Operator:

Good day, ladies and gentlemen, and welcome to Northrop Grumman's Second Quarter 2024 Conference Call. Today's call is being recorded. My name is Josh and I will be your operator today. At this time, all participants are in a listen-only mode. I would now like to turn the call over to your host, Mr. Todd Ernst, Vice President, Investor Relations. Mr. Ernst, please proceed.

Kathy Warden:

Thanks, Todd. Good morning, everyone. Thank you for joining us. As you saw from this morning's earnings release, we delivered excellent operating results again this quarter, building on our momentum from the first quarter. Our company's ability to respond to U.S. and international customer requirements with a wide range of advanced capabilities continues to drive strong growth, with sales up 7% in the quarter and 8% year-to-date. And our team's solid program performance, along with cost management discipline, led to operating income growth of 13% in the second quarter. The combined strength of our top and bottom line operating results was the primary driver of our 19% EPS growth. And in addition, we delivered robust free cash flow, which is up over $500 million compared to the first half of last year. Based on these strong first half results and confidence in our team's ability to deliver on continued robust demand in the second half, we are increasing our 2024 revenue and EPS guidance. The breadth and depth of our portfolio is an important differentiator, particularly when coupled with the effectiveness of our strategy in aligning our resources to anticipate and deliver on our customers' needs. Given this, I'm going to take the next couple of minutes to provide important context on our portfolio. When you step back and look at the key components of our business, you'll see that 85% of our sales come from a diverse collection of technology advanced capabilities, such as electronic, communications, crewed and uncrewed aircraft, space payloads, advanced weapons, command and control systems and other product areas, which are critical to global security. The capabilities we provide often as a supplier are in the nation's most advanced space air, land, sea and undersea platforms. In the last several years, we've been selected through dozens of competition to develop and build differentiating technologies that will provide an advantage to the U.S. and our allies through the 2030s. The remaining 15% of our sales is comprised of two prime programs in support of the nation's strategic deterrent, of course, that's Sentinel and B-21, with each generating a high single-digit percentage of our revenue today, and we expect that balance to continue for several years. With the recent realignment of our SCS division to our Defense Systems sector, we have four strong and differentiated segments that are more equal in size with each having multiple avenues for profitable growth. Our business is well aligned with the U.S. National Defense strategy. And as I've outlined in recent years, we've won significant roles on long-term programs that address the threat environment of today and are expected to do so for the next several decades. In addition, we continue to expand exportable product offerings, and we are developing our international partner and supplier base to position us for the growing international markets. We have also invested to increase our capacity to deliver the quantities of rocket motors, armaments and air and missile defense capabilities needed by the U.S. and our allies to defend freedom and deter aggression around the globe. Examples of this growth include the Guided Multiple Launch Rocket System or GMLRS, where our year-to-date revenue has grown by nearly 60%. Additionally, we were awarded over $500 million in contract for ammunition that we will begin delivering in the third quarter. And we see additional demand for international ammunition opportunities in the coming quarters. Overall, the key takeaway is that the breadth of our portfolio, our alignment to the key priorities for the U.S. and our allies and our role on each leg of the U.S. strategic trial provides us visibility into avenues for our business to grow even if U.S. budget growth slows. And as we've discussed frequently over the last two years, we're not just focused on top line growth, we're taking deliberate actions to enhance profitability through digital enablement, productivity, supplier management and cost efficiency. As we look at the remainder of this year and next, we expect solid growth across the portfolio to continue, particularly in areas such as weapon systems, advanced electronics and aeronautics. International sales are also progressing from our pipeline to our backlog and are expected to contribute to increased sales and profitability. Our outlook is supported by the national security spending environment. In the U.S., the fiscal year 2025 defense budget is moving through the appropriations process with recent markups by Congress. We were pleased to see the Senate Arm Services Committee increased the FY 2025 top line by $25 billion and we're encouraged by continued support for investment in defense. Northrop Grumman programs broadly and particularly the B-21 Sentinel in Colombia, which provide the basis for the U.S. strategic deterrent continue to receive strong support, bolstering our view that we're well positioned in this such an environment. Given the importance of the triad to the nation's deterrence, I'll provide an update on two legs of the triad for which Northrop Grumman is the prime industry partner to the Department of Defense. So, starting with Sentinel. Earlier this month, the DoD submitted to Congress certification of the of the Sentinel program as part of the Nunn-McCurdy process. This certification validates the need for the land-based leg of the triad and continued confidence in the Sentinel weapon system, the critical role it plays in safeguarding global security. DoD and the Air Force are working to restructure program to reflect the latest cost and schedule estimates. The majority of the cost growth is expected to occur in the production phase of the program, which is beyond the current EMD phase and outside of the future year's defense program or fight it. We continue to execute on our existing EMD contract, which includes the design, development and testing of the full system. We are partnered with the Air Force on completing the design of all aspects of the system and how many of the systems components already in development and tests, including all three stages of the missile, command and launch subsystems for launch activation, security and systems monitoring as well as transportation and support equipment. The progress we've made on the program is significant, and we remain committed to partnering with the U.S. Air Force to identify ways to reduce the costs associated with feeling this system. So, turning to the air leg of the triad. The B-21 is progressing well through the testing program, and as you know, has entered low rate initial production. The team continues to perform exceptionally well, and we remain within our schedule and cost estimates. As we recently shared, B-21 test pilots report that the aircraft is flying like the simulator, which is another indication that our digital environment has effectively predicted the performance of aircraft, thus reducing new discovery and risk. For these reasons and more, we continue to believe in the significant value this program will create for customers and shareholders over time. It's important to note that while the B-21 program is very important, it contributes less than 10% of our total sales, and we expect that to remain the case through the decade. Assuming stable economic conditions and continued strong performance by our team, we also expect program margin dollars to grow annually from here as we complete the EMD program and for five lots of production move into advanced production awards on the more profitable lab and beyond and add modernization and sustainment revenue to the program. As you can see, our portfolio includes a compelling mix of technology-driven capabilities and franchise programs that are well aligned to the evolving needs of all our customers. As a result, we've grown our organic revenue at greater than 5% compound annual growth over the past five years, including 5% growth projected in our increased 2024 guidance. We also continue to rapidly expand our cash flows, including generating over $1 billion of free cash in the second quarter. Based on the strength of portfolio, backlog and performance trends, we are reiterating our long-term cash flow outlook, which assumes a greater than 15% compound annual growth rate through 2026. To support growth in our business, we're maintaining our investments and capabilities across the company. We continue to target $1.8 billion in capital expenditures this year, which is around 4.5% of revenue and well above the industry average. Including R&D, we're investing approximately $3 billion in our portfolio. At the same time, we're efficiently returning capital to shareholders, including $2.3 billion in the first half of the year. In May, we increased the dividend by 10%. This is our 21st consecutive annual increase, as we continue to focus on delivering competitive sustainable dividend growth. Before I turn the call over to Dave to provide more details on our financial performance and outlook, I'd like to thank our team for another great quarter, as we continue to execute on our long-term strategy. We have an outstanding portfolio, a high-performing team and a bright outlook for the future. So with that, I'm going to turn the call over to Dave.

Operator:

Thank you. [Operator Instructions] Our first question comes from Kristine Liwag with Morgan Stanley. You may proceed.

Kathy Warden:

Good morning.

Dave Keffer:

Sure, Kristine, happy to clarify a few of those points. As you've noted, the NTE lots that follow the first five LRIP are currently projected to be more profitable than the LRIP lots. And to clarify that further, we are projecting a positive profit rate in Lot 6 based on our current projections. So, to your point, those NTE prices are set higher than the prices that are expected for the first five lots and with cost efficiencies that we're working hard to drive and program performance and productivity efforts very much in progress. Our current projections indicate positive profitability for those lots.

Scott Deuschle:

Hey good morning. Thanks for taking the question.

Scott Deuschle:

Dave, just to follow-up on Kristine's question. Is the difference on B-21 units, 22 to 40 that they have both a higher average base price and the EPA cost protection or units 1 to 22 also have that EPA protection?

Scott Deuschle:

Okay, great. And then, Kathy, there was a news article a while back about the issue the industry faces and sourcing ammonium percolate for making solid rocket motors. Is that something you guys have made some good headway on. And based on your comment on GMLRS output being up 60%, it sounds like the answer is yes, but just curious for your perspective. Thanks.

Operator:

Thank you. Our next question comes from Rob Stallard with Vertical Research. You may proceed.

Kathy Warden:

Good morning.

Kathy Warden:

Yes. Well, thank you. The DoD did a thorough review of a program as part of the [Indiscernible] process, and they were very transparent about the results of that review. For those of you who haven't seen it, they did a press release, they conducted media interviews about a week and a half ago to share those results and they met with many members of Congress. And in that process, they have not pointed to industry performance as the cause of cost growth. The things that they have pointed to include inflation, obviously, particularly as we look at the deployment cost, there's a big construction component of this job, and also the assumptions that were made many years ago that underestimated the complexity of the program. And those were two primary costs growth drivers that were identified. We are working with the Air Force to identify ways to perform better than those cost estimates. We will continue to do that. We are looking at everything from design alternatives that they have referenced in the restructure of the program to ensuring we have the right team in place to execute on every part of the program in that deployment and production phase. And, of course, we are continuing bolster our own staff and systems engineering on the program. But the reality is that most aspects of the program are progressing very well, and the Air Force has publicly made those comments – we are very focused on the ground in the structure, which is the piece of the program that is driving the vast majority the cost growth, and that's what our focus will continue to be through the restructure.

Operator:

Thank you. Our next question comes from Jason Gursky with Citi. You may proceed.

Kathy Warden:

Well, I'm not going to comment on any individual meetings that I had, but I have had a number of meetings with members of Congress on both sides of the aisle, and they have generally been very supportive of the need for the program and our team's role in that program. And I will also just note that the Department of Defense speak for the program and their findings on the Nunn-McCurdy and have spoken very clearly about that. The final thing I'll suggest is that while not everyone is a supporter of the land-based leg of the triad, you can look at the vote and the appropriations, which have fully funded the program, and it's more reflective of the landscape I painted, which is broad-based congressional support for the program and our role in it.

Operator:

Thank you. Our next question comes from Sheila Kahyaoglu with Jefferies. You may proceed.

Dave Keffer:

The way I would characterize that is, I think, first of all, you've touched on a key point that the mix in MS has shifted over the last few years to be more heavily cost type in nature. We think that mix will shift back in the direction of more fixed price work over the next several years. A lot of the growth in MS in recent years has been large cost-type development programs, leading technology efforts across its multiple mission areas. And as a result, its cost type mix has gone from the mid-30% back in 2021 to the mid-40% this year, gradually that will shift downward over time to include the second half of this year when consistent with last year, some of our greater sales volume in the second half in MS will be driven by programs that are more predominantly fixed price in nature, and that will blend the mix upward even as soon as the second half of this year. But I think another important point is the set of deliberate actions we're taking to improve productivity and performance and cost efficiency in our Mission Systems business as we're scaling to meet increased demand in our factories. And improvements there are being felt already in the business and are another driver of our confidence in second half margins for MS being higher than those we've delivered in this half. We're working closely with our suppliers and our production teams in MS to continue to deliver on those efforts and expect progress in the second half and beyond.

Operator:

Thank you. Our next question comes from Seth Seifman with JPMorgan. You may proceed.

Kathy Warden:

Sure. With the increase in our guidance this quarter, we expect 5% growth again this year, following a period, as I said, of about 5% compound annual growth for the last five years. So, looking forward, we'd expect solid growth across three of our four segments with the strong demand that I talked about earlier in the call, balanced across the portfolio. Space is likely to be exception to that next year. We are guiding around flat this year and down modestly net. And that's due largely to the impact of NCI and the restricted program that we talked about earlier this year being canceled, and then we do expect space to return to growth in 2026. So it's too soon to provide a detailed guide for 2025 at a company level, but that gives you a sense of the dynamics that we're expecting in the various segments. And with the broad-based portfolio that we have, the slight decline that we expect in sales in Space next year do not change our outlook for the company as a whole.

Dave Keffer:

Sure, Seth. Happy to comment on further. To your point, it was a really solid first half of the year and a solid second quarter for the AS business, top and bottom line performance were strong. And really since the beginning of the year, we've been projecting and noting that sales growth rate would moderate a bit in the second half of the year because of the timing of top line items in aeronautics, supplier deliveries and such, both on B-21 and on programs like F-35 that were going to lead to higher volume in the first half of the year than we saw a year ago. So, that's where we've seen the really strong year-over-year growth rates in the first half. We've been able to increase our guide for both sales and margin rate for the year. But to your point, it will involve slightly slower growth and slightly lower margin rates in the second half. We have initially guided 9.5% for the year and have now increased that rate because of the first two quarters at 10%. So we're continuing to project a really strong rate for the year. And I think that's evidence of the fact that we have a diversified mix of programs in AS and programs like our support for F-35 as well as Triton E-2D and others are in healthy production levels where we're doing a great job for our customers and delivering strong results for investors.

Gavin Parsons:

Thanks. Good morning.

Gavin Parsons:

I appreciate all the detail on B-21. That's really helpful, especially in terms of EBIT dollars growth. When do you foresee the peak margin rate headwind occurring from that program?

Gavin Parsons:

Got it. That's helpful. And then I guess on the expectation for equitable adjustment Lot 6 or beyond. I think there was some expectation that there might be one on the first five LRIPs. Is it more contractual now on the board expectation?

Gavin Parsons:

Thank you.

Cai von Rumohr:

Thanks so much. So help me understand on B-21. I mean, you took close to $1.6 billion charge over five lots, that's roughly $300 million a lot. So I assume that's moving from about zero last year up to $300 million negative. How do you get enough profit to offset that? Or when you talk about profit dollars and improving, are you talking from an accrued basis where you've taken the charge already?

Cai von Rumohr:

Got it. Thank you very much. And then secondly, they're talking about restructuring the Sentinel program. Is that likely to be, in your opinion, Kathy, an opportunity or a risk for Northrop Grumman?

Operator:

Thank you. Our next question comes from Doug Harned with Bernstein. You may proceed.

Kathy Warden:

Yes. So, as Dave said, we are now expecting book-to-bill in the year over 1 after a very strong second quarter. We do see lumpiness in awards, as we've talked about before, but consistently has been performing on an annual basis with book-to-bill over 1. And this year, it is again expected to be reflecting our mix of domestic versus international sales because awards are going to be strong in both categories, with international bookings being stronger this year than they have been in the past in domestic bookings remaining strong. In terms of the segments that are going to drive that, we've seen it shift more to our shorter-cycle businesses. So strong bookings are more concentrated now in our new defense systems and in Mission Systems than they are in AS and space. But of course, I'll point that in both those segments, we've had strong -- they've been the key driver of strong bookings in past and so they still have a really solid backlog.

Kathy Warden:

I would say we are more international sales than we are expecting our international sales to grow at a faster rate than our domestic. But also when you look at bookings and the strength of our alignment with the National Defense Strategy and the prioritization, particularly of triad and the growth that we expect on all three of the programs as they move through development into production. We do believe that they will be well-supported in the budget, and we'll see them take more share of the budget overall, even though each one of them is well below 1% of the overall DoD budget, they are well-prioritized within the spending profile.

Myles Walton:

Thanks. Good morning. Just had a quick follow-up question for you, Kathy, in your remarks earlier in the prepared remarks, you talked about high single-digit percentage of revenue on the Sentinel and B-21 and staying consistent with that over next several years. And I guess, I was expecting that the B-21 would drip into double digits within that time period, understanding that Sentinel might have a smoother or slower growth rate. Is that correct or incorrect in this assessment?

Myles Walton:

Okay. Very good. And then the space booking -- excuse me, space performance in the quarter, it sounded from your tone that it had improved. Are we now back to positive EACs or are we just less negative EACs that we're seeing?

Myles Walton:

Thank you.

Matt Akers:

Yes. Hey, good morning. Thanks for the question. Can you comment on the Navy new fire, the FXX, just what you're hearing on timing there and if you still have plenty to bid on that program?

Matt Akers:

Great. Thanks. And if I could do a follow-up. I guess Spirit AeroSystems is a supplier on B-21 -- any thoughts around the acquisition there with Boeing? And if there's a chance you would bring that work kind of in house?

Operator:

Thank you. Our next question comes from Pete Skibitski with Alembic Global. You may proceed.

Kathy Warden:

Yes. So we are excited that both NATO and Norway have expressed interest in Triton, and we are hopeful that announcements will be coming shortly on both. And as we look to build Triton for the U.S. and Australia, this simply adds to the production line outlook for Triton through the decade. And so we had envisioned this day coming where more countries would get the opportunity to see Triton once it was fielded has a tremendous ability to surveil large areas of ocean. You can think of the relevance to that in the Pacific, which is what was attractive to Australia and the U.S. Navy, but of course, in the Arctic, this is an area of great importance as well, which is driving to NATO and the Norwegian interest.

Operator:

Thank you. Our next question comes from Robert Spingarn with Melius Research. You may proceed.

Kathy Warden:

Yes. A couple of things to frame for you in answering those questions. The first is a reminder that the cost growth that is projected is indeed that a projection over a very long period of time. It covers not just work that we're doing right now to design, develop and tests, which will largely be through the remainder of this decade. The majority of those cost growth projections come for the fielding building out the missile silos for the system, 450 of them, and that doesn't happen really until the next decade. So that's why there's so much uncertainty. It's like any of us sitting here and trying to project what costs might look like 10 to 15 years from now, and that's what's baked into those estimates. The second part of your question is around the 80% growth. There's so much of that is well into the future. There are still decisions that the Air Force can make today that can drive solutions that reduce that cost projection. And that is what they're doing in the restructuring, looking at those options, and we are partnering with them to do that and very committed to help them do that. And, of course, on many of Northrop Grumman's program, we are performing well-below the government's independent cost estimates, which is what these are. These are not industry's estimates. These are the government cost estimates. And this is not growth on the current contract. This is projections of future growth. So with all of that in mind, there is time here to work through a number factors to determine what the actual cost growth would be and how that gets incorporated into future year defense programs, but it is not expected to have a significant impact in the next five years, and the Air Force has made that clear.

Operator:

Thank you. Our next question comes from Peter Arment with Baird. You may proceed.

Dave Keffer:

Sure. Clearly, a really strong Q2 for free cash flow performance, working capital very much an integral part of that. I think it's a good opportunity to take a step back then and look at the rest of this year and beyond? And what's factored into our multiyear outlook and our guidance for this year. And for working capital, the answer is essentially that our expectations are pretty flat that we're already performing at a very high level, very strong level for working capital and that we're not anticipating additional efficiencies nor are we anticipating erosion to those levels. So, when we talk about a 15% plus free cash flow CAGR from 2023 to 2026. That is not driven by further working capital efficiencies. It's driven by the expansion of operating profits as we continue to grow the top line, and we deliver on margin expansion opportunities. CapEx is at peak levels this year as it was last that will decline going forward, both in real dollars and clearly as a percentage of sales toward our longer-term target in the 3% range. And then we should see modestly stronger CAS pension recoveries as we showed in our latest projections earlier this year based on the actuarial environment today. And then the Section 174 impact on cash taxes will continue to decline each year. So that combination of factors is what leads to the 15-plus percent free cash flow growth in our outlook and working capital is essentially a flat element of that outlook.

Dave Keffer:

You bet.

Operator:

Thank you. And our final question comes from David Strauss with Barclays. You may proceed.

