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Northrop Grumman Corp. 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarter ended March 31, 2002. Northrop Grumman Corporation is a major defense contractor. The reporting period includes the full impact of significant 2001 acquisitions: Litton Industries, Newport News Shipbuilding, and the Electronics and Information Systems Group of Aerojet-General (EIS). On January 18, 2002, the company completed the acquisition of the remaining shares of Newport News, achieving 100% ownership. The company also adopted SFAS No. 142 effective January 1, 2002, ceasing the amortization of goodwill.

Key Financial Metrics

Segment Performance (Q1 2002 Sales): Electronic Systems ($1,238M), Ships ($1,077M), Information Technology ($929M), Integrated Systems ($807M), and Component Technologies ($125M).

Material Changes vs. Prior Period

• Revenue Growth: Sales more than doubled to $4.1 billion, driven primarily by the inclusion of Litton, Newport News, and EIS in the consolidated results.
• Profitability: Operating margin increased to $313 million. However, on a pro-forma basis adjusted for goodwill amortization changes, Q1 2001 net income was $132 million compared to $149 million in Q1 2002.
• Earnings Per Share: Diluted EPS decreased to $1.27 from $1.42. This decline is attributed to a substantial decrease in pension income ($24M vs $69M), higher interest expense due to acquisition financing, and a significant increase in shares outstanding (112.8M vs 72.8M).
• Cash Flow: Net cash used in operating activities was $99 million, compared to $33 million in the prior year. Cash and cash equivalents dropped from $464 million to $115 million due to acquisition payments and working capital fluctuations.
• Debt: Net debt increased to $5.4 billion from $5.0 billion at year-end 2001, reflecting cash expenditures to complete the Newport News acquisition.

Guidance, Outlook, and Risks

• Segment Outlook:
  • Electronic Systems: 2002 operating margin forecast at ~9% of sales.
  • Ships: 2002 operating margin expected at ~8% of sales.
  • Information Technology: 2002 sales expected between $4.2B-$4.4B; margin in high 5% range.
  • Integrated Systems: 2002 sales expected between $3.0B-$3.2B; margin in mid-to-high 8% range.
  • Component Technologies: 2002 sales expected at ~$620M; margin in low single digits, impacted by telecom downturn.
• Proposed Acquisition: The company proposed a combination with TRW Inc. on February 22, 2002. If completed, Northrop Grumman intends to divest TRW's automotive business. Transaction costs incurred to date are approximately $20 million.
• Liquidity and Taxes: The company expects to generate $100M-$200M in cash to pay down debt in 2002. A significant tax liability of approximately $1 billion related to the B-2 EMD contract is expected to become payable in March 2003 upon contract completion.
• Legal Contingency: A jury verdict of approximately $31 million plus $37 million in pre-judgment interest was awarded against the company in a dispute with Allison Gas Turbine regarding 1980s prototype aircraft. The company plans to appeal and believes the award should be overturned.

Investor Verification Checklist

• Acquisition Integration: Verify the final purchase price allocation for Newport News and EIS, as current figures are preliminary estimates subject to adjustment by June 30, 2002.
• TRW Transaction: Monitor the status of the proposed TRW merger and the feasibility of divesting the automotive business.
• Allison Gas Turbine Litigation: Track the outcome of the appeal regarding the ~$68 million adverse judgment.
• B-2 Tax Liability: Confirm the company's funding strategy for the ~$1 billion tax payment due in March 2003.
• Goodwill Impairment: Review the results of the initial goodwill impairment test required under SFAS No. 142, expected to be completed by June 30, 2002.