Orbital Sciences Corporation Q2 2008 Earnings Call Transcript

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Orbital Sciences Corporation (ORB) Q2 2008 Earnings Call July 17, 2008 9:00 AM ET


David W. Thompson, Chairman and Chief Executive Officer

Garrett E. Pierce, Vice Chairman and Chief Financial Officer

James R. Thompson, Vice Chairman and Chief Operating Office


Gary Liebowitz - Wachovia Securities

Howard Rubel - Jefferies & Company

Patrick McCarthy -Friedman, Billings, Ramsey Group, Inc.

Troy Lahr - Stifel Nicolaus

Jim Moran - Morgan Joseph & Co. Inc


At this time I would like to welcome everyone to the Second Quarter 2008 Financial Results Conference Call. (Operator Instructions)

David Thompson

Thank you for joining us for Orbital’s second quarter 2008 financial results call. I’m Dave Thompson and 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 financial press release. This paragraph emphasizes the major uncertainties and risks in the forward-looking statements that we will make this morning. Please keep this in mind as we discuss the company’s future financial and operational plans and our guidance for the year during today’s call.

We will follow our customary outline for the discussion this morning. I’ll begin by covering some highlights from the second quarter and then turn it over to Garrett, who will cover the company’s financial results in greater detail and also update you on our guidance for the full year, factoring in our recent divestiture of the company’s transportation management systems division.

After that J.R. will recap recent space mission and major system deliveries. He will also provide a preview of upcoming launches, system deliveries and other significant operational events that we plan over the next three or four months. Finally I’ll address second quarter new orders and contract backlog as well as our new business outlook for the second half of 2008. Then we’ll open up the call for your questions.

To set the stage for today’s discussion, I’d like to begin by highlighting four areas in which the company’s second quarter was noteworthy. We’ll cover each of these in more depth later on in this mornings call. But, to begin, Orbital’s financial results in the second quarter were very strong. Revenues increased 15% to $301 million, operating income rose 27% to $26.5 million and adjusted earnings per share increased about 59% to $0.35 per share in the quarter; this is before several one time adjustments relating to the gain on the sale of our TMS business and a partially offsetting impairment charge on some auction rate securities that we’re taking this quarter.

Free cash flow in the second quarter was $13.3 million and the company’s ending cash balance was a record $304 million at the end of June. Continuing the trend that we established late last year, our advanced space program segment again led the way this quarter with better than a 90% revenue increase and this was followed by strong contributions from our launch vehicles segment which exhibited a 13% revenue increase.

Garrett will give you all the financial details on a somewhat complicated quarter in a few minutes.

Second, from an operational standpoint our activity in the June quarter was highlighted by three major space missions. These consisted of two rocket launches and a group of space payloads that were deployed in the quarter. We also completed and prepared to ship to launch sites around the world two communications satellites and one scientific spacecraft that are scheduled for launches in the next couple of months and we delivered two additional launch vehicles for future missions as well.

Looking ahead we expect the company’s operational pace to increase in the months ahead with 10 or 11 major space missions planned over the next 100 days alone and J. R. will discuss operational results and outlook a little later in the call.

Third, our new business activity continued to build on the first quarters new order momentum. We recorded $425 million of new contract awards and option exercises in the second quarter. As I’ll detail a little later on, each of our three business segments contributed significantly to the second quarters new business results.

The company was also especially active in the June quarter in a variety of new business pursuits, having submitted over $2 billion worth of proposals on potential contracts since early April and with another $400 to $500 million of proposals that are now in preparation for deliveries that we expect to customers later this summer. As a result, our outlook is quite robust for new orders and contract backlog growth in the second half of the year.

Finally, as most of you know, we completed the sale of our Transportation Management Systems business to affiliated Computer Services in early June. This took place at the previously announced purchase price of approximately $43 million. The transaction generated net cash proceeds after expenses of approximately $40 million and a one time after tax gain on the sale of approximately $15 million. In our financial results and the updated guidance that Garrett will discuss, the TMS business is being accounted for as a discontinued operation.

Now I’d like to ask Garrett to take you through the financial results from the second quarter to discuss the TMS sale and its financial impacts in a little more detail and to update our guidance for 2008.

Garrett Pierce

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; it will be posted under the Investor Relations heading on our web site.

