Northrop Grumman - 10-Q quarterly report FY

 

 

 

 

 

 

 

 

 

For the Quarter Ended June 30, 2002

Commission file number 1-16411

 

 

(Exact name of registrant as specified in its charter)

 

 

DELAWARE		95-4840775
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

 

 

www.northropgrumman.com

 

(Address of principal executive offices and internet site)

 

 

(Registrant’s telephone number, including area code)

Securities Registered pursuant to Section 12(g) of the Act:

 

None

 

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 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 x

No ¨

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

Indicate the number of shares outstanding of each of the issuer’s classes of stock, as of the latest practicable date.

 

As of July 26, 2002

 

Common stock outstanding		112,964,781 shares
Preferred stock outstanding		3,500,000 shares

 

 

Northrop Grumman Corporation and Subsidiaries

 

 

 

 

$ in millions		(Unaudited) June 30, 2002			December 31, 2001
Assets:
Cash and cash equivalents		$    196			$    464
Accounts receivable, net of progress payments of $16,188 in 2002 and $13,609 in 2001		2,696			2,735
Inventoried costs, net of progress payments of $1,005 in 2002 and $900 in 2001		1,163			1,226
Deferred income taxes		57			36
Prepaid expenses and other current assets		141			128
Total current assets		4,253			4,589
Property, plant and equipment		4,356			3,940
Accumulated depreciation		(1,356	)		(1,173	)
Net property, plant and equipment		3,000			2,767
Goodwill, net of accumulated amortization of $774 in 2002 and 2001		8,840			8,668
Other purchased intangibles, net of accumulated amortization of $696 in 2002 and $606 in 2001		1,661			1,139
Prepaid retiree benefits cost and intangible pension asset		3,175			3,075
Benefit trust funds		270			433
Miscellaneous other assets, including deferred income taxes of $11 in 2002 and $2 in 2001		185			179
Total other assets		14,131			13,494
Total Assets		$21,384			$20,850

I-1

Northrop Grumman Corporation and Subsidiaries

 

$ in millions		(Unaudited) June 30, 2002			December 31, 2001
Liabilities and Shareholders’ Equity:
Notes payable to banks		$    146			$       38
Current portion of long-term debt		104			420
Trade accounts payable		867			1,019
Accrued employees’ compensation		669			847
Advances on contracts		540			656
Contract loss provisions		888			843
Income taxes payable and current deferred income taxes		722			481
Other current liabilities		847			828
Total current liabilities		4,783			5,132
Long-term debt		4,915			5,039
Accrued retiree benefits		2,237			1,931
Deferred income taxes		753			669
Other long-term liabilities		307			216
Minority interest		17			122
Mandatorily redeemable preferred stock		350			350
Paid-in capital
Preferred stock, 10,000,000 shares authorized; 3,500,000 shares issued and outstanding, reported above
Common stock, 800,000,000 shares authorized; issued and outstanding:
2002—113,011,735; 2001—108,556,081		4,849			4,451
Retained earnings		3,240			3,011
Unearned compensation		(15	)		(18	)
Accumulated other comprehensive loss		(52	)		(53	)
Total shareholders’ equity		8,022			7,391
Total Liabilities and Shareholders’ Equity		$21,384			$20,850

 

 

I-2

 

Northrop Grumman Corporation and Subsidiaries

 

(Unaudited)

		Three months ended June 30,								Six months ended June 30,
$ in millions, except per share		2002				2001				2002				2001
Product sales and service revenues		$	4,396			$	3,663			$	8,482			$	5,649
Cost of product sales and service revenues
Operating costs			3,587				3,019				6,973				4,567
Administrative and general expenses			453				369				840				617
Operating margin			356				275				669				465
Interest expense			(105	)			(114	)			(214	)			(161	)
Other, net			13				31				25				48
Income before income taxes			264				192				480				352
Federal and foreign income taxes			82				78				149				135
Net income		$	182			$	114			$	331			$	217
Weighted average common shares outstanding, in millions			112.84				83.41				112.12				77.67
Basic earnings per common share		$	1.56			$	1.29			$	2.85			$	2.72
Diluted earnings per common share		$	1.53			$	1.28			$	2.80			$	2.69
Dividends per common share		$	.40			$	.40			$	.80			$	.80
Dividends per mandatorily redeemable preferred share		$	1.75			$	1.69			$	3.50			$	1.69

