Northrop Grumman Corporation (NOC) Earnings Call Transcript & Summary

Okay. Let's get started. I'm Doug Harned, Bernstein's Global Aerospace analyst. And I am very excited to have back with us again, Kathy Warden, the Chairman and CEO of Northrop Grumman. I know Kathy has got a few things to say here first. So I'm going to turn it over to her. If you have questions, you can put them in through the pigeon hole link in there, but then we'll go straight into a fireside chat. So Kathy?

Thanks, Doug. Great to be back with you. Good morning. I wanted to share a few opening comments that before I do that, just to remind you that we might make forward-looking statements today. And with those forward-looking statements, there are risks and uncertainties. If you can find a full disclosure of those risks and uncertainties in our SEC filings. So as we come into this year, it has been a dynamic time, but we, as a company, are coming from a position of strength. We have a backlog of nearly $93 billion. We have continued to see our programs be well supported in the U.S. budget and reconciliation bill, and I'm sure we'll talk a bit more about that as we get into the conversation today. We also are seeing incredibly strong international demand for our products. I've talked before about having expanded our exportable product portfolio, having about 3x the number of products that we can export today as we did just 7 years ago when I stepped into this role, and that's providing strong tailwinds as well. There are a couple of recent announcements that I just want to draw to your attention. One is that our Board approved a 12% dividend increase last week. That is our 22nd annual increase. And we also, just yesterday, announced the divestiture of our training services business and we outlined the expected benefit of that in our first quarter call. So I'll refer you back to that, but I just wanted to let you know that it indeed did close. So with that, Doug, I will turn it to you. You have a lot of questions, and we'll get into the meat of what's happening in Washington.

Okay. Great. Thanks, Kathy. Just to start, can you take us through when you take an overall look at Northrop Grumman today, what are you seeing as the biggest opportunities and the biggest challenges.

Well, the largest opportunities we have, as I just noted, are the strong backlog that we have as a result of having a technology portfolio that is in high demand, both within the U.S. and globally. We also have a significant set of opportunities to expand with our current backlog programs that run 20, 30 years into the future like B-21 and Sentinel as good examples of being in the early stage of developing game-changing technology for the U.S. and the opportunities still sit ahead of us to move those programs into production and generate strong earnings and cash flow. I also look at the strength of our portfolio in terms of its alignment to new and emerging opportunities. I talked about the strength of international. I was just on the President's trip to the Middle East 2 weeks ago, and we see these opportunities emerging as additive to what we saw coming into the year. And of course, Golden Dome, which I'm sure we'll talk about a bit more is a new opportunity in the U.S. that has significant alignment with Northrop Grumman products that we can offer as part of that focus area as well.

Well, if you -- starting out with the budget because one thing we've seen, we have this -- the skinny budget, the President's 2026 sort of framework, which we don't have a lot of detail on that. And then we have this reconciliation bill, which adds a lot. But a lot of what's in there doesn't have to be obligated for 4 years and spending is over a very long period of time. So first, can you comment on how you see this budget coming together, timing of when we may know more and implications for you all?

So as you know, we don't have a lot of detail on the '26 budget, the skinny budget provides some areas of focus for spending in the Department of Defense. And those align well to what's in our portfolio, things like the nuclear modernization, munitions and missiles as well as space. And as we see the details programmatically, we believe our programs will be well supported, but that will come when the Congress receives that President's budget, which we expect shortly. But with that said, the skinny budget, plus what's in the reconciliation bill, the numbers that are being discussed would represent a 12% increase for 2025 budget. So it is a significant increase. If indeed, the reconciliation bill has passed and a significant portion of that 4-year funding is used in '26 and aligned in the way that the Congress has outlined in the bill.

Yes, because it's just -- it's been somewhat challenging to try and understand the timing of when many of those initiatives in that reconciliation bill would play out. But are you -- when you look at this and you try and apply that to the 2026 skinny budget, I mean you're still seeing significant growth. I guess that's my question?

