Northrop Grumman Corporation — FY2009 Form 10-K
Reporting period: Fiscal year ended December 31, 2009. The filing also presents unaudited quarterly data, including fourth-quarter 2009 results. Northrop Grumman is a diversified aerospace and defense contractor serving primarily the U.S. Government through five segments: Aerospace Systems, Electronic Systems, Information Systems, Shipbuilding, and Technical Services.
Financial performance and position
| Metric | 2009 | 2008 | Change |
|---|---|---|---|
| Sales and service revenues | $33.755 billion | $32.315 billion | Up 4% |
| Operating income | $2.483 billion | $(263) million | Improved from loss |
| Operating margin | 7.4% | (0.8)% | Improved |
| Earnings from continuing operations | $1.573 billion | $(1.379) billion | Returned to profitability |
| Diluted EPS from continuing operations | $4.87 | $(4.12) | Improved |
| Net earnings | $1.686 billion | $(1.262) billion | Improved |
| Net cash from operating activities | $2.133 billion | $3.211 billion | Down $1.078 billion |
| Free cash flow | $1.411 billion | $2.420 billion | Down $1.009 billion |
| Cash and cash equivalents | $3.275 billion | $1.504 billion | Up $1.771 billion |
| Long-term debt, including current portion | $4.282 billion | $3.920 billion | Up $362 million |
Annual net margin was approximately 5.0%; continuing-operations net margin was approximately 4.7%. Product sales increased 7% to $20.914 billion, while service revenues increased 1% to $12.841 billion. Higher pension costs pressured product and service cost ratios.
- U.S. Government revenue was approximately $31.0 billion, or 91.8% of total revenue; direct foreign sales were approximately 4.9%.
- Backlog was $69.2 billion at year-end versus $76.4 billion in 2008. Approximately 37% was expected to convert to 2010 sales.
- Approximately 67% of 2009 revenue came from flexibly priced contracts and 33% from firm fixed-price contracts.
- Total assets were $30.252 billion and shareholders’ equity was $12.687 billion at December 31, 2009.
- The company had an undrawn $2 billion revolving credit facility maturing August 10, 2012 and was in compliance with its covenants.
Fourth-quarter 2009 results
| Metric | Q4 2009 | Q4 2008 |
|---|---|---|
| Sales and service revenues | $8.925 billion | $8.775 billion |
| Operating income | $631 million | $(2.191) billion |
| Earnings from continuing operations | $375 million | $(2.561) billion |
| Diluted EPS from continuing operations | $1.19 | $(7.83) |
| Net earnings | $413 million | $(2.533) billion |
The Q4 2008 comparison was heavily affected by a $3.1 billion non-cash goodwill impairment charge, including $2.49 billion at Shipbuilding and $570 million at Aerospace Systems.
Material changes versus the prior comparable period
- Revenue increased $1.440 billion, led by Aerospace Systems, Electronic Systems, Information Systems, and Technical Services.
- Operating performance recovered sharply, primarily because 2008 included the goodwill impairment charge and major Shipbuilding contract charges. 2009 Shipbuilding operating income was $299 million versus a $2.307 billion loss in 2008.
- Aerospace Systems operating income rose to $1.071 billion from $416 million, while Electronic Systems increased to $969 million from $947 million.
- Information Systems operating income was broadly stable at $631 million, despite $37 million of non-recurring costs associated with the sale of the Advisory Services Division.
- Operating cash flow and free cash flow declined because of $858 million of pension contributions, including $800 million of voluntary pre-funding, and $1.3 billion of income taxes paid, including $508 million related to the ASD sale.
- The company issued $850 million of unsecured senior notes at fixed rates of 3.70% and 5.05%, used partly to retire $400 million of 8% senior debt.
- Northrop Grumman repurchased 23.1 million shares for approximately $1.1 billion and increased its remaining repurchase authorization to $924 million.
- The company sold its Advisory Services Division for $1.65 billion in cash and recorded a $15 million after-tax gain. ASD generated $1.536 billion of 2009 discontinued-operation revenue and $113 million of earnings from discontinued operations, including the divestiture gain.
Guidance, outlook, risks, and unusual items
- Management projected 2010 sales of approximately $34.0 billion to $34.6 billion, supported by year-end backlog.
- Management expected 2010 cash generation, cash on hand, and available credit to fund debt service, capital expenditures, taxes, pension and post-retirement obligations, dividends, and continued share repurchases.
- Expected 2010 benefit-plan funding included approximately $57 million of required pension contributions, $171 million for other post-retirement plans, and an additional voluntary pension contribution of approximately $300 million.
- Major risks include dependence on the U.S. Government, congressional appropriations and changing defense priorities, contract termination rights, cost growth on fixed-price contracts, bid protests, supplier and subcontractor performance, and government audits or investigations.
- Pension expense increased materially because of losses on plan assets in 2008. The pension and post-retirement benefit liability was $4.874 billion at year-end 2009.
- Environmental remediation costs were estimated at $239 million to $483 million, with $283 million accrued. The company stated it did not expect future remediation spending to have a material adverse effect, but estimates may change.
- Shipbuilding identified pipe-weld quality issues and bearing wear and lubrication-system debris affecting LPD 17-class ships. Management did not believe these matters would have a material adverse financial effect at year-end, but corrective actions and reviews were ongoing.
- Material contingencies include U.S. Government investigations and claims, environmental litigation, pension-related litigation, and disputes with insurers over Hurricane Katrina losses. The filing states that outcomes are uncertain but generally not expected to be materially adverse.
- The company had $20.485 billion of contractual obligations, including $4.258 billion of principal debt, $3.535 billion of debt interest, $9.520 billion of purchase obligations, and $1.700 billion of operating leases.
Investor verification points
- Verify the sustainability of the 2009 operating recovery after excluding the unusually large 2008 goodwill impairment and other Shipbuilding charges.
- Reconcile reported operating cash flow and free cash flow to pension pre-funding, ASD-related taxes, working-capital movements, and discontinued operations.
- Assess backlog quality, particularly the funded portion of $33.876 billion versus unfunded backlog of $35.310 billion, and the effect of the $5.8 billion reduction related to program termination and restructuring.
- Monitor U.S. defense appropriations, program cancellations or reductions, and the company’s 91.8% U.S. Government revenue concentration.
- Review fixed-price contract exposure, Shipbuilding quality matters, and potential cost growth or rework charges.
- Evaluate pension funding requirements, actuarial assumptions, and the sensitivity of expense and liabilities to discount rates and asset returns.
- Review the status and potential exposure of tax, environmental, government-contract, insurance, and other litigation matters.
- Confirm the effect of the ASD divestiture on future revenue mix, operating margins, backlog, and cash generation.