As mentioned we sold our transportation management systems unit to ACS in the second quarter and accordingly we had included a combined operating result and gains in the sale of TMS as discontinued operations net of income taxes for all periods presented.

During the second quarter the government closed its investigation of the company, which commenced in 2005, in addition the related key tan case was dropped.

The second quarter operating results of our launch systems group include a $4 million favorable effect, or $0.04 per share, related to the recovery of certain expenses incurred by the company in connection with this government investigation.

Revenues for the second quarter of 2008 set a new record of $301 million of 15% over the second quarter 2007. Both the advanced space programs and launch systems segments had increases in revenue and more specifically, the revenues of the advanced space program segment were up 92% over the prior year, reflecting the growth in the Orion human spacecraft program and intelligence defense programs.

Our launch systems segment showed significant growth with revenues up 13%, driven by the Interceptor and Space Launch product lines and the $4 million adjustment related to the recovery of expenses related to the government investigation. Our satellite space systems segment revenues were down by 9% due to reduction in the Science and Technology product line, which more than offset the increased revenues of our GEO product line.

Our operating income was $26.5 million or 8.8% return on revenue on the second quarter of 2008, compared to $20.9 million or 8% in 2007; however it should be noted that the second quarter of 2008 operating income includes the effect of research and development expenditures of $1.7 million that are not recovered under government contracts.

As discussed in our earnings release call for the first quarter, research and development cost is expected to reduce our full year 2008 operating income margin by about 125 basis points and reduce 2008 earnings per share $0.12 to $0.16 per share as unrecovered research and development expense is increased in the second half of 2008. We believe that our investment in the Taurus II product line will significantly expand our space launch vehicle market and provide significant revenue growth in future periods.

As stated previously, the second quarter 2008 revenues in the launch services segment were up 13%. The Interceptors and Space Launch product lines reported growth year-over-year. Launch systems segment operating income was up 27% compared to last year. The current quarters operating margin for the launch segment was 11.6% and includes the effect of unrecovered research and development expenditures of $1.7 million and the favorable $4 million recovery of costs incurred in connection with the government investigation.

The margin in our Interceptor product line was 12% for the quarter, compared to 10.6% in the second quarter of 2007.

Revenues on our space systems segment were down $10.4 million year-over-year primarily attributable to a decrease in the science and technology product line which was down about $13.7 million.

Revenues from the GEO product lines were higher in 2008 by about $5 million. The operating margin in the space systems segment increased to 7% in the second quarter 2008 as compared to 6.4% in the comparable quarter of 2007.

Revenues in our advanced space program segment were up 92%, attributable to the Orion program and our intelligence and defense programs.

Operating income was $5.7 million for the quarter, an increase of $2.6 million or 80% over the prior year. The operating margin percentage decreased 50 basis points, reflecting a favorable contract fee adjustment in the second quarter of 2007.

The sale of TMS resulted in a $14.8 million after tax gain. The net cash proceeds were about $40 million. TMS results of operations are reported as discontinued operation.

Research and development, independent research and development for the quarter was about $10.2 million versus $3.9 million in the prior year, an increase of $6.3 million, which is principally driven by the Taurus II development program.

Although average cash balances were about $75 million higher, interest income for the quarter decreased to $1.7 million compared to $3.2 million in the second quarter of last year. The effective interest rate on invested cash balances has declined about 350 basis points, from 5.5% in the prior year to 2% during the second quarter of 2008, reflecting today’s capital credit market environment.

During the second quarter, Orbital purchased approximately 140,500 shares of common stock for $3.4 million. As of the end of the second quarter 2008 we have approximately 4$46.6 million remaining in our $50 million purchase program authorized by the board of directors in
April of this year. Since the inception of our buy back program in 2004 we have purchased 9.7 billion shares at a total cost of $156 million or an average price of $16.10.

The repurchase program since the inception in 2004 to the end of this quarter has reduced outstanding shares by about 15%.

Free cash flow for the second quarter was strong at $13.3 million, primarily driven by cash flow within our advanced space program segment. Free cash flow included capital expenditures of $5.2 million. As previously disclosed, we hold investments in auction rate securities with a total PAR value of $34.5 million. These securities are classified as non-current investments on our balance sheet. In the fourth quarter of 2007 and in the first quarter of 2008 we recorded temporary impairment charges totaling $9 million to reflect a temporary impairment of these securities.

