Document/ExhibitDescriptionPagesSize 1: 10-Q Quarterly Report HTML 1.30M
2: EX-10.1 Consultant Agreement Between Northrop Grumman HTML 81K
Systems Corporation and Wesley G.
3: EX-15 Letter From Independent Registered Public HTML 24K
Accounting Firm
4: EX-31.1 Certification of Kathy J. Warden HTML 29K
5: EX-31.2 Certification of Kenneth L. Bedingfield HTML 29K
6: EX-32.1 Certification of Kathy J. Warden HTML 24K
7: EX-32.2 Certification of Kenneth L. Bedingfield HTML 24K
60: R1 Document and Entity Information Document HTML 75K
36: R2 Condensed Consolidated Statements of Earnings and HTML 90K
Comprehensive Income (Unaudited)
19: R3 Condensed Consolidated Statements of Financial HTML 118K
Position (Unaudited)
50: R4 Condensed Consolidated Statements of Financial HTML 46K
Position (Unaudited) (Parentheticals)
62: R5 Condensed Consolidated Statements of Cash Flows HTML 100K
(Unaudited)
37: R6 Condensed Consolidated Statements of Changes in HTML 65K
Shareholders' Equity (Unaudited)
20: R7 Basis of Presentation (Unaudited) HTML 90K
52: R8 Business Acquisition (Unaudited) Business HTML 77K
Acquisition (Unaudited)
58: R9 Earnings Per Share, Share Repurchases and HTML 50K
Dividends on Common Stock (Unaudited)
25: R10 Income Taxes (Unaudited) HTML 40K
32: R11 Fair Value of Financial Instruments (Unaudited) HTML 60K
68: R12 Investigations, Claims and Litigation (Unaudited) HTML 43K
42: R13 Commitments and Contingencies (Unaudited) HTML 44K
24: R14 Retirement Benefits (Unaudited) HTML 80K
31: R15 Stock Compensation Plans and Other Compensation HTML 39K
Arrangements (Unaudited)
67: R16 Leases (Unaudited) (Notes) HTML 69K
41: R17 Segment Information (Unaudited) HTML 439K
26: R18 Summary of Significant Accounting Policies HTML 90K
(Policies)
30: R19 Basis of Presentation (Unaudited) (Tables) HTML 53K
56: R20 Business Acquisition (Unaudited) Business HTML 71K
Acquisition (Unaudited) (Tables)
47: R21 Earnings Per Share, Share Repurchases and HTML 41K
Dividends on Common Stock (Unaudited) (Tables)
14: R22 Income Taxes (Unaudited) (Tables) HTML 33K
34: R23 Fair Value of Financial Instruments (Unaudited) HTML 51K
(Tables)
55: R24 Commitments and Contingencies (Unaudited) (Tables) HTML 34K
46: R25 Retirement Benefits (Unaudited) (Tables) HTML 84K
13: R26 Stock Compensation Plans and Other Compensation HTML 39K
Arrangements (Unaudited) (Tables)
33: R27 Leases (Unaudited) Leases (Tables) HTML 74K
54: R28 Segment Information (Unaudited) (Tables) HTML 444K
48: R29 Basis of Presentation (Unaudited) (Details 1) HTML 40K
44: R30 Basis of Presentation (Unaudited) (Details 2) HTML 30K
69: R31 Basis of Presentation (Unaudited) (Details 3) HTML 42K
28: R32 Business Acquisition (Unaudited) (Details 1) HTML 101K
22: R33 Business Acquisition (Unaudited) (Details 2) HTML 32K
45: R34 Business Acquisition (Unaudited) (Details 3) HTML 41K
70: R35 Earnings Per Share, Share Repurchases and HTML 51K
Dividends on Common Stock (Unaudited) (Details 1)
29: R36 Earnings Per Share, Share Repurchases and HTML 43K
Dividends on Common Stock (Unaudited) (Details 2)
23: R37 Income Taxes (Unaudited) (Details 1) HTML 36K
43: R38 Income Taxes (Unaudited) (Details 2) HTML 23K
71: R39 Fair Value of Financial Instruments (Unaudited) HTML 39K
(Details 1)
51: R40 Fair Value of Financial Instruments (Unaudited) HTML 34K
(Details 2)
57: R41 Fair Value of Financial Instruments (Unaudited) HTML 31K
Fair Value of Financial Instruments (Unaudited)
(Details 3)
38: R42 Investigations, Claims and Litigation (Unaudited) HTML 80K
(Details)
17: R43 Commitments and Contingencies (Unaudited) HTML 80K
(Details)
53: R44 Retirement Benefits (Unaudited) (Details) HTML 51K
59: R45 Stock Compensation Plans and Other Compensation HTML 45K
Arrangements (Unaudited) (Details)
39: R46 Leases (Unaudited) Total Lease Cost (Details 1) HTML 30K
18: R47 Leases (Unaudited) Lease Balance Sheet (Details 2) HTML 29K
49: R48 Leases (Unaudited) Lease Other Supplemental HTML 31K
Information (Details 3)
61: R49 Leases (Unaudited) Lease Maturities (Details 4) HTML 48K
65: R50 Leases (Unaudited) Future Minimum Lease Payments HTML 45K
Under 840 (Details 5)
40: R51 Segment Information (Unaudited) (Details 1) HTML 51K
21: R52 Segment Information (Unaudited) (Details 2) HTML 76K
27: R53 Segment Information (Unaudited) (Details 3) HTML 66K
64: R54 Segment Information (Unaudited) (Details 4) HTML 75K
63: XML IDEA XML File -- Filing Summary XML 128K
35: XML XBRL Instance -- noc-9302019x10q_htm XML 2.99M
15: EXCEL IDEA Workbook of Financial Reports XLSX 81K
9: EX-101.CAL XBRL Calculations -- noc-20190930_cal XML 202K
10: EX-101.DEF XBRL Definitions -- noc-20190930_def XML 530K
11: EX-101.LAB XBRL Labels -- noc-20190930_lab XML 1.48M
12: EX-101.PRE XBRL Presentations -- noc-20190930_pre XML 850K
8: EX-101.SCH XBRL Schema -- noc-20190930 XSD 143K
16: JSON XBRL Instance as JSON Data -- MetaLinks 322± 485K
66: ZIP XBRL Zipped Folder -- 0001133421-19-000055-xbrl Zip 284K
(Exact name of registrant as specified in its charter)
iDelaware
i80-0640649
(State
or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
i2980 Fairview Park Drive
iFalls
Church,
iVirginia
i22042
(Address of principal
executive offices)
(Zip Code)
(i703) i280-2900
(Registrant’s telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
iCommon Stock
iNOC
iNew
York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
iYes
☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
iYes ☒ No ☐
Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act:
iLarge Accelerated Filer ☒ Accelerated Filer ☐
Non-accelerated Filer ☐ Smaller
Reporting Company i☐
Emerging Growth Company i☐
If an emerging growth company, indicate by check mark if the
registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes i☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s
classes of common stock, as of the latest practicable date.
As of October 21, 2019, i168,532,761 shares of common stock were outstanding.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. iBASIS
OF PRESENTATION
Principles of Consolidation and Reporting
i
These unaudited condensed consolidated financial statements (the “financial statements”) include the accounts of Northrop Grumman Corporation and its subsidiaries and joint ventures or other investments for which we consolidate the financial results (herein referred to as “Northrop Grumman,” the “company,”“we,”“us,” or “our”). Material intercompany accounts, transactions and profits are eliminated in consolidation.
Investments in equity securities and joint ventures where the company has significant influence, but not control, are accounted for using the equity method.
On June 6, 2018 (the “Merger date”), the company completed its previously announced acquisition of Orbital ATK, Inc. (“Orbital ATK”) (the “Merger”). On the Merger date, Orbital ATK became a wholly-owned subsidiary of the company and its name was changed to Northrop Grumman Innovation Systems, Inc., which we established as a new, fourth business
sector (“Innovation Systems”). The operating results of Innovation Systems subsequent to the Merger date have been included in the company’s unaudited condensed consolidated results of operations. See Note 2 for further information regarding the Merger.
At September 30, 2019, the company was aligned in four operating sectors: Aerospace Systems, Innovation Systems, Mission Systems and Technology Services. In September 2019, the company announced changes effective January
1, 2020, which are intended to better align the company’s broad portfolio to serve its customers’ needs. There will be four sectors: Aeronautics Systems, Defense Systems, Mission Systems and Space Systems. This realignment is not reflected in any of the accompanying financial information.
i
These financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP” or “FAS”) and in accordance with the rules of the Securities and
Exchange Commission (SEC) for interim reporting. The financial statements include adjustments of a normal recurring nature considered necessary by management for a fair presentation of the company’s unaudited condensed consolidated financial position, results of operations and cash flows.
The results reported in these financial statements are not necessarily indicative of results that may be expected for the entire year. These financial statements should be read in conjunction with the information contained in the company’s 2018 Annual Report on Form 10-K.
iThe
quarterly information is labeled using a calendar convention; that is, first quarter is consistently labeled as ending on March 31, second quarter as ending on June 30 and third quarter as ending on September 30. It is the company’s long-standing practice to establish actual interim closing dates using a “fiscal” calendar, in which we close our books on a Friday near these quarter-end dates in order to normalize the potentially disruptive effects of quarterly closings on business processes. This practice is only used at interim periods within a reporting year.
As previously announced, effective January 1, 2019, we adopted Accounting Standards Codification (ASC) Topic 842, Leases, using the optional transition method to apply the
standard through a cumulative effect adjustment in the period of adoption. The adoption of this standard is reflected in the amounts and disclosures set forth in this Form 10-Q.
Accounting Estimates
i
Preparation of the financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements, as well as the reported amounts of sales and expenses during the reporting period. Estimates have been prepared using the most current and best available information; however, actual results could differ materially
from those estimates.
Revenue Recognition
The majority of our sales are derived from long-term contracts with the U.S. government for the production of goods, the provision of services, or a combination of both. The company classifies sales as product or service based on the predominant attributes of each performance obligation.
The company recognizes revenue for each separately identifiable performance obligation in a contract representing a promise to transfer a distinct good or
service to a customer. In most cases, goods and services provided under the company’s contracts are accounted for as single performance obligations due to the complex and integrated nature of our products and services. These contracts generally require significant integration of a group of goods and/or services to deliver a combined output. In some contracts, the company provides multiple distinct goods or services
to a customer, most commonly when a contract covers multiple phases of the product lifecycle (e.g., development, production, sustainment, etc.). In those cases, the company accounts for the distinct contract deliverables as separate performance obligations and allocates the transaction price to each performance obligation based on its relative standalone selling price, which is generally estimated using a cost plus a reasonable margin approach. Warranties are provided on certain
contracts, but do not typically provide for services beyond standard assurances and are therefore not considered to be separate performance obligations. Assets recognized from the costs to obtain or fulfill a contract are not material.
