Northrop Grumman: An Overview and Breakdown of Our Earnings

Northrop Grumman Corporation (NYSE:NOC) reported that fourth quarter 2010 earnings from continuing operations totaled$376 million, or $1.27 per diluted share, compared with $375 million, or $1.19 per diluted share, in the fourth quarter of 2009. Fourth quarter 2010 results included a previously announced one-time, pre-tax charge of $231 million, or $0.51 per diluted share, principally related to premiums paid to redeem $682 million in debt through the company’s November 2010 tender offer.

Earnings from continuing operations increased to $2 billion in 2010, or $6.77 per diluted share, from $1.6 billion, or $4.87 per diluted share in 2009. In addition to the fourth quarter charge related to the debt tender offer, 2010 results included a $113 million pre-tax charge related to the consolidation of the company’s Gulf Coast facilities and a $296 million tax benefit related to approval by the Internal Revenue Service (NYSE:IRS) and the U. S. Congressional Joint Committee on Taxation of the IRS’ examination of tax returns for the years 2004 through 2006. These three items, all of which were previously announced, resulted in a net increase in 2010 earnings from continuing operations of $0.24 per share.

Fourth quarter 2010 sales totaled $8.6 billion compared with $8.9 billion in the prior year period. The 2010 fourth quarter had fewer working days than the prior year period. Sales increased 3 percent in 2010 to $34.8 billion from $33.8 billion in 2009. New business awards for the 2010 fourth quarter totaled $9.2 billion, bringing total backlog to $64.2 billion as of Dec. 31, 2010. New business awards totaled $30 billion in 2010.

Fourth quarter 2010 cash provided by operations increased to $1.4 billion from $931 million in the prior year period. In the 2010 fourth quarter the company’s discretionary pension contributions totaled $440 million, and in the fourth quarter of 2009 the company paid income taxes of $508 million on the sale of its Advisory Services business TASC. Cash provided by operations totaled $2.5 billion in 2010 compared with $2.1 billion in 2009. Discretionary pension contributions totaled $830 million and $800 million for 2010 and 2009, respectively. Cash provided by operations in 2009 also included $102 million from discontinued operations, as well as the income taxes paid on the sale of TASC.

“Northrop Grumman had a very good fourth quarter and a strong finish to 2010. Operating income and cash generation exceeded our guidance for the year, demonstrating that across all our businesses, our employees are focusing on performance and building a track record of consistent execution. Northrop Grumman is well positioned to continue creating value for our customers and shareholders,” said Wes Bush, chief executive officer and president.

Table 1 – Financial Highlights

Fourth Quarter Total Year
($ in millions, except per share amounts) 2010 2009 2010 2009
Sales $ 8,607 $ 8,925 $ 34,757 $ 33,755
Operating income 788 631 3,070 2,483
as % of sales 9.2% 7.1% 8.8% 7.4%
Earnings from continuing operations $ 376 $ 375 $ 2,038 $ 1,573
Diluted EPS from continuing operations 1.27 1.19 6.77 4.87
Net earnings 376 413 2,053 1,686
Diluted EPS 1.27 1.31 6.82 5.21
Cash provided by operations 1,387 931 2,453 2,133
Free cash flow(1) 1,014 703 1,677 1,411
Pension-adjusted Operating Highlights
Operating income $ 788 $ 631 $ 3,070 $ 2,483
Net pension adjustment(1) 1 87 25 311
Pension-adjusted operating income(1) 789 718 3,095 2,794
as % of sales(1) 9.2% 8.0% 8.9% 8.3%
Pension-adjusted Per Share Data
Diluted EPS from continuing operations $ 1.27 $ 1.19 $ 6.77 $ 4.87
After-tax net pension adjustment per share(1) 0.18 0.05 0.63
Pension-adjusted diluted EPS from continuing operations(1) 1.27 1.37 6.82 5.50
Weighted average shares outstanding – Basic 291.8 311.8 296.9 319.2
Dilutive effect of stock options and stock awards 5.1 3.7 4.2 4.1
Weighted average shares outstanding – Diluted 296.9 315.5 301.1 323.3
(1) Non-GAAP metric – see definitions and reconciliations at the end of this press release.

