For Northrop's new CEO, budget cap return looms in the foreground

For Northrop Grumman's new CEO Kathy Warden, the government shutdown is less of a threat than a possible return of sequestration in the next fiscal year.

By and large, chief executives of defense companies have indicated on earnings calls this week that they do not see major headwinds looming over the spending environment for their key Pentagon customer.

But new Northrop Grumman CEO Kathy Warden did bring up one potential issue to pay attention to during the company’s fourth quarter and year-end earnings call Thursday, her first as chief executive. She succeeded former longtime chief Wes Bush on Jan. 1.

“Unless Congress and the president agree on a budget deal, the spending caps established by the Budget Control Act (of 2011) will return for fiscal years 2020 and 2021,” Warden said in her opening remarks to investors. “While we anticipate a deal will once again be reached, the caps could significantly reduce spending for defense and nondefense activities.”

In other words: the same kind of sequestration cuts that came down in 2013 are slated to hit again when the 2020 fiscal year begins on Oct. 1. And of course there is the prospect of another partial government shutdown that would close many civilian agencies once again after they were already shuttered for five weeks. Congress and the White House have until Feb. 15 to make a spending deal or those agencies close again.

The Trump administration’s fiscal 2020 budget request will not be released for another few weeks but in a similar tone to her industry peers, Warden is “encouraged by the focus on modernization and the prioritization of the capabilities outlined in the National Defense Strategy.”

Northrop posted $30.1 billion in revenue last year for a 6-percent increase helped by the Orbital ATK acquisition. For this year, Northrop is expecting another 6-percent growth to around $34 billion against that positive macro outlook for defense.

Even with the recent partial shutdown and maybe another one lingering in the background, Northrop's aerospace-and-defense prime peers are also expecting growth. Lockheed Martin and General Dynamics reported their 2018 results and 2019 guidance this week that indicate as much. And Raytheon said Thursday it expects a 6-8 percent increase on the top line this year from last year’s $32.2 billion in sales.

Also like other defense CEOs, Warden told analysts Northrop did not see a significant financial impact from the partial shutdown that closed NASA and the Homeland Security Department, but cautioned another one or a long-term continuing resolution could change that for them.

With Thursday being her first call as Northrop’s chief executive, Warden also detailed how the company is moving its nearly $4.3 billion technology services segment to a strategy focused on growth after years of shifting away from much of the work it has done before.

Part of that included a consolidation within the segment from being a three-division setup into two as Northrop previously disclosed late last year.

As of Jan. 1, the advanced defense services and system modernization and services are combined into a new “Global Services” unit. This unit houses much of Northrop’s IT services work, predominantly with civilian agencies like the Internal Revenue Service and Social Security Administration.

Warden said the creation of Global Services aims to “create a more competitive integrated services portfolio that focuses on high-end services for IT as well as analytics and operations in the areas of cyber, health care and intelligence.

“That business as it’s come together has been able to lay out a platform for transitioning to growth after just executing a strategy to get out of lower-end services and IT outsourcing. We now have that segment positioned to begin growing in competitive sets of caps and offerings that we can bring to the market.”

Global Services will focus on work such as software sustainment and development, modernization, secure networking cloud computing and IT infrastructure, training systems and cyber operations. Health care and intelligence programs will also be supported.

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