We are. And even though there are 4 years under which those funds could be appropriated, if the intent is that those be front-end loaded, which is what has been discussed by the President, when the administration has talked about spending over $1 trillion on defense, that would suggest that much of that reconciliation funding would get utilized in the earlier phases and that is indeed what we're hearing. But all of that is yet to play out, as I said. And when you look at specific elements in the reconciliation, there's significant funding for programs like B-21 and Sentinel. And so we have more insight into what the government is thinking about how those funds would be used than we do others like Golden Dome, that's a large pot of money, but the government has yet to define how that money will be spent in the acquisition strategy specifically to put that on contract.

You were just on the trip in the Middle East. I guess 2 things. Can you give us a sense of on the defense side and what -- in terms of possible things that Northrop Grumman might be able to contribute to within the umbrella of what was described as a very positive trip in terms of the U.S. defense exports? The first part. And then the second part, have you gotten any additional insight into tariffs? I know it's not the biggest issue for Northrop Grumman, but it's still there.

So let me start with my trip to the Middle East, which was a trip where we were really confirming demand on a number of things that we were already discussing with the Saudis, the Qataris and the Emirates. And this is areas like Integrated Air and Missile Defense. I've talked at length about our IBCS program and the global demand that we have seen emerge for that product offering. And in each of those 3 nations, there is interest in that product. Of course, we already are selling munitions. There's great interest in tactical missiles like AARGM and those areas were discussed. And then in each country, some unique areas, sensors and radars in Saudi, for instance. All in total, multibillion dollars of opportunity in each of those 3 countries, and this is a function of continuing to build on what was already expressed demand from these countries, but showing the U.S. support to export those products to them and to sense of urgency about moving forward on these opportunities. So a real tailwind to our business development efforts in the Middle East. You asked about tariffs. We certainly are understanding tariff risks as they exist in our portfolio, they are less than most companies just because we don't acquire much outside the United States, as you would expect, some of that is contractual based on the types of systems that we work on, we have requirements to buy U.S. So I shared in our first quarter earnings call that we have about 5% of our supply chain, which is less than $1 billion that we acquire outside the United States. Now of course, we look beyond just what we're buying. It's -- how does that fit into our supply chain and our product offerings and what impact could it have if we didn't have access or if the costs went up, and we have done that. And largely across our product portfolio, we do not see a risk of significant disruption. And where we have seen risks that we needed to mitigate we've done so well into in 2026. And in other cases, we're already working on second sources. So for each program, it's a slightly different mitigation strategy, but all of those are underway and we incorporate the risks as we see them today. So we've made no updates to our guidance based on tariffs, and we don't believe that we need to.

I'm curious, you said multibillion dollar opportunities in each of those countries. Are you referring to opportunities for Northrop Grumman of that scale?

Yes. And in the areas that I articulated. .

Yes. And when you think about that, and you put that kind of altogether with your other international opportunities, are you expecting a higher growth rate now? You've talked before about international -- how strong international growth appears to be. But how does that look now compared to your overall growth?

I would say that our international demand has continued to expand, including as we have progressed through this year. We have articulated that we expect international through the decade to grow double digit and that we do believe that international will continue to -- our international growth will continue to outpace our domestic growth, although that's a competition that we like to have. We want to see both grow and we are. And so as we look at the pipeline now, the pipeline is stronger, but it does take time to convert these opportunities into awards. So we don't expect a significant change in our '25 outlook. But as we look toward the end of the decade, this is just bolstering our strength of pipeline for sales in that period of time.

I want to turn over to aeronautics and talk a little bit about the B-21. That's obviously been -- it's a very important program for you. And in the last earnings call, you talked about this additional -- this charge has to do with different processes, has to do with some of the costs on the supplier side. Can you give us a little more detail on how you're thinking about that situation right now and what it means for margins on B-21?

