Northrop Grumman [NOC] on Wednesday reported a huge leap in its bottom line in the second quarter driven primarily by a lower tax rate and a pension benefit and the company increased its profit guidance for 2018 based on a lower than expected tax rate this year.

Net income jumped 24 percent to $689 million, $3.93 earnings per share (EPS), from $555 million ($3.16 EPS), beating consensus estimates by nine cents a share. Operating martin rate slipped 1.9 percent to 11.6 percent.

Sales increased 10 percent to $7.1 billion from $6.5 billion a year ago, with the June acquisition of the former Orbital ATK contributing $400 million to the top line.

While Innovation Systems, the name given to the new operating segment created through the Orbital ATK deal, drove most of the higher sales, revenues were also higher in the Aerospace Systems and Missions Systems segments. Aerospace sales were up on classified programs, which include the Air Force’s B-21 stealth bomber, and the F-35 Joint Strike Fighter, for which Northrop Grumman supplies the center fuselage to prime contractor Lockheed Martin [LMT], and unmanned aircraft systems.

Kathy Warden, president and chief operating officer of Northrop Grumman. Photo: Northrop Grumman
Kathy Warden, president and chief operating officer of Northrop Grumman. Photo: Northrop Grumman

Sales on the F-35 were up more than 40 percent in the quarter as Northrop Grumman delivered 32 center fuselages versus 20 in the first quarter and 18 in the second quarter of 2017, Kathy Warden, the company’s president and chief operating officer, said on an earnings call. Warden, who will become president and CEO on Jan. 1, 2019, said 116 center fuselages will be delivered this year.

Warden also said that the company has reached an agreement with Lockheed Martin on the Lot 11 F-35 low-rate initial production (LRIP) purchase. Lockheed Martin says it is close to wrapping up negotiations with the Defense Department on the LRIP 11 contract. She said the contract with Lockheed Martin builds in affordability for the customer and incentivizes performance for Northrop Grumman.

At the Mission Systems segment, sales were up on the radar for the F-35 and the Scalable Agile Beam Radar program, as well as classified and communications programs.

Excluding the impact of $39 million in operating profit contributed by Innovation Systems, operating profits were down overall at the other three segments as declines at Technology Services and Mission Systems more than offset a gain at Aerospace. The company said it took a charge for NASA’s James Webb Space Telescope program and a forward loss provision on an advanced capabilities program.

Wes Bush, chairman and CEO of Northrop Grumman, said the 15-year-old James Webb program has included a lot of inventing that has been successful and is now in the integration phase with plans for a launch in 2021. The company and NASA are “testing the heck out of” the telescope, which is resulting in finding issues.

The charge related to the advanced capabilities program wasn’t quantified but Bush said a review uncovered a flaw in the risk management process that is being treated with the fix applied throughout the company.

On the subject of the surprise leadership transition announced earlier this month, Bush said he’s stepping down as CEO at the end of this year following nine years at the helm of Northrop Grumman based on his belief “that healthy organizations use the dynamic of change to continuously improve themselves and to support a culture of excellence.” He said change includes “new leadership perspectives,” even at the top. He also said that the company has a good succession plan and that Warden is ready for her new role.

Bush said he’ll be working with Warden for the rest of the year to ensure a seamless transition. Bush will remain as chairman until next July. Warden said she remains focused on integrating Innovation Systems into the company, continued capture of business opportunities in the U.S. and abroad, and solid performance across the operating segments.

Going forward, Warden said she’ll continue the company’s performance driven culture, its approach to capital deployment, and incentives that drive performance.

Regarding the integration of Innovation Systems, Warden said Northrop Grumman is on track to meet or exceed the $150 million in planned cost savings by 2020. She said $25 million will be spent this year toward the cost synergies and $50 million in 2019.

With a lower than expected tax rate forecast for 2018, Northrop Grumman upped its earnings guidance by 40 cents to between $16.60 and $16.85 EPS this year. Sales are still expected to be about $30 billion. Free cash flow guidance was raised $100 million on the low end of the range to between $2.4 billion and $2.6 billion.

Free cash flow in the quarter was $676 million and backlog at the end of the quarter stood at $52.2 billion versus $42.9 billion at the end of 2017.