Northrop Grumman Corporation (NOC) Earnings Call Transcript & Summary

Okay. Let's get started. I'm really happy to have with us again, Kathy Warden, Chairman and CEO of Northrop Grumman. Kathy, you may have a few words to start out with here.

I do. Thanks, Doug. Thanks for having us again. I just want to start with a reminder that I may make forward-looking statements in my comments today, and those statements include risks and uncertainties, which you can find detailed in our SEC filings on our Investor Relations website. I also -- so I just spent a few minutes making some opening comments to provide context on the company before I hand it over to Doug for Q&A. For those of you who don't track the company closely in our first quarter results, we did show that we're off to a strong start for the year once again. We had revenue sales increased 9%. Our earnings up 10% and our free cash flow up 15% for the quarter, and we reaffirmed our company guidance, which is growth in the 4% to 5% range, and free cash flow growth in the midpoint, about 17%. So really strong business growth that is fueling earnings enhancements as well as free cash flow delivery. We've been putting that capital to work. Many of you know that we have been investing in our company over the last several years to support the growth that I just outlined, and we continue to do that this year. But we also have a robust strategy for returning capital to shareholders. We recently increased our dividend another 10%. This has been a consecutive trend for us for many years now, and we also have identified over $2 billion in share repurchases planned for this year. There are 2 programs that I am certain. Doug is going to ask about the B-21 and Sentinel, which we're proud to be executing to legs of the nation's strategic deterrent. But we also have thousands of other programs in the portfolio that are contributing to the strong organic growth within the organization. And it's really the diversity and breadth of that portfolio from space to armaments, to Integrated Air and Missile Defense and Mission Systems and microelectronics in general that are positioning the company, not only for the growth we're experiencing today but sustained growth into the future. So I'm looking forward to sharing some of the details on that and more. So I'll turn it over to you. You always have great questions.

Okay. Thanks, Kathy. Just to start off with, maybe if you look back over the last year, when we were sitting here, what's changed? What is different for Northrop Grumman today in terms of either opportunities or challenges?

Well, there's a lot that stayed the same, and it's important to start there. There is a strong global demand signal for Northrop Grumman products and services, and that hasn't changed. What though -- when you unpack that demand signal has changed, is stronger international growth prospects, particularly coming out of Europe. And we now see that to be a sustained long-term strength in demand signal for our products and services. The other thing that's changed, not just in the last 12 months but certainly over the last 36 months, is that our company has more products to serve that market. We have transitioned our Unmanned systems such that we now have exportable offerings in product lines like Triton. We have grown our Integrated Air and Missile Defense portfolio to have product lines that we can export to foreign nations. And I talked about this on our first quarter call with our IBCS product line. We have, through the addition of Orbital ATK to our company, filled out our tactical missiles and armaments capabilities. And so today, our company has significantly more product that we can export to fulfill these global demand signals. The other thing that has changed in the last year is that we are starting to see the macroeconomic pressures that we're putting a damper on our growth subside. And that includes the challenges with our supply chain, being able to deliver on time, that includes the tight labor market that we were all experiencing in the late '22 into early '23 time frame, which now we are able to meet our hiring goals, fully staff our programs. And so that too has unleashed a bit of ability to fulfill that demand and grow the business that we didn't have as we were sitting here a year ago.

Well, along that line, though, in terms of macro pressures, I mean, one of the issues that the industry is facing is defense budget that's under congressional caps. The new -- the new President's budget is actually negative growth in real terms. When you look at that from a Northrop Grumman standpoint, how does this budget situation look?

No surprises in this budget environment. The caps were put in place. We knew that they would have the impact that they indeed are having in the top line. But of course, we also saw the Congress pass the supplemental for this year, and we will see if that continues as we look into the future. So from a top line perspective, no doubt, there's more pressure under the Fiscal Responsibility Act and the caps that have been put in place today than we had a year ago but also some strong demand signals for U.S. modernization and dealing with the increasing costs associated with Defense programs due to inflation and the need to continue with the efforts that are underway. So I think this next year to 2 years will be very telling. But we're not at all limited by the budget that we saw from the President this year, and as Congress is deliberating on that budget, we're encouraged in what we're seeing that there will be continued bipartisan support for defense spending at the President's budget level, if not higher.

