How Northrop's future CEO plans to step into role

News from earlier this month that Northrop Grumman CEO Wes Bush would step down from the chief executive role was and continues to be a major moment for the defense and broader government market.

In his nine years as CEO, Bush greatly reshaped the "Big Five" defense company into what it is today through a major headquarters move, divestitures, and a tighter approach to new business pursuits and acquisitions. That was until the blockbuster deal for Orbital ATK that closed in June.

Along the way Bush was also was a major voice for industry through a stint as chairman of the Aerospace Industries Association's board of governors, multiple terms of service on the board and frequent speaking engagements to discuss the defense industrial base.

So Bush's decision to step down as CEO but stay on as executive chairman through July of next year is significant for the market. But for Northrop itself, current Chief Operating Officer Kathy Warden's pending elevation to the CEO role on Jan. 1 next year may not be as big a deal.

During Northrop's second quarter earnings call with investors Wednesday, Warden said she will look to largely continue some of the themes that have marked Bush's tenure as chief executive. She cited Northrop's focus on program performance, approach to capital deployment and synergies between the company's teams.

"I'm also confident we have a portfolio that's well-aligned to our customer's needs for today and well into the future," Warden told analysts in her first public remarks since the transition announcement.

"But of course I'm going to continue to assess the portfolio, the structure (and) our strategies of the organization to ensure that we do incorporate change to enhance value for our customers, our shareholders and our employees."

That approach of portfolio assessment has been a hallmark of Bush's tenure. Northrop in 2011 divested the shipbuilding business into what is now Huntington Ingalls Industries. The company has decided not to bid several large aerospace and space programs, including four major initiatives in the past year, and mostly stayed away from big-ticket acquisitions until the Orbital deal.

As COO, Warden is tasked with leading the integration of Orbital into Northrop as the company's fourth Innovation Systems segment. She told analysts that will continue to be her priority ahead of the transition to CEO.

The combination of Northrop-Orbital is envisioned as being able to give a "much more expanded offering to the national security space community," Warden said.

That partly means synergies between Northrop's portfolio of large complex systems with Orbital's class of medium- and smaller-sized vehicles to capture a greater share of work as the Air Force is looking to recapitalize its space architecture with added funding.

Northrop also in the midst of shifting its technology services segment to higher-margin, more complex contracts and work tied to the company's core defense platform portfolio. That has meant some revenue declines including this year's guidance of "low-to-mid" $4 billion in sales versus last year's $4.7 billion, according to Northrop's second quarter investor presentation.

As Warden described on the call, "we've been on the journey of reshaping the (technology services) portfolio for a couple of years." Northrop's contract to manage the Virginia state government's IT environment is being terminated on Aug. 17 although media reports have indicated that pact was expected to end eventually. The contract was due to expire on June 30, 2019.

That stands to be Northrop's "last large IT outsourcing contract" as the company shifts its services portfolio to "sustainment and modernization of both our own platforms and the platforms of others... as well as some of the higher-value activities," Warden said.

Not that the company is exiting IT services, far from it in fact. In addition to defense IT, Northrop has relationships over multiple decades with several civilian agencies seeking to bolster their aging IT infrastructures just as modernization is growing in prominence for both priorities and budgets.

Northrop in May secured its role on the potential 10-year, $850 million "Consular Systems Modernization" program with the State Department.

Under that contract, Northrop will modernize technology used to process visas and deliver passport services as part of the department's larger "ConsularOne" effort to modernize and consolidate consular services into a single technological framework.

The company has held the technology services segment's margin steady even as it has retuned the business to focus on other areas. Northrop expects the segment's operating margin to come in at around 10 percent for this year. That would follow the 11-percent margin posted last year and 10.6 percent in 2016.