Contracts are often modified for changes in contract specifications or requirements, which may result in scope and/or price changes. Most of the company’s contract
modifications are for goods or services that are not distinct in the context of the contract and are therefore accounted for as part of the original performance obligation through a cumulative estimate-at-completion (EAC) adjustment.
The company recognizes revenue as control is transferred to the customer, either over time or at a point in time. In general, our U.S. government contracts contain termination for convenience and/or other clauses that generally provide the customer rights to goods produced and/or in-process. Similarly, our non-U.S. government contracts generally
contain contractual termination clauses or entitle the company to payment for work performed to date for goods and services that do not have an alternative use. As control is effectively transferred while we perform on our contracts, we generally recognize revenue over time using the cost-to-cost method (cost incurred relative to total cost estimated at completion) as the company believes this represents the most appropriate measurement towards satisfaction of its performance obligations. Revenue for contracts in which the control of goods produced does not transfer until delivery to the customer is recognized at a
point in time (i.e., typically upon delivery).
Use of the cost-to-cost method requires us to make reasonably dependable estimates regarding the revenue and cost associated with the design, manufacture and delivery of our products and services. The company estimates profit on these contracts
as the difference between total estimated sales and total estimated cost at completion and recognizes that profit as costs are incurred. Significant judgment is used to estimate total sales and cost at completion.
Contract sales may include estimates of variable consideration, including cost or performance incentives (such as award and incentive fees), contract claims and requests for equitable adjustment (REAs). Variable consideration is included in total estimated sales to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. We estimate variable consideration as the most likely amount to which
we expect to be entitled.
We recognize changes in estimated contract sales or costs and the resulting changes in contract profit on a cumulative basis. Cumulative EAC adjustments represent the cumulative effect of the changes on current and prior periods; sales and operating margins in future periods are recognized as if the revised estimates had been used since contract inception. If it is determined that a loss is expected to result on an individual performance obligation, the entire amount of the estimable future loss, including an allocation of general and administrative (G&A) costs, is charged against income in the period the loss is identified.
Each loss provision is first offset against costs included in Unbilled receivables or Inventoried costs; remaining amounts are reflected in Other current liabilities.
i
The following table presents the effect of aggregate net EAC adjustments:
Three
Months Ended September 30
Nine Months Ended September 30
$ in millions, except per share data
2019
2018
2019
2018
Revenue
$
i142
$
i149
$
i462
$
i438
Operating
income
i125
i149
i421
i408
Net
earnings(1)
i99
i117
i333
i322
Diluted
earnings per share(1)
i0.58
i0.67
i1.96
i1.84
/
(1)
Based
on a 21 percent statutory tax rate.
EAC adjustments on a single performance obligation can have a material effect on the company’s financial statements. When such adjustments occur, we generally disclose the nature, underlying conditions and financial impact of the adjustments. No such adjustments were material to the financial statements during the three months ended September 30, 2019 and 2018.
Backlog represents the future sales we expect to recognize on firm orders received by the company and is equivalent to the company’s remaining performance obligations at the end of each period. It comprises both funded backlog (firm orders for which funding is authorized and appropriated) and unfunded backlog. Unexercised contract options and indefinite delivery indefinite quantity (IDIQ) contracts
are not included in backlog until the time the option or IDIQ task order is exercised or awarded.
Company backlog as of September 30, 2019 was $i65.0 billion. iWe
expect to recognize approximately 40 percent and 65 percent of our September 30, 2019 backlog as revenue over the next 12 and 24 months, respectively, with the remainder to be recognized thereafter.
For each of the company’s contracts, the timing of revenue recognition, customer billings, and cash collections results in a net contract asset or liability at the end of each reporting period. Fixed-price contracts
are typically billed to the customer either using progress payments, whereby amounts are billed monthly as costs are incurred or work is completed, or performance based payments, which are based upon the achievement of specific, measurable events or accomplishments defined and valued at contract inception. Cost-type contracts are typically billed to the customer on a monthly or semi-monthly basis.
Contract assets are equivalent to and reflected as Unbilled receivables in the unaudited condensed consolidated statements of financial position and are primarily related to long-term contracts
where revenue recognized under the cost-to-cost method exceeds amounts billed to customers. Unbilled receivables are classified as current assets and, in accordance with industry practice, include amounts that may be billed and collected beyond one year due to the long-cycle nature of many of our contracts. Accumulated contract costs in unbilled receivables include costs such as direct production costs, factory and engineering overhead, production tooling costs, and allowable G&A. Unbilled receivables also include certain estimates of variable consideration described above. These contract assets are not considered a significant financing component of the
company’s contracts as the payment terms are intended to protect the customer in the event the company does not perform on its obligations under the contract.
Contract liabilities are equivalent to and reflected as Advance payments and billings in excess of costs incurred in the unaudited condensed consolidated statements of financial position. Certain customers make advance payments prior to the company’s satisfaction of its obligations
on the contract. These amounts are recorded as contract liabilities until such obligations are satisfied, either over time as costs are incurred or at a point in time when deliveries are made. Contract liabilities are not a significant financing component as they are generally utilized to pay for contract costs within a one-year period or are used to ensure the customer meets contractual requirements.
The amount of revenue recognized for the three and nine months ended September 30,
2019 that was included in the December 31, 2018contract liability balance was $i209 million and $i1.2
billion, respectively. The amount of revenue recognized for the three and nine months ended September 30, 2018 that was included in the December 31, 2017contract liability balance was $i168
million and $i1.2 billion, respectively.
Disaggregation of Revenue
See Note 11 for information regarding the company’s sales by customer type, contract type and geographic
region for each of our segments. We believe those categories best depict how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors.
Accumulated Other Comprehensive Loss
i
The components of accumulated other comprehensive loss are as follows:
Unamortized prior service credit, net of tax expense of $21 for 2019 and $32 for 2018
$
i63
$
i98
Cumulative
translation adjustment
(i148
)
(i144
)
Other,
net
(i2
)
(i6
)
Total
accumulated other comprehensive loss
$
(i87
)
$
(i52
)
/
Reclassifications
from accumulated other comprehensive loss to net earnings related to the amortization of prior service credit were $i12 million and $i35
million, net of taxes, for the three and nine months ended September 30, 2019, respectively and were $i15 million and $i45
million, net of taxes, for the three and nine months ended
September 30, 2018, respectively. The reclassifications are included in the computation of net periodic pension cost (benefit). See Note 8 for further information.
Reclassifications
from accumulated other comprehensive loss to net earnings relating to cumulative translation adjustments and effective cash flow hedges were not material for the three and nine months ended September 30, 2019 and 2018.
Leases
i
The company
leases certain buildings, land and equipment. Under ASC 842, at contract inception we determine whether the contract is or contains a lease and whether the lease should be classified as an operating or a finance lease. Operating leases are included in Operating lease right-of-use assets, Other current liabilities, and Operating lease liabilities in our unaudited condensed consolidated statements of financial position.
The company recognizes operating lease right-of-use assets and operating lease liabilities based on the present value of the future minimum lease payments over the lease term at commencement date. We use our incremental borrowing rate based on
the information available at commencement date to determine the present value of future payments and the appropriate lease classification. Many of our leases include renewal options aligned with our contract terms. We define the initial lease term to include renewal options determined to be reasonably certain. In our adoption of ASC 842, we elected not to recognize a right-of-use asset and a lease liability for leases with an initial term of 12 months or less; we recognize lease expense for these leases on a straight-line basis over the lease term. We elected the practical expedient to not separate lease components from nonlease components and applied that practical expedient to all material classes of leased assets.
Many of the company’s real property
lease agreements contain incentives for tenant improvements, rent holidays or rent escalation clauses. For tenant improvement incentives, if the incentive is determined to be a leasehold improvement owned by the lessee, the company generally records a deferred rent liability and amortizes the deferred rent over the term of the lease as a reduction to rent expense. For rent holidays and rent escalation clauses during the lease term, the company records rental expense on a straight-line basis over the term of the lease. For these lease incentives, the company uses the date of initial possession as the commencement date, which is generally when the
company is given the right of access to the space and begins to make improvements in preparation for intended use.
Finance leases are not material to our unaudited condensed consolidated financial statements and the company is not a lessor in any material arrangements. We do not have any material restrictions or covenants in our lease agreements, sale-leaseback transactions, land easements or residual value guarantees.
Related Party Transactions
The company had no material related party transactions in any period presented.
Accounting Standards Updates
i
On
February 25, 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). ASC Topic 842 supersedes existing lease guidance, including ASC 840 - Leases. Among other things, ASU 2016-02 requires recognition of a right-of-use asset and liability for future lease payments for contracts that meet the definition of a lease and requires disclosure of certain information about leasing arrangements. On July 30, 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which, among other things, allows companies to elect an optional transition method to apply the new lease standard through a cumulative-effect adjustment in the period
of adoption.
We adopted the standard on January 1, 2019 using the optional transition method and, as a result, did not recast prior period unaudited condensed consolidated comparative financial statements. All prior period amounts and disclosures are presented under ASC 840. We elected the package of practical expedients, which, among other things, allows us to carry forward our prior lease classifications under ASC 840. We did not elect to adopt the hindsight practical expedient and are therefore maintaining the lease terms we previously determined under ASC 840. Adoption of the new standard resulted in the recording of additional lease assets and lease liabilities on the unaudited condensed consolidated statements of financial position with no cumulative impact to retained earnings and did not have a material impact on our results of operations or cash flows.
Other
accounting standards updates adopted and/or issued, but not effective until after September 30, 2019, are not expected to have a material effect on the company’s unaudited condensed consolidated financial position, annual results of operations and/or cash flows.
On June 6, 2018, the company completed its previously announced acquisition of Orbital ATK, by acquiring all of the outstanding shares of Orbital ATK for a purchase price of $i7.7
billionin cash. On the Merger date, Orbital ATK became a wholly-owned subsidiary of the company and its name was changed to Northrop Grumman Innovation Systems, Inc. We established Innovation Systems as a new, fourth business sector. Its main products include precision munitions and armaments; tactical missiles and subsystems; ammunition; launch vehicles; space and strategic propulsion systems; aerospace structures; space exploration products; and national security and commercial satellite systems and related components/services. The acquisition was financed with proceeds from the company’s debt financing completed in October 2017 and cash on hand. We believe this acquisition will enable us to
broaden our capabilities and offerings, provide additional innovative solutions to meet our customers’ emerging requirements, create value for shareholders and provide expanded opportunities for our combined employees.
Purchase Price Allocation
The acquisition was accounted for as a purchase business combination. As such, the company recorded the assets acquired and liabilities assumed at fair value, with the excess of the purchase price over the fair value of assets acquired and liabilities assumed recorded as goodwill. Determining the fair value of assets acquired and liabilities assumed requires significant judgment, including the amount and timing of expected future cash flows, long-term growth rates and discount rates. In some cases, the
company used discounted cash flow analyses, which were based on our best estimate of future sales, earnings and cash flows after considering such factors as general market conditions, customer budgets, existing firm and future orders, changes in working capital, long term business plans and recent operating performance. Use of different estimates and judgments could yield materially different results.
