NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1
. BASIS OF PRESENTATION
Principles of Consolidation and Reporting
These unaudited condensed consolidated financial statements include the accounts of Northrop Grumman Corporation and subsidiaries (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.
The accompanying unaudited condensed consolidated financial statements are prepared in accordance with the rules of the Securities and Exchange Commission (SEC) for interim reporting purposes. These 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 unaudited condensed consolidated financial statements are not necessarily indicative of results that may be expected for the entire year. These unaudited condensed consolidated financial statements should be read in conjunction with the information contained in the company’s Annual Report on Form 10-K for the year ended December 31, 2015 (2015 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 2015 Annual Report on Form 10-K to reflect changes in the company’s organizational structure and 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
The accompanying unaudited condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The preparation thereof 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 United States (U.S.) Government for the production of goods, the provision of services, or in some cases, a combination of both. In accounting for these contracts, we utilize either the cost-to-cost method or the units-of-delivery method of percentage-of-completion accounting, with cost-to-cost being the predominant method. The company estimates profit on contracts as the difference between total estimated sales and total estimated cost at completion and recognizes that profit either as costs are incurred (cost-to-cost) or as units are delivered (units-of-delivery). The company classifies sales as product or service depending upon the predominant attributes of the contract.
Net Estimate-At-Completion (EAC) Adjustments
- We recognize changes in estimated contract sales, costs or profits using the cumulative catch-up method of accounting. This method recognizes, in the current period, the cumulative effect of the changes on current and prior periods as net EAC adjustments; sales and profit in future periods of contract performance are recognized as if the revised estimates had been used since contract inception. If it is determined that a loss will result from the performance of a contract, the entire amount of the estimable future loss is charged against income in the period the loss is identified. Loss provisions are first offset against any costs that are included in unbilled accounts receivable or inventoried costs, and any remaining amount is reflected in liabilities.
Significant EAC adjustments on a single contract could have a material effect on the company’s unaudited condensed consolidated financial position or results of operations. Where such adjustments occur, we generally disclose the nature, underlying conditions and financial impact of the adjustments. No discrete event or adjustments to an individual contract were material to the accompanying unaudited condensed consolidated financial statements.
NORTHROP GRUMMAN CORPORATION
The following table presents the effect of aggregate net EAC adjustments:
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|
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Three Months Ended March 31
|
$ in millions, except per share data
|
2016
|
|
2015
|
Operating Income
|
$
|
129
|
|
|
$
|
187
|
|
Net Earnings
(1)
|
84
|
|
|
122
|
|
Diluted earnings per share
(1)
|
0.46
|
|
|
0.61
|
|
|
|
(1)
|
Based on statutory tax rates
|
Contract sales may include estimated amounts not contractually agreed to by the customer, including cost or
performance incentives (such as award and incentive fees), un-priced change orders, contract claims and requests for
equitable adjustment (REAs). Further, as contracts are performed, change orders can be a regular occurrence and
may be un-priced until negotiated with the customer. Un-priced change orders, contract claims (including change orders unapproved as to both scope and price) and REAs are included in estimated contract sales when management believes it is probable the un-priced change order, claim and/or REA will result in additional contract revenue and the amount can be reliably estimated based on the facts and circumstances known to us at the time. As of
March 31, 2016
, the company has initiated REAs with the U.S. government and an international customer seeking recovery of approximately
$300 million
under contracts related to two Aerospace Systems programs. A substantial portion of the REAs was initiated during the fourth quarter of 2015. The REAs relate to what we believe is work performed by the company at the direction of our customers that is beyond the scope of the related contracts as well as costs incurred by the company as a result of customer-caused delays and disruption. The total amount of additional contract sales we have assumed as of
March 31, 2016
is approximately
$225 million
. We are currently negotiating the REAs and the terms of the contracts with our customers. Recognized amounts related to claims and REAs as of March 31, 2015 were not material individually or in aggregate.
As of
March 31, 2016
, the company does not have any contract terminations in process that we anticipate would have a material effect on our unaudited condensed consolidated financial position, or our annual results of operations and/or cash flows.
Related Party Transactions
For all periods presented, the company had no material related party transactions.