So as we think about margins, let me just address that upfront. We take the charge, and we had already been booking at 0 on the low rate initial production lot, so it doesn't change our margin outlook on a go-forward basis. Just to clarify that. In terms of the charge itself, we have characterized it in 2 buckets, the first being the increase in cost and usage of what we call procured items. So this isn't so much in items that a supplier delivers. This is materials that we utilize in the production of the aircraft, and we saw inflation continue to make those costs increase and we also are utilizing more of it. And so we outlined that in our Q1 call. And then the second, as you noted, we made some process changes that would allow us to accelerate the rate at which we build the B-21. This is ongoing conversations that we've been having with the government that we believe made sense to make these process changes, and we continue to work with the government to outline the merits of moving faster in the build process as they contemplate what they would like that plan to be on a go-forward basis. So we've taken the costs associated with making that change in the first quarter. The program continues to obviously have opportunities and risks that we evaluate every quarter. We've been quite transparent about that. And we will continue to do so as we move through the program, we are progressively retiring risks associated with performance because we are just further along in the build process. Not only do we have more actuals behind us in that build process, but we have more learning and experience upon which to base our forward estimates.

Well, and I'm sure you know this well. But when you look at the history of major military aircraft programs, I honestly can't think of one in the last 30 years that didn't have substantial issues, cost, time line, performance. The B-21 has been interesting because that so far, at least what we've heard from the Air Force and from congressional committees is that the program has actually proceeded quite well in terms of timing and performance. But when I think many of us see a charge like this, you start to wonder, well, we're not in production yet really. And is there a risk that this could go the way of some of those others? How do you get confident in the outlook for the B-21 from here?

So as I've described in the past, there are a couple of things that we look at, and certainly, our investors can as well, and that is how is the aircraft progressing through the test program because testing is the time in which you would discover any challenges that need to be rectified in the aircraft. And so the Air Force and we are providing regular updates on how the Jet is progressing through test. And it is not only progressing through on a timely basis, meeting its scheduled milestones, but it is also performing to test expectations and the Air Force has reiterated that. And we do each quarter as we update you as well. The second area to look at is how are we progressing through the build process. And of course, the change that we talked about in the first quarter and the charge that resulted was part of the build process learning that we had. And so as we get further along in that build process, those risks become better understood, retired or incorporated. And so that is continuing to be what we will look at as we progress through the program. And as I've said, while those risks and opportunities exist, there is uncertainty that we are projecting into the future. The greatest challenge we've had so far -- by far has been our inflation assumptions when we did the program back in 2016, we had built a financial deal construct around inflation assumptions over the period of time that we would be executing and they indeed ended up being higher largely as a result of the inflation that we all experienced in the early part of this decade that was unanticipated. And so I know it's hard to reconcile how can we hear a program is doing so well and yet the financial outcomes wouldn't indicate that, that is largely the disconnect between those 2 items. But we try to be very clear and transparent about those risks associated with performance, those risks associated with macroeconomic and both still exist, but are lessened over time as we execute and get actuals behind us.

Moving on within Aeronautics. I mean as a large subcontractor on F-35, still a very important program. We're looking at depending on how budgets go, but assuming you can fill in any gaps with international deliveries, pretty flat production outlook over the next few years. So when you think of F-35 for Northrop Grumman, there's obviously upgrades, there is sustainment work that you participate in. How do you see the revenue trajectory going for F-35?

So we expect the revenue to be approximately 10% of company sales as it has been for the last couple of years over the next several as well. And it's a combination of multiple moving parts. There's the production of the aircraft and there in aeronautics, which is the bigger driver of our revenue, we are at our max capacity of 156 aircraft a year. So that's what that modeling is based on. We also are working on modernization with Block 4 upgrades. That's primarily in our Mission Systems business, and that's driving some growth on the program. And then sustainment has been a key driver of growth on a percentage basis. It's a much smaller percentage of our total revenue today, but growing at double-digit rates. So it is contributing some upside to our overall growth profile for the program.