During the second quarter of 2019, the company finalized its determination of the fair values of the assets acquired and liabilities assumed as of the Merger date. Based on additional information obtained during the measurement period, the company refined its initial assessment of fair value and recognized the following significant adjustments to its preliminary
purchase price allocation: Intangible assets increased $i220 million, Other current liabilities increased $i114
million, Pension and other postretirement benefit (OPB) plan liabilities increased $i56 million, Other non-current liabilities increased $i53
million, Other current assets increased $i44 million and Goodwill decreased $i36
million. These adjustments did not result in a material impact on the financial results of prior periods.
i
The Merger date fair value of the consideration transferred totaled $i7.7
billion in cash, which was comprised of the following:
$ in millions, except per share amounts
Purchase price
Shares of Orbital ATK common stock outstanding as of the Merger date
i57,562,152
Cash
consideration per share of Orbital ATK common stock
The following purchase price allocation table presents the company’s final determination of the fair values of assets acquired and liabilities assumed at the Merger date:
The
purchase price allocation resulted in the recognition of $i6.3 billion of goodwill, a majority of which was allocated to the Innovation Systems sector. The goodwill recognized is attributable to expected revenue synergies generated by the integration of Aerospace Systems, Mission Systems and Technology Services products and technologies with those of legacy Orbital ATK, synergies resulting from the consolidation or elimination of certain costs, and intangible assets that do not qualify for separate recognition, such as the assembled
workforce of Orbital ATK. None of the goodwill is expected to be deductible for tax purposes.
The
following table presents unaudited pro forma financial information prepared in accordance with Article 11 of Regulation S-X and computed as if Orbital ATK had been included in our results as of January 1, 2017:
The
unaudited supplemental pro forma financial data has been calculated after applying our accounting policies and adjusting the historical results of Orbital ATK with pro forma adjustments, net of tax, that assume the acquisition occurred on January 1, 2017. Significant pro forma adjustments include the following:
1.
The elimination of intercompany sales and costs of sales between the company and Orbital ATK of $i80
million for the nine months ended September 30, 2018.
2.
The elimination of nonrecurring transaction costs incurred by the company and Orbital ATK in connection with the Merger of $i71
million for the nine months ended September 30, 2018.
3.
The recognition of additional depreciation expense, net of removal of historical depreciation expense, of $i10
million for the nine months ended September 30, 2018 related to the step-up in fair value of acquired property, plant and equipment.
4.
The recognition of additional amortization expense, net of removal of historical amortization expense, of $i101
million for the nine months ended September 30, 2018 related to the fair value of acquired intangible assets.
5.
The elimination of Orbital ATK’s historical amortization of net actuarial losses and prior service credits and impact of the revised pension and OPB net periodic benefit cost as determined under the company’s plan assumptions of $i51
million for the nine months ended September 30, 2018.
6.
The income tax effect on the pro forma adjustments, which was calculated using the federal statutory tax rate, of $(i2)
million for the nine months ended September 30, 2018.
The unaudited pro forma financial information does not reflect the potential realization of revenue synergies or cost savings, nor does it reflect other costs relating to the integration of the two companies. This unaudited pro forma financial information should not be considered indicative of the results that would have actually occurred if the acquisition had been consummated on January 1, 2017, nor are they indicative of future results.
3. iEARNINGS
PER SHARE, SHARE REPURCHASES AND DIVIDENDS ON COMMON STOCK
Basic Earnings Per Share
i
We calculate basic earnings per share by dividing net earnings by the weighted-average number of shares of common stock outstanding during each period.
Diluted Earnings Per Share
Diluted earnings per share include the dilutive effect of awards granted to employees under stock-based compensation plans. The dilutive effect of these securities
totaled i0.8 million shares and i0.7
million shares for the three and nine months ended September 30, 2019. The dilutive effect of these securities totaled i0.8 million shares and i0.9
million shares for the three and nine months ended September 30, 2018, respectively.
Share Repurchases
On September 16, 2015, the company’s board of directors authorized a share repurchase program of up to $i4.0
billion of the company’s common stock (the “2015 Repurchase Program”). Repurchases under the 2015 Repurchase Program commenced in March 2016.
On December 4, 2018, the company’s board of directors authorized a new share repurchase program of up to an additional $i3.0
billion in share repurchases of the company’s common stock (the “2018 Repurchase Program”). By its terms, repurchases under the 2018 Repurchase Program will commence upon completion of the 2015 Repurchase Program and will expire when we have used all authorized funds for repurchases.
During the fourth quarter of 2018, the company entered into an accelerated share repurchase (ASR) agreement with Goldman Sachs & Co. LLC (Goldman Sachs) to repurchase $i1.0
billion of the company’s common stock under the
2015 Repurchase Program. Under the agreement, we made a payment of $i1.0
billion to Goldman Sachs and received an initial delivery of i3.0 million shares valued at $i800
million that were immediately canceled by the company. The remaining balance was settled on January 4, 2019 with a final delivery of i0.9 million shares from Goldman Sachs. The final average purchase price was $i260.32
per share.
As of September 30, 2019, repurchases under the 2015 Repurchase Program totaled $i3.4 billion; $i0.6
billion remained under this share repurchase authorization. By its terms, the 2015 Repurchase Program is set to expire when we have used all authorized funds for repurchases.
Share repurchases take place from time to time, subject to market conditions and management’s discretion, in the open market and in privately negotiated transactions. The company retires its common stock upon repurchase and, in the periods presented, has not made any purchases of common stock other than in connection with these publicly announced repurchase programs.
i
The
table below summarizes the company’s share repurchases to date under the authorizations described above:
In May 2019, the company increased the quarterly common stock dividend i10 percent to $i1.32
per share from the previous amount of $i1.20 per share.
In May 2018, the company increased the quarterly common stock dividend i9
percent to $i1.20 per share from the previous amount of $i1.10
per share.
In January 2018, the company increased the quarterly common stock dividend i10 percent to $i1.10
per share from the previous amount of $i1.00 per share.
4. iINCOME
TAXESi
Three Months Ended September 30
Nine
Months Ended September 30
$ in millions
2019
2018
2019
2018
Federal and foreign income tax expense
$
i122
$
i120
$
i460
$
i466
Effective
income tax rate
i11.6
%
i8.8
%
i14.8
%
i14.0
%
/
Current
Quarter
The third quarter 2019 effective tax rate increased to i11.6 percent from i8.8
percent in the third quarter of 2018.The company’s effective tax rate for the third quarter of 2019 includes benefits of $i89 million for research credits and$i17
million for foreign derived intangible income.The company’s tax rate for the third quarter of 2018 included a $i106 million benefit for research credits and manufacturing deductions and an $i84
million benefit associated with the Tax Cuts and Jobs Act (the “2017 Tax Act”).
Year to Date
The year to date 2019 effective tax rate increased to i14.8 percent from i14.0
percent in the prior year period.The company’s year to date2019 effective tax rate includes benefits of $i171 million for research credits and $i26
million for foreign derived intangible income. The company’s year to date2018 effective tax rate included a $i156 million benefit for research credits and manufacturing deductions and an $i84
million benefit associated with the 2017 Tax Act.
During the three and nine months ended September 30, 2019, we increased our unrecognized tax benefits by approximately $i294 million and $i327
million, respectively, related to our methods of accounting associated with the timing of revenue recognition and related costs, and the 2017 Tax Act. Since enactment of the 2017 Tax Act, the IRS
and U.S. Treasury Department have issued and are expected to further issue interpretive guidance that impacts taxpayers. We will continue to evaluate such guidance as it is issued.
We file
income tax returns in the U.S. federal jurisdiction and in various state and foreign jurisdictions. The Northrop Grumman 2014-2017 federal tax returns and refund claims related to its 2007-2016 federal tax returns are currently under IRS examination.In addition, legacy Orbital ATK federal tax returns for the year ended March 31, 2015, the nine-month transition period ended December 31, 2015 and calendar years 2016-2017 are currently under IRS examination.
5. iFAIR
VALUE OF FINANCIAL INSTRUMENTS
iThe company holds a portfolio of marketable securities consisting of securities to partially fund non-qualified employee benefit plans. A portion of these securities are held in common/collective trust funds and are measured at fair value using net asset value (NAV) per share as a practical expedient; and therefore are not required to be categorized in the fair value hierarchy table below. Marketable securities are included in Other non-current assets in the unaudited condensed consolidated statements of financial position.
The
company’s derivative portfolio consists primarily of commodity forward contracts and foreign currency forward contracts. The company periodically uses commodity forward contracts to hedge forecasted purchases of certain commodities. The contracts generally establish a fixed price for the underlying commodity and are designated and qualify as effective cash flow hedges of such commodity purchases. iCommodity
derivatives are valued based on prices of future exchanges and recently reported transactions in the marketplace. For foreign currency forward contracts, where model-derived valuations are appropriate, the company utilizes the income approach to determine the fair value and uses the applicable London Interbank Offered Rate (LIBOR) swap rates.
i
The following table presents the financial assets and liabilities the
company records at fair value on a recurring basis identified by the level of inputs used to determine fair value:
At
September 30, 2019, the company had commodity forward contracts outstanding that hedge forecasted commodity purchases of i4 million pounds of copper and i1
million pounds of zinc. Gains or losses on the commodity forward contracts are recognized in product and service cost as the performance obligations on related contracts are satisfied.
The derivative fair values and related unrealized gains/losses at September 30, 2019 and December 31,
2018 were not material. There were no transfers of financial instruments between the three levels of the fair value hierarchy during the nine months ended September 30, 2019.
The carrying value of cash and cash equivalents and commercial paper approximates fair value.
Long-term Debt
The estimated fair value of long-term debt was $i15.2
billion and $i14.3 billion as of September 30, 2019 and December 31, 2018, respectively. iWe
calculated the fair value of long-term debt using Level 2 inputs, based on interest rates available for debt with terms and maturities similar to the company’s existing debt arrangements. The carrying value of long-term debt was $i13.9 billion and $i14.4
billion as of September 30, 2019 and December 31, 2018, respectively. The current portion of long-term debt is recorded in Other current liabilities in the unaudited condensed consolidated statements of financial position.
