10-Q 1 oa_10qx100216xdoc1.htm 10-Q Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 2, 2016
 
OR
 
 
 
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the transition period from                    to                  
Commission file number 1-10582
ORBITAL ATK, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
 
41-1672694
(I.R.S. Employer
Identification No.)
45101 Warp Drive
 
 
Dulles, Virginia
 
20166
(Address of principal executive offices)
 
(Zip Code)
Registrant's telephone number, including area code: (703) 406-5000



Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o    No ý
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o    No ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ý
 
Accelerated Filer o
 
Non-Accelerated Filer o
 (Do not check if a
smaller reporting company)
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No ý
As of April 5, 2017, there were 57,653,024 shares of the registrant's common stock outstanding.
 




TABLE OF CONTENTS



PART I— FINANCIAL INFORMATION
ITEM 1.    FINANCIAL STATEMENTS
ORBITAL ATK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(unaudited)
 
 
Quarters Ended
 
Nine Months Ended
(Amounts in thousands except per share data)
 
October 2, 2016
 
October 4,
2015
 
October 2, 2016
 
October 4, 2015
 
 
 
 
(As Restated) (1)
 
 
 
 
Sales
 
$
1,043,702

 
$
1,143,246

 
$
3,183,442

 
$
3,217,974

Cost of sales
 
833,403

 
934,429

 
2,466,496

 
2,563,023

Gross profit
 
210,299

 
208,817

 
716,946

 
654,951

Operating expenses:
 
 
 
 
 
 
 
 
Research and development
 
24,887

 
28,666

 
80,418

 
78,698

Selling
 
28,099

 
28,137

 
82,140

 
81,549

General and administrative
 
66,337

 
65,204

 
195,388

 
268,442

Goodwill impairment
 

 

 

 
34,300

Gain on settlement
 

 
50,000

 

 
50,000

Income from continuing operations, before interest, income taxes and noncontrolling interest
 
90,976

 
136,810

 
359,000

 
241,962

Net interest expense
 
(17,614
)
 
(24,636
)
 
(51,193
)
 
(61,171
)
Loss on extinguishment of debt
 

 

 

 
(26,626
)
Income from continuing operations, before income taxes and noncontrolling interest
 
73,362

 
112,174

 
307,807

 
154,165

Income taxes
 
13,181

 
37,980

 
79,765

 
61,563

Income from continuing operations, before noncontrolling interest
 
60,181

 
74,194

 
228,042

 
92,602

Less net (loss) income attributable to noncontrolling interest
 
(135
)
 
147

 
(311
)
 
72

Income from continuing operations of Orbital ATK, Inc.
 
60,316

 
74,047

 
228,353

 
92,530

Discontinued operations:
 
 
 
 
 
 
 
 
Income from discontinued operations, before income taxes
 

 

 

 
17,504

Income taxes
 

 

 

 
667

Income from discontinued operations
 

 

 

 
16,837

Net income attributable to Orbital ATK, Inc.
 
$
60,316

 
$
74,047

 
$
228,353

 
$
109,367

Basic earnings per common share from:
 
 
 
 
 
 
 
 
Continuing operations
 
$
1.04

 
$
1.26

 
$
3.92

 
$
1.69

Discontinued operations
 

 

 

 
0.31

Net income attributable to Orbital ATK, Inc.
 
$
1.04

 
$
1.26

 
$
3.92

 
$
2.00

Weighted-average number of common shares outstanding
 
57,927

 
58,746

 
58,213

 
54,807

Diluted earnings per common share from:
 
 
 
 
 
 
 
 
Continuing operations
 
$
1.04

 
$
1.25

 
$
3.89

 
$
1.68

Discontinued operations
 

 

 

 
0.30

Net income attributable to Orbital ATK, Inc.
 
$
1.04

 
$
1.25

 
$
3.89

 
$
1.98

Weighted-average number of diluted common shares outstanding
 
58,257

 
59,304

 
58,642

 
55,228

Cash dividends per common share
 
$
0.30

 
$
0.26

 
$
0.90

 
$
0.84

Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net income attributable to Orbital ATK, Inc. and noncontrolling interest
 
$
60,181

 
$
74,194

 
$
228,042

 
$
109,439

Comprehensive income (Loss):
 
 
 
 
 
 
 
 
Pension and other postretirement benefit liabilities:
 
 
 
 
 
 
 
 
Reclassification of prior service credits for pension and postretirement benefit plans recorded to net income, net of tax (expense) benefit of $(12,500) and $2,691, $(7,547) and $8,258, respectively
 
20,215

 
(4,335
)
 
12,284

 
(13,291
)
Reclassification of net actuarial loss for pension and postretirement benefit plans recorded to net income, net of tax (expense) of $(11,146), $(14,196), $(35,578) and $(2,245), respectively
 
17,861

 
22,870

 
56,968

 
4,328

Valuation adjustment for pension and postretirement benefit plans, net of tax (expense) benefit of $0, $0, $(648) and $139,583, respectively
 

 

 
1,025

 
(224,389
)
Change in fair value of derivatives, net of tax (expense) benefit of $(563), $1,896, $(2,097) and $1,276 respectively
 
890

 
(2,996
)
 
3,315

 
(2,032
)
Other, net of tax (expense) benefit of $(190), $55, $(292) and $93, respectively
 
472

 
(88
)
 
1,076

 
(153
)
Change in cumulative translation adjustment, net of tax (expense) of $(9,650)
 

 

 

 
(21,381
)
Total other comprehensive income (loss)
 
39,438

 
15,451

 
74,668

 
(256,918
)
Comprehensive income (loss)
 
99,619

 
89,645

 
302,710

 
(147,479
)
Less comprehensive (loss) income attributable to noncontrolling interest
 
(135
)
 
147

 
(311
)
 
72

Comprehensive income (loss) attributable to Orbital ATK, Inc.
 
$
99,754

 
$
89,498

 
$
303,021

 
$
(147,551
)
(1) See Note 3 - Restatement
See Notes to the Condensed Consolidated Financial Statements.

2


ORBITAL ATK, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(Amounts in thousands except share data)
 
October 2, 2016
 
December 31, 2015
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
63,011

 
$
104,032

Net receivables
 
1,864,826

 
1,670,821

Net inventories
 
230,087

 
213,212

Income taxes receivable
 
335

 
50,769

Other current assets
 
86,081

 
89,645

Total current assets
 
2,244,340

 
2,128,479

Net property, plant and equipment
 
769,450

 
761,694

Goodwill and net intangibles
 
1,940,635

 
1,975,522

Other noncurrent assets
 
411,667

 
458,000

Total assets
 
$
5,366,092

 
$
5,323,695

LIABILITIES AND EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Current portion of long-term debt
 
$
40,000

 
$
40,000

Accounts payable
 
170,756

 
130,812

Accrued compensation
 
117,790

 
127,928

Contract loss reserve
 
200,569


235,841

Other current liabilities
 
623,465

 
719,854

Total current liabilities
 
1,152,580

 
1,254,435

Long-term debt
 
1,542,642

 
1,435,836

Pension and other postretirement benefits
 
699,162

 
820,834

Other noncurrent liabilities
 
119,974

 
127,152

Total liabilities
 
3,514,358

 
3,638,257

Commitments and contingencies (Notes 13 and 16)
 

 

Common stock—$.01 par value: authorized—180,000,000 shares; issued and outstanding— 57,892,300 shares at October 2, 2016 and 58,729,995 shares at December 31, 2015
 
579

 
587

Additional paid-in-capital
 
2,173,099

 
2,187,940

Retained earnings
 
1,218,814

 
1,043,043

Accumulated other comprehensive loss
 
(711,209
)
 
(785,908
)
Common stock in treasury, at cost—11,042,724 shares held at October 2, 2016 and 10,205,029 shares held at December 31, 2015
 
(840,042
)
 
(771,029
)
Total Orbital ATK, Inc. stockholders' equity
 
1,841,241

 
1,674,633

Noncontrolling interest
 
10,493

 
10,805

Total equity
 
1,851,734

 
1,685,438

Total liabilities and equity
 
$
5,366,092

 
$
5,323,695

See Notes to the Condensed Consolidated Financial Statements.

3


ORBITAL ATK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 
 
Nine Months Ended
(Amounts in thousands)
 
October 2, 2016
 
October 4, 2015
Operating Activities
 
 
 
 
Net income
 
$
228,042

 
$
109,439

Net loss from discontinued operations
 

 
(16,837
)
Income from continuing operations
 
228,042

 
92,602

Adjustments to reconcile income from continuing operations to cash provided by operating activities of continuing operations:
 
 
 
 
Depreciation and amortization
 
120,251

 
120,816

Amortization and write-off of deferred financing costs
 
1,806

 
12,481

Fixed asset impairment
 
4,809

 
14,833

Deferred income taxes
 
(12,110
)
 
(25,254
)
Goodwill impairment
 

 
34,300

Loss on the extinguishment of debt
 

 
26,626

Stock-based plans expense
 
17,516

 
28,369

Other
 
8,641

 
(2,884
)
Change in assets and liabilities:
 
 
 
 
Net receivables
 
(203,151
)
 
19,407

Net inventories
 
(22,575
)
 
36,644

Income taxes receivable
 
50,434

 
37,388

Accounts payable
 
39,373

 
32,834

Contact loss reserve
 
(23,754
)
 
(37,368
)
Accrued compensation
 
(6,902
)
 
3,924

Pension and other postretirement benefits
 
(7,622
)
 
1,693

Other assets and liabilities
 
(88,146
)
 
(120,030
)
Cash flows provided by operating activities of continuing operations
 
106,612

 
276,381

Cash flows provided by operating activities of discontinued operations
 

 
10,741

Cash flows provided by operating activities
 
106,612

 
287,122

Investing Activities
 
 
 
 
Capital expenditures
 
(105,535
)
 
(104,767
)
Cash acquired in Merger with Orbital
 

 
253,734

Cash dividend received from Vista Outdoor, net of cash transferred to Vista Outdoor in conjunction with the Distribution of Sporting Group
 

 
188,878

Other
 

 
145

Cash flows (used in) provided by investing activities of continuing operations
 
(105,535
)
 
337,990

Cash flows provided by investing activities of discontinued operations
 

 
49

Cash flows (used in) provided by investing activities
 
(105,535
)
 
338,039

Financing Activities
 
 
 
 
Borrowings on revolving credit facilities
 
800,000

 
723,000

Payments on revolving credit facilities
 
(665,000
)
 
(773,000
)
Payment of long-term debt
 
(30,000
)
 
(44,998
)
Payments made to extinguish debt
 

 
(1,746,260
)
Proceeds from issuance of debt
 

 
1,287,000

Payments made for debt issuance costs
 

 
(9,078
)
Purchase of treasury shares
 
(94,992
)
 
(71,585
)
Dividends paid
 
(52,586
)
 
(41,214
)
Other
 
480

 
4,481

Cash flows used in financing activities
 
(42,098
)
 
(671,654
)
Effect of foreign exchange rate fluctuations on cash
 

 
(1,340
)
Decrease in cash and cash equivalents
 
(41,021
)
 
(47,833
)
Cash and cash equivalents at beginning of period
 
104,032

 
112,920

Cash and cash equivalents at end of period
 
$
63,011

 
$
65,087

Supplemental Cash Flow Disclosures
 
 
 
 
Noncash investing and operating activity:
 
 
 
 
Capital expenditures included in accounts payable
 
$
3,727

 
$
5,296

Noncash financing and operating activity:
 
 
 
 
 Debt issuance costs included in accounts payable
 
$

 
$
819

Treasury shares purchased included in accounts payable
 
$
2,859

 
$
2,159

See Notes to the Condensed Consolidated Financial Statements.