And if we switch over to Unmanned systems, when you've seen some of the more mature programs kind of come down like Global Hawk, Triton is clearly a very important program. We've seen funding kind of come into the U.S. budget is obviously Australia, opportunities potentially in Europe. Can you talk about that? And what you see as a trajectory for that program?

Yes. Well, first of all, Triton is a platform that is highly relevant in theaters where you need long endurance. That's actually -- it's called a HALE platform, High-Altitude, Long-Endurance, because it can actually give you days of coverage being an unmanned aircraft, you don't have to worry about a pilot being able to be out on a mission for those long periods of time. Also, high-altitude gives it a resiliency. It's not easily observable or targeted. And so when you think about why was the platform developed in the first place and what's needed in the world today, it is a highly relevant platform, and that's why we're seeing international partners seek it now that it is in production and more certain cost profile. And so we expect it to continue to have growth. We have a production line that is secured with orders through the decade and are looking to expand upon that. And as we think about its role in the world today, it's primarily a surveillance platform, and it is a relatively low-cost alternative for the missions that it provides. So we expect it to continue to be operated and maintained well into the future.

So when you put all of this together, I know if we go back a couple of years, you had a lot of mature programs that were ramping down. it was still -- you were still in the process of kind of ramping up on B-21 revenues. When you look at the outlook today for Aeronautics, I'm assuming we're out of that valley. But what kind of growth should we expect in total?

So we have forecasted in our outlook, a mid-single-digit growth rate for Aeronautics this year. And that incorporates the factors that you were just talking about, some programs declining, others steady state and then, of course, programs like B-21 and a couple of others that are growing over the next several years. And so we expect that, that mix to continue to result in similar growth trajectory for AS beyond this year. But right now, we've just provided an outlook for guidance for 2025 in that mid-single-digit.

And when you think about margins now, because the B-21 will be booking at 0 margin here for a while. Should we be thinking of this as kind of a 9%-ish type margin business when you have that in?

So again, for this year, we're looking at high 9s, and that's coming off of the year last year where we performed around 10%, which was higher than we expected and higher than we had guided. So the team continues to perform very well on our mature production programs in aeronautics, which is helping from a mix standpoint to offset some of the B-21 pressure in margin rate. In addition, as we are more successful in the international pursuits that backlog comes with a higher expected margin rate as well. So those factors allow us to feel confident in what we've projected this year is high 9s.

If we go over to Defense Systems, Sentinel, currently cost-plus program. So relatively low margins. And you've had the issues here with the Air Force pushing out IOC into a -- little farther into the 2030s. What are the implications of those -- that Air Force delay on Northrop Grumman?

Well, last year, you may recall, I spoke about that change in the Sentinel program profile that the government was going to be doing a restructure. But based on what we knew about the time line coming out of the Nunn-McCurdy review we had changed our estimate complete our view of the program to reflect that flattening, is that slowing of growth on the program. And so that is what was incorporated into our updates last year for the program and our guidance this year. And so now what you see in the budget is the government will be doing the same. The budget will reflect that different annual profile, but we do not expect that to change at all what we have laid in, they are expected to fully fund the program for the industrial base needs to continue on the program that we have laid out.

Because it's interesting, too, and you mentioned this at the beginning. When you look at the priorities of the Trump administration, clearly, nuclear deterrence is right up at the top. Are there any opportunities sort of when you sort through what might be in these bills to expedite some of what the Air Force is doing.

Yes. And I think that's what you see reflected from the Congress as well in the reconciliation bill, adding funding to programs where they see the opportunity for additional resources to accelerate delivery. It's a conversation we're having on B-21, as I spoke about earlier, we are having the same conversation with the Congress and the Air Force around Sentinel of what additional funding could be applied to both risk reduce the program, but also accelerate our ability to fill the capability in the 2030s and what could we be doing today to make that happen. And we are collaborating with the Air Force to identify those opportunities and then bring them forward for funding.