On May 4, 2012, the company commenced an action, Northrop Grumman Systems Corp. v. United States, in the U.S. Court of Federal Claims. This lawsuit relates to an approximately $i875
million firm fixed-price contract awarded to the company in 2007 by the U.S. Postal Service (USPS) for the construction and delivery of flats sequencing systems (FSS) as part of the postal automation program. The FSS have been delivered. The company’s lawsuit is based on various theories of liability. The complaint seeks approximately $i63
million for unpaid portions of the contract price, and approximately $i115 million based on the company’s assertions that, through various acts and omissions over
the life of the contract, the USPS adversely affected the cost and schedule of performance and materially altered the company’s obligations under the contract. The United States responded to the company’s complaint with an answer, denying most of the company’s claims, and counterclaims seeking approximately $i410
million, less certain amounts outstanding under the contract. The principal counterclaim alleges that the company delayed its performance and caused damages to the USPS because USPS did not realize certain costs savings as early as it had expected. On April 2, 2013, the U.S. Department of Justice informed the company of a False Claims Act complaint relating to the FSS contract that was filed under seal by a relator in June 2011 in the U.S. District Court for the Eastern District of Virginia. On June
3, 2013, the United States filed a Notice informing the Court that the United States had decided not to intervene in this case. The relator alleged that the company violated the False Claims Act in a number of ways with respect to the FSS contract, alleged damage to the USPS in an amount of at least approximately $i179
millionannually, alleged that he was improperly discharged in retaliation, and sought an unspecified partial refund of the contract purchase price, penalties, attorney’s fees and other costs of suit. The relator later voluntarily dismissed his retaliation claim and reasserted it in a separate arbitration, which he also ultimately voluntarily dismissed. On September 5, 2014, the court granted the company’s motion for summary judgment and ordered the relator’s False Claims Act case be dismissed with prejudice. On February 16, 2018, both the company and the
United States filed motions to dismiss many of the claims and counterclaims referenced above, in whole or in part. The United States also filed a motion seeking to amend its answer and counterclaim, including to reduce its counterclaim to approximately$i193 million, which the court granted on June 11, 2018. On October 17, 2018, the court granted in part and
denied in part the parties’ motions to dismiss. On December 17, 2018, the court issued a Scheduling Order, proposed by the parties, providing for the parties to engage in mediation through March 1, 2019. After the government shutdown, the mediation was rescheduled for May 2019. The parties filed joint motions to suspend the deadlines for pretrial activities while the parties engage in mediation. On April 29, 2019 and June 5, 2019, the court issued Orders suspending the deadlines. Those suspensions ended on July 1, 2019, and on July 12, 2019, the court issued an Order scheduling trial to commence on February 3, 2020. Although
the ultimate outcome of these matters (“the FSS matters,” collectively), including any possible loss, cannot be predicted or reasonably estimated at this time, the company intends vigorously to pursue and defend the FSS matters.
On August 8, 2013, the company received a court-appointed expert’s report in litigation pending in the Second Federal Court of the Federal District in Brazil brought by the Brazilian Post and Telegraph Corporation (ECT), a Brazilian state-owned entity, against Solystic SAS (Solystic), a French subsidiary of the company, and itwo
of its consortium partners. In this suit, commenced on December 17, 2004, and relatively inactive for some period of time, ECT alleges the consortium breached its contract with ECT and seeks damages of approximately R$i111 million (the equivalent of approximately $i27
million as of September 30, 2019), plus interest, inflation adjustments and attorneys’ fees, as authorized by Brazilian law, which amounts could be significant over time. The original suit sought R$i89 million(the equivalent of approximately $i21
million as of September 30, 2019) in damages. In October 2013, ECT asserted an additional damage claim of R$i22 million (the equivalent of approximately $i5
million as of September 30, 2019). In its counterclaim, Solystic alleges ECT breached the contract by wrongfully refusing to accept the equipment Solystic had designed and built and seeks damages of approximately €i31 million (the equivalent of approximately $i34
million as of September 30, 2019), plus interest, inflation adjustments and attorneys’ fees, as authorized by Brazilian law. The Brazilian court retained an expert to consider certain issues pending before it. On August 8, 2013 and September 10, 2014, the company received reports from the expert, which contain some recommended findings relating to liability and the damages calculations put forth by ECT. Some of the expert’s recommended findings were favorable to the company and others were favorable to ECT. In November 2014, the parties submitted comments on the expert’s most
recent report. On June 16, 2015, the court published a decision denying the parties’ request to present oral testimony. In a decision dated November 13, 2018, the trial court ruled in ECT’s favor on one of its claims against Solystic, and awarded damages of R$i41 million (the equivalent of approximately $i10
million as of September 30, 2019) against Solystic and its consortium partners, with that amount to be adjusted for inflation and interest from November 2004 through any appeal, in accordance with the Manual of Calculations of the Federal Justice, as well as attorneys’ fees. On March 22, 2019, ECT appealed
the
trial court’s decision to the intermediate court of appeals. Solystic filed its appeal on April 11, 2019. The parties are exploring whether there is a possible path for a negotiated resolution of the dispute.
We are engaged in remediation activities relating to environmental conditions allegedly resulting from historic operations at the former United States Navy and Grumman facilities in Bethpage, New York. For over 20 years, we have worked closely with the United States Navy, the United States Environmental Protection Agency, the New York State Department of Environmental Conservation, the New York State Department of Health and other federal, state and local governmental authorities, to address legacy environmental conditions in Bethpage. We have incurred, and expect to continue to incur, as included in Note 7, substantial remediation costs related to
these environmental conditions. The remediation standards or requirements to which we are subject are being reconsidered and may change and costs may increase materially. As discussed in Note 7, the State of New York issued a Feasibility Study and Proposed Amended Record of Decision, proposing to impose additional remedial requirements. The company, along with other interested parties, has submitted comments on that proposal. The State of New York has said that, among other things, it is also evaluating potential natural resource damages. In addition, we are a party to various, and expect to become a party to additional, legal proceedings and disputes related to remediation, costs, allowability and/or alleged environmental impacts in Bethpage, including with federal and state entities, the Navy, local municipalities and water districts, and insurance carriers, as well as class action
and individual plaintiffs alleging personal injury and property damage and seeking both monetary and non-monetary relief. These Bethpage matters could result in additional costs, fines, penalties, sanctions, compensatory or other damages (including natural resource damages), determinations on allocation, allowability and coverage, and non-monetary relief. We cannot at this time predict or reasonably estimate the potential cumulative outcomes or ranges of possible liability of these aggregate Bethpage matters.
On August 12, 2016, a putative class action complaint, naming Orbital ATK and two of its then-officers as defendants, Steven Knurr, et al. v. Orbital ATK, Inc., No. 16-cv-01031 (TSE-MSN), was filed in the United States District Court for the Eastern District of Virginia. The complaint asserts claims on behalf of purchasers of Orbital ATK securities
for violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5, allegedly arising out of false and misleading statements and the failure to disclose that: (i) Orbital ATK lacked effective control over financial reporting; and (ii) as a result, it failed to record an anticipated loss on a long-term contract with the U.S. Army to manufacture and supply small caliber ammunition at the U.S. Army’s Lake City Army Ammunition Plant. On April 24, 2017 and October 10, 2017, the plaintiffs filed amended complaints naming additional defendants and asserting claims for alleged violations of additional sections of the Exchange Act and alleged false and misleading statements in Orbital ATK’s Form S-4 filed in connection with the Orbital-ATK Merger. The complaint seeks damages,
reasonable costs and expenses at trial, including counsel and expert fees, and such other relief as deemed appropriate by the Court. On June 7, 2019, the court approved the parties’ proposal to resolve the litigation for $i108 million, subject to certain terms and conditions. The company continues to negotiate with and pursue coverage litigation against
various of its insurance carriers.
The company is a party to various other investigations, lawsuits, arbitration, claims, enforcement actions and other legal proceedings, including government investigations and claims, that arise in the ordinary course of our business. The nature of legal proceedings is such that we cannot assure the outcome of any particular matter. However, based on information available to the company to date, the company does not believe that the outcome of any of these other matters pending against the company is likely to have a material adverse effect on the
company’s unaudited condensed consolidated financial position as of September 30, 2019, or its annual results of operations and/or cash flows.
7. iCOMMITMENTS AND CONTINGENCIES
U.S. Government Cost Claims
iFrom
time to time, the company is advised of claims by the U.S. government concerning certain potential disallowed costs, plus, at times, penalties and interest. When such findings are presented, the company and U.S. government representatives engage in discussions to enable the company to evaluate the merits of these claims, as well as to assess the amounts being claimed. Where appropriate, provisions are made to reflect the company’s estimated exposure for such potential disallowed costs. Such provisions are reviewed periodically using the most recent information available. The
company believes it has adequately reserved for disputed amounts that are probable and reasonably estimable, and that the outcome of any such matters would not have a material adverse effect on its unaudited condensed consolidated financial position as of September 30, 2019, or its annual results of operations and/or cash flows.
The table below summarizes management’s estimate of the range of reasonably possible future costs for environmental remediation, the amount accrued within that range, and the deferred costs expected to be recoverable through overhead charges on U.S. government contracts as of September 30, 2019 and December 31, 2018:
Estimated
remediation costs are not discounted to present value. The range of reasonably possible future costs does not take into consideration amounts expected to be recoverable through overhead charges on U.S. government contracts.
(2) As of September 30, 2019, $i163
million is recorded in Other current liabilities and $i380 million is recorded in Other non-current liabilities.
(3) As of September 30, 2019, $i128
million is deferred in Prepaid expenses and other current assets and $i295 million is deferred in Other non-current assets.
/
Although management cannot predict whether new information gained as our environmental remediation
projects progress, or as changes in facts and circumstances occur, will materially affect the estimated liability accrued, except with respect to Bethpage, we do not anticipate that future remediation expenditures associated with our currently identified projects will have a material adverse effect on the company’s unaudited condensed consolidated financial position as of September 30, 2019, or its annual results of operations and/or cash flows. With respect to Bethpage, the State of New York issued a Feasibility Study and Proposed Amended Record of Decision, proposing to impose additional remedial requirements. The company, along with other interested parties, has submitted comments on that proposal. The comments address, among other things,
the adequacy of the existing remedy, concerns with the state’s proposal, and an alternative approach. As discussed in Note 6, the remediation standards or requirements to which we are subject are being reconsidered and may change and costs may increase materially.
Financial Arrangements
In the ordinary course of business, the company uses standby letters of credit and guarantees issued by commercial banks and surety bonds issued principally by insurance companies to guarantee the performance on certain obligations. At September 30, 2019, there were $i452
million of stand-by letters of credit and guarantees and $i209 million of surety bonds outstanding.
Commercial Paper
The company maintains a commercial paper program that serves as a source of short-term financing with capacity to issue unsecured commercial paper notes up to $i2.0
billion. At September 30, 2019, there were $i399 million of outstanding short-term commercial paper borrowings at a weighted-average interest rate of i2.31
percent that have original maturities of ithree months or less from the date of issuance. The outstanding balance of commercial paper borrowings is recorded in Other current liabilities in the unaudited condensed consolidated statements of financial position.
Credit Facilities
The company maintains a five-year senior unsecured credit facility in an aggregate principal amount of $i2.0
billion (the “2018 Credit Agreement”) that matures in August 2023. At September 30, 2019, there was ino balance outstanding under this facility; however, the outstanding balance of commercial paper borrowings reduces the amount available for borrowing under the 2018 Credit Agreement. In October 2019, the company
amended the 2018 Credit Agreement to extend its maturity date by one year from August 2023 to August 2024.
