SEC Filing - Northrop Grumman

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM	10-Q



☒		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2020



☐		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)



Delaware		80-0640649
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

2980 Fairview Park Drive
Falls Church,	Virginia	22042
(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
Common Stock	NOC	New 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.

Yes ☒ 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).

Yes ☒ 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:

Large Accelerated Filer ☒ Accelerated Filer ☐

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 April 24, 2020, 166,702,730 shares of common stock were outstanding.

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NORTHROP GRUMMAN CORPORATION

TABLE OF CONTENTS



		Page
	PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Statements of Earnings and Comprehensive Income	1
	Condensed Consolidated Statements of Financial Position	2
	Condensed Consolidated Statements of Cash Flows	3
	Condensed Consolidated Statements of Changes in Shareholders’ Equity	4
	Notes to Condensed Consolidated Financial Statements
	1. Basis of Presentation	5
	2. Earnings Per Share, Share Repurchases and Dividends on Common Stock	7
	3. Income Taxes	8
	4. Fair Value of Financial Instruments	8
	5. Investigations, Claims and Litigation	9
	6. Commitments and Contingencies	10
	7. Retirement Benefits	12
	8. Stock Compensation Plans and Other Compensation Arrangements	12
	9. Segment Information	13
	Report of Independent Registered Public Accounting Firm	17
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Overview	18
	Consolidated Operating Results	19
	Segment Operating Results	20
	Product and Service Analysis	24
	Backlog	25
	Liquidity and Capital Resources	25
	Critical Accounting Policies, Estimates and Judgments	27
	Accounting Standards Updates	27
	Forward-Looking Statements and Projections	27
	Contractual Obligations	28
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
Item 4.	Controls and Procedures	28

	PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 6.	Exhibits	32
	Signatures	34

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NORTHROP GRUMMAN CORPORATION

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS AND COMPREHENSIVE INCOME

(Unaudited)



	Three Months Ended March 31
$ in millions, except per share amounts	2020			2019
Sales
Product	$	6,176		$	5,728
Service	2,444			2,461
Total sales	8,620			8,189
Operating costs and expenses
Product	4,952			4,517
Service	1,946			1,976
General and administrative expenses	788			760
Operating income	934			936
Other (expense) income
Interest expense	(125		)	(138		)
FAS (non-service) pension benefit	302			200
Other, net	(58		)	36
Earnings before income taxes	1,053			1,034
Federal and foreign income tax expense	185			171
Net earnings	$	868		$	863

Basic earnings per share	$	5.18		$	5.08
Weighted-average common shares outstanding, in millions	167.7			170.0
Diluted earnings per share	$	5.15		$	5.06
Weighted-average diluted shares outstanding, in millions	168.4			170.7

Net earnings (from above)	$	868		$	863
Other comprehensive loss
Change in unamortized prior service credit, net of tax	(10		)	(11		)
Change in cumulative translation adjustment and other, net	(9		)	4
Other comprehensive loss, net of tax	(19		)	(7		)
Comprehensive income	$	849		$	856

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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NORTHROP GRUMMAN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

(Unaudited)



$ in millions, except par value	March 31, 2020			December 31, 2019
Assets
Cash and cash equivalents	$	3,278		$	2,245
Accounts receivable, net	2,136			1,326
Unbilled receivables, net	5,918			5,334
Inventoried costs, net	785			783
Prepaid expenses and other current assets	1,011			997
Total current assets	13,128			10,685
Property, plant and equipment, net of accumulated depreciation of $5,952 for 2020 and $5,850 for 2019	6,956			6,912
Operating lease right-of-use assets	1,469			1,511
Goodwill	18,698			18,708
Intangible assets, net	974			1,040
Deferred tax assets	355			508
Other non-current assets	1,623			1,725
Total assets	$	43,203		$	41,089