Fourth quarter 2010 operating income increased 25 percent to $788 million from $631 million in the prior year period, and as a percent of sales increased 210 basis points to 9.2 percent from 7.1 percent. For 2010 operating income increased 24 percent to $3.1 billion from $2.5 billion in the prior year period, and as a percent of sales increased 140 basis points to 8.8 percent from 7.4 percent. The improvement for both periods principally reflects higher segment operating income and lower net pension adjustment, partially offset by higher corporate unallocated expenses.

Fourth quarter 2010 segment operating income increased $143 million, or 19 percent, and 2010 segment operating income increased $397 million, or 14 percent. As a percent of sales, fourth quarter 2010 segment operating income improved 200 basis points to 10.3 percent from 8.3 percent, and 2010 segment operating income improved by 90 basis points to 9.6 percent from 8.7 percent. The improvement in segment operating income and margin rate for both periods primarily reflects improved program performance.

Net pension adjustment improved by $86 million in the 2010 fourth quarter and $286 million for the full year. Unallocated corporate expenses totaled $95 million in the 2010 fourth quarter and$220 million for the full year, compared with $24 million and $111 million, respectively, for the prior year periods. The increase in corporate unallocated expenses in the 2010 fourth quarter is principally due to additional deferred state taxes and higher other unallowable costs. In 2009 unallocated corporate expenses for the year were reduced by a $64 million pre-tax gain for the settlement of certain litigation matters.

Federal and foreign income taxes totaled $143 million compared with $196 million in the fourth quarter of 2009. Fourth quarter 2010 included a $15 million credit for the extension of the Research and Development tax credit. The effective tax rate for the 2010 fourth quarter was 27.6 percent compared with 34.3 percent in the 2009 fourth quarter.

Federal and foreign income taxes totaled $557 million in 2010, including the $296 million benefit from the IRS settlement, compared with $693 million in 2009, which included a net tax benefit of $75 million, primarily for final settlement of the IRS’s examination of the company’s 2001 through 2003 tax returns. The effective tax rate for 2010 was 21.5 percent compared with 30.6 percent in 2009.

Fourth quarter 2010 diluted earnings per share are based on 296.9 million weighted average shares outstanding compared with 315.5 million in the fourth quarter of 2009. Diluted earnings per share for 2010 are based on 301.1 million weighted average shares outstanding compared with 323.3 million in 2009.

Table 2 – Cash Flow Highlights

Fourth Quarter Total Year
($ millions) 2010 2009 Change 2010 2009 Change
Cash provided by operations before
discretionary pension contributions(1) $ 1,651 $ 790 $ 861 $ 3,058 $ 2,595 $ 463
Discretionary pension pre-funding impact, net of tax (264) 141 (405) (605) (462) (143)
Cash provided by operations 1,387 931 456 2,453 2,133 320
Less:
Capital expenditures (372) (218) (154) (770) (654) (116)
Outsourcing contract & related software costs (1) (10) 9 (6) (68) 62
Free cash flow(1) $ 1,014 $ 703 $ 311 $ 1,677 $ 1,411 $ 266
(1) Non-GAAP metric – see definitions and reconciliations at the end of this press release

Table 3 – Cash Measurements, Debt and Capital Deployment

($ millions) 12/31/2010 12/31/2009
Cash & cash equivalents $ 3,701 $ 3,275
Total debt 4,829 4,294
Net debt(1) 1,128 1,019
Net debt to total capital ratio(2) 6% 6%
(1) Total debt less cash and cash equivalents.
(2) Net debt divided by the sum of shareholders’ equity and total debt.

Changes in cash and cash equivalents include the following items for cash from operations, investing and financing in 2010:

Operations

  • $830 million discretionary pension contributions
  • $2.5 billion provided by operations after discretionary pension contributions

Investing

  • $770 million for capital expenditures and $6 million for outsourcing contract and related software costs

Financing

  • $1.5 billion proceeds from issuance of long-term debt
  • $1.2 billion for repurchase of approximately 19.7 million shares of common stock
  • $1.2 billion payments of long-term debt
  • $545 million for dividends
  • $142 million proceeds from exercises of stock options and issuance of common stock

Table 4 – 2011 Guidance – Excludes Shipbuilding

($ in millions, except per share amounts)
Sales ~$27,500
Segment operating margin %(1) Mid 10%
Operating margin % ~11%
EPS from continuing operations $6.40 $6.60
Cash provided by continuing operations before
discretionary pension contributions(1) 2,300 2,700
Free cash flow provided by continuing operations
before discretionary pension contributions(1) 1,700 2,000
(1) Non-GAAP metric – see definitions at the end of this press release.

