NORTHROP GRUMMAN CORPORATION OVERVIEW
Northrop Grumman Corporation (herein referred to as "Northrop Grumman," the "company," "we," "us," or "our") is a leading global aerospace and defense company. We use our broad portfolio of capabilities and technologies to create and deliver innovative platforms, systems and solutions in space; manned and autonomous airborne systems, including strike; strategic deterrence systems; hypersonics; missile defense; weapons systems; cyber; command, control, communications and computers, intelligence, surveillance and reconnaissance (C4ISR); and logistics and modernization. We participate in many high-priority defense and government programs inthe United States (U.S. ) and abroad. We conduct most of our business with theU.S. government, principally theDepartment of Defense (DoD ) and intelligence community. We also conduct business with foreign, state and local governments, as well as commercial customers. The following discussion should be read along with the financial statements included in this Form 10-Q, as well as our 2020 Annual Report on Form 10-K, which provides additional information on our business and the environment in which we operate and our operating results. Divestiture of IT and Mission Support Services Business EffectiveJanuary 30, 2021 (the "Divestiture date"), we completed the previously announced sale of our IT and mission support services business (the "IT services divestiture") for$3.4 billion in cash and recorded a pre-tax gain on sale of$2.0 billion . The IT and mission support services business was comprised of the majority of the Information Solutions and Services (IS &S) division of Defense Systems (excluding ourVinnell Arabia business); select cyber, intelligence and missions support programs, which were part of theCyber and Intelligence Mission Solutions (CIMS) division of Mission Systems; and the Space Technical Services business unit of Space Systems. Operating results include sales and operating income for the IT and mission support services business prior to the Divestiture date. COVID-19 Coronavirus disease 2019 ("COVID-19") was first reported in late 2019 and has since dramatically impacted the global health and economic environment, including millions of confirmed cases, business slowdowns or shutdowns, government challenges and market volatility. We discuss in some detail in our Annual Report on Form 10-K the pandemic, its impacts and risks, and actions taken up to the time of filing. In this Form 10-Q, we provide an update. We continue closely to monitor and address the developments, including the impact on our company, our employees, our customers, our suppliers and our communities. The company continues to consider health data and guidance from theCenters for Disease Control and Prevention (CDC ), other health organizations, federal, state and local governmental authorities, and our customers, among others. During the first half of 2021, COVID-19 case rates and the health and economic impacts of the pandemic increased and decreased in different communities in theU.S. and globally. In theU.S. , theFood and Drug Administration (FDA) issued emergency use authorization for COVID-19 vaccines and the government began extensive efforts to administer them. The company also has taken various steps to facilitate access for our employees, in accordance with federal guidelines and state and local vaccination plans. We have provided paid leave and flexibility for employees to get vaccinated. During the second quarter of 2021, we began a phased transition back to our facilities for most employees who have been working remotely. The company continues to take robust actions globally to protect the health, safety and well-being of our employees, and to serve our customers with continued performance. We also continue to take steps to support our suppliers, with a particular focus on critical small and midsized business partners, including passing through increased progress payments from theDoD to our suppliers and accelerating payments to certain suppliers. The company's second quarter 2021 revenue and operating income were not significantly impacted by COVID-19. However, our employees, suppliers and customers, the company and our global community continue to face challenges and we cannot predict how this dynamic situation will evolve or the impact it will have on the company. For further information on the pandemic and the potential impact to the company of COVID-19, see "Liquidity and Capital Resources" below and "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2020 Annual Report on Form 10-K.U.S. Political and Economic Environment OnMay 28, 2021 , the Administration released its budget request for fiscal year 2022. The budget proposes$753 billion for national defense programs and$770 billion in non-defense discretionary funding. TheCongress is expected to continue to debate the defense budget. If not agreed, the government may be required to operate under a continuing resolution into fiscal year 2022, which could impact our programs and new starts, in particular. The Administration's budget request includes funding for the American Jobs Plan, a$2.3 trillion infrastructure and -18-
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NORTHROP GRUMMAN CORPORATION economic recovery plan, and the American Families Plan, a$1.8 trillion education and economic support plan. If some or all of these plans are enacted, they may have broader implications for the defense industry, our customers' budgets and priorities, and the overall economic environment, including the national debt. It is difficult to predict the specific course of future defense budgets. However, the threat to national security remains very substantial and we believe that our capabilities, particularly in space, missiles, missile defense, hypersonics, counter-hypersonics, survivable aircraft and mission systems should help our customers to meet the threats and, as a result, continue to allow for long-term profitable growth in our business. We understand that the government expects the debt ceiling will be breached around the end ofJuly 2021 and theTreasury Department will then begin taking "extraordinary measures" to finance the government. If the debt ceiling is breached, we may be required to continue to perform for some period of time on certain of ourU.S. Government contracts even if theU.S. Government is unable to make timely payments. The political environment, federal budget and debt ceiling are expected to continue to be the subject of considerable debate, which could have material impacts on defense spending broadly and the company's programs in particular. For further information on the risks we face from the current political and economic environment, see "Risk Factors" in our 2020 Annual Report