Northrop Grumman Corporation (NOC) Earnings Call Transcript & Summary

Okay. Good morning, everyone. My name is Peter Arment. I'm the senior aerospace defense analyst here at Baird, and we are delighted to be hosting Northrop Grumman here this morning. With us at the Baird Industrial Conference and with us joining us from Northrop is Kathy Warden, who's the Chairman, CEO and President; and Dave Keffer, who's the Chief Financial Officer. Dave is going to make a safe harbor statement, and then Kathy is going to kick things off with a few opening comments. So with that, again, thank you for joining us, Kathy and Dave. And Dave, go ahead.

Great. Thanks, Peter, and good morning, everyone. First, we'd like to wish you a happy Veterans Day to everyone on the call today. And before we get started, I would just remind you that today's discussion will include forward-looking statements, and those statements involve risks and uncertainties. Information about those risks and uncertainties can be found in our SEC filings. So with that, I'll turn it over to you, Kathy.

Thank you, Dave, and thank you, Peter, for having us today. I wish we could be with you in person, but virtual has to do these days. A couple of weeks ago, we reported our third quarter earnings, and I'm pleased to say that we were able to raise our revenue outlook for the year as well as our EPS and cash flow. And it's particularly gratifying given the challenging year that we've all faced due to COVID-19 this year. As I reflect on this year, it has already been a strong year with backlog building to a record high for our company, $81 billion, and that's after a strong year of backlog growth in 2019 as well, I think, back to when we were here with you last year and I was reporting a year-to-date backlog and book-to-bill of 1.4x sales. So we're really excited to see year-over-year improvement in backlog but also 2 solid years strung together now of growth for our company. As we look forward, we were able to provide an outlook in our third quarter call that also projects solid revenue growth. It projects solid earnings for next year and continued strong free cash flow. So we feel like it's been a solid year, building a good foundation for 2021, and we're winning. We are executing, and we are innovating. And these are the things that we've been focused on as a team as well as making sure that we're paying attention to the safety and well-being of our employees as we all continue to deal with the pandemic. So Peter, I'll turn it over to you and looking forward to our discussion.

Thanks so much for that, Kathy. I appreciate it. So on the third quarter call, you highlighted kind of the outlook for 2021, a $37-plus billion revenue outlook, which I think is up 3% to 5%, but if you -- and that includes the $400 million headwind at Lake City that you called out. And if we look at backing that out, that looks like strong mid-single-digit growth. Maybe just talk about a couple of the key drivers that you see for 2021 and then sustaining those longer term.

We certainly see multiple drivers. I'll start with our Space business, where we have the catalyst of GBSD that will be contributing nearly $1 billion of sales growth next year. But Space broadly has been growing in national security and restricted programs, in our tactical space business and in our civilian and commercial businesses as well. So we've seen the growth very broadly in our Space portfolio. Mission Systems is also a strong contributor to growth going into 2021. We expect to have mid-single-digit sales growth there as well. And in Mission Systems, it again, is across all of our business segments that are contributing to growth, but most notably, our airborne and ground radars. We see aerospace at a slightly lower growth rate next year, low single-digit growth, and that's due to a few factors. One is that business has been most impacted by COVID with our aerostructures business, in particular, and a bit of a plateau that's happening on F-35. We're still going to see growth there, but it will be more in the low single digits. So Aeronautics is looking towards a low single-digit growth rate next year. And as you noted, we do have some headwinds. Those are largely in our Defense Systems business with the Lake City contract. So Defense Systems will be roughly equal to this year's sales.

So you mentioned GBSD. So I think everyone -- it's been a big focus for everyone. I guess kind of a 2-part question, yes. How do we think about the ramp of that during this EMD phase of the award? And then you've touched upon a little bit of the profitability aspect that has been -- will put a little pressure on Space margins. Just maybe think about what's the right framework for investors in thinking long-term about when the milestones are for kind of seeing potential risk retired from a program like that?

So GBSD will be a significant contributor to margin dollars over the long term. The program is a multi-decadal program. And as we look into the first few years of a development program, we tend to take a conservative approach to booking rate because all the risks and opportunities are still ahead of us. As we retire those risks and realize opportunities, we typically see margin rates improve on our development contracts. And then, of course, as we transition into production, we see another step change typically in the margin rate on a program like GBSD. So that is what we are expecting. 2021, while GBSD will contribute almost half of our growth, we expect it to contribute less of the margin dollars because of a lower-margin rate, as you note, but still strongly contributing to margin dollar growth. And as we think about GBSD's contribution overall, it's only one of a number of programs that we have that generate the strong growth we're talking about next year.

Yes. And just one last one on just GBSD. Just given the talk of maybe a flattening budget, maybe do you think there's any changes in -- with a potential change administration about changes to our nuclear posture or some of the commentary out there regarding that on a program like this?

So I fully expect that a Biden-Harris administration would want to do another review. I've spoken about the facts that a nuclear posture review has been done regularly. And the Obama-Biden administration did one in 2010. Trump administration did one in 2018. Both of those concluded that the path that we're on for modernization of the ICBMs with the current GBSD program is the right path, and I fully expect that to be the conclusion if another review is conducted.

Understood. And then with the election in rearview mirror hopefully, I assume, any color around -- I need to think that there's going to be any shifting in DoD priorities when you think about how you -- the Northrop Grumman portfolio is aligned.

