2. 2
1. Understanding Cash Flow / Why is Cash Flow Critical
2. Understanding Working Capital and Current Trends
3. Cash Flow - A key consideration in business decisions
4. Factors Driving Cash Flow in U.S. Government Contracting
5. Contract Types in U.S. Government Contracting
6. How Do U.S. Government Contractors Get Paid (w/Scenarios)
7. Other Contracting and Payment Arrangements – UCAs (w/Scenarios)
8. How do Large Businesses get paid when performing as a subcontractor to a Prime
sub? How do Large Businesses pay their subs and suppliers?
9. Government Vs. Industry Perceptions
Topics
3. 3
What is Cash Flow – Net cash generated and spent by a business
What Comes In - Cash inflow can come from several sources – loans, investors, interest
on investments, but most often through payments from customers.
What Goes Out – Cash outflow goes to expenses
Cash flow terms: Cash Positive – Cash Neutral – Cash Negative
A Companies ability to create value for its stake-holders is determined by its
ability to generate positive cash flows – More cash coming in than going out
Positive cash flow indicates that a company's liquid assets are increasing,
enabling it to
Reinvest in its business for long-term positioning (for customers and shareholders)
Settle debts
Pay expenses
Have a buffer against future financial challenges
Return money to shareholders
Understanding Cash Flow
4. 4
Investors and creditors want to know if a company has enough cash and cash-equivalents to
cover short-term liabilities.
This is done by examining a company's cash flow statement - reports operating cash flow,
investing cash flow and financing cash flow - all of which are essential for assessing a
company’s liquidity, flexibility and overall financial performance.
Profitable companies can fail if operating activities do not generate enough cash to stay
liquid.
This can happen if profits are tied up in accounts receivable and inventory, or if a company
spends too much on capital expenditure.
Cash funds Business & Investment Operations – It is used to:
Invest in future Projects, Technologies, Innovations
Pay Salaries
Pay Expenses
Invest in Capital Projects/Equipment
Invest in Working Capital (labor, material, inventory)
Contributions to pension savings plans
Acquire businesses (e.g., Mergers or Asset Purchases)
Return Money to Shareholders (e.g., Dividends or Share Repurchase)
Why is Cash Flow Critical
For companies whose primary business/products support the U.S. Government, payments
for products and services sold is a primary source of Cash
5. 5
Working capital - basically represents the current assets less the current
liabilities of a company
Assets include receivables (billed and unbilled) and inventory
Liabilities include payables owed to suppliers, compensation owed, and any advances
provided for services to be performed in the future
Working capital is measured at a point in time
Includes cash owed in the future minus things owed to others
Working capital has an indirect correlation with cash flow
Working capital increases indicate cash flow reductions
A company has not been paid for products or services, but has paid suppliers and
employees
Working capital decreases indicate cash flow improvements
As a company is paid and cash is generated, receivables decrease and working capital
goes down
Understanding Working Capital
6. NORTHROP GRUMMAN PROPRIETARY LEVEL I
Aerospace & Defense – Working Capital
Trade Working Capital - % of Sales
Pure Play A&D Average
Industry Trade Working Capital
Pure Play A&D
$3.2
$3.7
$7.1
$8.6
$9.1
$12.3
$-
$2.0
$4.0
$6.0
$8.0
$10.0
$12.0
$14.0
2013 2014 2015 2016 2017 2018
3.8%
4.6%
7.9%
8.9% 8.7%
11.1%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
2013 2014 2015 2016 2017 2018
Pure Play A&D includes, Northrop Grumman, Raytheon and Lockheed Martin
$B
6
7. 7
Working Capital Trends
Recent A&D trends have required companies to increase working capital