on Form 10-K. CONSOLIDATED OPERATING RESULTS For purposes of the operating results discussion below, we assess our performance using certain financial measures that are not calculated in accordance with GAAP. Organic sales is defined as total sales excluding sales attributable to the company's IT services divestiture. This measure may be useful to investors and other users of our financial statements as a supplemental measure in evaluating the company's underlying sales growth as well as in providing an understanding of our ongoing business and future sales trends by presenting the company's sales before the impact of divestiture activity. Transaction-adjusted net earnings and transaction-adjusted earnings per share (transaction-adjusted EPS) exclude impacts related to the IT services divestiture, including the gain on sale of the business, associated federal and state income tax expenses, transaction costs, and the make-whole premium for early debt redemption. They also exclude the impact of mark-to-market pension and OPB ("MTM") expense and related tax impacts, which are generally only recognized during the fourth quarter. These non-GAAP measures may be useful to investors and other users of our financial statements as supplemental measures in evaluating the company's underlying financial performance by presenting the company's operating results before the non-operational impact of divestiture activity and pension and OPB actuarial gains and losses. These measures are also consistent with how management views the underlying performance of the business as the impact of the IT services divestiture and MTM accounting are not considered in management's assessment of the company's operating performance or in its determination of incentive compensation awards. We reconcile these non-GAAP financial measures to their most directly comparable GAAP financial measures below. These non-GAAP measures may not be defined and calculated by other companies in the same manner and should not be considered in isolation or as an alternative to operating results presented in accordance with GAAP. Selected financial highlights are presented in the table below: Three Months Ended June 30 % Six Months Ended June 30 % $ in millions, except per share amounts 2021 2020 Change 2021 2020 Change Sales$ 9,151 $ 8,884 3 %$ 18,308 $ 17,504 5 % Operating costs and expenses 8,107 7,890 3 % 16,422 15,576 5
%
Operating costs and expenses as a % of sales 88.6 % 88.8 % 89.7 % 89.0 % Gain on sale of business - - NM 1,980 - NM Operating income 1,044 994 5 % 3,866 1,928 101 % Operating margin rate 11.4 % 11.2 % 21.1 % 11.0 % Federal and foreign income tax expense 265 198 34 % 1,086 383 184
%
Effective income tax rate 20.4 % 16.5 % 25.2 % 17.0 % Net earnings 1,037 1,005 3 % 3,232 1,873 73
%
Diluted earnings per share$ 6.42 $ 6.01 7 %$ 19.89 $ 11.16 78 % -19-
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NORTHROP GRUMMAN CORPORATION Sales The tables below reconcile sales to organic sales: Three Months Ended June 30 2021 2020 IT services Organic IT services Organic Organic sales % $ in millions Sales sales sales Sales sales sales change Aeronautics Systems$ 2,913 $ -$ 2,913 $ 2,925 $ -$ 2,925 - % Defense Systems 1,427 - 1,427 1,886 (416) 1,470 (3) % Mission Systems 2,588 - 2,588 2,446 (131) 2,315 12 % Space Systems 2,748 - 2,748 2,048 (43) 2,005 37 % Intersegment eliminations (525) - (525) (421) 5 (416) Total$ 9,151 $ -$ 9,151 $ 8,884 $ (585) $ 8,299 10 % Six Months Ended June 30 2021 2020 IT services Organic IT services Organic Organic sales % $ in millions Sales sales sales Sales sales sales change Aeronautics Systems$ 5,903 $ -$ 5,903 $ 5,768 $ -$ 5,768 2 % Defense Systems 2,989 (106) 2,883 3,767 (805) 2,962 (3) % Mission Systems 5,177 (42) 5,135 4,793 (261) 4,532 13 % Space Systems 5,269 (16) 5,253 3,996 (87) 3,909 34 % Intersegment eliminations (1,030) 2 (1,028) (820) 9 (811) Total$ 18,308 $ (162) $ 18,146 $ 17,504 $ (1,144) $ 16,360 11 % Current Quarter Second quarter 2021 sales increased$267 million , or 3 percent, primarily due to higher sales at Space Systems and Mission Systems, partially offset by lower sales at Defense Systems principally due to the impact of the IT services divestiture. Second quarter 2021 organic sales increased$852 million , or 10 percent. Year to Date Year to date 2021 sales increased$804 million , or 5 percent, due to higher sales at Space Systems, Mission Systems and Aeronautics systems, partially offset by lower sales at Defense Systems principally due to the impact of the IT services divestiture. Year to date 2021 organic sales increased$1.8 billion , or 11 percent. As a result of the company using a fiscal calendar convention for interim reporting periods (as described in Note 1 to the financial statements), year to date 2021 sales at each sector benefited approximately 2 percent from three additional working days when compared to the prior year period. See "Segment Operating Results" below for further information by segment and "Product and Service Analysis" for product and service detail. See Note 9 to the financial statements for information regarding the company's sales by customer type, contract type and geographic region for each of our segments. -20-
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NORTHROP GRUMMAN CORPORATION Operating Income and Margin RateCurrent Quarter Second quarter 2021 operating income increased$50 million , or 5 percent, due to higher segment operating income and lower unallocated corporate expense, partially offset by a lower FAS/CAS operating adjustment. Second quarter 2021 operating margin rate increased to 11.4 percent reflecting a higher segment operating margin rate in addition to the items above. Second quarter 2021 general and administrative (G&A) costs as a percentage of sales increased to 10.9 percent from 9.4 percent in the prior year period primarily due to an increase in investments for future business opportunities as well as the timing of indirect cost recognition during the quarter. Year to Date Year to date 2021 operating income increased$1.9 billion , or 101 percent, primarily due to the IT services divestiture, including the$2.0 billion pre-tax gain on sale and$192 million of unallocated corporate expense for unallowable state taxes and transaction costs. Operating income also increased due to higher segment operating income and lower non-divestiture-related unallocated corporate expenses, partially offset by a lower FAS/CAS operating adjustment. Year to date 2021 operating margin rate increased to 21.1 percent reflecting the items above. Year to date 2021 G&A costs as a percentage of sales increased to 10.4 percent from 9.3 percent in the prior year period primarily due to an increase in investments for future business opportunities as well as the timing of indirect cost recognition during the year. See "Segment Operating Results" below for further information by segment. For information regarding product and service operating costs and expenses, see "Product and Service Analysis" below. Federal and Foreign Income TaxesCurrent Quarter The second quarter 2021 effective tax rate (ETR) increased to 20.4 percent from 16.5 percent in the prior year period primarily due to a change made in tax revenue recognition on certain long-term contracts, which increased taxable income in years prior to the 2017 Tax Cuts and Jobs Act at a rate above the current statutory rate. See Note 3 to the financial statements for additional information. Year to Date The year to date 2021 ETR increased to 25.2 percent from 17.0 percent in the prior period primarily due to federal income taxes resulting from the IT services divestiture. See Note 3 to the financial statements for additional information. -21-