In December 2016, a subsidiary of the company entered into a two-year credit facility, with two additional one-year option periods, in an aggregate principal amount of £i120 million (the equivalent of approximately $i148
million as of September 30, 2019) (the “2016 Credit Agreement”). The company exercised the second option to extend the maturity to December 2020. The 2016 Credit Agreement is guaranteed by the company. At September 30, 2019, there was £i60
million (the equivalent of approximately $i74 million) outstanding under this facility, which bears interest at a rate of LIBOR plus i1.10
percent. All of the borrowings outstanding under this facility mature less than one year from the date of issuance, but may be renewed under the terms of the facility. Based on our intent and ability to refinance the obligations on a long-term basis, a large majority of the borrowings are classified as non-current.
The cost (benefit) to the company of its retirement plans is shown in the following table:
Three
Months Ended September 30
Nine Months Ended September 30
Pension Benefits
OPB
Pension Benefits
OPB
$ in millions
2019
2018
2019
2018
2019
2018
2019
2018
Components
of net periodic benefit cost (benefit)
Service
cost
$
i92
$
i102
$
i4
$
i5
$
i276
$
i301
$
i12
$
i15
Interest
cost
i340
i316
i20
i20
i1,020
i906
i60
i58
Expected
return on plan assets
(i525
)
(i571
)
(i23
)
(i26
)
(i1,576
)
(i1,644
)
(i69
)
(i75
)
Amortization
of prior service credit
(i15
)
(i15
)
(i1
)
(i5
)
(i44
)
(i44
)
(i2
)
(i16
)
Net
periodic benefit cost (benefit)
$
(i108
)
$
(i168
)
$
i—
$
(i6
)
$
(i324
)
$
(i481
)
$
i1
$
(i18
)
/
Employer
Contributions
The company sponsors defined benefit pension and OPB plans, as well as defined contribution plans. iWe fund our defined benefit pension plans annually in a manner consistent with the Employee Retirement Income Security Act of 1974, as amended by the Pension Protection Act of 2006.
i
Contributions
made by the company to its retirement plans are as follows:
Three Months Ended September 30
Nine Months Ended September 30
$ in millions
2019
2018
2019
2018
Defined
benefit pension plans
$
i18
$
i273
$
i64
$
i318
OPB
plans
i10
i10
i34
i32
Defined
contribution plans
i98
i104
i377
i296
/
9. iSTOCK
COMPENSATION PLANS AND OTHER COMPENSATION ARRANGEMENTS
Stock Awards
i
The following table presents the number of restricted stock rights (RSRs) and restricted performance stock rights (RPSRs) granted to employees under the company’s long-term incentive stock plan and the grant date aggregate fair value of those stock awards for the periods presented:
Nine
Months Ended September 30
in millions
2019
2018
RSRs granted
i0.1
i0.1
RPSRs
granted
i0.2
i0.2
Grant
date aggregate fair value
$
i92
$
i119
/
RSRs
typically vest on the third anniversary of the grant date, while RPSRs generally vest and pay out based on the achievement of financial metrics over a three-year period.
The
following table presents the minimum and maximum aggregate payout amounts related to cash units (CUs) and cash performance units (CPUs) granted to employees in the periods presented:
Nine Months Ended September 30
$ in millions
2019
2018
Minimum
aggregate payout amount
$
i36
$
i36
Maximum
aggregate payout amount
i203
i205
/
CUs
typically vest and settle in cash on the third anniversary of the grant date, while CPUs generally vest and pay out in cash based on the achievement of financial metrics over a three-year period.
10. iLEASES
As described in Note 1, effective
January 1, 2019, we adopted ASC 842 using the optional transition method. In accordance with the optional transition method, we did not recast the prior period unaudited condensed consolidated financial statements and all prior period amounts and disclosures are presented under ASC 840. Finance leases are not material to our unaudited condensed consolidated financial statements and are therefore not included in the following disclosures.
Total Lease Cost
Total lease cost is included in Product and Service costs and G&A expenses in the unaudited condensed consolidated statement of earnings and comprehensive income and is recorded net of immaterial sublease income. iTotal
lease cost is comprised of the following:
As of September 30, 2019, we have approximately $i100 million in rental commitments for real estate leases that have not yet
commenced. These leases are expected to commence in 2020 and 2021 with lease terms of i2 to i12
years.
Rental expense for operating leases classified under ASC 840 for the three and nine months ended September 30, 2018 was $i97 million and $i270
million, respectively. These amounts are net of immaterial amounts of sublease income. iAs of December 31, 2018, future minimum lease payments under long-term non-cancelable operating leases as classified under ASC 840 were as follows:
The company is aligned in ifour
operating sectors, which also comprise our reportable segments: Aerospace Systems, Innovation Systems, Mission Systems and Technology Services.
i
The following table presents sales and operating income by segment:
Three
Months Ended September 30
Nine Months Ended September 30
$ in millions
2019
2018
2019
2018
Sales
Aerospace
Systems
$
i3,458
$
i3,282
$
i10,344
$
i9,899
Innovation
Systems
i1,584
i1,415
i4,520
i1,815
Mission
Systems
i3,029
i2,911
i9,043
i8,668
Technology
Services
i1,067
i1,040
i3,088
i3,232
Intersegment
eliminations
(i663
)
(i563
)
(i1,875
)
(i1,675
)
Total
sales
i8,475
i8,085
i25,120
i21,939
Operating
income
Aerospace Systems
i324
i376
i1,067
i1,074
Innovation
Systems
i164
i161
i500
i200
Mission
Systems
i398
i399
i1,189
i1,122
Technology
Services
i136
i111
i351
i328
Intersegment
eliminations
(i82
)
(i68
)
(i222
)
(i204
)
Total
segment operating income
i940
i979
i2,885
i2,520
Net
FAS (service)/CAS pension adjustment
i131
i176
i346
i440
Unallocated
corporate (expense) income
(i120
)
i17
(i398
)
(i123
)
Total
operating income
$
i951
$
i1,172
$
i2,833
$
i2,837
/
Net
FAS (Service)/CAS Pension Adjustment
For financial statement purposes, we account for our employee pension plans in accordance with FAS. However, the cost of these plans is charged to our contracts in accordance with the Federal Acquisition Regulation (FAR) and the related U.S. Government Cost Accounting Standards (CAS). The net FAS (service)/CAS pension adjustment reflects the difference between CAS pension expense included as cost in segment operating income and the service cost component of FAS expense included in total operating income.
Unallocated Corporate (Expense) Income
Unallocated corporate expense includes the portion of corporate costs not considered allowable or allocable under applicable
CAS or FAR, and therefore not allocated to the segments, such as a portion of management and administration, legal, environmental, compensation, retiree benefits and other corporate unallowable costs. Unallocated corporate expense also includes costs not considered part of management’s evaluation of segment operating performance, such as amortization of purchased intangible assets and the additional depreciation expense related to the step-up in fair value of property, plant and equipment acquired through business combinations.
Sales
to the U.S. government include sales from contracts for which we are the prime contractor, as well as those for which we are a subcontractor and the ultimate customer is the U.S. government. Each of the company’s segments derives substantial revenue from the U.S. government.
(2) International sales include sales from contracts for which we are the prime contractor, as well as those for which we are a subcontractor and the ultimate customer is an international customer. These sales include foreign military sales contracted through the U.S. government.
(3)
Percentages calculated based on total segment sales.
All
other is principally comprised of Europe and the Middle East.
/
(2)
Percentages calculated based on external customer sales.
-23-
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Northrop Grumman Corporation
Falls Church, Virginia
Results of Review of Interim Financial Information
We have reviewed the accompanying condensed consolidated statement of financial position of Northrop Grumman Corporation and subsidiaries (the “Company”) as of September 30, 2019, and the related condensed consolidated statements of earnings and comprehensive income and changes in shareholders’ equity for the three-month
and nine-month periods ended September 30, 2019 and 2018, and of cash flows for the nine-month periods ended September 30, 2019 and 2018, and the related notes (collectively referred to as the “interim financial information”). Based on our review, we are not aware of any material modifications that should be made to the accompanying interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.
We
have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated statement of financial position of Northrop Grumman Corporation and subsidiaries as of December 31, 2018, and the related consolidated statements of earnings and comprehensive income, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated January 30, 2019, we expressed an unqualified opinion on those consolidated financial statements, which included an explanatory paragraph regarding the Company’s change in its method of accounting for recognizing
pension and other postretirement benefit plans actuarial gains and losses and the manner in which it accounts for revenue from contracts with customers. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial position as of December 31, 2018, is fairly stated, in all material respects, in relation to the audited consolidated statement of financial position from which it has been derived.
Basis for Review Results
This interim financial information is the responsibility of the Company’s management. We are a public accounting firm registered with the PCAOB and are
required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our reviews in accordance with standards of the PCAOB. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Item 2. Management’s Discussion and Analysis of Financial Condition
and Results of Operations
OVERVIEW
Northrop Grumman Corporation (herein referred to as “Northrop Grumman,” the “company,”“we,”“us,” or “our”) is a leading global security company. We offer a broad portfolio of capabilities and technologies that enable us to deliver innovative platforms, systems and solutions for applications that range from undersea to outer space and into cyberspace. We provide capabilities in autonomous systems; cyber; command, control, communications and computers, intelligence, surveillance and reconnaissance (C4ISR); space; strike; and logistics and modernization. We participate in many high-priority defense and government programs in the United States (U.S.) and abroad. We conduct most of our business with
the U.S. government, principally the Department of Defense (DoD) and intelligence community. We also conduct business with foreign, state and local governments, as well as commercial customers.
The following discussion should be read along with the financial statements included in this Form 10-Q, as well as our 2018 Annual Report on Form 10-K, which provides additional information on our business and the environment in which we operate and our operating results.
Acquisition of Orbital ATK
On June 6, 2018 (the “Merger date”), the company completed its previously announced acquisition of Orbital ATK, Inc. (“Orbital ATK”)
(the “Merger”). On the Merger date, Orbital ATK became a wholly-owned subsidiary of the company and its name was changed to Northrop Grumman Innovation Systems, Inc., which we established as a new, fourth business sector (“Innovation Systems”). The operating results of Innovation Systems subsequent to the Merger date have been included in the company’s unaudited condensed consolidated results of operations. See Note 2 to the financial statements for further information regarding the acquisition of Orbital ATK.
In June 2018, the U.S. Federal Trade Commission (FTC) issued a Decision and Order enabling the acquisition to proceed and providing for solid rocket motors to be available
on a non-discriminatory basis under certain circumstances and processes. The company has taken and continues to take robust actions to help ensure compliance with the terms of the Order. Similarly, the Compliance Officer, appointed under the Order, and the FTC have taken and continue to take various actions to oversee compliance. In October 2019, the company received a civil investigative demand from the FTC requesting certain information relating to a potential issue of the company’s compliance with the Order in connection with a pending strategic missile competition. The company is working to respond to the request. We believe
the company has been and continues to be in full compliance with the Order, but we cannot predict any potential impact on the pending competition.