And on that -- in your conversations on the Hill, do you see any progress in getting, I would call it, a less dysfunctional situation in terms of getting budgets through?

An election year is always a challenge for bipartisanship. But I would say the area that we had seen that coming together is around national security priorities. It's not always the process we'd like on the time line we'd like. But each year, we have gotten defense appropriations passed in a way that supports what the administration has requested to continue with both the modernization and equipping of our forces. And I meet with many members of Congress. They're good people with the right intentions to support our military and ensure that the men and women who commit themselves to our work around the globe are given the best capabilities to enable them to do that work. And I don't see that changing.

Now recently, you made some changes. There are changes in the leadership and you move Sentinel out of space. Can you talk about those changes and what you're looking for there?

Yes. Well, first, I want to acknowledge that the changes we made were precipitated by 2 of our leaders announcing their intention to retire within the next year. The first is our Chief Financial Officer, Dave Keffer, who is here with me today. And I want to publicly thank him for the 5 years that he has spent as our CFO. He has been a tremendous resource to me, the leadership team, and an advocate for our company, and he'll continue to do so as he moves into the next chapter of his life. We also had a leader from our Mission Systems business, Mark Caylor, who's been with the company for many, many years, and he too is moving into the retirement phase of his life. And as he did that, we are taking our Defense systems leader, Roshan Roeder and putting her in charge of Mission Systems. She spent most of her career in that business, knows it very well, and we'll be able to step into leadership and how it's not skip a beat. At that time, we moved to Ben Davies who is leading our Sentinel program and our strategic missiles portfolio generally into lead Defense systems and are bringing with him that strategic missiles portfolio. It's really important from my perspective that we have continuity on Sentinel. Ben has established fantastic customer relations and trust as we navigate that program and his continuity and leadership will be key. And it also gave us the opportunity to bring together strategic missiles and tactical missiles into our Defense Systems portfolio and harvest some of the synergies that we anticipate those businesses will have by operating together. So it seems like a lot of movement but really makes sense in terms of getting the right leaders into the right place. And I'm most pleased that our succession plan within the company, which we have invested a lot of time and effort into working that we had great internal candidates ready to assume these leadership roles as we have leaders ready to move on to their next phase. So really, I think from an investor standpoint, you'll see that the company will continue to operate very consistently and strongly with these new leaders in place. And we have 2 outgoing leaders who are committed to successful. And in Dave's case, lengthy transitions to make sure that happens.

Now I want to jump to the B-21. So you took a significant charge for these first 5 LRIPs. Now can you talk about the current status of this program and how we can get comfortable that, that's not going to be a next charge in a sense?

Well, that is something we focus on each and every day, making sure that there isn't the next charge and not just because we're looking to avoid any further financial impact on the program but because that would be a reflection of us not executing the program to our plan. And we are committed to executing the program to our plan. We have stepped back and very thoughtfully reviewed what it will take to deliver this program through the 6 priced options that we have, and that is indeed what got incorporated into our financial accounting for the program and the charge that resulted. And we monitor that program as we do all of our programs, but that one, in particular, gets even more of my attention than the leadership team's attention to make sure we are progressing in line with the assumptions we made for executing the program. We are each and every day, retiring risk on that program as we continue to execute successfully both on completing the test program for the development effort as well as we now have started production. And we are absolutely laser-focused on managing each and every element of execution to avoid future charges but there are risks associated with any program execution, and that is true on this one as well.

Well, can you comment on how -- if I put the inflation issue aside and as you head through these LRIPs, which I assume will -- each one will be larger in terms of aircraft deliveries, if I put inflation aside, how are you doing in terms of performance and schedule and cost ex inflation?