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NORTHROP GRUMMAN CORPORATION Net Earnings The table below reconciles net earnings to transaction-adjusted net earnings: Three Months Ended June 30 % Six Months Ended June 30 % $ in millions 2021 2020 Change 2021 2020 Change Net earnings$ 1,037 $ 1,005 3 %$ 3,232 $ 1,873 73 % Gain on sale of business - - NM (1,980) - NM State tax impact1 - - NM 160 - NM Transaction costs - - NM 32 - NM Make-whole premium - - NM 54 - NM Federal tax impact of items above2 - - NM 614 - NM Adjustment, net of tax $ - $ - NM$ (1,120) $ - NM Transaction-adjusted net earnings$ 1,037 $ 1,005 3 %$ 2,112 $ 1,873 13 % (1)The state tax impact includes$62 million of incremental tax expense related to$1.2 billion of nondeductible goodwill in the divested business. (2)The federal tax impact was calculated by applying the 21 percent federal statutory rate to the adjustment items and also includes$250 million of incremental tax expense related to$1.2 billion of nondeductible goodwill in the divested business. Current Quarter Second quarter 2021 net earnings increased$32 million , or 3 percent, primarily due to higher operating income and an increase in non-operating FAS pension benefit, partially offset by an increase in income tax expense. Year to Date Year to date 2021 net earnings increased$1.4 billion , or 73 percent, primarily due to the IT services divestiture. Transaction-adjusted net earnings increased$239 million or 13 percent, primarily due to higher operating income and an increase in non-operating FAS pension benefit, partially offset by an increase in income tax expense. Diluted Earnings Per Share The table below reconciles diluted earnings per share to transaction-adjusted EPS: Three Months Ended June 30 % Six Months Ended June 30 % 2021 2020 Change 2021 2020 Change Diluted EPS$ 6.42 $ 6.01 7 %$ 19.89 $ 11.16 78 % Gain on sale of business per share - - NM (12.18) - NM State tax impact per share1 - - NM 0.98 - NM Transaction costs per share - - NM 0.20 - NM Make-whole premium per share - - NM 0.33 - NM Federal tax impact of line items above per share2 - - NM 3.78 - NM Adjustment, net of tax per share $ - $ - NM$ (6.89) $ - NM Transaction-adjusted EPS$ 6.42 $ 6.01 7 %$ 13.00 $ 11.16 16 % (1)The state tax impact includes$62 million of incremental tax expense related to$1.2 billion of nondeductible goodwill in the divested business. (2)The federal tax impact was calculated by applying the 21 percent federal statutory rate to the adjustment items and also includes$250 million of incremental tax expense related to$1.2 billion of nondeductible goodwill in the divested business. Current Quarter Second quarter 2021 diluted earnings per share increased 7 percent, reflecting a 3 percent increase in net earnings and a 3 percent reduction in weighted-average diluted shares outstanding. Year to Date Year to date 2021 diluted earnings per share increased 78 percent, principally due to a$6.89 increase associated with the IT services divestiture. Transaction-adjusted earnings per share increased$1.84 , or 16 percent, reflecting a 13 percent increase in transaction-adjusted net earnings and a 3 percent reduction in weighted-average diluted shares outstanding. -22-
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Table of ContentsNORTHROP GRUMMAN CORPORATION SEGMENT OPERATING RESULTS Basis of Presentation The company is aligned in four operating sectors, which also comprise our reportable segments: Aeronautics Systems, Defense Systems, Mission Systems and Space Systems. We present our sectors in the following business areas, which are reported in a manner reflecting core capabilities: Aeronautics Systems Defense Systems Mission Systems Space Systems Battle Management & Airborne Multifunction Launch & Strategic Autonomous Systems Missile Systems Sensors Missiles Maritime/Land Systems & Manned Aircraft Mission Readiness Sensors Space Navigation, Targeting & Survivability Networked Information Solutions Effective during the first quarter of 2021 within Mission Systems, the businesses of the former Cyber & Intelligence Mission Solutions business area that remained with Northrop Grumman after the IT services divestiture were merged with the Communications business unit andF-35 Communications , Navigation and Identification programs within the former Airborne, Sensors & Networks business area to form the Networked Information Solutions business area. The Airborne Sensors & Networks business area was then renamed the Airborne Multifunction Sensors business area to better reflect its new portfolio. This change had no impact on the segment operating results of Mission Systems as a whole. This section discusses segment sales, operating income and operating margin rates. In evaluating segment operating performance, we look primarily at changes in sales and operating income. Where applicable, significant fluctuations in operating performance attributable to individual contracts or programs, or changes in a specific cost element across multiple contracts, are described in our analysis. Based on this approach and the nature of our operations, the discussion of results of operations below first focuses on our four segments before distinguishing between products and services. Changes in sales are generally described in terms of volume, while changes in margin rates are generally described in terms of performance and/or contract mix. For purposes of this discussion, volume generally refers to increases or decreases in sales or cost from production/service activity levels and performance generally refers to non-volume related changes in profitability. Contract mix generally refers to changes in the ratio of contract type and/or lifecycle (e.g., cost-type, fixed-price, development, production, and/or sustainment). -23-