Liabilities
Trade accounts payable	$	2,071		$	2,226
Accrued employee compensation	1,472			1,865
Advance payments and billings in excess of costs incurred	2,027			2,237
Other current liabilities	4,607			3,106
Total current liabilities	10,177			9,434
Long-term debt, net of current portion of $1,790 for 2020 and $1,109 for 2019	14,299			12,770
Pension and other postretirement benefit plan liabilities	6,779			6,979
Operating lease liabilities	1,280			1,308
Other non-current liabilities	1,606			1,779
Total liabilities	34,141			32,270

Commitments and contingencies (Note 6)

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: 2020—167,099,297 and 2019—167,848,424	167			168
Paid-in capital	—			—
Retained earnings	9,011			8,748
Accumulated other comprehensive loss	(116		)	(97		)
Total shareholders’ equity	9,062			8,819
Total liabilities and shareholders’ equity	$	43,203		$	41,089

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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NORTHROP GRUMMAN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



	Three Months Ended March 31
$ in millions	2020			2019
Operating activities
Net earnings	$	868		$	863
Adjustments to reconcile to net cash used in operating activities:
Depreciation and amortization	297			302
Stock-based compensation	18			26
Deferred income taxes	156			33
Changes in assets and liabilities:
Accounts receivable, net	(810		)	(718		)
Unbilled receivables, net	(584		)	(759		)
Inventoried costs, net	(2		)	(124		)
Prepaid expenses and other assets	56			(23		)
Accounts payable and other liabilities	(833		)	(480		)
Income taxes payable, net	10			140
Retiree benefits	(237		)	(142		)
Other, net	68			(31		)
Net cash used in operating activities	(993		)	(913		)

Investing activities
Capital expenditures	(272		)	(284		)
Other, net	2			4
Net cash used in investing activities	(270		)	(280		)

Financing activities
Net proceeds from issuance of long-term debt	2,239			—
Payments to credit facilities	(7		)	(20		)
Net borrowings on commercial paper	744			814
Common stock repurchases	(344		)	(60		)
Cash dividends paid	(227		)	(211		)
Payments of employee taxes withheld from share-based awards	(63		)	(61		)
Other, net	(46		)	—
Net cash provided by financing activities	2,296			462
Increase (decrease) in cash and cash equivalents	1,033			(731		)
Cash and cash equivalents, beginning of year	2,245			1,579
Cash and cash equivalents, end of period	$	3,278		$	848

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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NORTHROP GRUMMAN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)



	Three Months Ended March 31
$ in millions, except per share amounts	2020			2019
Common stock
Beginning of period	$	168		$	171
Common stock repurchased	(1		)	(1		)
End of period	167			170
Paid-in capital
Beginning of period	—			—
End of period	—			—
Retained earnings
Beginning of period	8,748			8,068
Common stock repurchased	(348		)	(62		)
Net earnings	868			863
Dividends declared	(223		)	(206		)
Stock compensation	(45		)	(35		)
Other	11			—
End of period	9,011			8,628
Accumulated other comprehensive (loss) income
Beginning of period	(97		)	(52		)
Other comprehensive loss, net of tax	(19		)	(7		)
End of period	(116		)	(59		)
Total shareholders’ equity	$	9,062		$	8,739
Cash dividends declared per share	$	1.32		$	1.20

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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NORTHROP GRUMMAN CORPORATION

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”). 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.

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.

Effective January 1, 2020, the company reorganized its operating sectors to better align the company’s broad portfolio to serve its customers’ needs. The four new sectors, which also comprise our reportable segments, are Aeronautics Systems, Defense Systems, Mission Systems and Space Systems.

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 2019 Annual Report on Form 10-K and the Form 8-K that we expect to file with the SEC immediately after filing this Form 10-Q, which recasts the disclosures in certain portions of the 2019 Annual Report on Form 10-K to reflect changes in the company’s reportable segments.

The 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.

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. We recognize revenue as control is transferred to the customer, either over time or at a point in time. 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 our 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.

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NORTHROP GRUMMAN CORPORATION

We recognize changes in estimated contract sales or costs and the resulting changes in contract profit on a cumulative basis. Cumulative Estimate-at-Completion (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.

