Northrop Grumman Corporation — 2020 First-Quarter Form 10-Q
Reporting period: Three months ended March 31, 2020. The interim financial statements are unaudited and prepared under U.S. GAAP. Northrop Grumman reorganized its reportable segments effective January 1, 2020 into Aeronautics Systems, Defense Systems, Mission Systems and Space Systems. The company is a global aerospace and defense contractor with substantial reliance on the U.S. government.
Financial performance and position
| Metric | Q1 2020 | Q1 2019 | Change |
|---|
| Sales | $8.620 billion | $8.189 billion | Up 5% |
| Operating income | $934 million | $936 million | Approximately flat |
| Operating margin | 10.8% | 11.4% | Down 60 basis points |
| Net earnings | $868 million | $863 million | Up 1% |
| Diluted EPS | $5.15 | $5.06 | Up 2% |
| Effective tax rate | 17.6% | 16.5% | Up 110 basis points |
| Net cash used in operating activities | $(993) million | $(913) million | Greater use of $80 million |
| Free cash flow | $(1.265) billion | $(1.197) billion | Greater use of $68 million |
- Product sales increased 8% to $6.176 billion, while service sales decreased 1% to $2.444 billion.
- Cash and cash equivalents were $3.278 billion at March 31, 2020, compared with $2.245 billion at December 31, 2019.
- Accounts receivable increased to $2.136 billion and unbilled receivables increased to $5.918 billion from $1.326 billion and $5.334 billion, respectively, at year-end.
- Total assets were $43.203 billion and total shareholders’ equity was $9.062 billion at March 31, 2020.
- Carrying value of long-term debt was $16.1 billion, compared with $13.9 billion at December 31, 2019. Estimated fair value was $17.5 billion.
- Operating cash flow reflected substantial working-capital usage, including $810 million for accounts receivable, $584 million for unbilled receivables and $833 million for accounts payable and other liabilities.
- Capital expenditures were $272 million. Cash dividends paid were $227 million, and share repurchases totaled $344 million.
Segment results and material changes
| Segment | Q1 2020 sales | Sales change | Q1 2020 operating income | Operating income change |
|---|
| Aeronautics Systems | $2.843 billion | Up 1% | $259 million | Down 16% |
| Defense Systems | $1.881 billion | Up 6% | $196 million | Down 3% |
| Mission Systems | $2.347 billion | Up 6% | $348 million | Up 9% |
| Space Systems | $1.948 billion | Up 8% | $199 million | Up 6% |
- Sales increased in all four segments, led by Space Systems and Mission Systems.
- Aeronautics Systems margin declined to 9.1% from 10.9%, primarily due to lower favorable estimate-at-completion adjustments, the timing of F-35 risk retirements and contract mix.
- Defense Systems margin declined to 10.4% from 11.4%, partly because the prior-year period benefited from favorable adjustments on small-caliber ammunition programs.
- Mission Systems margin improved to 14.8% from 14.4%, primarily due to improved performance on Airborne Sensors & Networks programs.
- Space Systems margin declined modestly to 10.2% from 10.4%, primarily due to favorable commercial contract negotiations recognized in the prior-year quarter.
- Aggregate net estimate-at-completion adjustments contributed $124 million of operating income in Q1 2020, compared with $138 million in Q1 2019. The filing states that no individual adjustment was material to the financial statements.
- Net earnings benefited from a $102 million increase in the FAS non-service pension benefit, substantially offset by a $94 million decline in other income associated with lower marketable-securities returns.
Debt, liquidity and capital allocation
- In March 2020, Northrop Grumman issued $2.25 billion of unsecured senior notes: $750 million at 4.40% due 2030, $500 million at 5.15% due 2040 and $1.0 billion at 5.25% due 2050.
- Commercial paper borrowings were $744 million at a weighted-average interest rate of 1.88%. The commercial paper program has $2.0 billion of capacity.
- No borrowings were outstanding under the $2.0 billion revolving credit facility maturing in August 2024. A separate subsidiary facility had approximately $68 million outstanding and was extended to December 2020.
- In April 2020, the company entered into a one-year, $500 million uncommitted credit facility.
- Management stated that cash, operating cash flow and available financing sources are expected to fund operations for at least the next 12 months.
- The 2015 share-repurchase authorization was completed in March 2020. As of March 31, 2020, $2.98 billion remained under the 2018 authorization. The quarterly dividend was $1.32 per share.
Backlog, outlook and management commentary
- Backlog was $64.2 billion at March 31, 2020, down 1% from $64.8 billion at December 31, 2019. Funded backlog was $32.5 billion and unfunded backlog was $31.6 billion.
- Management expects approximately 45% of backlog to convert to revenue within 12 months and approximately 70% within 24 months.
- First-quarter net awards totaled $7.9 billion, including multiple restricted space contracts and awards for SABR, Triton, AARGM and GMD programs.
- COVID-19 impacts were not material to first-quarter 2020 financial results, but management expects the pandemic to reduce 2020 revenue and operating margins in portions of the business through supplier disruption, lower employee productivity, program delays and related challenges.
- Most facilities remained open because the defense industrial base was generally treated as essential or critical infrastructure. The company implemented remote work, social-distancing, travel-restriction, cleaning and personal-protective-equipment measures.
- Management stated that customers generally continued to pay on time and that higher DoD progress-payment rates and permitted deferral of certain payroll taxes should mitigate pressure on operating cash flow.
- The filing does not provide a clear quantitative full-year 2020 revenue, margin or earnings guidance figure.
Risks, contingencies and unusual items
- Key COVID-19 risks include workforce absenteeism, facility closures, supplier disruption, program delays, unrecovered costs, changes in government priorities and possible pressure on liquidity or access to capital.
- The company depends substantially on the U.S. government and is exposed to appropriations, procurement timing, contract performance, fixed-price contract cost growth and government payment practices.
- The FSS litigation with the U.S. Postal Service remained unresolved. The company seeks approximately $178 million in claims, while the government’s counterclaim had been reduced to approximately $193 million. Trial proceedings were postponed because of COVID-19, and the company stated that the outcome could not be predicted or reasonably estimated.
- Bethpage, New York environmental matters may require additional remediation. Accrued environmental costs were $533 million, with reasonably possible future costs of $448 million in excess of accrued amounts; the filing states that potential cumulative Bethpage outcomes cannot currently be estimated.
- A U.S. government review of an interest-rate assumption used in determining pension costs could have a material adverse effect, although no loss range was available.
- The company had $469 million of standby letters of credit and guarantees and $182 million of surety bonds outstanding.
- Tax authorities were examining various federal returns. Unrecognized tax benefits related to revenue-recognition methods and the 2017 Tax Act could decrease by up to $60 million within the next 12 months.
- The company reported effective disclosure controls and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Track COVID-19 effects on supplier performance, labor productivity, contract schedules, cost recovery and full-year revenue and margin outcomes.
- Assess operating-cash-flow conversion, receivables and unbilled receivables, particularly given first-quarter free cash flow of negative $1.265 billion.
- Monitor leverage, refinancing requirements, commercial paper usage, credit ratings and interest expense following the $2.25 billion debt issuance.
- Evaluate backlog quality, including the funded versus unfunded mix and the timing of conversion into revenue.
- Review Aeronautics Systems and Defense Systems margins, estimate-at-completion adjustments and fixed-price contract exposure.
- Follow the FSS litigation, Bethpage remediation, pension cost-assumption review and other government or environmental proceedings.
- Confirm the company’s subsequent full-year guidance, if issued, because this filing provides only qualitative expectations for COVID-19-related impacts.