In view of the prolonged credit crisis and without clarity as to the time frame for an improvement, we made a decision to write down certain auction rate securities as other than temporary under the accounting rules. Accountants view these securities as either temporary or other than temporary. The notion of temporary and permanent is not in the accounting province; therefore the threshold to reach other than temporary is very low. This resulted in a $10.6 million non-cash PNL charge in the second quarter of 2008. We believe that these securities will eventually monetize, but we cannot predict at this time when; however we do have ample liquidity to hold these securities for an extended period of time.

We are updating our guidance provided in our April earnings release conference call to reflect the sale of our TMS business unit, certain second quarter 2008-tax benefits reflected in continuing operations and our current operational forecast for the year. Accordingly we have reduced full year revenues by $60 million to a range of $1.1 billion to $1 billion 125 million, reflecting the sale of TMS and the elimination of forecasted revenue for 2008.

Our new range of operating income margin is 7 ¼% and 7 ½%. We increased our adjusted diluted EPS from continuing operations to $0.93 to $0.97 from the prior range of $0.84 to $0.89. This excludes the impact of the $10.6 million cash impairment charge mentioned previously and he forecasted earnings of TMS of approximately $0.05 for the year. That includes the favorable tax benefit of $4.9 million or approximately $0.08 per share impact recorded in continuing operations for the second quarter of 2008. The favorable impacts of the revenue-incurred costs related to the government investigation of $4 million or approximately $0.04 per share results are included in this estimate. Free cash flow remains unchanged at $80 to $85 million.

In conclusion, Orbital delivered another solid quarter and we remain positive about the outlook for the balance of the year. Now back to Dave.

David Thompson

Now I’d like to ask J.R. to update you on the company’s major operational events that took place in the second quarter and also to preview what’s ahead for us in the third quarter of 2008.

J.R. Thompson

The second quarter operational results were robust with strong performance from all of our groups. Highlights since our last report includes seven major system deliveries and successful execution of three missions.

The Pegasus launch of the Air Force C/NOFS spacecraft, communication navigation how age [ph] forecasting system, which by the way was the 25th successful Pegasus launch in a row. Launch, deployment and activation of five replacement ORBCOMM satellites and launch of a medium range target with a resulting intercept by the FAD [ph] missile defense system.

Also noteworthy is the added scope of the orbital boost vehicle interceptor work we have been asked by Boeing and the missile defense agency to propose, with the intent to award by the end of the year. This scope would extend our contract through 2013, which would include completing development of the two-stage interceptor, provide ten additional two-stage interceptors to production with intended deployment to Europe and provide support for all fielded interceptors including refurbishment and upgrade. But perhaps of even greater significance to the company is the COTS follow on proposal submitted to NASA in late June for the commercial resupply services to the International Space Station with award expected in November of this year. If selected, we would expect to carry out a dozen or so additional resupply missions to the space station over the five years between 2011 and 2015, which would give us a solid anchor tenant for the Taurus II launch vehicle program.

This has been a particular busy time in our satellite manufacturing area with the completion and shipment of the AMC-21, GEO communications satellite, completion of shipment preparations of the MEASAT communications satellite and near completion of NASA’s IBEX scientific satellites. Two additional satellites NSS-9 a GEO communications satellite and NASA’s OCO scientific satellite are in the final stages of integration and tests and are scheduled for shipment in the next 90 days.

I mentioned earlier the significance to Orbital of the potential award of the commercial resupply services contract to the international space station. NASA will be monitoring closely our progress on the two basis elements of this resupply system. The Taurus II launch vehicle and the SIGNUS space station rendezvous space craft that will carry into orbit.

During the quarter we had made good progress on both elements. The Taurus II launch vehicle, the primary launch site location at NASA’s Wallops Island, Virginia facility has been selected with facility construction to begin this fall and full activation targeted for the late spring in 2010. At NASA’s Stennis Space Center in Mississippi we have selected the E-1 test site for the aero jet AJ-26, which was previously Russia’s NK-33 engine acceptance testing.

