Northrop Grumman Corporation — Q1 2010 Form 10-Q Summary
Business context and reporting period
Northrop Grumman is a defense and government-technology contractor serving primarily the U.S. Department of Defense, with businesses in aerospace, electronics, information systems, shipbuilding and technical services. The filing covers the three months ended March 31, 2010; financial statements are unaudited. The company reported 301.2 million common shares outstanding as of April 26, 2010.
Financial performance and position
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Sales and service revenues | $8.610 billion | $7.935 billion | +8% |
| Operating income | $765 million | $619 million | +24% |
| Operating margin | 8.9% | 7.8% | +110 basis points |
| Earnings from continuing operations | $462 million | $366 million | +26% |
| Net earnings | $469 million | $389 million | +21% |
| Diluted EPS from continuing operations | $1.51 | $1.10 | +37% |
| Diluted EPS | $1.53 | $1.17 | +31% |
| Net cash used in operating activities | $(531) million | $(172) million | Higher use of $359 million |
| Free cash flow from operations | $(669) million | $(352) million | Higher use of $317 million |
Product sales increased 21% to $5.526 billion, while service revenues decreased 8% to $3.084 billion. Product-sales cost declined to 77.7% of product sales from 79.5%; service-revenue cost increased to 90.2% from 88.1%. General and administrative expense was 8.9% of revenue versus 9.0%.
Cash and cash equivalents were $1.961 billion at March 31, 2010, down from $3.275 billion at December 31, 2009. Total debt was approximately $4.201 billion, including $761 million of current maturities and $3.440 billion of long-term debt. The company had no balance outstanding under its $2 billion credit agreement.
Operating cash flow was pressured by higher trade working-capital requirements, an additional payroll period and higher tax payments. Investing cash use was $135 million, including $135 million of capital expenditures. Financing cash use was $648 million, including $507 million of share repurchases, $129 million of dividends and $89 million of long-term debt repayment.
Quarterly dividends were $0.43 per share. The company repurchased 8.3 million shares for $507 million and had $439 million remaining under its repurchase authorization. Backlog was approximately $67.5 billion, including $37.8 billion funded and $29.6 billion unfunded.
Material changes versus the prior comparable period
- Revenue growth reflected higher product sales, including increased activity in Aerospace Systems, Electronic Systems and Shipbuilding. Management estimated that approximately $400 million of additional revenue resulted from more working days in the 2010 period.
- Operating income benefited from improved Aerospace Systems and Technical Services performance, lower unallocated corporate expenses and a substantially lower net pension adjustment.
- Segment operating income increased 7% to $810 million, although segment margin declined modestly to 9.4% from 9.5%.
- Aerospace Systems revenue and operating income rose 10% and 15%, respectively. Shipbuilding revenue and operating income rose 25% and 26%, respectively, and Technical Services revenue and operating income rose 21% and 32%.
- Electronic Systems and Information Systems operating income each declined 1% to 2%, reflecting weaker program performance, workforce-reduction costs and lower revenue in selected programs.
- Discontinued-operations earnings fell to $7 million from $23 million. The 2010 amount primarily reflected an additional gain related to the December 2009 sale of the Advisory Services Division for $1.65 billion.
- Pension expense under GAAP declined to $149 million from $210 million, primarily due to favorable 2009 plan-asset returns. The company expects approximately $57 million of required pension contributions, $171 million of other post-retirement contributions and $330 million of additional voluntary pension contributions in 2010.
Guidance, outlook, risks and unusual items
Management reported no material changes to the products, industry outlook or business trends disclosed in the 2009 Form 10-K. It expects defense requirements and national-security budgets to remain generally responsive, with continuing priorities in modernization, ISR, cyber warfare, advanced electronics and related technologies. No specific revenue or earnings guidance was provided.
For 2010, management expects operating cash generation, supplemented if needed by borrowings, to support debt service, capital expenditures, benefit contributions, share repurchases and dividends. A final IRS and Congressional Joint Committee settlement received in April 2010 is expected to reduce uncertain tax liabilities by approximately $300 million in the second quarter, with most of the benefit recorded through the effective tax rate.
Key contingencies include U.S. Government investigations and claims, the Deepwater patrol-boat litigation scheduled for trial in November 2010, environmental remediation costs estimated at $239 million to $504 million, Hurricane Katrina insurance disputes, Shipbuilding quality issues, and potential U.S. Government claims for disallowed costs. Management does not currently expect these matters to have a material adverse effect, but outcomes are not assured.
The company recorded a $17 million Hurricane Ike business-interruption insurance gain in Shipbuilding during the quarter. Shipbuilding also continued addressing pipe-weld and propulsion-system issues on LPD-class ships. The filing states that contract estimates, claims, equitable adjustments and long-term program performance remain subject to management estimates and could change.
Most important facts for investors to verify
- Whether the strong revenue and earnings growth is sustainable after the unusually favorable working-day comparison and approximately $400 million of associated revenue.
- The timing and magnitude of operating cash-flow recovery as working capital normalizes.
- The impact of the expected $300 million tax settlement benefit in Q2 2010 and whether it is recurring.
- Execution, cost exposure and potential additional charges related to Shipbuilding quality issues and LPD programs.
- Resolution and financial exposure from Deepwater litigation, Hurricane Katrina insurance disputes, environmental remediation and government claims.
- The conversion of the $67.5 billion backlog, particularly the $29.6 billion unfunded portion, into funded orders and revenue.
- Debt maturities, liquidity after share repurchases and planned pension and post-retirement contributions.
- Future effects of proposed Cost Accounting Standards pension rules and health-care legislation on recoverability and benefit costs.