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NORTHROP GRUMMAN CORPORATION Segment Operating Income and Margin Rate Segment operating income, as reconciled in the table below, and segment operating margin rate (segment operating income divided by sales) are non-GAAP (accounting principles generally accepted inthe United States of America ) measures that reflect total earnings from our four segments, including allocated pension expense we have recognized under the Federal Acquisition Regulation (FAR) and the relatedU.S. Government Cost Accounting Standards (CAS), and excluding FAS pension service expense and unallocated corporate items (certain corporate-level expenses, which are not considered allowable or allocable under applicable CAS or FAR, and costs not considered part of management's evaluation of segment operating performance). These non-GAAP measures may be useful to investors and other users of our financial statements as supplemental measures in evaluating the financial performance and operational trends of our sectors. These measures may not be defined and calculated by other companies in the same manner and should not be considered in isolation or as alternatives to operating results presented in accordance with GAAP. Three Months Ended June 30 % Six Months Ended June 30 % $ in millions 2021 2020 Change 2021 2020 Change Segment operating income$ 1,117 $ 1,031 8 %$ 2,212 $ 1,998 11 % Segment operating margin rate 12.2 % 11.6 % 12.1 % 11.4 % CAS pension expense 121 205 (41) % 244 412 (41) % Less: FAS pension service expense (103) (102) 1 % (207) (204) 1 % FAS/CAS operating adjustment 18 103 (83) % 37 208 (82) % Gain on sale of business - - NM 1,980 - NM IT services divestiture - unallowable state taxes and transaction costs - - NM (192) - NM Intangible asset amortization and PP&E step-up depreciation (64) (77) (17) % (129) (159) (19) % Other unallocated corporate expense (27) (63) (57) % (42) (119) (65) % Unallocated corporate (expense) income (91) (140) (35) % 1,617 (278) (682) % Operating income$ 1,044 $ 994 5 %$ 3,866 $ 1,928 101 % Current Quarter Second quarter 2021 segment operating income increased$86 million , or 8 percent, due to higher sales and a higher segment operating margin rate. Higher operating income at Space Systems and Mission Systems was partially offset by lower operating income at Defense Systems, principally due to the impact of the IT services divestiture, and Aeronautics Systems. Second quarter 2020 segment operating income from the IT services business was$60 million . Segment operating margin rate increased to 12.2 percent from 11.6 percent due to higher operating margin rates at Mission Systems, Defense Systems and Space Systems, partially offset by a lower operating margin rate at Aeronautics Systems. Year to Date Year to date 2021 segment operating income increased$214 million , or 11 percent, due to higher sales and a higher segment operating margin rate. Higher operating income at Space Systems, Mission Systems and Aeronautics Systems was partially offset by lower operating income at Defense Systems, due to the impact of the IT services divestiture. Year to date 2021 segment operating income from the IT services business was$20 million as compared to$111 million in the prior year period. Year to date 2021 segment operating income includes a first quarter 2021 benefit of approximately$100 million due to the impact of lower overhead rates on the company's fixed price contracts. The lower projected overhead rates were principally driven by a reduction in projected CAS pension costs as well as operational performance at the sectors, which more than offset lower business base due to the IT services divestiture. Segment operating margin rate increased to 12.1 percent from 11.4 percent and reflects higher operating margin rates at all four sectors largely as a result of the items discussed above. FAS/CAS Operating Adjustment Second quarter 2021 and year to date 2021 FAS/CAS operating adjustment decreased primarily due to lower CAS pension expense resulting from favorable plan asset returns in 2020 and changes in certain CAS actuarial assumptions as ofDecember 31, 2020 . -24-
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NORTHROP GRUMMAN CORPORATION Unallocated Corporate (Expense) IncomeCurrent Quarter The decrease in second quarter 2021 unallocated corporate (expense) income is primarily due to the deferred state tax impact of a change in tax revenue recognition on certain contracts, as well as lower intangible asset amortization and PP&E step-up depreciation. Year to Date The increase in year to date 2021 unallocated corporate (expense) income is primarily due to a$2.0 billion pre-tax gain on the sale of our IT services business, partially offset by$192 million of unallowable state taxes and transaction costs associated with the divestiture. Unallocated corporate (expense) income also increased due to a net increase in deferred state tax assets principally resulting from certain state tax legislation adopted in 2020 that places temporary limitations on tax credits and a change in tax revenue recognition on certain contracts, as well as lower intangible asset amortization and PP&E step-up depreciation. Net EAC Adjustments - We record changes in estimated contract earnings at completion (net EAC adjustments) using the cumulative catch-up method of accounting. Net EAC adjustments can have a significant effect on reported sales and operating income and the aggregate amounts are presented in the table below: Three Months Ended June 30 Six Months Ended June 30 $ in millions 2021 2020 2021 2020 Favorable EAC adjustments$ 309 $ 241 $ 657$ 517 Unfavorable EAC adjustments (155) (129) (313) (281) Net EAC adjustments$ 154 $ 112 $ 344$ 236
Net EAC adjustments by segment are presented in the table below:
Three Months Ended June 30 Six Months Ended June 30
$ in millions 2021 2020 2021 2020
Aeronautics Systems $ 32 $ 22 $ 69 $ 34
Defense Systems 28 39 58 61
Mission Systems 61 59 149 138
Space Systems 33 (7) 70 5
Eliminations - (1) (2) (2)
Net EAC adjustments $ 154 $ 112 $ 344 $ 236
For purposes of the discussion in the remainder of this Segment Operating
Results section, references to operating income and operating margin rate
reflect segment operating income and segment operating margin rate,
respectively.
AERONAUTICS SYSTEMS Three Months Ended June 30 % Six Months Ended June 30 %
$ in millions 2021 2020 Change 2021 2020 Change
Sales $ 2,913 $ 2,925 - % $ 5,903 $ 5,768 2 %
Operating income 300 310 (3) % 608 573 6 %
Operating margin rate 10.3 % 10.6 % 10.3 % 9.9 %
Sales
Current Quarter
Second quarter 2021 sales were comparable to the prior year period. Higher
restricted and E-2 production volume was offset by a reduction in A350
production activity and lower volume on the B-2 Defensive Management Systems
Modernization (DMS) program as well as certain Global Hawk programs as they near
completion.