 

 

I-3

 

Northrop Grumman Corporation and Subsidiaries

 

 

		Six months ended June 30,
$ in millions		2002			2001
Paid-in Capital
At beginning of year		$4,451			$1,200
Stock issued in purchase of businesses		308			1,123
Employee stock awards and options exercised		90			53
		4,849			2,376
Retained Earnings
At beginning of year		3,011			2,742
Net income		331			217
Cash dividends		(102	)		(69	)
		3,240			2,890
Unearned Compensation
At beginning of year		(18	)
Issuance of unvested stock options					(33	)
Amortization of unearned compensation		3			2
		(15	)		(31	)
Accumulated Other Comprehensive Loss
At beginning of year		(53	)		(23	)
Change in cumulative translation adjustment		1			(1	)
		(52	)		(24	)
Total shareholders’ equity		$8,022			$5,211

 

 

I-4

 

Northrop Grumman Corporation and Subsidiaries

 

 

		Six months ended June 30,
$ in millions		2002			2001
Operating Activities
Sources of Cash
Cash received from customers
Progress payments		$2,903			$   756
Other collections		5,634			5,151
Interest received		62			14
Income tax refunds received		53			4
Other cash receipts		21			9
Cash provided by operating activities		8,673			5,934
Uses of Cash
Cash paid to suppliers and employees		7,909			5,792
Interest paid		200			104
Income taxes paid		88			50
Other cash payments		3			2
Cash used in operating activities		8,200			5,948
Net cash provided by (used in) operating activities		473			(14	)
Investing Activities
Payment for businesses purchased, net of cash acquired		(166	)		(2,303	)
Additions to property, plant and equipment		(214	)		(132	)
Proceeds from sale of property, plant and equipment		15			52
Other investing activities		(7	)		16
Net cash used in investing activities		(372	)		(2,367	)
Financing Activities
Proceeds from issuance of long-term debt					1,491
Borrowings under line of credit		508			1,172
Repayments of borrowings under line of credit		(400	)		(253	)
Principal payments of long-term debt/capital leases		(440	)		(10	)
Proceeds from issuance of stock		65			19
Dividends paid		(102	)		(69	)
Other financing activities					(63	)
Net cash (used in) provided by financing activities		(369	)		2,287
Decrease in cash and cash equivalents		(268	)		(94	)
Cash and cash equivalents balance at beginning of period		464			319
Cash and cash equivalents balance at end of period		$   196			$   225

I-5

 

Northrop Grumman Corporation and Subsidiaries

 

		Six months ended June 30,
$ in millions		2002			2001
Reconciliation of Net Income to Net Cash Provided by (Used in) Operating Activities:
Net income		$   331			$   217
Adjustments to reconcile net income to net cash provided (used)
Depreciation		204			113
Amortization of intangible assets		89			153
Common stock issued to employees		26			3
Gain on disposals of property, plant and equipment		(5	)		(12	)
Retiree benefits expense (income)		19			(123	)
Increase in
Accounts receivable		(2,510	)		(357	)
Inventoried costs		(61	)		(266	)
Prepaid expenses and other current assets		(10	)		(6	)
Increase (decrease) in
Progress payments		2,681			546
Accounts payable and accruals		(362	)		(390	)
Provisions for contract losses		33			15
Deferred income taxes		(317	)		190
Income taxes payable		428			(77	)
Retiree benefits		(97	)		(38	)
Other noncash transactions		24			18
Net cash provided by (used in) operating activities		$   473			$     (14	)
Noncash Investing and Financing Activities:
Conversion of debt to equity		$3
Purchase of businesses
Fair value of assets acquired		$   765			$7,922
Cash paid		(166	)		(2,303	)
Common stock issued		(308	)		(1,123	)
Mandatorily redeemable preferred stock issued					(350	)
Liabilities assumed		$   291			$4,146

