Northrop Grumman Corporation — FY2011 Form 10-K
Business context and reporting period
Annual report for the fiscal year ended December 31, 2011, with quarterly data for the fourth quarter. Following the March 31, 2011 spin-off of Huntington Ingalls Industries, the continuing business comprised Aerospace Systems, Electronic Systems, Information Systems, and Technical Services. More than 90% of revenue came from the U.S. Government.
Key financial metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Sales and service revenues | $26.412 billion | $28.143 billion | Down 6% |
| Operating income | $3.276 billion | $2.827 billion | Up 16% |
| Operating margin | 12.4% | 10.0% | Up approximately 240 bps |
| Earnings from continuing operations | $2.086 billion | $1.904 billion | Up 10% |
| Diluted EPS from continuing operations | $7.41 | $6.32 | Up 17% |
| Net earnings | $2.118 billion | $2.053 billion | Up 3% |
| Cash from continuing operations | $2.347 billion | $2.056 billion | Up 14% |
| Free cash flow from continuing operations | $1.855 billion | $1.471 billion | Up 26% |
Fourth-quarter 2011 revenue was $6.506 billion, operating income was $799 million, earnings from continuing operations were $550 million, and diluted EPS from continuing operations was $2.09.
- Year-end cash and cash equivalents were $3.002 billion; marketable securities were $223 million and held-to-maturity short-term investments were $250 million.
- Total long-term debt was $3.940 billion, including $5 million due within one year. The company had $2 billion of undrawn revolving credit facilities and was in compliance with covenants.
- Capital expenditures were $488 million. The company repaid $768 million of debt, repurchased 40.2 million shares for $2.3 billion, and paid $543 million of dividends.
- Quarterly dividends increased from $0.47 to $0.50 per share during 2011; declared dividends totaled $1.97 per share.
- Backlog was $39.5 billion at year-end, including $23.2 billion funded and $16.3 billion unfunded; approximately 59% was expected to convert to 2012 sales.
Material changes versus the prior comparable period
- Revenue declined across all four operating segments. The largest drivers were lower Aerospace Systems space and manned-aircraft volume, lower Electronic Systems land and self-protection volume, lower Information Systems activity, and the absence of consolidated NSTec revenue in Technical Services.
- Technical Services revenue fell 16%, primarily because reduced NSTec participation eliminated $579 million of 2010 revenue; operating income nevertheless rose 5% and margin improved to 8.0%.
- Segment operating margins improved in every segment: Aerospace Systems to 12.1%, Electronic Systems to 14.5%, Information Systems to 9.7%, and Technical Services to 8.0%.
- The 2011 effective tax rate rose to 32.3% from 19.5% in 2010. The 2010 rate benefited from a $298 million IRS settlement-related tax benefit.
- The company changed backlog measurement criteria in the fourth quarter, reducing reported backlog by approximately $3 billion, including $2.3 billion in Information Systems and $725 million in Technical Services. NSTec and program restructuring reduced backlog by additional amounts.
- Aggregate net favorable contract-estimate adjustments increased operating income by $738 million in 2011, compared with $675 million in 2010.
- The pension and post-retirement funded deficit increased to approximately $4.1 billion from $2.9 billion, while the company made $1.1 billion of pension contributions, including $1.0 billion voluntary.
Guidance, outlook, commentary, risks and unusual items
Management expected 2012 cash on hand and operating cash flow to cover debt service, contract obligations, capital expenditures, share repurchases, and dividends. Expected 2012 contributions were approximately $65 million for pension plans and $120 million for other post-retirement plans. Management also stated that the company could use its undrawn revolving facilities or access capital markets if needed.
Management viewed the company as well positioned in areas emphasized by the Department of Defense, including intelligence, surveillance and reconnaissance, cybersecurity, missile defense, long-range strike, satellite communications, modernization, and technical services. However, the Budget Control Act, potential sequestration beginning in 2013, program cancellations, procurement delays, and declining defense spending created substantial uncertainty.
- The HII spin-off generated a $1.429 billion cash contribution to Northrop Grumman. Shipbuilding results were reported as discontinued operations; 2011 discontinued-operations earnings were $32 million after tax.
- Environmental remediation costs were estimated at $294 million to $752 million, with $322 million accrued for probable costs.
- Contractual obligations totaled $15.709 billion, excluding approximately $3.5 billion of estimated minimum retiree-benefit funding over the next five years.
- Key risks include dependence on the U.S. Government, appropriations and sequestration, fixed-price contract cost growth, contract estimate changes, government audits and claims, cybersecurity, supply-chain disruption, pension assumptions, environmental liabilities, litigation, and possible tax or indemnity liabilities related to the HII spin-off.
- The company reported no goodwill impairment charges, no significant off-balance-sheet arrangements other than operating leases, and unqualified audit opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether defense-budget reductions, sequestration, and program cancellations affect backlog conversion, new awards, and segment revenue.
- The sustainability of 2011 margin expansion given the significant favorable contract-estimate adjustments.
- The effect of the $3 billion backlog measurement change and the amount of backlog that is funded versus unfunded.
- Future pension funding requirements and sensitivity to discount rates, asset returns, and the revised Cost Accounting Standards pension rule.
- Cash deployment priorities, including the remaining $1.7 billion share-repurchase authorization, dividends, debt maturities, and contractual obligations.
- Developments in environmental remediation, government cost claims, litigation, tax matters, and contingent liabilities associated with the HII separation.