Well, as we showed in our first quarter, we are in line with the assumptions that we made on the program. So we are executing to the plan I just outlined. And that includes not only Northrop Grumman but our suppliers in the supply chain, all of which we are embedded with and managing the incremental milestones that lead ultimately to that multiyear projection that we have for the program and all 5 lots that are priced option. So it will get executed through the decade. But these first months, quarters and years are very telling as we continue to execute those well, it gives me greater confidence that they will continue to be the case as we progress into the later lot.

Well, if I look at Aeronautics as a whole, so B-21 clearly growth but it has this pressure from a margin standpoint. Then you've got some program declining programs, F-18, B2, Global Hawk, but then you've got some other interesting international opportunities, Triton, E-2D. When you put all of those together, how should we think of Aeronautics in terms of a top line growth rate at this point?

So Aeronautics is growing. And we had predicted that. It actually returned to growth a year earlier than we thought it would, and that was not only on the strength of B-21. But as you note, the many other programs that make up the Aeronautics portfolio from mature production programs like F-35 and E-2 to programs like Triton, which was transitioning from its development phase into production, which not only supports growth prospects but margin tailwinds as well as the margin rate improves in that business. So there are many moving parts below the surface of Aeronautics but what we said at the segment level is we expect that business to be able to contribute to our growth, similar to what we're seeing and projecting at the company level, and we see margin tailwinds in parts of the business that offset the headwinds that we have discussed with having B-21 LRIP production booking at that 0%. I'll remind you, other parts of B-21 are profitable and all of that mixed together creates the conditions, which you're seeing in Aeronautics, which is a healthy margin rate, mid-9s is what we've guided for this year and being able to sustain that with the portfolio that we have.

So you're saying over the next few years, mid-9s even with that pressure from the B-21 LRIP portion.

We haven't guided beyond this year but we've talked pretty openly about our expectations that the mix in that business supports margin rates in this staying fairly consistent with what we're seeing.

Now F-35, we just had previous session, Lockheed Martin. But I just wanted to get a sense from you you've been, as I understand it, continuing to deliver to support that 156 per year production rate. When you look at some of the issues around Tech Refresh 3, perhaps delays in Block 4. Is there any point where this can affect you in terms of delivery rates?

So at this point, we have not had any indication that it will impact our delivery rates. For Aeronautics, we have over 450 aircraft on contract and the guidance that we continue to get from Lockheed Martin is to continue to deliver at our capacity, which is what we continue to do.

Okay. And then in terms of modifications and sustainment work, how does that play in to Northrop Grumman on F-35?

So we are involved in the modernization program out of our Mission Systems segment. And we also are involved in supporting the sustainment of the aircraft. We have an agreement with Lockheed Martin for a portion of that sustainment work share, and we've collectively as a program, seeing that continue to grow and expect that will continue as more aircraft get fielded. And the overall mix for us as a company, the production, the modernization and the sustainment still put F-35 at about 10% of our annual company sales. So a very important program to us in all dimensions and across 3 of our operating segments.

Now in Aeronautics -- so Triton has become -- it seems very interesting at this point, you've obviously had the long contract with Australia, this NATO now. Can you talk about Triton where that stands and where -- what the growth opportunities could be?

Yes. So as you note, we've been the U.S. Navy program of record. We also have sold the aircraft to Australia and will be delivering aircraft to them later this year. And now NATO, we have 5 aircraft that we are looking to deliver for their surveillance requirements in Europe. And we have multiple other countries who have expressed interest in the aircraft and are in the selection process. So this is exciting for us because as the program has progressed in its maturity and moved into production, and has gotten fielded, and shown what it is capable of, we are seeing more countries interested in fulfilling their requirements with this ready, in-production aircraft that they can feel very quickly.

Can you -- I'm going to jump over to the other big program, Sentinel. Sentinel I think you all know had an -- now has -- the cost estimates are substantially higher it had a Nunn-McCurdy breach. That is -- as I understand nothing to do with you. But can you talk about where Sentinel is, how that program is progressing? And specifically, how it's progressing for Northrop Grumman in terms of revenues and earnings?