U.S. Political and Economic Environment
Since the filing of our 2018 Annual Report on Form 10-K, full year appropriations for FY 2019 were enacted for all remaining U.S. government agencies and the President proposed an FY 2020 budget requesting $750 billion for national security. The President’s budget request addresses various capabilities highlighted in the U.S. National Security Strategy, the National Defense Strategy and the Missile Defense Review. On August 2, 2019, the Bipartisan Budget Act of 2019 was enacted, increasing spending caps under the Budget Control Act (BCA) for
FY 2020 and FY 2021, the final two fiscal years covered by the BCA, and suspending the debt ceiling through July 31, 2021. FY 2020 appropriations have not been enacted and on September 27, 2019, a continuing resolution was enacted to provide funding at FY 2019 levels through November 21, 2019. We believe our capabilities, particularly in space, missiles, missile defense, hypersonics, counter-hypersonics, low observable technology and cyber will allow us to continue to profitably grow our business in support of our customers’ needs.
Selected financial highlights are presented in the table below:
Three
Months Ended September 30
%
Nine Months Ended September 30
%
$ in millions, except per share amounts
2019
2018
Change
2019
2018
Change
Sales
$
8,475
$
8,085
5
%
$
25,120
$
21,939
14
%
Operating
costs and expenses
7,524
6,913
9
%
22,287
19,102
17
%
Operating
costs and expenses as a % of sales
88.8
%
85.5
%
88.7
%
87.1
%
Operating
income
951
1,172
(19
)%
2,833
2,837
—
%
Operating
margin rate
11.2
%
14.5
%
11.3
%
12.9
%
Federal
and foreign income tax expense
122
120
2
%
460
466
(1
)%
Effective
income tax rate
11.6
%
8.8
%
14.8
%
14.0
%
Net
earnings
933
1,244
(25
)%
2,657
2,873
(8
)%
Diluted
earnings per share
$
5.49
$
7.11
(23
)%
$
15.60
$
16.40
(5
)%
Sales
Current Quarter
Third quarter 2019 sales increased$390 million, or 5 percent, due to higher sales at all four sectors.
Year to Date
Year to date 2019 sales increased$3.2 billion due to the addition of a full nine months of Innovation Systems sales as well as higher sales at Aerospace Systems and Mission Systems, partially offset by lower sales at Technology Services.
See “Segment Operating Results” below for further information by segment and “Product and Service Analysis”
for product and service detail. See Note 11 to the financial statements for information regarding the company’s sales by customer type, contract type and geographic region for each of our segments.
Operating Income and Margin Rate
Current Quarter
Third quarter 2019 operating income decreased$221 millionand operating margin rate declined to11.2 percentprimarily
due to higher unallocated corporate expense, a decrease in the net FAS (service)/CAS pension adjustment and lower segment operating income. Third quarter 2018 unallocated corporate expense included a $223 million benefit recognized for the finalization of certain prior year cost claims.
Third quarter 2019 general and administrative (G&A) costs as a percentage of sales decreased to 9.2 percent from 10.1 percent primarily due to cost management, including cost synergies realized in connection with the 2018 acquisition of Orbital ATK, and higher sales.
Year to Date
Year to date 2019 operating
income was comparable to the prior year period and reflects a $365 million increase in segment operating income, including a full nine months of operating income from Innovation Systems, offset by higher unallocated corporate expense, largely due to the previously noted 2018 cost claim benefit, and a decrease in the net FAS (service)/CAS pension adjustment. Operating margin rate declined to11.3 percent principally due to the increase in unallocated corporate expense and decrease in the net FAS (service)/CAS pension adjustment.
Year to date 2019 G&A costs as a percentage of sales decreased to 9.2 percent from 10.3
percent primarily due to cost management, including the cost synergies described above.
For information regarding product and service operating costs and expenses, see “Product and Service Analysis” below.
Federal and Foreign Income Taxes
Current Quarter
The third quarter 2019 effective tax rate increased to 11.6 percent from 8.8 percent in the third quarter of 2018. See Note 4 to the financial statements for additional information.
The year to date 2019 effective tax rate increased to 14.8 percent from 14.0 percent in the prior year period. See Note 4 to the financial statements for additional information.
Net Earnings
Current Quarter
Third quarter 2019 net earnings decreased$311 million primarily due to lower operating income as well as a $70 million decrease in FAS (non-service) pension benefit.
Year to Date
Year to date 2019 net earnings decreased$216 million primarily due to a $182 million decrease in FAS (non-service) pension benefit and a $58 million decrease in other, net, principally due to lower interest income.
Diluted Earnings Per Share
Current Quarter
Third quarter 2019 diluted earnings per share decreased$1.62,
or 23 percent, principally reflecting a 25 percentdecrease in net earnings.
Year to Date
Year to date 2019 diluted earnings per share decreased$0.80, or 5 percent, reflecting an 8 percentdecrease in net earnings, partially offset by a 3 percent reduction in weighted-average diluted shares outstanding.
SEGMENT OPERATING RESULTS
Basis
of Presentation
The company is aligned in four operating sectors, which also comprise our reportable segments: Aerospace Systems, Innovation Systems, Mission Systems and Technology Services. As described above, on the effective date of the Merger, we established Innovation Systems as a new, fourth business sector. The segment operating results below include sales and operating income for Innovation Systems subsequent to the Merger date.
We present our sectors in the following business areas, which are reported in a manner reflecting core capabilities:
Aerospace
Systems
Innovation Systems
Mission Systems
Technology Services
Autonomous Systems
Defense Systems
Advanced Capabilities
Global Logistics and
Modernization
Manned Aircraft
Flight Systems
Cyber and ISR
Global Services
Space
Space Systems
Sensors and Processing
Effective
January 1, 2019, the former Advanced Defense Services and System Modernization and Services business areas of Technology Services were merged to create the Global Services business area. This change had no impact on the segment operating results of Technology Services as a whole.
In September 2019, the company announced changes effective January 1, 2020, which are intended to better align the company’s broad portfolio to serve its customers’ needs. There will be four sectors: Aeronautics Systems, Defense Systems, Mission Systems and Space Systems. This realignment is not reflected in any of the accompanying financial information.
This
section discusses segment sales, operating income and operating margin rates. In evaluating segment operating performance, we look primarily at changes in sales and operating income. Where applicable, significant fluctuations in operating performance attributable to individual contracts or programs, or changes in a specific cost element across multiple contracts, are described in our analysis. Based on this approach and the nature of our operations, the discussion of results of operations below first focuses on our four segments before distinguishing between products and services. Changes in sales are generally described in terms of volume, while changes in margin rates are generally described in terms of performance and/or contract
mix. For purposes of this discussion, volume generally refers to increases or decreases in sales or cost from production/service activity levels and performance generally refers to non-volume related changes in profitability. Contract mix generally refers to changes in the ratio of contract type and/or lifecycle (e.g., cost-type, fixed-price, development, production, and/or sustainment).
Segment operating income, as reconciled in the table below, and segment operating margin rate (segment operating income divided by sales) are non-GAAP (accounting principles generally accepted in the United States of America) measures that reflect total earnings from our four segments, including allocated pension expense recognized under the Federal Acquisition Regulation (FAR) and the related U.S. Government Cost Accounting Standards (CAS), and excluding FAS pension expense and unallocated corporate items (certain corporate-level expenses, which are not considered allowable or allocable under applicable CAS or FAR, and costs not considered part of management’s evaluation of segment operating performance). These non-GAAP measures may be useful to investors
and other users of our financial statements as supplemental measures in evaluating the financial performance and operational trends of our sectors. These measures may not be defined and calculated by other companies in the same manner and should not be considered in isolation or as alternatives to operating results presented in accordance with GAAP.
Three
Months Ended September 30
%
Nine Months Ended September 30
%
$ in millions
2019
2018
Change
2019
2018
Change
Segment
operating income
$
940
$
979
(4
)%
$
2,885
$
2,520
14
%
Segment
operating margin rate
11.1
%
12.1
%
11.5
%
11.5
%
CAS
pension expense
223
278
(20
)%
622
741
(16
)%
Less:
FAS (service) pension expense
(92
)
(102
)
(10
)%
(276
)
(301
)
(8
)%
Net
FAS (service)/CAS pension adjustment
131
176
(26
)%
346
440
(21
)%
Intangible
asset amortization and PP&E step-up depreciation
(98
)
(97
)
1
%
(292
)
(127
)
NM
Other
unallocated corporate (expense) income
(22
)
114
NM
(106
)
4
NM
Unallocated
corporate (expense) income
(120
)
17
NM
(398
)
(123
)
NM
Operating
income
$
951
$
1,172
(19
)%
$
2,833
$
2,837
—
%
Current
Quarter
Third quarter 2019 segment operating incomedecreased$39 million, or 4 percent, primarily due to lower segment operating income at Aerospace Systems, partially offset by higher operating income at Technology Services. Segment operating margin rate decreased to 11.1 percent principally due to a lower operating margin rate at Aerospace Systems.
Year to Date
Year to date 2019 segment operating income increased$365 million, or
14 percent, primarily due to the inclusion of a full nine months of operating income from Innovation Systems as well as higher operating income at Mission Systems and Technology Services. Segment operating margin rate of 11.5 percent was comparable to the prior year period.
Net FAS (service)/CAS Pension Adjustment
The decrease in our third quarter and year to date2019 net FAS (service)/CAS pension adjustment is primarily due to lower CAS expense largely as a result of changes in actuarial assumptions as of December 31, 2018. The year
to date decrease is partially offset by increased CAS expense due to the addition of Innovation Systems.
Unallocated Corporate (Expense) Income
Current Quarter
The increase in third quarter 2019 unallocated corporate expense is primarily due to the absence in 2019 of a $223 million benefit recognized for the finalization of certain prior year cost claims, partially offset by $57 million of lower deferred state taxes and legal expenses.
Year to Date
The increase in year to date2019
unallocated corporate expense is primarily due to the absence of the 2018 cost claim benefit noted above and $165 million of higher intangible asset amortization and PP&E step-up depreciation. This increase was partially offset by $61 million of lower deferred state taxes and legal expenses as well as $29 million of non-recurring Merger-related transaction costs in 2018.
Net Estimate-at-Completion (EAC) Adjustments - We record changes in estimated contract earnings at completion (net EAC adjustments) using the cumulative catch-up method of accounting. Net EAC adjustments can have a significant effect on reported sales and operating income and the aggregate amounts are presented in the table below:
Three
Months Ended September 30
Nine Months Ended September 30
$ in millions
2019
2018
2019
2018
Favorable EAC adjustments
$
285
$
296
$
803
$
740
Unfavorable
EAC adjustments
(160
)
(147
)
(382
)
(332
)
Net EAC adjustments
$
125
$
149
$
421
$
408
Net
EAC adjustments by segment are presented in the table below:
Three Months Ended September 30
Nine Months Ended September 30
$ in millions
2019
2018
2019
2018
Aerospace
Systems
$
13
$
80
$
117
$
229
Innovation
Systems(1)
33
16
114
16
Mission Systems
46
37
134
132
Technology
Services
40
22
71
42
Eliminations
(7
)
(6
)
(15
)
(11
)
Net
EAC adjustments
$
125
$
149
$
421
$
408
(1)
Amounts
reflect EAC adjustments after the percent complete on Innovation Systems contracts was reset to zero as of the Merger date.