Slower or less robust payment terms (capping payments, progress payments, worse
Performance-Based payment terms) from customers
No change in obligations to maintain payments to supply base (particularly small business)
Contractors require cash to survive
As customers shift payment terms, contractors finance more from banks at
higher interest rates
Cost of financing from Banks vs US treasury increases the cost of doing business
Increases in working capital prohibit a business from maximizing
investment and efficiency
Limit a company’s ability to invest quickly in research, development or capital to meet
customers future needs
8. 8
Cash Flow is one of several key financial considerations when assessing
business opportunities (future programs)
With continuing downward pressure on profit margins (fees) cash flow
considerations become even more critical
Cash Flow expectations can impact:
Profitability considerations
Investment decisions
Business markets/pursuit decisions
Cash Flow - A key consideration in business decisions
9. 9
Multiple factors shape the timing and volume of cash flow coming in as
payments for products and services, driven by:
Type of Contract utilized
Choice of payment regulations (FAR/DFAR)
Negotiated Fees
Negotiated Payment events /timing
Timing of Contract Negotiations
Factors Driving Cash Flow in U.S. Government Contracting
10. 10
Contract type significantly drives payment scenarios and cash flow timing
and results
Contract type is defined by the U.S. Government (Contracting Officer);
choice of contract type depends on a number of factors including:
Nature and Complexity of the work
Urgency of the requirement
Period of performance
Need for a balance between performance risk and reward
Maturity of the requirement or work/product (new or continuation)
Whether contractors have adequate accounting systems
Factors Driving Cash Flow in U.S. Government Contracting
11. 11
Contract Types in U.S. Government Contracting
Two Primary types of contracts are
utilized
Fixed Price
Cost Reimbursable (Cost Plus)
Cost Reimbursable is generally used
when requirements or end results
can’t be clearly defined at the start
of performance
Fixed Price is generally used when
the requirements are well defined or
mature
Multiple ‘types’ of Cost Reimbursable
and Fixed Price contracts exist, each
with unique features and differing
impacts to cash flow
12. 12
Cost Reimbursable Contracts
A significant portion of U.S. Government acquisitions utilize Cost Reimbursable contract
types, especially when acquiring unique systems, products or capabilities or broadly
defined services
Allows contractor to bill and be paid 100% of “allowable” costs, generally billing every two
weeks
Generally include withhold/reserve up to 15% of the total fees paid or $100,000
Cost Plus Fixed Fee (CPFF)
Allows for the billing of Fee throughout the program – as percent complete or hours
delivered
Cost Plus Award Fee (CPAF)
Allows for the billing of Award Fee at set times based on a performance score
Cost Plus Incentive Fee (CPIF)
Allows for the billing of Incentive Fee as established in the contract schedule based on a
target fee (US Government can adjust fee payments based on performance against the
target cost). Can also include Incentive payments tied to other items – Schedule,
performance, etc.
How Do U.S. Government Contractors Get Paid
Cost reimbursable contracts generally provide for good cash flow and consistent timing
of “cost” payments
13. 13
Fixed Price Contract (Firm Fixed Price, Fixed Price Incentive) payments
generally follow two forms:
1. Payment at completion
Upon Acceptance of final delivery of products
Upon Acceptance of separately priced units of work under a single contract
2. Financing Payments
Payments to Contractors before acceptance of supplies or services by the Government.
Used on non-commercial contracts when deliveries are scheduled to begin six months or
more after contract award.
