Northrop Grumman Corporation — Form 10-Q Summary
Business Context and Reporting Period
Northrop Grumman is a global security company serving primarily the U.S. Government, including the Department of Defense and intelligence community, with additional international, state, local government and commercial customers. The filing covers the unaudited three months ended March 31, 2016, compared with the three months ended March 31, 2015. Effective January 1, 2016, the company reorganized its reporting structure into Aerospace Systems, Mission Systems and Technology Services.
Financial Performance and Position
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total sales | $5,956 million | $5,957 million | Flat |
| Operating income | $739 million | $780 million | Down 5% |
| Operating margin | 12.4% | 13.1% | Down 70 basis points |
| Net earnings | $556 million | $484 million | Up 15% |
| Diluted EPS | $3.03 | $2.41 | Up 26% |
| Cash used in operating activities | $60 million | $654 million | Use decreased by $594 million |
| Free cash flow | $(358) million | $(771) million | Improved by $413 million |
Product sales increased 1% to $3,478 million, while service sales decreased 2% to $2,478 million. Net earnings benefited substantially from a lower effective tax rate of 17.8%, compared with 31.3% in the prior-year period, including an $80 million discrete tax benefit from adoption of ASU 2016-09 and extension of the research tax credit.
Cash and cash equivalents were $1,277 million at March 31, 2016, down from $2,319 million at December 31, 2015. Total assets were $23,933 million and shareholders’ equity was $5,621 million. Long-term debt was $6,387 million, with a carrying value of total long-term debt, including the current portion, of approximately $6,389 million. The company had no balance outstanding under its $1.6 billion unsecured credit facility and was in compliance with its covenants.
Capital expenditures were $298 million, including $159 million for the purchase of a facility previously leased by Mission Systems. Financing activities included $282 million of share repurchases, $159 million of cash dividends and $107 million of debt repayments. The quarterly dividend was $0.80 per share. Approximately $4.0 billion remained available under the 2015 share repurchase authorization at March 31, 2016.
Segment Results and Material Changes
- Aerospace Systems: Sales increased 3% to $2,574 million, but operating income declined 8% to $286 million and margin fell to 11.1% from 12.5%. Higher volume on E-2D, F-35, Global Hawk and Triton programs was offset by lower margins on several manned-aircraft programs and program mix effects.
- Mission Systems: Sales declined 1% to $2,693 million, while operating income increased 3% to $353 million and margin improved to 13.1% from 12.7%. Higher margins in Advanced Capabilities and volume growth in Sensors and Processing partly offset lower Cyber and ISR activity.
- Technology Services: Sales decreased 4% to $1,214 million and operating income decreased 5% to $126 million. The decline primarily reflected lower volume, program completions and the ramp-down of the ICBM program.
Aggregate favorable estimate-at-completion adjustments were $129 million in Q1 2016, compared with $187 million in Q1 2015. These adjustments contributed approximately $84 million of net earnings and $0.46 of diluted EPS in the current period. No individual contract adjustment was material to the financial statements.
Total backlog increased during the quarter, led by Aerospace Systems and Mission Systems, while Technology Services backlog declined modestly. The company recorded various awards, including a portion of the B-21 Long-Range Strike Bomber program. The filing does not provide a clear total backlog value in the supplied text.
Outlook, Risks, Contingencies and Unusual Items
Management stated that cash balances, operating cash flow and available borrowing capacity are expected to be sufficient to fund operations for at least the next 12 months. The filing does not provide specific full-year revenue, earnings or cash-flow guidance.
- Fiscal 2017 appropriations remained uncertain. A continuing resolution or government shutdown could restrict new contract starts and limit program budgets.
- The company has initiated requests for equitable adjustment with the U.S. Government and an international customer seeking approximately $300 million. Approximately $225 million of additional contract sales had been assumed in estimates as of March 31, 2016; negotiations were ongoing.
- FSS litigation involving the U.S. Postal Service includes company claims of approximately $178 million and a government counterclaim of approximately $410 million. The ultimate outcome and potential loss could not be estimated.
- Environmental remediation liabilities were accrued at $377 million, within a reasonably possible future-cost range of $364 million to $808 million. Management did not expect currently identified projects to have a material adverse effect.
- The company had $238 million of standby letters of credit and guarantees and $150 million of surety bonds outstanding.
- Tax examinations and appeals for 2007–2013 could result within the next 12 months in a reduction of unrecognized tax benefits of up to $175 million and income tax expense of up to $45 million, although timing and outcome are uncertain.
- Adoption of ASU 2016-09 increased first-quarter operating cash flow by $80 million and reduced financing cash flow by the same amount; it also produced the $80 million tax benefit.
- Key disclosed risks include dependence on the U.S. Government, appropriations and procurement changes, contract-estimate risk, cyber threats, pension assumptions and asset returns, supplier performance, litigation, environmental costs, international operations and program execution.
Important Facts for Investors to Verify
- Whether operating-margin pressure at Aerospace Systems persists and whether segment margins recover from the lower Q1 level.
- The extent to which net EAC adjustments, tax benefits and share repurchases affected reported EPS and are repeatable.
- Conversion of increased backlog, including B-21-related awards, into funded contracts and revenue.
- Cash-flow normalization after the prior-year $500 million voluntary pension contribution and the current-year facility purchase.
- Resolution and financial impact of the approximately $300 million requests for equitable adjustment and the FSS litigation.
- Future U.S. defense appropriations, continuing-resolution exposure and potential effects on contract awards and program timing.