Business Context and Reporting Period
Northrop Grumman Corporation, a global aerospace and defense company serving primarily the U.S. Department of Defense and intelligence community, filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2022. Reportable segments were Aeronautics Systems, Defense Systems, Mission Systems, and Space Systems. The 2021 comparable period included the IT and mission support services divestiture, completed January 30, 2021, which generated $3.4 billion of cash proceeds and a $2.0 billion pretax gain.
Financial Results and Key Metrics
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Sales | $8.971 billion | $8.720 billion | $26.569 billion | $27.028 billion |
| Operating income | $844 million | $1.043 billion | $2.695 billion | $4.909 billion |
| Operating margin | 9.4% | 12.0% | 10.1% | 18.2% |
| Net earnings | $915 million | $1.063 billion | $2.816 billion | $4.295 billion |
| Diluted EPS | $5.89 | $6.63 | $18.06 | $26.55 |
| Operating cash flow | Not separately provided | Not separately provided | $650 million | $2.125 billion |
| Adjusted free cash flow | Not separately provided | Not separately provided | $(53) million | $1.527 billion |
- Q3 sales increased 3%, while nine-month sales decreased 2%. Nine-month organic sales, excluding the divested IT services business, declined 1%.
- Q3 net earnings declined 14% and diluted EPS declined 11%. Nine-month net earnings declined 34%, primarily because 2021 included the IT services divestiture gain and related effects.
- Q3 and nine-month segment operating income declined 3% and 4%, respectively. Segment margin was 11.2% in Q3 and 11.7% year to date.
- Q3 sales growth was led by Space Systems, up 18%; Mission Systems increased 1%, while Aeronautics Systems declined 7% and Defense Systems declined 5%.
- Nine-month Space Systems sales increased 13%, while Aeronautics Systems declined 10%, Defense Systems declined 11%, and Mission Systems declined 2%.
- Cash and cash equivalents were $1.666 billion at September 30, 2022, compared with $3.530 billion at December 31, 2021. Total debt was $12.872 billion, including current debt of $1.069 billion, versus $12.783 billion at year-end 2021.
- The company had $13.943 billion of shareholders’ equity and $42.733 billion of total assets at September 30, 2022.
- Capital expenditures were $803 million in the first nine months, compared with $682 million in the prior-year period.
- The company repurchased $1.011 billion of stock and paid $786 million of dividends during the first nine months. The quarterly dividend was increased 10% to $1.73 per share in May 2022.
Material Changes Versus the Prior Comparable Period
- Operating income and margins were pressured by lower FAS/CAS pension-related benefits, higher unallocated corporate expense, lower net favorable contract estimate-at-completion adjustments, inflation, labor constraints, and supply-chain delays.
- Q3 2022 operating income included a $55 million FAS/CAS operating adjustment compared with a $(61) million adjustment in Q3 2021, and unallocated corporate expense increased to $108 million from $53 million. The prior year included a $60 million insurance settlement benefit.
- Nine-month 2022 results exclude the $2.0 billion pretax IT services divestiture gain and $192 million of associated unallocated corporate expenses recorded in 2021. Transaction-adjusted nine-month net earnings declined 11% and transaction-adjusted diluted EPS declined 8%.
- Operating cash flow declined 69% to $650 million, mainly because of increased trade working capital requirements and tax payments related to IRC Section 174. Unbilled receivables increased to $6.430 billion from $5.492 billion at year-end 2021.
- Backlog increased 5% to $79.649 billion from $76.046 billion at December 31, 2021. Approximately 40% is expected to convert to revenue over the next 12 months and 60% over the next 24 months.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- The filing does not provide a clear new quantitative full-year revenue, earnings, or cash-flow guidance figure.
- Management cited continued demand related to heightened global security concerns and the Ukraine conflict, but also noted inflation, extended material lead times, labor shortages, supply-chain disruptions, and cost growth. Direct COVID-19 impacts were generally declining, although future effects remained uncertain.
- A continuing resolution enacted September 30, 2022 generally maintained fiscal 2022 funding levels through December 16, 2022, creating potential timing and budget risks for defense programs.
- The company expects the current IRC Section 174 R&D amortization rules to result in approximately $1.0 billion of 2022 tax payments; cash impact could range from $670 million to $1.0 billion depending on potential legislative changes.
- Unrecognized tax benefits were approximately $1.7 billion, including $449 million related to IRC Section 451(b). An unfavorable resolution could materially affect future cash flows.
- The company entered into a new five-year $2.5 billion revolving credit facility in August 2022. No borrowings were outstanding under its credit facilities or commercial paper program at September 30, 2022, and the company was in compliance with its debt covenants.
- Environmental remediation liabilities were $584 million, with $357 million of reasonably possible future costs in excess of accrued amounts. The company stated that costs could increase materially if remediation standards or facts change.
- The company received an approximately $83 million judgment in its favor in the USPS litigation, plus approximately $7,000 of additional daily interest, subject to a potential appeal.
- A government dispute concerning assumptions used in calculating Cost Accounting Standards pension expense could materially affect financial position, results, or cash flows; the company cannot currently estimate a potential loss range.
- Other risks include dependence on U.S. government appropriations, fixed-price contract performance, cybersecurity, supplier and subcontractor viability, export and geopolitical restrictions, workforce availability, environmental claims, pension performance, tax exposure, and legal or regulatory investigations.
Most Important Facts for Investors to Verify
- Whether supply-chain, labor, and inflationary pressures continue to reduce contract margins and cash conversion.
- The timing and amount of U.S. defense appropriations after the continuing resolution expires.
- Progress on converting the $79.6 billion backlog into revenue and cash, particularly in Space Systems development programs.
- Future cash requirements under IRC Section 174 and the potential effect of tax legislation or IRS guidance.
- Developments in the CAS pension-cost dispute, Bethpage environmental remediation, tax examinations, and other legal proceedings.
- The sustainability of dividends and share repurchases given negative adjusted free cash flow through the first nine months and cash of $1.7 billion.