The Taurus II first stage design contract has been negotiated and signed with our Ukrainian supplier and this work is going quite well. The test program which will qualify this design is being defined now. The contract for production planning and long lead materials for the initial three first stage units has been awarded. Our targeted major milestones continue to be delivery of the first modified production flight capable engine in the spring of 2009, initiation of engine testing in early summer 2009, second stage motor testing about the same time, completion of the Wallops Island launch site build and activation by late spring 2010, delivery of a flight equivalent first stage to begin integrated testing in early summer 2010, and conduct of the launch of the cost demo flight to the International Space Station by the year.

On the Cygnus spacecraft side the system requirements review of the space station rendezvous vehicle bus is being conducted this week for NASA with engineering design on track for completion in the spring of next year.

Fabrication and assembly of the first spacecraft will begin about a year from now with delivery to Wallops Island launch site slated for early fall in 2010.

Progress continues in the development of the launch abort system for the Orion spacecraft. Several development motor fry’s were successfully conducted during the quarter and a number of system components are not at Della’s for integration testing prior to delivery to the Pattaborg [ph] test site at White Sands Missile range. This test is now expected to occur in the first quarter of 2009.

Looking ahead to the third quarter, we planned 13 major system deliveries: two refurbished OBV interceptors; delivery to Boeing of the OBV interceptor schedule for the next test flight which is now planned for early December of this year; three supersonic C-skimming targets; a medium range target; the Pegasus rocket for the IBEX mission; a Minotaur I rocket to launch the TSX III spacecraft; three GEO communications satellites; and one NASA scientific satellite.

Missions schedules include a target launch of the Minotaur II vehicle; two GEO communications satellite launches; AMC-21 from karu French dian [ph] and miaset [ph] from Mercantour Russia. Four supersonic sea skimming targets launched two at a time in a stream rate operation against US Navy ore ships. So it will be a busy quarter.

Hiring continues to be a priority for us. 130 new employees were added in the quarter, with 280 being added in the first half of the year. The Chandler office expansion opened in May and at the Dulles, new building remains on track for year-end completion. We are well along a path to open a Southern California engineering center in the late fall to augment our staff with experienced propulsion personnel. This growth trend is expected to continue.

With that, I’ll now return the discussion to Dave.

David Thompson

I will now report in more detail on the company’s second quarter new business acquisition and our contract back logs and also talk about Orbital’s overall market outlook for the next six months.

Of the company’s $425 million in total new business volume in the second quarter, about $230 million was in the form of new firm orders, $145 million was in new option orders and $50 million was in option exercises under previously awarded contracts.

Our launch vehicles and satellite segments each received approximately $175 million of total new business awards in the quarter. These were followed by our advanced space program segment which recorded about $75 million of new business in second quarter.

Major new orders in the June quarter included the award of the Koreasat 6 Geosynchronous Communication Satellite, a sizable addition to our OBV interceptor program, a contract for a military space payload which will be added to a satellite we are already building, and several space technical service program awards with NASA. As a result of these new orders and option exercises, the company’s firm backlog at the end of June was $2.07 billion and our total backlog at the end of June was approximately $4.16 billion. We now have about 98’% of our targeted 2008 revenue and nearly 70% of our expected 2009 revenue in contract backlog.

Looking ahead to the third and fourth quarters, Orbital’s new business prospects are unusually strong. As I noted earlier we currently have well over $2 billion worth of proposals representing approximately 40 launch vehicles and satellites that are under evaluation by customers and expected to be awarded before the end of the year. While I do not expect us to win all of these bids, I do believe, based on this new robust pursuit activity that Orbital will continue to build our contract backlog during the second half of 2008 with year-end firm backlog now targeted at between $2.3 and $2.4 billion.

I expect our strongest market areas for new orders over the next five or six months to be human space systems, especially the operational follow on to the COTS demonstration mission that J.R. talked about, space launch vehicles, missile defense target vehicles and communication satellites.

Finally I’d like to add a bit to the update that J.R. gave you on our progress on the Taurus II launch vehicle development program and on our market outlook for this new vehicle.

As J.R. indicated the development program is now moving at full speed. We have most of our major suppliers under contracts for the design and testing work that they will do over the next two years and we plan to soon finalize additions to those contracts for the first several production units that will be delivered in 2010.