Accounting Standards Updates
On March 30, 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-09,
Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
. The company adopted ASU 2016-09 during the first quarter of 2016. Among other things, the ASU requires that entities recognize excess tax benefits and deficiencies related to employee share-based payment transactions as income tax expense or benefit. The ASU also eliminates the requirement to reclassify excess tax benefits and deficiencies from operating activities to financing activities in the statement of cash flows. As a result of adoption, the company recognized an
$80 million
tax benefit as a discrete item during the first quarter of 2016. Adoption also resulted in an
$80 million
increase in operating cash flows and a corresponding
$80 million
reduction in financing cash flows for the period ended March 31, 2016.
On February 25, 2016, the FASB issued ASU No. 2016-02,
Leases (Topic 842)
. ASU 2016-02 supersedes existing lease guidance, including Accounting Standards Codification (ASC) 840 -
Leases
. Among other things, the new standard requires recognition of a right-of-use asset and liability for future lease payments for contracts that meet the definition of a lease. ASU 2016-02 will be effective January 1, 2019, although early adoption is permitted. The standard must be applied using a modified retrospective approach. We are currently evaluating the timing of adoption as well as the effect ASU 2016-02 will have on the company’s consolidated financial position, annual results of operations and cash flows.
On May 28, 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with Customers
.
ASU 2014-09 supersedes existing revenue recognition guidance, including ASC 605-35,
Revenue Recognition - Construction-Type and Production-Type Contracts.
ASU 2014-09 outlines a single set of comprehensive principles for recognizing revenue under U.S. GAAP. Among other things, it requires companies to identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time. These concepts, as well as other aspects of ASU 2014-09, may change the method and/or timing of revenue recognition for certain of our contracts.
On July 9, 2015, the FASB approved a one year deferral of the effective date of ASU 2014-09 to
NORTHROP GRUMMAN CORPORATION
annual reporting periods beginning after December 15, 2017. ASU 2014-09 may be applied either retrospectively or through the use of a modified-retrospective method. We are currently evaluating both methods of adoption as well as the effect ASU 2014-09 will have on the company’s consolidated financial position, annual results of operations and cash flows.
Other accounting standards updates effective after
March 31, 2016
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.
Reclassifications
The company adopted ASU 2015-03,
Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs
, during the first quarter of 2016. As a result, we now present capitalized debt issuance costs as a reduction in the carrying amount of long-term debt. This change resulted in a reclassification of
$30 million
and
$27 million
of other non-current assets reported in our 2015 and 2014 consolidated statements of financial position to long-term debt, which reduced our previously reported total assets and total liabilities as of December 31, 2015 and 2014.
Shareholders’ Equity
The company records the difference between the cost of shares repurchased and their par value as well as tax withholding in excess of related stock compensation expense as a reduction of paid-in capital to the extent available and then as a reduction of retained earnings.
Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss are as follows:
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$ in millions
|
March 31,
2016
|
|
December 31, 2015
|
Unamortized benefit plan costs, net of tax benefit of $3,288 as of March 31, 2016 and $3,350 as of December 31, 2015
|
$
|
(5,140
|
)
|
|
$
|
(5,241
|
)
|
Cumulative translation adjustment
|
(86
|
)
|
|
(82
|
)
|
Net unrealized gain on marketable securities and cash flow hedges, net of tax
|
2
|
|
|
3
|
|
Total accumulated other comprehensive loss
|
$
|
(5,224
|
)
|
|
$
|
(5,320
|
)
|
Unamortized benefit plan costs consist primarily of net after-tax actuarial losses totaling
$5.3 billion
and
$5.5 billion
as of
March 31, 2016
and
December 31, 2015
, respectively. Net actuarial gains or losses are re-determined annually or upon remeasurement events and principally arise from changes in the interest rate used to discount our benefit obligations and differences between expected and actual returns on plan assets.
Reclassifications from accumulated other comprehensive loss to net earnings related to the amortization of benefit plan costs were
$101 million
and
$96 million
, net of taxes, for the
three
months ended
March 31, 2016
and
2015
, respectively. The reclassifications represent the amortization of net actuarial losses and prior service credits for the company’s retirement benefit plans, and are included in the computation of net periodic pension cost. See Note
8
for further information.
Reclassifications from accumulated other comprehensive loss to net earnings, relating to cumulative translation adjustments, marketable securities and effective cash flow hedges for the
three
months ended
March 31, 2016
and
2015
, respectively, were not material. Reclassifications for cumulative translation adjustments and marketable securities are recorded in other income, and reclassifications for effective cash flow hedges are recorded in operating income.