And since this is a very large program for you, when you look forward, do you have the sense of when you might start to move into an LRIP situation where you would then start to get higher margins on this?

So we have said late this decade into early next decade is when you would see us move into production. And yes, there will be long lead just like there is on any program of this type that starts to lay in later this second.

Okay. So AARGM-ER, a big program in Defense Systems. Can you talk about where your opportunities are, particularly internationally? I know Poland is an important customer. Where can this go?

So for AARGM, we are really excited about how that program is delivering. And then AARGM extended range, which provides an even more capable missile is also moving toward production. And as we have both of those systems qualified for multiple fighter aircraft, we have seen our international pipeline expand dramatically. Dozens of countries that have been approved for export for those missiles. And so the focus for our team is ramping up so that we can produce faster right now. The demand is there. We have to be able to ramp supply. And so that has been the focus of our capacity expansion at facilities like our Allegany Ballistics Lab, where we have invested significant resource to expand our capacity of solid rocket motor production, but we have also there built an integration facility where we can expand our capacity to build AARGM-ER. And so as we do that, it will be -- it will help us to be able to fulfill these international orders as they come.

Is it because you've guided to double-digit organic sales growth in Defense Systems? So certainly, you have Sentinel, but it seems like it's these other programs that are really kind of pushing your top line up there. Another one is clearly IBCS. And I know you described something on the order of $10 billion in potential opportunities. But -- and I think you've now having discussions in Japan as well. So can you take us through how large IBCS can be? I understand the opportunities that are out there, but what can we see that in terms of revenue and growth in the next few years?

We expect IBCS to be a significant growth driver for us internationally. We have, as I've shared before, over a dozen countries, a significant number of NATO countries. But as you noted, also Japan, as I was visiting the Middle East, I mentioned all 3 nations expressing interest in Integrated Air and Missile Defense and the IBCS product specifically. So we are seeing a broad-based demand signal for that product. And the reason is it allows you to provide Integrated Air and Missile Defense in a way that reduces your need for sensors and kinetic effectors driving down your overall ownership costs of a complete system to do the Integrated Air and Missile Defense mission. And so it really is a program that we believe, is going to continue to have value in each of the individual nations, but also it becomes a global franchise, where it supports the interoperability of nations who are engaged together to either protect a particular area of operation or to share information coming off of your sensors. And so this, in any ways, is beyond just the value that a single country the system can provide as it integrates with others who are operating the similar Integrated Air and Missile Defense architecture.

So if we look at this double-digit growth for Defense Systems. I mean, can you help us kind of break down on that a little bit in terms of what the highest growth pieces are? Because there are several things in here.

So it is a factor of all of the elements of the portfolio that you just talked about are contributing nicely to growth above the mid-single digit that we have talked about for the company as a whole. The DS portfolio is benefiting more from international growth through IBCS and the missile systems that we just talked about. Tactical weapons, not only our own, we spoke about AARGM and AARGM-ER. There's also stand-in attack weapon where we are a prime integrator and that program is growing, but we also are expanding our supply agreements for solid rocket motors for other people's tactical missile programs, GMLRS, Hellfire, et cetera. And then we are also on the front end of areas of growth like hypersonics and the work that we're doing specifically on the HACM program, which also is out of our Defense Systems portfolio. And then, of course, Sentinel. So when you add all of that up, there is growth coming from each of those areas and significantly outpacing what we see as market growth across the portfolio.

And I believe in something else in there, which maybe it's harder to talk about hypersonic defense?

Yes. That's actually in our space portfolio, the glide phase interceptor program is a program designed for intercepting glide phase hypersonic weapons. And we are very pleased to have started execution on that program as well. We think that it has relevance directly to Golden Dome, but it is a collaborative piece of work with the Missile Defense Agency in the U.S. and our Japanese partners. And so it is obviously intended for our allies as well as we develop and begin to produce that capability.

