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Text: These risks and uncertainties may cause actual company results to differ materially.
Today, we are very pleased to announce another strong quarter.
I'll begin by recognizing our Northrop Grumman employees for their continued focus on operational excellence.
Our results represents a successful execution of our strategy, the strength of our portfolio and the commitment of our team to deliver for our customers and shareholders.
As the global threat environment continues to rapidly evolve and other nations gain more complex and sophisticated capabilities, our customers need innovative and affordable solutions to be delivered with increasing speed and agility.
With the investments we've made in advanced technologies, combined with our talented workforce and adoption of digital transformation capabilities, Northrop Grumman is well-positioned to meet our customers' needs and continue to strengthen our position for the future.
This quarter, we once again delivered strong growth and operating performance.
Our sales increased by 3% to $9.2 billion.
Adjusting for the effects of our first-quarter divestiture of the IT services business, organic sales increased 10%.
While we do expect this growth rate to moderate in the second half of the year, we continue to have a robust pipeline of opportunities in 2021 and beyond.
Additionally, program execution across the portfolio was exceptional, which drove our segment operating margins to exceed 12%.
This follows on strong Q1 performance resulting in a year-to-date segment operating margin of 12.1%, and we continue to expect solid performance for the remainder of the year.
Earnings per share increased 7% this quarter and transaction-adjusted earnings per share has increased 16% year to date.
Transaction-adjusted free cash flow is also trending favorably and has increased 26% year to date.
As a result, we ended the quarter with just under $4 billion in cash on the balance sheet.
This provides us continued flexibility for capital deployment.
We completed the $2-billion accelerated share repurchase in Q2 and continue to expect to repurchase over $3 billion for the year.
Additionally, we increased our dividend by 8% in May.
We are executing a balanced capital deployment strategy, which includes investing in the solutions our customers need and also returning cash to investors.
Over the next couple of years, we continue to expect to return the majority of our free cash flow to shareholders through share repurchases and dividends.
In terms of budget updates from Washington, the Biden administration issued its budget request for fiscal-year 2022 in May.
And it reinforces the administration's statements around investing in capabilities to maintain U.S. national security advantages.
The request aligns well with the investments we've made at Northrop Grumman as we've positioned our portfolio for the future.
And while it's still relatively early in the budget process, we're pleased to see strong support for national security from the Congress, including a $25 billion increase to the president's budget request approved last week by the Senate Armed Services Committee.
Both the House Appropriations Committee and SASC have voiced strong support for many of our programs, including B-21, GBSD, Triton and F-35, to name a few.
We look forward to working with the Congress and the administration as they make progress on the fiscal-year 2022 budget.
NASA was also well-supported in the budget, with a 7% year-over-year increase in proposed funding.
NASA priorities include returning to the moon via the Artemis program, where we are a key supplier of critical technologies, including the Habitation and Logistics Outpost or HALO, and the solid rocket boosters for the Space Launch System, also known as SLS.
This provides meaningful opportunity for the company, and it demonstrates the diverse nature of our space business.
Turning to business highlights from the quarter.
I'll share a few examples that helped to demonstrate the strength of our portfolio and our technology leadership across key markets.
In partnership with the Air Force, the B-21 program remains on track, with two test aircraft in production today, and we continue to make solid progress toward first flight.
This program leverages the confluence of Northrop Grumman's long history in aircraft development and advanced low observability capabilities.
The Air Force recently published an artist rendering and a B-21 fact sheet that provides additional insights into the program.
The fact sheet highlights that the B-21 is being designed with open systems architecture to reduce integration risk and enable future modernization efforts to allow for the aircraft to evolve as the threat environment changes.
As we've discussed on many of these calls, Northrop Grumman is a leader in communications and networking solutions, providing the connective tissue for military platforms, sensors and systems that weren't designed to communicate with one another, passing information and data using secure, open systems similar to how we use the Internet and 5G in our day-to-day lives.
Our systems played an important role in the Northern Edge 2021 joint exercise, which was held in May, and showcased how we enable warfighters to easily communicate and securely share actionable information regardless of platform.
As part of the exercise, Northrop Grumman systems were validated on three separate platforms.
Our Freedom Pod was the part of a demonstration with the Air National Guard and our Freedom Radios were a key part of two demonstrations centered on advanced fifth-generation communication.
And as a reminder, the Freedom Radios equip both the F-35 and F-22.
We are also enabling joint all-domain command and control through our Integrated Air and Missile Defense Battle Command System or IBCS.
Army successfully engaged a cruise missile target in a highly contested electronic attack environment during the developmental flight test using Northrop Grumman's IBCS.
This latest flight test integrated the widest variety of sensors to date, including a Marine Corps G/ATOR radar, which is our GaN-based expeditionary radar that entered full-rate production last year, as well as F-35 and other ground sensors and interceptors.