The following table presents the effect of aggregate net EAC adjustments:



	Three Months Ended March 31
$ in millions, except per share data	2020		2019
Revenue	$	136	$	166
Operating income	124		138
Net earnings⁽¹⁾	98		109
Diluted earnings per share⁽¹⁾	0.58		0.64


⁽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 March 31, 2020 and 2019.

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 an option or IDIQ task order is exercised or awarded.

Company backlog as of March 31, 2020 was $64.2 billion. We expect to recognize approximately 45 percent and 70 percent of our March 31, 2020 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. 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. 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. The amount of revenue recognized for the three months ended March 31, 2020 and 2019 that was included in the contract liability balances at the beginning of each year was $781 million and $674 million, respectively.

Disaggregation of Revenue

See Note 9 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.

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NORTHROP GRUMMAN CORPORATION

Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss are as follows:



$ in millions	March 31, 2020			December 31, 2019
Unamortized prior service credit, net of tax expense of $13 for 2020 and $17 for 2019	$	41		$	51
Cumulative translation adjustment and other, net	(157		)	(148		)
Total accumulated other comprehensive loss	$	(116	)	$	(97	)

Related Party Transactions

For all periods presented, the company had no material related party transactions.

Accounting Standards Updates

Accounting standards updates adopted and/or issued, but not effective until after March 31, 2020, 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.

2. 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

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 0.7 million shares and 0.7 million shares for the three months ended March 31, 2020 and 2019, respectively.

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 and were completed in March 2020.

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”). Repurchases under the 2018 Repurchase Program commenced in March 2020 upon the completion of the company’s 2015 Repurchase Program. As of March 31, 2020, repurchases under the 2018 Repurchase Program totaled $20 million; $2.98 billion remained under this share repurchase authorization. By its terms, the 2018 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 or 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	Three Months Ended March 31
Repurchase Program Authorization Date	Amount Authorized (in millions)		Total Shares Retired (in millions)	Average Price Per Share⁽¹⁾		Date Completed	2020	2019
September 16, 2015	$	4,000	15.4	$	260.33	March 2020	0.9	1.1
December 4, 2018	$	3,000	0.1	306.22			0.1	—


⁽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.

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3. INCOME TAXES



	Three Months Ended March 31
$ in millions	2020			2019
Federal and foreign income tax expense	$	185		$	171
Effective income tax rate	17.6		%	16.5		%

The first quarter 2020 effective tax rate increased to 17.6 percent from 16.5 percent in the first quarter of 2019 primarily due to nondeductible losses on marketable securities and an increase in reserves for uncertain tax positions. These were partially offset by an increase in research credits, which totaled $41 million in the first quarter of 2020 and $31 million in the prior year period. Both periods benefited from $13 million of excess tax benefits for employee share-based compensation.

In March 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted. The CARES Act includes certain changes to U.S. tax law that impact the company, including a technical correction to the 2017 Tax Cuts and Jobs Act, which makes certain qualified improvement property eligible for bonus depreciation. The CARES Act did not have a significant impact on the company’s first quarter 2020 effective tax rate.

The company has recorded unrecognized tax benefits related to our methods of accounting associated with the timing of revenue recognition and related costs, and the 2017 Tax Act. It is reasonably possible that within the next 12 months our unrecognized tax benefits related to these matters may decrease by up to $60 million. 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.

4. FAIR VALUE OF FINANCIAL INSTRUMENTS

The 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 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:



	March 31, 2020								December 31, 2019
$ in millions	Level 1		Level 2			Total			Level 1		Level 2			Total
Financial Assets (Liabilities)
Marketable securities	$	288	$	4		$	292		$	364	$	1		$	365
Marketable securities valued using NAV						16								17
Total marketable securities	288		4			308			364		1			382
Derivatives	—		(3		)	(3		)	—		(3		)	(3		)

The notional value of the company’s foreign currency forward contracts at March 31, 2020 and December 31, 2019 was $85 million and $98 million, respectively. The portion of notional value designated as a cash flow hedge was $3 million and $7 million as of March 31, 2020 and December 31, 2019, respectively.