Kathy Warden:

Sure. So, we've talked about several factors. The first is getting the macroeconomic headwinds behind us related to inflation flowing through our contracts, the disruption and challenges that we've had with supply chain deliveries, and those are largely getting behind us, although we do still have some contracts that is flowing through, and we're seeing those impacts, as we talked about in Mission Systems today. But as those headwinds dissipate, then it really is about the strength of the portfolio shining through in operating results. And you're starting to see that take hold. What I would say is that from a cost efficiency standpoint, the team is making sure that the business is sized appropriately and everything from human capital to facilities to our infrastructure. We also are investing in digital enablement, as you know, which is a tailwind to program performance as we've demonstrated on B-21 with our ability to adhere to modeling that predicts future and then hit that performance in the product, that is derisking our programs and driving improved margin opportunity. And then some more structural items like the mix shift that we spoke about on the call, our cost plus business, which we've had a heavy concentration of here in these last few years, including programs like Sentinel with lower booking rates, which will over time move toward fixed price and more profitable programs. And then, of course, international, which is a portfolio tailwind as more of our business comes from international sources. So it's that full combination of paths that we are working. We're showing progress on each as we move forward, and it bolsters our confidence that we can drive this business to another 100 basis points of margin performance over the decade.

Kathy Warden:

I would.

Kathy Warden:

Thank you. All right. So, with that, I'd like to conclude by once again thank you to team for a fantastic quarter. And in particular, I want to recognize Mark Taylor who is retiring from our company tomorrow after a distinguished Northrop Grumman career and over a decade on our executive leadership team. And also I want to note that in the coming months, Dave, Todd and I look forward to introducing Ken Cruse, who is here with us in the room to our investor community as our incoming CFO effective October 1. So in the meantime, we look forward to talking with you in October and seeing you over the course of the summer, and thank again for joining our call today.

Operator:

Good day, ladies and gentlemen, and welcome to Northrop Grumman's First Quarter 2024 Conference Call. Today's call is being recorded. My name is Josh, and I will be your operator today.

Kathy Warden:

Thank you, Todd. Good morning, everyone. It's so good to have you joining us today. So earlier this morning, we released our first quarter results. And as you can see, we are off to a strong start to the year with broad-based growth across our portfolio. The team's relentless execution of our strategy, which includes technology leadership aligned to our customers' priorities and a laser focus on performance has positioned us for continued success. Growing global demand for our capabilities led to an exceptional 9% year-over-year increase in Q1 sales, driven by growth in all 4 of our sectors.

Operator:

[Operator Instructions]

Ronald Epstein:

Kathy, if you could speak to just maybe a little more detail in that $95 billion supplemental, what potentially is in there for Northrop given everything you guys have been doing in those related businesses.

Kathy Warden:

There are a number of opportunities in aeronautics that we are pursuing that being one of them. It doesn't really have an impact on our near-term outlook for that business. As we shared today, we're raising the sales guidance for that business this year, and that's really on the strength of the current portfolio and the growth that we continue to see there, but we will continue to pursue additive opportunities that maybe program being one of them.

Douglas Harned:

You talked a little bit about outlook for book-to-bill this year and backlog was down in each segment in Q1. I understand some of the space issues. But on AS, DS and MS, if you're looking at a book-to-bill of above 1 for the year, can you talk about where that's likely to come from? What will drive those business units since that the backlog was down in Q1?

Douglas Harned:

Well, and then just on space, you mentioned the importance of Sentinel and you've talked over the last quarter about some of the Nunn-McCurdy breach and those issues. But when you look at the Air Force moving the IOC schedule back by 2 years, how does that affect your growth path on Sentinel?

Operator:

Our next question comes from Kristine Liwag with Morgan Stanley.

Kathy Warden:

It doesn't change the economics of the program. What happened is the budget was set based on the independent cost estimates. And as we move towards the contract phase where LRIP was exercised the first option, the government is now reconciling to our contract value. There was no change in price schedule quantities. It's just a reflection of them moving off of an independent cost estimate and moving to our contract value, which, of course, was lower than their independent cost estimates.

Sheila Kahyaoglu:

Kathy, I wanted to ask about DS. Maybe can you talk about the puts and takes there just given supply chain as well as services and incremental opportunities such as IBCS and Missile Systems. How do you think about the trajectory just given some of the positive movements we've seen in missiles, initial defense and obviously, supplementals and the driver of potential margin improvement there?

Seth Seifman:

Kathy, I wanted to ask on autonomous aircraft and the CCA program, we saw last night the news about Anduril selection along with General Atomics. And I was wondering if you can -- with that news, maybe update us on Northrop's strategy to capture a new work in the autonomous space.

Kathy Warden:

We are obviously working toward affordability in our product line, so we do not want to be viewed as only offering exquisite and expensive technology. So we've been working to drive down the cost of our offerings, and I think we had quite a compelling offering on CCA and can compete in that marketplace. We are really positioned to provide the best solutions that our customer needs against a high-end threat, however, we are not looking to compete in a more commoditized part of the market that's very low cost and not survivable systems. That's just not our business model, and we know that. So we'll remain disciplined in where we invest in the pieces of the market that we pursue, but we think that what we provide is still highly relevant.

David Strauss:

Kathy, I wanted to ask about MS margins. A couple of years ago, we were running in the 15 level, they stepped down a little bit last year. You took down a margin guide there. Can you just kind of talk about what's driving the lower margins? Is it just solely mix that's driving the lower margin in that MS?

Kathy Warden:

Yes. As we look at the slower growth, it is largely development programs that are dilutive to the both space margin rate and the company margin rate. So as -- that part of the business is no longer as significant. You will see that be both margin and cash tailwinds because there was also CapEx investments planned that we will not extend in those programs now either.

Cai Von Rumohr:

Good performance, Kathy. So following up on Dave's focus on space, I think I've got 2 questions. First, the restricted program that was canceled, is there any chance that we heard a rumor it might have been related to a supplier issue. Is there any chance that, that function or that program might reappear again in the future?

Kathy Warden:

So let me start with your first question on the restricted program. There's very little I can say, given the nature of that program, except to say that the Air Force canceled that program largely due to budgetary concerns and prioritization, but the requirement likely does still exist. And so we will see how that plays out over time. I also -- as we look at the broader space portfolio, we'll answer your SDA question more generally. We see a whole variety of opportunities that we can pursue, so we're simply selective on which ones we're best positioned to win, where we think that we can competitively.

Cai Von Rumohr:

But you did know bid that one program. As we move forward, is the pricing here getting a little bit more competitive as more people join the party?

Operator:

Our next question comes from Robert Stallard with Vertical Research.

Kathy Warden:

We looked at the FY '25 president's budget is very much in line with our expectations. So no surprises and no concerns about our portfolio. Obviously, we talked about two things where budget was a factor in DA choosing to down select early on NGI was largely due to budgetary constraints. And then, of course, the restricted space program that we mentioned, but those we have now digested and, of course, reflected not only in our outlook, but my comments about the FY '25 budget. .

Robert Stallard:

Which is -- I've got a quick follow-on on that actually because you did mention exports as well. And I was wondering if you could give us an update on what sort of scale as a percentage of revenues, exports are at the moment and what that could grow to in the future.

Operator:

Our next question comes from Pete Skibitski with Alembic Global.

Kathy Warden:

Absolutely. It's a critically important part of our portfolio. We're very focused on delivering for our customers in that portfolio. And there have been challenges that we own. We've been working on a development program for nearly 10 years. It's going to deliver an amazing step function improvement in propulsion for the Columbia class submarines. And we are near delivering those first care of turbine generators. And that's what the Secretary of the Navy was referring to in his testimony on the Hill.

Scott Deuschle:

Dave, just to clarify, what's the message on space growth beyond this year? Does it reaccelerate off this 4% or so this year?

Kathy Warden:

Yes, of course. So as we look at our weapons portfolio today, it's about 6% to 7% of revenue. It's growing double digit, and we expect that to continue. A good part of that growth will be supported both by the supplemental that I spoke about in my opening comments in response to Ron's question, but also the European demand has strengthened. So we have a number of opportunities, countries across Europe looking to do the exact same thing the U.S. is doing in replenishing stockpiles for munitions.

Operator:

Our next question comes from Myles Walton with Wolfe Research.

Kathy Warden:

Yes. So in terms of backlog, what you would look to see as we signed the IBCS deals that I mentioned with additional countries as we sign the contracts for Triton that I highlighted in the call today. The IVEWS that are in the early stages, the 2 countries progressing toward awards. These are all awards that would be in new franchises that we have not had in the past. While we continue to see just the standard growth in areas like F-35 international and the Triton portfolio with the Australians that are already underway or E-2D franchise with France and Japan. So those are still in the backlog and then you'd add to that, the opportunities that I highlighted this morning that are new franchises for us.

Kathy Warden:

It has, although really what we see now is a whole set of opportunities for product lines that were not in our backlog over the last 5 years. So that's the difference. Our portfolio has largely been high-end capabilities that aren't exportable. And as you look at how the portfolio has evolved over time, these new franchises that I spoke about today or franchises like Triton now getting permissibility for exports to more countries is really opening up a whole new set of opportunities for our company.

Gavin Parsons:

Kathy, you mentioned you've finalized negotiations with additional suppliers on the B-21. Were those all in line with your expectations? Can you share what percentage of suppliers are now locked in? And then when you expect that to be fully finalized?

Gavin Parsons:

Okay. Great. That's helpful. And then, Dave, maybe just on Aeronautics margin, I think you mentioned the strength in 1Q will be a little lighter through the rest of the year. But was 1Q as expected? Was that in guide? Or did you perform better than you thought you would in the first quarter?

Operator:

Our next question comes from Matt Akers with Wells Fargo.

Kathy Warden:

Well, there has been strong bipartisan support for the program. We expect that will continue. It, of course, is the nation's policy as reviewed in the nuclear posture review to have 3 legs of strategic deterrence. So we do expect that the program will be recertified, but the government needs to take the process seriously. It's a good process. And they're working through the phases of that recertification now. And as I said, we're providing support to them and stay committed and very focused on delivering the program in the meantime, not getting distracted by the activity associated with the Nunn-McCurdy but supporting it fully.

David Keffer:

Sure. I agree with your characterization that there was good progress in the first quarter. And you'll see that further detailed in our 10-Q disclosures as well. We had been running substantially above the levels of 2022 and 2023 in prior years before the macroeconomic disruptions. And so over time, we anticipate that we will normalize to levels more like our history and we saw progress towards that in the first quarter, as you mentioned, particularly in AS.

Operator:

Our next question comes from Jason Gursky with Citi.

Kathy Warden:

So we are seeing interest in modernizing really the entire architecture and space. And I've been talking about this for a while, so whether it's intelligence surveillance reconnaissance, communications, missile warning and tracking, the entire space architecture is being upgraded, both in terms of advancing the capability of those sensors and payloads but also the coverage with the broadening of the space architecture. And so we're involved selectively in all of those areas. As you know, we play a key role in ISR communications, and very informed of both missile tracking and missile warning.

Jason Gursky:

Okay. And maybe a similar kind of discussion on the ground systems side of things and whether that's all the sensor and payloads that we're launching up in the space are driving the ground system business, just kind of what the competitive environment looks like for you there?

Todd Ernst:

Josh, have time for one more question.

Peter Arment:

Nice results. Kathy, can you maybe just talk a little bit about what you expect on your CapEx kind of profile. When we think about last year, you had a big step up and things are staying elevated here, but you also have just tremendous demand signals, both domestically and internationally. Just how you're thinking about how CapEx should trend? Have you made enough of the investment. It sounds like you have on the solid rocket side and microelectronics, but just thinking about more broadly?

Operator:

Good day, ladies and gentlemen. Welcome to Northrop Grumman's Fourth Quarter and Year-End 2023 Conference Call. Today's call is being recorded. My name is Josh, and I will be your operator today. [Operator Instructions] I would now like to turn the call over to your host, Mr. Todd Ernst, Vice President, Investor Relations. Mr. Ernst, please proceed.

Kathy Warden:

Thanks Todd. Good morning everyone and thank you for joining us. Before discussing our 2023 results, I wanted to take a moment to thank our team for their hard work and dedication to our important mission. Our talented workforce which is now over a 100,000 strong continues to deliver some of the most advanced technologies in the world. These capabilities are used by our customer’s everyday to defend freedom and deter aggression around the globe. The geopolitical landscape has grown even more complex driving continued increases in global security spending. Our strategies has positioned us well to compete and win in this growing market which has translated into accelerating topline growth for Northrop Grumman. Revenue increased by over 7% in 2023 [indiscernible] more than a billion above the midpoint of our original 2023 guidance. In addition, our book-to-bill for the year was 1.14 times, that’s in line with our exceptional four year average. As a result of this award strength, we achieved a new record backlog which now exceeds $84 billion and now provides a healthy foundation for our continued growth. The underlying performance of our company is strong. We generated free cash flow at the high end of our guidance range, and we comfortably exceeded our sales and EPS guidance range, absence of B-21 charge. While we're disappointed that our assessment of conditions for the low rate initial production portion of the B-21 program necessitated this charge in the quarter, we are confident in our ability to deliver on the company's forward outlook, which remains unchanged. We're also proud of the performance of the B-21 team, which continues to execute an unparalleled aircraft development program. As we look forward, we will continue to execute our business strategy, which at its core is based on technology differentiation, a laser focus on performance, and value delivery for our customers and shareholders. To support this strategy, we are prioritizing investment in our capacity and capabilities. In 2023, we invested over $2.9 billion in R&D and CapEx, that's 7.5% of sales, to continue driving innovation and capacity to support our customer mission success. We also delivered over $2.6 billion to shareholders through dividends and share repurchases, representing a return of approximately 125% of our 2023 free cash flow. So now I'll highlight a few examples of progress we've made across the portfolio that further bolster my confidence in our future. Shortly after the close of the fourth quarter, we announced our GEM 63XL solid rocket boosters helped to successfully power ULA’s Vulcan launch vehicle on its first mission. Future Vulcan missions will utilize additional GEM 63XLs in support of Amazon, Kuiper, and other ULA customers, providing a significant growth opportunity for our propulsion business. And this is an important milestone because it supports our investment to significantly ramp production capacity of GEM 63s in the coming years. Global demand for our weapons system increased in 2023, and we expect this trend to continue. In this market, we're both a supplier and a prime. We're a supplier of propulsion systems, warheads, fuses, and cannons across a highly diversified customer base, and a prime contractor for predominantly air-to-ground missiles, including AARGM, AARGM-ER, and Stand-in Attack Weapon. Weapons systems currently represents approximately 7% of total revenue, and based on the demands we're seeing, we expect this business to grow faster than the company average for the foreseeable future, with a significant portion of this expansion coming from international customers. In our Mission Systems business, demand remains exceptionally strong, with a 2023 book-to-bill above 1.2 times, the highest of all of our segments. As we've seen in recent years, the restricted portfolio of Mission Systems is a meaningful driver of growth as our customers pursue solutions that enable them to operate inside the decision loop of potential adversaries who are also advancing their computing capabilities. We are helping our customers stay ahead by developing advanced microelectronics, sensors, processors, and secure communication. Our product lines are enabling faster cycles of modernization, positioning our customers with decision advantage in this rapidly advancing technology environment. And we continue to make significant progress on the EMD phase of Sentinel, which is the next generation land-based leg of the strategic triad. We are achieving milestones to mature the design and reduce risk, including key test activities, such as the successful static fire test of the Sentinel Stage 2 solid rocket motor for the missile earlier this month. Last week, the Air Force submitted to Congress a new set of cost estimates for the program, which triggered a Nunn-McCurdy Breach. This in turn launches a review of the program by the Department of Defense, which we expect to be ongoing for the next several months. It's important to note that the cost growth is primarily driven by estimates for the command and launch facility build-out, which is part of the military construction and procurement phases of the program. We and our industry team are continuing to perform on the EMD phase in close partnership with the U.S. Air Force. And we'll work with the government to explore opportunities to reduce costs on the program with a focus on the late 2020s and beyond when the program is expected to move into the procurement phase. And in the fourth quarter, the B-21 entered its flight test phase. This is a major milestone for the program and achieving it within the baseline schedule is a credit to the Northrop Grumman team and our close partnership with the U.S. Air Force over the past several years. Following this milestone, we were awarded the first LRIP lot in the fourth quarter and production is now underway. Let me take a few moments to provide a little more detail on the B-21 charge. The possibility of which we started talking with you about at this time last year. As you know, like all of industry, we and our suppliers have experienced cost pressure from recent global macroeconomic conditions, which are significantly different from the assumptions the team made when bidding these five production lots in 2015. During the fourth quarter of 2023, we again reviewed our estimated profitability on the LRIP phase of the program. And we now believe it is probable each of the first five LRIP lots will be performed at a loss. The charge is largely driven by a change in our assumptions regarding funding to mitigate the impact of macroeconomic disruptions on the LRIP phase of the program and higher projected manufacturing costs that reflect recent supplier negotiations and our experience in completing the first aircraft. The after tax cash impact related to these updates will be spread over a number of years. Importantly, we have absorbed this effect and we have not changed our outlook for free cash flow growth over the next several years. This is a game changing capability that will be of great value to our nation. And we are focused on executing the program in a way that also delivers value to our shareholders over the coming decades. Turning now to the budget environment. Global national security spending is increasing as the U.S. and allies invest in capabilities to deter and defend against aggression. Demand for our capabilities remain strong due to our differentiated portfolio and alignment to customer priorities including the triad, space and weapons. In the U.S., our franchise programs remain well supported by Congress and the Department of Defense. And this gives us confidence in our outlook even in a constrained U.S. budget environment. We are pleased to have an NDAA in place that provides continued support for defense spending. And we're hopeful that Congress will enact appropriations soon. Our guidance assumes we will not have a shutdown or a full year CR, and we're encouraged by the progress we've seen so far towards passing appropriations in the March timeframe. Additionally, we are monitoring progress on supplemental funding and we see opportunities in expanding the industrial base and increasing munitions production in this pending request. Our allies are also increasing their defense spending and we expect our alignment with their needs for aircraft, weapon systems and mission systems to be an additional source of growth. So as we look to the future, we have the right portfolio and team to deliver on our long-term outlook. Our organic sales have grown at a greater than 5% annual rate since 2019. And our guidance calls for continued growth of 4% to 5% in 2024. Segment operating margin dollars are expected to grow at roughly the same rate as sales in 2024. And our 2024 EPS guidance range of $24.45 to $24.85 at the midpoint represents roughly 6% growth excluding the B-21 charge and 11% growth compared to our initial EPS estimates which we provided for in 2023. In addition, the structural building blocks to expand our margins that we outlined in last year's 2Q earnings call, including dissipating macroeconomic headwinds, implementation of productivity and cost savings initiatives and future favorable mix shift remain in place. We are laser focused on performance and bid discipline to drive margin expansion. And importantly, we continue to expect our free cash flow to grow at a double digit rate over the coming years. We are reaffirming our 2024 and 2025 free cash flow outlook. And we've also introduced a 2026 outlook of $3.3 billion at the midpoint. With the businesses generating significant cash flow, we have considerable flexibility in deploying capital to generate value for customers and shareholders. Our top priority remains investing to support our business strategy. And we expect to invest over 7% of sales again in 2024 in capital expenditures and R&D. At the same time, we'll continue to provide strong capital returns to our shareholders. Last month, our board of directors increased our share repurchase authorization by an additional $2.5 billion, and we ended the year with a remaining authorization of $3.6 billion. For 2024, we expect to increase our share repurchases to at least $2 billion. This includes a $1 billion ASR that we plan to initiate in the coming days based on the strong liquidity position with which we entered this year. So when we take these factors, sustainable top-line growth with expanding margins, and couple those with declining capital intensity and lower projected cash taxes, you get a recipe for robust cash flow growth for years to come. So now I'll turn it over to Dave to provide you more details on the segment results, 2024 guidance, and the forward outlook. Dave?