The company’s 2011 guidance reflects the anticipated separation of the Shipbuilding business from Northrop Grumman in 2011. The guidance provided above is based on operating results for the continuing operations: Aerospace Systems, Electronic Systems, Information Systems and Technical Services.

Table 5 – Business Results

Consolidated Sales & Segment Operating Income(1)
Fourth Quarter Total Year
($ millions) 2010 2009 Change 2010 2009 Change
Sales
Aerospace Systems $ 2,666 $ 2,763 (4%) $ 10,910 $ 10,419 5%
Electronic Systems 1,873 2,077 (10%) 7,613 7,671 (1%)
Information Systems 2,085 2,174 (4%) 8,395 8,536 (2%)
Shipbuilding 1,730 1,664 4% 6,719 6,213 8%
Technical Services 795 750 6% 3,230 2,776 16%
Intersegment eliminations (542) (503) (2,110) (1,860)
$ 8,607 $ 8,925 (4%) $ 34,757 $ 33,755 3%
Segment operating income(1)
Aerospace Systems $ 322 $ 291 11% $ 1,256 $ 1,071 17%
Electronic Systems 272 274 (1%) 1,023 969 6%
Information Systems 178 107 66% 756 624 21%
Shipbuilding 134 88 52% 325 299 9%
Technical Services 49 40 23% 206 161 28%
Intersegment eliminations (68) (56) (240) (195)
Segment operating income(1) $ 887 $ 744 19% $ 3,326 $ 2,929 14%
as a % of sales(1) 10.3% 8.3% 200 bps 9.6% 8.7% 90 bps
Reconciliation to operating income
Unallocated corporate expenses $ (95) $ (24) (296%) $ (220) $ (111) (98%)
Net pension adjustment(1) (1) (87) 99% (25) (311) 92%
Reversal of royalty income included above (3) (2) (50%) (11) (24) 54%
Operating income 788 631 25% 3,070 2,483 24%
as a % of sales 9.2% 7.1% 210 bps 8.8% 7.4% 140 bps
Net interest expense (65) (62) (5%) (281) (281) 0%
Charge on debt redemption (231) NM (231) NM
Other, net 27 2 1,250% 37 64 (42%)
Earnings from continuing operations before
income taxes
519 571 (9%) 2,595 2,266 15%
Federal and foreign income taxes (143) (196) 27% (557) (693) 20%
Earnings from continuing operations 376 375 0% 2,038 1,573 30%
Earnings from discontinued operations 38 (100%) 15 113 (87%)
Net earnings $ 376 $ 413 (9%) $ 2,053 $ 1,686 22%
(1) Non-GAAP metric – see definitions and reconciliations at the end of this press release.

Results for TASC, divested in December 2009, are reported as discontinued operations for all periods presented.

Aerospace Systems ($ millions)
Fourth Quarter Total Year
2010 2009 % Change 2010 2009 % Change
Sales $ 2,666 $ 2,763 (3.5%) $ 10,910 $ 10,419 4.7%
Operating income 322 291 10.7% 1,256 1,071 17.3%
as % of sales 12.1% 10.5% 11.5% 10.3%

Aerospace Systems fourth quarter 2010 sales declined 4 percent, principally due to fewer working days in the 2010 fourth quarter than in the prior year period and lower volume for civil space and missile defense programs. Aerospace Systems sales increased 5 percent in 2010 due to higher volume for manned and unmanned aircraft programs and restricted programs, which was partially offset by lower volume for missile defense programs.

Aerospace Systems fourth quarter 2010 operating income increased 11 percent, and as a percent of sales increased to 12.1 percent from 10.5 percent. Higher operating income and margin rate for the fourth quarter reflect improved program performance and lower costs. Aerospace Systems 2010 operating income increased 17 percent and as a percent of sales increased to 11.5 percent from 10.3 percent. Higher operating income and margin rate for the year reflect higher volume, improved program performance and lower costs.

