Northrop Grumman Corporation — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; comparative periods ended June 30, 2010. Financial statements are unaudited. Northrop Grumman provides aerospace, electronics, information systems, and technical services, primarily to the U.S. Government and Department of Defense. The Shipbuilding business was spun off as Huntington Ingalls Industries (HII) effective March 31, 2011, and is reported as discontinued operations.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Sales and service revenues | $6.560 billion | $7.255 billion | $13.294 billion | $14.169 billion |
| Operating income | $841 million | $750 million | $1.652 billion | $1.429 billion |
| Net earnings | $520 million | $711 million | $1.050 billion | $1.180 billion |
| Diluted EPS from continuing operations | $1.81 | $2.44 | $3.48 | $3.77 |
| Cash provided by continuing operations | $(34) million | $552 million | $78 million | $100 million |
| Free cash flow from continuing operations | $(128) million | $476 million | $(139) million | $(82) million |
Operating margin improved to approximately 12.8% in Q2 2011 from 10.3% in Q2 2010, and to approximately 12.4% for the first six months from 10.1%. Segment operating margin was 12.0% in Q2 and 11.3% for the six months, versus 10.9% and 10.6%, respectively, in the comparable periods.
- Product sales declined 11% in Q2 and 8% for the six months; service revenues declined 8% and 4%, respectively.
- All four segments reported lower revenue for the six months: Aerospace Systems $5.328 billion, Electronic Systems $3.599 billion, Information Systems $4.056 billion, and Technical Services $1.344 billion.
- Electronic Systems segment operating income increased to $521 million for the six months from $490 million, while Aerospace Systems was essentially flat at $632 million versus $631 million. Information Systems declined to $383 million from $388 million; Technical Services increased to $105 million from $101 million.
- Cash and cash equivalents were $2.810 billion at June 30, 2011, compared with $3.701 billion at December 31, 2010.
- Long-term debt carrying value was approximately $4.0 billion, down from $4.7 billion at year-end. The company repaid $750 million of notes at maturity in February 2011. Its $2 billion credit agreement had no balance outstanding.
- Total assets were $25.377 billion and shareholders’ equity was $12.149 billion at June 30, 2011.
- Backlog was $41.8 billion, including $23.4 billion funded and $18.4 billion unfunded, compared with $46.8 billion at December 31, 2010.
Material changes versus the prior comparable period
- Revenue decreased $695 million in Q2 and $875 million for the six months, primarily from lower volume in Aerospace Systems and Electronic Systems and the deconsolidation of the National Security Technologies joint venture. NSTec contributed $288 million of six-month 2010 revenue but none in 2011.
- Operating income increased despite lower revenue, primarily from contract performance improvements and a substantially higher net pension adjustment. The six-month net pension adjustment was $202 million versus $3 million in 2010.
- Net earnings and EPS declined because Q2 2010 included approximately $298 million of tax benefits from an IRS examination settlement. Excluding that settlement, the comparable 2010 effective tax rates were broadly similar to 2011.
- The HII spin-off generated a $1.429 billion cash contribution to Northrop Grumman and reduced paid-in capital by $1.892 billion. HII’s operations were reclassified to discontinued operations for all periods presented.
- The company repurchased approximately $1.013 billion of common stock during the first six months, including approximately 15.6 million shares under an accelerated share repurchase agreement. The repurchase authorization had approximately $3.0 billion remaining at June 30.
- The quarterly dividend increased from $0.47 to $0.50 per share. Six-month dividends declared were $277 million, or $0.97 per share.
Outlook, risks, contingencies, and unusual items
- No formal numerical revenue, earnings, or cash-flow guidance is provided in the filing. Management stated that cash from operations, available credit facilities, and potential capital-market borrowings are expected to support debt service, capital expenditures, pension contributions, share repurchases, and dividends.
- Management highlighted uncertainty around U.S. federal deficit reduction, defense-budget pressures, the Department of Defense strategic review, troop reductions in Iraq and Afghanistan, and the unresolved federal debt ceiling. Reduced appropriations, delayed funding, or delayed government payments could materially affect revenue, liquidity, and cash flow.
- An extended delay in U.S. Government payments could require the company to finance contract performance from cash and credit resources; additional financing, if needed, was not committed.
- The company contributed $550 million to pension plans during the first six months, including $500 million voluntary contributions. Pension and post-retirement liabilities were $2.597 billion at June 30.
- Environmental remediation costs were estimated at $299 million to $730 million; $328 million had been accrued. Management did not expect future remediation expenditures to have a material adverse effect, but estimates remain subject to changes in remediation requirements, contamination findings, responsible parties, and technology.
- Outstanding financial arrangements included $152 million of standby letters of credit, $197 million of bank guarantees, and $140 million of surety bonds.
- The Orange County Water District environmental litigation had a trial scheduled for February 2012. An ERISA litigation matter received class certification, and summary-judgment motions were pending. Management stated that the disclosed matters were not expected to have a material adverse effect, but could not assure victory in the ERISA matter.
- The Department of Justice closed its criminal investigation concerning alleged antitrust violations in July 2011 without further action. The company did not expect a material adverse effect.
Most important facts for investors to verify
- Whether defense-budget reductions, appropriations delays, or the federal debt-ceiling developments affect contract awards, backlog conversion, and customer collections.
- Whether the revenue decline and $41.8 billion backlog reflect a continuing volume trend, particularly in Aerospace Systems, Electronic Systems, and Technical Services.
- The sustainability of improved margins, including the impact of contract performance adjustments and the unusually large pension adjustment.
- Cash conversion and liquidity after pension funding, capital expenditures, dividends, and continued share repurchases.
- The final settlement of the accelerated share repurchase agreement and its effect on cash, shares outstanding, and shareholders’ equity.
- Future pension funding requirements and environmental remediation costs, including potential changes to the disclosed $299 million–$730 million remediation range.
- The financial and operating effects of the HII spin-off and NSTec deconsolidation on future comparability.