UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM | |
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
For the Quarterly Period Ended September 30, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
Commission File Number 1-16411
NORTHROP GRUMMAN CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||
(Address of principal executive offices) | (Zip Code) | ||
(703 ) 280-2900
(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 |
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.
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).
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:
Non-accelerated Filer ☐ Smaller Reporting Company ☐
Emerging Growth Company ☐
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 ☐ 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, 168,532,761 shares of common stock were outstanding.
TABLE OF CONTENTS
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Item 3. | ||
Item 4. | ||
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Item 1A. | ||
Item 2. | ||
Item 6. | ||
i
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS AND COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended September 30 | Nine Months Ended September 30 | ||||||||||||||
$ in millions, except per share amounts | 2019 | 2018 | 2019 | 2018 | |||||||||||
Sales | |||||||||||||||
Product | $ | $ | $ | $ | |||||||||||
Service | |||||||||||||||
Total sales | |||||||||||||||
Operating costs and expenses | |||||||||||||||
Product | |||||||||||||||
Service | |||||||||||||||
General and administrative expenses | |||||||||||||||
Operating income | |||||||||||||||
Other (expense) income | |||||||||||||||
Interest expense | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
FAS (non-service) pension benefit | |||||||||||||||
Other, net | |||||||||||||||
Earnings before income taxes | |||||||||||||||
Federal and foreign income tax expense | |||||||||||||||
Net earnings | $ | $ | $ | $ | |||||||||||
Basic earnings per share | $ | $ | $ | $ | |||||||||||
Weighted-average common shares outstanding, in millions | |||||||||||||||
Diluted earnings per share | $ | $ | $ | $ | |||||||||||
Weighted-average diluted shares outstanding, in millions | |||||||||||||||
Net earnings (from above) | $ | $ | $ | $ | |||||||||||
Other comprehensive loss | |||||||||||||||
Change in unamortized prior service credit, net of tax | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Change in cumulative translation adjustment and other, net | ( | ) | ( | ) | |||||||||||
Other comprehensive loss, net of tax | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Comprehensive income | $ | $ | $ | $ | |||||||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(Unaudited)
$ in millions, except par value | September 30, 2019 | December 31, 2018 | |||||
Assets | |||||||
Cash and cash equivalents | $ | $ | |||||
Accounts receivable, net | |||||||
Unbilled receivables, net | |||||||
Inventoried costs, net | |||||||
Prepaid expenses and other current assets | |||||||
Total current assets | |||||||
Property, plant and equipment, net of accumulated depreciation of $5,709 for 2019 and $5,369 for 2018 | |||||||
Operating lease right-of-use assets | |||||||
Goodwill | |||||||
Intangible assets, net | |||||||
Deferred tax assets | |||||||
Other non-current assets | |||||||
Total assets | $ | $ | |||||
Liabilities | |||||||
Trade accounts payable | $ | $ | |||||
Accrued employee compensation | |||||||
Advance payments and billings in excess of costs incurred | |||||||
Other current liabilities | |||||||
Total current liabilities | |||||||
Long-term debt, net of current portion of $45 for 2019 and $517 for 2018 | |||||||
Pension and other postretirement benefit plan liabilities | |||||||
Operating lease liabilities | |||||||
Deferred tax liabilities | |||||||
Other non-current liabilities | |||||||
Total liabilities | |||||||
Commitments and contingencies (Note 7) | |||||||
Shareholders’ equity | |||||||
Preferred stock, $1 par value; 10,000,000 shares authorized; no shares issued and outstanding | |||||||
Common stock, $1 par value; 800,000,000 shares authorized; issued and outstanding: 2019—168,701,653 and 2018—170,607,336 | |||||||
Paid-in capital | |||||||
Retained earnings | |||||||
Accumulated other comprehensive loss | ( | ) | ( | ) | |||
Total shareholders’ equity | |||||||
Total liabilities and shareholders’ equity | $ | $ | |||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30 | |||||||
$ in millions | 2019 | 2018 | |||||
Operating activities | |||||||
Net earnings | $ | $ | |||||
Adjustments to reconcile to net cash provided by operating activities: | |||||||
Depreciation and amortization | |||||||
Non-cash lease expense | |||||||
Stock-based compensation | |||||||
Deferred income taxes | |||||||
Changes in assets and liabilities: | |||||||
Accounts receivable, net | ( | ) | ( | ) | |||
Unbilled receivables, net | ( | ) | ( | ) | |||
Inventoried costs, net | ( | ) | ( | ) | |||