Yes. And with that, I want to transition over to space. When you look at the Golden Dome concept, so you have the hypersonic defense. You also have clearly a lot of participation in space-based systems that are relevant here. How are you thinking about the opportunities associated with Golden Dome?

We clearly believe that Golden Dome will be an architecture that includes many different systems and will be acquired through many different programs, some of which exist today and just we'll need to have more capacity and others which will be new. I just spoke about glide phase interceptor and that is a hypersonic interceptor as I noted, but we also have, for decades, been a leader in the missile warning and tracking space within Northrop Grumman. We are on multiple programs today that provide a base layer for missile tracking and warning, including the space development agencies, Tranche 1 for the tracking layer, the HPPSS satellite prototype that we build and then, of course, more traditional like our OPIR next-generation polar satellites. So we understand how to do that missile track and warning from space, and we also do the mission management, for the ground base taking all of that information, making sense of it to inform the operators. In addition, when I think of what that mission management scope looks like, it's not just about space, it includes things like we were just discussing with Integrated Air and Missile Defense, more underlayer, if you will, for tracking of close-in missiles. And so we expect that to be part of Golden Dome and IBCS providing a starting point for such an architecture there. And then space-based interceptors themselves, we are the largest propulsion provider for interceptors today, and we expect that would be a market for us going forward on programs that include build-out of more space-based interceptors. So it's really a broad-based approach. We expect in some of these areas, we would be a prime provider and others, a supplier and we see it as many captures inside of a set of opportunities that are emerging now, but likely will be coming to fruition over a number of years.

Well, when you think of this, obviously a huge, complex system we're talking about. We've had, in the past, there have been a lot of complex systems and we've had JADC2, future combat systems, even call GMD, would even be one of those. When you look at this, what are your thoughts in terms of -- what do you think the best way to go would be in terms of really a technical -- you've got national teams, you've had like company-led teams. What do you think the right answer is for a technical solution and for an acquisition solution?

So General Guetlein has been selected to be the government program manager, and I have a lot of confidence in his understanding of how to define an architecture, but then acquire pieces of that architecture in a coordinated but a separate way. And I believe that is what makes the most sense here because, as I said, there are some programs where you just need more of it. And so the easiest and fastest thing to do is to add resources to either move faster or buy more quantity of the things that are already being contracted that fit nicely within the architecture. There are other areas where you will need to develop new capability. And so that takes a little more time, you run competition, and you will engage new industry players to do that. And that whole ecosystem means an industrial base that is fraud. I think you want to use all the players on the field because this is a lot of resource and schedule that requires the government to move very fast. So I don't think it makes sense for this to be viewed as a single acquisition, but instead, an architecture and a framework for buying that includes many different pathways to get there.

Okay. Very complex road ahead. If continuing on space. So after the loss of NGI and you had the classified contracts. So your space revenues came down some. Can you talk about now what your outlook is in terms of growth in space and where it's most likely to come from?

The growth in space will continue to be broad-based up until this point and has included growth drivers like restricted space, which continues to be a growth opportunity for us in the future. It has included the propulsion systems that I spoke of, particularly as we look forward the highest growth area we expect there is actually space launch for programs like Kuiper, where we would provide the propulsion systems for Amazon to launch its satellite. We also see that our Space business has been mostly for the U.S. government. There is some opportunity for international expansion in space, which would be forward growth. It has not been a key contributor up into this point. So those would be the growth drivers. And then the area that we're looking at that we don't expect to contribute to growth going forward is NASA based on what we're hearing about NASA budget. But that's a relatively small portion of our space portfolio today.

Yes. I'm curious on that. Yes, we've seen changes in the NASA budget. I mean, that I guess, becomes -- does that become a lower priority for you? Or is it -- how are you thinking about NASA now in the whole scheme of things?

Yes. It's not that it's a low priority, but it has been a relatively small portion of our portfolio even now. And we expect, as I said, that it will not be a growth driver for us. So in that regard, it's not an area that we would invest significantly in but it is an area we'll continue to support because NASA has an important mission, always has, and we think it will continue to. It's just not going to be as well resourced in the foreseeable future based on what we're hearing.