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The derivative fair values and related unrealized gains/losses at March 31, 2020 and December 31, 2019 were not material. There were no transfers of financial instruments between the three levels of the fair value hierarchy during the three months ended March 31, 2020.

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 $17.5 billion and $15.1 billion as of March 31, 2020 and December 31, 2019, 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 $16.1 billion and $13.9 billion as of March 31, 2020 and December 31, 2019, respectively. The current portion of long-term debt is recorded in Other current liabilities in the unaudited condensed consolidated statements of financial position.

Unsecured Senior Notes

In March 2020, the company issued $2.25 billion of unsecured senior notes for general corporate purposes, including debt repayment and working capital, as follows:


•	$750 million of 4.40% senior notes due 2030 (the “2030 Notes”),


•	$500 million of 5.15% senior notes due 2040 (the “2040 Notes”) and


•	$1.0 billion of 5.25% senior notes due 2050 (the “2050 Notes”).

We refer to the 2030 Notes, the 2040 Notes and the 2050 Notes, together, as the “notes.” Interest on the notes is payable semi-annually in arrears. The notes are generally subject to redemption, in whole or in part, at the company’s discretion at any time, or from time to time, prior to maturity at a redemption price equal to the greater of 100% of the principal amount of the notes to be redeemed or an applicable “make-whole” amount, plus accrued and unpaid interest.

5. 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 February 3, 2020, the parties commenced what was expected to be a seven-week trial. The first four weeks of trial have concluded, but the court postponed the remaining three weeks until May 2020 as a result of COVID-19-related concerns. 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.

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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, ECT alleges the consortium breached its contract with ECT and seeks damages of approximately R$111 million (the equivalent of approximately $22 million as of March 31, 2020), 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 $17 million as of March 31, 2020) in damages. In October 2013, ECT asserted an additional damage claim of R$22 million (the equivalent of approximately $4 million as of March 31, 2020). 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 March 31, 2020), 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 $8 million as of March 31, 2020) 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 assessing 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 6, 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 6, the State of New York issued a Feasibility Study and an Amended Record of Decision, seeking to impose additional remedial requirements. The company is engaged in discussions with the State of New York and certain other potentially responsible parties. 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.

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 March 31, 2020, or its annual results of operations and/or cash flows.

6. COMMITMENTS AND CONTINGENCIES

U.S. Government Cost Claims and Contingencies

From 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

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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 March 31, 2020, or its annual results of operations and/or cash flows.

Recently, the U.S. government has raised questions about an interest rate assumption used by the company to determine our CAS pension cost in previous years. We are currently engaging with the government to address their questions. Although we believe our pension-related assumptions are appropriate, the sensitivity to changes in interest rate assumptions makes it reasonably possible the outcome of this matter could have a material adverse effect on our financial position, results of operations and/or cash flows, although we are not currently able to estimate a range of any potential loss.

Environmental Matters

The table below summarizes the amount accrued for environmental remediation costs, management’s estimate of the amount of reasonably possible future costs in excess of accrued costs and the deferred costs expected to be recoverable through overhead charges on U.S. government contracts as of March 31, 2020 and December 31, 2019:



$ in millions	Accrued Costs⁽¹⁾⁽²⁾		Reasonably Possible Future Costs in Excess of Accrued Costs⁽²⁾		Deferred Costs⁽³⁾
March 31, 2020	$	533	$	448	$	439
December 31, 2019	531		448		436

⁽¹⁾As of March 31, 2020, $163 million is recorded in Other current liabilities and $370 million is recorded in Other non-current liabilities.

⁽²⁾Estimated remediation costs are not discounted to present value. The reasonably possible future costs in excess of accrued costs do not take into consideration amounts expected to be recoverable through overhead charges on U.S. government contracts.