Operator:

Thank you.[Operator Instructions] Our first question comes from Kristine Liwag with Morgan Stanley. You may proceed.

Kathy Warden:

Good morning.

Kathy Warden:

So Kristine, we've been working with the customer. And as we noted, the conversations continue. And last year, in 2023, we and Air Force disclosed that about $60 million of $1.5 billion that Congress appropriated for inflation was allocated to the advanced procurement for Lot 1 on this program. But we have yet to work through what that relief may be in future lots. We have, of course, as we said, updated our assumptions -- and through conversation and the tight budget environment, we've actually lowered the expectations for inflation relief. And so at this point, our focus is on executing this program and finding opportunities in the performance on the program while we continue to work with the government to see if there is any inflation relief opportunity.

Kathy Warden:

Thank you.

Richard Safran:

Kathy, Dave good morning. So I know you're going to get a lot of questions on the B-21, but I thought I'd ask you about to expand on your opening remarks about Sentinel. I thought you might talk a bit more about the actions you're taking at the program back on track. How are you seeing risk on the program right now? And I guess, importantly, what you think the government's level support for the program is given all the headlines and what we've been seeing?

Richard Safran:

Thanks for that. Feel better.

Operator:

Thank you. One moment for questions. Our next question comes from Ron Epstein with Bank of America. You may proceed.

David Keffer:

Sure. I can go ahead and get started with that. And see if we can address a number of questions you raised. First of all, in terms of the future, we'll continue to update our projections every quarter as we do with all of our large programs. But it's important to note, we have a lot more information today than we did at this time last year, having completed the production in the ground test phase of the first aircraft. We also have the majority of the suppliers now under contract with the remaining in advanced stages of negotiations. We have our latest estimates for productivity and reasonable learning curves that we believe are appropriate based on our historical experience. Of course, we now have one lot under contract, and we'll finalize quantities of the next four lots over time as well. In the economy and inflationary factors have stabilized a bit over the past year, and we'll continue to track those, of course, over time as well. But perhaps most importantly, we're still performing well on this program, which is continuing to provide a critical capability for our customers. In terms of the long-term NPV, we think that's the most important thing is that our customers will get great value from the aircraft. We'll deliver them over time, and that should, over time, also lead to value for the company and our shareholders.

Douglas Harned:

Thank you. Good morning. I wanted to go back to the Sentinel program. And when -- what you've described is that I think because that EMD is going well. But when you look at where this is headed and what came out with the Air Force commentary on the Nunn-McCurdy breach. A couple of things that I wanted to understand better. They're talking about potentially a 2-year delay in IOC, they're also -- also you talked about it a little bit, but to understand how much of this breach is due to potential changes in requirements and things that are, in a sense, under your purview versus those that may be under others, including the government customer?

Douglas Harned:

And does the delay in the timing, does this have much effect right now on your outlook for the overall profitability of the program.

Operator:

Thank you. One moment for questions. Our next question comes from Sheila Kahyaoglu with Jefferies. You may proceed.

David Keffer:

Sure. Thanks for the question, Sheila. I'm happy to dig into that. The strength of the free cash flow outlook we really think of as one of the highlights our report today. And so happy to dig into that in more detail. And I think you heard correctly that 60% of the charge is associated with the period through 2026 from a cash flow perspective. I think importantly, the strength of the broad base of other programs across the business is serving to offset those pressures. And that's what we're seeing in our ability to maintain and build confidence in our multiyear outlook including adding a strong 2026 year to that outlook that continues the double-digit growth trajectory that we expect for the next several years. We had a great finish to 2023 for free cash flow, really strong working capital performance, and that is enabling us to build confidence in our ability to continue to perform at similar levels going forward. As a company, we've put a lot of focus on working capital efficiency, on capital efficiency, on driving cash returns on recent investments and that is clearly showing up in the results and the performance of all of our sectors. We're proud of their performance on cash in Q4 and in the outlooks for 2024 and beyond. And the net effect of all of these factors is that unchanged free cash flow outlook for 2024 and 2025, along with a strong 2026. I'd highlight in terms of what drives that going forward? What's the underlying force as you point out? Certainly, the operations of the business growth in the top line is, first and foremost, with an opportunity for growth at the margin rate line as well that leads to really strong margin dollar volume, which will convert into cash through the strong working capital performance that we expect to continue which is essentially a stable assumption in our outlook. We're not looking for significant additional efficiencies given just how strong we were at the end of 2023. And then as we noted earlier, there are other structural factors that should help as well with CAS pension reimbursement growing slightly over the next few years and cash tax is projected to decline over that same period. So essentially, all of those factors will lead to strong -- strong free cash flow growth outlook for the next several years and beyond.

Operator:

Thank you. One moment for questions. Our next question comes from Seth Seifman with JPMorgan. You may proceed.

David Keffer:

Sure. I can start on that, Seth. I think you've read properly into the $143 million EAC adjustment with Lot 1 having been awarded and the other is not yet awarded, that one does take the form of an EAC adjustment. So that $143 million is the lot 1 amount we are currently projecting. And the future progression while we can't get into much detail because that would involve a lot sizes and quantities and other classified details. Clearly, the implication is that there's modest growth from lot 1 to future lots on average. Over time, I think you're thinking of this the right way that our current projections would indicate an average of a couple of hundred million dollars a year of after-tax impact on our -- on the cash line from B-21, and that's, as I referred to a few minutes ago, the headwind we've been able to mitigate through strength in the rest of the business. In terms of your point about opportunity to outperform that over the long-term. Clearly, it is a core focus of our team to continue to drive efficiencies in the learning curves, successful outcomes of our negotiations with suppliers. We continue to engage and partner with our customer to understand macroeconomic impacts on the program and address opportunities for funding of relief, as Kathy mentioned earlier. And so we'll continue to address all of those opportunities. This is something we'll update you in the rest of the Street on over time.

Cai Von Rumohr:

Thanks so much. Kathy best wishes to feel better.

Cai Von Rumohr:

So anyway, so you had the loss on the B-21 kind of it didn't look like a loss couple of quarters ago. You've had your second loss on Halo. This is clearly proving to be an environment where on fixed price contract, there is more risk. Have you changed your strategy regarding how you bid and specifically with reference to Tranche 2 of the tracking satellites because you were on Tranche 1 and you were not on Tranche 2. So have you changed your strategy in terms of how you're bidding? And are there any contracts that you bid before changing your strategy that would still have risk that we're not aware of today?

Cai Von Rumohr:

Thanks so much. Feel better.

Operator:

Thank you. One moment for questions. Our next question comes from Gavin Parsons with UBS. You may proceed.

Kathy Warden:

Good morning.

Kathy Warden:

With all of our EACs, B-21 included, we do our best based on what we know today to project conditions out into the future. Now with that said, that's difficult to do longer-term that period of performance is. So in this case, we're looking out over greater than 5 years. So as we get into those out years, that's a bit more speculative, but we do incorporate our expectations for changes in everything from material labor pricing to productivity and learning.

David Keffer:

No, I'd refer you to our tax disclosures for more than enough detail on all of those fronts. It's tough to put a range around those things. We're looking forward to getting through processes, as you know, from those disclosures, we have a lot of open years that have yet to be resolved and looking forward to working with the IRS to come to reasonable resolutions there, and we'll update you on any book or tax differences from current reserves as we get there.

Scott Deuschle:

Hey good morning.

Scott Deuschle:

Dave, can you give us a sense for the proportion of supplier costs across the 5 LRIP lots that have now been fixed versus what's still open to negotiation?

Scott Deuschle:

Okay. Great. And then just as a follow-up, where does the commercial inventory come from in the space business? And is that EBIT headwind mostly gone now? Or is there any more of that left to come in 2024? Thank you.

Operator:

Thank you. One moment for questions. Our next question comes from Ken Herbert with RBC Capital Markets. You may proceed.

Kathy Warden:

Thanks, Ken. We laid out 3 drivers, the first of which being stabilization in macroeconomics, and we are certainly seeing that in 2024, which is why we see our margin rates this year in line with last with some opportunity for improvement as we go throughout the year. We layer on top of that cost and productivity actions that we are taking in the company, and that will provide some tailwinds in 2024 growing tailwinds into 2025. And the mix shift really is a bit of a longer-term proposition for us. We've talked about that being a shift from cost type to fixed price, where we expect 2023 was really our high watermark for cost type, but a very gradual shift in that mix to fixed price with more of it coming in the latter half of this decade. And then international mix is the other where we don't expect significant international growth in 2024, but we do expect that to step up based on our pipeline and particularly the strong weapons demand outside the U.S. in 2025. That gives you a sense of what will be a tailwind to margin rate win.

Myles Walton:

Thanks, good morning. I was wondering, Dave, or Kathy, you previously talked about a $4 billion free cash flow target in 2028, effectively doubling what you've done in 2023. I just want to make sure that's still on the table, despite the charge absorption in that period of time? And then maybe, Kathy, on the margin expansion specific to Aerospace, is that still a 10% margin business? Or do we have to glide slope down a little bit further into 2025, 2026.

Kathy Warden:

And Myles, on AS margins, what we're seeing, as Dave noted earlier is that with the B-21 growth being a bit stronger than we had anticipated, AS is stepping up on top line. It is putting some pressure on margin rate, but margin dollars are exactly where we had anticipated they would be coming into 2024, and our guide therefore, remained consistent for AS on a dollar basis, even though we now are looking at more of a mid-9s rate projection. As you go out over time, it's less dependent on what happens with absorbing that lower rate on B-21 and more what happens in terms of other new programs coming into the AS portfolio and the rate at which we will book those programs. So we'll provide you more insight into that over the coming year as we look towards 2025 and beyond.

Robert Spingarn:

Hey good morning. Kathy, a few minutes ago, you alluded to international and I wanted to bring up IBCS because it's had some strong demand signals from international customers and thought maybe you could dig into that program a little bit, give us a sense of how large it is in revenue or how -- in 2023 or 2024? And how big it might be, let's say, 5 years from now?

Operator:

Thank you. One moment for questions. Our next question comes from George Shapiro with Shapiro Research. You may proceed.

Kathy Warden:

Let me start with the first part of your question and Dave will cover the second. As we noted, we identified this risk last year, and we, throughout the year, revisited it on a quarterly basis. There were 2 primary changes in the fourth quarter that both led us to deem it probable loss as well as impacted the value of that loss. First, we significantly reduced our projections for funding related to macroeconomic impacts, as we've talked about a couple of times already. Although we continue to partner with the government to address these impacts. We believe it's prudent in light of the current budget status to reduce those assumptions. And so we did that. The second is we've experienced growth in our cost projection, both in the internal production costs as we've continued to build aircraft as Dave talked about through our negotiations with suppliers. We have learned and built that learning into the forward-looking estimates that we now have in the EAC, so those were the factors. As we've talked about, we did a very detailed look at this EAC in the fourth quarter and had matured and had actual data to reflect on that we did not have at an earlier point.

Todd Ernst:

Josh, we have time for one more question.

Jason Gursky:

Hey good morning everybody. Dave, just a clarification question for you to start. You mentioned in your prepared remarks that there were some shifting priorities from the government and the space business that was leading to a deceleration in growth. I was wondering if you could provide a little bit more color on what those shifting priorities might be? And then Kathy, I just wanted to provide you maybe a bit of an open-ended question to kind of wrap all this together here. Just broadly talk about all the risks and opportunities that you see in front of you on the execution side of things. You've obviously got record backlog here and we know about the B-21 risk. But I'm wondering if you could just maybe highlight and wrap this all together, do we have a balanced risk and opportunities portfolio here, we a little bit more overweight risk than we are opportunity? And maybe just kind of dive into a little bit of the details of what you're seeing and maybe what you're all doing to address those issues. Thanks.

Jason Gursky:

Kathy?

Operator:

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation.

Operator:

Good day, ladies and gentlemen, and welcome to Northrop Grumman's Third Quarter Conference Call. Today's call is being recorded. My name is Josh, and I will be your operator today. [Operator Instructions] I would now like to turn the call over to your host, Mr. Todd Ernst, Vice President, Investor Relations. Mr. Ernst, please proceed.

Kathy Warden:

Thanks, Todd. Good morning, everyone. Thank you for joining us. We are all witnessing significant geopolitical tensions across the globe, including the ongoing war in Ukraine and the horrific attacks in Israel. We truly hope that peace and safety can be established for the people in these regions, and we'll continue in our steadfast support for the U.S. and our allies in their pursuit of global security and stability. On this morning's call, in addition to reviewing our third quarter results and important program events in the quarter, I'll address the U.S. budget and trends we see in the global environment. And as usual, at this time of year, I'll provide our initial outlook for next year. So starting with the quarter. Our book-to-bill was 1.5x with approximately $15 billion in awards, and our sales increased 9% year-over-year with growth across all four of our business segments. Our backlog now stands at $84 billion. It's a new record, and it strengthens the foundation for our future growth. It also continues to reflect the alignment we have with our customers' priorities and the continued success of our business strategy. Segment operating income increased by 8% year-over-year, and the OM rate increased over last quarter. Earnings per share were $6.18, up 5% compared to last year. Strong earnings rose nearly $900 million in free cash flow in the quarter, and we remain on track to achieve our 2023 free cash flow target. Excellent cash generation continues to provide us the flexibility to invest in our capabilities and capacity while returning capital to shareholders. We remain committed to returning over 100% of our free cash flow to investors this year, including $1.5 billion of share repurchases. And year-to-date, we've returned approximately $2 billion to shareholders in dividends and repurchases. So turning now to the U.S. defense budget. As is common in recent years, the federal government is operating under a continuing resolution to start fiscal year 2024. We're encouraged by bipartisan support for national security priorities and are hopeful an agreement will be reached on full year appropriations soon. Our guidance and outlook assume a full year budget is passed by the end of this calendar year or early next year. And as we saw last week, the administration continues to make supplemental request for urgent needs, including those in Ukraine and Israel to include investments in weapon systems and defense industrial-based readiness. The federal government is also developing its budget plans for fiscal year 2025, which we expect to be submitted to Congress early next year. We are working closely with our customers to plan for future capabilities and navigate the fiscal pressures they see to ensure our programs remain well supported. As we have been discussing throughout the year, we are also seeing an increase in international demand for our capabilities. We've seen a particular increase in our weapon systems portfolio and missile defense technologies like the IBCS product line. One notable example of this growing demand is with AARGM-ER where we've now received interest for more than a dozen countries and just this week, the opportunity for a foreign military sale to Finland was announced. We are also working with the U.S. government to provide new advanced weapons capabilities. During the second quarter, we received a $705 million contract from the United States Air Force to develop the Stand in Attack weapon, also known as SAW, an air to ground weapon with the capability to strike mobile defense targets. Our SAW offering builds on the capabilities we provide with our high-speed AARGM missile, which is in production. Building off a mature product baseline, we're able to reduce the developmental time, cost and risk to the SAW program. These missiles are expected to be the air-to-ground weapon of choice for the F-35 and other fighters. In our Space business, we remain focused on being at the forefront of technology, and that strategy has enabled us to build a differentiated portfolio that provides end-to-end solutions for our customers. from new space architectures to launch capabilities. We see broad applications for the technologies we've developed with a particular focus on national security missions. This includes helping to turn the Space Development Agency's vision of a new low earth orbit constellation of satellites into reality. In August, we were awarded a $712 million contract to design and build 36 satellites for SDA's tranche two transport layer data constellation. With this award, along with our work on SDA's tracking layer and tranche one of the transport layer, we are now building nearly 100 satellites for the proliferated war fighter space architecture. Our success in this area highlight our ability to compete and win in highly competitive and dynamic new markets within the space domain. In addition, we had two notable launch events in the quarter. We successfully launched our 19th resupply mission to the International Space Station as we continue to execute under NASA's commercial resupply contract. And five of our GEM 63 solid rocket boosters helped to power ULA's Atlas V launch of a national security payload. These rocket motors will continue to support future ULA launches to include ULA's Vulcan rocket. For next-generation interceptor, we successfully manufactured the first set of solid rocket motor cases in August, and we're on track for our preliminary design review in the fourth quarter, more than a year earlier than the original contract date. These are just a few examples of the focus we have on strong program performance across the portfolio. Now before I turn the call over to Dave to provide more details on the quarter, I'd like to provide some initial color on our 2024 outlook. We continue to see solid growth across all four of our businesses. with sales growth of approximately 4% to 5% compared to our latest 2023 guidance, which we've now raised by $800 million throughout the year. We also expect operating income to grow by 4% to 5% year-over-year. We reaffirm our free cash flow outlook range of $2.25 billion to $2.65 billion in 2024, which accounts for continued investment in the capabilities and capacity needed to grow our business and support our customers. So in summary, Northrop Grumman is well positioned to drive value creation for our customers and our shareholders. We are focused on executing our strategy, driving operating performance and generating cash for our disciplined capital deployment. So now with that, I'll turn it over to Dave to provide some more details on the segment results, 2023 guidance and our outlook.

Operator:

[Operator Instructions] Our first question comes from Douglas Harned with Bernstein. You may proceed.

Kathy Warden:

Thanks, Doug. So the puts and takes that we've been talking about have materialized as we expected. The biggest factor was the programs that were declining are largely through our year-over-year comparison now. Those include Global Hawk, which is in sustainment; Triton, which is still in production. But as we look forward, that rate is fairly stable and so it is not contributing to significant growth. What is contributing to growth is B-21, and we expected that ramp to start this year and continue and we still anticipate that. And then other stabilizing factors of the F-35, E-2D large programs that have generally remained constant. As we look forward, we see that same profile in those program categories, and that will contribute to growth at AS. We do expect that margin rates will be near that 10% mark that we've been talking about. And we've gone through, again, those major categories of the portfolio and how they contribute. Our mature production is about 60% of the portfolio and that tends to have above 10% margins, whereas the B-21 has contributed lower margins and will, as we move into production, contribute 0 on the production. That's our planning assumption, of course. And so it's the mix of that entire portfolio that brings us to that approximately 10% expectation toward the near to midterm.

Kathy Warden:

Absolutely. So at this point in the year, as is normal, we wanted to provide an outlook. They are broad ranges. So the 4% to 5% both for sales and operating margin, it gives us opportunity to do further planning and characterizing of the budget as that becomes more clear, and we'll provide more precise guidance in January. What I would say is that we are still on track for the trends that we have spoken of in operating margin. We see improvements, and that is reflected in our guidance for 2023 in the fourth quarter, again, sequential improvement over Q3 performance. And we expect as we move into next year, there are continued opportunities for improvement in operating margins. They are related to macroeconomic trends largely inflation, labor cost, productivity. And so we'd like to get a little bit more time under our belt before we get concrete about what that improvement might look like. So we are expecting some modest margin rate improvement into next year as we have outlined for Q4 of this year. I also just want to point to the fact that the free cash flow growth is the real point for our investors to understand, while earnings growth will be there, we also have headwinds that have historically in the last couple of years, challenged us on free cash flow that are dissipating. We've talked about -- and I'm sure we'll talk more on today's call about Section 174, which is a decreasing headwind over time. We also see the pension headwind curtailing. And then, of course, since we reduce our CapEx spend starting in 2025, even more robust free cash flow growth. But looking at 20% year-over-year free cash flow growth is really an important milestone for us. and something we're very focused on delivering.