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 includes the dilutive effect of awards granted to employees under stock-based compensation plans. The dilutive effect of these securities totaled
2.1 million
shares and
2.8 million
shares for the
three
months ended
March 31, 2016
and
2015
, respectively.
NORTHROP GRUMMAN CORPORATION
Share Repurchases
On May 15, 2013, the company’s board of directors authorized a share repurchase program of up to
$4.0 billion
of the company’s common stock (2013 Repurchase Program). Repurchases under the 2013 Repurchase Program commenced in September 2013 and were completed in March 2015. On December 4, 2014, the company’s board of directors authorized a new share repurchase program of up to
$3.0 billion
of the company’s common stock (2014 Repurchase Program). Repurchases under the 2014 Repurchase Program commenced in March 2015 and were completed in March 2016.
On September 16, 2015, the company’s board of directors authorized a new share repurchase program of up to
$4.0 billion
of the company’s common stock (2015 Repurchase Program). Repurchases under the 2015 Repurchase Program commenced in March 2016 upon the completion of the company’s 2014 Repurchase Program. As of
March 31, 2016
, repurchases under the 2015 Repurchase Program totaled
$11 million
; approximately
$4.0 billion
remained under this share repurchase authorization. By its terms, the 2015 Repurchase Program is set to expire when we have used all authorized funds for repurchases.
Share repurchases take place from time to time, subject to market conditions and management’s discretion, in the open market or in privately negotiated transactions. The company retires its common stock upon repurchase and has not made any purchases of common stock other than in connection with these publicly announced repurchase programs in the periods presented.
The table below summarizes the company’s share repurchases to date under the authorizations described above:
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Shares Repurchased
(in millions)
|
Repurchase Program
Authorization Date
|
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Amount
Authorized
(in millions)
|
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Total
Shares Retired
(in millions)
|
|
Average
Price
Per Share
(1)
|
|
Date Completed
|
|
Three Months Ended March 31
|
|
2016
|
|
2015
|
May 15, 2013
|
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$
|
4,000
|
|
|
32.8
|
|
|
$
|
121.97
|
|
|
March 2015
|
|
—
|
|
|
2.7
|
|
December 4, 2014
|
|
$
|
3,000
|
|
|
18.0
|
|
|
$
|
166.70
|
|
|
March 2016
|
|
1.4
|
|
|
2.6
|
|
September 16, 2015
|
|
$
|
4,000
|
|
|
0.1
|
|
|
$
|
198.61
|
|
|
|
|
0.1
|
|
|
—
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|
|
|
(1)
|
Includes commissions paid.
|
Dividends on Common Stock
In May 2015, the company increased the quarterly common stock dividend
14
percent to
$0.80
per share from the previous amount of
$0.70
per share.
3
. SEGMENT INFORMATION
The company is aligned in
three
operating sectors, which also comprise our reportable segments: Aerospace Systems, Mission Systems and Technology Services. Effective January 1, 2016, the company streamlined our sectors from four to three to better align our business with the evolving needs of our customers and enhance innovation across the company. Mission Systems and Technology Services were created by merging elements of our former Electronic Systems, Information Systems and Technical Services sectors. The new Mission Systems sector is composed of the majority of our former Electronic Systems sector and the businesses from our former Information Systems sector focused on the development of new capabilities for our military and intelligence customers. The new Technology Services sector was formed by combining the services portfolio in the former Information Systems sector with the former Technical Services sector. Among other operations that were realigned, the military and civil space hardware business in Azusa, California, previously reporting to the Electronic Systems sector, moved to the Aerospace Systems sector, and the electronic attack business, previously in the Aerospace Systems sector, moved to the Mission Systems sector.
NORTHROP GRUMMAN CORPORATION
The following table presents sales and operating income by segment:
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Three Months Ended March 31
|
$ in millions
|
2016
|
|
2015
|
Sales
|
|
|
|
Aerospace Systems
|
$
|
2,574
|
|
|
$
|
2,498
|
|
Mission Systems
|
2,693
|
|
|
2,711
|
|
Technology Services
|
1,214
|
|
|
1,267
|
|
Intersegment eliminations
|
(525
|
)
|
|
(519
|
)
|
Total sales
|
5,956
|
|
|
5,957
|
|
Operating income
|
|
|
|
Aerospace Systems
|
286
|
|
|
312
|
|
Mission Systems
|
353
|
|
|
344
|
|
Technology Services
|
126
|
|
|
133
|
|
Intersegment eliminations
|
(64
|
)
|
|
(54
|
)
|
Total segment operating income
|
701
|
|
|
735
|
|
Reconciliation to total operating income:
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|
Net FAS/CAS pension adjustment
|
74
|
|
|
83
|
|
Unallocated corporate expenses
|
(33
|
)
|
|
(38
|
)
|
Other
|
(3
|
)
|
|
—
|
|
Total operating income
|
$
|
739
|
|
|
$
|
780
|
|
Net FAS/CAS Pension Adjustment
For financial statement purposes, we account for our employee pension plans in accordance with GAAP under FAS (GAAP Financial Accounting Standards). 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) that govern such plans. The net FAS/CAS pension adjustment
reflects the difference between CAS pension expense included as cost in segment operating income and FAS expense determined in accordance with GAAP.