 

 

I-6

Northrop Grumman Corporation and Subsidiaries

 

 

		Three months ended June 30,								Six months ended June 30,
$ in millions		2002				2001				2002				2001
Net Sales
Electronic Systems		$	1,338			$	1,236			$	2,576			$	1,937
Ships			1,157				549				2,234				549
Information Technology			1,036				1,017				1,965				1,606
Integrated Systems			829				766				1,636				1,499
Component Technologies			130				158				255				158
Intersegment eliminations			(94	)			(63	)			(184	)			(100	)
Total Net Sales		$	4,396			$	3,663			$	8,482			$	5,649
Operating Margin (Loss)
Electronic Systems		$	117			$	86			$	216			$	122
Ships			95				33				174				33
Information Technology			40				48				90				72
Integrated Systems			99				64				192				144
Component Technologies			(2	)			(6	)			(6	)			(6	)
Total segment operating margin			349				225				666				365
Adjustments to reconcile to total operating margin:
Royalty income reclassification			(4	)			(7	)			(10	)			(7	)
Unallocated corporate expenses			(16	)			(30	)			(36	)			(39	)
Unallocated state tax benefit (provision)			4				(4	)			2				(14	)
Pension income			23				91				47				160
Total Operating Margin		$	356			$	275			$	669			$	465
Contract Acquisitions
Electronic Systems		$	1,199			$	2,231			$	2,669			$	3,218
Ships			1,207				5,824				3,054				5,824
Information Technology			1,004				1,437				2,077				2,073
Integrated Systems			580				448				1,890				1,063
Component Technologies			139				281				268				281
Intersegment eliminations			(116	)			(104	)			(169	)			(142	)
Total Contract Acquisitions		$	4,013			$	10,117			$	9,789			$	12,317
Funded Order Backlog
Electronic Systems										$	6,124			$	6,260
Ships											10,592				5,275
Information Technology											1,548				1,410
Integrated Systems											3,777				3,855
Component Technologies											231				123
Intersegment eliminations											(234	)			(149	)
Total Funded Order Backlog										$	22,038			$	16,774

I-7

 

Northrop Grumman Corporation and Subsidiaries

 

(Unaudited)

 

 

The unaudited consolidated condensed financial statements include the accounts of Northrop Grumman Corporation (the company) and its subsidiaries. All material intercompany accounts, transactions and profits are eliminated in consolidation. See the “Acquisitions” and “Proposed Acquisition” footnotes contained herein for additional information.

 

 

 

Certain prior year amounts have been reclassified to conform to the 2002 presentation.

 

 

Basic earnings per share are calculated by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during each period, after giving recognition to stock splits and stock dividends. Net income available to common shareholders is calculated by reducing net income by the amount of dividends accrued on mandatorily redeemable preferred stock. Diluted earnings per share reflect the dilutive effect of stock options and other stock awards granted to employees under stock-based compensation plans and the dilutive effect of the equity security units. Shares issuable pursuant to mandatorily redeemable preferred stock have not been included in the diluted earnings per share calculation because their effect is currently anti-dilutive.

I-8

 

Northrop Grumman Corporation and Subsidiaries

 

		Three months ended June 30,						Six months ended June 30,
$ in millions, except per share		2002			2001			2002			2001
Basic Earnings per Share
Net income		$	182		$	114		$	331		$	217
Less preferred dividends			6			6			12			6
Income available to common shareholders		$	176		$	108		$	319		$	211
Weighted-average common shares outstanding, in millions			112.84			83.41			112.12			77.67
Basic earnings per share		$	1.56		$	1.29		$	2.85		$	2.72
Diluted Earnings per Share
Net income		$	182		$	114		$	331		$	217
Less preferred dividends			6			6			12			6
Income available to common shareholders		$	176		$	108		$	319		$	211
Weighted-average common shares outstanding			112.84			83.41			112.12			77.67
Dilutive effect of stock options and awards and equity security units			1.98			.64			1.67			.70
Weighted-average diluted shares outstanding, in millions			114.82			84.05			113.79			78.37
Diluted earnings per share		$	1.53		$	1.28		$	2.80		$	2.69