Ronald Epstein:

Yes. Across the industry, there's been a lot of discussion about from supply chain capacity constraints, labor constraints. One thing that's popped up in a lot of discussions is just the availability of solid rocket motors for missiles and so on and so forth. Just broadly, Kathy, how is Northrop handling? You're getting a surge in demand at a time where kind of post COVID and all that, I mean, labor has been tough and supply chains are tough. I mean how is it going? And what's Northrop doing to handle that?

Ronald Epstein:

Got it. Got it. And then maybe a follow-on for Dave. Is there -- can you give us any update on how you're thinking about the B-21 LRIP? Because that's something that's kind of always on everybody's mind.

Operator:

Our next question comes from Sheila Kahyaoglu with Jefferies. You may proceed.

David Keffer:

Sheila, it's Dave. I'm happy to provide some additional color there. The 2024 updates that we provided on the call today should give you a sense for our near-term sales and earnings growth expectations underlying that free cash flow expansion. We do expect to continue to see a leading sales profile in the growth of our business. And as we've talked about, we anticipate long-term margin expansion opportunity as well. And so both of those are foundational to our multiyear free cash flow growth expectations. On top of that, we've talked about the last couple of years that the 2023 and 2024 would be a period of peak capital intensity for the business, and that is consistent with our current expectation. Large programs that we've had for a number of years as well as new wins we've had that have grown our backlog so significantly over the past couple of years have all contributed to a peak period of capital intensity right now that we have clarity on sources of decline in the middle of the decade. And so we expect that capital intensity to be alleviating in 2025 and beyond. Working capital performance is really among the best in class at this point. And even with a modest headwind from the progress pay changes, we anticipate continuing to be able to deliver stable working capital performance, not a meaningful driver of headwind or tailwinds there. And then you get to the two items Kathy mentioned earlier, modestly higher CAS pension recoveries currently projected over the next few years. Of course, those will continue to fluctuate based on -- primarily on asset returns, but other actuarial changes that are possible as well. And then on the cash tax side, as we've noted, a pretty stable outlook for free -- for cash taxes from what we've been anticipating previously, and that outlook is for declining cash taxes over the next several years largely driven by the Section 174 movement as we get through the period of amortization over these five years. So all in all, a number of key tailwinds most critical of which, of course, is the expectation of continued growth and margin opportunity in the business.

Myles Walton:

Kathy, could you comment a bit on relative growth rates at a minimum for the segments next year? And just playing off the space backlog, which continues to expand pretty wildly, maybe just dig in a little bit deeper as to how the complexion of that backlog might play out on hopefully a margin expansion profile from here?

Myles Walton:

And can you just clarify on the underlying margins, EACs were still negative within space. Is there -- and we've seen that for now five quarters. Are there programs you could point to, to say, okay, these are running off and that's why we're going to have this margin expansion profile?

Operator:

Our next question comes from Kristine Liwag with Morgan Stanley. You may proceed.

Kathy Warden:

Yes. Thank you. So in my comments, I alluded to the fact that AARGM is a product line that we have. We've talked about the base AARGM product, the AARGM-ER, or extended range, and now the SAW award and with each of those products are building off of a mature technical baseline. As I've talked about our approach to thinking about fixed price, I have often said fixed price is appropriate where it's either a commercial item or an item that has reached a design maturity and been risk reduced to where we know what it will take to deliver that product. Because of the maturity of AARGM and us having a product line that met the Air Force requirements for SOL to bring forward, we are able to reduce cost schedule and, of course, have better risk management. That allows us to have the risk tolerance then to bid fixed price. And I recognize that in competition, there are many factors, but when a company has invested and gotten the mature product line, there is a natural advantage that comes with that. And that's the situation we found ourselves in with SAW in that specific competition.

Kathy Warden:

No, it does not. As we look at the timing of the LRIP award, as Dave said, we still expect that to happen this year. And as we have talked about before, first flight is a milestone that the Air Force is looking to achieve before they make that award, and we are on track still anticipating first flight this year.

Robert Stallard:

Kathy, I just wanted to follow up on your budget commentary at the start of the call. I'm wondering if you're putting any contingency plans in place in case we get arbitrary DoD budget cuts as a result of this craziness in Congress.

Robert Stallard:

Yes. And then as a follow-up, you mentioned the strong demand on the defense export market at the moment. I was wondering if there could be any capital deployment opportunities there, either Northrop Grumman acquiring companies overseas or making other investments.

Operator:

Our next question comes from Cai von Rumohr with TD Cowen. You may proceed.

Kathy Warden:

Yes. I like the way you're thinking. It's exactly the challenge that me and the team are discussing amongst ourselves is to how we do drive margin improvements next year. And in the Q2 call, I laid out for our investors what that path is and the key factors associated with improvement. And let me just touch on each of those and then I can tie it also to where the segments see the greatest opportunity. For macroeconomic factors, I've talked about those already on the call. We are seeing inflation be a bit secure than we had hoped at this point in time. We are incorporating that into our forward estimate, but it is impacting our ability to return to higher levels of profitability factor. Productivity is another area where we are working to improve productivity, not just within our company, but our supply chain. That is opportunity. That would be upside to a flattish look next year. Although, as I also indicated, we are expecting some modest improvement in margin rate next year. What then we look at is the mix, and that has been a factor for both base and mission systems over the last couple of years, particularly notable for mission systems this year. We don't see a significant mix shift going into next year. It is a very gradual mix shift. And so that -- those two pieces of the business will still feel some margin rate pressure until they can shift to more production in the portfolio. As you note, our Defense Systems business has the most both top line and margin upsize that could come as the result of growing international demand as well as what we see domestically, particularly through the supplemental. Those are uncertain at the moment. So we do factor those in our plan, but that could be a source of upsize. But then, of course, we are managing risks across the entire portfolio. And so when we put all of that together, we're looking at some modest rate improvement into next year and really striving to do better. But at this point in the year, we are very comfortable with what we've laid out as a set of expectations.

Kenneth Herbert:

Kathy, maybe I just wanted to follow up on the strong bookings this year. Can you call out or maybe help quantify how much of that could have been or is international? And as we think about sort of this growing set of international opportunities, maybe not so much in '24, but how much international growth could you see next year and into '25? And I guess, more importantly, how could that impact margins as I think about maybe international being slightly accretive to margins?

Kenneth Herbert:

That's helpful. And is there any way to think about just with, obviously, a lot of what we hear in the geopolitical environment, are you seeing that yet translate into sort of bid opportunities when you think about international? I'm just trying to get a sense as to with all of the -- all of sort of this growing expectation, how much you're actually seeing that yet transpire or actually materialize in terms of real opportunity you're going after?

Operator:

Our next question comes from Scott Deuschle with Deutsche Bank. You may proceed.

Kathy Warden:

Yes, there's really nothing I can comment on with regard to that, Scott. I will simply say we do continue to work with the Air Force on ensuring that we have the resources necessary to make B-21 program successful.

David Keffer:

Sure. A couple of thoughts there. One, you saw a similar trend last year in our MS business with its strongest margin performance in the fourth quarter of the year, driven by the mix of business that we tend to see spike in the fourth quarter with more predominance of mature fixed price programs in that fourth quarter sales mix. We anticipate a similar trend this year. With that said, need to continue to perform and execute well and with efficiency across that MS portfolio to deliver on that result. In aggregate, the 23% margin guidance change for MS is really driven by mix. A lot of the growth in MS this year has been in critical work in the restricted portfolio that tends to be at this phase in its life cycle cost-type work. There is opportunity for that work to shift back towards more fixed price over time. But the fact that most of the growth in MS this year has been driven by growth in cost-type contracts has been a pressure on its margin rate. With that said, it along with the rest of our businesses drove margin dollar growth year-over-year in Q3, and we anticipate the same trend in Q4.

Gavin Parsons:

Dave, I was hoping you could go into just a little bit more detail on the Section 174 change and what the offset is given it would seem like that has to be pretty sizable, especially if you get some recapture from 2022?

Gavin Parsons:

Got it. That's helpful. Kathy, you mentioned stickier inflation. Any update on discussions with customers for relief on that front?

Operator:

Our next question comes from Seth Seifman with JPMorgan. You may proceed.

David Keffer:

So I appreciate the question, Seth. I know it's been a common line of discussion for us, and it's an interesting topic. I would say this probably isn't the time or the place for us to assess differences in our own interpretation of guidance from peers. We're not familiar with the interpretations of our peers. When it comes to our own view of Section 174, it is broader than IRAD and includes a portion of our contract-driven R&D as well. With that said, as I mentioned, we'll continue to assess potential future guidance, even following on and clarifying guidance provided in September. And we're open to different interpretations based on different guidance we may get in the future. But importantly, as I mentioned, a difference in contract type interpretation is not nearly as impactful for us as others have said it is for them. And so I think, in aggregate, this should be less of a focus. That interpretation difference should be less of a focus for the Street going forward than it has been for us in the recent past. And the important point to take away is that our cash tax forecast hasn't changed in any meaningful way and remains a tailwind for us. It's a small piece of the much more important puzzle that is really strong free cash flow growth opportunity for us over these next five years, leading to a lot of optionality as it relates to capital deployment. And I think that's the more important headline.

David Strauss:

Wanted to ask specifically on B-21 and your guidance for -- it sounds like 10% margins at AS next year. Are you assuming, Kathy, any incremental inflation [indiscernible] on B-21 in that?

David Strauss:

Okay. And apologies, Dave, I got to go back to Section 174. Just to level set us, are you -- in your free cash flow forecast this year, are you still assuming $700 million impact from Section 174 and stepping down roughly 20% from there next year?

Kathy Warden:

Thanks, David. So quickly before concluding the call, I just want to take a moment to acknowledge our team and thank them for their contributions to our company and our customers. And in particular, I want to thank our General Counsel Sheila Cheston, who is retiring after 13 years with the company. Sheila has been instrumental in instilling a culture of strong ethics and she has provided outstanding counsel for the company and been a trusted partner to the Board and to me and the leadership team. Kathy Simpson is our new General Counsel. She is also a valued member of our team. She's been with us for many years, and she brings a wealth of broad-based legal and strategic expertise to the role. So we're thrilled to have her. And I also want to congratulate Rob Fleming, our new Space System Sector President and thank Tom Wilson for his leadership in guiding the space business for the last several years during a period of just tremendous growth. Tom is now taking a new role with the company who's going to help us expand our business development capabilities across the entire enterprise. And Rob has extensive experience running complex businesses during his 18 years with our company. He most notably and recently led the Strategic Space Systems division, which is the largest segment of our space sector, and I think what you see from our team is that the depth and strength of our team allows us to make these internal transitions very smoothly. I'm looking forward to working them and them meeting you in future years. So thank you for joining the call today, and we look forward to speaking with you again on our fourth quarter call in January.

Todd Ernst:

Thanks, Josh. And good morning and welcome to Northrop Grumman second quarter 2023 conference call. We will refer to a PowerPoint presentation that is posted to the IR website on the call this morning. Before we get started, matters discussed on today's call, including guidance and outlooks for 2023 and beyond reflect the company's judgment based on information available at the time of this call. They constitute forward-looking statements pursuant to safe harbor provisions of Federal Securities Laws. For looking statements involve risks and uncertainties, including those noted in today's press release and our SEC filings. These risks and uncertainties may cause actual company results to differ materially. Today's call will include non-GAAP financial measures that are reconciled to GAAP results in our earnings release. And on today's call are Kathy Warden, our Chair, CEO and President and David Keffer, our CFO. At this time, I'd like to turn the call over to Kathy, Kathy?

David Keffer:

Thanks, Kathy. And good morning, everyone. We're pleased to report another solid quarter, we remain focused on executing our strategy and believe we're well positioned to grow our topline earnings and cash flows for years to come. The demand environment continues to be robust, supported by the alignment of our portfolio with our customers highest priority missions. And those Kathy described, we see a path to expand margins in the second half of this year and beyond. As macro pressures ease and we drive efficiencies into our business as it grows and experiences mixed tailwinds. Now turning to Q2 results, we generated $10.9 billion of new awards, a higher total than we previously expected, our book-to-bill was 1.14 and was driven by restricted awards of $5.4 billion. This brings our year-to-date total to $8.6 billion in restricted bookings. Looking forward, we expect a number of production awards in the second half of the year, including the first lot of B-21 LRIP. Moving to sales on Slide 4 in our earnings deck, we’ve delivered strong topline growth of 9% in the second quarter. Building on the momentum from Q1 as a result of our success in bringing on new employees, incremental improvements in the supply chain and continued backlog strength our sales are growing at a higher rate, and we've increased our full year guidance. With respect to segment results all four of our businesses grew in the second quarter. Space continues to lead the way with their second consecutive quarter of 17% sales growth as GBSD, NGI and restricted space programs continue to ramp. In defense system sales increased 10% on the strength of their armaments and Missile Defense franchises. Mission Systems growth of 5% was driven by restricted programs in the networked information solutions business and aeronautics systems returned to growth as higher volume on restricted programs outpaced the headwinds on legacy programs as we've anticipated. Turning to Slide 5, segment margins in the second quarter were 11%. Keep in mind that Q2 of last year included over $70 million or 80 basis points of benefit from a land sale and a contract related legal matter. Most importantly, margin dollars improved incrementally from Q1, largely meeting our expectations. Program performance remains strong across the portfolio, as the team does a good job in navigating the lingering disruption from the pandemic and macro economic factors we've been discussing. One area of pressure we experienced in the quarter was a $36 million unfavorable adjustment on NASA's habitation and logistics outposts program or HALO in our space system sector. Moving to earnings per share on Slide 6, diluted EPs in the second quarter were $5.34. This included lower net pension income of roughly $1 per share partially offset by more favorable returns on marketable securities than in the same period last year. Slide 7 highlights the non operational pension headwinds we experienced in Q2 on a year-over-year basis 2023 pension income will be lower for all periods when compared to 2022. But these headwinds are expected to dissipate as we look to 2024. With respect to cash, we generated strong free cash flow in the second quarter of over $600 million, a significant increase compared to the same period last year in which we had an outflow of $460 million. This improvement was driven by increased billings and timing of collections across the company. We paid roughly $360 million of cash taxes associated with section 174. And we continue to expect a full year impact of a little over $700 million. Moving to 2023 guidance. We'll start with a few updates to our sector estimates which you can see on Slide 8, our space business continues to deliver outstanding sales growth and bookings, demonstrating the strength of its diverse portfolio capabilities. As a result, we're increasing sales guidance for space to the high $13 billion range. Remember, as recently as 2019, this business was generating revenue in the mid $7 billion range. So our guidance this year reflects a Fantastic Four year CAGR of roughly 17%. At defense systems based on the strength of their year to their year-to-date results, we're increasing our full year expectations for this business to the mid to high $5 billion range. This represents growth in the low single digit range. There are no changes to our revenue expectations at [AS or MS]. With respect to margin rates. We're maintaining our expectations for as AS, DS and MS and we're projecting a lower operating margin rate at space to reflect the rapid increase in new program winds and their first half results. At the company level, this translates to an increase to our sales guidance of $400 million in a growth rate between 4% and 6% for the full year, we're maintaining our expectations for segment operating income dollars, we expect a slightly higher full year tax rate of 17% and we reduced our projection for shares outstanding to the mid $152 millions to reflect our latest share repurchase expectations. Our EPS outlook continues to assume Q3 Closer of the sale of the minority investment for which we increased our full year EPS guidance by $0.40 last quarter. This quarter, we're increasing the lower end of our guidance range by $0.20. We remain on track with our full year outlook for cash and continue to expect to grow our free cash flow to about $3 billion by 2025. This represents a greater than 20% CAGR driven by the growth of our business and structural tailwinds from cash taxes, lower CapEx and higher CAS recoveries. In over the next five years, we see an opportunity to approximately double our current level of free cash flow. Lastly, we continue to execute our balanced capital deployment plan. This includes investments of over $2.8 billion in R&D and CAPEX this year and returning excess capital to shareholders via our quarterly dividend and share repurchase plans. For the year, we continue to expect to return over 100% of our free cash flow to shareholders, including roughly $1.5 billion in share repurchases. We also plan to retire $1 billion of notes that mature in August, and we don't have any additional bond maturities until 2025. Overall, the Northrop Grumman team delivered a strong first half of the year, our business strategy is working and we're continuing to drive additional growth in sales earnings in cash. With growing global demand for a portfolio of solutions and solid program performance. We're building long term value for all our stakeholders. With that, let's open up the call for questions.

Robert Stallard:

Thank you so much. Good morning.

Robert Stallard:

A couple of questions from me. First of all, Kathy, thanks for your commentary on the margin expectations for the next few years. But I was wondering, as you talk about this, what are you expecting on the B-21 LRIP? Is that still anticipated to be around a sort of breakeven margin in your expectation? And then secondly, does the end of the F-18 have an impact on this?

Kathy Warden:

It is a fixed price program. We had worked with the government in a cost plus structure through the preliminary design review. So we had a more mature design before transitioning into a fixed price contract structure. And as I noted in my comments, we’re being even more disciplined moving forward in ensuring that we work with the government to have the appropriate use of fixed price contracts. We think that is best applied for commercial items or production programs with stable requirements in mature design is it's turning out on the HALO program. The requirements are not as stable as we or the government anticipated. And we're working with them to address that change management as we go forward.

Richard Safran:

Kathy, David, Todd, good morning. How are you?

Richard Safran:

So, you've been a bit reluctant to talk about this so far, but I thought I'd see if you'd comment on the NGAD Sixth-Generation Fighter Program since the Air Force just recently announced the competition. What I'd like to know is if you're thinking about bidding this as a prime, and I'd also like to know if you could, if this program is considered part of your, your growth strategy, so any color you could provide that would be helpful. Thanks.

Richard Safran:

Okay, thank you.

Operator:

Thank you one moment for questions. Our next question comes from Ron Epstein with Bank of America Merrill Lynch. You may proceed.

Kathy Warden:

Well, I'll just say that, when I noted we have other opportunities we are pursuing. I won't disclose at this point exactly what those are a little more information comes out on other programs. But you could assume that if we feel we're well positioned, and the government is appropriately balancing risk and reward as I said that that would be a program we would pursue.

Operator:

Thank you. One moment for questions. Our next question comes from Kristine Liwag with Morgan Stanley, you may proceed.

Kathy Warden:

Oh, Kristine, certainly your words, not mine. But we do feel that discipline has served us well in the past and selecting how much risk to take and what to pursue. And we've learned lessons from some of our own experience as well. So we are applying those as we think about what to bid and what not to bid going forward. And that is critical to us, expanding our margins back to what investors expect of this company. And it's the three factors I mentioned. But the discipline, and ensuring we have the right combination of risk reward is important. And it's not just important for us to be able to meet our commitments to investors, but for the entire industrial base to remain healthy, so that we can have industrial base that investors want to invest in.

Kathy Warden:

Thanks, Kristine.

Doug Harned:

Good morning. Thank you. On the margin question, even when we look at history, generally inflation, it doesn't affect defense companies that much. And we've obviously seen a very difficult two years where it rose, and you've talked about this rose very quickly, and you've had to absorb costs and fixed price contracts. When you look forward. You talked about being able to run out some of the contracts that were priced before we had that higher inflation level. But when you look at repricing contracts that go into next tranches, new work, do you expect that you're going to be able to get back to be able to price off a base cost level that could allow you to have the same kind of performance we saw in the sense in the pre COVID era?

Douglas Harned:

And then, clearly and it sounds like you're looking at this so over the next 12 months or so you see this shift but clearly it also requires more money in the budget. We saw a lot of money come in in '23 budget from the senate last year. But you're expecting then in the budget to also be able to cover these higher costs?