Over the last two months we made the important decisions that J.R. referenced regarding our engine testing and launch site locations and are now getting underway with a preparation work leading to the start of construction at both sites this fall. We remain on track to complete all vehicle and support equipment engineering design by the end of this year, to focus on propulsion and structures testing in 2009 and to be ready to conduct the first two launches in the second half of 2010.

Meanwhile, our market outlook for Taurus II has not changed in the last three months. We continue to forecast an average annual addressable market demand of between seven and nine launches per year of similar medium class rockets in the 2010 to 2013 period and we believe that Taurus II should be able to capture between 50% and 60% of this market. If this comes to pass that should result in four to five potential launches per year valued at $275 to $350 million in annual revenues for our company.

To wrap up, Orbital’s second quarter was a very good one in all major respects. Our new business volume continued to be robust. Our operational performance was solid and our financial results were strong. As always, there are strategic and execution challenges in our business, but we remain quite optimistic that the remainder of 2008 will continue to be a good period for the company and for our shareholders.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Gary Liebowitz of Wachovia Securities.

Gary Liebowitz - Wachovia Securities

Garrett, can you just go over your customary score card for the GEO satellite outlook and also if you can comment on whether you’re seeing any indication that the scientific satellite market might present some opportunities in the second half of the year.

David Thompson

We started the year with an outlook across the industry for 20 to 22 new geosynchronous communications satellite orders. We have increased that now by two, so we are currently projecting between 22 and 24 commercial satellite orders in 2008. Through the middle of July, by our count, 14 new GEO satellites have been placed under contract: four of those, roughly 30% have been in the small class that we compete for and Orbital received two of those four orders.

At our level we began the year with a baseline of three new orders with an upside of four, we’ve increased that now to a plan of four orders with an upside of five. We currently have three proposals outstanding; we expect to submit at least one more by the end of the year. Two of the three currently outstanding proposals are with existing customers, while one is with a new customer and we would expect those three proposals and possibly one other to be decided on by customers between now and the end of this year.

With regard to the outlook in the science satellite market my view is that that area will continue to be relatively slow over the next six months from the standpoint of new order potential. On a more positive note, however, taking a medium term look that would include 2009 and maybe the early part of 2010 I continue to expect a bit of a rebound in NASA scientific satellite funding over the next couple of years.

NASA’s requested budget for fiscal year 2009, which begins this fall, included funding for two new relatively small earth science satellites and as many as three new small satellites in other scientific areas, such as astrophysics and solar physics. Recently, in that latter category, NASA has selected for preliminary evaluation six candidates for those three slots and Orbital is the potential satellite builder for three of those six.

So, we continue to hold a strong position as that market area rebounds, as I believe it will over the next couple of years. I think we’ll see a bit of a turn around of our revenue in that product area, but as Garrett noted, for the first half of the year and as I would add for the second half of the year, we expect that science satellite activity will be down in 2008 relative to what we’ve seen over the last couple of years. Hopefully though, if we continue to perform well for NASA and our other science satellite customers, when the funding rebound comes we’ll be able to grow with that.

Gary Liebowitz - Wachovia Securities

Thanks Dave. If I can ask just one more: ULA has been out there saying that they’re not quite ready to cede that medium sized launch market. In your prepared comments you said you hadn’t changed your market outlook, so should I assume that there was nothing new with respect to what you always have been talking about how they want to remain in this market at least until the next decade and they have an inventory to get them there?

David Thompson

Yes that’s correct. There is nothing new in that area from our perspective. ULA is a joint venture that was formed a year or so ago between Lockheed and Boeing to produce and sell the larger Delta 4s and Atlas 5 rockets also is now the organization that will operate the Delta 2. There is an inventory of four or five previously built Delta 2s that have not yet been sold and it’s my understanding that ULA will continue to make those inventory vehicles available through, if there is customer demand for them, in the early years of the next decade. If they were to sell those at a steady rate that would absorb approximately one launch per year between 2011 and 2014, so it would be a factor in a market that might average eight per year, but it doesn’t change our outlook with regard to the Taurus II prospects.

