The Boring Portfolio, Feb. 24, 1999

<THE BORING PORTFOLIO>
More on Orbital
And legalese and accounting fun

By Alex Schay (TMF Nexus6)

ALEXANDRIA, VA (Feb. 24, 1999) -- Ahh, contingent liabilities, what fun. Remember when Saddam Hussein's troops invaded Kuwait? All sorts of companies in the oil services business ended up having to record contingent liabilities -- which are defined as potential liabilities that may become actual liabilities if some event does or does not occur. Take Halliburton (NYSE: HAL), it recorded a $16.5 million expense at the time of the Iraqi occupation, with a corresponding liability in the same amount in order to acknowledge that losses might occur.

However, the most common contingent liabilities do not stem from the actions of desert dictators on the warpath, but rather from law firms out for cash. (I'll try to refrain from going after the easy lawyer jokes.) A company that is defending itself in a lawsuit might ultimately have to pay some form of legal settlement to a third party, and thus shareholders need to be apprised of this. Since Orbital Sciences (NYSE: ORB) announced its radical accounting changes and the firm's stock took a nosedive, newswires have carried almost daily announcements of new class action lawsuits, commenced ostensibly "on behalf of shareholders."

Here's a chart of how the accounting treatment works when a firm has to assess the possibility of damage from a lawsuit:

                Potential Loss
                Subject to             
Likelihood of   Reasonable      Accounting
an Actual Loss  Estimation      Treatment                     
Probable        Yes             Debit an expense account
                                and credit a liability account

Probable        No              Disclosed in financial
                                statement footnotes

Reasonably      Yes/No          Disclosed in financial
Possible                        statement footnotes

Remote          Yes/No          Ignored

As you can see from the chart, the bar is set pretty high for an actual adjustment to the financial statements. With respect to the lawsuits against Orbital, in a report coming from Communications Today, an Orbital spokesperson stated, "As far as we are concerned, there is no basis or justification for a lawsuit against the company." Although this is a fairly predictable response, readers have to remember that most companies are subject to litigation year round, and there are endless examples of class-action suits sprouting up when accounting changes are announced at a firm.

Moving on to the "business" at hand. Orbital Sciences reiterated its projections for the coming year in its fourth quarter conference call:

• Revenue growth between 20-25%, with margin improvements
• Total infrastructure backlog growth to $5 billion
• Thirty launches set for the year
• A completion of Magellan's turnaround and margin expansion
• Ramp up ORBCOMM subscribers to the 250,000 unit level

Last year at around this time, first quarter returns for Orbital came in as follows: the space/ground infrastructure business (consisting of rockets, satellites, electronics, and satellite ground systems), accounted for 84% of total revenues, gaining 47.2% year over year and almost doubling profits. The satellite-access business (consisting of global positioning systems) represented the remaining 16% of revenues, and achieved a huge gain thanks to some acquisitions. As well, ORBCOMM and ORBIMAGE almost doubled their losses in comparison with the prior period.

In terms of revenue composition for the 1998 fiscal year, that 84% total from the infrastructure business in the first quarter ended up being an exact forecast of the total revenue composition in the re-stated results. Infrastrucuture is the backbone of Orbital's business and consists of launch vehicles, like the Pegasus and Taurus, as well as satellite manufacturing, satellite imaging ground stations and image processing software, and various electronic and sensor systems. The long-term contract adjustments made by the company reduced 1998 revenues, operating income, and net income in the infrastructure systems sector by approximately $15,000,000, $17,500,000 and $18,800,000, respectively (the total for the year was around $617 million).

As far as the long-term contract adjustments go, Orbital began to face a possible "problem" back in December when the firm's MacDonald, Dettwiler and Associates (MDA) subsidiary was faced with a huge contract extension on RadarSat 2. That's right, the new contract was for $130 million, which dwarfed the $30 million estimate on the original contract. The new contract forced the old contract to be accounted for on the same basis as the fresh business -- that is, on a "percentage of completion" schedule. The $5 million charge taken in the fourth quarter for this move will ultimately result in profit being recognized over this year and the next.

In similar fashion to this adjustment at MacDonald Detweiller, roughly $18.8 million in contract adjustments were taken at the infrastructure group, thanks to the re-amortization of profits over longer periods (due to lengthening contracts).

Well, as usual, this is getting a little bit long. We'll have to save some more of the accouting and quantitative issues for next time. Until then, see you on the message boards. The word on the street is that Dale is working up one heck of a post on American Bankers (NYSE: ABI) -- so check it out.

• Discuss Boring Investing on the Boring Port message board.
• 10/01/98: The New Boring Port Transitions Facts

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CSL     ---    41.88
CSCO  -3       99.94
GTW   -3 3/8   79.13

                   Day    Month   Year  History
        BORING   -1.36%  -0.55%  -2.18%  31.34%
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    Rec'd   #  Security     In At       Now    Change
  6/26/96  225 Cisco Syst    23.96     99.94   317.18%
  8/13/96  200 Carlisle C    26.32     41.88    59.07%
   2/9/99  100 Gateway 20    72.38     79.13     9.33%
 12/31/98    8 Berkshire   2244.00   2405.00     7.17%


    Rec'd   #  Security     In At     Value    Change
  6/26/96  225 Cisco Syst  5389.99  22485.94 $17095.95
  8/13/96  200 Carlisle C  5264.99   8375.00  $3110.01
 12/31/98    8 Berkshire  17952.00  19240.00  $1288.00

   2/9/99  100 Gateway 20  7237.50   7912.50   $675.00


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