Operator:

Thank you. One moment for question. Our next question comes from Sheila Kahyaoglu with Jefferies. You may proceed.

Kathy Warden:

So, a good bit of the growth has been and continue this year to come from two programs

Operator:

Thank you. One moment for questions. Our next question comes from Matt Akers with Wells Fargo. You may proceed.

Kathy Warden:

Yes, thanks for the question. So, this is in regards to Sentinel or GBSD as many of you know it. And there was a GAO report that's focused schedule pressure. We've been talking about that and the U.S. Airforce has as well as we have seen disruption in supply that has flowed through to schedule pressure on the program. We're in the process of working with the Airforce on looking to optimize the schedule to see what we can pull outward obviously it's shifting right and how we can maintain the initial operating capability day which is the primary focus of the government, so that we cannot place those missiles in silos as anticipated later in the decade.

David Keffer:

Sure, thanks Matt. We continue to feel really good about our working capital status as efficient I think as any across the industry and particularly strong in the second quarter. We mentioned a $1 billion of improvement year-over-year in free cash flow that was bolstered by the strength of our invoicing and collections efforts during the quarter which puts us in good status. We think about where we stand year-to-date compared to a year ago. We continue to expect a kind of typical seasonal pattern with the strongest free cash flow and therefore working capital efficiency in the fourth quarter of the year. But overall feel good about our working capital efforts.

Peter Arment:

Yes, thanks. Good morning, Kathy, Dave, Todd. Hey Kathy, thanks for your comment on the mix and kind of the longer-term outlook on where that transitions from cost plus to kind of fixed price mix for the company. Is 2023 kind of the peak year or is it more like next year for cost plus and just a related to kind of just your comments on working capital. How do we think about the working capital profile kind of over that similar period? Is that like a that does have become a headwind or is it an opportunity for you. Thanks.

Operator:

Thank you. One moment for question. Our next question comes from George Shapiro with Shapiro Research. You may proceed.

David Keffer:

Hey George, it's Dave. So, as we talked about on the call, the first flight at aircraft was successfully powered on in Q2. We remain on track for first flight this year. Again, that timing continues to depend on events and data of course over time. And we anticipate that that first LRIP contract will be awarded following first flight. We will continue to evaluate the performance in the outlook for B-21 LRIP as well as the EMD portion of the program on a quarterly basis and provide updates as we have them. Of course, those will be informed by continued progress in driving efficiencies on the program as well as our understanding of that first LRIP contract lot and beyond. So, we'll take all of that into account each quarter as we update our thinking.

Kathy Warden:

Go ahead, well you can give us a follow-up.

Operator:

Oh, no problem. [Audio Gap] -- 9% or so. So, about half what you experienced in the first step. Can you provide reasons for that slowing?

Unidentified Analyst:

Okay. Thanks very much, Dave.

Seth Seifman:

Hey, thanks very much. Good morning. I wanted to ask first about space and it seems like definitely I appreciate the detailed commentary on the overall margin outlook. It seems like space has been the business where a lot of that margin pressure has been felt most not just maybe from foreseeable things like mix but from surprises that have caused the company to go down the margin there. What is it about the portfolio in space that's driving that now? And how do you assess the risk from here, is space still the sector where there is maybe the most margin risk due to continued work on fixed price development programs like HALO and maybe exposure to either the SDA Tranches which I think are also kind of fixed price development work. How do you see that now?

Seth Seifman:

Great. And maybe just as a quick follow-up in AI. Perhaps feudal attempt to bring out a little bit more information about the NGAD strategy. I believe the collaborative combat aircraft portion of NGAD is a separate solicitation. Are you planning to pursue that?

Operator:

Thank you. One moment for questions. Our next question comes from Myles Walton with Wolfe Research. You may proceed.

Kathy Warden:

So, I'll start and then turn it to Dave. As I think about margin profile, we do expect the second half of this year to be stronger than the first half and based on our guide you could expect us to see that progress that we have largely from macroeconomic disruptions dissipating through the year to continue into 2024. The mix shift that I focus is more gradual. I talked about that shift toward 60% fixed price in 2027, so you could think of that as a progression through 2024 to those later years. And so, we're not going to guide today around 2024. We will provide just some more specifics as the year progresses and certainly at the beginning of the year next year. But you could think of it as a steady progression of improvement not a dramatic change from where we've been performing this year.

Myles Walton:

Okay. Thank you.

David Strauss:

Good morning, and thank you.

Kathy Warden:

Right. So, we're really pleased with the progress that we've seen this year, our sales guidance increasing at space and TS and our other two sectors continuing to see progression towards their growth objectives as well. As we think about this year, a good portion of that growth is the strong backlog that we developed and continued win of competitive bid. Part of it too though is what we've been talking about with the phenomena of having supplier deliveries to late last year and starting to come in this year having ramped our headcount significantly in the latter part of last year and early part of this year, is contributing to growth rate. Those elements you wouldn’t think of as it continued, it was a bit of at that wave that we've now seen come into this year. But the growth based on backlog performance and new winds, we do expect to continue into next year and its better see another year of healthy growth in 2024.

David Strauss:

Great. A quick follow-up on the F-18. How big is that still for you today and when would you expect that to completely run off?

Operator:

Thank you. One moment for questions. Our next question comes from Jason Gursky with Citigroup. You may proceed.

Kathy Warden:

So, the remainder of backlog on B-21 is relatively small because what's in backlog is the EMD program completion. Production has yet to be awarded, so the lots we've been talking about is how to get to the first slot of production and contract later this year. But of course, it is priced and so that is a contractual commitment, but we have not yet been awarded it, so it's not showing up in backlog. Programs that are a significant amount of that backlog, our program like Sentinel, a sizable program that was awarded in 2020 or 2021 and is going to carry forward for several more years as part of that EMD program and backlog. And there are several others, but none that rise to that level. But I will remind you that Sentinel program is a cost plus program.

Jason Gursky:

Okay, right. And then I'm sorry to beat a dead horse here on the space margins. But I did find your comment, Kathy, interesting about the potential for the business to operate above 10%, I think you said you want to drive it to 10. But there'll be opportunities for it potentially to go above that metric at some point in the future. I'm just kind of curious as to whether that is a comment for the broad portfolio of your space programs because when I historically think of spacecraft and space based assets, I tend to think of lower margin rates for that kind of work historically because it's been a lot of cost plus kind of work. So I'm wondering if this is a comment about the broad portfolio and would include assets that are going to be operating up in space? And is that comment -- if that is true, is it because you've got more fixed price work going on there than has historically been the case?

Todd Ernst:

Josh, we have time for one more question.

Kathy Warden:

We consider it with each opportunity, just as I discussed in Alpha process around military aircraft, we don't have a blanket, we will do this and we won't do that we think about each opportunity in terms of its risk profile. The maturity of our designs and offerings at the time that we're being asked to bid also weighs heavily into our thinking about that decision. And so in the case of the Space Development Agency, we are executing on several programs for them today and performing quite well. So we have chosen wisely and been disciplined in how we have taken on that work and will continue to do that. The beauty of our portfolio, as we've talked about before, is we can choose to prime. But if we don't see the right mix of risk reward we can also choose to be a supplier and still bring the capability forward that the government needs and expects from us.

Kathy Warden:

Great. Well, I think that's about all we have time for. So thank you to each of you for joining our call today. I also again want to extend my appreciation to the Northrop Grumman team for their continued strong performance and contribution to global security. I hope that all of you enjoy the remainder of your summer and I look forward to seeing you throughout the summer and talking to you again in October. Take care.

Operator:

Good day ladies and gentlemen and welcome to Northrop Grumman's First Quarter Conference Call. Today's call is being recorded. My name is Lisa, and I will be your operator today. [Operator Instructions] I would now like to turn the call over to your host, Mr. Todd Ernst, Vice President, Investor Relations. Mr. Ernst, please proceed.

Kathy Warden:

Thanks, Todd. Good morning, everyone and thank you for joining us. Northrop Grumman is off to a solid start to the year. Our team is driving industry-leading growth by executing our strategy, meeting the growing global demand from our customers and performing on our programs. As a result, we increased sales by 6% and delivered strong earnings per share in the quarter. Additionally, we're delivering on our capital deployment strategy which prioritizes investing in our business and returning cash to shareholders. In the first quarter, we continued thoughtful investments in the capability and capacity needed to support our customers' operational initiatives and we initiated a $500 million accelerated share repurchase plan, returning a total of nearly $1 billion to shareholders through dividends and share repurchases. Based on first quarter results and our continued expectations for growth and strong operational performance, we're reaffirming our 2023 segment guidance. We're increasing our EPS guidance based on our continued confidence in our business outlook and to account for the divestiture of a small minority investment signed this week and expected to close this year. As we look to the long term, increasing breadth to freedom and security persist around the world. Given this, we expect continued support in Congress and the administration for the priorities outlined in the National Defense strategy which align well with the Northrop Grumman portfolio solution. This support was reaffirmed in the administration's budget request which was released in March. DoD investment accounts are up by nearly 4% for fiscal year 2024. Northrop Grumman programs continued to be well supported in the budget request, particularly in the areas of strategic deterrence, space, missile defense and advanced computing and communication technologies. The 2024 budget request also reflects the growing need for weapons capability and capacity, with overall funding increasing more than 20% compared to fiscal year 2023 and significant funding increases to major weapon programs, including many of which we provide key components. Two of our franchise programs, GBSD and B-21, each fall total investment account funding increased by approximately 10%. The future year defense plan or also prioritizes these programs, with funding projected to nearly double from about $8 billion in fiscal year 2023 to $15 billion in 2028. Outside the U.S., the geopolitical landscape remains dynamic. Global defense budgets are increasing as many U.S. outlies modernize and expand their defense capabilities. An important part of our long-term growth strategy is focused on leveraging our portfolio to meet these growing global needs and we continue to make progress in this area. In February, Australia issued a request for AARGM-ER, a high-speed, long-range air-to-ground missile that provides counter air defense capability. Northrop Grumman is a prime contractor for AARGM-ER. And this recent FMS request has a potential value of over $500 million. Australia is one of over a half dozen additional countries expressing interest in this capability. In addition, last month, the Defense Security Cooperation Agency approved the sale of 5 additional E-2D Hawkeye aircraft to Japan. These aircraft, along with the existing backlog, are expected to extend E-2D production well past mid-decade. These international opportunities, together with a broad set of others in IBCS, munitions and sensors, form a strong foundation to grow our international revenue at a double-digit rate over the next several years. With this global demand signal as a backdrop, we've been executing a strategy over the past few years to significantly enhance capabilities and capacity in our weapons portfolio. This portfolio includes components such as electronics, propulsion systems, warheads, infuses as well as missiles, armaments and interceptors. And as a result, we have multiple positions on key programs as both a supplier and a prime contractor. Let me share a few examples of progress we've made on this strategy. In the first quarter, we received awards for nearly $350 million for medium- and large-caliber ammunition, Bushmaster cannon and propulsion products for the guided multiple launch rocket system, or GMLRS. In addition, we're developing smarter, more advanced weapons required for future high-end fight with innovations in next-generation strike weapons, high-speed propulsion and smart ammunition. One example of this advancement is the Air Force's Stand-in Attack Weapon, also known as SiAW, a high-speed longer-range air-to-ground missile. During the first quarter, we received an award that takes us to the next phase of this competitive program. To meet our customers' growing demand in this area, we have invested nearly $1 billion since acquiring Orbital ATK, building our capacity for weapons and missile components. Our investments significantly increased capacity to produce solid rocket motors supporting our expectation for continued demand for this capability as well as increased capacity for GEM 63 boosters which supports the growing launch needs of our civil and commercial customers. We're also investing to increase capacity in our missile integration facility located at the Allegheny Ballistics Laboratory in West Virginia. Our newest 113,000 square foot facility is a factory of the future. It is designed to support production of up to 600 strike missiles per year. Production operations will commence with the second lot of low rate initial production for AARGM-ER, adding to other programs that we currently support this complex, including GMLRS Hellfire and Precision Strike Missile, among several others. In addition, we're building a new hypersonic center of excellence in Elkton, Maryland. Later to open this summer, this new production facility is designed to provide full life cycle production for hypersonic weapons from design and development to production and integration using the latest digital engineering and smart manufacturing technologies. The Elkton facility supports programs like hypersonic attack cruise missile, known as and Air launched powered hypersonic weapon that we're producing in partnership with Raytheon Technologies. We're not only a provider of missile systems, we also are a leading provider of missile defense system. This is a rapidly growing area within our business and includes a diverse set of franchise programs. Our work in missile defense is now approaching 10% of company revenue and we see an opportunity to expand that in the years ahead. Our broad end-to-end missile defense portfolio includes sensors, interceptors and command and control systems. One example is our prime contractor role on the next-generation Overhead Persistent Infrared, or OPIR Polar segment. This OPIR satellite constellation will operate at a highly elliptical orbit and provide critical strategic missile defense warning capabilities. Importantly, we also provide proliferated low earth orbit missile defense capabilities on programs like HBTSS and recent awards for SDA tracking Tranche 1. In addition, we're a prime integrator on next-generation INTERCEPT capabilities, including NGI and glide phase Interceptor. They protect against advanced ballistic and hypersonic missile threats. Shortly after the close of the quarter, we received approval for full rate production for IBCS, an integrated air and missile defense system. This key milestone allows the U.S. Army to set the fielding schedule for IBCS to its Air Defense unit which will significantly bolster regional defense capabilities. Over the fighter period, domestic deliveries of IBCS units are expected to increase by 40%. And as a reminder, Poland selected IBCS to serve as the centerpiece of its air and missile defense modernization and a number of other allies are also evaluating the system. Before turning the call over to Dave, I'd like to touch on a couple of key program updates, starting with B-21. The program remains on the government's baseline for cost and schedule and we're continuing to work towards first flight which will be informed by events and data and remains on track for this year. There are no material changes in our EACs this quarter for the EMD phases of the program and we continue to expect to receive the first LRIP award later this year. The B-21 program is expected to be the centerpiece of the Air Force's long-range strike portfolio for decades to come. With steady growth in the projected funding across the site, as I outlined and strong customer demand for its unmatched range, health and survivability, the long-term outlook for the B-21 program remains robust. On GBSD, we achieved 2 key milestones in the quarter. This includes its first full-scale static test fire of the Stage 1 followed rocket motor and the successful completion of a series of wind tunnel tests which tested the system in both subsonic and hypersonic environments. The comprehensive test campaign validated our digital modeling and simulations and improved design maturity of the missile. And earlier this month, the James Web-based telescope industry team led by Northrop Grumman won the prestigious trophy for revolutionizing the field of Aster physics. I want to congratulate the team for a pioneering design and unwavering commitment which were instrumental in winning our industry's highest honor. Overall, our strong start to the year is a clear indicator of this team's performance. We see continued robust demand for our solutions in the U.S. and abroad and we believe we're well positioned to maintain our industry-leading profitable growth and deliver value creation for shareholders and customers alike. With that said, I'll hand the call over to Dave to cover the details of our financial results and our outlook. Dave?

Operator:

[Operator Instructions] The first question will come from Doug Harned of Bernstein.

Kathy Warden:

Yes, Doug, thanks for the question. So to talk about the assumptions that we made then on inflation and even that we're making now, I would look to publicly available information. We tend to use indices to think about long-term projections on macroeconomic condition. So if you roll the clock back to 2015 and look at what the Fed was doing, they were managing inflation to a 2% target and doing that pretty effectively. So you can imagine that that's the set of assumptions that we would have been relying on as we looked out into the future. I'm not saying that's exactly what we did. We're not going to disclose that but those indices give you a good sense of what we would have been thinking. Of course, the last couple of years, inflation has been higher than that. And the thing about inflation, particularly as it relates to labor, is it doesn't tend to come back down on labor once salaries are elevated, they tend to set a new labor benchmark. And so as we think about the future, we're expecting those costs at least to remain elevated over the remainder of the execution of the contract. In areas like materials and other supplies, we do believe those will follow the indices associated with those commodities. And so there will be some variation of what we can buy those materials out into the future and the indices are a good way to think about that as well.

Kathy Warden:

Well, we certainly believe so. And as I noted in our last call, that is what we're working toward. And so we continue to have discussions with the government, both congressionally with the dollars that they have appropriated for inflation relief for contracts just like this and the Department of Defense as they think about how to allocate those funds and we'll continue to work that very actively. And of course, wouldn't expect that relief to come all at once but in the annual appropriations associated with the program or a separate funds like we saw in 2023 for inflation relief. Now with that said, we also are working to offset these increases with other elements inside of our control, our overhead rates, the other costs that flow into segment operating margin that can have a beneficial effect as well. We're not relying fully on actions the government will take, although we do believe that both the government and Northrop Grumman should be working to mitigate these impacts and share this risk together.

Seth Seifman:

I wonder if you could talk a little bit about Aeronautics and kind of other than restricted programs. I assume B-21, we saw a number of declines in the quarter. And that's not very surprising. Those are kind of mature programs. But where do you see, excluding B-21, where we have the budget documents, when do you see the rest of the Aeronautics portfolio sort of stabilizing? And then, if you could talk about the potential for any other growth drivers in the portfolio, especially potentially in the Autonomous area over time and how you're thinking about aligning with the Air Force's strategy there?

Seth Seifman:

Great. I guess if I could sneak in one more. You talked a lot about the investments that you're making in your prepared remarks and I thought that was very helpful. And I kind of plays into this idea that we're in sort of a different world where the customer needs kind of more spare capacity. How do you think about return on investment in that world where maybe there's a need for more spare capacity? And is there a willingness on the customer side to kind of recognize that and provide some value for it as well?

Operator:

Our next question will come from Sheila Kahyaoglu of Jefferies.

Kathy Warden:

So as we look at the profile on large programs like B-21 and Sentinel. You are right point out that all of that doesn't come to Northrop Grumman and our suppliers. Some of that is government funding. And that's particularly true with the Sentinel program because there is a significant of government activities associated with the work that will go on in the missile field and the coordination and collaboration across government to enable the construction scope. So when we look at our profile on these programs, it is a subset of the overall budget growth but it tends to follow in terms of relative year-over-year growth. What we will experience, not necessarily in that year because those appropriated funds or for what will be extended, it then takes us time to extend those funds, sometimes 18 to 24 months depending on the scope of work kind of program like B-21 and Sentinel. So when you net all of what I just said, the signal from the budget tells you there is continued and sustained growth in both of those programs through the that, that growth will come and be sustained not just through that 2028 period if you could expect it to continue, both when you look at what the government has said about quantities on B-21 and how they ramp as well as Sentinel moving into production in that time frame and still be ramping. So it's not just about '24 to '28 projections that you see in the Fidelis but looking beyond that into the next decade.

Operator:

The next question will be coming from Ronald Epstein of Bank of America.

Kathy Warden:

Yes, certainly. So you're right to point out that our strategy in space is broad-based. The cornerstone of it is as the cornerstone of our business tied to national security and supporting the U.S. and our allies to operate effectively and freely in space. But we also have a strategic significant pillar in space exploration as evidenced in our work in James Webb and more scientific missions but also our work in the Artemis program in space exploration. And our commercial ventures are largely tied to enabling those two strategic pillars within our space business. So when we are looking at the technologies that we need in space, we are well integrated across all elements of a solution, meaning we think about launch, even if we're not the launch provider, having partnerships with companies that can provide us the ability to launch. And that's the relationship we have with Firefly, being able to build the satellites that provide value and that's both being a bus provider as well as the payload, then being able to operate, command and control those assets in space. So that's more of a JADC2 contribution with the space domain in mind. And then, of course, that means being able to operate on the ground as well as be able to have these satellites able to communicate and share data. So this ties to the core competencies we have across this company in other domains and we are working to bring all of that to the space domain. And the space domain is the fastest growing area, not only of our business but our customers' budget, both NASA and the Department of Defense has been very well supported in recent budgets and we expect that to continue. So our objective is to use this opportunity to continue to grow our share and our relevance in those markets.