For purposes of the discussion in the remainder of this Segment Operating Results section, references to operating income and operating margin rate reflect segment operating income and segment operating margin rate, respectively.
AEROSPACE
SYSTEMS
Three Months Ended September 30
%
Nine Months Ended September 30
%
$ in millions
2019
2018
Change
2019
2018
Change
Sales
$
3,458
$
3,282
5
%
$
10,344
$
9,899
4
%
Operating
income
324
376
(14
)%
1,067
1,074
(1
)%
Operating
margin rate
9.4
%
11.5
%
10.3
%
10.8
%
Sales
Current Quarter
Third quarter 2019 sales increased5 percent, due to higher sales in all three business areas. Manned aircraft sales reflect higher volume on the E-2 program and a higher rate of F-35 production activity, partially offset by lower B-2 sales. Space sales reflect higher volume on Next Generation Overhead Persistent Infrared (Next Gen OPIR) programs. Autonomous Systems sales increased due to higher volume on multiple programs, including Global Hawk, partially offset by lower NATO AGS volume as that program nears completion.
Year to Date
Year to date 2019 sales increased4 percent
due in large part to higher volume on restricted programs. Manned Aircraft sales reflect a higher rate of F-35 production activity and higher volume on the E-2 program. Space sales reflect higher volume on Next Gen OPIR programs. Autonomous Systems sales include lower NATO AGS volume as that program nears completion.
Operating Income
Current Quarter
Third quarter 2019 operating income declined to $324 million and operating margin rate decreased to 9.4 percent principally due to lower net favorable EAC adjustments. This reflects the timing of favorable adjustments as well as unfavorable adjustments for the B-2 Defensive Management System Modernization program
and delays in production for certain commercial space components.
Year to date 2019 operating income decreased$7 million, or 1 percent, due to a lower operating margin rate, which more than offset higher sales. Operating margin rate decreased
to 10.3 percent from 10.8 percent, primarily due to lower net favorable EAC adjustments on Manned Aircraft and Space programs.
INNOVATION SYSTEMS
Three Months Ended September 30
%
Nine
Months Ended September 30
%
$ in millions
2019
2018
Change
2019
2018
Change
Sales
$
1,584
$
1,415
12
%
$
4,520
$
1,815
NM
Operating
income
164
161
2
%
500
200
NM
Operating
margin rate
10.4
%
11.4
%
11.1
%
11.0
%
The
sales and operating income above reflect the operating results of Innovation Systems subsequent to the Merger date.In our year to date comparative discussion below, we reference pro forma sales prepared in accordance with Article 11 of Regulation S-X and computed as if Orbital ATK had been included in our results in the year prior to the Merger, or as of January 1, 2017. Refer to Note 2 to the financial statements for additional supplemental consolidated pro forma financial information. This pro forma financial information should not be considered indicative of the results that would have actually occurred if the Merger had been consummated on January 1, 2017, nor are they indicative of future results.
Sales
Current
Quarter
Third quarter 2019 sales increased12 percentdue to higher sales in all three business areas. Space Systems sales reflect higher volume on national security satellite systems. Defense Systems sales increased primarily due to higher volume on precision munitions and armament products, as well as tactical missiles and subsystems, including the Advanced Anti-Radiation Guided Missile-Extended Range (AARGM-ER) program. Flight Systems sales reflect higher volume on military and commercial aerospace structures.
Year to Date
Year to date 2019 sales increased $403 million, or 10 percent, compared
with year to date 2018 pro forma sales of$4.1 billion due to higher sales in all three business areas. Flight Systems sales reflect higher volume on military aerospace structures and launch vehicles, principally Ground-based Midcourse Defense. Defense Systems sales increased primarily due to higher volume on tactical missiles and subsystems, including AARGM-ER, and precision munitions and armament products. Space Systems sales reflect higher volume on national security satellite systems.
Operating Income
Current Quarter
Third quarter 2019 operating income increased2 percent
primarily due to higher sales, partially offset by a lower operating margin rate of 10.4 percent. The prior period operating margin rate reflects favorable indirect rate performance and recovery of an insurance claim.
Year to Date
Year to date 2019 operating income totaled $500 million and operating margin rate was 11.1 percent. Year to date results benefited from the timing of favorable negotiations on certain commercial contracts.
MISSION
SYSTEMS
Three Months Ended September 30
%
Nine Months Ended September 30
%
$ in millions
2019
2018
Change
2019
2018
Change
Sales
$
3,029
$
2,911
4
%
$
9,043
$
8,668
4
%
Operating
income
398
399
—
%
1,189
1,122
6
%
Operating
margin rate
13.1
%
13.7
%
13.1
%
12.9
%
Sales
Current Quarter
Third quarter 2019 sales increased4 percent due to higher sales in all three business areas. Advanced Capabilities sales increased primarily due to higher volume on marine systems. Cyber and ISR sales reflect higher volume on space and restricted programs. Sensors and Processing sales increased principally due to higher volume on airborne radar and electronic warfare programs, partially offset by lower volume from targeting pods.
Year to date 2019 sales increased4 percent due to higher sales in all three business areas. Sensors and Processing sales increased principally due to higher volume on airborne radar and restricted programs, partially offset by lower volume on communications programs. Cyber and ISR sales increased principally due to higher volume on space and restricted programs. Advanced Capabilities sales increased principally due to higher volume on restricted programs and marine systems, partially offset by lower missile defense volume, primarily related to the JRDC program.
Operating Income
Current
Quarter
Third quarter 2019 operating income was comparable to the prior year and operating margin rate was 13.1 percent compared with 13.7 percent in the prior year period. The primary driver of the margin rate change was a higher level of indirect rate benefits in the third quarter of 2018. Third quarter 2019 results reflect continued strong performance at Sensors and Processing, improved performance at Advanced Capabilities, and lower performance on Cyber and ISR programs.
Year to Date
Year to date 2019 operating income increased6 percent due to higher sales and a higher operating margin rate. Operating margin
rate increased to 13.1 percentprimarily due to improved performance on Advanced Capabilities and Sensors and Processing programs, partially offset by lower performance on Cyber and ISR programs.
TECHNOLOGY SERVICES
Three
Months Ended September 30
%
Nine Months Ended September 30
%
$ in millions
2019
2018
Change
2019
2018
Change
Sales
$
1,067
$
1,040
3
%
$
3,088
$
3,232
(4
)%
Operating
income
136
111
23
%
351
328
7
%
Operating
margin rate
12.7
%
10.7
%
11.4
%
10.1
%
Sales
Current Quarter
Third quarter 2019 sales increased3 percent due to higher sales in both business areas. Global Logistics and Modernization sales increased primarily due to higher sales on electronic systems sustainment programs, partially offset by lower volume on autonomous systems support programs. Global Services sales increased principally due to higher volume on defense services programs and a civil program, partially offset by the completion of a state and local services contract in 2018.
Year to Date
Year to date 2019 sales decreased4 percent primarily due to program completions across the sector. Global Services sales declined principally due to the completions in 2018 of a state and local services contract and of certain defense services contracts, largely the JRDC program, partially offset by higher volume on a civil program. Global Logistics and Modernization sales declined primarily due to the completion in 2018 of a manned aircraft sustainment program, KC-10, partially offset by higher volume on electronic systems sustainment programs.
Operating Income
Current Quarter
Third quarter 2019 operating
income increased23 percent and operating margin rate increased to 12.7 percent due to improved performance in both business areas, including a favorable adjustment on a Global Logistics and Modernization sustainment program.
Year to Date
Year to date 2019 operating income increased7 percent and operating margin rate increased to 11.4 percent due to improved performance in both business areas, including a favorable adjustment on a Global Logistics and Modernization sustainment
program.
The following table presents product and service sales and operating costs and expenses by segment:
Three
Months Ended September 30
Nine Months Ended September 30
$ in millions
2019
2018
2019
2018
Segment Information:
Sales
Operating Costs and Expenses
Sales
Operating
Costs and Expenses
Sales
Operating Costs and Expenses
Sales
Operating Costs and Expenses
Aerospace Systems
Product
$
2,956
$
2,691
$
2,775
$
2,457
$
8,783
$
7,915
$
8,339
$
7,436
Service
502
443
507
449
1,561
1,362
1,560
1,389
Innovation
Systems
Product
1,451
1,304
1,246
1,101
4,019
3,577
1,600
1,418
Service
133
116
169
153
501
443
215
197
Mission
Systems
Product
1,887
1,625
1,818
1,582
5,631
4,826
5,349
4,624
Service
1,142
1,006
1,093
930
3,412
3,028
3,319
2,922
Technology
Services
Product
143
131
132
119
406
373
356
325
Service
924
800
908
810
2,682
2,364
2,876
2,579
Segment
Totals
Total Product
$
6,437
$
5,751
$
5,971
$
5,259
$
18,839
$
16,691
$
15,644
$
13,803
Total
Service
2,701
2,365
2,677
2,342
8,156
7,197
7,970
7,087
Intersegment
eliminations
(663
)
(581
)
(563
)
(495
)
(1,875
)
(1,653
)
(1,675
)
(1,471
)
Total
segment(1)
$
8,475
$
7,535
$
8,085
$
7,106
$
25,120
$
22,235
$
21,939
$
19,419
(1)
A
reconciliation of segment operating income to total operating income is included in “Segment Operating Results.”
Product Sales and Costs
Current Quarter
Third quarter 2019 product sales increased$466 million, or 8 percent. The increase was primarily due to higher product sales in all three business areas at Innovation Systems and higher volume on restricted, E-2 and Next Gen OPIR programs at Aerospace Systems.
Third quarter 2019 product costs increased$492 million, or 9 percent, consistent with the higher product sales described above and reflects a lower product margin at Aerospace Systems.
Year to Date
Year to date 2019 product sales increased$3.2 billion, or 20 percent. The increase was primarily due to a full nine months of product sales from Innovation Systems and higher volume on restricted, E-2 and F-35 programs at Aerospace Systems.
Year to date 2019 product costs increased$2.9 billion, or 21 percent, consistent with the higher product sales described above and reflects a lower product margin at Aerospace Systems.
Third quarter 2019 service sales increased$24 million, or 1 percent. The increase was primarily due to higher service sales at Mission Systems.
Third quarter 2019 service costs increased$23 million, or 1 percent, consistent with the higher service sales described above.
Year to Date
Year to date 2019 service sales increased$186 million, or 2 percent. The increase
was primarily driven by a full nine months of service sales from Innovation Systems and higher service sales at Mission Systems, partially offset by lower service sales at Technology Services principally due to several program completions.
