ACQUISITION OF ORBITAL ATK

On June 6, 2018, the company completed its previously announced acquisition of Orbital ATK, a global leader in aerospace and defense technologies, by acquiring all of the outstanding shares of Orbital ATK for a purchase price of $7.7 billion in cash. On the Merger date, Orbital ATK became a wholly-owned subsidiary of the company and its name was changed to Northrop Grumman Innovation Systems, Inc. We established Innovation Systems as a new, fourth business sector, whose main products include launch vehicles and related propulsion systems; missile products, subsystems and defense electronics; precision weapons, armament systems and ammunition; satellites and associated space components and services; and advanced aerospace structures. The acquisition was financed with proceeds from the company’s debt financing completed in October 2017 and cash on hand. We believe this acquisition will enable us to broaden our capabilities and offerings, provide additional innovative solutions to meet our customers’ emerging requirements, create value for shareholders and provide expanded opportunities for our combined employees.

The operating results of Innovation Systems subsequent to the Merger date have been included in the company's consolidated results of operations. Innovation Systems recognized sales of $400 million, operating income of $39 million and net earnings of $30 million for the three and six months ended June 30, 2018.

The company recognized $23 million and $29 million of acquisition-related costs that were expensed as incurred during the three and six months ended June 30, 2018, respectively. These costs are included in Product and Service cost in the unaudited condensed consolidated statement of earnings and comprehensive income.

Preliminary Purchase Price Allocation

The acquisition was accounted for as a purchase business combination. As such, the company recorded the assets acquired and liabilities assumed at fair value, with the excess of the purchase price over the fair value of assets acquired and liabilities assumed recorded as goodwill. The company has completed a preliminary analysis to determine those fair values, and the amounts recorded as of June 30, 2018 reflect management’s initial assessment of fair value as of the Merger date. Determining the fair value of assets acquired and liabilities assumed requires significant judgment, including the amount and timing of expected future cash flows, long-term growth rates and discount rates. In some cases, the company used discounted cash flow analyses, which were based on our best estimate of future sales, earnings and cash flows after considering such factors as general market conditions, customer budgets, existing firm and future orders, changes in working capital, long term business plans and recent operating performance. Use of different estimates and judgments could yield materially different results.

The company expects substantially to finalize its purchase price allocation by the end of 2018 after we have further analyzed and assessed a number of the factors used in establishing the fair values of assets acquired and liabilities assumed as of the Merger date including, but not limited to, contractual and operational factors underlying the customer-related intangible assets and property, plant and equipment; details surrounding tax matters; and assumptions underlying certain existing or potential reserves, such as those for legal and environmental matters. The final fair value determination could result in material adjustments to the values presented in the preliminary purchase price allocation table below.

The Merger date fair value of the consideration transferred totaled $7.7 billion in cash, which was comprised of the following:



($ in millions, except per share amounts)	Purchase price
Shares of Orbital ATK common stock outstanding as of the Merger date	57,562,152
Cash consideration per share of Orbital ATK common stock	$	134.50
Total purchase price	$	7,742

The following preliminary purchase price allocation table presents the company’s initial estimate of the fair values of assets acquired and liabilities assumed at the Merger date:



($ in millions)	As of June 6, 2018
Cash and cash equivalents	$	85
Accounts receivable, net	616
Unbilled receivables, net	1,237
Inventoried costs, net	220
Other current assets	193
Property, plant and equipment	1,500
Goodwill	6,295
Intangible assets	1,305
Deferred tax assets	(230		)
Other non-current assets	131
Total assets acquired	11,352
Trade accounts payable	(397		)
Accrued employee compensation	(158		)
Advance payments and amounts in excess of costs incurred	(222		)
Below market contracts⁽¹⁾	(155		)
Other current liabilities	(298		)
Long-term debt	(1,687		)
Pension and other post-retirement benefit plan liabilities	(557		)
Other non-current liabilities	(136		)
Total liabilities assumed	(3,610		)
Total purchase price	$	7,742


⁽¹⁾	Included in Other current liabilities.

