Northrop Grumman [NOC] on Thursday reported higher earnings in its third quarter despite a drop in sales as the company benefited from an insurance settlement, a pension tailwind and improved operating margin.
Sales fell 4 percent to $8.7 billion from $9.1 billion a year ago due to the divestiture in January of the information technology services business, which accounted for $606 million in revenue a year ago. Excluding the IT divestiture, organic sales increased 3 percent.
Net income increased 8 percent to $1.1 billion, $6.63 earnings per share (EPS), from $1 billion ($5.89 EPS), walloping consensus estimates by 64 cents per share. Operating margin at the company’s four business segments combined improved 40 basis points to 11.9 percent due to a combination of improved performance and the elimination of the drag on profits that the lower margin IT services business carried.
The impact of the IT business divestiture was felt across three of the company’s operating segments although Defense Systems bore the brunt, with sales down 24 percent. In addition to the divestiture, the segment’s sales also fell in part due to the close out of a contract supporting the Army’s Lake City ammunition plant in Missouri. The segment’s operating income also fell due to the divestiture.
The Aerospace Systems segment, which was not affected by the business divestiture, also reported lower sales on lower volume on classified programs, the F-35 fighter aircraft, the B-2 stealth bomber Defensive Management Systems Modernization, and some Global Hawk unmanned aircraft systems programs.
The top line in the Aerospace business also suffered from COVID-19 impacts at the company and its suppliers that led to worker production inefficiencies. On top of the direct COVID-19 challenges, more employees took leave that had been pent up amid the ongoing pandemic, Kathy Warden, Northrop Grumman’s chairman, president and CEO, said on the company’s earnings call.
The segment’s operating income also fell on the lower sales and a lower margin rate, which was due to a $42 million contract adjustment on the F-35 stemming from COVID-19 impacts.
Warden said that overall the supply chain and labor challenge the company is facing due to COVID are “minimal.”
Space Systems, Northrop Grumman’s fastest growing segment, is the only business that increased sales, despite a $48 million top-line hit related to the IT services divestiture. Sales were up 22 percent, driven by growth in the Ground Based Strategic Deterrent (GBSD) ICBM program, the Next Generation Interceptor (NGI) missile defense program, and classified work.
Warden said that the GBSD development has ramped up “significantly this year” and will add just over $1 billion incremental sales in 2021 versus 2020 and another $500 million incremental revenue in 2022. Operating income in the segment was up 29 percent on improved performance on classified programs.
Given strong performance so far this year, the insurance settlement and pension improvements, Northrop Grumman raised its adjusting earnings guidance by 80 cents EPS to between $25.20 and $25.60 for 2021, and expects sales to be about $36 billion, right at the mid-point of the prior outlook.
The company also provided general guidance for 2022, with sales up in the low single-digit percentage-wise on continued organic growth, driven by Space Systems on GBSD, NGI and the rampup of classified programs. Defense Systems and Mission Systems are also expected to grow while Aerospace Systems will decline in the mid-single digits on lower revenue in unmanned aircraft, the JSTARS ground surveillance aircraft, F/A-18 fighters, and classified programs.
Higher pension and corporate expenses in 2022 are expected to create a $2-plus EPS headwind, more than offsetting strong operating margins, which will lead to lower earnings, Dave Keffer, Northrop Grumman’s chief financial officer, said on the earnings call.
Free cash flow in 2022 will decline due to higher pension costs and cash taxes, and then increase by double-digits through 2024 on strong operating performance, Keffer said.
Transaction adjusted free cash flow was $1.1 billion in the quarter. Orders totaled $6.9 billion and backlog stood at $74.8 billion, down 8 percent from $81 billion at the end of 2020.