4


NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)
1. Basis of Presentation and Responsibility for Interim Financial Statements
The unaudited condensed consolidated financial statements of Orbital ATK, Inc. ("the Company" or "Orbital ATK") as set forth in this quarterly report have been prepared in accordance with the requirements of the U.S. Securities and Exchange Commission ("SEC") for interim reporting. As permitted under those rules, certain footnotes and other financial information that are normally required by accounting principles generally accepted in the United States can be condensed or omitted. The Company's accounting policies are described in the notes to the consolidated financial statements in its Amended Transition Report on Form 10-K/A ("Form 10-K/A") for the nine-month transition period ended December 31, 2015 filed on February 24, 2017 with the SEC. Management is responsible for the unaudited condensed consolidated financial statements included in this document. The unaudited condensed consolidated financial statements included in this document, in the opinion of management, include all adjustments necessary for a fair statement of the Company’s financial position as of October 2, 2016, its results of operations for the quarter and nine months ended October 2, 2016 and October 4, 2015 and cash flows for the nine months ended October 2, 2016 and October 4, 2015. The condensed consolidated balance sheet as of December 31, 2015 was derived from the audited financial statements included in the Form 10-K/A but does not include all of the information and footnotes required by Generally Accepted Accounting Principles ("U.S. GAAP") for complete financial statements.
On February 9, 2015, the Company completed a tax-free spin-off of and distribution of its former Sporting Group to its stockholders (the "Distribution") as a new public company called Vista Outdoor Inc. ("Vista Outdoor"). Immediately following the Distribution, the Company combined with Orbital Sciences Corporation ("Orbital") through the merger of a Company subsidiary with Orbital (the "Merger"). These transactions are discussed in greater detail in Note 5. Following the Distribution and Merger, the Company changed its name from Alliant Techsystems Inc. to Orbital ATK, Inc.
As a result of the Distribution, Sporting Group is no longer reported within the Company's results from continuing operations but is reported as a discontinued operation for all prior periods presented. The Company used the acquisition method to account for the Merger; accordingly, the results of Orbital have been included in the Company's condensed consolidated financial statements since the date of the Merger.
Following the Distribution and Merger, the Company reorganized its business groups and realigned its reporting segments. The Company's remaining businesses, combined with the businesses of Orbital, are now reported in three segments: Flight Systems Group, Defense Systems Group and Space Systems Group, as discussed in Note 20. The business comprising Sporting Group is presented as a discontinued operation - see Note 5.
Sales, expenses, cash flows, assets and liabilities can and do vary during the year. Therefore, the results and trends in these interim financial statements may not be the same as those for the full year. Certain reclassifications have been made to prior year amounts to conform to current year presentation.
This Form 10-Q should be read in conjunction with the Company's consolidated financial statements and notes included in its Form 10-K/A.
Fiscal Year Change and the presentation of the Nine Months Ended October 4, 2015. On March 10, 2015, the Company's Board of Directors approved a change in the Company's fiscal year end from March 31 to a calendar year ending on December 31 of each year. The Company's interim quarterly periods are based on 13-week periods and ending on the Sunday closest to the last calendar day of each of March, June and September. The Company filed a Transition Report on Form 10-K for the nine-month transition period ended December 31, 2015 on March 15, 2016, which was subsequently amended on February 24, 2017. Information in this document referring to the nine months ended October 4, 2015, includes the Company's restated results for the quarters ended March 31, 2015, July 5, 2015 and the quarter ended October 4, 2015 as disclosed in the Company's Form 10-K/A. Additionally, the restated results for the quarter ended March 31, 2015 were also reported in the Amended Quarterly Report on Form 10-Q for the quarter ended April 3, 2016 (filed with the SEC on April 3, 2017).
Restatement of Previously Issued Unaudited Condensed Consolidated Financial Statements. In this Form 10-Q, the Company has restated its unaudited condensed consolidated statement of comprehensive income for the quarter ended October 4, 2015 as disclosed in the Company’s Form 10-K/A.
2. New Accounting Pronouncements
Accounting Standards Updates Adopted
In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") 2016-09, Compensation-Stock Compensation (Topic 718) Improvements to Employee Share-Based Payment Accounting,

5

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

which requires the recognition of the income tax effects of awards in the income statement when the awards vest or are settled, thus eliminating additional paid in capital pools. The guidance also allows for the employer to repurchase a greater number of an employee's shares for tax withholding purposes without triggering liability accounting. In addition, the guidance allows for a policy election to account for forfeitures as they occur rather than on an estimated basis. The guidance is effective for annual reporting periods beginning after December 15, 2016 with early adoption permitted. The Company elected to early adopt this ASU in the quarter ended April 3, 2016. The adoption of this new standard did not have a material impact on the Company's consolidated financial statements.
In May 2015, the FASB issued ASU 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent), which removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. Such investments should be disclosed separate from the fair value hierarchy. This ASU became effective retrospectively for the Company beginning in the quarter ended April 3, 2016. The adoption of this new standard did not have an impact on the Company's consolidated financial statements but impacted certain disclosures reflected in the notes to the accompanying condensed consolidated financial statements.
In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, and in August 2015, the FASB issued ASU No. 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements. These ASUs more closely align the treatment of debt issuance costs with debt discounts and premiums and requires debt issuance costs to be presented as a direct deduction from the carrying amount of the related debt. The amendments in these ASUs became effective for the Company in the quarter ended April 3, 2016. The adoption of these new standards impacted the presentation of the current and prior period debt issuance costs included in Note 12.
In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis, which simplifies the consolidation evaluation process by placing more emphasis on risk of loss when determining a controlling financial interest. This new standard is effective for interim and annual periods beginning after December 15, 2015. The adoption of this new standard did not have a material impact on the Company's consolidated financial statements.
Accounting Standards Updates Issued But Not Yet Adopted
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires recognition of lease assets and lease liabilities for those leases classified as operating leases under previous generally accepted accounting principles in the United States ("U.S. GAAP"). The new standard is effective for annual reporting periods beginning after December 15, 2018 with early adoption permitted. The Company currently is evaluating the potential changes from this ASU to its future financial reporting and disclosures.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which will replace numerous requirements in U.S. GAAP, including industry-specific requirements, and provide companies with a single revenue recognition model for recognizing revenue from contracts with customers. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. Under the new standard, the Company expects to continue using the cost-to-cost percentage-of-completion method to recognize revenue for most of its long-term contracts. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. The Company has not yet selected a transition method. The Company currently is evaluating the potential changes from this ASU to its future financial reporting and disclosures. In July 2015, the FASB approved the deferral of the new standard's effective date by one year. The new standard will now be effective for annual reporting periods beginning after December 15, 2017. The FASB will permit companies to adopt the new standard early, but not before the original effective date of annual reporting periods beginning after December 15, 2016.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments. The guidance clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows. It addresses eight specific cash flows where there currently exists diversity in the way these cash flows are reported. They are (1) Debt Prepayment or Debt Extinguishment Costs; (2) Settlement of Zero-Coupon Debt Instruments; (3) Contingent Consideration Payments Made after a Business Combination; (4) Proceeds from the Settlement of Insurance Claims; (5) Proceeds from the Settlement of Corporate-Owned Life Insurance (COLI) Policies including Bank-Owned Life Insurance Policies; (6) Distributions Received from Equity Method Investees; (7) Beneficial Interests in Securitization Transactions; and (8) Separately Identifiable Cash Flows and Application of the Predominance Principle. In the absence of

6

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

specific guidance, an entity should classify each separately identifiable cash source and use on the basis of the nature of the underlying cash flows. The guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows.
As an example, for item (1) the cash flows will be classified as financing activities; for item (3) contingent payments made soon after the acquisition will be classified as investing activities and financing activities if made thereafter and for item (5) cash payments made to settle COLI policies will be classified as investing activities and premium payments may be classified as cash outflows for investing, operating or a combination of both.
The standard is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, provided that all of the amendments are adopted in the same period. The guidance requires retrospective application but if it is impracticable to do so for an issue, the amendments related to that issue would be applied prospectively. The Company is still evaluating the provisions of ASU 2016-15 and its impact on the condensed consolidated statement of cash flows.
Other new pronouncements issued but not effective for the Company until after October 2, 2016 are not expected to have a material impact on the Company's continuing financial position, results of operations or liquidity.
3. Restatement
In February 2017, the Company filed the Form 10-K/A to restate its consolidated financial statements for the nine-month transition period ended December 31, 2015 ("2015 transition period"), fiscal year ended March 31, 2015 ("fiscal 2015"), fiscal year ended March 31, 2014 ("fiscal 2014"), the quarters in the 2015 transition period and fiscal 2015 (the "Restatement") to correct errors primarily related to (i) the estimation of contract costs at completion on the long-term contract (the “Lake City Contract”) with the U.S. Army to manufacture and supply small caliber ammunition at the Lake City Army Ammunition Plant ("LCAAP") causing a forward loss provision to not be identified timely and recorded in prior periods; and (ii) correcting the Company’s accounting policy for measurement of forward loss provisions. In this Form 10-Q, the Company restated its unaudited condensed consolidated financial statement of comprehensive income for the quarter ended October 4, 2015 for the consequential impact of these errors.
The Audit Committee of the Board of Directors, in consultation with senior management, determined that the Company should conduct an internal investigation, under its supervision, of the circumstances surrounding the misstatements in the accounting for the Lake City Contract and related matters. The investigation was undertaken by outside counsel, along with independent counsel for the Audit Committee. Counsel received assistance from outside forensic accountants. As disclosed in the Form 10-K/A, the investigation was previously completed.
Based on the internal investigation, the Audit Committee and senior management concluded as follows: Certain personnel at the Small Caliber Systems Division and, in some cases, Defense Systems Group, acted inappropriately and failed to adhere to the high standards established in the Company’s policies and expected by senior management and the Board of Directors. Specifically, with respect to the Lake City Contract: (a) there likely was a bias toward maintaining a targeted profit rate; (b) in some cases, there appears to have been inappropriate use of management reserves to maintain the targeted profit rate; (c) some members of the Small Caliber Systems Division finance staff failed to follow up and inquire further into indicators that cost overruns were occurring, and if such inquiries had been made, it could have led to further contemporaneous discussion and an earlier conclusion that the Lake City Contract was in a forward loss position; and (d) negative information was suppressed, and concerns at the Small Caliber Systems Division about cost overruns were not escalated appropriately to higher-level Company management or finance staff, nor were they communicated to the Audit Committee, the Board of Directors or the independent registered public accounting firms.
The Lake City Contract is within the Small Caliber Systems Division, a business unit within the Company’s Defense Systems Group, and is a fixed price contract accounted for under the percentage-of-completion revenue recognition method. The Lake City Contract was entered into in September 2012. It has an initial term of seven years plus the possibility of an award term extension of an additional three years if by July 17, 2017 the Company does not provide written notice of rejection to the U.S. Army. It is probable that the Company will provide written notice of rejection to the U.S. Army. As a result, the Restatement presents the total estimated forward loss provision for the initial seven-year term.
Management identified that the underlying contract costs estimated at completion for the Lake City Contract in prior periods contained misstatements which, when corrected, resulted in the Lake City Contract’s estimated costs at completion exceeding the contracted revenues. This necessitated a forward loss charge for the seven-year term of the Lake City Contract to be recorded for the entire anticipated forward loss on the contract in the period in which the loss became evident. The Company determined that $31,500 of the loss was evident at contract signing (second quarter of fiscal 2013) and $342,000 became