The
decrease
in net FAS/CAS pension adjustment for the
three
months ended
March 31, 2016
, as compared with the same period in
2015
, is primarily due to lower than expected asset returns during 2015, partially offset by the increase in our FAS discount rate assumption as of December 31, 2015 and the continued phase-in of the effects of CAS harmonization.
Unallocated Corporate Expenses
Unallocated corporate expenses include the portion of corporate expenses not considered allowable or allocable under applicable CAS or
the FAR, and therefore not allocated to the segments. Such costs consist of a portion of management and administration, legal, environmental, compensation costs, retiree benefits and certain unallowable costs such as lobbying activities, among others.
Unallocated corporate expenses
decreased
for the
three
months ended
March 31, 2016
, as compared to the same period in
2015
, principally due to higher deferred state taxes in 2015 resulting from a
$500 million
discretionary pension contribution made in the first quarter of 2015, partially offset by an increase in environmental costs.
4. INCOME TAXES
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|
Three Months Ended March 31
|
$ in millions
|
2016
|
|
2015
|
Federal and foreign income tax expense
|
$
|
120
|
|
|
$
|
220
|
|
Effective income tax rate
|
17.8
|
%
|
|
31.3
|
%
|
NORTHROP GRUMMAN CORPORATION
The company’s effective tax rate for the
three
months ended
March 31, 2016
was lower than the comparable 2015 period principally due to an
$80 million
benefit recognized in the first quarter of 2016 resulting from the adoption of ASU No. 2016-09 described in Note 1 and extension of the research tax credit, partially offset by the absence of refund claims filed in 2015.
We file income tax returns in the U.S. federal jurisdiction and in various state and foreign jurisdictions. Our 2007-2013 tax returns are currently either under Internal Revenue Service examination or appeals. The company believes it is reasonably possible that within the next twelve months, we may resolve certain matters related to the years under examination or appeals, resulting in a reduction of our unrecognized tax benefits up to
$175 million
and a reduction of our income tax expense up to
$45 million
.
5
. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents comparative carrying value and fair value information for our financial assets and liabilities:
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|
|
|
|
|
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|
|
March 31, 2016
|
|
December 31, 2015
|
$ in millions
|
Carrying
Value
|
|
Fair
Value
|
|
Carrying
Value
|
|
Fair
Value
|
Financial Assets (Liabilities)
|
|
|
|
|
|
|
|
Marketable securities
|
|
|
|
|
|
|
|
Trading
|
$
|
300
|
|
|
$
|
300
|
|
|
$
|
303
|
|
|
$
|
303
|
|
Available-for-sale
|
6
|
|
|
6
|
|
|
7
|
|
|
7
|
|
Derivatives
|
5
|
|
|
5
|
|
|
5
|
|
|
5
|
|
Long-term debt, including current portion
|
$
|
(6,389
|
)
|
|
$
|
(7,097
|
)
|
|
$
|
(6,496
|
)
|
|
$
|
(6,907
|
)
|
There were no transfers of financial instruments between the three levels of the fair value hierarchy during the
three
months ended
March 31, 2016
.
The carrying value of cash and cash equivalents approximates fair value.
Investments in Marketable Securities
The company holds a portfolio of marketable securities consisting of securities that are classified as either trading or available-for-sale to partially fund non-qualified employee benefit plans. These assets are recorded at fair value on a recurring basis and substantially all of these instruments are valued using Level 1 inputs, with an immaterial amount valued using Level 2 inputs. As of
March 31, 2016
and
December 31, 2015
, marketable securities of
$306 million
and
$310 million
, respectively, were included in other non-current assets in the unaudited condensed consolidated statements of financial position.