Year to Date
Year to date 2021 sales increased $135 million , or 2 percent, due to higher
volume on restricted programs and the E-2 and F-35 production programs. These
increases more than offset lower volume on A350 production activity and B-2 DMS
as well as certain Global Hawk programs as they near completion.
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NORTHROP GRUMMAN CORPORATION Operating IncomeCurrent Quarter Second quarter 2021 operating income decreased$10 million , or 3 percent, due to a lower operating margin rate. Operating margin rate decreased to 10.3 percent from 10.6 percent principally due to a$21 million benefit recognized in the prior period in connection with the resolution of a government accounting matter, partially offset by higher net favorable EAC adjustments. Year to Date Year to date 2021 operating income increased$35 million , or 6 percent, due to a higher operating margin rate and higher sales. Operating margin rate increased to 10.3 percent from 9.9 percent principally due to higher net favorable EAC adjustments, which were largely driven by the previously described first quarter 2021 reduction in overhead rates. DEFENSE SYSTEMS Three Months Ended June 30 % Six Months Ended June 30 % $ in millions 2021 2020 Change 2021 2020 Change Sales$ 1,427 $ 1,886 (24) %$ 2,989 $ 3,767 (21) % Operating income 177 217 (18) % 354 415 (15) % Operating margin rate 12.4 % 11.5 % 11.8 % 11.0 % Sales Current Quarter Second quarter 2021 sales decreased$459 million , or 24 percent, primarily due to a$416 million reduction in sales related to the IT services divestiture. Second quarter 2021 organic sales decreased$43 million , or 3 percent, principally due to the close-out of the contract at the Army'sLake City ammunition plant (Lake City ), partially offset by higher volume on the Guided Missile Launch Rocket System (GMLRS) program, Republic of Korea Global Hawk Contractor Logistics Support (ROK Global Hawk CLS) program and production ramp-up on advanced fuze programs. Year to Date Year to date 2021 sales decreased$778 million , or 21 percent, primarily due to a$699 million reduction in sales related to the IT services divestiture. Year to date 2021 organic sales decreased$79 million , or 3 percent, principally due to the close-out ofLake City , partially offset by higher volume on several programs including GMLRS, RoK Global Hawk CLS, advanced fuzes, B-2 sustainment and the Advanced Anti-Radiation Guided Missile program. Operating Income Current Quarter Second quarter 2021 operating income decreased$40 million , or 18 percent, primarily due to the impact of the IT services divestiture. Operating margin rate increased to 12.4 percent from 11.5 percent and reflects improved performance at Battle Management and Missile Systems due, in part, to changes in mix as a result of recent contract completions. Year to Date Year to date 2021 operating income decreased$61 million , or 15 percent, primarily due to the impact of the IT services divestiture. Operating margin rate increased to 11.8 percent from 11.0 percent primarily due to improved performance at Battle Management and Missile Systems due to the items discussed above. MISSION SYSTEMS Three Months Ended June 30 % Six Months Ended June 30 % $ in millions 2021 2020 Change 2021 2020 Change Sales$ 2,588 $ 2,446 6 %$ 5,177 $ 4,793 8 % Operating income 408 347 18 % 805 700 15 % Operating margin rate 15.8 % 14.2 % 15.5 % 14.6 % -26-
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Table of ContentsNORTHROP GRUMMAN CORPORATION SalesCurrent Quarter Second quarter 2021 sales increased$142 million , or 6 percent, due to higher volume across the sector, partially offset by a$131 million reduction in sales related to the IT services divestiture. Second quarter 2021 organic sales increased$273 million , or 12 percent. Maritime/Land Systems and Sensors sales increased primarily due to higher volume on land systems, including the Ground/Air Task-Oriented Radar (G/ATOR) program, and higher marine systems and international volume. Navigation, Targeting and Survivability sales increased primarily due to higher intercompany volume on the Ground Based Strategic Deterrent (GBSD) program. Airborne Multifunction Sensors sales increased principally due to higher airborne radar volume, including the Scalable Agile Beam Radar (SABR) and Multi-role Electronically Scanned Array (MESA) programs. Networked Information Solutions sales increased primarily due to higher volume on electronic warfare programs, including the Joint Counter Radio-Controlled Improvised Explosive Device Electronic Warfare (JCREW) program. Year to Date Year to date 2021 sales increased$384 million , or 8 percent, due to higher volume across the sector, partially offset by a$219 million reduction in sales related to the IT services divestiture. Year to date 2021 organic sales increased$603 million , or 13 percent. Maritime/Land Systems and Sensors sales increased primarily due to higher volume on land systems, including G/ATOR, and higher marine systems and restricted volume. Airborne Multifunction Sensors sales increased principally due to higher airborne radar volume, including SABR and MESA, and higher restricted volume. Navigation, Targeting and Survivability sales increased primarily due to higher intercompany volume on GBSD as well as higher volume on targeting, infrared countermeasures and navigation programs. Networked Information Solutions sales increased primarily due to higher volume on electronic warfare programs, including JCREW. Operating IncomeCurrent Quarter Second quarter 2021 operating income increased$61 million , or 18 percent, due to higher sales volume and a higher operating margin rate. Operating margin rate increased to 15.8 percent from 14.2 percent principally due to the favorable resolution of certain government accounting matters and changes in contract mix toward more fixed-price content, largely as a result of the IT services divestiture. Year to Date Year to date 2021 operating income increased$105 million , or 15 percent, due to higher sales volume and a higher operating margin rate. Operating margin rate increased to 15.5 percent from 14.6 percent and reflects a benefit for the previously described first quarter 2021 reduction in overhead rates as well as the matters discussed above. SPACE SYSTEMS Three Months Ended June 30 % Six Months Ended June 30 % $ in millions 2021 2020 Change 2021 2020 Change Sales$ 2,748 $ 2,048 34 %$ 5,269 $ 3,996 32 % Operating income 301 209 44 % 577 411 40 % Operating margin rate 11.0 % 10.2 % 11.0 % 10.3 % Sales Current Quarter Second quarter 2021 sales increased$700 million , or 34 percent, primarily due to higher sales in both the Launch & Strategic Missiles and Space business areas, partially offset by a$43 million reduction in sales related to the IT services divestiture. Second quarter 2021 organic sales increased$743 million , or 37 percent. Launch & Strategic Missiles sales increased primarily due to ramp-up on GBSD and the Next Generation Interceptor (NGI) program as well as higher volume on Commercial Resupply Service (CRS) missions and hypersonics programs. Space sales were driven by higher volume on restricted programs, Artemis and the Next Generation Overhead Persistent Infrared (Next Gen OPIR) program. -27-
