Northrop Grumman Corporation — Q2 2021 Form 10-Q Summary
Business context and reporting period
Northrop Grumman is an aerospace and defense contractor serving primarily the U.S. government, including the Department of Defense and intelligence community. The filing covers the three and six months ended June 30, 2021. Reportable segments are Aeronautics Systems, Defense Systems, Mission Systems and Space Systems. The interim financial statements are unaudited and were reviewed by Deloitte & Touche LLP.
On January 30, 2021, the company completed the sale of its IT and mission support services business for $3.4 billion in cash. The divestiture generated a $2.0 billion pre-tax gain, and the business's results are included through the divestiture date.
Financial performance and key metrics
| Metric | Q2 2021 | Q2 2020 | Change |
|---|---|---|---|
| Total sales | $9.151 billion | $8.884 billion | Up 3% |
| Operating income | $1.044 billion | $994 million | Up 5% |
| Operating margin | 11.4% | 11.2% | Up 20 basis points |
| Net earnings | $1.037 billion | $1.005 billion | Up 3% |
| Diluted EPS | $6.42 | $6.01 | Up 7% |
| Operating cash flow | Six months: $962 million, down from $1.344 billion | ||
| Adjusted free cash flow | Six months: $583 million, down from $803 million |
Six-month sales increased 5% to $18.308 billion. Operating income increased 101% to $3.866 billion, primarily because of the $2.0 billion divestiture gain. Six-month net earnings increased 73% to $3.232 billion and diluted EPS increased 78% to $19.89. Excluding divestiture-related items, transaction-adjusted net earnings increased 13% to $2.112 billion and transaction-adjusted EPS increased 16% to $13.00.
Q2 organic sales increased 10%, while six-month organic sales increased 11%. Product sales rose 11% in Q2 and service sales declined 18%, largely reflecting the divested IT services business.
Segment performance
| Segment | Q2 sales | Q2 operating income | Q2 margin |
|---|---|---|---|
| Aeronautics Systems | $2.913 billion | $300 million | 10.3% |
| Defense Systems | $1.427 billion | $177 million | 12.4% |
| Mission Systems | $2.588 billion | $408 million | 15.8% |
| Space Systems | $2.748 billion | $301 million | 11.0% |
Space Systems was the strongest growth contributor, with sales up 34% and operating income up 44%, supported by GBSD, NGI, hypersonics, Artemis and Next Gen OPIR programs. Mission Systems sales increased 6% and operating income increased 18%. Defense Systems sales declined 24%, primarily because of the divestiture, while organic sales declined 3%. Aeronautics Systems sales were flat and operating income declined 3%.
Liquidity, capital allocation and debt
- Cash and cash equivalents were $3.941 billion at June 30, 2021, compared with $4.907 billion at December 31, 2020.
- Long-term debt was $12.764 billion, down from $14.261 billion at year-end 2020. The company repaid $700 million of notes at maturity and redeemed $1.5 billion of notes early, recording a $54 million pre-tax make-whole charge.
- Six-month financing cash outflow was $4.950 billion, including $2.236 billion of debt repayments, $2.143 billion of share repurchases and $486 million of dividends.
- The company completed a $2.0 billion accelerated share repurchase, retiring approximately 6.1 million shares at a final average price of $327.29 per share.
- The quarterly dividend increased 8% to $1.57 per share in May 2021. The 2018 repurchase authorization had approximately $0.7 billion remaining at June 30, and a new $3.0 billion authorization is scheduled to begin after completion of the 2018 program.
- No commercial paper borrowings were outstanding. The company had a $2.0 billion revolving credit facility, no outstanding balance under that facility, and was in compliance with applicable covenants.
- Management expects cash, operating cash flow and available financing sources to be sufficient to fund operations for at least the next 12 months.
Material changes, outlook and risks
- The IT services divestiture materially affected year-to-date comparisons, producing a $2.0 billion pre-tax gain, $3.4 billion of investing cash proceeds and related tax, transaction and debt-redemption costs.
- Backlog was $76.6 billion at June 30, 2021, down 5% from December 31, 2020, including the divestiture-related reduction. Approximately 40% was expected to convert to revenue over the next 12 months and 60% over the next 24 months. Second-quarter net awards were $6.5 billion and year-to-date net awards were $15.4 billion.
- The filing does not provide a clear formal full-year financial guidance update. Management cited long-term opportunities in space, missiles, missile defense, hypersonics, survivable aircraft and mission systems.
- COVID-19 did not significantly affect Q2 revenue or operating income, but risks remain from workforce disruptions, supply-chain constraints, program delays, cost recovery uncertainty and changing government priorities.
- Defense spending and new program starts may be affected by congressional budget negotiations, a potential continuing resolution and debt-ceiling uncertainty. The company may be required to perform on certain contracts even if government payments are delayed.
- Contract accounting depends on estimates of costs and revenue at completion. Six-month favorable net estimate-at-completion adjustments were $344 million, compared with $236 million in the prior year.
- Significant contingencies include the Bethpage, New York environmental remediation matters, the USPS flats sequencing systems litigation, and a U.S. government challenge to CAS pension interest-rate assumptions. The potential impact of the CAS matter could be material, but the company cannot currently estimate a loss range.
- Environmental remediation liabilities were $611 million, with $364 million of reasonably possible future costs in excess of accrued amounts. The company also had $499 million of standby letters of credit and guarantees and $79 million of surety bonds outstanding.
Important facts for investors to verify
- Assess ongoing operating performance using organic and transaction-adjusted results rather than relying on the reported year-to-date gain from the divestiture.
- Monitor cash conversion, working-capital requirements and the effect of taxes paid on divestiture proceeds; six-month operating cash flow and adjusted free cash flow declined year over year.
- Evaluate backlog quality, funding status and conversion timing, particularly the large unfunded backlog in Space Systems.
- Track Defense Systems revenue pressure following the divestiture and the sustainability of growth and margins in Mission Systems and Space Systems.
- Review future developments in the Bethpage environmental matters, USPS litigation and CAS pension dispute, including possible changes to liabilities or recoverability.
- Confirm the effect of U.S. defense appropriations, continuing-resolution risks, debt-ceiling actions and COVID-19-related cost recovery on future contract performance and cash flows.