This was the eighth successful flight test performed with the IBCS program.
And the program is on track for a competitive down-select of full-rate production later this year.
In addition, we are making great progress on the GBSD program.
In the second quarter, the team officially closed out the EMD baseline review with our Air Force customer, and we completed the integrated baseline review.
The IBR is a critical step in setting cost and scheduled baselines and is an important milestone for the program.
And earlier this month, we were awarded a contract to continue our support of the Minuteman III ground subsystems until their successful transition to the GBSD system.
So taking a step back, the examples that I just provided highlight our strong performance, technology leadership and broad portfolio and its tight connection to national security priority, from modernizing our strategic deterrents to breakthrough technologies that connect our forces.
Based on the strong results and performance of our company year to date and our latest outlook for the remainder of the year, we are increasing our 2021 revenue, segment OM rate and transaction-adjusted earnings per share guidance.
Additionally, after two years of book to bill over 1.3, we expect our book to bill for the full year to be close to one this year, with key booking opportunities in the second half of the year that include HALO, SLS, F-35 and several restricted programs, laying the foundation for continued growth.
We are very proud of our ESG record and the high marks we've received in many environmental and in social rankings.
We have built an organization with a robust governance structure, diverse and inclusive working environment, and an ongoing and evolving focus on responsible environment stewardship.
In May, we published our most recent sustainability report.
It provides transparency into the progress and actions we've taken in these areas and more.
To help ensure we adhere to these priorities every day, key components of our ESG goals are reflected in nonfinancial metrics that are incorporated into the leadership team's annual incentive compensation.
And just last week, we announced the appointment of a Chief Sustainability Officer, who will report to me and drive further enhancements to our ESG program.
Our second-quarter results and enhanced 2021 outlook demonstrate that our strong fundamental trends continue.
Over the long term, we are well-positioned to provide our customers innovative and affordable solutions to help address national security threats while driving profitable growth and value creation for our shareholders.
My comments begin with second-quarter highlights on Slide 3.
We delivered another quarter of excellent organic sales growth and outstanding segment operating margin rate and higher EPS.
Our year-to-date transaction-adjusted free cash flow increased 26%, and we continue to return cash to shareholders through our buyback program and our quarterly dividend, which we increased by 8% in Q2.
As a result of our outstanding first-half performance and enhanced outlook for the year, we're pleased to be raising our sales, segment operating margin rate and earnings per share guidance.
Slide 4 provides a bridge between second-quarter 2020 and second-quarter 2021 sales.
Normalizing for the IT services divestiture, which was a $585 million headwind in the second quarter of 2021, our organic sales increased 10% compared to last year.
Working days were the same in both periods.
Moving to Slide 5, which compares our earnings per share between Q2 of 2020 and Q2 2021, our earnings per share increased 7% to $6.42.
Operational performance contributed $0.60 of growth and lower unallocated corporate costs driven by state tax changes added another $0.22.
Our marketable securities performance was a modest earnings benefit in Q2.
But compared to the even more favorable equity markets experienced in the same quarter last year, it represented a year-over-year headwind of $0.18.
Lastly, we experienced a higher federal tax rate in the period due to a change in tax revenue recognition on certain contracts for years prior to the 2017 Tax Cuts and Jobs Act.
Next, I'll begin a review of sector results on Slide 6.
Aeronautics sales were roughly flat for the quarter and up 2% year to date.
Sales in both periods were higher in Manned Aircraft, principally due to higher volume on restricted programs and E-2D, partially offset by lower production activity on A350 and lower volume in Autonomous Systems.
At defense systems, sales decreased by 24% in the quarter and 21% year to date, and on an organic basis, sales were down roughly 3% in both periods.
Lower organic sales were driven by the completion of our Lake City activities, which represented a headwind of $120 million in the quarter and $260 million year to date.
This was partially offset by higher volume in both periods on GMLRS, as well as ramp-up on the Global Hawk Contractor Logistics Support program for the Republic of Korea.
Mission systems sales were up 6% in the second quarter and 8% year to date.
On an organic basis, MS delivered another double-digit sales increase in the quarter of almost 12%, and organic sales were higher in all four of its business units in both periods.
Turning to space systems, sales continue to grow at a robust rate, rising 34% in the second quarter and 32% year to date.
Sales in both of its business areas were higher in the quarter and year-to-date periods, reflecting continued ramp-up on GBSD and NGI, as well as higher volume on restricted programs, Artemis and Next Generation OPIR.
Moving to segment operating income and margin rate on Slide 7.
We had an outstanding operational quarter with segment margin rate at 12.2%.
Aeronautics' Q2 operating income decreased 3% due to a benefit of $21 million recognized in the second quarter of 2020 from the resolution of a government accounting matter.
Operating margin rate was consistent at 10.3% in Q2 and the year-to-date period.