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NORTHROP GRUMMAN CORPORATION Year to Date Year to date 2021 sales increased$1.27 billion , or 32 percent, primarily due to higher sales in both the Launch & Strategic Missiles and Space business areas, partially offset by a$71 million reduction in sales related to the IT services divestiture. Year to date 2021 organic sales increased$1.34 billion , or 34 percent. Launch & Strategic Missiles sales increased primarily due to ramp-up on GBSD and NGI as well as higher volume on hypersonics and CRS programs. Space sales were driven by higher volume on restricted programs, Artemis and the Next Gen OPIR program. Operating IncomeCurrent Quarter Second quarter 2021 operating income increased$92 million , or 44 percent, due to higher sales volume and a higher operating margin rate. Operating margin rate increased to 11.0 percent from 10.2 percent principally due to higher net favorable EAC adjustments on commercial space programs. Year to Date Year to date 2021 operating income increased$166 million , or 40 percent, due to higher sales volume and a higher operating margin rate. Operating margin rate increased to 11.0 percent from 10.3 percent primarily due to higher net favorable EAC adjustments, which were largely driven by improved performance on commercial space programs as well as the previously described reduction in overhead rates. PRODUCT AND SERVICE ANALYSIS The following table presents product and service sales and operating costs and expenses by segment: Three Months Ended June 30 Six Months Ended June 30 $ in millions 2021 2020 2021 2020 Operating Operating Operating Costs Operating Costs Costs and Costs and Segment Information: Sales and Expenses Sales and Expenses Sales Expenses Sales Expenses Aeronautics Systems Product$ 2,484 $ 2,230 $ 2,512 $ 2,247 $ 5,008 $ 4,504 $ 4,921 $ 4,446 Service 384 342 384 342 806 711 792 700 Intersegment eliminations 45 41 29 26 89 80 55 49 Total Aeronautics Systems 2,913 2,613 2,925 2,615 5,903 5,295 5,768 5,195 Defense Systems Product 641 560 753 676 1,321 1,155 1,523 1,380 Service 591 517 953 831 1,288 1,141 1,893 1,657 Intersegment eliminations 195 173 180 162 380 339 351 315 Total Defense Systems 1,427 1,250 1,886 1,669 2,989 2,635 3,767 3,352 Mission Systems Product 1,774 1,515 1,646 1,388 3,534 3,008 3,154 2,662 Service 560 451 616 554 1,152 948 1,279 1,124 Intersegment eliminations 254 214 184 157 491 416 360 307Total Mission Systems 2,588 2,180 2,446 2,099 5,177 4,372 4,793 4,093 Space Systems Product 2,294 2,045 1,571 1,402 4,352 3,874 3,060 2,727 Service 423 374 449 413 847 755 882 810 Intersegment eliminations 31 28 28 24 70 63 54 48 Total Space Systems 2,748 2,447 2,048 1,839 5,269 4,692 3,996 3,585 Segment Totals Total Product$ 7,193 $ 6,350 $ 6,482 $ 5,713 $ 14,215 $ 12,541 $ 12,658 $ 11,215 Total Service 1,958 1,684 2,402 2,140 4,093 3,555 4,846 4,291 Total Segment(1)$ 9,151 $ 8,034 $ 8,884 $ 7,853 $ 18,308 $ 16,096 $ 17,504 $ 15,506
(1)A reconciliation of segment operating income to total operating income is included in "Segment Operating Results."
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Table of ContentsNORTHROP GRUMMAN CORPORATION Product Sales and CostsCurrent Quarter Second quarter 2021 product sales increased$711 million , or 11 percent, primarily due to higher volume on the GBSD, restricted, Artemis, Next Gen OPIR and NGI programs at Space Systems. Second quarter 2021 product costs increased$637 million , or 11 percent, consistent with the higher product sales described above. Year to Date Year to date 2021 product sales increased$1.6 billion , or 12 percent, principally due to increases in product sales at Space Systems and Mission Systems, partially offset by a decrease at Defense Systems. The increase at Space Systems was primarily driven by higher volume on the GBSD, restricted, Artemis, Next Gen OPIR and NGI programs. The increase at Mission Systems was driven by higher volume across the sector. The decrease at Defense Systems was primarily driven by the close-out ofLake City . Year to date 2021 product costs increased$1.3 billion , or 12 percent, consistent with the higher product sales described above. Service Sales and CostsCurrent Quarter Second quarter 2021 service sales decreased$444 million , or 18 percent, primarily due to the IT services divestiture. Second quarter 2020 sales from the IT services business, which were largely included in service sales, were$585 million . The reductions associated with the IT services divestiture were partially offset by higher service volume on several programs at Defense Systems and Mission Systems. Second quarter 2021 service costs decreased$456 million , or 21 percent, consistent with the lower service sales described above and reflect higher net favorable EAC adjustments on Mission Systems service programs. Year to Date Year to date 2021 service sales decreased$753 million , or 16 percent, primarily due to the IT services divestiture. Year to date 2021 sales from the IT services business, which were largely included in service sales, were$162 million as compared to$1.1 billion in the prior year period. The reductions associated with the IT services divestiture were partially offset by higher service volume on several programs at Defense Systems and Mission Systems. Year to date 2021 service costs decreased$736 million , or 17 percent, consistent with the lower services sales described above. BACKLOG Backlog represents the future sales we expect to recognize on firm orders received by the company and is equivalent to the company's remaining performance obligations at the end of each period. It comprises both funded backlog (firm orders for which funding is authorized and appropriated) and unfunded backlog. Unexercised contract options and indefinite delivery indefinite quantity (IDIQ) contracts are not included in backlog until the time an option or IDIQ task order is exercised or awarded. Backlog is converted into sales as costs are incurred or deliveries are made. Backlog consisted of the following as ofJune 30, 2021 andDecember 31, 2020 : June 30, 2021 December 31, 2020 Total Total $ in millions Funded Unfunded Backlog Backlog % Change in 2021 Aeronautics Systems$ 10,635 $ 10,325 $ 20,960 $ 24,002 (13) % Defense Systems 5,988 683 6,671 8,131 (18) % Mission Systems 10,032 3,337 13,369 13,805 (3) % Space Systems 6,449 29,197 35,646 35,031 2 % Total backlog$ 33,104 $ 43,542 $ 76,646 $ 80,969 (5) % New Awards Second quarter and year to date 2021 net awards totaled$6.5 billion and$15.4 billion , respectively, and backlog totaled$76.6 billion . Significant second quarter new awards include$1.7 billion for restricted programs,$0.4 billion -29-