7

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

evident at the time of initial production (second quarter of fiscal 2014) and restated those periods and the consequential impact in subsequent periods.
Due to the contract loss identified at the Lake City facility, the Company recognized an impairment charge for the long lived assets capitalized for the Lake City Ammunition Plant asset group in fiscal 2014. Subsequent to the impairments, costs incurred for the purchase or construction of additional long-lived assets related to this contract were expensed in the periods incurred, as such costs will not be recovered, and the depreciation expense recorded in subsequent periods was revised. The impairment charge recognized on long lived assets was $8,962, $3,576 and $2,295 in the quarters ended March 31, 2015, July 5, 2015 and October 4, 2015, respectively.
The Company corrected its accounting policy from measurement of a forward loss provision based on gross profit to measurement based on gross profit along with general and administrative costs and adjusted the previously recorded forward loss provisions. The Company's prior accounting policy for measurement of a forward loss excluded general and administrative costs from the forward loss determination resulting in an incorrect measurement of a forward loss as these costs should be included in the measurement. The aggregate impact of this correction to the contract loss reserve liability, excluding the adjustment for the Lake City Contract, was an increase of $3,061 at October 4, 2015. As part of the correction in accounting policy, the Company also reclassified certain forward loss provisions recorded in net receivables to the contract loss reserve liability.
In addition to the matters in (i) and (ii) described above, the Company also corrected for (iii) certain immaterial misstatements identified during an account review and analysis exercise.
A summary of the impact of these matters on income before income taxes and noncontrolling interest is presented below:
 
 
Increase / (Decrease) Restatement Impact
 
 
Quarter ended
 October 4, 2015
Lake City Contract Loss and Related Adjustments:
 
 
Sales
 
$
(8,121
)
Cost of sales
 
$
(8,809
)
Gross profit
 
$
688

Income before interest expense, income taxes and noncontrolling interest
 
$
688

Income before income taxes and noncontrolling interest
 
$
688

 
 
 
Contract Loss Reserve Adjustment:
 
 
Sales
 
$

Cost of sales
 
$
(646
)
Gross profit
 
$
646

Income before interest expense, income taxes and noncontrolling interest
 
$
646

Income before income taxes and noncontrolling interest
 
$
646

 
 
 
Account Review and Analysis and Other:
 
 
Sales
 
$
(2,250
)
Cost of sales
 
$
742

Gross profit
 
$
(2,992
)
Income before interest expense, income taxes and noncontrolling interest
 
$
(2,992
)
Income before income taxes and noncontrolling interest
 
$
(2,992
)

The restatement adjustments were tax effected and any tax adjustments reflected in the condensed consolidated financial statements relate entirely to the tax effect on the restatement adjustments.


8

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

The account balances labeled “As Reported” in the following table represents the amounts previously reported in the Company's Quarterly Report on Form 10-Q for the quarter ended October 4, 2015 filed on November 5, 2015 with the SEC. The columns labeled First Restatement Adjustments and Second Restatement Adjustments represent the restatement adjustments disclosed in the Transition Report on Form 10-K for the 2015 transition period previously filed with the SEC on March 15, 2016 and the restatement adjustments disclosed in the Form 10-K/A filed with the SEC in February 2017, respectively. The effects of these prior period errors on the unaudited condensed consolidated statement of comprehensive income for the quarter ended October 4, 2015 were as follows:
 
 
Quarter Ended October 4, 2015
Consolidated Statements of Comprehensive Income (Unaudited)
 
As Reported
 
First Restatement Adjustments
 
Second Restatement Adjustments
 
As Restated
Sales
 
$
1,134,886

 
$
18,731

 
$
(10,371
)
 
$
1,143,246

Cost of sales
 
884,734

 
58,408

 
(8,713
)
 
934,429

Gross profit
 
250,152

 
(39,677
)
 
(1,658
)
 
208,817

Operating expenses:
 
 
 
 
 
 
 
 
Research and development
 
28,666

 

 

 
28,666

Selling
 
28,137

 

 

 
28,137

General and administrative
 
69,384

 
(4,180
)
 

 
65,204

Gain on settlement
 

 
50,000

 

 
50,000

Income before interest, income taxes and noncontrolling interest
 
123,965

 
14,503

 
(1,658
)
 
136,810

Interest expense, net
 
(24,293
)
 
(343
)
 

 
(24,636
)
Income before income taxes and noncontrolling interest
 
99,672

 
14,160

 
(1,658
)
 
112,174

Income taxes
 
33,123

 
5,487

 
(630
)
 
37,980

Net income before noncontrolling interest
 
66,549

 
8,673

 
(1,028
)
 
74,194

Less net income attributable to noncontrolling interest
 
147

 

 

 
147

Net income attributable to Orbital ATK, Inc.
 
$
66,402

 
$
8,673

 
$
(1,028
)
 
$
74,047

 
 
 
 
 
 
 
 
 
Basic earnings per common share from:
 
 
 
 
 
 
 
 
Net income attributable to Orbital ATK, Inc.
 
$
1.13

 
 
 
 
 
$
1.26

Weighted-average number of common shares outstanding
 
58,746

 
 
 
 
 
58,746

Diluted earnings per common share from:
 
 
 
 
 
 
 
 
Net income attributable to Orbital ATK, Inc.
 
$
1.12

 
 
 
 
 
$
1.25

Weighted-average number of diluted common shares outstanding
 
59,304

 
 
 
 
 
59,304

Comprehensive income attributable to Orbital ATK, Inc.
 
$
81,853

 
$
8,673

 
$
(1,028
)
 
$
89,498

4. Fair Value of Financial Instruments
The current authoritative guidance on fair value clarifies the definition of fair value, prescribes a framework for measuring fair value, establishes a fair value hierarchy based on the inputs used to measure fair value, and expands disclosures about the use of fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
The valuation techniques required by the current authoritative literature are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect internal market assumptions. These two types of inputs create the following fair value hierarchy:
Level 1—Quoted prices for identical instruments in active markets.
Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3—Significant inputs to the valuation model are unobservable.

9

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

The following section describes the valuation methodologies used by the Company to measure its financial instruments at fair value.
Derivative financial instruments and hedging activities—In order to manage its exposure to commodity pricing, foreign currency risk and interest rate risk on debt, the Company periodically utilizes commodity, foreign currency and interest rate derivatives, which are considered Level 2 instruments. As discussed further in Note 8, the Company has outstanding commodity forward contracts that were entered into to hedge forecasted purchases of copper and zinc, as well as outstanding foreign currency forward contracts that were entered into to hedge forecasted transactions denominated in a foreign currency. Commodity derivatives are valued based on prices of futures exchanges and recently reported transactions in the marketplace. The Company currently holds four interest rate swaps with a total notional value of $300,000. These swaps are valued based on future LIBOR rates and the established fixed rate is based primarily on quotes from banks. Foreign currency derivatives are valued based on observable market transactions of spot currency rates and forward currency prices.
The carrying amounts of the Company’s financial instruments, other than derivatives, which include net receivables, inventory, accounts payable, accrued liabilities and other current assets and liabilities, are reasonable estimates of their related fair values. The fair value of the variable-rate long-term debt is calculated based on current market rates for debt of the same risk and maturities. The fair value of the fixed-rate debt is based on market quotes for each issuance. The Company considers these to be Level 2 instruments.
The Company’s non-financial instruments measured at fair value on a non-recurring basis include goodwill, indefinite-lived intangible assets and long-lived tangible assets. The valuation methods used to determine fair value require a significant degree of management judgment to determine the key assumptions. As such, the Company generally classifies non-financial instruments as either Level 2 or Level 3 fair value measurements.
The following tables set forth, by level within the fair value hierarchy, the Company's financial assets and liabilities that are measured at fair value on a recurring basis:
 
 
October 2, 2016
 
 
Fair Value Measurements Using Inputs Considered as
 
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
Derivatives
 
$

 
$
3,188

 
$

Liabilities
 
 
 
 
 
 
Derivatives
 
$

 
$
2,700

 
$

 
 
December 31, 2015
 
 
Fair Value Measurements Using Inputs Considered as
 
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
Derivatives
 
$

 
$
3,979

 
$

Liabilities
 
 
 
 
 
 
Derivatives
 
$

 
$
8,353

 
$

Recorded carrying amount and fair value of debt was as follows:
 
 
October 2, 2016
 
December 31, 2015
 
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
Fixed-rate debt
 
$
700,000

 
$
732,750

 
$
700,000

 
$
712,500

Variable-rate debt
 
$
895,000

 
$
889,531

 
$
790,000

 
$
787,697

Investments in marketable securities—The Company has investments in marketable securities held in a common collective trust ("CCT") that are primarily fixed income securities used to pay benefits under a nonqualified supplemental executive retirement plan for certain executives and highly compensated employees. Investments in a collective investment vehicle are valued by multiplying the investee company's net asset value per share with the number of units or shares owned at the valuation date as determined by the investee company. Net asset value per share is determined by the investee company's custodian or fund administrator by deducting from the value of the assets of the investee company all of its

10

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

liabilities and dividing the resulting number by the outstanding number of shares or units. Investments held by the CCT, including collateral invested for securities on loan, are valued on the basis of valuations furnished by a pricing service approved by the CCT's investment manager, which determines valuations using methods based on market transactions for comparable securities and various relationships between securities which are generally recognized by institutional traders, or at fair value as determined in good faith by the CCT's investment manager. The fair value of these securities, not subject to leveling, is included within other noncurrent assets on the Company's consolidated balance sheet. The fair value of these securities is measured on a recurring basis and was $12,383 and $12,065 as of October 2, 2016 and December 31, 2015, respectively.
5. Mergers, Acquisitions and Divestitures
On February 9, 2015, the Company completed the spin-off and Distribution of its former Sporting Group to its stockholders and merged with Orbital pursuant to a transaction agreement, dated April 28, 2014 (the "Transaction Agreement"). The Company completed the Merger with Orbital in order to create a global aerospace and defense company with greater technical and industrial capabilities and increased financial resources. Both the Distribution and Merger were structured to be tax-free to U.S. stockholders for U.S. federal income tax purposes. Under the Transaction Agreement, a subsidiary of the Company merged with and into Orbital, with Orbital continuing as a wholly-owned subsidiary of the Company.
Pursuant to the Distribution, Company stockholders received two shares of Vista Outdoor for each share of Company common stock held. The Company distributed a total of approximately 63.9 million shares of Vista Outdoor common stock to its stockholders of record as of the close of business on February 2, 2015 the record date for the Distribution. As a result of the Distribution, Sporting Group is no longer reported within the Company’s results from continuing operations but is reported as a discontinued operation for all prior periods presented in accordance with ASC Topic 205, "Presentation of Financial Statements." Sales reported as discontinued operations were $186,000 for the nine months ended October 4, 2015.
In connection with the Merger, each outstanding share of Orbital common stock was converted into the right to receive 0.449 shares of Company common stock. The Company issued approximately 27.4 million shares of common stock to Orbital stockholders. Immediately following the Merger, Orbital stockholders owned 46.2% of the common stock of the Company and existing stockholders owned 53.8%. Based on the closing price of the Company's common stock following the Distribution on February 9, 2015 as reported on the New York Stock Exchange, the aggregate value of the consideration paid or payable to former holders of Orbital common stock was approximately $1,800,000. The Company used the acquisition method to account for the Merger; accordingly, the results of Orbital have been included in the Company's consolidated financial statements since the date of the Merger.