Electronic Systems ($ millions)
Fourth Quarter Total Year
2010 2009 % Change 2010 2009 % Change
Sales $ 1,873 $ 2,077 (9.8%) $ 7,613 $ 7,671 (0.8%)
Operating income 272 274 (0.7%) 1,023 969 5.6%
as a % of sales 14.5% 13.2% 13.4% 12.6%

Electronic Systems fourth quarter 2010 sales declined 10 percent due to fewer working days in the 2010 fourth quarter than in the prior year period and lower volume for several programs nearing completion and contracts transitioning to their next phase, all of which were partially offset by higher volume for targeting systems programs. Electronic Systems 2010 sales were comparable to 2009 sales.

Electronic Systems fourth quarter 2010 operating income was comparable to the prior year period, and as a percent of sales increased to 14.5 percent from 13.2 percent. The higher margin rate for the fourth quarter reflects improved program performance for intelligence, surveillance and reconnaissance programs, including postal automation, and improved performance on land and self-protection systems programs. Electronic Systems 2010 operating income increased 6 percent, and as a percent of sales increased to 13.4 percent from 12.6 percent. Higher operating income and margin rate reflect higher volume for targeting systems and improved performance for land and self-protection systems programs.

Information Systems ($ millions)
Fourth Quarter Total Year
2010 2009 % Change 2010 2009 % Change
Sales $ 2,085 $ 2,174 (4.1%) $ 8,395 $ 8,536 (1.7%)
Operating income 178 107 66.4% 756 624 21.2%
as a % of sales 8.5% 4.9% 9.0% 7.3%

Information Systems fourth quarter 2010 sales declined 4 percent primarily due to fewer working days in the 2010 fourth quarter than in the prior year period and lower volume for intelligence and defense programs, which was partially offset by higher volume for civil systems programs. Information Systems sales declined 2 percent in 2010 principally due to lower volume for intelligence and civil systems programs, which was partially offset by higher volume for defense programs.

Information Systems fourth quarter 2010 operating income increased 66 percent and as a percent of sales increased to 8.5 percent from 4.9 percent. Information Systems operating income increased 21 percent in 2010 and as a percent of sales increased to 9 percent from 7.3 percent. Higher operating income and rate in the fourth quarter and the year reflect improved program performance for civil systems programs, as well as the absence of expenses incurred in the fourth quarter of 2009 associated with the divestiture of TASC.

Shipbuilding ($ millions)
Fourth Quarter Total Year
2010 2009 % Change 2010 2009 % Change
Sales $ 1,730 $ 1,664 4.0% $ 6,719 $ 6,213 8.1%
Operating income 134 88 52.3% 325 299 8.7%
as % of sales 7.7% 5.3% 4.8% 4.8%

Shipbuilding fourth quarter 2010 sales increased 4 percent due to higher volume for submarine and expeditionary warfare programs, which more than offset the impact of fewer working days in the 2010 fourth quarter and lower volume for aircraft carrier and surface combatant programs. Shipbuilding sales increased 8 percent in 2010 due to higher volume for expeditionary warfare, aircraft carrier and submarine programs, partially offset by lower volume for surface combatant programs.

Fourth quarter 2010 operating income increased 52 percent, and as a percent of sales increased to 7.7 percent from 5.3 percent. Higher operating income and rate reflect higher volume and improved program performance for expeditionary warfare, aircraft carrier and submarine programs. Operating income increased 9 percent in 2010, consistent with the increase in sales, and as a percent of sales was unchanged at 4.8 percent.

Technical Services ($ millions)
Fourth Quarter Total Year
2010 2009 % Change 2010 2009 % Change
Sales $ 795 $ 750 6.0% $ 3,230 $ 2,776 16.4%
Operating income 49 40 22.5% 206 161 28.0%
as a % of Sales 6.2% 5.3% 6.4% 5.8%

Technical Services fourth quarter 2010 sales increased 6 percent primarily due to higher volume for integrated logistics and modernization programs, which more than offset the impact of fewer working days in the 2010 fourth quarter than the prior year period. Technical Services sales increased 16 percent in 2010, principally due to higher volume for integrated logistics and modernization programs.

Technical Services fourth quarter 2010 operating income increased 23 percent, and as a percent of sales increased to 6.2 percent from 5.3 percent. Operating income increased 28 percent in 2010 and as a percent of sales improved to 6.4 percent from 5.8 percent. The improvements in operating income and rate are due to higher volume, improved business mix and improved performance.

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