Now on the SDA tracking layer, you did not go into Tranche 2. How are you thinking about that? And how should we think of the tracking layer and the transport layer, how do you look at those in terms of the evolution of those systems and your participation?

Well, we look at how well we're positioned and where to compete, and there are so many opportunities that we do. We are selective and disciplined. We had bid and won and are executing on Tranche 1 and we were maturing that capability now in production. So we have that experience behind us to inform future bids like tranche 3. At the same time, we were also executing and maturing our payloads on HBTSS, similar technology, and we were doing that for the Missile Defense Agency. So we just make sure that we have a pathway through government-funded work to progress the technology, which we did on both of those. And that then we use that as the basis for competitively bidding in ways that we have assurance we can execute, and that's what we've done here. So I feel good about how we're positioned, continuing to position in missile track and warning.

I guess one of the -- not just here, but one of the things we're seeing more broadly is the participation by a number of new entrants. And that's certainly been true with some of the FDA programs. We saw it in CCA with Anduril. How are you thinking about these new competitors here? And what implications are there for you all?

Look, we embrace competition. It makes us better to have competitors who are driving the technology base forward. And yet, we feel well positioned with the talent that we have, the experience that we have, the capacity that we've invested in, so that we can scale our offerings. And we, of course, as you would expect, have looked across our portfolio at our win rate even in areas where the government has chosen to use their OTAs and non-FAR-base acquisition models. And we have -- we're very comfortable with where our win rate is. It's very good. And so that leads me to believe it's not about contract type. It's not about who you're competing against, it's about how good your offering is, and that's what we focus on as a company. And that's what we'll continue to focus on. I feel like we have all the ingredients within the company to continue to bid and win in those environments. But we also partner. And so when we see a company big or small, that's bringing a novel technology or capability that we don't have, but we still have the expertise and the mission knowledge, then we partnered with them and we work together, and that's another way to market for us.

If we go over to Mission Systems, Mission Systems is a very hard 1 from the outside to model in detail. There's so many programs in there. Can you give us a sense of what the most important programs for growth in that business are today?

So Mission Systems is difficult to model because it is a lot of programs that are in that $1 billion class and it's technology that goes into a platform usually and so you can't see it and touch the way you can, an aircraft or a spacecraft, but it is what sits inside those platforms that help them provide the mission, and that's why we call the business Mission Systems. And so in many ways, it drives more value in the total system than just the revenue it produces. It's why it's our highest margin business because that technology innovation is reflected in the margins that we can get for the work that we do in that portfolio. And where we have traditionally focused is in sensing, warning, that radars, managing the electronic spectrum, that's electronic warfare sensors and capabilities. And then also in the computing itself, and you've heard me talk about how in that business, we have 2 foundries, and we are developing our own chip technology often that is providing performance better than what you have commercially because it needs to be there. It's a requirement that you wouldn't know it to do with that kind of power in your smartphone. It would be beyond the capacity you could utilize. So we're off developing our own technology to go into systems like that and enable government applications in form factors that are very, very small. And we focus on things like power per energy consumption, the same kinds of things other tech companies are doing, but it's a different set of requirements. And I think a lot of people just don't appreciate that, that kind of innovation is coming not out of Silicon Valley, but out of a defense company, and it has for several decades.

And as you say, I mean, the margins are -- have been very good. You've been -- you've had margins sort of generally in the kind of the 14% range for some time. But international sales have been growing. It's now up to, I think, 19% level. Should we expect to see margins move up? Can they go to at least 15% type margins if that mix shift occurs?

