Northrop Grumman Corporation — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2009. The interim financial statements are unaudited. Northrop Grumman provides aerospace, electronics, information and technical services, and shipbuilding products and services, primarily to the U.S. Government and Department of Defense.
Financial performance and position
| Metric | Q3 2009 | Q3 2008 | 9M 2009 | 9M 2008 |
|---|---|---|---|---|
| Sales and service revenues | $8,726 million | $8,381 million | $26,003 million | $24,733 million |
| Operating income | $655 million | $771 million | $1,963 million | $2,041 million |
| Net earnings | $490 million | $512 million | $1,273 million | $1,271 million |
| Diluted EPS from continuing operations | $1.52 | $1.50 | $3.89 | $3.65 |
| Net cash from operating activities | $544 million | $1,373 million | $1,202 million | $2,174 million |
| Free cash flow | $384 million | $1,183 million | $708 million | $1,630 million |
- Revenue increased 4% year over year in the quarter and 5% for the nine-month period. All five operating segments reported higher nine-month revenue.
- GAAP operating margin was approximately 7.5% in Q3 2009 versus 9.2% in Q3 2008, and 7.5% for the first nine months versus 8.3% in the prior-year period.
- Segment operating income increased 2% in Q3 and 14% for the nine months; segment margin was 9.0% and 8.8%, respectively. The difference from GAAP operating income primarily reflects unallocated expense, pension adjustments, and royalty income adjustments.
- Cash and cash equivalents were $1,924 million at September 30, 2009, compared with $1,504 million at December 31, 2008.
- Total long-term debt was $4,685 million, including $491 million of current maturities, versus $3,920 million at December 31, 2008. The company issued $850 million of senior notes in July 2009: $350 million due 2014 at 3.70% and $500 million due 2019 at 5.05%.
- Total liabilities were $18,416 million and shareholders’ equity was $12,429 million at September 30, 2009. Pension and post-retirement plan liabilities totaled $5,349 million.
- The company reported $71.5 billion of total backlog, consisting of $35.2 billion funded and $36.2 billion unfunded, compared with $78.1 billion at December 31, 2008.
Material changes versus the prior comparable period
- Operating income declined despite higher revenue, mainly because of higher pension costs, lower performance in Electronic Systems, higher Q3 unallocated expenses, and the absence of significant 2008 royalty income from patent infringement settlements.
- Net earnings were broadly flat for the nine-month period, while diluted EPS increased because weighted-average diluted shares declined to 326.1 million from 344.5 million, reflecting share repurchases and the prior-year preferred-stock conversion.
- Operating cash flow decreased by $972 million for the nine months, primarily due to $800 million of voluntary pension contributions and higher trade working-capital requirements. Free cash flow decreased by $922 million.
- Northrop Grumman repurchased 14.7 million shares for approximately $663 million during the first nine months, with $282 million remaining under the authorization at quarter-end. It paid $405 million of dividends and increased the quarterly dividend from $0.40 to $0.43 per share.
- Shipbuilding nine-month operating income improved to $211 million from $26 million, primarily because of lower negative performance adjustments compared with 2008. Electronic Systems Q3 operating income fell 18%, while Information Systems Q3 operating income increased 32%.
- The company reorganized from seven to five operating segments and realigned certain logistics, services, and technical-support programs. Prior-period segment information was revised for the realignment.
- Backlog declined by approximately $6.6 billion from year-end, including a $5.1 billion reduction related to termination for convenience of the Kinetic Energy Interceptor program.
Outlook, commentary, risks, and unusual items
- Management stated that there were no material changes to the products, industry outlook, or business trends described in the 2008 Form 10-K. It expected defense spending to remain responsive to the international security environment, with opportunities in intelligence, surveillance and reconnaissance, unmanned systems, cybersecurity, information systems, and nontraditional warfare capabilities.
- Management stated that 2009 operating cash flow, supplemented by credit facilities and capital-market borrowings as necessary, was expected to fund debt service, contract obligations, capital expenditures, benefit contributions, share repurchases, and dividends.
- The third quarter included approximately $75 million of net tax benefits from the IRS settlement covering 2001–2003 tax years and provisions for other uncertain tax positions. The effective tax rate was 21.5% in Q3 and 29.7% for the nine months, compared with 31.4% and 33.6%, respectively, in 2008.
- The company contributed $832 million to pension plans through September 30, including $800 million of voluntary contributions, and did not expect additional voluntary pension contributions in 2009.
- A quality issue involving certain pipe welds at Gulf Coast Shipbuilding could require rework on ships in production and previously delivered. Management did not believe the matter would have a material adverse effect based on information then available.
- Material contingencies include the Deepwater 123-foot patrol-boat litigation, environmental remediation with reasonably possible future costs estimated at $242 million to $466 million and $291 million accrued, ERISA litigation, Hurricane Katrina insurance disputes, government investigations, and possible contract, quality, supplier, and cost-allowability issues.
- The company reported no material changes to previously disclosed risk factors or contractual obligations. It had $532 million of unused standby letters of credit, $133 million of bank guarantees, $451 million of surety bonds, and a guarantee of a $200 million Shipbuilding loan.
- On October 15, 2009, after quarter-end, the company used part of the July debt proceeds to retire $400 million of matured 8% senior debt.
Important facts for investors to verify
- Whether operating and segment margins recover as pension costs, program performance issues, and shipbuilding quality matters develop.
- The conversion of the $71.5 billion backlog into funded orders, revenue, and cash, particularly after the $5.1 billion KEI termination.
- Working-capital trends and the sustainability of operating cash flow after unusually large pension contributions.
- Total debt maturities, refinancing needs, and liquidity after the $850 million debt issuance and subsequent $400 million repayment.
- Potential exposure from Deepwater litigation, ERISA claims, environmental remediation, Hurricane Katrina insurance disputes, and government investigations.
- The effect of defense-budget decisions, program cancellations, cost-accounting changes, and contract performance revisions on future revenue and margins.
- The extent to which the $75 million Q3 tax benefit and other unusual items affect the comparability of reported earnings.