Kathy Warden:

I do. And I've said that we shouldn't get wedded to double-digit growth that we've been experiencing consistently for the last several years because we have been in a position of winning significant new programs and seeing those programs ramp. And the business itself has nearly doubled. It's pretty amazing to see what's happened in the last few years. So I don't expect that to be the growth profile for the next several years but I do expect it to continue to be a growth engine in our company. And as we just talked about programs like Sentinel, the most significant growth on some of these is yet to come because many of the programs are in the development phase, where we are just building the first of. The opportunity is when those transition into production for both higher volumes and higher margins. And that's still very much ahead of us.

Robert Spingarn:

So Kathy, just a follow-up on Ron's question on space. SpaceX announced a separate division called Star Shield that's going to be focused on defense work. How do you think about their push into national security? And is there an opportunity actually to partner with them? So is it more of a positive potentially or negative?

Operator:

The next question will be coming from Jason Gursky of Citi.

Kathy Warden:

Yes. So why don't I start with Mission Systems. It's been a steady grower. We anticipate that it will continue to be. It hasn't been our fastest grower but it's just really consistent. And I expect that to be the position Mission Systems finds itself and going forward. And that's not to say there aren't a lot of changes happening within that business. It is a highly competitive business and one where technical differentiation is critical but they are staying at the forefront of technology to remain competitive. So, some examples of that are as aircraft of the fourth gen are retired eventually, they have roles -- significant roles on some of those. And so that work starts to dissipate. But at the same time, they are competing for next-generation technologies. And you see this even playing out on the F-35, where we talked about the new radar development award that we got is that platform is being modernized with Block IV upgrades. And so I'm really pleased with that team's competitive position stay at the forefront of technology and continue to win new work but that will be necessary for them to continue this mid-single-digit growth rate that we've got become accustomed to there. In terms of Defense, it's a little bit of a different story. There, we have been a flattish business and that has been because we weren't seeing significant growth in weapons. It was a pretty stable business and we were seeing the work in our aircraft modernization decline. What I expect to see going forward is that our weapons portfolio growth more than offset the declines in the other part of the portfolio and it will be a net grower for us. How much is dependent on how quickly that global demand that I talked about in today's call matures and also how successful we are in winning work on both new weapons development programs as well as second source on some existing programs. And I'm optimistic there. But this year will be really pivotal in indicating what we think the growth for that business will be. But we do see it being a growth business next year.

Kristine Liwag:

With the debt ceiling standoff, there's been a lot of discussion of an extended CR in fiscal year '24 which tend to have more of a disruptive impact on programs that are ramping or transitioning. You've previously mentioned that you expect the first B-21 LRIP contract later this year as it transitions from development. But if the program award date slips past the end of September and into fiscal year '24, what could that mean for the program?

Operator:

The next question comes from Myles Walton of Wolfe.

David Keffer:

Well, why don't I start on the first and then I'll hand it over to Kathy. On your first question, we talked on the call about last year's $67 million EAC benefit on the B-21 EMD program in this quarter. When things get to that level of magnitude, well into the tens of millions, we tend to disclose and describe and quantify those in more detail. When we have things in the $10 million and $20 million [ph], as we do every quarter, as you'd imagine a business of our size, we tend to group those together and describe them as we have in this case, the benefit of the license sale and the downside from the JV. So, you can expect things like that to have been in that much lower range but still meaningful in terms of thinking through run rates and full year impacts.

Operator:

The next question will be coming from Cai von Rumohr of Cowen.

Kathy Warden:

Yes. So it's a very intuitive question. As we look at 2023, there are not many competitive new awards or even down select. As I've talked about, we have a good bit of work in our portfolio where we are in a usually 2-horse race programs like NGI is a good example of that. But we don't see many of those this year. They become more substantive in '24 and even '25. And -- so we'll provide more color on those as we guide for '24 later this year. What I'll tell you about 2023 is that the majority of our sales this year are in backlog and we don't see much in the way of competitive new awards. It's really immaterial for us this year.

Robert Stallard:

Kathy, one for you. The Australian government put out a defense strategy report, I think it was earlier this week. And in there, they seem to be contemplated whether they thought they might buy the B-21 which is a bit of a surprise to me at least. I was wondering this might be a sign that the U.S. government is a little bit more open to the U.S. defense industry exporting some of its more sophisticated equipment, including Northrop Grumman?

Operator:

The next question is coming from Ken Herbert of RBC.

Kathy Warden:

We certainly remain active in looking at opportunities to expand through acquisition. I would say that on the breadth of our portfolio and the strength of it, there are no gaps that I see an imperative to use acquisitions to fill those gaps that we are positioned to do so largely through both organic investing and external partnering which is an important tool in our toolkit. It doesn't require acquiring companies to have those very strategic partnerships with them, one of which we talked about earlier in the call with Firefly, for instance. But with that said, the regulatory environment is certainly top of mind when I think about execution risk associated with acquisition as well. So we take all of that into consideration and likely wouldn't see a path to do a significant strategic acquisition in the near term.

David Strauss:

Kathy, you mentioned the updated funding profile for B-21 and Sentinel that were in the budget. Specifically, I wanted to ask about B-21. It looks like there was some shift there where development dollars were added and production dollars were shifted to the right. So if you could comment on what that reflects, first of all? And second of all, what that could mean for your margin profile in the program, given your strong performance during the development phase?

Todd Ernst:

We have time for one more question.

Peter Arment:

Kathy, just circling back to kind of how you kicked off the call talking about kind of increased demand signals on Munitions and some of the Missile Defense capabilities like IBCS. Just when we think about international, how do you think a lot of this growth starts to layer in? Is it more '24, '25 or in beyond? Or do you see some of this growth actually showing up more to the left of that?

Operator:

Thank you. Ladies and gentlemen, thank you for participating in today's conference. This concludes today's call. And you all may disconnect.

Operator:

Good day, ladies and gentlemen, and welcome to Northrop Grumman's Fourth Quarter and Year-End 2022 Conference Call. Today's call is being recorded. My name is Norma, and I'll be your operator today. [Operator Instructions]. I would now like to turn the conference over to your host today, Mr. Todd Ernst, Treasurer and Vice President, Investor Relations. Mr. Ernst, please proceed.

Kathy Warden:

Thanks, Todd. Good morning, everyone, and thank you for joining us. The Northrop Grumman team delivered another year of strong performance in 2022, positioning our company for the coming year and beyond. A growing global demand environment and the team's success in capitalizing on competitive opportunities drove exceptional bookings. Top line growth accelerated throughout the year, driven in part by improving labor trends. I'll note that we set our sales and EPS guidance ranges at the beginning of 2022, and even in a dynamic macro environment, we navigated the challenges to deliver at or above the high end of those ranges, and then importantly, to deliver capability for our customers. This performance highlights our solid operating execution, our ability to win new business and the alignment of Northrop Grumman's portfolio to our customers' priorities. We enter 2023 with a backlog of more than 2x our annual sales. This strong backlog, along with increasing demand and rising global defense budget supports our expectations for continued growth. Given this and supported by robust headcount growth, we have increased our 2023 sales guidance range from our October outlook. We are projecting solid segment margin performance that takes into consideration inflationary pressures and supply chain disruptions, consistent with the expectations we outlined on the October call. And we expect a greater than 20% compound annual growth in our multiyear cash flow outlook that supports continued investments in the business and significant returns of capital to shareholders. Before providing more details on our outlook, I'm going to highlight a few notable achievements from the previous year that underscore the tenets of our long-term strategy and illustrate our positioning for the future. In 2022, the James Webb Space Telescope proved its status as the world's most powerful space telescope and an engineering marvel. It achieved full operational status, shared first images in July and continues to discover and inspire with its incredible insights into distinct galaxies. This project is just one example of the technology innovation and leadership our team brings to our customers. And it has provided an excellent platform for attracting talent to our industry and our company. In 2022, we continued to win new competitive awards across the company, achieving a book-to-bill ratio of 1.07. Two notable new awards are the space development agencies tracking and transport layers. As our customers look to expand their resilient national security space capabilities, these programs leverage our advanced space solutions for low earth orbit and showcase our ability to compete and win programs across a range of missions. We also completed over 40 successful launch and space missions in the year, exemplifying our end-to-end capabilities in the space market and our ability to perform at scale. Further, our solid rocket boosters helped propel NASA's base launch system as part of the Artemis 1 mission with the largest human-rated solid rocket boosters ever built. We also received a $2 billion award for GEM 63 solid rocket boosters in support of Amazon's Project Kuiper. Together, SLS and Kuiper validate the robust investments that we've made in solid rocket motor capabilities. We also delivered advanced architectures that integrate sensors to provide unprecedented situational awareness for our customers. One example is our IBCS solution. After successful testing in the fourth quarter, IBCS is poised to transition from LRIP to full-rate production in 2023. IBCS integrate systems that weren't designed to work together, creating a seamless air and missile defense network and allowing customers to better utilize their defense assets. This capability is needed more than ever to address advanced threats and it's one where we've seen a significant increase in interest across our global customer base with 10 additional countries expressing interest in obtaining this system. We continue to keep our focus on innovating and leveraging our strong position in advanced technology. This includes the development of a new radar for the F-35. This radar is capable of defeating current and projected adversarial air and surface threats and is compatible with variants of the F-35 aircraft. And we capped off a strong year with the historic unveiling of the B-21 Raider. The B-21 is a multifunctional platform with unmatched range, stealth and survivability, and it will be the backbone of future U.S. air power for decades to come. We continue to perform well on the program and remain on track for first flight later this year. As the program transitions into low rate initial production, we are working to address macroeconomic conditions, especially related to inflation and their impact on material, suppliers and labor. Importantly, I want to highlight that our B-21 unit cost projections remain below the government's independent cost estimates. The program has strong support from the U.S. Air Force, Congress and our suppliers. And in the words of Secretary Austin from last month's rollout, "This aircraft is proof of the department's commitment to building advanced capabilities that will fortify America's ability to deter aggression today, and in the future." Our 2022 achievements underscore the breadth of our portfolio across a wide range of domains and technologies and the strong performance of the entire Northrop Grumman team. As we look forward, defense budgets are on the rise, and we see our global customers continuing to seek proven solutions to address rapidly evolving and increasingly sophisticated threats. We are meeting their urgent needs in areas such as air and missile defense solutions, medium and large caliber ammunitions and armaments, advanced radar capabilities and global surveillance to name just a few. And we are partnering to expand our opportunity set and positioning our international business for future growth. We clearly saw increased demand in 2022, and we continue to expect to grow our international business over the next several years. In the U.S., we are encouraged by the continued strong support for National Security, including overwhelming bipartisan support for a 10% spending increase in the fiscal year 2023 defense budget that was passed in December. Our portfolio and the capabilities we offer are well supported by the administration and Congress. Growing security challenges will test our resolve in ways not seen for a generation, and we are confident this administration and the new Congress will find ways to work together to meet them. We expect the President's fiscal year 2024 budget request to support robust funding for the highest priority capabilities outlined in the National Defense Strategy. And our strategy has positioned us well. We're clearly maintaining our technology leadership and growing our portfolio of offerings, which is aligned to customer priorities. Another key element of our long-term strategy is keeping a laser focus on performance and driving cost efficiencies throughout the business. The current macroeconomic environment reinforces the importance of doing so. An example of our effort is the implementation of digital solutions across the company. Beyond the benefit of transforming how we design, test and manufacture the next generation of systems, our digital initiatives are streamlining business functions and increasing productivity. We are also optimizing our facilities and consolidating our real estate footprint. Every day, we seek new and innovative ways to drive performance and increased efficiency while remaining agile and meeting our customers' expectations. Our capital deployment strategy supports our business strategy. We are investing to not only drive efficiencies but also to allow our customers to stay ahead of the threat environment. In 2022, we invested over 7% of revenue in R&D and capital expenditures to provide the capability and capacity needed to address the threats of today and tomorrow. We also continue to return cash to shareholders. Last year, we increased our dividend by 10%, which was the 19th consecutive increase. And during the year, we delivered over $1 billion to shareholders through the dividend and returned another $1.5 billion through share repurchases. So looking forward to 2023, we are well positioned for continued growth, and our revenue outlook has improved from the high $37 billion range we shared in October. We now expect sales to be in the range of $38 billion to $38.4 billion, representing about 4.5% growth at the midpoint. Margins are expected to remain solid in the 11.3% to 11.5% range. We are projecting strong free cash flow growth that supports our capital deployment strategy. And we expect to return more than 100% of free cash flow to shareholders again in 2023. Our backlog, strong recent global demand growth and our ability to deliver products that address an increasingly complex security environment give us confidence in our outlook. So with that, I'll hand it over to Dave to cover the details of our financial results and more on guidance.

Operator:

[Operator Instructions]. Our first question comes from the line of Kristine Liwag with Morgan Stanley.

Kathy Warden:

Yes. So as we noted, we are performing exceptionally well on the B-21 program, and we have continued government support for the quantities of at least 100 that are represented in the program of record. But given that this contract was initially awarded in 2015, the recent and really unprecedented macroeconomic impact of inflation, labor, supply chain disruption has affected the cost estimate to perform on the LRIP phase of the program. And importantly, we noted our projected cost per unit are still below the government cost estimates upon which the funding profile is based. And that's important because it supports the overall buy plan of the U.S. government. And just to, as a reminder on timing, the government hasn't yet exercised any of the LRIP options. So like we do on any price options, we continue to look at what the future may hold and reflect that in our estimates that complete, but those are indeed estimates of cost and future performance. So while -- as we note in the K , we don't currently consider a loss on LRIP to be probable, if it were ultimately to occur, it would spread over all 5 lots of the program. And particularly, that's important related to any cash flow impact. So as we look at 2023, we do not see that as material in our cash flow outlook. And even as we put together our 3-year cash flow outlook, we wouldn't see that as being material. So hopefully, that gives you a sense of what is contributing to B-21 cost estimates. Inflation clearly is the primary driver there. as we think about what's changed recently in our estimates, and we are working to mitigate those impacts, as you say, and we have some time as we move forward and get into production to continue to do that.

Ronald Epstein:

Maybe my first question is on space. The performance there is better than I think anybody was anticipating. What's underlying that? And how should we think about that going forward maybe even beyond 2023?

Ronald Epstein:

And then you mentioned in your -- just as a follow-on in your prepared remarks that your growth has been supported by your ability to hire folks. How has that been -- I know, I mean, it's kind of across the entire industry and your supply chains, getting labor has been difficult, particularly skilled labor that's kind of up to spec. How have you guys been able to do that? And what's underlying that?

Operator:

Our next question comes from Sheila Kahyaoglu with Jefferies.

Kathy Warden:

As we've noted, we had talked about 12% being the fundamental margin rate that we believe this business, this portfolio can perform at, and we would be working our way back to that as particularly mix becomes less of a headwind in the middle of the decade. We still see that. But we are having these temporal pressures related to inflation that are flowing through all of our programs, B-21 most notable because of its scale and that we did it very long ago. As we think about how we are offsetting those costs, we talked about some of those ways today. We are working to digitally enable our business, which reduces program costs directly and improve profitability. But we also are applying that to our back office to streamline business processes and reduce costs that flow into our overheads also making our rates more competitive. And reducing the impact of cost growth. So those things that -- real estate has been key. You saw today, we talked about a few things that we did in the real estate area already in 2022, but we have many more of those lined up as ways to continue to offset any cost growth that we see and drive towards those higher margins.

Richard Safran:

Kathy, Dave, Todd, I think we probably all agree the stock right now seems to reflect the idea that defense is going to be a bill payer as we move to a period of deficit reduction. And I realize this question puts you a little bit on the spot forecasting government spending. But I wanted to know if you'd expand on your optimistic opening remarks. Talk about your macro outlook relative to what seems to be being priced into your stock? And if you think modernization might be sacrificed as part of the budget negotiations?

Richard Safran:

Just as a quick follow-up on inflation. The comments on the B-21 that you've been making, is there a general trend here is when your contracts you're signing right now with the government, are they generally accounting for inflationary effects or are you not finding that?

Operator:

Our next question comes from Douglas Harned with Bernstein.

Kathy Warden:

So Doug, this year is really a continuation of those same trends flowing through the top line. The programs that have been declining. We've seen the majority of those declines, but they do still flow into the '23, '22 compare. So it is things like Joint STARS and Global Hawk. F-35 being a big revenue contributor in AS is relatively flat. So that ties directly into the narrative about their revenues being flat. And then B-21 is an increase, but it's not a significant increase yet because we're just moving from EMD into LRIP and these 2 combined are not a significant increase in the program as of yet.

Kathy Warden:

So we stay focused on investing in the future capability needed and more so lately in the capacity needed. And in many ways, the reason we are being asked take on more share of the market is because we've been investing in this business and are able to take on that additional business because we have outfitted our manufacturing facilities to support the growth. As with the government is asking, we have been responsive. And so as a result, we are winning more business in that area. But we expect to be able to compete even as other new entrants come into the space because we do have a long heritage of expertise that contributes to our solid rocket motor business. And that's for all size, as I talked today and highlighted some of the larger solid rocket boosters that we build in support of SLS and GEM 63 for Kuiper. But that's true in businesses like [indiscernible] , where we are taking on more of the needed capacity because we've been investing in our manufacturing capacity there as well.

Seth Seifman:

I wonder if you could talk a little bit about the profitability in the space business. The margin guidance came down there, margin rate guidance came down there a couple of times during the year. And it's kind of perceived to be kind of a 10% business, I think, is what we've talked about in the past and looking to a second year in the mid-9s here in 2023. So what's changed there over the past year?

Seth Seifman:

Okay. Okay. Great. And then just as a follow-up, Dave. So the working capital performance was quite good in '22. I think the way that measuring here. Working capital actually came down a bit despite the growth and despite the tough operating environment, only 6% of sales, which is below some of your peers. What's the opportunity from here? Or is there kind of a normalization at some point where actually for a growing business, the normal level of working capital is higher?

Operator:

And our next question comes from Myles Walton with Wolfe Research.

David Keffer:

Sure. I'll start on your first of those questions. The award of that first lot of LRIP will be a noteworthy event but not a triggering event of any kind from an accounting perspective. We will update our projections quarterly as we have been. We'll continue to do so. And so at this time, we don't believe that a loss is probable and therefore, we have not booked one. We do believe that a loss is possible, which is why we're including it in our remarks and our 10-K disclosures. It's something we will continue to work over time. Obviously, this is going to continue for a number of years. As Kathy has talked about, we'll continue to do everything we can to mitigate inflationary pressures and work with our customers and our suppliers in the process. Kathy, anything you'd like to add?

Operator:

Our next question comes from Robert Stallard with Vertical Research Partners.

David Keffer:

Sure. Thanks for those questions. The answers are pretty straightforward. As we noted, the impact on our cash taxes in 2022 from the R&D tax legislation was just under $1 billion. We would anticipate that being about 20% less per year, just under $200 million or so on average less per year. And so that is the magnitude of the annual tailwind that we'd anticipate for the next 5 years or so. Overall, cash taxes, excluding the impact of that R&D tax amortization will increase slightly over the coming years, but that's factored into our multiyear outlook. And as for equipment sales, I appreciate the question there. We received the final payment associated with the equipment sale that we booked a couple of years ago in 2022. And so we don't anticipate we're having our multiyear cash flow outlook, any continued recoveries from equipment sales.

