Northrop Grumman Corporation (NOC) Earnings Call Transcript & Summary

Good morning, everyone. This is Sheila Kahyaoglu with the Jefferies Aerospace and Defense Equity Research team with stage 2 of our Virtual Jefferies Industrials Conference. We're very lucky to have Northrop here with us, first time in a long time. So thank you Todd Ernst for bringing David Keffer here, Corporate Vice President and CFO. With that, I'm going to hand it over to you guys for some quick remarks, and we'll head into a question and answer.

Okay. Great. Thanks, Sheila. Just before we get started, I just need to read some safe harbor comments here. I want to remind everyone that today's discussions involve forward-looking statements. Those statements involve risks and uncertainties and information about these risks and uncertainties can be found in our SEC filings.

Thanks, Todd. We had our earnings release and call last week, as you know, Sheila, and those on the phone likely do as well. So I don't have any long remarks to kick things off with this morning. Certainly, we were pleased with the Q2 results, first half results in general and the strength of that performance that led to the guidance raises that we announced last week. So happy to dig into those in more detail today, talk a bit more about the overall backdrop and kick things off with your questions. So back to you, Sheila.

Perfect. I think a lot of what we're seeing in defense right now, there's a little bit of uncertainty about what the outlook looks like, but for you guys, that doesn't seem to be the case given you're kind of leading the pack in terms of growth. So I guess with that, how are you thinking about the budget set up for fiscal 2022? Where do you think the opportunities are for you guys? And where are some of the watch items you guys are looking out for?

Sure. We're pleased overall with where the budget process stands. So there was a lot of conjecture before we kicked this off over the last 6 months or so with the President's request and the more recent House and Senate discussions. And so with the President's figure at [ 7 15 ] and now a SaaS markup with $25 billion of additional that the House is now considering as well. We think that sets up perhaps a bit more favorably than many had hoped or feared or expected just a couple of quarters ago. In terms of the key priorities areas, those are largely set by the threat environment. And so we haven't seen a lot of change with the new administration compared to the last in terms of where those priorities are. And for us, we think that creates a lot of alignment with our portfolio. Certainly, restricted space continues to be an area of budget focused, nuclear deterrence, long-range fires. On the technology side, AI and cyber and then a lot of, of course, focus on this broader JADC2 concept. And so all of those are areas where we have a lot of work today and ambition to continue to grow in the future. In terms of risk areas, I think that mantra is largely unchanged as well. Legacy programs, those platforms that are of less use in the fight going forward and against the threat environment of pure and near-pure adversaries going forward are those that will be at the most risk. But in aggregate, we think it's more likely today that you'll see a low- to mid-single-digit growth outlook certainly than we or most around the industry expected just a couple of quarters ago. So in aggregate, I think it's a positive story, at least based on what we know today.

Sure. And I think one of the most positive stories is the Space business. It's about 30% of your sales. But how are you thinking about the drivers of that outside of where GBSD is, whether it's OPIR or the restricted growth and just kind of the growth trajectory of that business medium term and how we should think about that 37% organic in the second quarter?

Sure. I mean, certainly, that 30% -- 37% organic growth rate in Q2 and the 30-plus percent organic growth we've put up for a couple of quarters in a row now are difficult levels to sustain and we've projected over 20% for the full fiscal year, which we feel very positively about. You're right, though, that the drivers of that growth go well beyond the GBSD program. Obviously, GBSD was a critical win for us and is a key area of focus as we ramp up that program now. But as Kathy mentioned on the call last week, that was less than half of our growth in the Space business in the first half of the year, about 40% was driven by GBSD. And for the year, it's around half of our growth projection implied by our guidance with GBSD growing a little less than $1 billion this year compared to last. So certainly, that's a core piece of it. But you mentioned a few of the others, and I'll note a few additional ones as well. It's really broad-based growth across the rest of our space portfolio. OPIR is a key element of it. Of course, the NGI win that we had earlier this year is a strong contributor as well. On the NASA side, the Artemis program, a key enabler of growth, well supported by the budget at this point. And our recent HALO win is exemplary of that, the SLS piece of that portfolio another growth driver for us. And as we mentioned in the first quarter, even on the smaller portion of our Space business that's on the commercial side, we had some healthy growth in performance in that piece of the business. So it really is broad-based and obviously, an overall sector we feel good about. I think it's highly likely we'll continue to see that business as the fastest-growing sector within Northrop Grumman in the near term.

And just on that last note, in terms of the commercial piece, commercial exposure, how big is it for you guys? And what are some of the opportunities in commercial space and catalyst to watch for?

