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. Its four reporting segments during the period were Aerospace Systems, Electronic Systems, Information Systems and Technical Services. The filing covers the three and nine months ended September 30, 2015, compared with the corresponding 2014 periods. The interim financial statements are unaudited.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Sales | $5,979 million | $5,984 million | $17,832 million | $17,871 million |
| Operating income | $794 million | $769 million | $2,387 million | $2,434 million |
| Operating margin | 13.3% | 12.9% | 13.4% | 13.6% |
| Net earnings | $516 million | $473 million | $1,531 million | $1,563 million |
| Diluted EPS | $2.75 | $2.26 | $7.89 | $7.28 |
| Operating cash flow | $557 million | $933 million | $529 million | $1,103 million |
| Free cash flow | $455 million | $824 million | $195 million | $818 million |
Product sales increased 4% in the quarter and 1% year to date, while service sales declined 5% and 1%, respectively. The effective tax rate was 29.2% in the quarter and 29.4% year to date, compared with 31.8% and 30.1% in the prior-year periods.
At September 30, 2015, cash and cash equivalents were $1.292 billion, down from $3.863 billion at December 31, 2014. Long-term debt, including the current portion, had a carrying value of approximately $6.527 billion, compared with $5.928 billion at year-end 2014. Total shareholders’ equity was $5.697 billion, down from $7.235 billion. The company had no balance outstanding under its $1.6 billion credit facility and was in compliance with its covenants.
Year-to-date investing cash usage was $298 million, including $334 million of capital expenditures. Financing cash usage was $2.802 billion, including $2.864 billion of share repurchases and $458 million of dividends. The company issued $600 million of 3.85% unsecured senior notes due 2045 and made a voluntary $500 million pension contribution.
Material changes versus the prior comparable period
- Quarterly operating income increased $25 million despite essentially flat sales, while year-to-date operating income declined $47 million.
- Quarterly net earnings increased 9%; year-to-date net earnings declined 2%. Diluted EPS increased 22% in the quarter and 8% year to date, aided substantially by lower share count from repurchases.
- Segment operating income declined 14% in the quarter and 6% year to date. Segment margin declined to 12.1% from 14.0% in the quarter and to 12.4% from 13.1% year to date.
- Aerospace Systems sales increased, but operating income declined $99 million in the quarter and $76 million year to date. Electronic Systems sales increased in the quarter but year-to-date operating income declined $46 million. Information Systems sales declined 3% in both periods, while Technical Services sales increased 1% in the quarter and 3% year to date.
- Prior-year results benefited from $75 million of settlements related to intellectual-property and terminated-program claims and from favorable HATFA-related pension effects. These benefits did not recur in 2015.
- Net favorable cumulative contract-estimate adjustments were $112 million in the quarter and $461 million year to date, versus $194 million and $556 million in the prior-year periods.
- Operating cash flow and free cash flow fell materially year to date, driven principally by the $500 million pension contribution, adverse trade working-capital movements and higher capital expenditures.
Guidance, outlook, commentary and risks
The filing does not provide a clear quantitative full-year revenue, earnings or cash-flow guidance figure. Management stated that cash balances, operating cash generation and potential borrowing are expected to fund operations for at least the next 12 months.
Management expects fourth-quarter 2015 federal income tax expense to increase by approximately $25 million and unallocated corporate state-tax expense to increase by approximately $45 million following an IRS-approved accounting-method change.
Total backlog was $35.890 billion at September 30, 2015, down from $38.199 billion at December 31, 2014, including $21.791 billion of funded backlog and $14.099 billion of unfunded backlog. Nine-month new awards were estimated at $15.5 billion. On October 27, 2015, the U.S. Air Force announced an LRS-B development and early-production award; it was not included in third-quarter awards or backlog, and the protest period had not expired.
Key risks include dependence on U.S. Government funding, continuing resolutions, sequestration, potential government shutdowns or debt-ceiling disruptions, program cancellations or delays, contract-estimate changes, pension assumptions, litigation, environmental obligations, cybersecurity threats, supplier performance and international business conditions. The company disclosed a reasonably possible environmental-remediation cost range of $351 million to $794 million and accrued $368 million.
The FSS litigation with the U.S. Government remains unresolved; the company seeks approximately $178 million in claims while the government has asserted a counterclaim of approximately $410 million. The filing states that the ultimate outcome cannot currently be predicted or estimated. Other than the FSS matters, management does not expect pending proceedings to have a material adverse effect.
Important facts for investors to verify
- Whether the LRS-B award survives any protest and when it is added to backlog and future guidance.
- The sustainability of earnings after excluding prior-year settlements, HATFA effects and current-period contract-estimate adjustments.
- Whether working-capital trends and pension funding continue to constrain operating cash flow and free cash flow.
- The pace and funding of the $4.0 billion 2015 share-repurchase authorization after completion of the prior program.
- The ultimate outcome and potential exposure from the FSS litigation, tax matters and environmental remediation.
- The effect of the planned January 1, 2016 reorganization from four reporting sectors to three and the subsequent adoption impact of the new revenue-recognition standard.