Unidentified Analyst:

This is actually Jack on for Cai today. Just a quick question back to kind of the Section 174, Dave, I know in the past, I'm not sure if you quantified that if you could actually provide that dollar figure if you could. I know it steps down 20% each year. But looking back at your guide from last year at this time for '24, it looks like a larger delta than an implied $700 million headwind. So just to confirm, is that incremental CapEx going higher? Or if you could just provide some color there, that would be helpful.

Operator:

Our next question comes from Peter Arment with RW Baird.

Kathy Warden:

Yes. So we do expect the trend to continue in terms of -- as assets get into service, we continue to support. But we also have assets like Global Hawk that are coming down. So I don't see a material change in that mix as we look forward, Peter.

Kenneth Herbert:

Kathy, in your opening comments, I think you maybe called out international opportunities, perhaps a little bit more than I can remember from recent quarters. Can you help frame maybe how much of an uptick in international opportunities could be reflected or international sales could be reflected in the '23 guide, if that was all a part of any of the upward revision -- and then as you think about beyond '23, how meaningful is international in terms of an uptick for you? I know historically, obviously, it hasn't been as meaningful as part of the mix of some of your peers, but maybe you can comment on that expanding opportunity set?

Operator:

Our question comes from Scott Deuschle with Credit Suisse.

Kathy Warden:

Yes. Well, as you note, we have used ASRs as the tool in the past. And as we indicated in the call today, we do plan to put more than 100% of our free cash flow back into the deployment to shareholders. The fact that our valuation is down, really, we don't try to time the market per se. But we do think about that as we are kind of weighing our options for capital deployment this year, and we do have the flexibility to increase share repurchase from our original plan. So that is something we're actively contemplating.

George Shapiro:

Dave, I had one for you. In the operating income discussion in space, you had a big gain, $45 million charge. And you said it was all -- the $96 million gain only partially offset the lower EACs. When I look at the K for the year, you had minus $38 million in space versus $134 million last year. So if you kind of just discuss what happened in the quarter and just why such a significant change year-over-year?

George Shapiro:

But Dave, it's still unusual to see negative EACs for the year. So I was just wondering, are there any specifics that you could point to maybe was for the year or just for this quarter?

George Shapiro:

Okay. And then just one general one for you, Kathy. I mean, with the better sales growth you're guiding to in '23, a result of the budget or new awards won or both? And then also, with 16% sales growth in Q4 and outlay is likely to grow 7% or 8% in '23 based on the budget investment authority of 15. Why does the growth rate slow that much in '23? I mean why wouldn't it be higher than what you're suggesting?

Todd Ernst:

Norma, we have time for one more question.

David Strauss:

Great. A lot of discussion on B-21 and EMD and LRIP. Just -- how should we think about what happens to AS margins over the next couple of years as I assume EMD flans out or starts to come down where you've been taking positive adjustments and LRIP ramps up from here?

David Strauss:

Okay. And Kathy, maybe your thoughts on what bookings could look like this year, what you're anticipating for the book to bill this year?

Todd Ernst:

All right. Great. Thanks. Kathy, over to you.

Operator:

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.

Operator:

Good day, ladies and gentlemen. Welcome to the Northrop Grumman's Third Quarter 2022 Conference Call. Today's call is being recorded. My name is Michelle and I will be your operator today. [Operator Instructions] I would like to turn the call over to your host, Mr. Todd Ernst, Treasurer and Vice President, Investor Relations. Mr. Ernst, please proceed.

Kathy Warden:

Thanks, Todd. Good morning, everyone. Thank you for joining us. The Northrop Grumman team delivered another quarter of solid performance. Our top line returned to growth with continued strong execution. Demand for our products remained robust with a book-to-bill ratio of near 1, including a number of key awards in our restricted and Missile Defense portfolios. And we remain on track to deliver strong results for the year, with growth expected to accelerate as we look toward next year. Taking a step back for a moment from the quarter, I'd like to start with an update on the global security environment. Earlier this month, the Biden administration released its full version of the National Security Strategy which is used as a guide for policy and budget decisions. The strategy spotlights the dynamic and challenging threat landscape around the world and stresses the importance of working with allies, maintaining a strong industrial base and continuing to invest in advanced technology. It also reinforces the triad as a top priority. So, it's clear that Northrop Grumman's portfolio continues to be extremely well aligned with the requirements outlined in the National Security Strategy. This is reflected in the administration's fiscal year 2023 budget request which showed alignment with these priorities and strong support for many of our key programs. Throughout this summer, congressional committees marked up the administration's defense budget request, generally increasing the proposed level of funding with the intent of strengthening the country's defense posture and addressing the impacts of inflation. Based on these additions, we believe that the ultimate fiscal year '23 base defense budget will be higher than the President's budget request. And as you know, we started off this fiscal year in another continuing resolution which currently extends to mid-December and this is factored into our guidance. We are confident in our program funding positions and hopeful that the annual budget will be passed by year-end. Meanwhile, global commitments to invest in Defense and National Security capability continue. In Europe, we've seen increased demand for our Integrated Air and Missile Defense solutions and precision weapons and advanced ammunition. In the Asia Pacific region, we've seen similar interest in Air and Missile Defense as well as Maritime ISR, Advanced Radar and other Mission Systems. All this points to a strong demand environment for Northrop Grumman. And we're doing our part by investing in solutions and capacity to address many of our customers' most pressing needs. This year, we expect to invest over $2.5 billion in CapEx and research and development. And as a result, we're winning new business and bolstering our backlog for long-term growth. Our backlog has increased year-to-date in each of our 4 segments and is up nearly 5% overall. Given this, we now expect that our full year 2022 book-to-bill ratio will be over 1, a significant improvement from where we started the year. This increase is attributed not only to the robust defense budget environment but also a strong competitive win rate. That said, we recognize that our industry and many others are experiencing macroeconomic volatility that we haven't seen in decades. Inflation remains at 40-year high, lead times have been extended in certain areas of our supply chain and the labor market shows signs of easing but it remains tight for critical skills. Our team is tackling these challenges, keeping a focus on our people and performance and driving efficiencies across the business. In the labor market, we've driven improvements in hiring and retention over the past several months which Dave will describe in more detail. This was instrumental in our return to growth in the third quarter. And it's worth noting that this favorable trend has continued into the fourth quarter as well. This supports our full year 2022 guidance and our outlook for accelerated sales in 2023. In the supply chain, we continue to experience disruptions in delayed deliveries in certain areas of our business which we have -- that has been a headwind to growth. It's a risk that we're closely monitoring and we're working with our suppliers to mitigate. But we do anticipate that supply chain challenges will continue in 2023 and this is now reflected into our 2023 outlook. Elevated inflation levels in both labor and supply chain has persisted more than expected as we came into this year. To address this, we are implementing operational efficiencies and working with many of our customers on program funding and other contract actions to support the health of the defense industrial base. We believe this balanced approach is the best solution to allow continued investment in the capabilities to support our customers' mission. With that said, we see these as temporal challenges and remain committed to driving our segment margin rates higher over time. Turning now to the execution of our long-term strategy. One of the key elements of our strategy is a relentless focus on performance. That's why I was particularly pleased to receive the 2022 Deming Cup for operational excellence on behalf of Northrop Grumman earlier this week. The award recognizes our achievements and leadership in creating a culture of operational excellence and continuous improvement across the company. Our customers recognize this commitment and have entrusted us to deliver some of the most technologically advanced next-generation systems and solutions. The B-21 Raider is 1 such example and we're excited to unveil the aircraft to the public on December 2. The B-21s outstanding performance can be directly tied to our company's investment in digital tools and facilities and the incredible U.S. Air Force and Northrop Grumman team, who are developing this sixth-generation platform. The program continues to progress through testing in preparation for first flight in 2023. Last month, we announced a data sharing agreement on B-21, enhancing data access and collaboration across the program, including the launch of a shared environment for the B-21 digital twin. This data sharing agreement enhances our partnership with the Air Force and further demonstrates our digital maturity on the program. Our Mission Systems solutions are another area of our portfolio where innovation is critical to success, where the fast pace of threats and new technologies is driving the need for platforms and sensors to be able to connect with one another, share data and be part of a broader family of systems. In this growing market, we're building on our strong position in sensors, secure communications and networking to compete for and win new opportunities. For example, last month, we were selected to be a member of the Air Force's ABMS Digital Infrastructure Consortium. And we're also seeing interest from global customers including the Australian Defense Force where we recently demonstrated a product solution with robust C2 functionality to link sensors and effectors across domains. Another significant area of focus for the U.S. and our allies is the modernization of Missile Defense solutions to address current and future missile threats. We continue to strengthen our position in this area with a $1.3 billion Ground-based Midcourse Defense Weapon System award in the third quarter. This award builds on our Missile Defense portfolio and helps our customers defend against intermediate and intercontinental missile attacks. And turning to our weapons business. I'm pleased to share that we've now delivered more than 100,000 Precision Guidance Kits to the U.S. Army. These projectiles provide enhanced precision to artillery units and come embedded with built-in safety features. We've exceeded requirements on both accuracy and reliability with these upgrades. And one last area that I'll highlight is hypersonics, where we continue to win new competitive business. Last month, the Air Force selected our Raytheon and Northrop Grumman team to develop the Hypersonic Attack Cruise Missile also known as HACM. HACM builds on our scramjet propulsion technology and ushers in a new era of faster, more survivable weapons. This program is one of several hypersonic opportunities within our portfolio. We're approaching this market as both a prime and a sub, bringing our expertise in high-speed propulsion, survival navigation and targeting capabilities and systems integration to multiple solutions. These are just a few examples of markets where we continue to grow our business by delivering the products and solutions that our customers want and need, while also building long-term value for our shareholders. So now, I'll turn it over to Dave, who will provide more color on our Q3 results and touch on our expectations for 2023. Dave?

Operator:

[Operator Instructions] Our first question comes from the line of Doug Harned with Bernstein.

Kathy Warden:

Doug, thanks for the question. Supply chain certainly is central to not only the remainder of this year but next. So let me try to characterize, not particularly in numerical terms but in more -- less quantitative terms, what we have been seeing. It is in particular areas of the supply chain. So it is not widespread but it's in areas that are important -- is component to our development programs, in particular, where we have seen delays that then result in impacts to those development efforts. And so it's the timing of sales not necessarily a deferment of sales, if you will. And this year, I would point to our 2022 original guidance which was our expectations with either minimal or no supply chain disruption, because when we put that plan together late last year, we were not anticipating the level of supply chain disruption nor the duration of supply chain disruption that we've experienced. So throughout the year, we've pointed you now to the low end of our sales guidance. And I would say the best way to think quantitatively about the impact is, we would have expected to be on the high end of that guidance had we not experienced the supply chain disruption. Now I do want to point out and we've said it in the call that we expect these challenges to persist into 2023. So when I talk about timing, we do not expect all of what we experienced in 2022 to recover by the end of 2023. We expect these issues to be a bit sticky for the next year. We do expect them to resolve in the 18- to 24-month time frame.

Dave Keffer:

Sure. Doug, I'm happy to shed some light on that. In both cases, those trends are consistent with what we've communicated previously and the drivers are therefore consistent as well. Starting in AS, we project a stable 2023 given that there is anticipated growth in programs, including B-21 but then offset by modest declines in programs like the legacy programs in the HALE portfolio, Joint STARS, et cetera, modest decline in F-18 likely over the next couple of years. So again, continuation of trends we've been talking about for a while and we continue to anticipate a growth recovery in 2024 for that business. In Space, the expansion and the growth opportunity is broad-based across multiple orbits, across multiple mission areas from missile tracking to ISR, growth in our supportive launch capabilities. It's really an outstanding segment of performance for us recently on the growth side. You see a growing market but growth also in our market share. Of course, GBSD is a contributor to that growth but by no means the only one. Each of our divisions in that business is growing at a nice clip. So we’re really pleased to be able to continue that outlook in ‘23.

Ronald Epstein:

Maybe just a question on capital deployment. You're going to be generating a lot of cash as you pointed that out. What's your plans to do with that into next year? Is there -- is it just share buybacks? Or is there some selected M&A? Or how are you thinking about that?

Ronald Epstein:

Got it. And then one follow-on, if I can. On the supply chain stuff that’s been impacting the whole industry. Are you seeing DoD doing anything to help resolve it? Because some of the issues, it seems like you’re running into it, everybody’s running into it. Is DoD doing anything to help the industry?

Operator:

And our next question is going to come from the line of Myles Walton with Wolfe Research.

Dave Keffer:

Myles, it's Dave. I'm happy to address that one. I think the way we look at it is, the really strong head count growth that we've had over the last quarter, in particular but the last 6 months broadly, adding approximately 4% to our overall employee count or over 3,500 employees really shores up the labor visibility for labor-driven sales for 2022 and sets us off on a good track for '23. And to your point, that means the supply base and its performance are key to the fourth quarter. With that said, we've had a year now of these more challenged supply chain conditions to become accustomed to where there are constraints and where there are not. And I give a lot of credit to our supply chain folks and our program teams, who are managing and mitigating those challenges every day. We think we've got that captured in our outlook for Q4. The pressures to date have pushed us towards the low end of the sales range for the full year and we think that's appropriate caution as a result of the supply chain conditions but feel that we've bounded it well in that range as we think about Q4 and the full year now.

Dave Keffer:

There was not any 1 single program EAC that drove a material change this quarter in the Space business or any other across our portfolio. I think you're right to point to the broader market conditions. Costs are escalating at a level not expected a year or 2 ago. We're mitigating that very well across our business. But in fact, our latest expectations are factored into the EACs on our programs and that did have a dampening effect, particularly in Space's margins in Q3.

Kristine Liwag:

One of your peers has recently announced significant new share repurchase authorizations using debt. Considering the multiyear visibility in the cash flow, the strength in the balance sheet and the upward pressure on defense budgets, would you consider levering up an increased buyback similar to what the company did a decade ago?

Kristine Liwag:

And if I could do a follow-up. You mentioned that you expect supply chain issues to persist into 2023. Can you provide more color on what’s embedded in your 2023 revenue outlook of 4% to 5%? Where are the risks and opportunities to that?

Operator:

Our next question comes from the line of Rob Stallard with Vertical Research Partners.

Dave Keffer:

Thanks for the question, Rob. We do not anticipate meaningful movements in the segments as we look at '23. Let's talk in aggregate first and then I'll give you some color on the segments. As you'll recall, our segment OM rate was in the 12% range in the first half of this year. We talked on the call today about the fact that, that will fluctuate a bit from quarter-to-quarter. We worked through some of -- temporal challenges that we and most other industries face these days around inflation and supply chain and such and noted some of that in the Q3 result. Year-to-date, we're in that guidance range we've provided for the full year. As we talk about next year, we noted mid- to high 11% or our current expectation. Think of that as in the range of 20 basis points lower next year than we're seeing this year. And at a business level, what I'd highlight is in a few of the areas where we had unique upside in the first half of the year, that's where we would expect that to normalize and create some of the lower margin profile next year. I'd note, AS had a land sale in the second quarter. So you can think of that as 20, 30 basis points of margin rate pressure on a year-over-year comp basis. In Space, we think the volume of new development work they've continued to add and the pressure that's put on their margin this year is again a good reflector of what you'd be likely to see next year in Space. Mission Systems and Defense continues to perform well on the margin rate side and we don't anticipate meaningful movement there. MS did have some strong upside in the first half. So we'll look to see what they can continue to deliver in '23. Again, no meaningful movements across the board. I'd just adjust for some of those comparability items in '23 to get a segment level view.

Kathy Warden:

Yes, Rob, thanks for the question. We are also very excited about the rollout on December 2 but we are keeping our focus on the performance of the program. So while it's important for us to celebrate milestones as they come. It's also long-term program, as you suggest. And so we are working that program as we are all to each quarter reflect what we know about the current environment and our projections going forward. And as we outlined earlier this year, we spent a good bit of time actually talking through the B-21 and how we were keeping our assumptions updated. That continues to hold true. And so there’s nothing to report to you in any material change on our outlook for the profitability on that program.

Sheila Kahyaoglu:

You talked about flattish Defense sales next year. Can you give us some of the puts and takes in the business with supply chain? Does that continue to linger and what’s going on in the services side? And maybe incremental opportunities with programs, such as IBCS and missiles and how you do think about Europe playing into that as well?

Operator:

And our next question comes from the line of George Shapiro with Shapiro Research.

Dave Keffer:

Sure. George, as you know, we don't have a specific dollar for dollar expectation of net EACs on any one program or in fact, in aggregate, going into a typical year. What we do get a sense for is kind of trends in aggregate volume. And in 2021, for example, we had a unique trend associated with the benefit in our rates from the pension benefit. In 2022, we've had a couple of upside items, as you mentioned, in AS. But broadly speaking, the pressures that we've noted from the macro environment this year. And what I'd characterize '23 as is more of a continuation of some of those macro pressures, as Kathy outlined nicely earlier in the supply chain and the inflationary environment. And so we'd anticipate what I'd characterize as a continuation of the lower net EAC trend in '23 based on what we know today. But I wouldn't put too fine of a point on the dollar amount today. We'll give you more insights on that as we get into the January guidance call.

Dave Keffer:

That high 11% margin rate is predicated on a certain volume of both program performance and net EAC benefits. We're projecting a wider range currently in the mid-11s to the high 11s, because it's tough to project, as Kathy noted earlier, with too much specificity given the macro environment we're in today. Our program performance continues to be exceptional. But we think today, the appropriate outlook is about 20 basis points lower margin rate next year with continuation of -- kind of the second half trends we're seeing this year in net EACs. I think that's about as specific as we can be at this point in the process, George.

Dave Keffer:

We project GBSD to be a little less than half of that growth. NGI will also be a contributor but then there are a number of other programs. The wins we've talked about this year at Space Development Agency, continued growth in the GEM63 portfolio with the Amazon Kuiper expansion there. There are a number of drivers of growth across our Space portfolio, both national security, civilian and otherwise.

Seth Seifman:

Kathy and Dave, I know you are just in the early stages of 2023, so sorry to bring up 2024 but you guys have talked about cash flow target for that year and also segment margin, I think, in the 12% range. Are you still on target for reaching those goals?

Seth Seifman:

Great. And just as a quick follow-up, with the supply chain challenges lingering into 2023 and probably lessening through the year, should we expect a similar distribution of sales throughout the year in ‘23 that we’ve seen in ‘22 in terms of the percentage per quarter?

Operator:

Our next question comes from the line of Ken Herbert with RBC Capital Markets.

Kathy Warden:

Thanks for the question. When we look at the portfolio, it has been broad-based in terms of the improvement that we've seen in our expectations for book-to-bill. All 4 segments now projecting over 1. And it has been most pronounced in Space, where we've called out some specific opportunities that were competitive. So to your point, taking share that we were able to secure that we may not have anticipated winning as many of those as we started the year as we ultimately have. We feel that we are in a good position with backlog in each of the businesses going into 2023, supporting the accelerated growth that we've laid out in our outlook for next year. We don't expect that our book-to-bill next year will be as robust as it was this year, because we do have quite a bit of backlog that we will be carrying into the year and the opportunities that is not as strong in 2023 but we do see then that picking up again in '24 and '25. So I would tell you, we tend not to look at awards on a single year basis and calculate book-to-bill only on a single year. We look at it on a running basis and our system is strong, as an aggregate over the last 3 years, we expect that to continue well into the future.