Prepaid expenses and other assets | ( | ) | ( | ) | |||
Accounts payable and other liabilities | ( | ) | |||||
Income taxes payable, net | ( | ) | ( | ) | |||
Retiree benefits | ( | ) | ( | ) | |||
Other, net | ( | ) | ( | ) | |||
Net cash provided by operating activities | |||||||
Investing activities | |||||||
Acquisition of Orbital ATK, net of cash acquired | ( | ) | |||||
Capital expenditures | ( | ) | ( | ) | |||
Other, net | |||||||
Net cash used in investing activities | ( | ) | ( | ) | |||
Financing activities | |||||||
Payments of long-term debt | ( | ) | ( | ) | |||
Net payments to credit facilities | ( | ) | ( | ) | |||
Net borrowings on commercial paper | |||||||
Common stock repurchases | ( | ) | ( | ) | |||
Cash dividends paid | ( | ) | ( | ) | |||
Payments of employee taxes withheld from share-based awards | ( | ) | ( | ) | |||
Other, net | ( | ) | ( | ) | |||
Net cash used in financing activities | ( | ) | ( | ) | |||
Decrease in cash and cash equivalents | ( | ) | ( | ) | |||
Cash and cash equivalents, beginning of year | |||||||
Cash and cash equivalents, end of period | $ | $ | |||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited)
Three Months Ended September 30 | Nine Months Ended September 30 | ||||||||||||||
$ in millions, except per share amounts | 2019 | 2018 | 2019 | 2018 | |||||||||||
Common stock | |||||||||||||||
Beginning of period | $ | $ | $ | $ | |||||||||||
Common stock repurchased | ( | ) | ( | ) | ( | ) | |||||||||
Shares issued for employee stock awards and options | |||||||||||||||
End of period | |||||||||||||||
Paid-in capital | |||||||||||||||
Beginning of period | |||||||||||||||
Common stock repurchased | ( | ) | |||||||||||||
Stock compensation | ( | ) | |||||||||||||
End of period | |||||||||||||||
Retained earnings | |||||||||||||||
Beginning of period | |||||||||||||||
Impact from adoption of ASU 2018-02 and ASU 2016-01 | ( | ) | |||||||||||||
Common stock repurchased | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Net earnings | |||||||||||||||
Dividends declared | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Stock compensation | ( | ) | |||||||||||||
End of period | |||||||||||||||
Accumulated other comprehensive (loss) income | |||||||||||||||
Beginning of period | ( | ) | ( | ) | ( | ) | |||||||||
Impact from adoption of ASU 2018-02 and ASU 2016-01 | |||||||||||||||
Other comprehensive loss, net of tax | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
End of period | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Total shareholders’ equity | $ | $ | $ | $ | |||||||||||
Cash dividends declared per share | $ | $ | $ | $ | |||||||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. BASIS OF PRESENTATION
Principles of Consolidation and Reporting
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.
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.
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
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
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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).
Contract Estimates
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.
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 | $ | $ | $ | $ | |||||||||||
Operating income | |||||||||||||||
Net earnings(1) | |||||||||||||||
Diluted earnings per share(1) | |||||||||||||||
(1) |
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.
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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.
Company backlog as of September 30, 2019 was $65.0 billion. We 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.
Contract Assets and Liabilities
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, 2018 contract liability balance was $209 million and $1.2 billion, respectively. The amount of revenue recognized for the three and nine months ended September 30, 2018 that was included in the December 31, 2017 contract liability balance was $168 million and $1.2 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
The components of accumulated other comprehensive loss are as follows:
$ in millions | September 30, 2019 | December 31, 2018 | ||||||
Unamortized prior service credit, net of tax expense of $21 for 2019 and $32 for 2018 | $ | $ | ||||||
Cumulative translation adjustment | ( | ) | ( | ) | ||||
Other, net | ( | ) | ( | ) | ||||
Total accumulated other comprehensive loss | $ | ( | ) | $ | ( | ) | ||
Reclassifications from accumulated other comprehensive loss to net earnings related to the amortization of prior service credit were $12 million and $35 million, net of taxes, for the three and nine months ended September 30, 2019, respectively and were $15 million and $45 million, net of taxes, for the three and nine months ended
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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
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
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.