ULA has also stated that they would consider the possibility of restarting Delta 2 production, with that decision to be made approximately in 2012. If they did restart production then, they said that it would take several years before any new Delta 2s would be available; so I continue to be quite bullish if we can complete our development program and carry out the first several launches successfully and maintain our cost position with regard to the business prospects for Taurus II.


Your next question comes from Howard Rubel with Jefferies & Company.

Howard Rubel - Jefferies & Company

Garrett, I wasn’t sure I understood the whole tax benefit, could you elaborate on that again?

Garrett Pierce

Sure, what I said was in the quarter we had a tax benefit of $4.9 million which was reflected in continuing operations and it’s reflected in the tax calculation. We have NOLs net loss operating carry forwards; we also have capital loss carry forwards that are fully reserved and as you do the accounting, when you have a gain, as we did in TMS and other things that we consider in making the tax calculation, but the full reserve we had was released and when that’s released it’s put through our continuing operations. It’s a little counter intuitive, but that’s where the $4.9 goes and that’s a, if you will, a drop rate to the bottom line so it has, as we said about a $0.04 or $0.05 impact on the numbers.

Howard Rubel - Jefferies & Company

And the reason why you don’t get any tax benefit on the auction rate preferred charge? I mean would you get it if you realized it or?

Garrett Pierce

You’re correct Howard, but we don’t get a tax benefit on the auction rate securities because it’s a valuation, it’s an estimate, there is no tax charge in the sense that there was a completed transaction; so when these securities are monetized there would be a tax impact. Our hope is that they will monetize, eventually, at PAR, but based on the accounting rules and the marketing environment run right now we elected to take that charge.

I’m going to roll back to the question, I stated correctly it was $4.9 was the impact of the taxes and that is an after tax number, so it’s $0.08 impact on the quarter.

Howard Rubel - Jefferies & Company

So the tax rate going forward for the year, the incremental rate would still be roughly 40 or can you give us?

Garrett Pierce

Correct, you’re absolutely right. It was just this quarter and the tax rate going forward would be approximately 40%.

Howard Rubel - Jefferies & Company

Then, J.R., for a moment you alluded to the way you’re working in a partnership with NASA to make sure that Taurus II is a success. Could you talk a little bit about that and then could you talk about where your concerns are? I mean, the schedule sounds like it’s hitting on all cylinders. In our world looking outside looking in we always see some risks; could you just address them a little bit please?

J.R. Thompson

It’s certainly true, I mean to answer the second part first, it’s a company wide aggressive schedule. I think we’re quite confident in the outcome of it. The first stage designer are the Ukrainians, they’ve got a long heritage for using proven engines. The heritage there, the Russian NK 33 over 1000 have been built, so we feel we’re in good shape there.

We’ve made, I think, good selections in our launch site and in our test program. A little bit of that was bias towards the Stennis facility here just because of the customer there. They’re showing a lot of interest in that program and I’m sure we’ll be quite involved in it.

On the spacecraft side, the Cygnus side, I mentioned that we’ve got an ongoing program review with NASA in house here at Dulles this week, a lot of participation there; there seems to be a lot of enthusiasm for that program. I think if we’re selected for the resupply missions, that is going to provide a real solid anchor tenant for us and it’s going to also, I believe NASA is going to be quite familiar with the rocket and is going to start looking at it seriously for their scientific missions.

So, it’s I think normal risks, so to speak, in the development area. We’ve got a little less than

2 ½ years now to launch. A lot of work to do, but we’ve got a lot of enthusiasm for it and I’m quite bullish on it right now.


Your next question comes from Patrick McCarthy -Friedman, Billings, Ramsey Group, Inc.

Patrick McCarthy -Friedman, Billings, Ramsey Group, Inc.

You made a comment in your discussion about order flow in the quarter that I think was new, you were talking about the military space payload going on one of the satellites that you’re building. My first question is, is that satellite that you’re building a government satellite, or is it a commercial satellite?

Then, what’s your outlook there for the military space payload business?

David Thompson

The specific order that I referred to in the second quarter is for an experimental payload that will be hosted on one of the commercial communications satellites that Orbital is building for SES

America. We several years back carried out a similar program with what was then Panam Sat, of course now Infosat, in hosting a civil government payload on one of our earlier communications satellites. What we’re doing is taking that idea and applying it to a military payload in a slightly more ambitious program. So, that’s the situation with regard to the first question.