11

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

Valuation of Net Assets Acquired
The following amounts represent the final determination (as of the Merger date) of the fair value of identifiable assets acquired and liabilities assumed in the Merger, including adjustments made to date during the one year measurement period from the date of the Merger:
Purchase Price:
 
 
Value of common shares issued to Orbital shareholders (1)
 
$
1,749,323

Value of replacement equity-based awards to holders of Orbital equity-based awards (2)
 
8,654

Total purchase price
 
$
1,757,977

 
 
 
Value of assets acquired and liabilities assumed:
 


Cash
 
$
253,734

Net receivables
 
558,639

Net inventories
 
75,294

Intangibles
 
173,000

Property, plant and equipment
 
277,438

Deferred tax assets, net
 
64,821

Other assets
 
36,878

Goodwill
 
826,548

Accounts payable
 
(52,028
)
Contract fair value liabilities
 
(130,888
)
Other liabilities
 
(325,459
)
Total purchase price
 
$
1,757,977

_________________________________________
(1) 
Equals 27.4 million Orbital ATK shares issued to Orbital shareholders multiplied by $63.94, the closing share price of the Company's common stock on the closing date of the Merger.
(2) 
The fair value of replacement equity-based awards attributable to pre-Merger service was recorded as part of the consideration transferred in the Merger.
The consideration paid for Orbital's assets and liabilities was determined using the fair market value of the Company stock issued on the closing date of the Merger along with restricted stock awards granted to certain employees of Orbital.
Goodwill recognized from the Merger primarily relates to the expanded market opportunities, expected synergies and benefits of increased scale and scope of combined human, physical and financial resources attributable to merging the operations of the two companies. As stated above, the Merger was a tax-free transaction and as such, goodwill is not amortized for tax purposes.
In determining the fair values of identifiable assets acquired and liabilities assumed, a review was conducted for any significant contingent assets or liabilities existing as of the Merger date. There were no significant contingencies identified related to any legal or government action.
The accompanying condensed consolidated statements of comprehensive income (loss) for the nine months ended October 2, 2016 included a measurement period adjustment of $6,000 pertaining to the fair value of intangibles. All elements in the determination of the fair value of identifiable assets acquired and liabilities assumed in the Merger were completed during the quarter ended April 3, 2016.

12

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

Supplemental Pro Forma Data
The following unaudited supplemental pro forma data for the nine months ended October 4, 2015 presents condensed consolidated information as if the Merger had been completed on April 1, 2013. The pro forma results were calculated by combining the results from continuing operations of the Company with the stand-alone results of Orbital for the pre-Merger period, which were adjusted to eliminate historical sales between the companies and to account for certain costs which would have been incurred during this pre-Merger period:
 
 
Nine Months Ended October 4, 2015
Sales
 
$
3,335,115

Income from continuing operations
 
$
103,418

Basic per common share from continuing operations
 
$
1.74

Diluted per common share from continuing operations
 
$
1.73

The unaudited supplemental pro forma data above includes the following significant adjustments made to account for certain costs which would have been incurred if the Merger had been completed on April 1, 2013, as adjusted for the applicable income tax impact:
 
 
Nine Months Ended October 4, 2015
Amortization of acquired Orbital intangible assets (1)
 
$
3,877

Interest expense adjustment (2)
 
$
(6,069
)
Transaction fees for advisory, legal and accounting services (3)
 
$
(19,134
)
_________________________________________
(1) Added the amortization of acquired Orbital intangible assets recognized at fair value in purchase accounting and eliminated historical Orbital intangible asset amortization expense.
(2) Reduced interest expense for the net reduction in debt of the Company and Orbital.
(3) Excluded transaction fees for advisory, legal and accounting services incurred in the nine months ended October 4, 2015.
The unaudited supplemental pro forma data above does not reflect the potential realization of cost savings related to the integration of the two companies. Further, the pro forma data should not be considered indicative of the results that would have occurred if the Merger had been completed on April 1, 2013, nor are they indicative of future results.
Ongoing Business with Vista Outdoor
In conjunction with the Distribution, the Company entered into two supply agreements and a Transition Services Agreement ("TSA") with Vista Outdoor. The supply agreements call for Vista Outdoor to purchase certain minimum quantities of ammunition and gun powder from the Company through March 2017 or 2018, as applicable. The supply agreements, which are priced at arms-length, expire in 2017 (powder) and 2018 (ammunition) and may be extended in one-to-three year increments. Under the terms of the TSA, the Company provided Vista Outdoor with administrative services for 12 months following the Distribution and provided tax-related services through August 31, 2016. At the option of Vista Outdoor, the Company is currently providing tax-audit related services to Vista Outdoor. Under the terms of the TSA, Vista Outdoor has this option through August 31, 2017. Fees for services under the TSA are charged to Vista Outdoor.
Sales to Vista Outdoor under the supply agreements were $58,677 and $167,788 for the quarter and nine months ended October 2, 2016, respectively; and $43,589 (as restated) and $119,956 for the quarter and for the period from the date of Distribution to October 4, 2015, respectively. Prior to the Merger, sales to Sporting Group previously reported as intercompany sales and eliminated in consolidation $13,595 for the nine months ended October 4, 2015.
6. Goodwill and Net Intangibles
The changes in the carrying amount of goodwill by segment were as follows:
 
 
Flight Systems Group
 
Defense Systems Group
 
Space Systems Group
 
Total
Balance, December 31, 2015
 
$
922,991

 
$
363,247

 
$
542,128

 
$
1,828,366

Measurement period adjustments
 
5,467

 

 
(1,822
)
 
3,645

Balance, October 2, 2016
 
$
928,458

 
$
363,247

 
$
540,306

 
$
1,832,011

Goodwill recorded within Defense Systems Group is presented net of accumulated impairment losses totaling $3,700 at October 2, 2016. Goodwill recorded within Space Systems Group is presented net of accumulated impairment losses totaling $142,800 at October 2, 2016.
Net Intangibles consisted of the following:
 
 
October 2, 2016
 
December 31, 2015
Amortizing intangibles: 
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Intangibles
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Intangibles
Contract Backlog
 
$
173,000

 
$
(68,324
)
 
$
104,676

 
$
179,000

 
$
(36,696
)
 
$
142,304

Patented technology
 
11,018

 
(7,070
)
 
3,948

 
11,018

 
(6,206
)
 
4,812

Customer relationships and other
 
1,905

 
(1,905
)
 

 
24,294

 
(24,254
)
 
40

Net Intangibles
 
$
185,923

 
$
(77,299
)
 
$
108,624

 
$
214,312

 
$
(67,156
)
 
$
147,156

The contract backlog asset in the table above is being amortized as the underlying costs are recognized under the contracts. The other assets in the table above are being amortized using a straight-line method. Amortization expense related to net intangible assets was $10,821 and $32,535 for the quarter and nine months ended October 2, 2016, respectively, and $13,218 and $33,183 for the quarter and nine months ended October 4, 2015, respectively. The Company expects amortization expense related to these assets to be as follows:
 
 
Contract Backlog
 
Patents
 
Total
Remainder of 2016
 
$
10,543

 
$
311

 
$
10,854

2017
 
35,882

 
1,180

 
37,062

2018
 
25,609

 
1,120

 
26,729

2019
 
21,760

 
1,072

 
22,832

2020
 
10,882

 
265

 
11,147

Thereafter
 

 

 

Total
 
$
104,676

 
$
3,948

 
$
108,624

7. Earnings Per Share Data
Basic earnings per share ("EPS") is computed based upon the weighted-average number of common shares outstanding for each period. Diluted EPS is computed based on the weighted-average number of common shares outstanding and increased to include the dilutive effect of outstanding stock-based equity awards for each period.

13

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

In computing basic and diluted EPS for both the quarter and nine months ended October 2, 2016 and October 4, 2015, the reported earnings for each respective period were divided by the weighted-average shares outstanding, determined as follows (in thousands):
 
 
Quarter Ended
 
Nine Months Ended
 
 
October 2, 2016
 
October 4, 2015
 
October 2, 2016
 
October 4, 2015
Basic weighted-average number of shares outstanding
 
57,927

 
58,746

 
58,213

 
54,807

Dilutive common share equivalents - share-based equity awards
 
330

 
558

 
429

 
421

Diluted weighted-average number of shares outstanding
 
58,257

 
59,304

 
58,642

 
55,228

Anti-dilutive stock options excluded from the calculation of diluted shares
 
147

 
89

 
147

 
102

8. Derivative Financial Instruments
The Company is exposed to market risks arising from adverse changes in commodity prices affecting the cost of raw materials and energy, interest rates and foreign exchange risks. In the normal course of business, these risks are managed through a variety of strategies, including the use of derivative instruments. Commodity forward contracts are periodically used to hedge forecasted purchases of certain commodities, foreign currency exchange contracts are used to hedge forecasted transactions denominated in a foreign currency, and the Company periodically uses interest rate swaps to hedge forecasted interest payments and the risk associated with variable interest rates on long-term debt.
The Company entered into forward contracts for copper and zinc in 2016. The contracts establish a fixed price for the underlying commodity and are designated and qualify as effective cash flow hedges of purchases of the commodity. Ineffectiveness is calculated as the amount by which the change in the fair value of the derivatives exceeds the change in the fair value of the anticipated commodity purchases.
The Company entered into interest rate swaps in fiscal 2014 in order to manage interest costs and the risk associated with variable rates, whereby the Company pays a fixed rate on a total notional amount of $300,000 and receives one-month LIBOR. The fair value of interest rate swap agreements approximates the amount at which they could be settled, based on future LIBOR, and the established fixed rate is based primarily on quotes from banks. The Company performs assessments of the effectiveness of hedge instruments on a quarterly basis and determined the hedges to be highly effective. The counterparties to the interest rate swap agreements expose the Company to credit risk in the event of nonperformance. At October 2, 2016, the outstanding swap agreements were in a net liability position which would require the Company to make the net settlement payments to the counterparties if the agreements were settled as of that date. The Company does not anticipate nonperformance by the Company's counterparties. The Company does not hold or issue derivative financial instruments for trading purposes.
The Company entered into foreign currency forward contracts in 2016 to hedge forecasted cash payments to a customer. This transaction was designated and qualified as an effective cash flow hedge. Ineffectiveness with respect to forecasted inventory purchases or customer cash receipts is calculated based on changes in the forward rate until the anticipated purchase or cash receipt occurs; ineffectiveness of the hedge of the accounts payable is evaluated based on the change in fair value of its anticipated settlement.
The fair values of the commodity and foreign currency forward contracts are recorded in other assets or liabilities, as appropriate, and the effective portion is reflected in accumulated other comprehensive income (loss) in the financial statements. The gains or losses on the commodity forward contracts are recorded in inventory as the commodities are purchased and in cost of sales when the related inventory is sold. The gains or losses on the foreign currency forward contracts are recorded in earnings when the related inventory is sold or customer cash receipts are received.
Outstanding commodity forward contracts that hedge forecasted commodity purchases were as follows:
 
