine. And just to move on to something else here, what is the – what is the CapEx plan for 2009 that's embedded in that free cash flow guidance?

Dave Thompson

Right now it's roughly double the CapEx level that we incurred last year, and I think Garrett quoted last year is at 26.

Garrett Pierce

Yes, it's about 45 million, 50 million something in that range.

Dave Thompson

45 million to 50 million.

Tyler Hojo – Sidoti & Company

Okay. And just lastly, just the cash balance $328 million, what are your plans there? Maybe if you could just talk about potential additional share buybacks or whatever else could be on store?

Dave Thompson

Well, I could tell you our plan is just to sleep well at night with that but –

Tyler Hojo – Sidoti & Company

Okay.

Dave Thompson

No. We had a – as Garrett said, we had a very active year last year, just under $50 million was deployed in 2008 for buybacks and we have a 6 million or so left in our current authorization, which runs through the end of April. At the regular board meeting in April, we'll be proposing a reload of some magnitude to that plan, and so I would expect that we will continue to be active in the market this year, and for as long as we think that's accretive and enhances value for shareholders. To go back – to go back to the CapEx question, the big jump from 26 million or so million last year to on the order of 50 million this year is also driven by primarily by Taurus II. We also have a little bit of capital that's above and beyond our ordinary level planned for this year and next year for the Cigna's spacecraft and other matters related to COTS and CRS. But the – once again, not only from a P&L standpoint, but from a CapEx standpoint, the driver this year is going to be Taurus II.

Garrett Pierce

But, Tyler, the number that goes was research and development is a gross number. We recover a substantial portion of that in our rates to the government. And so while you see a big step function, up in revenue, there is, in our overhead rates, there is a recovery of some of that cost. So again, the step function from year to year 2007 to 2008 and 2009 is principally driven by Taurus II and to some extent by COTS. But then offset in additional gross margin through recovery of some of this in our overhead rates.

Tyler Hojo – Sidoti & Company

Understood. Great. Thanks.

Dave Thompson

Okay, well, thanks to everyone. I think at this point, we'll bring the call to a close. I want to thank you all again for joining us this morning and we look forward to talking with you again soon with a first quarter report in April. Thank you all and good morning.

Operator

Thank you and this concludes today's conference call. You may now disconnect.

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