Derivative Financial Instruments and Hedging Activities
The company’s derivative portfolio consists primarily of foreign currency forward contracts. The notional value of the company’s derivative portfolio at
March 31, 2016
and
December 31, 2015
, was
$129 million
and
$141 million
, respectively. The portion of the notional value designated as cash flow hedges at
March 31, 2016
and
December 31, 2015
, was
$7 million
and
$10 million
, respectively. Substantially all of these instruments are valued using Level 2 inputs. 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 derivative fair values and related unrealized gains/losses at
March 31, 2016
and
December 31, 2015
, were not material.
Long-term Debt
The fair value of long-term debt is calculated using Level 2 inputs based on interest rates available for debt with terms and maturities similar to the company’s existing debt arrangements.
Unsecured Senior Notes
In February 2015, the company issued
$600 million
of unsecured senior notes due
April 15, 2045
with a fixed interest rate of
3.85 percent
. We used the net proceeds from this offering for general corporate purposes,
i
ncluding the funding of a
$500 million
voluntary contribution to our pension plans in the first quarter of 2015 and a debt repayment of
$107 million
in the first quarter of 2016.
NORTHROP GRUMMAN CORPORATION
6
. INVESTIGATIONS, CLAIMS AND LITIGATION
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 December 19, 2014, the company filed a motion for partial summary judgment asking the court to dismiss the principal counterclaim referenced above. On June 29, 2015, the Court heard argument and denied that motion without prejudice to filing a later motion to dismiss. Although the ultimate outcome of these matters (“the FSS matters,” collectively), including any possible loss, cannot be predicted or 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
$31 million
as of
March 31, 2016
), 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
$24 million
as of
March 31, 2016
) in damages. In October 2013, ECT asserted an additional damage claim of
R$22 million
(the equivalent of approximately
$6 million
as of
March 31, 2016
). 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
$35 million
as of
March 31, 2016
), 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. At some future point, the court is expected to issue a decision on the parties’ claims and counterclaims that could accept or reject, in whole or in part, the expert’s recommended findings.
The company is one of several defendants in litigation brought by the Orange County Water District in Orange County Superior Court in California on December 17, 2004, for alleged contribution to volatile organic chemical contamination of the County’s shallow groundwater. The lawsuit includes counts against the defendants for violation of the Orange County Water District Act, the California Super Fund Act, negligence, nuisance, trespass and declaratory relief. Among other things, the lawsuit seeks unspecified damages for the cost of remediation, payment of attorney fees and costs, and punitive damages. Trial on the statutory claims (those based on the Orange County Water District Act, the California Super Fund Act and declaratory relief) concluded on September 25, 2012. On October 29, 2013, the court issued its decision in favor of the defendants on the statutory claims. On May 9, 2014,
NORTHROP GRUMMAN CORPORATION
the court granted defendants’ dispositive motions on the remaining tort causes of action. Notice of entry of judgment was filed on July 1, 2014. The Orange County Water District filed a notice of appeal on August 28, 2014. The Orange County Water District filed its opening brief on October 14, 2015. The company has filed its response. The Orange County Water District’s reply is currently due in the second quarter of 2016.
The company is a party to various investigations, lawsuits, claims 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, and other than with respect to the FSS matters discussed separately above, the company does not believe that the outcome of any matter 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, 2016
, or its annual results of operations or cash flows.
7
. COMMITMENTS AND CONTINGENCIES
Guarantees of Subsidiary Performance Obligations
From time to time in the ordinary course of business, the company guarantees obligations of its subsidiaries under certain contracts. Generally, the company is liable under such an arrangement only if its subsidiary is unable to perform under its contract. Historically, the company has not incurred any substantial liabilities resulting from these guarantees.
In addition, the company’s subsidiaries may enter into joint ventures, teaming and other business arrangements (collectively, Business Arrangements) to support our products and services in U.S. and international markets. The company generally strives to limit its exposure under these arrangements to its subsidiary’s investment in the Business Arrangements or to the extent of such subsidiary’s obligations under the applicable contract. In some cases, however, the company may be required to guarantee performance by the Business Arrangements and, in such cases, the company generally strives to obtain cross-indemnification from the other members of the Business Arrangements.
At
March 31, 2016
, the company is not aware of any existing event of default that would require it to satisfy any of these guarantees.