Well, let me first say, it has everything to do with our execution on the program to be able to help the Air Force find ways to deliver this capability for the taxpayer in an appropriate and affordable way. So we are in partnership with the Department of Defense to deliver this capability. Yes, the program has like every program and every one experienced the impacts of inflation when the program was cost estimated. Last 4 years ago, it was before the start of the pandemic, and we all know what has happened to materials, particularly construction costs during that time frame. And so those cost increases are now being reflected in the latest government cost estimates associated with the program and need to be understood, dealt with and rationalized. But as the prime on the program, we take ownership to work with the government to help that happen. As we are working through that process and the government will work through a process here in the next 6 weeks or so to determine whether they recertify the program and any changes they want to make to it going forward, we will then rebaseline associated with these changes. The program is core to national security. It's been supported through many reviews by each new administration who comes in and does the nuclear posture review that we need to try at, and that is the current policy of the land. So I do anticipate that the program would be recertified and then we will go into the process of incorporating any changes into the baseline and press forward. At the same time, this review is going on, however, we are also heads down executing the development portion of the program because largely, these impacts are related to the deployment phase of the program. When we get out into the missile fields and are doing the work on the silos, which doesn't happen in...

That's post 2030...

That is post 2030 at this point. We'll do some early implementation as part of the development program, but the production as you would think about it in this program, we call it more deployment happens in the 2030s. And so most of what I've just characterized is impacting that time frame, not the work that we're doing today. And I think that's where your comment came from that we are not distracted by the review of what's going to happen later in the program, we are executing on the program as it exists today.

But what it does do, I would think -- I mean, the delay in deployment stretches out your -- in other words, there might have been some more growth, and it's a cost-plus development contract, but there might have been some more interim growth pre-2030 before than there is now, that has -- that's stretched out. Is that right?

Well, the program is likely to end up larger and so a larger program stretched out over a couple more years. The profile probably doesn't look very different because the overall program is bigger as well. It's not the same size program stretched out over 2 more years. It's a bigger, don't you think?

Yes. And then I want to jump around a little bit here. If we go back to where we were in the budget before with the supplemental passage, how does that benefit you? How do you see Northrop Grumman winning in that?

Well, I've talked about a couple of areas already. Certainly, as the U.S. and our allies look to replenish stockpiles of weapons, we are part of that supply chain and also a prime deliverer of some of those capabilities, some of which are funded in the supplemental. We also received direct funding in the supplemental to add some surge capacity for solid rocket motors, which has been a bottleneck in the supply for tactical missiles in particular. And so we'll be off executing that to further increase capacity above what Northrop Grumman invested to get to 3x our capacity, and I shared this in our first quarter earnings call, that work is largely complete. And fueling what you've heard from some other companies about their ability to deliver more growth because the supply chain bottlenecks are starting to be alleviated in that space, and we're proud of our investment and contribution to make that happen. But on top of that, the government has authorized some funding to us to go create even more search capacity. And we also have some the shipbuilding industrial base, the submarine industrial base funding coming to us to support the scale-up that we are doing in support of those programs as well. So a pretty broad and comprehensive set of opportunities that we are getting funding through the supplemental either directly or through province.

One of the programs that you've talked about in that has clearly increasing demand in Europe is IBCS. You made a comment that, that could be on the order of $10 billion for IBCS. Can you help us understand that a little better and where the demand is and how that might ramp?

So the demand is worldwide. It's country allies that are looking to improve their Integrated Air and Missile Defense capabilities, which is just develop all of our allies right now, but particularly in Europe is where we've seen the demand increase substantially just in these last 24 months. And when I talked about the franchise of IBCS being approximately $10 billion, it includes the countries that have expressed interest in -- or in the sales pipeline today, which is 7 countries in addition to where we are already fielding the capability, which is the U.S. and Poland.

And I just -- one thing that struck me is just more broadly. Northrop Grumman, if I go back 5 years ago or so, international was a pretty small part. I mean they can participate in F-35, things like that. But where do you see international going? It seems like there's a larger range of opportunities here.