Northrop Grumman Corporation — FY2015 Form 10-K Summary
Business context and reporting period
Annual report for the fiscal year ended December 31, 2015, filed February 1, 2016. Northrop Grumman is a global defense and security contractor serving primarily the U.S. Department of Defense, intelligence community, foreign governments, and selected commercial customers. At year-end, operations were organized into Aerospace Systems, Electronic Systems, Information Systems, and Technical Services; the company realigned these into three sectors effective January 1, 2016, without restating the 2015 financial information.
The company had approximately 65,000 employees. U.S. Government sales represented 83% of 2015 sales, compared with 84% in 2014 and 86% in 2013.
Financial performance and position
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Sales | $23.526 billion | $23.979 billion | Down 2% |
| Operating income | $3.076 billion | $3.196 billion | Down 4% |
| Operating margin | 13.1% | 13.3% | Down 20 bps |
| Net earnings | $1.990 billion | $2.069 billion | Down 4% |
| Diluted EPS | $10.39 | $9.75 | Up 7% |
| Operating cash flow | $2.162 billion | $2.593 billion | Down 17% |
| Free cash flow | $1.691 billion | $2.032 billion | Down 17% |
| Capital expenditures | $471 million | $561 million | Down 16% |
| Year-end cash and equivalents | $2.319 billion | $3.863 billion | Down $1.544 billion |
| Long-term debt, including current portion | $6.526 billion | $5.928 billion | Up $598 million |
| Total backlog | $35.923 billion | $38.199 billion | Down 6% |
The effective tax rate declined to 28.7% from 29.6%, primarily because of additional research tax credits. Interest expense increased to $301 million from $282 million. Product sales were $13.966 billion and service sales were $9.560 billion. Company-sponsored research and development increased to $712 million from $569 million.
Year-end total assets were $24.454 billion and shareholders’ equity was $5.522 billion. Pension and other post-retirement liabilities totaled $6.172 billion. The company had $1.6 billion available under its amended revolving credit facility, with no borrowings outstanding, and was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Sales declined primarily because of lower U.S. Government contract volume at Aerospace Systems and Information Systems. International sales increased to $3.339 billion from $3.045 billion.
- Aerospace Systems sales were essentially flat at $10.004 billion, but operating income declined 7% to $1.220 billion. The prior-year period included $75 million of settlements relating to intellectual-property claims and a terminated program.
- Electronic Systems sales declined 2% to $6.842 billion and operating income declined 7% to $1.068 billion, reflecting lower volume, unfavorable mix, and less favorable program performance.
- Information Systems sales declined 5% to $5.894 billion, while operating income increased 1% to $616 million as improved performance offset lower volume.
- Technical Services sales increased 1% to $2.838 billion, while operating income declined 3% to $254 million, primarily because of lower income from an unconsolidated joint venture.
- Aggregate favorable net estimate-at-completion adjustments were $580 million, compared with $664 million in 2014. These adjustments contributed approximately $377 million to 2015 net earnings and $1.97 to diluted EPS.
- Operating cash flow was affected by working-capital changes and a $500 million voluntary pension contribution made in March 2015.
- The company issued $600 million of 3.85% unsecured senior notes due 2045 and repurchased $3.182 billion of common stock. It completed the previously announced repurchase of 60 million shares by the end of 2015.
- Quarterly dividends increased 14% to $0.80 per share, resulting in $3.10 of dividends declared per share for 2015.
- Backlog declined $2.276 billion, with Aerospace Systems backlog down 12%. Technical Services backlog increased 17%. The LRS-B contract award was not included in 2015 backlog or new awards because of a pending bid protest and automatic stay.
Guidance, outlook, commentary, risks and unusual items
Management stated that cash on hand, operating cash generation, and available financing are expected to fund operations for at least the next 12 months. The filing does not provide a clear quantified 2016 revenue, earnings, margin, or cash-flow guidance.
- The Bipartisan Budget Act of 2015 increased defense and non-defense sequester caps for fiscal years 2016 and 2017, and the Consolidated Appropriations Act of 2016 provided $1.1 trillion of discretionary federal funding through September 2016. Management nevertheless identified long-term budget pressure, continuing resolutions, sequestration, appropriations delays, a potential government shutdown, and changing defense priorities as significant risks.
- The company’s concentration in the U.S. Government creates exposure to funding reductions, program cancellations, stop-work orders, contract terminations, and delayed collections.
- Approximately 48% of 2015 sales were under fixed-price contracts. Cost growth, technical issues, schedule delays, subcontractor performance, supplier constraints, and inaccurate estimates-at-completion could reduce profitability.
- Cybersecurity, classified-information protection, export controls, government audits, investigations, bid protests, international operations, environmental obligations, pension assumptions, and goodwill impairment are material risk areas.
- At December 31, 2015, the company had initiated requests for equitable adjustment seeking approximately $300 million on two Aerospace Systems programs and had included approximately $225 million of additional contract sales in its estimates. Recovery remains subject to negotiation.
- The company disclosed ongoing litigation related to a U.S. Postal Service contract, including company claims of approximately $178 million and government counterclaims of approximately $410 million; the ultimate outcome could not be estimated.
- Environmental remediation accruals were $370 million, with a reasonably possible future-cost range of $353 million to $812 million, before expected recoveries through U.S. Government contract overhead charges.
- Contractual obligations totaled $20.838 billion, including $6.523 billion of debt principal, $4.114 billion of debt interest, $8.318 billion of purchase obligations, and $839 million of operating leases.
- The company exercised an option on January 4, 2016 to purchase a leased facility for approximately $150 million, expected to close in the first quarter of 2016.
Deloitte & Touche issued unqualified opinions on the consolidated financial statements and internal control over financial reporting.
Most important facts for investors to verify
- Whether the LRS-B bid protest was resolved and when the related contract value entered backlog and revenue.
- The status, collectability, and accounting treatment of the approximately $300 million in requests for equitable adjustment, including the $225 million already reflected in estimates.
- Current backlog conversion, funded versus unfunded backlog, and the effect of declining Aerospace Systems backlog.
- 2016 operating cash flow after the 2015 voluntary pension contribution and required 2016 pension and post-retirement contributions.
- Remaining authorization and execution pace under the $4.0 billion 2015 share-repurchase program, together with debt maturities and interest obligations.
- Potential effects of U.S. defense appropriations, continuing resolutions, sequestration, program reprioritization, and bid protests.
- Changes in pension assumptions, plan asset performance, required funding, and the $6.172 billion retirement-benefit liability.
- Developments in the U.S. Postal Service litigation, other government investigations, environmental matters, and uncertain tax positions.