At defense systems, operating income decreased by 18% in the quarter and 15% year to date, primarily due to the impact of the IT services divestiture.
Operating margin rate increased to 12.4% in the quarter and 11.8% year to date.
The increase in operating margin rate was largely driven by improved business performance and business mix in battle management and missile systems programs.
Operating income in Mission Systems rose 18% in the quarter and 15% year to date due to higher sales volume and improved performance.
Operating margin rate increased to 15.8% in the quarter and benefited from the favorable resolution of certain cost accounting matters, as well as changes in business mix, as a result of the IT services divestiture.
Year to date, operating margin rate increased to 15.5%.
Space systems operating income rose 44% in the quarter and 40% year to date, and operating margin rate was 11% in both periods.
Higher operating income is primarily a result of the higher sales volume, along with the timing of risk retirements contributing to higher net favorable earnings adjustments in both periods.
Now turning to sector guidance on Slide 8.
You'll note that we are now providing quantified ranges for sales and OM rates instead of the broader descriptions, such as low to mid or mid to high, given the improved visibility that we have as we pass the midpoint of this fiscal year.
We are increasing the sales outlooks of our defense, mission systems and space sectors, given the strong volume they each produced in the first half and solid outlooks for second-half performance.
We're slightly reducing sales guidance for aeronautics, reflecting the continued plateauing of several of our production programs after years of outsized growth.
For operating margin rate, we're increasing our guidance at defense, MS and space, and the margin rate at AS remains unchanged.
Moving to consolidated guidance on Slide 9.
We're raising our 2021 outlook for several key metrics.
For sales, we're increasing the midpoint of our guide by $500 million to a range of $35.8 billion to $36.2 billion.
This translates to full-year organic growth of over 4% and over 5% excluding the 2020 equipment sale at AS.
As you review our sales trends, keep in mind that the first half benefited from one month of the IT services business and had seven more working days than the second half will have.
We expect the company to have higher organic sales per working day in the second half of the year than the first.
We're also increasing both our segment operating margin rate and our overall operating margin rate ranges by 10 basis points to 11.6% to 11.8% and 15.5% to 15.7%, respectively.
Keep in mind that the gain from the IT services divestiture contributed approximately 5 points of our overall operating margin benefit.
We're proud of our profit performance in the first half and continue to expect strong results in the second half of the year.
First-half net favorable EAC adjustments were particularly strong with lower rates driving Q1 outperformance and program risk retirements contributing to Q2 strength.
For unallocated corporate expense, our updated guidance reflects a $30 million reduction associated with state tax changes.
And we now foresee an effective federal tax rate in the high 17% range, excluding the effects of the divestiture, which is an increase from our prior guidance.
We project a federal tax rate of approximately 22.5% on a GAAP basis.
Finally, we're raising our earnings per share guidance, which I'll highlight on Slide 11.
The increase in guidance is driven by $0.40 of segment operational improvement.
Lower unallocated corporate costs almost fully offset the headwind from the higher federal tax rate, leading to an increase in our transaction-adjusted earnings per share guidance of $0.35 at the midpoint.
Next, I'd like to take a moment to talk about cash.
Since our call in January, we've raised the midpoint of our sales guide by $700 million.
With those additional sales come additional working capital needs to fuel the growth.
But in light of our outstanding first-half cash flow performance, we project that we can absorb that additional working capital in our existing transaction-adjusted free cash flow guidance of $3 billion to $3.3 billion.
We believe this range reflects continued strength in cash conversion, balanced with prudent investments in key growth segments of our market.
I also wanted to provide more information on the projected impact on our 2022 CAS pension recoveries from the American Rescue Plan Act, which was passed this spring.
While asset returns and actuarial assumptions will continue to influence the final number, our current estimate is approximately $185 million of CAS recoveries in 2022, down $55 million from our January guide and down about $300 million from our expected 2021 level.
We continue to expect minimal required pension contributions over the next several years.
Regarding cash deployment, as Kathy mentioned, we completed our $2 billion accelerated share repurchase in the second quarter, retiring over six million shares at an average price of around $327 per share.
And we continue to target over $3 billion of total buybacks in 2021.
At the end of the second quarter, we had approximately $3.7 billion of remaining share repurchase authorization.
In conclusion, we're very pleased to have delivered another quarter of rapid growth, outstanding program performance, strong cash flow and accretive cash deployment.
And with that, Todd, I think we're ready to open up the call for Q&A.
Nicole, can you remind everyone how to get into the queue?

user
northrop raises full-year forecast on space unit strength.
qtrly earnings per share $6.42; qtrly transaction-adjusted earnings per share $6.42.
qtrly total sales $9.15 billion, up 3%.
raises 2021 sales guidance to $35.8 billion to $36.2 billion.
sees 2021 mtm-adjusted diluted earnings per share $31.30 to $31.70; sees 2021 operating margin 15.5% to 15.7%.

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