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.
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2. ACQUISITION OF ORBITAL ATK
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 $7.7 billion in 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 $220 million, Other current liabilities increased $114 million, Pension and other postretirement benefit (OPB) plan liabilities increased $56 million, Other non-current liabilities increased $53 million, Other current assets increased $44 million and Goodwill decreased $36 million. These adjustments did not result in a material impact on the financial results of prior periods.
The Merger date fair value of the consideration transferred totaled $7.7 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 | ||||
Cash consideration per share of Orbital ATK common stock | $ | |||
Total purchase price | $ | |||
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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:
$ in millions | As of June 6, 2018 | |||
Cash and cash equivalents | $ | |||
Accounts receivable | ||||
Unbilled receivables | ||||
Inventoried costs | ||||
Other current assets | ||||
Property, plant and equipment | ||||
Goodwill | ||||
Intangible assets | ||||
Other non-current assets | ||||
Total assets acquired | ||||
Trade accounts payable | ( | ) | ||
Accrued employee compensation | ( | ) | ||
Advance payments and billings in excess of costs incurred | ( | ) | ||
Below market contracts(1) | ( | ) | ||
Other current liabilities | ( | ) | ||
Long-term debt | ( | ) | ||
Pension and OPB plan liabilities | ( | ) | ||
Deferred tax liabilities | ( | ) | ||
Other non-current liabilities | ( | ) | ||
Total liabilities assumed | ( | ) | ||
Total purchase price | $ | |||
(1) | Included in Other current liabilities in the unaudited condensed consolidated statements of financial position. |
The following table presents a summary of purchased intangible assets and their related estimated useful lives:
Fair Value (in millions) | Estimated Useful Life in Years | |||||
Customer contracts | $ | |||||
Commercial customer relationships | ||||||
Total customer-related intangible assets | $ | |||||
The purchase price allocation resulted in the recognition of $6.3 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.
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Unaudited Supplemental Pro Forma Information
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:
$ in millions, except per share amounts | Nine Months Ended September 30, 2018 | |||
Sales | $ | |||
Net earnings | ||||
Diluted earnings per share | ||||
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 $ |
2. | The elimination of nonrecurring transaction costs incurred by the company and Orbital ATK in connection with the Merger of $ |
3. | The recognition of additional depreciation expense, net of removal of historical depreciation expense, of $ |
4. | The recognition of additional amortization expense, net of removal of historical amortization expense, of $ |
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 $ |
6. | The income tax effect on the pro forma adjustments, which was calculated using the federal statutory tax rate, of $( |
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. EARNINGS PER SHARE, SHARE REPURCHASES AND DIVIDENDS ON COMMON STOCK
Basic Earnings Per Share
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
Share Repurchases
On September 16, 2015, the company’s board of directors authorized a share repurchase program of up to $4.0 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 $3.0 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 $1.0 billion of the company’s common stock under the
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2015 Repurchase Program. Under the agreement, we made a payment of $1.0 billion to Goldman Sachs and received an initial delivery of 3.0 million shares valued at $800 million that were immediately canceled by the company. The remaining balance was settled on January 4, 2019 with a final delivery of 0.9 million shares from Goldman Sachs. The final average purchase price was $260.32 per share.
As of September 30, 2019, repurchases under the 2015 Repurchase Program totaled $3.4 billion; $0.6 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.
The table below summarizes the company’s share repurchases to date under the authorizations described above:
Shares Repurchased (in millions) | |||||||||||||||||||
Repurchase Program Authorization Date | Amount Authorized (in millions) | Total Shares Retired (in millions) | Average Price Per Share(1) | Date Completed | Nine Months Ended September 30 | ||||||||||||||
2019 | 2018 | ||||||||||||||||||
September 16, 2015 | $ | $ | |||||||||||||||||
December 4, 2018 | $ | — | — | ||||||||||||||||
(1) | Includes commissions paid. |
Dividends on Common Stock
In May 2019, the company increased the quarterly common stock dividend 10 percent to $1.32 per share from the previous amount of $1.20 per share.
In May 2018, the company increased the quarterly common stock dividend 9 percent to $1.20 per share from the previous amount of $1.10 per share.