The second question, concerning our general outlook in the military and defense, or rather the defense and intelligence satellite business, continues to be quite robust. In fact over the next three or four quarters I expect that we will see growth in the military and intelligence satellite business at Orbital becoming one of our major growth engines. Some of the areas that have played that role for Orbital over the last couple of years will tend to plateau and fade a bit as growth engines and in addition to Taurus II and the space station resupply market and additional growth in commercial satellites, I think military and intelligence satellites are expected to be one of the new growth engines as we move out of 2008 and into 2009. So our prospects there are good as well.

Patrick McCarthy -Friedman, Billings, Ramsey Group, Inc.

Within that is potentially payload specific business on commercial satellites or is that something that you are thinking about separately?

David Thompson

The idea of hosting government secondary payloads on commercial satellites is a part of that, part of that bigger picture. It’s certainly not the whole situation though.

Patrick McCarthy -Friedman, Billings, Ramsey Group, Inc.

My second question is, you touched on it briefly in a previous question, but just back to the competitive environment on Taurus II. My two questions are when you look at that 50% to 60% kind of hit rate that you’re thinking about, who would take out the other 40% to 50% on the order flow side? I mean, who are you counting on? Is it ULA or is it somebody else?

Then your seven to nine launches per year estimate is that domestic or is that global?

David Thompson

Good questions in both cases. The seven to nine launches per year estimate that I gave is largely domestic. In particular it excludes a market that we may eventually compete in with Taurus II but which we are not currently planning to pursue, at least in the first couple of years of Taurus IIs operational life, mainly the market for launching smaller GEO synchronous communications satellites of the type that we specialize in. The reason that I’m excluding that in the near term is in order to be effective in that market we would need to bring up a second launch site, probably at Caper Canaveral in Florida and we would have to make some modifications to the Taurus II rocket and right now I think we’ve got our hands full during the next couple of years with the development program and during the first few years of the operational life of the vehicles making sure that we’re doing everything to lean to reliable and timely launches of the basic Taurus II vehicle.

So, the seven to nine per year is largely domestic. There might be an occasional non-US commercial imaging satellite or a non-US scientific satellite that would factor into that, but that would be 10% or less of the total. So essentially you can think of that as a domestic market. We see the components adding up to the seven to nine per year being two or three in the space station cargo market, three maybe four in the scientific and defense or national security market and a couple of others in areas like commercial imaging satellites and a few other things that don’t neatly fit into those earlier categories.

We expect that with regard to market share in addition to what we hope to capture in the way of four to five missions a year we’d expect that the inventory Delta 2s will factor in on average maybe one a year beyond 2010. Certainly they’ll be a lot more active between now and then, but after 2010 just using the inventory that they should average about one a year through 2013 or 2014. Then the remainders I guess are up for grabs.

I guess there is upside potential for us. There is also potential for the SpaceX Falcon rockets. If they emerge as viable contenders so we’ll just have to wait and see, that’s a little hard to predict. Hopefully we’ll do a good job and capture 50+% share of that market within the first few years after we become operational.

Patrick McCarthy -Friedman, Billings, Ramsey Group, Inc.

Just one quick one: $5.00 a share in cash now, do you have any new thoughts on capital deployment?

David Thompson

I think we continue to look at one prong of the three pronged strategy acquisitions, but there’s not much going on there now; so for the near term, the foreseeable future, I think we will be more active in the two other areas, namely product development investments not only in Taurus II and the Cygnus spacecraft or the space station cargo mission, but we’re also beginning to look either on our own or with a partner at potentially moving up a bit in performance and capacity in our commercial satellite product line. Several of our larger customers are encouraging that.

We haven’t made a decision to proceed with a upgraded communications satellite yet, but that certainly could represent a call on some of our cash down the road and we also expect to continue to be active in our stock to repurchase program beyond the numbers that Garrett referred to there. We have been active this month and I expect we will, over the course of the next nine months, follow through on the full allocation that the board provided back in April or May.


Your next question comes from Troy Lahr from Stifel Nicolaus.

Troy Lahr - Stifel Nicolaus

I was just wondering if you guys could walk through the margins a little bit. At launch vehicle I think even after the benefit you did 8.2, which is pretty good compared to where you were in the first quarter. So can you maybe talk about the sequential improvement there?