 

 

Effective January 1, 2002, the company adopted Statement of Financial Accounting Standards (SFAS) No. 142 – Goodwill and Other Intangible Assets, which changes the accounting for goodwill from an amortization method to an impairment-only approach. Impairment tests are required as of the company-determined measurement date and at the same time in subsequent years. In accordance with the statement, amortization of goodwill, including goodwill recorded in past business combinations, ceased December 31, 2001. During the second quarter of 2002, the company completed the first step of the required initial test for potential impairment of goodwill recorded at January 1, 2002. The results indicate potential impairment only in the reporting units of the Component Technologies sector. The second step of the goodwill impairment test, used to measure the amount of impairment loss, will be completed no later than December 31, 2002.

 

I-9

 

Northrop Grumman Corporation and Subsidiaries

 

 

 

		Electronic					Information		Integrated		Component
$ in millions		Systems		Ships			Technology		Systems		Technologies		Total
Balance as of January 1, 2002		$2,590		$3,308			$1,109		$938		$723		$8,668
Goodwill acquired during the period				322									322
Fair value adjustments to net assets acquired		2		(166	)		8				6		(150	)
Balance as of June 30, 2002		$2,592		$3,464			$1,117		$938		$729		$8,840

 

 

 

		Gross
		Carrying		Accumulated
$ in millions		Amount		Amortization
Contract and program intangibles		$2,220		$(634	)
Other purchased intangibles		137		(62	)
Total		$2,357		$(696	)

 

 

$ in millions
Year Ended December 31,
2002		$	178
2003			175
2004			174
2005			159
2006			96

 

I-10

 

Northrop Grumman Corporation and Subsidiaries

 

		Three months ended June 30,						Six months ended June 30,
$ in millions		2002			2001			2002			2001
Operating Margin(Loss)
Electronic Systems – as reported		$ 117			$   86			$ 216			$ 122
Add back goodwill amortization					21						38
Electronic Systems – adjusted		117			107			216			160
Ships – as reported		95			33			174			33
Add back goodwill amortization					9						9
Ships – adjusted		95			42			174			42
Information Technology – as reported		40			48			90			72
Add back goodwill amortization					16						26
Information Technology – adjusted		40			64			90			98
Integrated Systems – as reported		99			64			192			144
Add back goodwill amortization					8						16
Integrated Systems – adjusted		99			72			192			160
Component Technologies – as reported		(2	)		(6	)		(6	)		(6	)
Add back goodwill amortization					9						9
Component Technologies – adjusted		(2	)		3			(6	)		3
Segment Operating Margin – as reported		349			225			666			365
Add back goodwill amortization					63						98
Segment Operating Margin – adjusted		$ 349			$ 288			$ 666			$ 463
Total Operating Margin – as reported		$ 356			$ 275			$ 669			$ 465
Add back goodwill amortization					63						98
Total Operating Margin – adjusted		$ 356			$ 338			$ 669			$ 563
Net Income
As reported		$ 182			$ 114			$ 331			$ 217
Add back goodwill amortization, net of tax					61						90
Adjusted		$ 182			$ 175			$ 331			$ 307
Basic Earnings Per Share
As reported		$1.56			$1.29			$2.85			$2.72
Add back goodwill amortization, net of tax					.74						1.16
Adjusted		$1.56			$2.03			$2.85			$3.88
Diluted Earnings Per Share
As reported		$1.53			$1.28			$2.80			$2.69
Add back goodwill amortization, net of tax					.73						1.15
Adjusted		$1.53			$2.01			$2.80			$3.84

I-11

 

Northrop Grumman Corporation and Subsidiaries

 

 

In 2001, the company purchased Litton Industries, Inc. (Litton), EIS and 80.7 percent of Newport News. On January 18, 2002, the company completed the acquisition of the remaining shares of Newport News and now owns 100 percent of Newport News. Newport News is the nation’s sole designer, builder and refueler of nuclear-powered aircraft carriers and one of only two domestic companies capable of designing and building nuclear-powered submarines. To complete the acquisition, the company issued an additional 3.2 million shares of its common stock and paid cash for the balance of the Newport News shares. In total, the company issued 16.6 million shares of its common stock in connection with the acquisition of Newport News. These shares were valued at $95.22 per share for purchase accounting purposes. In accordance with generally accepted accounting principles, this value was determined based on the average closing stock price of the company’s common stock from December 3, 2001, through December 7, 2001. Following the completion of the acquisition, the company eliminated the 19.3 percent minority interest from its financial statements.

