UPDATE 3-Northrop boosts profit, raises full-year forecast

Wed Jul 24, 2013 4:34pm EDT

* U.S. budget uncertainly slowing orders

* Shares rose nearly 5 percent to hit intraday all-time high

* Margins up, backlog down

By Andrea Shalal-Esa

WASHINGTON, July 24 (Reuters) - U.S. arms maker Northrop Grumman Corp shrugged off Pentagon budget cuts to report higher-than-expected quarterly earnings on Wednesday and raised its forecast for the full year, driving its shares up nearly 5 percent to a new all-time high.

The maker of Global Hawk unmanned spy planes and defense electronics also boosted its operating margin and raised its outlook for full-year profitability, but acknowledged that uncertainty about the U.S. budget was slowing orders.

Chief Executive Wes Bush said $37 billion in "sequestration" cuts imposed on the Pentagon in fiscal 2013 were slowing government orders, particularly in the company's shorter-cycle businesses like technical services and information systems.

Bush said he did not expect major disruptions to 2013 revenues, but said the slowdown in orders would have a ripple effect on Northrop's revenues, earnings and cash flow in 2014.

He said the company was already planning for further mandatory budget cuts in fiscal 2014, which begins on Oct. 1, since U.S. lawmakers were not likely to reach a compromise that would avert an additional $50 billion in Pentagon budget cuts.

He said Northrop was urging government customers to avoid delays in contract awards that could raise costs, but was also continuing to aggressively look for more cost-cutting measures.

He said the company was trying to align its portfolio with the Pentagon's priority investment areas, such as unmanned systems, intelligence and surveillance, logistics, cyber and manned military aircraft.

Asked how long the company could continue to improve its margins in a worsening budget climate, Northrop Chief Financial Officer Jim Palmer likened it to running on a treadmill: "You have got to continually run as fast as the treadmill is going."

He said the company was benefitting from cost reductions now, but government officials would base future contracts on the company's lower cost structure, which would inevitably squeeze the currently high margins.

Buoyed by the news, Northrop shares bolted to a new all-time high of $92.99 but fell back to close at $90.30, a gain of 1.7 percent from Tuesday.

In the second quarter, higher sales in aerospace and electronic systems more than offset declines in information systems and technical services.

Net profit rose to $488 million from $480 million a year earlier. Per-share earnings jumped to $2.05 from $1.88 due to a 7 percent decline in shares outstanding. Second-quarter revenue edged up to $6.29 billion from $6.27 billion.

The company said it has repurchased 12.6 million shares this year, part of its goal of buying back 60 million shares by the end of 2015 if market conditions permit. Bush said he was confident the company's cash flow would support that plan.

"Investors have rewarded Northrop with strong returns this year because of that policy, even though its business is declining," said William Loomis, defense analyst with Stifel Nicolaus, noting that Northrop had been the most aggressive among the defense companies in returning cash to shareholders.

Analysts polled by Thomson Reuters I/B/E/S had forecast, on average, earnings of $1.70 per share on $5.98 billion in revenues.

Northrop raised its earnings guidance for the full year to a range of $7.60 to $7.80 per share from an earlier forecast of $6.85 to $7.15. It said revenue would likely reach $24.3 billion, up from an earlier forecast of $24 billion.

At the end of June, the company's order backlog was $37.7 billion, down 7.5 percent from December in what analysts said was a sign of harder times to come. Northrop said the decline was mainly due to "reduced customer spending in response to the current U.S. budget environment."

Joe Nadol of JPMorgan, in a note to investors, said the deteriorating backlog was a source of concern, noting that backlog declined in each of the company's four businesses.

As seen at other defense companies, Northrop's operating margins were strong in the second quarter. Overall margin edged slightly higher to 12.8 percent.

The company said it now expects an overall margin of 12 percent for the full year, nearly a full percentage point above the upper range of its earlier forecast.

The aerospace business posted a 9 percent rise in second-quarter sales, largely due to higher volume on the Lockheed Martin Corp F-35 fighter jet, for which Northrop is a key supplier, and growth in certain unmanned systems.

The electronic systems sector boosted sales by 2 percent and earnings by 17 percent, reflecting continued demand for high-end electronics for international and space programs.

But the information systems division suffered a 9 percent decline in revenue and a 30 percent drop in operating profit, reflecting lower sales and a $27 million reduction in net favorable adjustments from a year earlier.

In technical services, revenue dropped 8 percent and earnings fell 7 percent.

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