Northrop Grumman Corporation: 2009 Q2 Form 10-Q Summary
Business context and reporting period
Northrop Grumman is a diversified aerospace and defense contractor serving primarily the U.S. Department of Defense, other government customers, and selected commercial and international customers. The filing covers the three and six months ended June 30, 2009, with comparisons to the corresponding 2008 periods. In January 2009, the company reorganized from seven to five reportable segments: Aerospace Systems, Electronic Systems, Information Systems, Shipbuilding, and Technical Services.
Key financial metrics
| Metric | Three months ended June 30, 2009 | Three months ended June 30, 2008 | Six months ended June 30, 2009 | Six months ended June 30, 2008 |
|---|
| Sales and service revenues | $8,957 million | $8,628 million | $17,277 million | $16,352 million |
| Operating income | $653 million | $806 million | $1,308 million | $1,270 million |
| Net earnings | $394 million | $495 million | $783 million | $759 million |
| Diluted EPS from continuing operations | $1.21 | $1.40 | $2.38 | $2.15 |
| Net cash from operating activities | $830 million | $607 million | $658 million | $801 million |
| Free cash flow | $676 million | $431 million | $324 million | $447 million |
- Second-quarter revenue increased approximately 4%; six-month revenue increased approximately 6%.
- Second-quarter operating margin was approximately 7.3%, versus 9.3% in 2008. Six-month operating margin was approximately 7.6%, versus 7.8%.
- Second-quarter net margin was approximately 4.4%, versus 5.7%; six-month net margin was approximately 4.5%, versus 4.6%.
- Product sales rose to $5,420 million in the second quarter from $4,849 million, while service revenues declined to $3,537 million from $3,779 million.
- The effective tax rate on continuing operations was 33.9% for the quarter and 34.0% for the six months, compared with 34.6% and 35.0%, respectively, in 2008.
- Cash and cash equivalents were $1,056 million at June 30, 2009, compared with $1,504 million at December 31, 2008. Current assets were $7,256 million and current liabilities were $7,243 million.
- Debt consisted of $493 million of current long-term debt, $3,348 million of long-term debt, and $27 million of bank notes payable. The carrying value of total long-term debt was $3,841 million.
- Shareholders’ equity was $12,189 million at June 30, 2009, compared with $11,920 million at year-end 2008.
Segment performance
| Segment | Q2 2009 revenue | Q2 2009 operating income | Six-month 2009 revenue | Six-month 2009 operating income |
|---|
| Aerospace Systems | $2,673 million | $257 million | $5,129 million | $515 million |
| Electronic Systems | $1,967 million | $251 million | $3,755 million | $480 million |
| Information Systems | $2,585 million | $204 million | $5,076 million | $427 million |
| Shipbuilding | $1,524 million | $14 million | $2,899 million | $98 million |
| Technical Services | $702 million | $43 million | $1,334 million | $80 million |
- Aerospace Systems and Electronic Systems delivered the strongest growth, supported by higher volume on aircraft, unmanned systems, space, electronic warfare, missile-defense, and naval programs.
- Information Systems revenue increased, but quarterly operating income declined slightly due to weaker performance on state and local programs.
- Shipbuilding was the principal weakness. Second-quarter revenue declined 10% and operating income fell 89% due largely to a $105 million pre-tax charge for cost growth on LPD-class ships and LHA 6.
Material changes versus the prior comparable period
- Quarterly net earnings declined $101 million and diluted EPS from continuing operations declined $0.19, despite higher revenue. The main factors were Shipbuilding cost growth and substantially higher GAAP pension expense.
- Six-month net earnings increased $24 million and diluted EPS increased $0.23, aided by the absence of the $326 million Shipbuilding charge recorded in the first quarter of 2008.
- Six-month segment operating income increased 22% to $1,510 million, but reported operating income increased only 3% to $1,308 million because of a $152 million unfavorable net pension adjustment in 2009 versus a $128 million favorable adjustment in 2008.
- Six-month operating cash flow decreased $143 million, primarily because of $214 million of discretionary pension contributions and higher trade working-capital requirements.
- The company repurchased 10 million shares for approximately $437 million during the first six months and paid $269 million of dividends. The quarterly dividend increased from $0.40 to $0.43 per share.
- Backlog declined to approximately $70.4 billion from $78.1 billion at December 31, 2008. The decrease included a $5.1 billion reduction following termination for convenience of the Kinetic Energy Interceptor program.
Guidance, outlook, risks, contingencies, and unusual items
- Management stated that cash from operations, supplemented by credit facilities if necessary, is expected to fund debt service, capital expenditures, required and voluntary benefit contributions, share repurchases, and dividends during 2009. The company also believed it could access debt capital markets under then-current conditions.
- The company expected approximately $500 million of voluntary pension contributions in 2009; total discretionary contributions reached $500 million after an additional $286 million contribution in July.
- Management cited potential growth opportunities in intelligence, surveillance and reconnaissance, cyber-security, information systems, persistent surveillance, directed-energy systems, and modernization of defense and homeland-security assets. The 2010 presidential defense budget request was identified as approximately $533.7 billion.
- A $99 million second-quarter gain resulted from the settlement of two offsetting government matters involving microelectronics parts and the company’s TSSAM claim. The settlement had no cash-flow impact. The quarter also included $35 million of provisions for legal and investigative matters.
- Shipbuilding is assessing weld-quality issues affecting certain ships in production and previously delivered. Management did not believe the matter would have a material adverse effect based on information available at filing.
- Environmental remediation costs were estimated at $187 million to $267 million, with $236 million accrued. The company had $519 million of unused standby letters of credit, $129 million of bank guarantees, $447 million of surety bonds, and guaranteed a $200 million Shipbuilding loan.
- Material legal and regulatory exposures include the Skinner pension litigation, Deepwater-related False Claims Act litigation, government investigations, Orange County groundwater litigation, and disputes regarding Hurricane Katrina insurance recoveries. Outcomes remain uncertain, although management generally did not expect a material adverse effect.
- Management identified risks related to defense-budget changes, contract performance and cost estimates, pension asset returns and funding requirements, government investigations, litigation, insurance recoveries, environmental remediation, subcontractors, labor, tax matters, and the availability of government contract costs for reimbursement.
- The company adopted applicable new fair-value and derivative disclosure requirements. SFAS No. 167 was scheduled to become effective January 1, 2010; management was evaluating its impact.
Most important facts for investors to verify
- Whether Shipbuilding cost growth, weld-quality issues, and future contract estimates produce additional charges or affect margins.
- The timing and amount of future pension contributions, pension expense, and potential recovery of pension costs under revised Cost Accounting Standards.
- The sustainability of operating cash flow after discretionary pension funding and working-capital investment.
- The effect of the $5.1 billion KEI backlog reduction and the conversion of the remaining $70.4 billion backlog into funded revenue.
- Progress and potential exposure in the Deepwater, pension-plan, environmental, antitrust, and Hurricane Katrina insurance matters.
- Future defense appropriations, program cancellations, contract awards, and changes in U.S. government spending priorities.