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NORTHROP GRUMMAN CORPORATION for F-35,$0.3 billion for GMLRS,$0.3 billion for E-2 and$0.2 billion for Global Hawk. In connection with the IT services divestiture, the company reduced backlog by$1.4 billion during the first quarter of 2021 ($1.0 billion at Defense Systems,$0.2 billion at Mission Systems and$0.2 billion at Space Systems). LIQUIDITY AND CAPITAL RESOURCES We endeavor to ensure efficient conversion of operating income into cash and to increase shareholder value through cash deployment activities. In addition to our cash position, we use various financial measures to assist in capital deployment decision-making, including cash provided by operating activities and adjusted free cash flow, a non-GAAP measure described in more detail below. AtJune 30, 2021 , we had$3.9 billion in cash and cash equivalents. EffectiveJanuary 30, 2021 , we completed the IT services divestiture for$3.4 billion in cash. Proceeds were primarily used in the first quarter of 2021 for a$2.0 billion accelerated share repurchase and to fund redemption of$1.5 billion of the company's 2.55 percent unsecured notes dueOctober 2022 . InApril 2021 , we renewed our one-year$500 million uncommitted credit facility. The Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") established a program with provisions to allowU.S. companies to defer the employer's portion of social security taxes betweenMarch 27, 2020 andDecember 31, 2020 and pay such taxes in two installments in 2021 and 2022. Our first installment of deferred social security taxes of approximately$200 million is due in the fourth quarter of 2021. Under Section 3610, the CARES Act also authorized the government to reimburse qualifying contractors for certain costs of providing paid leave to employees as a result of COVID-19. The company continues to seek, and anticipates continuing to seek, recovery for certain COVID-19-related costs under Section 3610 of the CARES Act and through our contract provisions, though it is unclear how much we will be able to recover. In addition, theU.S. Department of Defense (DoD ) has, to date, taken steps to increase the rate for certain progress payments from 80 percent to 90 percent for costs incurred and work performed on relevant contracts. Cash and cash equivalents and cash generated from operating activities, supplemented by borrowings under credit facilities, commercial paper and/or in the capital markets, if needed, are expected to be sufficient to fund our operations for at least the next 12 months. Operating Cash Flow The table below summarizes key components of cash flow provided by operating activities: Six Months Ended June 30 % $ in millions 2021 2020 Change Net earnings$ 3,232 $ 1,873 73 % Gain on sale of business (1,980) - NM Non-cash items(1) (33) 402 (108) % Pension and OPB contributions (74) (69) 7 % Changes in trade working capital (164) (898) (82) % Other, net (19) 36 (153) % Net cash provided by operating activities$ 962 $ 1,344 (28) % (1)Includes depreciation and amortization, non-cash lease expense, stock based compensation expense, deferred income taxes and net periodic pension and OPB income. Year to date 2021 cash provided by operating activities decreased$382 million principally due to$390 million of federal and state taxes paid in connection with the IT services divestiture. Adjusted Free Cash Flow Adjusted free cash flow, as reconciled in the table below, is a non-GAAP measure defined as net cash provided by or used in operating activities less capital expenditures, plus proceeds from the sale of equipment to a customer (not otherwise included in net cash provided by or used in operating activities) and the after-tax impact of discretionary pension contributions. Adjusted free cash flow includes proceeds from the sale of equipment to a customer as such proceeds were generated in a customer sales transaction. It also includes the after-tax impact of discretionary pension contributions for consistency and comparability of financial performance. This measure may not be defined and calculated by other companies in the same manner. We use adjusted free cash flow as a key factor in our -30-
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NORTHROP GRUMMAN CORPORATION planning for, and consideration of, acquisitions, the payment of dividends and stock repurchases. This non-GAAP measure may be useful to investors and other users of our financial statements as a supplemental measure of our cash performance, but should not be considered in isolation, as a measure of residual cash flow available for discretionary purposes, or as an alternative to operating cash flows presented in accordance with GAAP. The table below reconciles net cash provided by operating activities to adjusted free cash flow: Six Months Ended June 30 % $ in millions 2021 2020 Change Net cash provided by operating activities$ 962 $ 1,344 (28) % Capital expenditures (435) (541) (20) % Proceeds from sale of equipment to a customer 56 - NM Adjusted free cash flow$ 583 $ 803 (27) % Year to date 2021 adjusted free cash flow decreased$220 million due to lower net cash provided by operating activities, partially offset by a decrease in capital expenditures and the receipt of additional proceeds from the fourth quarter 2020 sale of equipment to a customer. Investing Cash Flow Year to date 2021 net cash provided by investing activities was$3.0 billion compared to net cash used in investing activities of$539 million in the prior year period, principally due to$3.4 billion in cash received from the sale of our IT services business during the first quarter of 2021. Financing Cash Flow Year to date 2021 net cash used in financing activities was$5.0 billion compared to net cash provided by financing activities of$1.1 billion in the prior year period, principally due to$2.2 billion in debt repayments,$2.1 billion of share repurchases and$486 million of dividends paid in the current year period as compared to$2.2 billion of net proceeds from the issuance of long-term debt,$490 million of share repurchases and$469 million of dividends paid in the prior year period. Credit Facilities, Commercial Paper and Financial Arrangements - See Note 6 to the financial statements for further information on our credit facilities, commercial paper and our use of standby letters of credit and guarantees. Share Repurchases - See Note 2 to the financial statements for further information on our share repurchase programs. Long-term Debt - See Note 4 to the financial statements for further information. CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS There have been no material changes to our critical accounting policies, estimates or judgments from those discussed in our 2020 Annual Report on