 
Number of Pounds
Copper
 
11,375

Zinc
 
3,830

Interest rate swap agreements in order to manage interest costs and risk associated with variable interest rates were as follows:
 
 
Notional
 
Fair Value
 
Pay Fixed
 
Receive Floating
 
Maturity Date
Non-amortizing swap
 
$
100,000

 
$
(574
)
 
1.29
%
 
0.52
%
 
August 2017
Non-amortizing swap
 
$
100,000

 
$
(1,781
)
 
1.69
%
 
0.52
%
 
August 2018
Non-amortizing swap
 
$
50,000

 
$
(9
)
 
0.65
%
 
0.52
%
 
November 2016
Non-amortizing swap
 
$
50,000

 
$
(254
)
 
1.10
%
 
0.52
%
 
November 2017
The amount to be paid or received under these swaps is recorded as an adjustment to interest expense.
Outstanding foreign currency forward contracts were as follows:

14

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

 
 
Quantity Hedged
Euros sold
 
49,820

Euros purchased
 
3,207

Fair values in the condensed consolidated balance sheets related to derivative instruments designated as hedging instruments were as follows:
 
 
 
 
Asset Derivatives
Fair Value
 
Liability Derivatives
Fair Value
 
 
Location
 
October 2, 2016
 
December 31, 2015
 
October 2, 2016
 
December 31, 2015
Commodity forward contracts
 
Other current assets /
other current liabilities
 
$
1,557

 
$

 
$

 
$
4,445

Commodity forward contracts
 
Other noncurrent assets /
other noncurrent liabilities
 
486

 

 

 

Foreign currency forward contracts
 
Other current assets /
other current liabilities
 
1,126

 
2,875

 
81

 
1,442

Foreign currency forward contracts
 
Other noncurrent assets /
other noncurrent liabilities
 
19

 
1,095

 

 
18

Interest rate contracts
 
Other current assets /
other current liabilities
 

 
9

 
583

 

Interest rate contracts
 
Other noncurrent assets /
other noncurrent liabilities
 

 

 
2,036

 
2,448

Total
 
 
 
$
3,188

 
$
3,979

 
$
2,700

 
$
8,353

Due to the customer contract requirements, the benefits associated with the commodity contracts may be passed on to the customer and not realized by the Company.
Gains and losses reclassified from AOCI in the condensed consolidated statements of comprehensive income related to derivative instruments were as follows:
 
 
Gain (Loss) Reclassified from AOCI
 
 
Location
 
Amount
Quarter ended October 2, 2016
 
 
 
 
Commodity forward contracts
 
Cost of sales
 
$
137

Interest rate contracts
 
Interest expense
 
$
(673
)
Foreign currency forward contracts
 
Cost of sales
 
$
(110
)
Quarter ended October 4, 2015
 
 
 
 
Commodity forward contracts
 
Cost of sales
 
$
(919
)
Interest rate contracts
 
Interest expense
 
$
(1,011
)
Foreign currency forward contracts
 
Cost of sales
 
$
(834
)
 
 
 
 
 
Nine months ended October 2, 2016
 
 
 
 
Commodity forward contracts
 
Cost of sales
 
$
(3,595
)
Interest rate contracts
 
Interest expense
 
$
(2,179
)
Foreign currency forward contracts
 
Cost of sales
 
$
(74
)
Nine months ended October 4, 2015
 
 
 
 
Commodity forward contracts
 
Cost of sales
 
$
(3,727
)
Interest rate contracts
 
Interest expense
 
$
(3,041
)
Foreign currency forward contracts
 
Cost of sales
 
$
(10,527
)

15

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

The ineffective portion of derivative instruments was not material and no derivatives were excluded from effectiveness testing during the quarter and nine months ended October 2, 2016 and October 4, 2015; accordingly, the Company did not recognize any related gains or losses in the income statement.
All derivatives used by the Company during the periods presented were designated as hedging instruments for accounting purposes.
The Company expects the remaining unrealized losses will be realized and reported in cost of sales or interest expense depending on the type of contract consistent with realized gains and losses noted in the table above. Estimated and actual gains or losses will change as market prices change.
9. Accumulated Other Comprehensive Loss ("AOCI")
The following table summarizes the components of AOCI, net of income taxes:
 
 
October 2, 2016
 
December 31, 2015
Derivatives
 
$
256

 
$
(3,059
)
Pension and other postretirement benefits
 
(713,986
)
 
(784,294
)
Available-for-sale securities
 
2,521

 
1,445

Total AOCI
 
$
(711,209
)
 
$
(785,908
)

16

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

10. Net Receivables
Net receivables, including amounts due under long-term contracts, consisted of the following:
 
 
October 2, 2016
 
December 31, 2015
Billed receivables
 
$
378,641

 
$
217,522

Unbilled receivables
 
1,486,721

 
1,454,327

Less allowance for doubtful accounts
 
(536
)
 
(1,028
)
Net receivables
 
$
1,864,826

 
$
1,670,821

Receivable balances are shown net of customer progress payments received of $609,255 as of October 2, 2016 and $584,325 as of December 31, 2015.
Unbilled receivables represent the balance of recoverable costs and accrued profit, comprised principally of revenue recognized on contracts for which billings have not been presented to the customer because the amounts were earned but not contractually billable as of the balance sheet date. As of October 2, 2016 and December 31, 2015, the net receivable balance includes contract-related unbilled receivables which the Company does not expect to collect within the next 12 months of $293,200 and $311,600, respectively.
11. Net Inventories
Net inventories consisted of the following:
 
 
October 2, 2016
 
December 31, 2015
Raw materials
 
$
80,767

 
$
88,365

Contracts in process
 
148,987

 
124,315

Finished goods
 
333

 
532

Net inventories
 
$
230,087

 
$
213,212

12. Long-term Debt
Long-term debt consisted of the following:
 
 
October 2, 2016
 
December 31, 2015
Senior Credit Facility:
 
 
 
 
Term Loan A due 2020
 
$
760,000

 
$
790,000

Revolving Credit Facility due 2020
 
135,000

 

5.25% Senior Notes due 2021
 
300,000

 
300,000

5.50% Senior Notes due 2023
 
400,000

 
400,000

Principal amount of long-term debt
 
1,595,000

 
1,490,000

Unamortized debt issuance costs:
 
 
 
 
   Senior Credit Facility
 
5,318

 
6,302

   5.25% Senior Notes due 2021
 
1,668

 
1,915

   5.50% Senior Notes due 2023
 
5,372

 
5,947

Unamortized debt issuance costs
 
12,358

 
14,164

Long-term debt less unamortized debt issuance costs
 
1,582,642

 
1,475,836

Less: Current portion of long-term debt
 
40,000

 
40,000

Long-term debt
 
$
1,542,642

 
$
1,435,836

Senior Credit Facility
In September 2015, the Company refinanced its former senior credit facility with a new senior credit facility (the "Senior Credit Facility"), which is comprised of a term loan of $800,000 (the "Term Loan A") and a revolving credit facility of

17

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

$1,000,000 (the "Revolving Credit Facility"), which mature in September 2020. The Term Loan A is subject to quarterly principal payments of $10,000, with the remaining balance due at maturity. Substantially all tangible and intangible assets of the Company and certain domestic subsidiaries, excluding real property, are pledged as collateral under the Senior Credit Facility. Borrowings under the Senior Credit Facility bear interest at a per annum rate equal to either the sum of a base rate plus a margin or the sum of a LIBOR rate plus a margin. Each margin is based on the Company's total leverage ratio. In compliance with the terms of the Senior Credit Facility, the current base rate margin is 0.5% and the current LIBOR margin is 1.5%. The weighted-average interest rate for the Term Loan A, after taking into account the interest rate swaps discussed below, was 2.33% at October 2, 2016. The Company pays a quarterly commitment fee on the unused portion of the Revolving Credit Facility based on its total leverage ratio. Based on the Company's current total leverage ratio, this fee is currently 0.25%. As of October 2, 2016, the Company had borrowings of $135,000 under the Revolving Credit Facility and had outstanding letters of credit of $128,121, which reduced amounts available on the Revolving Credit Facility to $736,879. There are unamortized debt issuance costs of $6,667 associated with the former senior credit facility in addition to debt issuance costs incurred related to the new Senior Credit Facility that are being amortized to interest expense over five years, the term of the Senior Credit Facility.
5.50% Senior Notes
In September 2015, the Company issued $400,000 aggregate principal amount of 5.50% Senior Notes (the "5.50% Notes") that mature on October 1, 2023. These notes are general unsecured obligations. Interest on these notes is payable on April 1 and October 1 of each year. The Company has the right to redeem some or all of these notes from time to time on or after October 1, 2018, at specified redemption prices. Prior to October 1, 2018, the Company may redeem some or all of these notes at a price equal to 100% of their principal amount plus accrued and unpaid interest to the date of redemption and a specified make-whole premium. In addition, prior to October 1, 2018, the Company may redeem up to 35% of the aggregate principal amount of these notes with the net cash proceeds of certain equity offerings, at a price equal to 105.5% of their principal amount plus accrued and unpaid interest to the date of redemption. Debt issuance costs of $6,136 related to these notes are being amortized to interest expense over eight years, the term of the notes.
5.25% Senior Notes
In fiscal 2014, the Company issued $300,000 aggregate principal amount of 5.25% Senior Notes (the "5.25% Notes") that mature on October 1, 2021. These notes are general unsecured obligations. Interest on these notes is payable on April 1 and October 1 of each year. The Company has the right to redeem some or all of these notes from time to time on or after October 1, 2016, at specified redemption prices. Debt issuance costs of $2,625 related to these notes are being amortized to interest expense over eight years, the term of the notes.
Interest Rate Swaps
As of October 2, 2016, the Company had interest rate swap agreements in order to manage interest costs and the risk associated with variable interest rates - see Note 8.
Rank and Guarantees
The 5.50% Notes and the 5.25% Notes are the Company's general unsecured and unsubordinated obligations and rank equally in right of payment with all of the Company’s existing and future unsecured and unsubordinated indebtedness, rank senior in right of payment to all of the Company's existing and future subordinated indebtedness and are effectively subordinated to all existing and future senior secured indebtedness, including the Senior Credit Facility, to the extent of the collateral. The 5.50% Notes and the 5.25% Notes are guaranteed on an unsecured basis, jointly and severally and fully and unconditionally, by substantially all of the Company's domestic subsidiaries. The Senior Credit Facility obligations are guaranteed on a secured basis, jointly and severally and fully and unconditionally, by substantially all of the Company's domestic subsidiaries. All of these guarantor subsidiaries are 100% owned by the Company. The Company, exclusive of these guarantor subsidiaries, has no independent operations or material assets. The guarantee by any Subsidiary Guarantor of the Company's obligations in respect of the 5.50% Notes and the 5.25% Notes will be released in each of the following circumstances:
if, as a result of the sale of its capital stock, such Subsidiary Guarantor ceases to be a Restricted Subsidiary;
if such Subsidiary Guarantor is designated as an "Unrestricted Subsidiary" with respect to the 5.25% Notes and the 5.50% Notes;
upon defeasance or satisfaction and discharge of the 5.25% Notes and the 5.50% Notes, as applicable; and