In January 2018, the company increased the quarterly common stock dividend 10 percent to $1.10 per share from the previous amount of $1.00 per share.
4. INCOME TAXES
Three Months Ended September 30 | Nine Months Ended September 30 | ||||||||||||||
$ in millions | 2019 | 2018 | 2019 | 2018 | |||||||||||
Federal and foreign income tax expense | $ | $ | $ | $ | |||||||||||
Effective income tax rate | % | % | % | % | |||||||||||
Current Quarter
The third quarter 2019 effective tax rate increased to 11.6 percent from 8.8 percent in the third quarter of 2018. The company’s effective tax rate for the third quarter of 2019 includes benefits of $89 million for research credits and $17 million for foreign derived intangible income. The company’s tax rate for the third quarter of 2018 included a $106 million benefit for research credits and manufacturing deductions and an $84 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 14.8 percent from 14.0 percent in the prior year period. The company’s year to date 2019 effective tax rate includes benefits of $171 million for research credits and $26 million for foreign derived intangible income. The company’s year to date 2018 effective tax rate included a $156 million benefit for research credits and manufacturing deductions and an $84 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 $294 million and $327 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
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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.
5. FAIR VALUE OF FINANCIAL INSTRUMENTS
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. Commodity 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.
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:
September 30, 2019 | December 31, 2018 | |||||||||||||||||||||||
$ in millions | Level 1 | Level 2 | Total | Level 1 | Level 2 | Total | ||||||||||||||||||
Financial Assets (Liabilities) | ||||||||||||||||||||||||
Marketable securities | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Marketable securities valued using NAV | ||||||||||||||||||||||||
Total marketable securities | ||||||||||||||||||||||||
Derivatives | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||
At September 30, 2019, the company had commodity forward contracts outstanding that hedge forecasted commodity purchases of 4 million pounds of copper and 1 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 notional value of the company’s foreign currency forward contracts at September 30, 2019 and December 31, 2018 was $86 million and $114 million, respectively. The portion of notional value designated as a cash flow hedge at September 30, 2019 was $9 million. At December 31, 2018, no portion of the notional value was designated as a cash flow hedge.
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 $15.2 billion and $14.3 billion as of September 30, 2019 and December 31, 2018, respectively. We 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 $13.9 billion and $14.4 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.
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6. INVESTIGATIONS, CLAIMS AND LITIGATION
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 $875 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 $63 million for unpaid portions of the contract price, and approximately $115 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 $410 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 $179 million annually, 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 $193 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 two 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$111 million (the equivalent of approximately $27 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$89 million (the equivalent of approximately $21 million as of September 30, 2019) in damages. In October 2013, ECT asserted an additional damage claim of R$22 million (the equivalent of approximately $5 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 €31 million (the equivalent of approximately $34 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$41 million (the equivalent of approximately $10 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
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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 $108 million, subject to certain terms and conditions. The company continues to negotiate with and pursue coverage litigation against various of its insurance carriers.
7. COMMITMENTS AND CONTINGENCIES
U.S. Government Cost Claims
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Environmental Matters
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:
$ in millions | Range of Reasonably Possible Future Costs(1) | Accrued Costs(2) | Deferred Costs(3) | |||||||
September 30, 2019 | $528 - $997 | $ | $ | |||||||
December 31, 2018 | 447 - 835 | |||||||||
(1) | 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, $163 million is recorded in Other current liabilities and $380 million is recorded in Other non-current liabilities.
(3) As of September 30, 2019, $128 million is deferred in Prepaid expenses and other current assets and $295 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 $452 million of stand-by letters of credit and guarantees and $209 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 $2.0 billion. At September 30, 2019, there were $399 million of outstanding short-term commercial paper borrowings at a weighted-average interest rate of 2.31 percent that have original maturities of three 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 $2.0 billion (the “2018 Credit Agreement”) that matures in August 2023. At September 30, 2019, there was no 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 £120 million (the equivalent of approximately $148 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 £60 million (the equivalent of approximately $74 million) outstanding under this facility, which bears interest at a rate of LIBOR plus 1.10 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.
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At September 30, 2019, the company was in compliance with all covenants under its credit agreements.
8. RETIREMENT BENEFITS
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 | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||
Interest cost | |||||||||||||||||||||||||||||||
Expected return on plan assets | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||||||