 

 

 

 

 

		Three months ended June 30,				Six months ended June 30,
		(Actual)		(Pro-Forma)		(Actual)		(Pro-Forma)
$ in millions, except per share		2002		2001		2002		2001
Net sales		$4,396		$4,228		$8,482		$8,015
Net income		182		166		331		328
Basic earnings per share		1.56		1.57		2.85		3.10
Diluted earnings per share		1.53		1.56		2.80		3.08

I-12

 

 

On June 30, 2002, the company, TRW and a wholly-owned subsidiary of the company entered into a definitive merger agreement. Under the terms of the agreement, unanimously approved by the boards of directors of TRW and the company, the company will acquire TRW for approximately $60 per share in exchange for Northrop Grumman common stock, subject to a collar, in a transaction valued at approximately $7.8 billion, plus the assumption of TRW’s net debt at the time of closing. The exact exchange ratio will be determined by dividing $60 by the average of the reported closing sale prices per share of the company’s common stock on the New York Stock Exchange for the five consecutive trading days ending on and including the second trading day prior to the closing of the merger. The exchange ratio will not be less than 0.4348 nor more than 0.5357. If the actual average sale price of the company’s common stock is less than $112, TRW shareholders will receive less than $60 in value of Northrop Grumman common stock per share of TRW common stock, and if the actual average sale price of the company’s common stock is more than $138, TRW shareholders will receive more than $60 in value of Northrop Grumman common stock per share of TRW common stock.

 

 

 

 

 

I-13

Northrop Grumman Corporation and Subsidiaries

 

 

In April 2002, the Financial Accounting Standards Board issued SFAS No. 145 – Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This statement clarifies guidance related to the reporting of gains and losses from extinguishment of debt and resolves inconsistencies related to the required accounting treatment of certain lease modifications. The provisions of this statement relating to extinguishment of debt become effective for financial statements issued for fiscal years beginning after May 15, 2002. The provisions of this statement relating to lease modification are effective for transactions occurring after May 15, 2002. Management does not expect that adoption of this standard will have a material effect on the company’s financial position, results of operations or cash flows.

 

 

 

 

As previously reported in the company’s 2001 annual report and quarterly report for the first quarter of 2002, on March 13, 2002, a jury in Indianapolis, Indiana returned a verdict of approximately $31 million in favor of Allison Gas Turbine for cost overruns on the engine exhaust liner and trailing edge of a discontinued prototype aircraft from a competitive award process which occurred in the 1980s. On May 3, 2002, the approximate sum of $37 million of pre-judgment interest was awarded in this matter. The company expects to obtain substantial relief from the current adverse judgment in the case by an appeal, based upon substantive and procedural legal grounds, and has established a reserve in accordance with this expectation. The company believes that the jury’s award in the trial was not warranted by the law applicable to the case and should be overturned. It is not possible at this time to predict the result of the appeal.

I-14

 

Northrop Grumman Corporation and Subsidiaries

 

 

The 2002 results include the operations of Litton Industries, Inc. (Litton), acquired in the second quarter of 2001, Newport News Shipbuilding Inc. (Newport News) and the Electronics and Information Systems Group of Aerojet-General Corporation (EIS), both acquired in the fourth quarter of 2001. These acquisitions are important components of the increase in sales, operating margin and net income for 2002 compared with 2001.