⁽³⁾As of March 31, 2020, $131 million is deferred in Prepaid expenses and other current assets and $308 million is deferred in Other non-current assets. These amounts are evaluated for recoverability on a routine basis.

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 March 31, 2020, or its annual results of operations and/or cash flows. With respect to Bethpage, the State of New York issued a Feasibility Study and an Amended Record of Decision, proposing to impose additional remedial requirements. The company is engaged in discussions with the State of New York and other potentially responsible parties. As discussed in Note 5, 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 March 31, 2020, there were $469 million of stand-by letters of credit and guarantees and $182 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 March 31, 2020, there were $744 million of outstanding short-term commercial paper borrowings at a weighted-average interest rate of 1.88 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 2024 and is intended to support the company’s commercial paper program and other general corporate purposes. Commercial paper borrowings reduce the amount available for

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borrowing under the 2018 Credit Agreement. At March 31, 2020, there was no balance outstanding under this facility.

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 $149 million as of March 31, 2020) (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 March 31, 2020, there was £55 million (the equivalent of approximately $68 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 are recorded in Other current liabilities in the unaudited condensed consolidated statement of financial position.

At March 31, 2020, the company was in compliance with all covenants under its credit agreements.

7. RETIREMENT BENEFITS

The cost to the company of its pension and other postretirement benefit (OPB) plans is shown in the following table:



	Three Months Ended March 31
	Pension Benefits						OPB
$ in millions	2020			2019			2020			2019
Components of net periodic benefit cost (benefit)
Service cost	$	102		$	92		$	4		$	4
Interest cost	307			340			17			20
Expected return on plan assets	(594		)	(525		)	(26		)	(23		)
Amortization of prior service credit	(15		)	(15		)	1			(1		)
Net periodic benefit cost (benefit)	$	(200	)	$	(108	)	$	(4	)	$	—

Employer Contributions

The company sponsors defined benefit pension and OPB plans, as well as defined contribution plans. We 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.

Contributions made by the company to its retirement plans are as follows:



	Three Months Ended March 31
$ in millions	2020		2019
Defined benefit pension plans	$	20	$	23
OPB plans	12		12
Defined contribution plans	256		191

8. STOCK COMPENSATION PLANS AND OTHER COMPENSATION ARRANGEMENTS

Stock Awards

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:



	Three Months Ended March 31
in millions	2020		2019
RSRs granted	0.1		0.1
RPSRs granted	0.2		0.2
Grant date aggregate fair value	$	87	$	91

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.

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Cash Awards

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:



	Three Months Ended March 31
$ in millions	2020		2019
Minimum aggregate payout amount	$	31	$	36
Maximum aggregate payout amount	175		203

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.

9. SEGMENT INFORMATION

The following table presents sales and operating income by segment:



	Three Months Ended March 31
$ in millions	2020			2019
Sales
Aeronautics Systems	$	2,843		$	2,818
Defense Systems	1,881			1,768
Mission Systems	2,347			2,210
Space Systems	1,948			1,801
Intersegment eliminations	(399		)	(408		)
Total sales	8,620			8,189
Operating income
Aeronautics Systems	259			308
Defense Systems	196			202
Mission Systems	348			319
Space Systems	199			188
Intersegment eliminations	(49		)	(50		)
Total segment operating income	953			967
Net FAS (service)/CAS pension adjustment	105			108
Unallocated corporate expense	(124		)	(139		)
Total operating income	$	934		$	936

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

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

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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.

