Northrop Grumman Corporation — Q1 2013 Form 10-Q Summary
Business context and reporting period
Quarterly period ended March 31, 2013. Northrop Grumman is a global security company operating through Aerospace Systems, Electronic Systems, Information Systems, and Technical Services. The U.S. government, primarily the Department of Defense and intelligence community, is its principal customer. The interim financial statements were reviewed, not audited, and are not necessarily indicative of full-year results.
Financial performance and position
| Metric | Q1 2013 | Q1 2012 |
|---|---|---|
| Total sales | $6.104 billion | $6.198 billion |
| Operating income | $759 million | $796 million |
| Operating margin | 12.4% | 12.8% |
| Net earnings | $489 million | $506 million |
| Diluted EPS | $2.03 | $1.96 |
| Operating cash flow | $1 million | $(105) million |
| Capital expenditures | $40 million | $81 million |
| Free cash flow from operations | $(39) million | $(186) million |
- Product sales increased to $3.421 billion from $3.341 billion, while service sales declined to $2.683 billion from $2.857 billion.
- The effective tax rate decreased to 31.3% from 33.1%, including a $20 million benefit from reinstated research tax credits.
- Cash and cash equivalents were $3.183 billion at March 31, 2013, versus $3.862 billion at December 31, 2012.
- Long-term debt, including the current portion, had a $3.942 billion carrying value and a $4.787 billion estimated fair value. Long-term debt excluding the current portion was $3.937 billion at quarter-end.
- Total current assets were $7.846 billion versus current liabilities of $5.555 billion. Management stated that cash, operating cash generation, and available financing are expected to fund operations for at least the next 12 months.
- Financing cash uses included $456 million of share repurchases and $130 million of dividends. The quarterly dividend was $0.55 per share.
Material changes versus the prior comparable period
- Sales decreased $94 million, or 2%, primarily because of lower Information Systems and Technical Services sales, portfolio-shaping actions, and reduced customer funding.
- Operating income declined $37 million, or 5%, and operating margin decreased 40 basis points. Net favorable cumulative catch-up contract adjustments fell to $174 million from $265 million.
- Diluted EPS increased 4% because share repurchases more than offset lower net earnings.
- Operating cash flow improved by $106 million, primarily from better trade working capital, but remained approximately breakeven.
- Aerospace Systems sales rose 4% to $2.485 billion, aided by ten F-35 LRIP 5 deliveries and higher unmanned-system activity; its margin declined to 10.9% from 11.7%.
- Information Systems sales fell 9% to $1.674 billion and operating income fell 17% to $171 million, reflecting force reductions, program completions, lower funding, and fewer favorable contract adjustments.
- Total backlog decreased to $39.410 billion from $40.809 billion at December 31, 2012. Q1 contract awards were approximately $4.7 billion.
- Capital expenditures declined by $41 million, while financing cash use increased by $258 million, principally because of higher repurchases.
Guidance, outlook, risks, contingencies, and unusual items
- The filing does not provide clear numerical full-year revenue, earnings, margin, or cash-flow guidance.
- Management expects reduced fiscal 2013 defense budget levels and sequestration to result in lower contract awards, with related effects on revenue, earnings, and cash flow likely to lag award reductions. The company expects sequestration to have potentially serious long-term effects.
- Potential fiscal 2014 appropriation delays, continuing resolutions, and the federal debt ceiling could delay government payments. The company may have to continue performing on certain contracts even if timely payment is unavailable.
- Management identified opportunities in long-range strike, missile defense, command and control, cybersecurity, unmanned systems, satellite systems, and related technology areas, but future funding remains uncertain.
- The company recorded a $500 million voluntary defined-benefit pension contribution in April 2013, after quarter-end. Required 2013 funding was estimated at approximately $66 million for pension plans and $110 million for post-retirement plans.
- Northrop Grumman is pursuing claims against the U.S. government related to the approximately $875 million USPS flats sequencing systems contract, seeking approximately $178 million in claims. The government has asserted counterclaims of approximately $410 million. A related False Claims Act complaint alleges damages of at least approximately $179 million annually; potential damages may be trebled. The ultimate outcome and possible loss cannot currently be estimated.
- Environmental remediation costs were estimated at $330 million to $770 million before recoveries; $352 million was accrued for probable costs at March 31, 2013.
- Outstanding financial arrangements included $199 million of standby letters of credit, $273 million of bank guarantees, and $165 million of surety bonds.
- Contract accounting estimates are material: cumulative catch-up adjustments increased Q1 2013 operating income by $174 million. No individual contract adjustment was material, but changes in estimates can significantly affect reported results.
Most important facts for investors to verify
- Whether sequestration, future appropriations, debt-ceiling actions, or continuing resolutions reduce awards, delay payments, or affect key programs.
- The sustainability of operating cash flow and free cash flow after working-capital movements, pension contributions, dividends, and share repurchases.
- The quality and recurrence of contract-estimate benefits, particularly the $174 million of net favorable Q1 catch-up adjustments.
- Backlog conversion, funded backlog of $24.556 billion, and the decline in total backlog from year-end.
- Potential exposure from the USPS litigation and related False Claims Act matter, including the government’s approximately $410 million counterclaims.
- Pension funding needs, the impact of the $500 million voluntary contribution, and the company’s substantial pension and post-retirement liability of $6.025 billion.
- Progression of Information Systems and Technical Services declines, program completions, and customer funding reductions.