 

 

 

		Three months ended June 30,							Six months ended June 30,
$ in millions, except per share		2002				2001			2002				2001
Segment operating margin
Electronic Systems		$	117			$	107		$	216			$	160
Ships			95				42			174				42
Information Technology			40				64			90				98
Integrated Systems			99				72			192				160
Component Technologies			(2	)			3			(6	)			3
Total segment operating margin		$	349			$	288		$	666			$	463
Total operating margin		$	356			$	338		$	669			$	563
Net Income		$	182			$	175		$	331			$	307
Diluted Earnings Per Share		$	1.53			$	2.01		$	2.80			$	3.84
Weighted average diluted shares outstanding, in millions			114.82				84.05			113.79				78.37

 

I-15

 

Northrop Grumman Corporation and Subsidiaries

 

 

 

		Three months ended June 30,						Six months ended June 30,
$ in millions		2002			2001			2002			2001
Electronic Systems
Aerospace Electronic Systems		$   399			$   359			$   709			$   622
C4ISR&N		311			290			597			490
Defensive Electronic Systems		226			179			431			262
Navigation Systems		177			188			354			188
Space Systems		105			80			221			142
Other		120			140			264			233
		1,338			1,236			2,576			1,937
Ships
Aircraft Carriers		490						963
Surface Combatants		191			218			380			218
Amphibious and Auxiliary		228			166			389			166
Submarines		155						285
Commercial and International		84			131			154			131
Services and Other		36			40			109			40
Intrasegment Eliminations		(27	)		(6	)		(46	)		(6	)
		1,157			549			2,234			549
Information Technology
Government Information Technology		657			611			1,237			878
Enterprise Information Technology		167			208			305			349
Technology Services		162			146			314			273
Commercial Information Technology		50			52			109			106
		1,036			1,017			1,965			1,606
Integrated Systems
Air Combat Systems		470			406			955			812
Airborne Early Warning/Electronic Warfare		187			186			355			352
Airborne Ground Surveillance/Battle Management		174			176			326			341
Intrasegment Eliminations		(2	)		(2	)					(6	)
		829			766			1,636			1,499
Component Technologies		130			158			255			158
Intersegment eliminations		(94	)		(63	)		(184	)		(100	)
Total sales		$4,396			$3,663			$8,482			$5,649

I-16

 

Northrop Grumman Corporation and Subsidiaries

 

 

 

 

 

I-17

 

Northrop Grumman Corporation and Subsidiaries

 

 

 

 

 

 

 

 

 

 

Contract acquisitions totaled $4 billion for the second quarter of 2002 compared with $10.1 billion reported for the same period a year ago, and $9.8 billion in the 2002 six-month period as compared to $12.3 billion in the 2001 six-month period. Last year’s second quarter results included $7.5 billion of funded order backlog acquired in the Litton transaction. During the second quarter of 2002, the company won two significant programs, DD(X), the Navy’s advanced 21st century family of surface combatants, and Deepwater, the Coast Guard’s modernization program, which have not yet been reflected in funded order backlog. Electronic Systems reported contract acquisitions of $2.7 billion in the first half of 2002 reflecting the inclusion of Litton and EIS businesses and higher F-35 and F-22 funding. In the six-month period Ships reported contract acquisitions of $3.1 billion resulting from the funding of

I-18

 

Northrop Grumman Corporation and Subsidiaries

 

Virginia-class submarines, LHD 8, and refueling and overhaul of the carrier USS Eisenhower. Information Technology reported contract acquisitions of $2.1 billion, principally in the Government Information Technology business area. Integrated Systems reported $1.9 billion in contract acquisitions, reflecting higher F/A-18E/F and unmanned vehicle systems funding. Component Technologies reported $268 million in contract acquisitions. The company’s funded order backlog at June 30, 2002, increased to $22.0 billion from $16.8 billion reported a year earlier.