Year to date 2019 service costs increased$110 million, or 2 percent, consistent with the higher service sales described above.
BACKLOG
Backlog represents the future sales we expect to recognize on firm orders received by the
company and is equivalent to the company’s remaining performance obligations at the end of each period. It comprises both funded backlog (firm orders for which funding is authorized and appropriated) and unfunded backlog. Unexercised contract options and indefinite delivery indefinite quantity (IDIQ) contracts are not included in backlog until the time the option or IDIQ task order is exercised or awarded. Backlog is converted into sales as costs are incurred or deliveries are made.
Third quarter and year to date 2019 net awards totaled $10.1 billion and $35.9 billion, respectively, and backlog increased to $65.0 billion as of September 30, 2019. Significant new awards in the third quarter include $1.4 billion to deliver an additional nine E-2D Advanced Hawkeye aircraft and related equipment to Japan, $608 million for space restricted programs, $504 million for the F-35 program, $481 million for the Triton program and $312 million for targets and countermeasures used to test the Ballistic Missile Defense System.
LIQUIDITY AND
CAPITAL RESOURCES
We endeavor to ensure the most efficient conversion of operating income into cash for deployment in our business and to maximize shareholder value through cash deployment activities. In addition to our cash position, we use various financial measures to assist in capital deployment decision-making, including cash provided by operating activities and free cash flow, a non-GAAP measure described in more detail below.
Cash and cash equivalents and cash generated from operating activities, supplemented by borrowings under credit facilities, commercial paper and/or in the capital markets, if needed, are expected to be sufficient to fund our operations for at least the next 12 months.
The table below summarizes key components of cash flow provided by operating activities:
Nine Months Ended September 30
%
$
in millions
2019
2018
Change
Net earnings
$
2,657
$
2,873
(8
)%
Non-cash
items(1)
1,041
891
17
%
Changes in assets and liabilities:
Trade
working capital
(1,392
)
(1,400
)
(1
)%
Retiree benefits
(422
)
(847
)
(50
)%
Other,
net
(51
)
(67
)
(24
)%
Net cash provided by operating activities
$
1,833
$
1,450
26
%
(1)
Includes
depreciation and amortization, non-cash lease expense, stock based compensation expense and deferred income taxes.
Year to date 2019 cash provided by operating activities increased$383 million principally due to a $250 million voluntary pre-tax pension contribution ($163 million after-tax) made in the third quarter of 2018 and improved trade working capital.
Free Cash Flow
Free cash flow, as reconciled in the table below, is a non-GAAP measure defined as net cash provided by operating activities less capital expenditures, and may not be defined and calculated by other companies
in the same manner. We use free cash flow as a key factor in our planning for, and consideration of, acquisitions, the payment of dividends and stock repurchases. This non-GAAP measure may be useful to investors and other users of our financial statements as a supplemental measure of our cash performance, but should not be considered in isolation, as a measure of residual cash flow available for discretionary purposes, or as an alternative to operating cash flows presented in accordance with GAAP.
The table below reconciles net cash provided by operating activities to free cash flow:
Nine
Months Ended September 30
%
$ in millions
2019
2018
Change
Net cash provided by operating activities
$
1,833
$
1,450
26
%
Less:
capital expenditures
(793
)
(786
)
1
%
Free cash flow
$
1,040
$
664
57
%
Year
to date 2019 free cash flow increased$376 million principally due to the increase in net cash provided by operating activities.
Investing Cash Flow
Year to date 2019 net cash used in investing activities decreased to $785 million from $8.4 billion principally due to $7.7 billion paid in 2018 for the acquisition of Orbital ATK, net of cash acquired.
Financing Cash Flow
Year
to date 2019 net cash used in financing activities decreased to $1.5 billion from $3.0 billion principally due to lower debt and credit facility repayments of $2.0 billion, partially offset by increased share repurchases and lower net borrowings on commercial paper.
Credit Facilities, Commercial Paper and Financial Arrangements - See Note 7 to the financial statements for further information on our credit facilities, commercial paper and our use of standby letters of credit and guarantees.
Share Repurchases - See Note
3 to the financial statements for further information on our share repurchase programs.
Long-term Debt - See Note 5 to the financial statements for further information.
CRITICAL
ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS
There have been no material changes to our critical accounting policies, estimates or judgments from those discussed in our 2018 Annual Report on Form 10-K.
ACCOUNTING STANDARDS UPDATES
See Note 1 to our financial statements for further information on accounting standards updates.
FORWARD-LOOKING STATEMENTS AND PROJECTIONS
This Form 10-Q and the information we are incorporating by reference contain statements that constitute “forward-looking statements” within the meaning
of the Private Securities Litigation Reform Act of 1995. Words such as “will,”“expect,”“anticipate,”“intend,”“may,”“could,”“should,”“plan,”“project,”“forecast,”“believe,”“estimate,”“outlook,”“trends,”“goals” and similar expressions generally identify these forward-looking statements. Forward-looking statements include, among other things, statements relating to our future financial condition, results of operations and/or cash flows. Forward-looking statements are based upon assumptions, expectations, plans and projections that we believe to be reasonable when made, but which may change over time. These statements are not guarantees of future performance and inherently involve a wide range of risks and uncertainties that are difficult to predict. Specific risks that could cause actual results to differ materially from those expressed
or implied in these forward-looking statements include, but are not limited to, those identified and discussed more fully in the section entitled “Risk Factors” in our 2018 Annual Report on Form 10-Kand from time to time in our other filings with the Securities and Exchange Commission (SEC). They include:
•
our dependence on the U.S. government for a substantial portion of our business
•
significant delays or reductions in appropriations
for our programs and U.S. government funding more broadly
the use of estimates when accounting for our contracts and the effect of contract cost growth and/or changes in estimated contract
revenues and costs
•
our exposure to additional risks as a result of our international business, including risks related to geopolitical and economic factors, laws and regulations
•
the improper conduct of employees, agents, subcontractors, suppliers, business partners or joint ventures in which we participate and the impact on our reputation, our ability to do business, and our financial position, results of operations and/or cash flows
•
cyber
and other security threats or disruptions faced by us, our customers or our suppliers and other partners
•
the performance and financial viability of our subcontractors and suppliers and the availability and pricing of raw materials, chemicals and components
•
changes in procurement and other laws, regulations and practices applicable to our industry, findings by the U.S. government as to our compliance with such laws and regulations, and changes in our customers’ business practices globally
•
increased competition within our markets and bid protests
•
the ability to maintain a qualified workforce
•
our ability to meet performance obligations under our contracts,
including obligations that are technologically complex, require certain manufacturing expertise or are dependent on factors not wholly within our control
•
environmental matters, including unforeseen environmental costs and government and third party claims
•
natural disasters
•
the
adequacy and availability of our insurance coverage, customer indemnifications or other liability protections
•
products and services we provide related to hazardous and high risk operations, including the production and use of such products, which subject us to various environmental, regulatory, financial, reputational and other risks
the future investment performance of plan assets, changes in actuarial assumptions associated with our pension and other postretirement benefit plans and legislative or other regulatory actions impacting our pension, postretirement and health and welfare plans
•
our ability successfully to integrate the Orbital ATK business and realize fully the anticipated benefits of the acquisition, without adverse consequences
•
our
ability to exploit or protect intellectual property rights
•
our ability to develop new products and technologies and maintain technologies, facilities, and equipment to win new competitions and meet the needs of our customers
•
changes in business conditions that could impact business investments and/or recorded goodwill or the value of other long-lived assets
•
unanticipated
changes in our tax provisions or exposure to additional tax liabilities, including qualification of the Alliant Techsystems Inc. spin-off of Vista Outdoor Inc. as a tax-free transaction
You are urged to consider the limitations on, and risks associated with, forward-looking statements and not unduly rely on the accuracy of forward-looking statements. These forward-looking statements speak only as of the date this report is first filed or, in the case of any document incorporated by reference, the date of that document. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.
CONTRACTUAL
OBLIGATIONS
There have been no material changes to our contractual obligations from those discussed in our 2018 Annual Report on Form 10-K.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes to our market risks from those discussed in our 2018 Annual Report on Form 10-K.
Item 4. Controls and Procedures
DISCLOSURE CONTROLS AND PROCEDURES
Our
principal executive officer (Chief Executive Officer and President) and principal financial officer (Corporate Vice President and Chief Financial Officer) have evaluated the company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934 (the Exchange Act)) as of September 30, 2019, and have concluded that these controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. These disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed
in the reports that we file or submit is accumulated and communicated to management, including the principal executive officer and the principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the three months ended September 30, 2019, no changes occurred in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
We have provided information about certain legal proceedings in which we are involved in Notes 6 and 7 to the financial statements.
We are a party to various investigations, lawsuits, arbitration, claims, enforcement actions and other legal proceedings, including government investigations and claims, that arise in the ordinary course
of our business. These types of matters could result in administrative, civil or criminal fines, penalties or other sanctions (which terms include judgments or convictions and consent or other voluntary decrees or agreements); compensatory, treble or other damages; non-monetary relief or actions; or other liabilities. Government regulations provide that certain allegations against a contractor may lead to suspension or debarment from future government contracts or suspension of export privileges for the company or one or more of its components. The nature of legal proceedings is such that we cannot assure the outcome of any particular matter. For additional information on pending matters, please see Notes 6 and 7
to the financial statements, and for further information on the risks we face from existing and future investigations, lawsuits, arbitration, claims, enforcement actions and other legal proceedings, please see “Risk Factors” in our 2018 Annual Report on Form 10-K.
Item 1A. Risk Factors
For a discussion of our risk factors, please see the section entitled “Risk Factors” in our 2018 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Purchases of Equity Securities
– The table below summarizes our repurchases of common stock during the third quarter of 2019:
Period
Number of Shares Purchased
Average Price Paid per Share(1)
Number of Shares Purchased as Part of
Publicly Announced Plans or Programs
Approximate Dollar Value of Shares that May Yet Be Purchased under the Plans or Programs ($ in millions)
Share repurchases take place from time to time, subject to market conditions and management’s discretion, in the open market and in privately negotiated transactions. The company retires its common stock upon repurchase and, in the periods presented, has not made any purchases of common stock other than in connection with these publicly announced repurchase programs.
See Note 3 to the financial statements for further information on our share repurchase programs.
Northrop Grumman Corporation Quarterly Report on Form 10-Q for the quarter ended September
30, 2019, formatted in XBRL (Extensible Business Reporting Language): (i) the Cover Page, (ii) Condensed Consolidated Statements of Earnings and Comprehensive Income, (iii) Condensed Consolidated Statements of Financial Position, (iv) Condensed Consolidated Statements of Cash Flows, (v) Condensed Consolidated Statements of Changes in Shareholders’ Equity, and (vi) Notes to Condensed Consolidated Financial Statements. The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
*104
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
+
Management
contract or compensatory plan or arrangement
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