18

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

if such Subsidiary Guarantor has been released from its guarantees of indebtedness under the credit agreement governing the Senior Credit Facility (the "Credit Agreement") and all capital markets debt securities.
Scheduled Minimum Loan Payments
The scheduled minimum loan payments on outstanding long-term debt are as follows:
Remainder of 2016
 
$
10,000

Calendar 2017
 
40,000

Calendar 2018
 
40,000

Calendar 2019
 
40,000

Calendar 2020
 
765,000

Thereafter
 
700,000

Total
 
$
1,595,000

Covenants and Default Provisions
The Company's Senior Credit Facility and the indentures governing the 5.50% Notes and the 5.25% Notes impose restrictions on the Company, including limitations on its ability to incur additional debt, enter into capital leases, grant liens, pay dividends and make certain other payments, sell assets, or merge or consolidate with or into another entity. In addition, the Senior Credit Facility limits the Company's ability to enter into sale-and-leaseback transactions. The 5.50% Notes and 5.25% Notes limit the aggregate sum of dividends, share repurchases and other designated restricted payments to an amount based on the Company's net income, stock issuance proceeds and certain other items since April 1, 2001, less restricted payments made since that date. The Senior Credit Facility allows the Company to make unlimited "restricted payments" (as defined in the Credit Agreement), which, among other items, would allow payments for future stock repurchases, as long as the Company maintains a certain amount of liquidity and maintains certain senior secured debt limits, with a limit, when those senior secured debt limits are not met, of $250,000 plus proceeds of any equity issuances plus 50% of net income since October 7, 2010. The Senior Credit Facility also requires the Company to meet and maintain specified financial ratios, including a minimum interest coverage ratio and a maximum consolidated total leverage ratio. The Company's debt agreements contain cross-default provisions so that noncompliance with the covenants within one debt agreement could cause a default under other debt agreements as well. The Company's ability to comply with these covenants and to meet and maintain the financial ratios may be affected by events beyond its control. Borrowings under the Senior Credit Facility are subject to compliance with these covenants. As of October 2, 2016, the Company was in compliance with the financial covenants.
13. Employee Benefit Plans
The components of net periodic benefit cost for pension benefits were as follows:
 
 
Pension Benefits
 
 
Quarter Ended
 
Nine Months Ended
 
 
October 2, 2016
 
October 4, 2015
 
October 2, 2016
 
October 4, 2015
Service cost
 
$
4,556

 
$
4,815

 
$
13,645

 
$
14,445

Interest cost
 
25,360

 
30,348

 
76,186

 
90,866

Expected return on plan assets
 
(40,578
)
 
(40,117
)
 
(121,733
)
 
(119,867
)
Amortization of unrecognized net loss
 
31,355

 
37,690

 
94,167

 
112,989

Amortization of unrecognized prior service cost
 
(5,151
)
 
(5,213
)
 
(15,453
)
 
(15,638
)
Net periodic benefit cost
 
15,542

 
27,523

 
46,812

 
82,795

Special termination benefit cost / curtailment
 

 

 
1,673

 

Net periodic benefit cost
 
$
15,542

 
$
27,523

 
$
48,485

 
$
82,795


19

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

During the nine months ended October 2, 2016, the Company recorded a settlement expense of $1,673 to recognize the impact of lump sum benefit payments made in the nonqualified supplemental executive retirement plan.
The components of net periodic benefit income for other postretirement benefits were as follows:
 
 
Other Postretirement Benefits
 
 
Quarter Ended
 
Nine Months Ended
 
 
October 2, 2016
 
October 4, 2015
 
October 2, 2016
 
October 4, 2015
Service cost
 
$

 
$
1

 
$
1

 
$
1

Interest cost
 
841

 
1,126

 
2,523

 
3,446

Expected return on plan assets
 
(780
)
 
(922
)
 
(2,405
)
 
(2,732
)
Amortization of unrecognized net loss
 
364

 
495

 
1,091

 
1,393

Amortization of unrecognized prior service cost
 
(1,291
)
 
(1,813
)
 
(3,871
)
 
(5,706
)
Net periodic benefit income
 
$
(866
)
 
$
(1,113
)
 
$
(2,661
)
 
$
(3,598
)
Effective January 1, 2016, the Company changed the approach used to measure service and interest costs for pension and other postretirement benefits. Prior to January 1, 2016, the Company measured service and interest costs utilizing a single weighted-average discount rate derived from the yield curve used to measure the plan obligations. Beginning January 1, 2016, the Company has elected to measure service and interest costs by applying the specific spot rates along that yield curve to the plans' liability cash flows. The Company believes the new approach provides a more precise measurement of service and interest costs by aligning the timing of the plans’ forecasted cash flows to the corresponding spot rates on the yield curve. This change does not affect the measurement of plan obligations. The Company accounted for this change on a prospective basis as a change in accounting estimate, resulting in lower pension expense compared to the method used prior to January 1, 2016.
Employer Contributions. During the nine months ended October 2, 2016, the Company contributed $39,500 to the pension trust. The Company also paid $4,776 to retirees in connection with its nonqualified supplemental executive retirement plan and $4,814 to retirees in connection with its other postretirement benefit plans.
During the remainder of 2016, the Company is not required to make any additional pension benefit contributions in order to meet the minimum required contributions for 2016. In addition, the Company anticipates making additional payments of approximately $692 to retirees under the nonqualified plan and $2,674 to retirees in connection with its other postretirement benefit plans during the remainder of 2016.
During the quarter ended October 2, 2016, the Company amended its retiree health care plan to provide coverage through a private exchange effective January 1, 2017. The exchange offers the retiree a broad choice of health care plans from which to choose. The Company will contribute fixed payments to a Health Retirement Account (HRA), when applicable, for those retirees who previously had subsidized health care coverage through the Company. The contributions to the HRA account are retirees' funds to be spent on qualified health care premiums and eligible out-of pocket expenses. The plan amendment caused a remeasurement that increased the Company's funded status as of October 2, 2016 by $36,444 and will reduce expenses recorded in future periods.
14. Income Taxes
The Company's income taxes include federal, foreign and state income taxes. Income taxes for interim periods are based on estimated effective annual income tax rates.
The effective income tax rates for the quarters ended October 2, 2016 and October 4, 2015 were 18.0% and 33.9% (as restated), respectively. The decrease in the rate from the quarter ended October 4, 2015 is primarily due to increased benefits from the Research and Development tax credit, the true up of prior-year taxes and settlement of the examination by the Internal Revenue Service ("IRS") of the fiscal 2013 and 2014 tax returns in the quarter ended October 2, 2016.
The effective income tax rates for the nine months ended October 2, 2016 and October 4, 2015 were 25.9% and 39.9%, respectively. The decrease in the rate from the nine months ended October 4, 2015 is primarily due to the impact of goodwill impairment and nondeductible transaction costs in the nine months ended October 4, 2015, as well as increased benefits from the Domestic Manufacturing Deduction, increased Research and Development tax credits, the true up of prior-year taxes and settlement of the examination by the IRS of the fiscal 2013 and 2014 tax returns partially offset by an increase in state tax expense in the nine months ended October 2, 2016.

20

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

The Company or one of its subsidiaries files income tax returns in the U.S. federal, various U.S. state and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or foreign income tax examinations by tax authorities for years prior to 2010. The IRS has completed the audits of the Company through fiscal 2014. The Company believes appropriate provisions for all outstanding issues have been made for all remaining open years in all jurisdictions.
Although the timing and outcome of audit settlements are uncertain, it is reasonably possible that a $11,176 reduction of the uncertain tax benefits will occur in the next 12 months. The settlement of these unrecognized tax benefits could result in an increase in net income from $0 to $10,074.
15. Stock-based Compensation
The Company has 5,000,000 shares of $1.00 par value preferred stock authorized, none of which has been issued.
The Company sponsors five stock-based incentive plans: the Orbital ATK, Inc. 2015 Stock Incentive Plan (the "2015 Stock Incentive Plan"); three legacy ATK plans (the Alliant Techsystems Inc. 2005 Stock Incentive Plan, the Non-Employee Director Restricted Stock Plan and the 1990 Equity Incentive Plan); and one legacy Orbital plan, under which the Company assumed the obligation to issue Company common stock pursuant to the terms of the Transaction Agreement relating to the Merger (the Orbital Sciences Corporation 2005 Amended and Restated Stock Incentive Plan). At October 2, 2016, the Company had authorized up to 3,750,000 common shares under the 2015 Stock Incentive Plan, of which 2,812,847 common shares were available to be granted. No new grants will be made out of the other four plans.
During the quarter ended October 2, 2016, the Company adopted an Employee Stock Purchase Plan ("ESPP") whereby eligible employees may purchase shares of the Company's common stock at the lesser of 85% of the fair market value of a share of common stock at the beginning or at the end of the quarterly offering period. The ESPP is compensatory and the fair value of the shares purchased is determined using the Black-Scholes option pricing model.
There are five types of awards outstanding under the Company's stock incentive plans: performance awards, total stockholder return performance awards ("TSR awards"), restricted stock units, restricted stock and stock options. The Company issues treasury shares upon (i) the payment of performance awards, TSR awards and restricted stock units, (ii) the grant of restricted stock and (iii) the exercise of stock options.
Restricted Stock Units. Pursuant to the terms of the Transaction Agreement and under the terms of the ATK 2005 Stock Incentive Plan, all of the performance awards and TSR awards outstanding as of February 9, 2015 were converted into time-vesting restricted stock units with vesting periods corresponding to the respective performance periods. During the nine months ended October 2, 2016, 42,935 shares were issued upon the vesting of restricted stock units for the performance period ending in 2016. As of October 2, 2016, there were 53,449 restricted stock units outstanding for the performance period ending in 2017.
Performance Awards. Performance shares are valued at the fair value of the Company's stock as of the grant date and expense is recognized based on the number of shares expected to vest under the terms of the award under which they are granted.
As of October 2, 2016, there were 81,689 shares reserved for executive officers and key employees for the performance period beginning April 1, 2015 and ending December 31, 2017. Of these shares, up to 50% will become payable only upon achievement of a financial performance goal relating to absolute earnings per share growth; and up to 50% will become payable only upon achievement of a performance goal relating to absolute sales growth.
As of October 2, 2016, there were 73,802 shares reserved for executive officers and key employees for the performance period beginning January 1, 2016 and ending December 31, 2018. Of these shares, up to 50% will become payable only upon achievement of a financial performance goal relating to return on investment of capital; and up to 50% will become payable only upon achievement of a performance goal relating to absolute sales growth.
TSR Awards. As of October 2, 2016, there were 73,802 shares and 81,689 shares reserved for TSR awards for key employees for the fiscal year 2016-2018 and 2015-2017 performance periods, respectively. The Company used an integrated Monte Carlo simulation model to determine the fair value of the TSR awards. The Monte Carlo model calculates the probability of satisfying the market conditions stipulated in the award. This probability is an input into the trinomial lattice model used to determine the fair value of the awards as well as the assumptions of other variables, including the risk-free interest rate and expected volatility of the Company's stock price in future periods. The risk-free rate is based on the U.S. dollar-denominated U.S. Treasury strip rate with a remaining term that approximates the life assumed at the date of grant. There were 73,802 TSR

