Hey, Rich!


You missed one!

One what?

Defense contractor. You covered Raytheon (NYSE: RTN), Lockheed Martin (NYSE: LMT), and General Dynamics (NYSE: GD) last week -- but what about Northrop Grumman (NYSE: NOC)? It reported too, you know.

Oh, yes. It did.
And interestingly, Northrop was the only one of these defense-contracting giants to report anything like what you could call a "bad" quarter. Sales for the first quarter were all right -- up 6% year over year. Backlog hit new highs as well, as Northrop added $12.1 billion in new orders over the course of the quarter, while booking only $7.7 billion in sales. But thanks to a $0.61-per-share charge to earnings, Northrop's Q1 profits plummeted 32% in comparison with Q1 2007, bottoming out at just $0.76 per share.

The charge, incurred because of cost overruns and poor performance at Northrop's 4-year-old LHD-8 amphibious assault ship program, torpedoed any chance of earnings growth in Q1 and probably ruined chances for any growth this year as well. Last year, Northrop earned $5.12 per share, diluted. This year's guidance, updated to include the costs of the LHD-8 fiasco, has Northrop earning no more than $5.15 per share, and perhaps as little as $4.90. Sales are still expected to be up 3% at $33 billion. But operating margins will slip into percentages in the upper 8s, and free cash flow will also take a hit: Management is looking for something between $1.7 billion and $2.1 billion by year-end.

CEO Ronald Sugar has described the decision to take this charge thusly: "the ship does not meet our quality standards and it will not be delivered until it does." Hard to argue with that, but the news couldn't have come at a worse time for Northrop. The company is mired in a very public fight with Boeing (NYSE: BA) over Northrop's successful bid to build the Air Force's new KC-X Tanker. I can't help but think that Boeing will point to Northrop's failure to deliver the LHD-8 on time and on budget to illustrate the company's unreliability (not that Boeing is in any position to throw stones).

So far, Northrop has only loaded $1.5 billion worth of tanker-related revenue into its backlog, so Boeing's challenge does pose some risk to Northrop's new guidance numbers. Still, with Northrop shares trading for only 13 times this year's anticipated free cash flow, and the company expected to grow at nearly 16% going forward, it looks to me like the risk is more than priced into the stock.

Foolish takeaway
Risks assail Northrop by air and by sea, but the shares still look ship-shape here to me. (Here ends my contribution to National Poetry Month.)

Check out the defense earnings stories Rich didn't miss last week:

Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a disclosure policy.