So I do not expect significant shifts. The defense budget is threat-based. And as we look at the threats and how they've evolved over the last few years, we don't see any particular catalyst for change in how the threat is viewed by this administration. And when we think about the priorities, Space as the domain is one that requires significant investment for the recapitalization of assets. And we have started that recapitalization, but there are many years of effort ahead to complete that work, and we expect it will continue to be a well-funded area. We also think the triad and nuclear deterrents will continue to be a high priority, given the focus on China and Russia, in particular, and areas like hypersonics, artificial intelligence, connection of sensors. Those types of capabilities are going to be highly relevant well into the future.

So much of Space is classified or restricted, so it's always a little bit of a challenge. But there's a lot going on in other areas in terms of satellites and launches. Also, one of the things that I think that everyone posted on was the acquisition of Orbital ATK and how well that's gone on the integration side and talking about potential revenue synergies. So maybe you could just talk a little bit kind of ex-GBSD in Space and some of the bigger drivers there, in particular, I guess, talking about the integration side, too.

Well, the integration of Orbital ATK into Northrop Grumman has gone extremely well. We are realizing the revenue synergies that we anticipated. As a matter of fact, we're exceeding them. And we, at the beginning of this year, structured the organization to bring all of our Space business together into one sector, and that has allowed us operate even more effectively together as one team in approaching the various aspects of the Space market. And to the point that you made, it is a broad market. So when we think about Space, there's the national security element of the business, where Northrop Grumman had strong presence in Orbital ATK a bit less. We've brought the strengths of both organizations together now to serve that market. And you've seen our restricted business grow significantly in Space over the last 2 years. We also are taking advantage of the expertise of Orbital ATK in growing our NASA business, particularly with the NASA focus on the Artemis program, which will put the first woman and another man back on the moon by 2024. And that program, we have multiple elements of support to it. But it was just in a review yesterday with the team talking about how we're going to take elements of James Webb Space Telescope, which Northrop Grumman has been developing, and bring that together with some of the expertise of Orbital ATK in our human landing system offering. So there's just synergy that's happening every day between the teams that's leading to a stronger integrated space portfolio for Northrop Grumman.

Has that been one of the biggest surprises? I guess, culturally, it probably was going to be a very good fit, but just some of the revenue synergies, whether they came -- are coming in sooner than kind of what you modeled out when you did the acquisition.

Yes. It has been a pleasant surprise. We knew that Space was a growing market segment. It was why we were very interested in bringing these capabilities together, but it has accelerated even beyond our expectations. And therefore, we're seeing the revenue synergies earlier than we expected.

Yes, that's exciting. One of the other areas that came up when the acquisition was announced was about potentially being a third supplier for missiles. And do you still see that as an opportunity? And is it worth the investment when you think about this opportunity longer term over the next 3 to 5 years? I know you have the AARGM contract and just thinking about certain things like that.

I do still see it as an area of growth and synergy for us. When you look at the AARGM contract, we already are a missile prime, as you noted, but we are looking to grow our capability as a missile prime and at the same time, be a good supplier to the other parties that are already missile primes. And so that includes everything from the fuses and propulsion to guidance systems and the like. So we're not moving into the prime missile systems provision at the expense of still focusing on our core expertise that are the components of missile systems as well. We expect that we'll be able to do both successfully and not just for the success of Northrop Grumman with the success of all of our customers and the primes that we work with today.

Terrific. Let's move over to maybe talk a little bit about Aeronautics. It's been a big growth driver, but you're seeing a little bit of a headwinds that you called out in 2021. I -- specifically, the HALE portfolio is a contributor. How should we think about -- when you talk about unmanned or your autonomous systems when we view this outlook?

Aeronautics does have some headwinds. I noted, most notably the aerospace structures business and the growth that we had anticipated from Airbus and Boeing. And that has obviously modulated this year already, and we expect that to continue into next year. We also have some headwinds. Just as I said, F-35 growth rate is reducing. And so those are the 2 primary areas driving Aeronautics' growth rate from '20 to '21. But unmanned is a piece of that as well. I have noted some of the pressures there on both the Global Hawk and the Triton program in the budget. And so we do expect our unmanned portfolio with those 2 programs to be slightly lower in revenue in 2021 than in 2020.

But do you see opportunities internationally, I think, for both Global Hawk and Triton? And how should we think about either expanding into a number of countries or getting approvals for systems like that?

We do see international opportunity. And this year was a very strong year for Triton, in particular, with the Australians, making the determination to buy 3 aircraft, and we expect them to buy more. And we do believe that the changes that have been made in the regulatory environment around unmanned systems export will open up additional markets for us in the future. We have been delivering Global Hawks to Japan and Korea this year, and we've also finished our deliveries to NATO. So Global Hawk has been our workhorse in terms of providing unmanned capability to our international allies. And going forward, we see Triton having that same opportunity.

Now you mentioned F-35. Just in the context, if that's been a big growth driver and now that's kind of hitting a steady state for you. Maybe just talk about -- it comes up a lot on other calls about sustainment of F-35. How does Northrop kind of participate in those activities?

We are an active participant in the U.S. sustainment activity. And there's also international opportunity that we have pursued that with the international partners, we will be able to offer them support, particularly for the Mission Systems in addition to the airframe. And oftentimes, we think about the sustainment of the airframe itself, but we do have performance-based logistics contracts that are in place or being put in place for the Mission Systems components that we deliver on the aircraft as well. And as a reminder, that's the radar, the communications and navigation as well as currently the distributed aperture system.

Okay, terrific. Lastly, just in Aeronautics, and we know it's a restricted program and you can't make any comments on the B-21. But I guess, what is the latest Air Force public statements that maybe you could share with us just to give everyone kind of an overview?