U.S. Government Cost Claims
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 the U.S. Government representatives engage in discussions to enable the company to evaluate the merits of these claims, as well as to assess the amounts being claimed. Where appropriate, provisions are made to reflect the company’s estimated exposure for matters raised by the U.S. Government. 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 estimable, and the outcome of any such matters would not have a material adverse effect on its unaudited condensed consolidated financial position as of
March 31, 2016
, or its annual results of operations and/or cash flows.
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
March 31, 2016
and
December 31, 2015
:
|
|
|
|
|
|
|
|
|
|
|
|
$ in millions
|
|
Range of Reasonably Possible Future Costs
(1)
|
|
Accrued Costs
(2)
|
|
Deferred Costs
(3)
|
March 31, 2016
|
|
$364 - $808
|
|
$
|
377
|
|
|
$
|
192
|
|
December 31, 2015
|
|
353 - 812
|
|
370
|
|
|
186
|
|
|
|
(1)
|
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
March 31, 2016
,
$110 million
is recorded in other current liabilities and
$267 million
is recorded in other non-current liabilities.
(3)
As of
March 31, 2016
,
$62 million
is deferred in inventoried costs and
$130 million
is deferred in other non-current assets. These amounts are evaluated for recoverability on a routine basis.
NORTHROP GRUMMAN CORPORATION
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, we do not anticipate 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, 2016
, or its annual results of operations and/or cash flows.
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, 2016
, there were
$238 million
of stand-by letters of credit and guarantees and
$150 million
of surety bonds outstanding.
Indemnifications
The company has retained certain environmental, income tax and other potential liabilities in connection with certain of its divestitures. The settlement of these liabilities is not expected to have a material adverse effect on the company’s unaudited condensed consolidated financial position as of
March 31, 2016
, or its annual results of operations and/or cash flows.
Operating Leases
Rental expense for operating leases was
$91 million
and
$81 million
for the
three
months ended
March 31, 2016
and
2015
, respectively. These amounts are net of immaterial amounts of sublease rental income.
Credit Facility
The company maintains an unsecured credit facility in an aggregate principal amount of
$1.6 billion
(the “Credit Agreement”) that matures in July 2020. At March 31, 2016, the company was in compliance with all covenants under the Credit Agreement and there was
no
balance outstanding.
8
. RETIREMENT BENEFITS
The cost to the company of its retirement plans is shown in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31
|
|
Pension
Benefits
|
|
Medical and
Life Benefits
|
$ in millions
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Components of net periodic benefit cost
|
|
|
|
|
|
|
|
Service cost
|
$
|
112
|
|
|
$
|
121
|
|
|
$
|
8
|
|
|
$
|
9
|
|
Interest cost
|
321
|
|
|
306
|
|
|
24
|
|
|
24
|
|
Expected return on plan assets
|
(463
|
)
|
|
(494
|
)
|
|
(21
|
)
|
|
(22
|
)
|
Amortization of:
|
|
|
|
|
|
|
|
Prior service credit
|
(15
|
)
|
|
(15
|
)
|
|
(6
|
)
|
|
(7
|
)
|
Net loss from previous years
|
178
|
|
|
171
|
|
|
3
|
|
|
6
|
|
Net periodic benefit cost
|
$
|
133
|
|
|
$
|
89
|
|
|
$
|
8
|
|
|
$
|
10
|
|
Employer Contributions
The company sponsors defined benefit pension and post-retirement 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. Additionally, in the first quarter of 2015, we made a voluntary pension contribution of
$500 million
.
NORTHROP GRUMMAN CORPORATION
Contributions made by the company to its retirement plans are as follows:
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31
|
$ in millions
|
2016
|
|
2015
|
Defined benefit pension plans
|
$
|
27
|
|
|
$
|
525
|
|
Medical and life benefit plans
|
11
|
|
|
6
|
|
Defined contribution plans
|
87
|
|
|
85
|
|
9. 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
|
|
2016
|
2015
|
RSRs granted
|
|
0.2
|
|
0.2
|
|
RPSRs granted
|
|
0.3
|
|
0.4
|
|
Grant date aggregate fair value
|
|
$
|
87
|
|
$
|
87
|
|
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 for the
three
-year period beginning January 1 of the year of grant.
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
|
|
2016
|
2015
|
Minimum aggregate payout amount
|
|
$
|
34
|
|
$
|
34
|
|
Maximum aggregate payout amount
|
|
193
|
|
190
|
|
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 for a
three
-year period beginning January 1 of the year of grant.