Disaggregation of Revenue



Sales by Customer Type	Three Months Ended March 31
	2020				2019
$ in millions	$		%⁽³⁾		$		%⁽³⁾
Aeronautics Systems
U.S. government⁽¹⁾	$	2,361	83	%	$	2,334	83	%
International⁽²⁾	444		16	%	435		15	%
Other customers	12		—	%	25		1	%
Intersegment sales	26		1	%	24		1	%
Aeronautics Systems sales	2,843		100	%	2,818		100	%
Defense Systems
U.S. government⁽¹⁾	1,259		67	%	1,141		65	%
International⁽²⁾	340		18	%	363		21	%
Other customers	111		6	%	97		5	%
Intersegment sales	171		9	%	167		9	%
Defense Systems sales	1,881		100	%	1,768		100	%
Mission Systems
U.S. government⁽¹⁾	1,671		71	%	1,613		73	%
International⁽²⁾	483		21	%	376		17	%
Other customers	17		1	%	24		1	%
Intersegment sales	176		7	%	197		9	%
Mission Systems sales	2,347		100	%	2,210		100	%
Space Systems
U.S. government⁽¹⁾	1,803		93	%	1,669		93	%
International⁽²⁾	68		3	%	43		2	%
Other customers	51		3	%	69		4	%
Intersegment sales	26		1	%	20		1	%
Space Systems sales	1,948		100	%	1,801		100	%
Total
U.S. government⁽¹⁾	7,094		83	%	6,757		83	%
International⁽²⁾	1,335		15	%	1,217		15	%
Other customers	191		2	%	215		2	%
Total Sales	$	8,620	100	%	$	8,189	100	%


⁽¹⁾	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.

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Sales by Contract Type	Three Months Ended March 31
	2020				2019
$ in millions	$		%⁽¹⁾		$		%⁽¹⁾
Aeronautics Systems
Cost-type	$	1,343	48	%	$	1,312	47	%
Fixed-price	1,474		52	%	1,482		53	%
Intersegment sales	26				24
Aeronautics Systems sales	2,843				2,818
Defense Systems
Cost-type	628		37	%	623		39	%
Fixed-price	1,082		63	%	978		61	%
Intersegment sales	171				167
Defense Systems sales	1,881				1,768
Mission Systems
Cost-type	846		39	%	835		41	%
Fixed-price	1,325		61	%	1,178		59	%
Intersegment sales	176				197
Mission Systems sales	2,347				2,210
Space Systems
Cost-type	1,398		73	%	1,306		73	%
Fixed-price	524		27	%	475		27	%
Intersegment sales	26				20
Space Systems sales	1,948				1,801
Total
Cost-type	4,215		49	%	4,076		50	%
Fixed-price	4,405		51	%	4,113		50	%
Total Sales	$	8,620			$	8,189


⁽¹⁾	Percentages calculated based on external customer sales.

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Sales by Geographic Region	Three Months Ended March 31
	2020				2019
$ in millions	$		%⁽²⁾		$		%⁽²⁾
Aeronautics Systems
United States	$	2,373	84	%	$	2,359	85	%
Asia/Pacific	207		8	%	233		8	%
All other⁽¹⁾	237		8	%	202		7	%
Intersegment sales	26				24
Aeronautics Systems sales	2,843				2,818
Defense Systems
United States	1,370		80	%	1,238		77	%
Asia/Pacific	82		5	%	88		6	%
All other⁽¹⁾	258		15	%	275		17	%
Intersegment sales	171				167
Defense Systems sales	1,881				1,768
Mission Systems
United States	1,688		78	%	1,637		81	%
Asia/Pacific	176		8	%	135		7	%
All other⁽¹⁾	307		14	%	241		12	%
Intersegment sales	176				197
Mission Systems sales	2,347				2,210
Space Systems
United States	1,854		97	%	1,738		98	%
Asia/Pacific	5		—	%	12		—	%
All other⁽¹⁾	63		3	%	31		2	%
Intersegment sales	26				20
Space Systems sales	1,948				1,801
Total
United States	7,285		85	%	6,972		85	%
Asia/Pacific	470		5	%	468		6	%
All other⁽¹⁾	865		10	%	749		9	%
Total Sales	$	8,620			$	8,189


⁽¹⁾	All other is principally comprised of Europe and the Middle East.


⁽²⁾	Percentages calculated based on external customer sales.

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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 March 31, 2020, and the related condensed consolidated statements of earnings and comprehensive inco