21

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

awards granted with a fair value of $87.85 per share and 3,208 TSR awards granted with a fair value of $94.93 per share during the nine months ended October 2, 2016.
Restricted Stock Awards. Restricted stock granted to non-employee directors and certain key employees totaled 160,242 shares during the nine months ended October 2, 2016. Restricted shares vest over periods generally ranging from one to three years from the date of award and are valued at the fair value of the Company's common stock as of the grant date.
Stock Options. Stock options are granted periodically, with an exercise price equal to the fair market value of the Company's common stock on the date of grant, and generally vest from one to three years from the date of grant. Options are generally granted with seven-year or ten-year terms. The weighted-average fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model and represents the difference between fair market value on the date of grant and the estimated market value on the expected exercise date. The option pricing model requires the Company to make assumptions. The risk-free rate is based on U.S. Treasury zero-coupon issues with a remaining term that approximates the expected life assumed at the date of grant. Expected volatility is based on the historical volatility of the Company's stock over the past seven years. The expected option life is based on the contractual term of the stock option and expected employee exercise and post-vesting employment termination trends. There were 72,328 stock options granted during the nine months ended October 2, 2016 with a weighted-average fair value of $20.53 per stock option. There were 74,543 stock options granted during the nine months ended October 4, 2015 with a weighted-average fair value of $39.44 per stock option.
Stock-based compensation expense totaled $6,317 and $17,515 in the quarter and nine months ended October 2, 2016; and $6,046 and $28,369 in the quarter and nine months ended October 4, 2015. The income tax benefit recognized for stock-based compensation was $2,182 and $6,445 during the quarter and nine months ended October 2, 2016; and $2,194 and $9,815 during the quarter and nine months ended October 4, 2015.
16. Contingencies
Litigation.   From time to time, the Company is subject to various legal proceedings, including lawsuits, which arise out of, and are incidental to, the conduct of the Company's business. The Company does not consider any of such proceedings that are currently pending, individually or in the aggregate, notwithstanding that the unfavorable resolution of any matter may have a material effect on net earnings in any particular quarter, to be material to its business or likely to result in a material adverse effect on its operating results, financial condition or cash flows.
Securities Class Action.   On August 12, 2016, a putative class action complaint, naming the Company, our Chief Executive Officer and our Chief Financial Officer as defendants, was filed in the United States District Court for the Eastern District of Virginia (Steven Knurr v. Orbital ATK, Inc., et al., No. 16-cv-01031 (TSE-MSN)). The class action complaint asserts claims on behalf of purchasers of Orbital ATK securities for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, arising out of allegedly false and misleading statements and the failure to disclose that: (i) the Company lacked effective control over financial reporting; and (ii) as a result, the Company failed to record an anticipated loss on its long-term contract with the U.S. Army to manufacture and supply small caliber ammunition at the U.S. Army’s Lake City Army Ammunition Plant. The complaint seeks a determination that this matter is a proper class action and certifying the plaintiff as the class representative, an award of damages, an award of reasonable costs and expenses of trial, including counsel and expert fees, and an award of such other relief as deemed appropriate by the Court. The Company intends to defend this action vigorously.
SEC Investigation.   The SEC is conducting a non-public investigation relating to our historical accounting practices as a result of the prior restatement of the Company’s unaudited condensed consolidated financial statements for the quarterly periods ended July 5, 2015 and October 4, 2015 as described in the Company's Amendment to the Transition Report on Form 10-K for the nine-month transition period ending December 31, 2015 filed on March 15, 2016. The Company has also voluntarily self-reported to the SEC regarding matters pertaining to the Restatement described in the Company's Amendment to the Form 10-K for the nine-month transition period ending December 31, 2015 filed on February 24, 2017. The Company is cooperating fully with the SEC in connection with these matters.
U.S. Government Investigations.   The Company is also subject to U.S. Government investigations from which civil, criminal or administrative proceedings could result. Such proceedings could involve claims by the U.S. Government for fines, penalties, compensatory and treble damages, restitution and/or forfeitures. Under government regulations, a company, or one or more of its operating divisions or subdivisions, can also be suspended or debarred from government contracts, or lose its export privileges, based on the results of investigations. The Company believes, based upon all available information, that the outcome of any such pending government investigations will not have a material adverse effect on its operating results, financial condition or cash flows.
Claim Recovery.   Profits expected to be realized on contracts are based on management's estimates of total contract sales value and costs at completion. Estimated amounts for contract changes and claims are included in contract sales only when realization is estimated to be probable. Unbilled receivables included $13,175 and $25,042 as of October 2, 2016 and December 31, 2015, respectively, for contract claims.
Environmental Liabilities.   The Company's operations and ownership or use of real property are subject to a number of federal, state, and local environmental laws and regulations, including those for discharge of hazardous materials, remediation of contaminated sites and restoration of damage to the environment. At certain sites that the Company owns or operates or formerly owned or operated, there is known or potential contamination that the Company is required to investigate or remediate. The Company could incur substantial costs, including remediation costs, resource restoration costs, fines, and

22

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

penalties, or third party property damage or personal injury claims, as a result of liabilities associated with past practices or violations of environmental laws or noncompliance with environmental permits.
The Company has been identified as a potentially responsible party (“PRP”), along with other parties, in several regulatory agency actions associated with hazardous waste sites. As a PRP, the Company may be required to pay a share of the costs of the investigation and clean-up of these sites. While uncertainties exist with respect to the amounts and timing of the ultimate environmental liabilities, based on currently available information, the Company has concluded that these matters, individually or in the aggregate, will not have a material adverse effect on operating results, financial condition, or cash flows.
The Company could incur substantial costs, including cleanup costs, resource restoration, fines and penalties or third party property damage or personal injury claims, as a result of violations or liabilities under environmental laws or noncompliance with environmental permits. While environmental laws and regulations have not had a material adverse effect on the Company's operating results, financial condition, or cash flows in the past and the Company has environmental management programs in place to mitigate these risks, it is difficult to predict whether they will have a material impact in the future.
The liability for environmental remediation represents management's best estimate of the present value of the probable and reasonably estimable costs related to known remediation obligations. The receivable represents the present value of the amount that the Company expects to recover, as discussed below. Both the liability and receivable have been discounted to reflect the present value of the expected future cash flows, using a discount rate of 0.2% and 0.7% as of October 2, 2016 and December 31, 2015, respectively. The Company's discount rate is calculated using the 20-year Treasury constant maturities rate, net of an estimated inflationary factor of 1.9%, rounded to the nearest quarter percent.
The following is a summary of the amounts recorded for environmental remediation:
 
 
October 2, 2016
 
December 31, 2015
 
 
Liability
 
Receivable
 
Liability
 
Receivable
Amounts (payable) receivable
 
$
(43,939
)
 
$
19,762

 
$
(41,824
)
 
$
18,236

Unamortized discount
 
524

 
(179
)
 
1,718

 
(568
)
Present value amounts (payable) receivable
 
$
(43,415
)
 
$
19,583

 
$
(40,106
)
 
$
17,668

Amounts expected to be paid or received in periods more than one year from the balance sheet date are classified as noncurrent. Of the $43,415 discounted liability as of October 2, 2016, $5,706 was recorded in other current liabilities. Of the $19,583 discounted receivable, the Company recorded $3,318 in other current assets. As of October 2, 2016, the estimated discounted range of reasonably possible costs of environmental remediation was $43,415 to $68,340.
The Company expects that a portion of its environmental compliance and remediation costs will be recoverable under U.S. Government contracts. Some of the remediation costs that are not recoverable from the U.S. Government that are associated with facilities purchased in a business acquisition are covered by various indemnification agreements, as described in Note 14 to the audited consolidated financial statements included in the Company’s Form 10-K/A.
17. Share Repurchases
On March 11, 2015, the Company's Board of Directors authorized the Company to repurchase up to the lesser of $75,000 or 1.0 million shares of its common stock through December 31, 2015. On August 4, 2015, the Board of Directors increased the amount authorized for repurchase to the lesser of $100,000 or 1.4 million shares of the Company's common stock. On October 29, 2015, the Board of Directors further increased the amount authorized for repurchase to the lesser of $250,000 or 3.25 million shares through December 31, 2016. On November 1, 2016, the Board of Directors further increased the amount authorized for repurchase to the lesser of $300,000 or 4.0 million shares and extended the repurchase period through March 31, 2017. On February 27, 2017, the Board of Directors further increased the amount authorized for repurchase to $450,000 and extended the repurchase period through March 31, 2018.
Shares of the Company's common stock may be purchased in the open market, subject to compliance with applicable laws and regulations and the Company’s debt covenants, depending upon market conditions and other factors. The Company purchased 576,407 shares for $43,750 and 1,104,511 shares for $87,991 during the quarter and nine months ended October 2, 2016, respectively. The Company purchased 497,145 shares for $36,275 and 825,986 shares for $60,777 during the quarter and nine months ended October 4, 2015.

