Northrop Grumman Corporation — Q1 2021 Form 10-Q
Business context and reporting period
Northrop Grumman is a global aerospace and defense contractor serving primarily the U.S. government, including the Department of Defense and intelligence community. The filing covers the three months ended March 31, 2021, compared with the three months ended March 31, 2020. The interim financial statements were reviewed, not audited, by Deloitte & Touche LLP.
On January 30, 2021, the company completed the $3.4 billion cash divestiture of its IT and mission support services business and recorded a $2.0 billion pretax gain.
Financial performance and position
| Metric | Q1 2021 | Q1 2020 | Change |
|---|---|---|---|
| Total sales | $9.157 billion | $8.620 billion | 6% |
| Organic sales | $8.995 billion | $8.061 billion | 12% |
| Operating income | $2.822 billion | $934 million | 202% |
| Operating margin | 30.8% | 10.8% | Up 20.0 points |
| Net earnings | $2.195 billion | $868 million | 153% |
| Diluted EPS | $13.43 | $5.15 | 161% |
| Transaction-adjusted net earnings | $1.075 billion | $868 million | 24% |
| Transaction-adjusted diluted EPS | $6.57 | $5.15 | 28% |
| Net cash used in operating activities | $(66) million | $(993) million | Improved $927 million |
| Adjusted free cash flow | $(271) million | $(1.265) billion | Improved $994 million |
Product sales increased 14% to $7.022 billion, while service sales declined 13% to $2.135 billion, primarily because of the divestiture. The company reported $190 million of net favorable estimate-at-completion adjustments, compared with $124 million in the prior-year quarter.
Segment sales and operating income were: Aeronautics Systems, $2.990 billion and $308 million; Defense Systems, $1.562 billion and $177 million; Mission Systems, $2.589 billion and $397 million; and Space Systems, $2.521 billion and $276 million. Segment operating margin increased to 12.0% from 11.2%.
At March 31, 2021, cash and cash equivalents were $3.517 billion, compared with $4.907 billion at December 31, 2020. Long-term debt was $12.764 billion, compared with $14.261 billion at year-end. No commercial paper or credit-facility borrowings were outstanding, and the company stated that available liquidity is expected to fund operations for at least the next 12 months.
Material changes versus the prior comparable period
- Reported earnings benefited substantially from the $2.0 billion pretax IT services divestiture gain. The transaction also generated $3.4 billion of cash proceeds.
- Reported operating margin rose sharply because of the divestiture gain; the transaction-adjusted results provide a more comparable view of ongoing performance.
- Organic sales increased 12%, led by Space Systems, Mission Systems and Aeronautics Systems. Defense Systems organic sales declined 2%.
- Space Systems sales increased 29% and operating income increased 37%; Mission Systems sales increased 10% and operating income increased 12%; Aeronautics Systems sales increased 5% and operating income increased 17%.
- Defense Systems sales declined 17% and operating income declined 11%, primarily because of the divested business and the close-out of the Lake City ammunition plant contract.
- The company repaid $700 million of notes at maturity and redeemed $1.5 billion of 2.55% notes, recording a $54 million pretax make-whole premium. It also paid $2.0 billion under an accelerated share repurchase agreement and received an initial delivery of approximately 5.9 million shares.
- Backlog was $79.3 billion at March 31, 2021, down 2% from December 31, 2020, including a $1.4 billion reduction related to the divestiture. Approximately 40% was expected to convert to revenue within 12 months and 60% within 24 months.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide a clear numerical full-year earnings, sales or cash-flow guidance figure. Management expects ongoing demand from high-priority defense areas, including space, missiles, missile defense, hypersonics, survivable aircraft and mission systems, but noted uncertainty around future defense budgets, appropriations, priorities and the federal debt ceiling.
Management stated that Q1 2021 revenue and operating income were not significantly affected by COVID-19. However, the company continues to face potential worker, supplier, facility, program, cost-recovery and government-funding disruptions. The company is seeking recovery of certain COVID-19-related costs under the CARES Act and contract provisions, but the amount recoverable is unclear.
- The company faces significant dependence on the U.S. government and exposure to delays or reductions in appropriations, procurement changes, bid protests and contract-performance requirements.
- Contract accounting relies on estimates of costs and revenues at completion. Future unfavorable estimate changes, cost growth or loss contracts could affect earnings and cash flow.
- Environmental remediation liabilities were $621 million accrued at March 31, 2021, with $342 million of reasonably possible future costs in excess of accrued amounts. Bethpage, New York, remediation requirements and potential natural resource damages could increase costs materially.
- A U.S. government dispute over the company’s CAS pension interest-rate assumptions could have a material adverse effect, although the company cannot currently estimate a potential loss range.
- The Postal Service litigation involves company claims of approximately $178 million and a government counterclaim of approximately $193 million; the ultimate outcome cannot currently be predicted or reasonably estimated.
- The company has a $200 million first installment of deferred Social Security taxes due in Q4 2021.
Important facts for investors to verify
- Separate the $2.0 billion divestiture gain and related tax, transaction and debt-redemption effects from recurring operating performance.
- Verify the final settlement of the $2.0 billion accelerated share repurchase, including the number of additional shares delivered or any cash payment.
- Monitor backlog conversion, new awards and the effect of the IT services divestiture on future sales and margins.
- Assess operating cash flow seasonality and whether the company converts improved earnings into positive full-year cash flow.
- Track potential exposure from the CAS pension matter, Bethpage environmental remediation and the Postal Service litigation.
- Evaluate changes in U.S. defense budgets, appropriations, procurement priorities and COVID-19-related cost recovery.