 

 

In the first half of 2002 the company produced cash from operations of $473 million compared with a use of $14 million for the same period last year. The working capital change in the first half was an increase of $13 million, which is a result of normal fluctuations in timing of receipts and disbursements, working down advances on contracts, and payments associated with acquired businesses. The company’s net debt at June 30, 2002, was $4.97 billion, down slightly from the $5.03 billion reported at December 31, 2001, due in part to use of cash from operations to reduce principal amounts outstanding. The company currently expects to generate $100 million to $200 million in cash available to pay down debt this year. For the remainder of 2002, cash generated from operations is expected to be sufficient to service debt, finance capital expenditures and continue paying dividends to the company’s shareholders. During the first quarter of 2002 the company paid off long-term debt of $427 million acquired in the Newport News acquisition. The company’s liquidity and financial flexibility are expected to be provided by cash flow generated by operating activities, supplemented by the borrowing capacity available under the company’s credit facility. Upon completion of the B-2 EMD contract, federal and state income taxes deferred since the inception of the contract in 1981 will become payable. The contract is expected to be completed in the fourth quarter of 2002 with federal taxes of approximately $1 billion related to this contract being payable in March 2003. The company plans to use cash generated from operations supplemented by additional borrowings under the credit facility and/or additional funds raised from public or private capital markets to pay these taxes. The IRS is presently completing its audits of the B-2 program through the tax years ending December 31, 2002. Upon completion of these audits, the IRS has indicated that they may adopt a position that the B-2 program was completed in a year prior to 2002, which would create the potential for additional interest expense. Although it is not possible to predict the outcome of the tax audits at this time, management believes that its tax accounting for the B-2 program reflects the appropriate timing of contract completion.

 

 

On June 30, 2002, the company, TRW and a wholly-owned subsidiary of the company entered into a definitive merger agreement. Under the terms of the agreement, unanimously approved by the boards of directors of TRW and the company, the company will acquire TRW for approximately $60 per share in exchange for Northrop Grumman common stock, subject to a collar, in a transaction valued at approximately $7.8 billion, plus the assumption of TRW’s net debt at the time of closing. The exact exchange ratio will be determined by dividing $60 by the average of the reported closing sale prices per share of the company’s common stock on the New York Stock Exchange for the five consecutive trading days ending on and including the second trading day prior to the closing of the merger. The exchange ratio will not be less than 0.4348 nor more than 0.5357. If the actual average sale price of the company’s common stock is less than $112, TRW shareholders will receive less than $60 in value of Northrop Grumman common stock per share of TRW common stock, and if the actual average sale price of the company’s common stock is more than $138, TRW shareholders will receive more than $60 in value of Northrop Grumman common stock per share of TRW common stock.

I-19

 

Northrop Grumman Corporation and Subsidiaries

 

 

 

 

 

 

 

In April 2002, the Financial Accounting Standards Board issued SFAS No. 145 – Rescission of FASB Statements Nos. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections. This statement clarifies guidance related to the reporting of gains and losses from extinguishment of debt and resolves inconsistencies related to the required accounting treatment of certain lease modifications. The provisions of this statement relating to extinguishment of debt become effective for financial statements issued for fiscal years beginning after May 15, 2002. The provisions of this statement relating to lease modification are effective for transactions occurring after May 15, 2002. Management does not expect that adoption of this standard will have a material effect on the company’s financial position, results of operations or cash flows.

 

 

 

 

Certain statements and assumptions in this Management’s Discussion and Analysis and elsewhere in this quarterly report on Form 10-Q contain or are based on “forward-looking” information (that Northrop Grumman believes to be within the definition in the

I-20

 

Northrop Grumman Corporation and Subsidiaries

 