23

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

In accordance with the Transaction Agreement entered into on April 28, 2014, we did not repurchase any outstanding shares prior to the closing of the Distribution and Merger during the quarter ended March 31, 2015.
18. Changes in Estimates
The majority of our sales are accounted for as long-term contracts, which are accounted for using the percentage-of-completion method. Accounting for contracts under the percentage-of-completion method requires judgment relative to assessing risks and estimating contract revenues and costs. Profits expected to be realized on contracts are based on management’s estimates of total contract sales value and costs at completion. Estimated amounts for contract changes, including scope and claims, are included in contract sales only when realization is probable. Assumptions used for recording sales and earnings are modified in the period of change to reflect revisions in contract value and estimated costs. In the period in which it is determined that a loss will be incurred on a contract, the entire amount of the estimated loss, based on gross profit along with general and administrative costs, is charged to cost of sales. Changes in estimates of contract value, costs or profits are recognized using the cumulative catch-up method of accounting. The cumulative effect of a change in estimate is recognized in the period a change in estimate occurs.
Changes in contract estimates occur for a variety of reasons including changes in contract scope, unforeseen changes in contract cost estimates due to unanticipated cost growth or risks affecting contract costs and/or the resolution of contract risks at lower costs than anticipated, as well as changes in contract overhead costs over the performance period. Changes in estimates could have a material effect on the Company's consolidated financial position or annual results of operations.
Aggregate net changes in contract estimates recognized using the cumulative catch-up method of accounting increased operating income by approximately $6,000 and $27,000 for the quarters ended October 2, 2016 and October 4, 2015, respectively. The changes in estimates for the quarter ended October 2, 2016 were primarily attributable to changes in scope on the Company's contracts in all segments, primarily in Flight Systems Group. The changes in estimates for the quarter ended October 4, 2015 were attributable to profit margin improvements in all segments, primarily in Flight Systems Group and Space Systems Group.
Aggregate net changes in contract estimates recognized using the cumulative catch-up method of accounting increased operating income by approximately $92,000 and $81,000 for the nine months ended October 2, 2016 and October 4, 2015, respectively. The changes in estimates for the nine months ended October 2, 2016 were attributable to profit margin improvements in all segments, primarily in Defense Systems Group and Flight Systems Group. The changes in estimates for the nine months ended October 4, 2015 were attributable to profit margin improvements in all segments, primarily Defense Systems Group and Flight Systems Group. Estimated costs to complete on loss contracts at October 2, 2016 and December 31, 2015 were $1,248,549 and $1,392,218, respectively.
19. Restructuring Costs
The Company had restructuring liabilities for termination benefits of $400 and $3,589 and facility-related liabilities of $19,570 and $26,154, at October 2, 2016 and December 31, 2015, respectively. The decrease in restructuring liabilities for the nine months ended October 2, 2016, was primarily attributed to cash expenditures for termination benefits and facilities.
20. Operating Segment Information
The Company operates its business structure within three operating segments. These operating segments ("groups") are defined based on the reporting and review process used by the Company's chief executive officer and other management.  The operating structure aligns the Company's capabilities and resources with its customers and markets and positions the Company for long-term growth and improved profitability.
Flight Systems Group develops rockets that are used as small- and medium-class space launch vehicles to place satellites into Earth orbit and escape trajectories, interceptor and target vehicles for missile defense systems and suborbital launch vehicles that place payloads into a variety of high-altitude trajectories. The group also develops and produces medium- and large-class rocket propulsion systems for human and cargo launch vehicles, strategic missiles, mi

24

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

ssile defense interceptors and target vehicles. Additionally, the group operates in the military and commercial aircraft and launch structures markets. Other products include illuminating flares and aircraft countermeasures.
Defense Systems Group develops and produces small-, medium-, and large-caliber ammunition, precision weapons and munitions, high performance gun systems, and propellant and energetic materials. It operates the Lake City Army Ammunition Plant in Independence, Missouri ("LCAAP") and a Naval Sea Systems Command ("NAVSEA") facility in Rocket Center, West Virginia. Defense Systems Group is also a leader in tactical solid rocket motor development and production for a variety of air-, sea- and land-based missile systems. The group serves a variety of domestic and international customers in the defense and security markets in a prime contractor, partner or supplier role. Defense Systems Group also provides propulsion control systems that support Missile Defense Agency and NASA programs, airborne missile warning systems, advanced fuzes and defense electronics. The group produces the U.S. Navy's Advanced Anti-Radiation Guided Missile ("AARGM") and has developed advanced air-breathing propulsion systems and special-mission aircraft for defense applications.
Space Systems Group develops and produces small- and medium-class satellites that are used to enable global and regional communications and broadcasting, conduct space-related scientific research and perform other activities related to national security. In addition, Space Systems Group develops and produces human-rated space systems for Earth-orbit and deep-space exploration, including delivering cargo to the International Space Station. This Group is also a provider of spacecraft components and subsystems and specialized engineering and operations services to U.S. Government agencies.
The following summarizes the Company's results by segment:
 
 
Quarters Ended
 
Nine Months Ended
 
 
October 2, 2016
 
October 4, 2015
 
October 2, 2016
 
October 4, 2015
 
 
 
 
(As Restated)
 
 
 
 
Sales to external customers:
 
 
 
 
 
 
 
 
Flight Systems Group
 
$
360,531

 
$
356,131

 
$
1,081,513

 
$
1,040,076

Defense Systems Group
 
451,286

 
440,749

 
1,326,076

 
1,355,703

Space Systems Group
 
231,885

 
346,366

 
775,853

 
822,195

Total external sales
 
1,043,702

 
1,143,246

 
3,183,442

 
3,217,974

Intercompany sales:
 
 
 
 
 
 
 
 
Flight Systems Group
 
2,463

 
7,173

 
9,542

 
42,041

Defense Systems Group
 
4,668

 
1,488

 
14,396

 
18,892

Space Systems Group
 
16,661

 
5,021

 
37,497

 
14,532

Corporate
 
(23,792
)
 
(13,682
)
 
(61,435
)
 
(75,465
)
Total intercompany sales
 

 

 

 

Total sales
 
$
1,043,702

 
$
1,143,246

 
$
3,183,442

 
$
3,217,974

 
 
 
 
 
 
 
 
 
Income from continuing operations, before interest, income taxes and noncontrolling interest:
 
 
 
 
 
 
 
 
Flight Systems Group
 
$
43,886

 
$
94,015

 
$
151,454

 
$
186,247

Defense Systems Group
 
33,066

 
34,299

 
126,437

 
130,778

Space Systems Group
 
19,347

 
20,986

 
95,766

 
30,293

Corporate
 
(5,323
)
 
(12,490
)
 
(14,657
)
 
(105,356
)
Total income from continuing operations, before interest, income taxes and noncontrolling interest
 
$
90,976

 
$
136,810

 
$
359,000

 
$
241,962


25

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Amounts in thousands except share and per share data, unless otherwise indicated)

 
 
October 2, 2016
 
December 31, 2015
Total assets:
 
 
 
 
Flight Systems Group
 
$
2,307,885

 
$
2,223,787

Defense Systems Group
 
1,287,290

 
1,184,071

Space Systems Group
 
1,242,167

 
1,272,425

Corporate
 
528,750

 
643,412

Total assets
 
$
5,366,092

 
$
5,323,695

Certain administrative functions are primarily managed by the Company at the corporate headquarters ("Corporate"). Some examples of such functions are human resources, pension and postretirement benefits, corporate accounting, legal, tax and treasury. Significant assets and liabilities managed at Corporate include those associated with debt, restructuring, pension and postretirement benefits, environmental liabilities, litigation liabilities, strategic growth costs and income taxes.
Costs related to the administrative functions managed by Corporate are either recorded at Corporate or allocated to the segments based on the nature of the expense. The difference between pension and postretirement benefit expense calculated under U.S. GAAP and the expense calculated under U.S. Cost Accounting Standards is recorded at the corporate level which provides for greater clarity on the operating results of the business segments. Administrative expenses such as corporate accounting, legal and treasury costs are allocated out to the business segments. Environmental expenses are allocated to each segment based on the origin of the underlying environmental cost. Transactions between segments are recorded at the segment level, consistent with the Company's financial accounting policies. Intercompany balances and transactions involving different segments are eliminated at the Company's consolidated financial statements level and are shown above in Corporate. The amortization expense related to purchase accounting attributed to the acquisition of Orbital is also recorded in Corporate.
21. Subsequent Events
As a result of the Restatement, the Company was unable to timely file its Quarterly Reports on Form 10-Q with the SEC for the fiscal quarters ended July 3, 2016 and October 2, 2016 ("the 2016 Quarterly Reports"), as well as its Annual Report on Form 10-K for 2016. The Company has entered into an extension agreement with its Senior Credit Facility lender group to extend, until April 14, 2017, the deadline under its credit agreement for filing with the SEC the 2016 Quarterly Reports, as well as an Amended Form 10-Q for the fiscal quarter ended April 3, 2016 and the Company's Annual Report on Form 10-K for 2016. As a result of the extension, the Company is in compliance with the financial covenants as of the date of the filing of this Form 10-Q based on the Company's restated financial results.



26


ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in thousands except share and per share data and unless otherwise indicated)
Restatement of Previously Issued Consolidated Financial Statements
In this Form 10-Q, we have restated our unaudited condensed consolidated statement of comprehensive income for the quarter ended October 4, 2015 as disclosed in the Company’s Amended Transition Report on Form 10-K/A ("Form 10-K/A") for the nine-month transition period ended December 31, 2015 filed on February 24, 2017 with the SEC. This Form 10-Q is reflective of the Restatement and should be read in conjunction with the Company’s consolidated financial statements and notes included in the Form 10-K/A for the nine-month transition period ended December 31, 2015. See Note 3 - Restatement in the Notes to the Condensed Consolidated Financial Statements in Part I, Item I - Financial Statements for additional information regarding the errors identified and the restatement adjustments made to the condensed consolidated financial statements.
Forward-looking Information is Subject to Risk and Uncertainty
Some of the statements made and information contained in this report, excluding historical information, are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements give the Company's current expectations or forecasts of future events. Words such as "may," "will," "expected," "intend," "estimate," "anticipate," "believe," "project," or "continue," and similar expressions are used to identify forward-looking statements. From time to time, the Company also may provide oral or written forward-looking statements in other materials released to the public. Any or all forward-looking statements in this report and in any public statements the Company makes could be materially different. They can be affected by assumptions used or by known or unknown risks or uncertainties. Consequently, no forward-looking statements can be guaranteed. Actual results may vary materially. You are cautioned not to place undue reliance on any forward-looking statements. You should also understand that it is not possible to predict or identify all such factors and you should not consider the following list to be a complete statement of all potential risks and uncertainties. Any change in the following factors may impact the achievement of results:
the effect of the Restatement of our previously issued financial results, and any actual or unasserted claims, investigations or proceedings as a result of the Restatement,
our ability to remediate the material weaknesses in our internal controls over financial reporting described in Part I, Item 4, Controls and Procedures, of this Form 10-Q,
reductions or changes in NASA or U.S. Government military spending, timing of payments and budgetary policies, including impacts of sequestration under the Budget Control Act of 2011 and sourcing strategies,
intense competition for U.S. Government contracts and programs,
increases in costs, which the Company may not be able to react to due to the nature of its U.S. Government contracts,
changes in cost and revenue estimates and/or timing of programs,
potential termination of U.S. Government contracts and the potential inability to recover termination costs,
other risks associated with U.S. Government contracts that might expose the Company to adverse consequences,
government laws and other rules and regulations applicable to the Company, including procurement and import-export control,
reduction or change in demand and manufacturing costs for military and commercial ammunition,
the manufacture and sale of products that create exposure to potential product liability, warranty liability or personal injury claims and litigation,
risks associated with expansion into new and adjacent commercial markets,
results of the Merger or other acquisitions or transactions, including our ability to successfully integrate acquired businesses and realize anticipated synergies, cost savings and other benefits, and costs incurred for pursuits and proposed acquisitions,
greater risk associated with international business, including foreign currency exchange rates and fluctuations in those rates,

27


federal and state regulation of defense products and ammunition,
costs of servicing the Company's debt, including cash requirements and interest rate fluctuations,
actual pension and other postretirement plan asset returns and assumptions regarding future returns, discount rates, service costs, mortality rates and health care cost trend rates,
security threats, including cyber-security and other industrial and physical security threats, and other disruptions,
supply, availability and costs of raw materials and components, including commodity price fluctuations,
performance of the Company's subcontractors,
development of key technologies and retention of a qualified workforce,
performance of our products,
fires or explosions at any of the Company's facilities,
government investigations and audits,
environmental laws that govern current and past practices and rules and regulations, noncompliance with which may expose the Company to adverse consequences,
impacts of financial market disruptions or volatility to the Company's customers and vendors,
unanticipated chan