NORTHROP GRUMMAN CORP quarterly report, Q2 FY2010

Northrop Grumman Corporation — Form 10-Q Summary

Business context and reporting period

Quarterly report for the three and six months ended June 30, 2010. Northrop Grumman provides aerospace, electronics, information technology, technical services and shipbuilding products and services, primarily to the U.S. government and Department of Defense. The filing was reviewed by Deloitte & Touche LLP and was not audited.

Financial performance and position

Metric	Three months ended June 30	Six months ended June 30
Revenue	$8.826 billion, versus $8.545 billion	$17.436 billion, versus $16.480 billion
Operating income	$716 million, versus $614 million	$1.481 billion, versus $1.233 billion
Net earnings	$711 million, versus $394 million	$1.180 billion, versus $783 million
Diluted EPS from continuing operations	$2.34, versus $1.13	$3.85, versus $2.23
Operating margin	8.1%, versus 7.2%	8.5%, versus 7.5%
Operating cash flow	$619 million, versus $830 million	$88 million, versus $658 million
Free cash flow from operations	$515 million, versus $676 million	$(154) million, versus $324 million

Revenue increased 3% in the second quarter and 6% year to date. Product sales increased, while year-to-date service revenues declined. Segment operating margin improved to 8.7% from 8.0% in the quarter and to 9.1% from 8.7% year to date, reflecting performance improvements across most segments.

Cash and cash equivalents were $2.044 billion at June 30, 2010, down from $3.275 billion at December 31, 2009.
Total debt carrying value was approximately $4.2 billion, including $760 million of current debt and $3.438 billion of long-term debt. The company reported no balance outstanding under its $2 billion credit agreement.
Total assets were $29.694 billion and shareholders’ equity was $12.903 billion at June 30, 2010.
Capital expenditures were $238 million for the first six months. Dividends paid were $270 million and cash share repurchases were $855 million.
Backlog was $66.012 billion at June 30, 2010, compared with $69.186 billion at December 31, 2009, including $35.992 billion funded and $30.020 billion unfunded.

Material changes versus the prior comparable period

Revenue growth was led by Aerospace Systems, Shipbuilding and Technical Services. Information Systems revenue declined modestly.
Aerospace Systems operating income increased 30% in the quarter and 23% year to date, with margin rising to 11.8% and 11.4%, respectively.
Information Systems operating income increased 26% in the quarter and 11% year to date despite lower revenue, aided by performance improvements, including risk retirement on the NYCWiN program.
Shipbuilding recorded a $113 million pre-tax charge related to the planned wind-down of shipbuilding work at Avondale, Louisiana. The segment reported a $16 million operating loss in the quarter, compared with $14 million of income in the prior-year quarter.
The company recognized approximately $296 million of net tax benefits from the IRS and Joint Committee settlement of 2004–2006 tax returns. Management said this settlement and the shipyard charge increased 2010 diluted EPS from continuing operations by approximately $0.73 on a net basis.
Operating cash flow declined substantially because of collection timing, higher tax payments and increased employee-benefit funding, including $330 million of voluntary pension contributions.
The company repurchased 14.8 million shares for approximately $876 million during the first six months and authorized a new $2 billion repurchase program. Only $48 million remained under the prior authorization at quarter-end.
The quarterly dividend increased from $0.43 to $0.47 per share.
The Advisory Services Division, sold in December 2009, remained classified as discontinued operations. A further $7 million after-tax gain was recorded in 2010 from a purchase-price adjustment.

Guidance, outlook, risks and unusual items

Management stated that there were no material changes to the products, industry outlook or business trends described in the 2009 Form 10-K. For 2010, the company expects operating cash generation, supplemented if necessary by credit facilities and capital-market borrowings, to fund debt service, capital expenditures, pension contributions, share repurchases and dividends.

The company expects defense spending to remain subject to federal deficit pressures, program reductions and Department of Defense efforts to reduce overhead, although modernization, procurement, maintenance, ISR and cyber capabilities remain priorities.
Management is evaluating strategic alternatives for Shipbuilding, including a possible spin-off. No transaction is assured, and completion could depend on regulatory approvals, third-party consents, operating performance and tax opinions or rulings.
Avondale consolidation is expected to generate additional restructuring, severance, relocation and asset write-down costs. The filing does not provide a clear total estimate for these future costs.
Shipbuilding continues to address quality issues involving LPD-class ship pipe welds and propulsion-system bearings. Management does not currently expect a material adverse effect, but additional corrective costs and contract performance risks remain.
Environmental remediation costs were estimated at $265 million to $625 million, with $313 million accrued at June 30, 2010. The company stated that future expenditures are not expected to be materially adverse.
Outstanding financial support instruments included $424 million of standby letters of credit, $126 million of bank guarantees and $452 million of surety bonds. The company also guaranteed specified Shipbuilding debt obligations.
Pending matters include government investigations, False Claims Act litigation involving converted Coast Guard patrol boats, ERISA litigation, environmental claims and Hurricane Katrina insurance disputes. Management stated that these matters are not expected to have a material adverse effect, but outcomes remain uncertain.
The filing identifies potential timing differences between required pension funding and recoverable CAS pension costs. A proposed CAS rule could affect contract costs beginning in 2011, subject to final rulemaking.

Important facts for investors to verify

Whether Shipbuilding’s Avondale closure, LPD 23 and 25 forward losses, quality issues and potential restructuring costs exceed current estimates.
Whether the Shipbuilding strategic review produces a spin-off or other transaction and the associated tax, regulatory and execution consequences.
Whether working-capital requirements, pension contributions and tax payments continue to suppress operating and free cash flow.
The sustainability of earnings excluding the $296 million tax benefit and other unusual items.
The conversion of the $66.0 billion backlog into funded revenue and cash, particularly the $30.0 billion unfunded portion.
Potential exposure from government claims, litigation, environmental remediation, insurance disputes and contract-performance contingencies.
The impact of defense-budget reductions and program changes on major platforms and service contracts.