Private Securities Litigation Reform Act of 1995) and involve risks and uncertainties. Such “forward-looking” information includes, among other things, the statements as to the impact of the proposed acquisition of TRW on revenues and earnings. Such statements are subject to numerous assumptions and uncertainties, many of which are outside Northrop Grumman’s control. These include, among others, completion of the merger with TRW and related governmental regulatory processes, Northrop Grumman’s ability to successfully integrate the operations of TRW and a successful transaction or other resolution with respect to the TRW automotive sector. These assumptions also include Northrop Grumman’s future revenues, expected program performance and cash flows, the outcome of contingencies including timing and amounts of tax payments, litigation, environmental remediation, divestitures of businesses, and anticipated costs of capital investments. Northrop Grumman’s operations are subject to various additional risks and uncertainties resulting from its position as a supplier, either directly or as subcontractor or team member, to the U.S. Government and its agencies as well as to foreign governments and agencies; actual outcomes are dependent upon factors, including, without limitation, Northrop Grumman’s successful performance of internal plans; government customers’ budgetary restraints; customer changes in short-range and long-range plans; domestic and international competition in both the defense and commercial areas; product performance; continued development and acceptance of new products; performance issues with key suppliers and subcontractors; government import and export policies; acquisition or termination of government contracts; the outcome of political and legal processes; legal, financial, and governmental risks related to international transactions and global needs for military aircraft, military and civilian electronic systems and support, information technology; naval vessels, space systems and related technologies, as well as other economic, political and technological risks and uncertainties and other risk factors set out in Northrop Grumman’s filings from time to time with the Securities and Exchange Commission, including, without limitation, Northrop Grumman’s reports on Form 10-K and Form 10-Q. Additional information regarding these factors is contained in the company’s other SEC filings, including without limitation, the company’s Annual Report on Form 10-K for the year ended December 31, 2001 and the Form S-4 filed on March 4, 2002, and amended on April 17, 2002.

 

 

The company is exposed to market risk, primarily related to interest rates and foreign currency exchange rates. Financial instruments subject to interest rate risk include fixed-rate long-term debt obligations, variable-rate short-term debt outstanding under the credit facility, short-term investments, and long-term notes receivable. Substantially all borrowings are fixed-rate long-term debt obligations, significant portions of which are not callable until maturity. The company’s sensitivity to a 1 percent change in interest rates is tied to its $2.5 billion credit facility, which has no balance outstanding at June 30, 2002. The estimated expense would be 1 percent of any outstanding balance. The company may enter into interest rate swap agreements to manage its exposure to interest rate fluctuations. At June 30, 2002, no interest rate swap agreements were in effect. The company enters into foreign currency forward contracts to manage foreign currency exchange rate risk related to receipts from customers and payments to suppliers denominated in foreign currencies. Foreign currencies are traditionally converted to U.S. dollars upon receipt to limit currency fluctuation exposures. At June 30, 2002, the amount of foreign currency forward contracts outstanding was not material. The company does not consider the market risk exposure relating to foreign currency exchange to be material. The company does not hold or issue derivative financial instruments for trading purposes. Standby letters of credit are used by the company to guarantee future performance on its contracts.

I-21

 

Northrop Grumman Corporation and Subsidiaries

 

 

We have reviewed the accompanying consolidated condensed statements of financial position of Northrop Grumman Corporation and subsidiaries as of June 30, 2002, and the related consolidated condensed statements of income for the three-month and six-month periods ended June 30, 2002 and 2001, and the related consolidated condensed statements of changes in shareholders’ equity and cash flows. These financial statements are the responsibility of the Corporation’s management.

 

 

 

 

 

 

 

I-22

 

Northrop Grumman Corporation and Subsidiaries

 

 

 

 

As previously reported, in October 1999, the company was served with a fifth amended complaint that was filed by the government in the United States District Court of the Central District of California in this action, which was commenced in May 1995. The complaint alleges that the company violated the False Claims Act by knowingly supplying BQM-74C aerial target drones that contained various defective components between 1988 and 1998. The government seeks to recover damages up to $213 million plus pre-judgment interest and penalties under theories of fraud, payment by mistake, unjust enrichment, breach of warranty and breach of contract. Damages awarded pursuant to the False Claims Act may be trebled by the court. The company intends to vigorously defend this matter. During the second quarter, the trial was postponed and no trial date is currently pending.

 

 

 

The company, as a government contractor, is from time to time subject to U.S. Government investigations relating to its operations. Government contractors that are found to have violated the False Claims Act, or are indicted or convicted for violations of other federal laws, or are considered not to be responsible contractors may be suspended or debarred from government contracting for some period of time. Such convictions could also result in fines. Given the company’s dependence on government contracting, suspension or debarment could have a material adverse effect on the company.

 

II-1

 

Northrop Grumman Corporation and Subsidiaries