Sure. Obviously, that's a rapidly evolving part of the market today. And while it's not large for us, in aggregate, that NASA, kind of civilian piece plus commercial is less than 20% of our Space business. There are growth opportunities there. And there are opportunities for us to both prime and to partner with new entrants and traditional players in that -- those parts of the market, as you can see us, certainly on some of the larger NASA opportunities with strong teaming relationships. What we look to do on the commercial side is to rather than build a core business in commercial to leverage the core capabilities we have in the National Security Space portfolio that we've built both in legacy Northrop and legacy Orbital ATK over the last several decades and apply those where they're best used in the commercial market. One of the recent examples that's been in the news is our MEV business, the Mission Extension Vehicle. But we also have had some recent announcements over the last year or 1.5 years about C-band satellite wins. And so we're looking for opportunities like those to address core needs of the commercial market, while still focusing on Northrop's primary business and space, which is in the national security part of that market.

Yes, that's great. And maybe can we turn to over to the Aeronautics portfolio. How are you thinking about the F-35 from here? Perhaps remind us what's the split of the business, given it's no longer divided between 2 segments or mostly in aeronautics, some in mission and some in defense? And is there an inflection where sustainment becomes more relevant for you guys?

Sure. So in aggregate, our F-35 business is around 10% of the total company revenue. In our AS piece, that production work in AS is the largest component of our portion of the F-35 program. MS' modernization work is the second largest, and then there's a substantially smaller piece today around sustainment in our Defense Systems business. And so you have the largest portion in AS. As we've talked about on the last 2 earnings calls, we deliver ahead of the prime on that program in order for our portions of the program to then be integrated into the overall platform. And so our growth has been plateauing of late sooner than you would expect the primes to, and we expect that plateauing to continue going forward. And so on the production side, we expect kind of flat to down AS sales as a result. And then there's opportunity for a bit of continued growth, kind of flat to up in the MS portfolio. And while DS is the smallest of the 3, our Defense Systems portion, that sustainment work is the portion that has the best opportunity to grow. So it's off the smallest base, but certainly over many years going forward, we'll look for continued opportunities to grow our sustainment work on F-35.

And kind of how does that tie into your overall manned portfolio? Where are ongoing growth opportunities with programs such as E-2D and this actually over into the restricted business and general trends there?

Sure. Obviously, there's a limited amount we can say on the restricted side and we leave it to the customer to say the majority about the B-21 program in particular. But some of the trends apply across our manned portfolio. We talked the most about F-35 because it's the largest unrestricted piece of our AS portfolio, as I just mentioned. We see similar trends in terms of a plateauing of growth and given where we are in the life cycle of a program like F-18, for example. E-2D continues to show some opportunity for growth, both domestically and internationally as we talked about, the SaaS markups earlier and additionally, 2D aircraft are -- is a portion of that markup. So there's some continued opportunity in the U.S. and a paramount internationally, where we've talked about France and other countries with key mission needs that can be addressed by E-2D. But broadly speaking, we expect these current trends in our manned portfolio in AS that we talked about on the call last week to be with us for a while. Of course, we're looking at next-gen opportunities in the manned air market and certainly feel like we have a lot to bring to bear in that part of the market. But that's longer-term impact to our growth outlook as opposed to the next couple of years.

The best part of virtual is, I can check my model and actually see if manned is supposed to be flattish between now and 2023. So that's what I was doing. So sorry for the pause. You flagged some headwinds on Global Hawk. How do we think about your unmanned business? And are there opportunities to actually expand like how big could a program like Skyborg be for you guys? What are other unmanned programs you're watching for? And then more broadly, how does this work with other segments in terms of aeronautics or mission around sensors in terms of overall Northrop?

Sure. I think you've talked about a few of the key moving pieces there in our unmanned business. Certainly, Global Hawk and Triton will for the next couple of years, continue to be the largest programs we discussed there. I do think there are opportunities longer term for some of the smaller next-gen programs like Skyborg domestically or MOSQUITO and other programs in the U.K. and internationally, more broadly speaking, to become larger portions of our portfolio. Certainly, we have a lot to offer there and are involved in early stage work around kind of R&D and initial proof-of-concept type work around those next-gen platforms. But for -- given the scale of our work historically in Global Hawk and Triton, those will be the largest programs that we discussed on the unmanned side for the next couple of years. Around Global Hawk, the key that we've been discussing recently is the timing of retirement of those block 20s and 30s. And that has been delayed a bit and pushed out beyond this year. But we do think the likelihood is that, that retirement will occur, and so we are planning for that. On the Triton side, again, on the SaaS markup side, there are 2 additional Tritons. And so we'll continue to have a careful eye on the budget scenarios around the Triton portfolio as well as the international adoption and sales opportunities in Australia, among other countries for trading. But I think the trends we've been talking about in our broader manned AS business around these legacy platforms plateauing a bit are addressed or do cover the unmanned side as well. And so I would say those apply to the Global Hawk and Triton programs. Likewise, there is long-term growth opportunity in the areas you mentioned, Skyborg being kind of a key example of that domestically, but it will be years before that becomes a substantial sales opportunity for us.

That makes sense. In terms of JADC2 concept, you mentioned earlier, any way to size that, you have IBCS and award is I think expected in the second half. I just imagine that being a video game for the Army the last time I was at AUSA. Is that actually for the JADC2 contract and concept? And how could other opportunities emerge from that?