How Do U.S. Government Contractors Get Paid
14. 14
Contract Financing Payments come in several forms
Advance payments
Generally only used in cases of contractor financial hardship, or with some educational
or research institutes
Commercial advance and interim payments
Allows for limited advance payments for specifically commercial items
Progress payments
Commonly used for major systems / platforms
Performance-based payments
Commonly used for major systems / platforms
How Do U.S. Government Contractors Get Paid
15. 15
How Do U.S. Government Contractors Get Paid Progress Payments
Progress Payments
Allows payments before contract completion
Establishes Billings/Payment on the basis of actual costs incurred (or on the basis
of completed work (construction, shipbuilding))
Includes limits on the amount that may be provided to the contractor
Per FAR and DFAR, the customary progress payment rate is 80% of allowable and
allocable costs (higher % for a small business (FAR: 85%, DFARS: 90%))
Payments at 80% of cost – with remaining cost (~20%) as products are
completed
Profit is not billed to until completion/acceptance of final delivery
Creates cash-negative scenarios for long periods (years) on programs with long
production lead times (e.g. aircraft)
Progress Payments require significant working capital to maintain performance, diminishing
available resources for other uses
16. 16
How Do U.S. Government Contractors Get Paid Performance-Based Payments
Performance-Based Payments (PBPs) – FAR Basis
Allows payments before contract completion
Payments are made on the basis of objective, quantifiably measurable events,
results or accomplishments
Defined and valued in the contract prior to performance
FAR limits billing to 90% of PRICE (sum of cost + profit) for the Line Item or
Contract
Allows for recovery of profit dollars in situations where cost is <90% of price
May bill for the line item price or contract price, less any payments received
(liquidation) after contractors complete line items or the entire contract
Performance Based Payments can provide improved cash flow when compared to Progress
Payments, assuming reasonable frequency of billing events
17. 17
How Do Government Contractors Get Paid Performance-Based Payments
Performance-Based Payments (PBPs) – DFARS (DoD)
Allows payments before contract completion
Payments are made on the basis of objective, quantifiably measurable events,
results or accomplishments
Defined and valued in the contract prior to performance
PBP are negotiated, often after award; may require the contractor provide
consideration
DFAR limits billing to 100% of Cost for the Line Item or Contract
(Draft Rule proposed to revise the limit to 90% of price)
After contractors complete line items or the entire contract, they may invoice
for the line item or contract price, less any payments received (liquidation)
More restrictive than regulations offered in other Federal Agencies using the
FAR (However, the draft rule would match the FAR)
18. 18
Scenario - Cash Flow on a Sample Production Contract
Payment terms significantly constrain company’s ability to invest in the business and
improving payment terms costs virtually nothing to government.
Issues:
• Unable to recover 100%
of cost until final delivery
(~57 month duration)
• Unable to bill fee until first
delivery (~46 months from
start)
• Negative cash flow for
four years on each lot (24
aircraft)
Recommended options:
• Improve PBP terms to FAR guidelines of 90% of price or better
• Make a portion of fee billable earlier in the contract
• Higher progress payment rates on long duration contracts when PBP financing is not utilized
Performance Based Payments
2018
Q1 Q2 Q3 Q4
Calendar Year
Quarter
2019
Q1 Q2 Q3 Q4
2020
Q1 Q2 Q3 Q4
2021
Q1 Q2 Q3 Q4
2022
Q1 Q2 Q3 Q4
Illustrative Production
Build: 6 A/C
$750M notional contract
value
Aircraft Build
Ground/Flt Test
#1 #2 #3 #4 #6
~13 Months
Progress
Payments
Deliveries
12 Months
Long Lead Parts
~32 Months per A/C
#5
Notional Margin
FAR
(90% Price)
DFAR
(100% cost)
Progress Payments
(80% cost)
AAC Funding
gets Progress
Payments in all
Scenarios
Lost Investment Opportunity
19. 19
Other Contracting and Payment Arrangements - UCAs
Use of Undefinitized Contractual Actions (UCAs) – FFP/FPI
Type of Agreement that starts a contract/program in advance of reaching
agreement on contractual terms, cost/profit/price, schedule, etc. to meet
needs
Negotiations required and expected to occur within reasonable time yet requires
significant proposal activity and negotiation effort
Often takes significant time to negotiate
Fee/Profit is often challenged due to “reduced risk” associated with completed work
Generally only able to bill using Progress Payments (80% of cost) pending definitization
20. 80% Progress Payments during UCA period adversely impacts Contractors
20
Scenarios - Impact of UCA on cash flow
Cash flow if definitized
in 2015 w/ PBP
Cash flow w/ Prog. Pmts. until
definitized in Q4/2018 w/ PBP
Sample
4 aircraft build
(UCA 48
months)
Sample
4 aircraft build
(UCA 6
months)
2014
Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
2014
Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
2020
Calendar Year
Quarter
2015 2016 2017 2018 2019
2019 2020
Quarter
Calendar Year 2015 2016 2017 2018
UCA
~48 months
Definitized,On Contract
~18 months
Progress Payments Contract Award Performance BasedPayments
AV #1 AV #2 AV #3,AV #4
Completion
UCA
~6 months
Definitized,On Contract
~60 months
Progress Payments Definitization
Performance Based Payments AV #1 AV #2 AV #3,AV #4
Completion
Sample
4 aircraft build
(UCA 48 months)
Sample
4 aircraft build
(UCA 6 months)
Notional cash flow value $500M
Lost Investment Opportunity
Notional Margin
21. 21
How do businesses get paid when performing as a subcontractor?