Kathy Warden:

For Space, we've seen broad-based opportunities across both Launch and Missiles as well as our Space segment and we expect that to continue, there are multiple programs that will be selected for next phase and be awarded in that time frame in both elements of our Space business.

Scott Deuschle:

Anything you can say about the equipment sales that impacted Q3 free cash flow? Is that similar in nature to the large equipment sales that AS booked a while back?

Scott Deuschle:

Okay. Got it. And then, Kathy, just on NGI. Is it reasonable to think that you might be able to offer some cost savings to your customer there, if there’s product commonality between the Interceptor and then the GBSD booster? And would you potentially design for commonality there in order to drive that cost benefit to the customer?

Operator:

And our next question comes from the line of David Strauss with Barclays.

Kathy Warden:

Well, David, actually, when we look across the entirety of the company, F-35 is pretty flat going into 2023. So we have a lot of moving parts, as you indicated. In Aerospace, we have volume that is fairly consistent in our case. Because remember, we build a couple of years, about 18 months ahead of Lockheed Martin. And so we are maxing out at our limitations of capacity for building center fuselages. And so that project flattish into 2023, as Dave noted earlier. But in our Mission Systems side of the business, while we have DAS which is being replaced with new product insertion. We're also working on new products insertion in the other elements of the portfolio. So we have some development work going on in Block 4 that continues to grow and production there, too, is fairly stable as we look out over this time period and sustainment is growing. So when you take all of those elements across the entirety of our portfolio, F-35 is pretty flat going into 2023 and we expect to be relatively flat going into 2024, maybe a little bit of upside to that.

Dave Keffer:

I would say, it's a combination of all of those factors but leaning more towards the macro factors. This is a unique environment that we're all operating in these days and we're eyes wide open to the continuation of a lot of those pressures in 2023. And that's why we think it's not a huge impact but call it, 20 basis points compared to the high levels we've been operating at in 2022. I think importantly, as you get down to the earnings per share line, excluding the noncash pension element of it, we anticipate EPS growth faster than even the 4% to 5% accelerated sales growth. So we're managing through these times, I think, particularly well when you think about the pace of EPS acceleration as well.

Kathy Warden:

Thanks, Todd. Look, before concluding today's call, I'd just like to take a moment to thank our entire team for another strong quarter in what we have appropriately characterized this challenging macroeconomic time. So business fundamentals for Northrop Grumman remain incredibly strong and that's due to the work of this entire team. But I want to especially think 1 of our team members, Mary Petryszyn, who will be retiring from Northrop Grumman in January. She has provided 10 years of outstanding service to our company, most recently as the Defense Systems front and we wish her the very best. On October 17, I'm sure you all noted that Roshan Roeder became our new President of Defense Systems. She is an experienced executive in our company. I'm very confident in her ability to take the business to the next level and I look forward to introducing her to many of you. So, thank you for joining our call today. I expect to see many of you in the coming months. But for those, I don’t see, let me wish you a healthy and happy holiday season and we look forward to talking to you in January.

Operator:

Good day ladies and gentlemen and welcome to the Northrop Grumman's Second Quarter 2022 Conference Call. Today's call is being recorded. My name is Victor and I will be your operator today. [Operator Instructions] I would now like to turn the call over to your host, Mr. Todd Ernst, Treasurer and Vice President, Investor Relations. Mr. Ernst, please proceed.

Kathy Warden:

Thanks, Todd. Good morning, everyone and thank you again for joining us. I'd like to start today's call by highlighting the James Webb space telescope and the incredible images released just a few weeks ago. This extraordinary telescope represents countless Northrop Grumman engineers, technicians, scientists and cross-functional teams working in partnership with NASA for over 2 decades. In addition to leading the industry team, we designed and built the deployable Sun Shield, provided the spacecraft, develop the Observatory subsystems and integrated the total system. The advanced technology we've created and the images it captures will inspire the next generation of innovators and scientists and we believe will be one of Webb's many legacies. Webb exemplifies the defining characteristic of our business strategy to develop and produce innovative technology solutions to address our customers' toughest challenges. This strategy differentiates us and aligns our portfolio with our customers' priorities. And as a result, we strengthened our position in the market. As a reminder, the 4 core focus areas of our strategy are technology leadership, sustainably and profitably growing our business, keeping a laser focus on performance and deploying capital in value-creating ways. This strategy continues to yield results. In the second quarter, we saw strong demand across our businesses with a book-to-bill ratio of 1.48, driven by awards for F-35, GEM 63 and restricted programs. All of our businesses had a book-to-bill ratio above 1 in the quarter, driving a 6% sequential increase in our backlog which now totals $80 billion. Given this backlog growth and our continued alignment to customers' budgets and priorities, we are even more confident we can accelerate our revenue in 2023 from the low single digits we're guiding this year. In the quarter, we did experience certain challenges from the broader macroeconomic environment, including a tight labor market and supply chain delays which impacted sales timing. However, we're pleased with the progress our team continues to make in addressing these challenges and hiring trends improved as we progressed through the second quarter, laying the foundation for sales growth in the second half of the year. As our business grows, we remain focused on performance and driving cost efficiencies across the business. This continued focus contributed to another quarter of solid margin performance. Our segment OM rate was a robust 12.2% in Q2 and stands at 12% year-to-date. Dave will cover further details of our quarterly results and guidance update momentarily but first, I'd like to touch on some highlights from the quarter. The technology developed for James Webb is one example of Northrop Grumman's innovation. Another example is how we are using technology to produce innovative and affordable solutions for our customers. To that end, we're investing in digital design capabilities and advanced manufacturing facilities. In close partnership with our customers, we are digitally transforming how we design, test and manufacture the next generation of systems. And you've heard our customers acknowledge the results. particularly with some of the largest programs, including B-21 and GBSD. We are marrying our world-class engineering talent with the latest digital tools, machine learning and agile principles. And as we announced this quarter, we are also investing in factories of the future, including our state-of-the-art manufacturing facility in West Virginia which will incorporate the latest in digital manufacturing, automation and modular work sells. Once operational in 2024, this facility will support production of up to 600 strike missiles per year, optimizing quality and reducing cost and cycle time as well as bolstering tactical weapon supply chain capacity for our customers. For the last few years, we've taken an enterprise-wide approach in mission-focused areas that are aligned with our customers' priorities. These are areas where we see opportunity to leverage our technology know-how and our domain expertise and high capabilities from across our businesses. Today, I want to highlight a few of them and the related results we've seen so far this year. One example of this is in national security space. Our customers have made it clear that space underpins many missions vital to our national security. And we recognize that we need to think about space differently as a rapidly evolving contested domain. Given this, our focus is on providing space based offerings that include a mix of exquisite solutions in combination with proliferated constellations of low earth orbit satellites, also known as LEO which together create a more resilient architecture. We've recently seen the benefits of this approach. For example, after the close of the second quarter, we received a $617 million contract for the SDA tracking layer which is a LEO constellation of 14 satellites designed to provide global warning, tracking and targeting of advanced missile threats, including hypersonic missiles. This builds on the SDA transport layer contract we were awarded in February which is also a LEO constellation of 42 satellites, providing resilience, low latency, high volume data transport in support of U.S. military missions around the world. In addition to these, we booked another $700 million in Q2 in restricted space awards and now have $11.3 billion of restricted space backlog. We continue to see the national security space area as one of the strongest growth drivers for our company. Another focus area where we are pulling capability and expertise from across the portfolio is missile defense and Counter Hypersonics. In the second quarter, we were awarded a contract from the Missile Defense Agency to continue development of the glide phase interceptor program. GPI will play a central role in ensuring the United States maintains the most reliable and advanced missile defense systems capable of outpacing and defeating evolving missile threats. This complements our missile defense modernization work already underway on NGI, HBTSS and IBCS. We have also been supporting international customers to modernize their missile defense system. For example, last week, we delivered the first of the 6 production IBCS engagement operation centers for Poland's medium-range air and missile defense system. Our capital deployment approach is also an important part of the strategy I just laid out for you. Our first priority is to invest in executing our business strategy. By investing in our factories, digital design tools and our people who are a key source of our technology leadership, we are creating long-term sustainable value. We also remain committed to returning at least 100% of free cash flow to shareholders this year. In the second quarter, we increased our dividend by 10%, marking our 19th consecutive annual increase. Our new quarterly dividend will be nearly double the level we paid in the beginning of 2017. We are also returning capital to shareholders through stock repurchases and we continue to target at least $1.5 billion in repurchases this year. Before Dave shares more details about our financial results, I'd like to briefly talk about the defense demand environment. We've seen a fundamental shift in global commitment of resources for defense and national security, particularly in Europe. Just this year, we've seen Finland and Sweden progress their membership in NATO and many European countries increase or state their plans to increase their defense budget. The geopolitical environment has highlighted an increased requirement for defense and deterrent. In the U.S., this has also resulted in strong bipartisan support for defense spending. Recently, the Congressional Arm Services Committee has marked up their version of the FY '23 defense bill with both providing bipartisan support for further increases in defense spending above the president budget. For Northrop Grumman, the U.S. FY '23 base defense budget request included strong support for key programs like T21, GBSD, NGI, IBCS, next-generation OPIR and Triton. And there is an opportunity for additional funding for GATOR, E-2D, F-35 and F-18 that we've seen in proposed plus ups from Congress. But I will note that as has become the norm in recent years, there is a high probability of starting the fiscal year on a CR, so we have anticipated this in our outlook for 2022. The budget is a strong reflection of the alignment of our company with our customers and reinforces my confidence that we are well positioned for this environment. So with that, I'll turn the call over to Dave and then I'll have a few closing remarks before we turn to Q&A. Dave?

Kathy Warden:

Thanks, Dave. So in summary, demand remains robust and we saw outstanding bookings and backlog growth in the quarter and year-to-date. This demand is creating momentum that supports our expectation for accelerating growth for the remainder of this year and into next. Additionally, our capital deployment strategy is aimed at supporting long-term growth and creating value for our shareholders. We believe the investments we are making today in digital tools and factories of the future are already enabling stronger program performance and contributing to our operating results. So I'm incredibly proud of the Northrop Grumman team as we execute our strategy and position the company for long-term success. So with that, we're ready for Q&A.

Mariana Perez:

This is Mariana Perez Mora on for Ron today. So on labor. Most of the industry is experiencing significant pressure from a tight labor market. And it seems that you are managing these challenges better and even seen some improvements in the second half. Could you please describe and give us some color on what are you doing to navigate these challenges?

Mariana Perez:

Perfect. And then on supply chain, how -- or what kind of tools do you have to improve your visibility or material lead times? Do you have flexibility to reach out long-term agreements in advance or increasing inventories to provide any potential future disruptions?

Dave Keffer:

I think that's well characterized, Kathy, at a program level, in addition to being confident in our ability to deliver more in the second half, the timing of demand is also more weighted toward the second half of this year as opposed to last year when the demand timing at a program level happened to be a bit more weighted toward the first half of the year. So that too contributes to the stronger year-over-year growth outlook for the second half of this year.

Richard Safran:

So, I wanted to ask you about the news, the FTC is making about Orbital. You probably were expecting this, at least I would guess. This was initially brought out when Lockheed was buying Aerojet. So I want to know if you could briefly talk to the issues that the FTC is focusing on. If you could discuss what the range of outcomes might be? And I know it's always a bit difficult but if you could speculate on the impact. Any comment you would give there would be appreciated.

Richard Safran:

Okay, that helps. As a quick follow-up here. On your comments about international, I want to know if you could expand a little bit on that. What type of equipment are you getting the most interest for? Could you discuss a little bit about the timing, how that's going to translate to the -- and flow into the P&L. And then just look a bit old school here with increasing international demand, we should expect more higher-margin commercial contract? I just want to know if that's -- if you think that's the case?

Operator:

Our next question comes from the line of Doug Harned from Bernstein.

Dave Keffer:

Sure, I'm happy to touch on that one, Doug. In the first quarter, we had an unusually high volume of favorable net EACs in the second quarter net EACs were light. This is the typical nature of a business like Aeronautics, where there is quarterly fluctuation. But in aggregate, we have even a slightly stronger outlook for the year, as we described earlier on the margin rate side than we did previously. So you need to look through and look past quarterly fluctuations in net EACs and toward the overall outlook. On the sales side, that net EAC fluctuation rolls through sales as well. And so I'd note that it was relatively stable in the first and second quarter. AS is another business, as we described earlier in our comments where we see a higher volume of material receipts projected in the second half than the first. And so I think, a reasonable second half ramp from where we are today and very consistent with the projections we've been providing for a couple of quarters now.

Dave Keffer:

Sure. We're -- as you mentioned, we're incredibly pleased with the backlog growth, the award volume that we've had in space programs like both the transport and tracking layers of the FDA architecture are great examples there of work we're doing, really at multiple layers with multiple products supporting multiple mission areas in the national security and civilian space markets. In terms of how that backlog then breaks down in terms of award volume over time -- or sales volume over time, it's been our fastest-growing business and we anticipate that it will continue to be our fastest-growing business and not just any 1 program, GBSD is obviously a large contributor to its growth last year and this year. But the growth is much broader based. And so while GBSD has grown about $0.5 billion in our '22 estimates and should show similar growth in '23, we would anticipate a similar volume of growth outside of GBSD going forward. and our growth outside of GBSD for this year is actually exceeding GBSD's growth on a dollar basis in space. So really broad-based outstanding growth, not just in backlog but to your point in converting to sales as well.

Cai von Rumohr:

Yes. So you and your partner on MGI were selected for the glide phase interceptor that's an interceptor, NGI is an interceptor. Are there any read acrosses in terms of having one list that would make you better positioned for NGI if it goes sole source? And what do you think the chances are it goes to all source?

Cai von Rumohr:

And secondly, you also had a number of wins you alluded to in the LEO area. Can you -- as you look at the second half, are there any major opportunities we should keep our eye on competitive bids?

Operator:

Our next question comes from the line of Kristine Liwag from Morgan Stanley.

Kathy Warden:

Thanks for the question, Kristine. I was just in Europe a few weeks ago. And I would say that I see truly a fundamental shift in recognizing the threat environment is real and it's now, right? I think in recent years, within Europe, there's been a sense that we're working toward a longer-term threat horizon and perhaps the pacing of national and defense security spending would have been appropriate in that environment but the fact that the threat is more imminent is addressed in what you're seeing is planned or committed increases in defense spending across most of the European nations. That does take several years so to translate into specific needs, by plan and sales for companies like ours. So I do expect that there might be some modulation based on broader economic factors and other spending priorities. But I don't see there being another inflection point back to a view that defense spending isn't a high priority. So I just see it fairly ensuring.

Kathy Warden:

Yes. So as I noted, despite the urgency, it does take generally at least 18 to 24 months to translate intent into specific programs aspirations, customer wanting to buy x quantity of certain systems in production. And it takes even a little longer if it's something that is not in production if it's a developmental program. And so that can be 3, 4, 5 years. So as I think about the landscape in Europe, obviously, the time is now to be advising and insights on what can address their highest priority demands just as we do with U.S. customers but I don't see it having a material impact on revenues for us or other AMC companies in the next 18 months. So I'd say it's more in the 2024 time horizon that we would look forward to have a more material impact.

Robert Stallard:

Kathy, I just like to follow up actually on the question I asked you 3 months ago about inflation and fixed price contracts. I was wondering how things have evolved over the last quarter versus your expectations? And whether you are making any structural changes to the way you do business, considering we are in this higher inflation environment?

Robert Stallard:

Okay. And then just a quick follow-up. There was a news report yesterday that the Air Force is looking to retire all its Global Hawks in, I think, 2027. I think is this in line with your expectations?

Operator:

Our next question from Sheila Kahyaoglu from Jefferies.

Kathy Warden:

So Sheila, it continues to be about 10% of our annual sales in total across all aspects of our contribution to the program. As we have worked through our new contract for Lot 15 through 17, we have factored in the demand that Lockheed has for our components and we still see our outlook for '22 and even into '23 intact as a result of the new expectations around demand. As we look over a longer period of time, we still see production being the lion's share of our revenue volume. The sustainment is the fastest-growing element of our contribution to the program. And in Mission Systems, we have a combination of development and production because we're supporting the Block IV upgrades. And that most notably is revenue support for Mission Systems even as we phase out of the DAS program which also is in Mission Systems. We see Mission Systems revenue being fairly stable because of that increased volume around Block IV.

Dave Keffer:

Sure. Happy to jump in on that one, Sheila. In aggregate, that you can think of that franchise in the 1% of sales range. But as you point out, they are important domestic and international components to that today and equally importantly, international opportunity going forward as well. Certainly, it's a critical mission set that our IBCS capability can meet by attaching a kind of previously disconnected sensors and shooters and bringing new capability to disparate systems which is really central to the modern mission set, both domestically and abroad. So we look for that to be a growing franchise. We're really pleased with the competitive awards of the past year. There should be some second half growth in the program. And again, it's a critical part of our Defense Systems franchise.

David Strauss:

Kathy, I think on the last call, you kind of endorsed the current consensus revenue estimate for 2023 which I think is around $38 billion. Is that still the right way to think about the revenue trajectory next year? And it would seem like you would be able to get there pretty much on B-21 and GBSD growth. So are you assuming, what does the rest of the portfolio look like next year ex B-21 and GBSD in terms of growth?

David Strauss:

Okay. And Dave, thanks for the color on pension. Obviously with you guys, a lot of moving pieces with the mark-to-market and all of that. I think you had previously said FAS has relatively, I think, in total, relatively flat in '23 versus '22. I mean are based on more things today, I mean, can you help us at all? Are we looking at like a couple of hundred million dollar headwind '23 versus '22.

Operator:

Our next question will come from the line of Seth Seifman from JPMorgan.

Dave Keffer:

Sure. Thanks, Seth. So I would point out a few things. One, we've had outstanding returns on our pension assets over any period you look at historically, over the last 20 years, well above market return expectations. We're really proud of the value that, that has generated and the benefit that, that is both to the company and to our government customers. As a result, we are very well funded today. We talked about a 96% funded status level that fluctuates day-to-day, given market movements. But again, we're in slightly better funded position today than we were even as of the first of this year, given the changes in the interest rate environment offset by the changes in the asset returns that you'd expect. So there's a lot of moving pieces under the surface. But in aggregate, we don't today feel a burning need to make a change to our long-term strategy. It has been working. It's been a value to the company, to the participants and to the government. And as a result, it's certainly something we'll continue to assess over time. But at this point, we're pleased with asset returns over any long period of time, Pleased with the funded status that results from that and we'll continue to keep you apprised if there are any changes along the way.

Dave Keffer:

Sure. In aggregate, for a sector like AS, we would expect, in a typical year, to have a healthy underlying OM rate. And in a typical year, we would have some volume of favorable net EAC adjustments. Of course, at any given time, we don't know which programs those may come from because we've factored our risks and opportunities into our current EACs and we need to perform well and retire risks in order to drive those improvements in EACs. So I'd be reticent to be able to point to any particular program that we think will be a key or much less the key driver of EAC benefits over time. But certainly, within our restricted and unrestricted portfolios, we need to continue to execute well, drive efficiencies in every one of those programs and again, continue to have some volume of net EAC pickups on top of the healthy underlying segment OM rate in the business. It's a segment whose execution we're proud of with some critical programs and we'll look to continue to build on that.

Noah Poponak:

Why is there currently such a large variance between the pace of DoD budget outlay versus DoD budget authorization?