Form 10-K. ACCOUNTING STANDARDS UPDATES See Note 1 to our financial statements for further information on accounting standards updates. FORWARD-LOOKING STATEMENTS AND PROJECTIONS This Form 10-Q and the information we are incorporating by reference contain statements that constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as "will," "expect," "anticipate," "intend," "may," "could," "should," "plan," "project," "forecast," "believe," "estimate," "outlook," "trends," "goals" and similar expressions generally identify these forward-looking statements. Forward-looking statements include, among other things, statements relating to our future financial condition, results of operations and/or cash flows. Forward-looking statements are based upon assumptions, expectations, plans and projections that we believe to be reasonable when made, but which may change over time. These statements are not guarantees of future performance and inherently involve a wide range of risks and uncertainties that are difficult to predict. Specific risks that could cause actual results to differ materially from those expressed or implied in these forward-looking statements include, but are not limited to, those identified and discussed more fully in the section entitled "Risk Factors" in our 2020 Annual Report on Form 10-K and from time to time in our other filings with theSecurities and Exchange Commission (SEC). These risks and uncertainties are amplified by the global COVID-19 -31-
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NORTHROP GRUMMAN CORPORATION pandemic, which has caused and will continue to cause significant challenges, instability and uncertainty. They include: •the impact of the COVID-19 outbreak or future epidemics on our business, including the potential for worker absenteeism, facility closures, work slowdowns or stoppages, supply chain disruptions, additional costs and liabilities, program delays, our ability to recover costs under contracts, changing government funding and acquisition priorities and processes, changing government payment rules and practices, insurance challenges, and potential impacts on access to capital, the markets and the fair value of our assets •our dependence on theU.S. government for a substantial portion of our business •significant delays or reductions in appropriations for our programs, andU.S. government funding and program support more broadly •investigations, claims, disputes, enforcement actions, litigation and/or other legal proceedings •the use of estimates when accounting for our contracts and the effect of contract cost growth and/or changes in estimated contract revenues and costs •our exposure to additional risks as a result of our international business, including risks related to geopolitical and economic factors, suppliers, laws and regulations •the improper conduct of employees, agents, subcontractors, suppliers, business partners or joint ventures in which we participate and the impact on our reputation and our ability to do business •cyber and other security threats or disruptions faced by us, our customers or our suppliers and other partners •the performance and financial viability of our subcontractors and suppliers and the availability and pricing of raw materials and components •changes in procurement and other laws, regulations, contract terms and practices applicable to our industry, findings by theU.S. government as to our compliance with such requirements, and changes in our customers' business practices globally •increased competition within our markets and bid protests •the ability to maintain a qualified workforce with the required security clearances and requisite skills •our ability to meet performance obligations under our contracts, including obligations that require innovative design capabilities, are technologically complex, require certain manufacturing expertise or are dependent on factors not wholly within our control •environmental matters, including unforeseen environmental costs and government and third party claims •natural disasters •health epidemics, pandemics and similar outbreaks •the adequacy and availability of our insurance coverage, customer indemnifications or other liability protections •products and services we provide related to hazardous and high risk operations, including the production and use of such products, which subject us to various environmental, regulatory, financial, reputational and other risks •the future investment performance of plan assets, changes in actuarial assumptions associated with our pension and other postretirement benefit plans and legislative or other regulatory actions impacting our pension and postretirement benefit obligations •our ability appropriately to exploit and/or protect intellectual property rights •our ability to develop new products and technologies and maintain technologies, facilities, and equipment to win new competitions and meet the needs of our customers •unanticipated changes in our tax provisions or exposure to additional tax liabilities •changes in business conditions that could impact business investments and/or recorded goodwill or the value of other long-lived assets -32-
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NORTHROP GRUMMAN CORPORATION You are urged to consider the limitations on, and risks associated with, forward-looking statements and not unduly rely on the accuracy of forward-looking statements. These forward-looking statements speak only as of the date this report is first filed or, in the case of any document incorporated by reference, the date of that document. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law. CONTRACTUAL OBLIGATIONS There have been no material changes to our contractual obligations from those discussed in our 2020 Annual Report on Form 10-K. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes to our market risks from those discussed in our 2020 Annual Report on Form 10-K. Item 4. Controls and Procedures DISCLOSURE CONTROLS AND PROCEDURES Our principal executive officer (Chairman, Chief Executive Officer and President) and principal financial officer (Corporate Vice President and Chief Financial Officer) have evaluated the company's disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934 (the Exchange Act)) as ofJune 30, 2021 , and have concluded that these controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in theSEC's rules and forms. These disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit is accumulated and communicated to management, including the principal executive officer and the principal financial officer, as appropriate to allow timely decisions regarding required disclosure. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING During the three months endedJune 30, 2021 , no changes occurred in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. -33-
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