How do businesses get paid when performing as a sub?
Prime’s do not have to flow down the same payment methodology, payment
schedule, or contract type to its subcontractors
Payments to subcontractors vary from contract to contract
Depends on contract type
Contract relationship or subcontractor’s role on the program (major vs. minor)
Nature of work/products
Company size (may require faster payment for small businesses vs. large)
Subcontractors payment terms may align with primes’ payment terms and timing
Includes use of Progress Payments and Performance-Based Payments
Payment timing (time from submission of an invoice to payment received) are based on the
specific “deal” and may be aligned with payment terms/timing being received by the prime
Often subcontractors and vendors realize better payment terms that those realized
by the prime
Primes must receive bills from its subcontractors/vendors so that they can accrue those
cost in their billings to the Government (and must pay those vendor costs as customary)
Challenging payment provisions or timing of payments to prime contractors often impacts
cash-flow and financials for multiple companies (vendors & subcontractors)
22. Government Vs. Industry Perceptions
1. Cash Deployment
2. Estimating Fair Value In Industry Capital Investments
3. Risk Work Authorizations and Cash
4. Actual Profits and Industry Investments
5. Government Payments vs. Commercial Payments
6. Share Goals, Common Values & Motivators
22
24. NORTHROP GRUMMAN PROPRIETARY LEVEL I
Aerospace & Defense
Dividend + Share Repurchases - % of Sales
Pure Play A&D
A&D Average includes, Northrop Grumman, Raytheon and Lockheed Martin
9.1%
4.2%
7.0%
7.7%
7.1%
8.8%
8.8%
8.3%
7.2%
8.5%
6.5%
7.7%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
2016 2017 2018
NOC
RTN
LMT
A&D (Avg.)
24
25. NORTHROP GRUMMAN PROPRIETARY LEVEL I
Northrop Grumman
R&D and Capital Expenditures
Dividends & Share Repurchases - $
Key
Investment in business through R&D and Capital Expenditures
Returns to shareholders through dividends and share repurchases
$1.6
$1.6
$2.0
$2.2
$1.1
$2.1
$-
$0.5
$1.0
$1.5
$2.0
$2.5
$3.0
2016 2017 2018
6.6%
6.0%
6.7%
9.1%
4.2%
7.0%
0.0%
5.0%
10.0%
15.0%
2016 2017 2018
$B
R&D and Capital Expenditures
Dividends & Share Repurchases - % of Sales
25
26. NORTHROP GRUMMAN PROPRIETARY LEVEL I
Aerospace & Defense / Commercial Industry
Aerospace & Defense / Commercial Industry Return on Sales (ROS)
2016-2018
Commercial Industry Average includes Apple, Google and Microsoft
13.3%
16.1%
12.5%
27.7%
12.4%
16.7%
13.5%
26.7%
12.6%
16.8%
13.6%
25.8%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
NOC RTN LMT Commercial
2016
2017
2018
26
27. NORTHROP GRUMMAN PROPRIETARY LEVEL I
Northrop Grumman
Progress & PBPs,
85%
Total Due, 15%
International/Other
Progress & PBPs,
75%
Total Due, 25%
US Government
Percent of Unbilled Receivables (Net)
(Total Due v. Received Through Progress or Performance Based Payments)
3-Year Average (2016 – 2018)
1. USG Unbilled Receivables includes FMS
1
27