Then also, I thought in the press release you mentioned higher costs on Pegasus. If you can just kind of walk us through that, if I got that right.

Garrett Pierce

The quarter, as I said in the release, we had strong returns on the Interceptor product line versus the prior quarter. The space launch area had an up tick in sales, the margins were down a little bit and the suborbital was essentially flat and the margins were where they had been running in the comparable quarter 2007. We obviously had the benefit of the $4 million recovery from the government investigation and the numbers, but I would say that as we looked at, generally the revenues are up in the interceptor and space launch area, the margins are up and the interceptor area is down a little bit in space launch and that doesn’t really reflect the trend and suborbital was strong as it was in the comparable quarter, so that generated the margins in the launch group.

Troy Lahr - Stifel Nicolaus

Did you have higher costs on Pegasus in the quarter?

Garrett Pierce

It’s not really higher costs; it’s just our estimates of our overhead which do move around on the projects. There are certain projects we did incur some additional costs but it is not a trend in the product line.

David Thompson

What I could add there, sort of from an operational standpoint is that we originally had a Pegasus launch of an orbital built scientific satellite that J. R. referred to a little earlier that was scheduled for about this, I think it was July originally, at the beginning of the year, that’s the launch date we were targeting. That launch moved out about 2 ½ months. It’s now set for, I believe, the first week of October and there are some fixed costs associated with the Pegasus program that we don’t have and to that extent in many of our other areas; so those fixed costs dropped to that particular contract which was already 90+% complete. So, that contract carried the lions share extending the fixed costs for the better part of three months.

J.R. Thompson

Then you’ve got a catch up adjustment in the quarter when you have that delay and that explains the difference.

Troy Lahr - Stifel Nicolaus

Also at the satellites and space systems sequentially margins were down pretty meaningfully here. Is that just the mix shift between commercial and science and technology and maybe could you just tell us where you see that mix shift right now and kind of where is it going to be 12 months out, maybe just kind of ballpark it for us between commercial and defense and science?

David Thompson

Okay, yes, let’s see. Although the operating margins in satellites and space systems improved from the comparable quarter last year by, I think about 60 basis points, I think they were down from the first quarter —.

Troy Lahr - Stifel Nicolaus

Well that’s including benefit right, of the payable contracts settlement? I thought you benefited by about $1.1 million this quarter.

Garrett Pierce

We did benefit, but it was a part of ordinary business. It was an issue of an incentive that we were due and they had contested that. We felt we were correct per the contract and the arbitrator agreed with us, so yes that did come through in the quarter.

David Thompson

To the other part of the question, looking ahead, our target by the end of this year, but the fourth quarter, is to be pretty close to 8% in that business. The challenge there will be to continue to improve operating margins in the commercial geosynchronous satellite product line. I think the science and technology in the space technical service areas should continue to perform at or slightly above that level. The commercial satellites have established a very good trend over the last couple of years, which was further reinforced this quarter, but we’re not finished with our work there and so we’re looking to come out of the year on the order of 100 basis points higher margin than we had in the second quarter.

Troy Lahr - Stifel Nicolaus

Is it more commercial now or is it more still science and technology?

David Thompson

The pendulum has swung towards commercial. I would guess for the year as a whole the commercial satellite work will generate approximately 75% of segment revenues and the scientific satellite work and related activity will be the other 25%.

Troy Lahr - Stifel Nicolaus

One other question on your guidance, just so I’m clear: were any of these items that we were talking about that the cost recovered for the investigation and the $1 million settlement. Was that previously in your guidance, because it looks like your guidance went up by about $0.08, but you had an $0.08 tax benefit, but then offsetting TMS seems to be these one time items. Is that how I should think about that, that your guidance changes?

Garrett Pierce

Yes, you’re correct. The government settlement for $4 million was not in our previous guidance.


Your last question comes from Michael French - Morgan Joseph & Co. Inc.

Jim Moran - Morgan Joseph & Co. Inc

Sorry, I just had it on mute there. It’s actually Jim Moran for Michael French and all my questions were answered.

David Thompson

At this point we’ll bring the discussion to a close. I’d like to thank everyone for joining us this morning and I hope you all have a good day. Thank you.

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