Northrop Grumman Corporation — Q2 2023 Form 10-Q Summary
Business context and reporting period
Northrop Grumman is an aerospace and defense technology company serving primarily the U.S. Department of Defense, intelligence community and international customers. The filing covers the three and six months ended June 30, 2023; financial statements are unaudited and prepared under U.S. GAAP.
The company operates through Aeronautics Systems, Defense Systems, Mission Systems and Space Systems. Approximately 86% of first-half 2023 sales were to the U.S. government, with total backlog of $78.8 billion at June 30, 2023.
Key financial metrics
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Sales | $9.576 billion | $8.801 billion | $18.877 billion | $17.598 billion |
| Operating income | $967 million | $954 million | $1.914 billion | $1.851 billion |
| Operating margin | 10.1% | 10.8% | 10.1% | 10.5% |
| Net earnings | $812 million | $946 million | $1.654 billion | $1.901 billion |
| Diluted EPS | $5.34 | $6.06 | $10.83 | $12.16 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $217 million | $(685) million |
| Adjusted free cash flow | Not provided for quarter | Not provided for quarter | $(396) million | $(1.192) billion |
Product sales increased 10% in the quarter and 8% year to date; service sales increased 6% in the quarter and 5% year to date. The second-quarter effective tax rate was 17.7%; the year-to-date rate was 16.7%.
At June 30, 2023, cash and cash equivalents were $3.384 billion, total assets were $45.609 billion, long-term debt was $13.796 billion and total liabilities were $30.123 billion. Commercial paper outstanding was $779 million at a weighted-average interest rate of 5.73%. The company had no borrowings under its $2.5 billion credit facility and was in compliance with its debt covenants.
Capital expenditures were $613 million in the first six months. Financing cash flow was $1.202 billion, including $1.995 billion of long-term debt issuance and $768 million of net commercial paper borrowings, offset partly by $931 million of share repurchases and $554 million of dividends paid.
Material changes versus the prior comparable period
- Second-quarter sales increased 9%, while operating income increased only 1%; operating margin declined from 10.8% to 10.1%.
- Second-quarter net earnings decreased 14% and diluted EPS decreased 12%, primarily because the non-operating FAS pension benefit declined by $244 million year over year. Year-to-date net earnings decreased 13% and EPS decreased 11% for the same principal reason.
- Year-to-date operating cash flow improved to $217 million from an outflow of $685 million, primarily because of improved trade working capital, increased billings and cash collections.
- Space Systems sales increased 17% in both the quarter and first half, but second-quarter operating income fell 9% because of lower margins, a $36 million unfavorable HALO estimate-at-completion adjustment and a $15 million commercial inventory write-down.
- Mission Systems sales increased 5% in the quarter and 4% year to date, while operating income declined 3% and 5%, respectively, due partly to a prior-year $33 million contract-related legal benefit and unfavorable contract mix.
- Aeronautics Systems second-quarter sales increased 2% and operating income increased 8%; first-half sales declined 2% and operating income declined 9%, partly because 2022 included a $67 million favorable B-21 EMD estimate-at-completion adjustment and a $38 million property-sale gain.
- Defense Systems sales increased 10% in the quarter and 8% year to date, while operating income was essentially flat because of lower margins and lower estimate-at-completion benefits.
- The company issued $2.0 billion of unsecured senior notes in February 2023, consisting of $1.0 billion due 2033 at 4.70% and $1.0 billion due 2053 at 4.95%.
- The quarterly dividend increased 8% to $1.87 per share in May 2023. The 2021 repurchase authorization was completed in April, and $1.7 billion remained available under the 2022 authorization at June 30.
Guidance, outlook, commentary and risks
The filing does not provide a specific full-year financial guidance table. Management expects the challenging macroeconomic environment, including inflation, labor constraints, supply-chain disruption and higher interest rates, to continue affecting the company and its customers during 2023. Management also cited heightened global security tensions and expects sustained demand in areas such as space, missile defense, advanced weapons, survivable aircraft and mission systems.
- Backlog was $78.805 billion, including $37.896 billion funded and $40.909 billion unfunded. Management expects approximately 40% of backlog to convert to revenue within 12 months and 65% within 24 months.
- Management believes one or more of the five B-21 low-rate initial production options could be performed at a loss; the estimated range of potential loss is $0 to $1.2 billion. No loss was recorded because a loss was not considered probable.
- The DOJ has issued a criminal subpoena and civil investigative demand concerning financial and cost accounting controls related to CAS pension expense interest-rate assumptions. The company cannot predict the outcome, and the DCMA matter could materially affect financial position, results or cash flows, although no loss range is currently estimable.
- Environmental remediation liabilities were accrued at $562 million, with $353 million of reasonably possible future costs in excess of accrued amounts, primarily related to legacy Bethpage, New York conditions. The company also faces related lawsuits for which cumulative outcomes cannot currently be estimated.
- Unrecognized tax benefits were approximately $1.6 billion, including $601 million associated with IRC Section 451(b). Unfavorable resolution could materially affect future cash flows. The company estimates the Section 174 research-cost amortization requirement will reduce 2023 operating cash flow by approximately $720 million.
- A pending sale of a minority investment is subject to government approvals and closing conditions; management expects a pre-tax gain of approximately $100 million when completed, currently expected in the third quarter.
- The company reported no material changes to market risk or critical accounting policies and concluded that disclosure controls were effective as of June 30, 2023.
Most important facts for investors to verify
- Whether Space Systems and other fixed-price programs experience additional cost growth, including the HALO and B-21 programs.
- The outcome and potential financial exposure of the DOJ, DCMA and CAS pension-cost matters.
- Conversion of the $78.8 billion backlog into funded orders, revenue and cash flow, particularly the large unfunded Space Systems backlog.
- Operating cash flow and adjusted free cash flow after the expected approximately $720 million 2023 cash impact from IRC Section 174.
- Debt maturities, including the 3.25% senior notes due in August 2023, and the company’s ongoing use of commercial paper.
- Completion and realized gain on the planned minority-investment sale.
- Future environmental remediation costs and developments in Bethpage-related litigation.