Below market contracts represent liabilities on certain acquired programs where the expected costs at completion exceed the expected sales under contract. We measured these liabilities based on the estimated price to transfer the obligations to a market participant at the Merger date plus a reasonable profit margin. These liabilities will be reduced as the company incurs costs to complete its performance obligations on the underlying programs. This reduction will be included in sales and is estimated as follows: $52 million in 2018, $70 million in 2019, $32 million in 2020 and $1 million in 2021.

The following table presents a preliminary summary of purchased intangible assets and their related estimated useful lives:

The preliminary purchase price allocation resulted in the recognition of $6.3 billion of goodwill, a majority of which was allocated to the Innovation Systems sector (refer to Note 5). The goodwill recognized is attributable to expected revenue synergies generated by the integration of Aerospace Systems, Mission Systems and Technology Services products and technologies with those of legacy Orbital ATK, synergies resulting from the consolidation or elimination of certain costs, and intangible assets that do not qualify for separate recognition, such as the assembled workforce of Orbital ATK. None of the goodwill is expected to be deductible for tax purposes.

Supplemental Pro Forma Information

The following table presents unaudited pro forma financial information as if Orbital ATK had been included in our results as of January 1, 2017:



	Three Months Ended June 30				Six Months Ended June 30
($ in millions, except per share amounts)	2018		2017		2018		2017
Sales	$	8,078	$	7,555	$	16,078	$	15,039
Net earnings	791		572		1,615		1,225
Basic earnings per share	4.53		3.28		9.26		7.01
Diluted earnings per share	4.51		3.26		9.21		6.97

The unaudited supplemental pro forma financial data has been calculated after applying our accounting policies and adjusting the historical results of Orbital ATK with pro forma adjustments, net of tax, that assume the acquisition occurred on January 1, 2017. Significant pro forma adjustments include the following:


1.	The impact of the adoption of ASC Topic 606 on Orbital ATK’s historical sales of $2 million and $21 million, and cost of sales of $2 million and $9 million, for the three and six months ended June 30, 2017.


2.	The elimination of intercompany sales and costs of sales between the company and Orbital ATK of $33 million and $80 million for the three and six months ended June 30, 2018 and $35 million and $65 million for the three and six months ended June 30, 2017.


3.	The elimination of nonrecurring transaction costs incurred by the company and Orbital ATK in connection with the Merger of $64 million and $71 million for the three and six months ended June 30, 2018.


4.	The recognition of additional depreciation expense, net of removal of historical depreciation expense, of $7 million for the three and six months ended June 30, 2018, and $8 million and $10 million for the three and six months ended June 30, 2017, respectively, related to the step-up in fair value of acquired property, plant and equipment.

Additional interest expense related to the debt issued to finance the Merger, including amortization of the debt issuance costs associated with the newly issued debt, of $66 million and $133 million for the three and six months ended June 30, 2017. Interest expense and amortization of debt issuance costs have been included in the company's historical financial statements since the date of issuance (October 12, 2017).


6.	The recognition of additional amortization expense, net of removal of historical amortization expense, of $34 million and $92 million for the three and six months ended June 30, 2018, respectively, and $65 million and $130 million for the three and six months ended June 30, 2017, respectively, related to the fair value of acquired intangible assets.

The elimination of Orbital ATK's historical amortization of net actuarial losses and prior service credits and impact of the revised pension and other post-retirement net periodic benefit cost as determined under the company’s plan assumptions of $20 million and $51 million for the three and six months ended June 30, 2018 and $29 million and $54 million for the three and six months ended June 30, 2017.

The unaudited pro forma financial information does not reflect the potential realization of revenue synergies or cost savings, nor does it reflect other costs relating to the integration of the two companies. This pro forma financial information should not be considered indicative of the results that would have actually occurred if the acquisition had been consummated on January 1, 2017, nor are they indicative of future results.

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