We have talked about that there are 2 tailwinds to margins that are mix related in Mission Systems. One, you just noted, which is as international as a percentage of sales, which in Mission Systems has been up in the mid-20s at times. And as you know, today is about 19, so there's definitely some room to move there, and we see that based on the pipeline that we have built for Mission Systems internationally. And then the second is we are at a high watermark historically for cost plus development work in Mission Systems. These are where we're building the first dose. And once we get through that, we'll move into production and production obviously has historically been significantly higher margins. So as that shift occurs, and we move out of development into production, that's also a tailwind to Mission Systems margins. So yes, is the short answer to your question, we believe both of those dynamics lead to better margins at MS.

Okay. Very good. If we put this all together, so you've maintained your free cash flow outlook, which is going to about $4 billion in 2028 and that's even with the B-21 charge, which will be some hit on cash. Can you talk about what's enabled you to stay with that guidance even in the face of this one issue?

Well, we build our ranges based on a number of factors. One is assumptions about the growth environment that we expect over a multiyear period and other is the margins that we anticipate. The third is the investment levels that we will have in the business. And then there are some nonoperating items as well that contribute to free cash flow. And so as we've stepped back and looked at all of those elements and the things that are inside of our control, but also externally what we believe those factors are and revisited what those ranges were that we put in place out through 2028. For free cash flow, we see a path to still execute those. And so we have not made any changes.

And then when you look at the cash, can you describe your cash deployment priorities.

Yes. So our cash deployment priorities have not changed. They've been consistent and remain consistent. We see a strong opportunity environment. So our first priority is to invest in the business and realize that long-term potential in our business by making the investment in both capabilities and capacities needed to go after and successfully prosecute against the opportunity space that we see both domestically and internationally. Our second priority has been to pay a competitive dividend. And as I indicated at the beginning of this discussion, having just done our 22nd annual increase and a double-digit increase at that with this one being 12%, showing that we are moving continually to return through dividends, cash to our shareholders. And then the final is we selectively also have been using share repurchase as a way to return cash to shareholders. And this year, we've committed to 100% free cash flow return to our shareholders. And so we will make up that delta above the dividend with share repurchase.

And just related to that, when you look at your portfolio, you have the exit of the services and training business, you made some changes over in the past, you made a couple of other divestitures. How are you thinking about your portfolio today? Is it where you want it to be? Are there areas that you could think of adding or maybe are not -- if something might be noncore?

We are very pleased with the portfolio that we have, both the breadth and depth. We're able to lead on large opportunities and be a prime that can execute and deliver. But we also are a supplier in many areas because we are one of a few technology providers in key technologies that are needed across the defense industrial base, and we can do that at scale. And so we are pleased with the portfolio we have. We are working on a number of areas of expansion, international, I've noted. And so we continue to mostly drive through partnerships the ability to build that same scale and presence where needed outside the United States to execute on that international portfolio, but that's something we'll continue to look at. And then we also make selective investments in partners where we're codeveloping technology. And so we have done some of that. Right now, M&A does not that into our strategy is something that we need to do to expand the portfolio. We've been able to execute successfully with what we have internally and the partnerships that we have built and investments that we've made in our partners outside the company. But we continue to be quite active. And as you have noted, we have done some divestitures where we wanted to free up our capacity, both time and attention of management and resources to invest in other places, and we'll continue to do that where it makes sense as well.

Well, good. So just to finish up over the next 12 months, what are your priorities, where are you going to be focusing your time?

Well, I'll be helping the team to navigate in this dynamic environment to do what we do best, and that is first, execute and deliver for our customers because that positions us continue to win and capture the opportunity that I've talked about. And I will continue to work with the team to make sure that we are capturing those opportunities in a disciplined way, both domestically and internationally. We will continue to make smart choices about where to invest in capability and capacity for the long run of the company, and position ourselves, not just for the rest of this decade, but into the 2030s. And I feel really positive about how we have grown this company and its backlog in the areas in which we have been successful doing that and how that positions us into the future. And then finally, focused on continuing in the long term to build the talent that we need in the company to execute as we scale and continue to compete, deliver and win.

Great. Well, again, thank you very much for joining us here, Kathy.

Thank you. Great to be back.