Northrop Grumman Corporation (NOC) Earnings Call Transcript & Summary

Good morning, everyone. My name is Peter Arment, senior aerospace defense analyst here at Baird. We are delighted to have with us Northrop Grumman Corporation. With us from Northrop Grumman, we have Kathy Warden, who's Chair, CEO and President. Northrop Grumman is an $82 billion market cap company. It's had a terrific year, a strong 2025, recently reported 5% organic growth, healthy margin expansion, robust free cash flow growth, and they've highlighted some mid-single-digit organic growth. I think that's above peers for next year, and they're on a path to double their free cash flow by 2028. I think, Kathy, thank you again for supporting the conference. Really appreciate it. Kathy is going to make a quick safe harbor statement, and then we'll jump into Q&A.

Thank you, Peter, for that introduction. It's terrific to be back with you again. I would like to remind you that I may make some forward-looking statements, and those come with risks and uncertainties. For more details on those risks and uncertainties, you can reference our SEC filings. And with that, you did a fantastic job of summarizing the company's performance through the year. We absolutely are looking for the government shutdown to get resolved this week and to head into the rest of the fourth quarter strong. I look forward to turning it over to you and answering any questions you have.

Yes. Well, so maybe we'll just start with the current landscape. I think maybe if you could set the stage kind of the big picture, how you're seeing from -- you just mentioned the shutdown, but also there's been a lot of memos that have been circulating coming out of the Pentagon and how actionable you see this. Maybe you could set the stage, stay the state from there.

Absolutely. There is a good bit of transformation going on within the Department of War. We are seeing new acquisition strategies, a focus on a national defense strategy that now is much more inclusive of a homeland security emphasis and the budget to go with that. And we are seeing a department that wants to move at speed with our industry partners. All of this to me is incredibly encouraging. We came into the year knowing that the demand environment was very strong, both in the U.S. and globally. And now what we're seeing is a department that is looking to make acquisition reform to help expend those dollars in the right ways more quickly and to partner with industry and open up the aperture for us to bring forward solutions to help them do that. So it's an exciting time in the industry. As you know, there are a few things that we are working through the government shutdown. Certainly, as we talked a few weeks ago in our earnings call, we were looking forward to that getting resolved by this time so that we could see some of the delays that we were experiencing break free. We have seen some slow in payments. So we're looking to get that issue behind us as we complete this year. But we still believe that our guidance ranges hold with a resolution within these next few days and then 6 or so weeks left in the year to get that behind us. As we look into 2026, though, a really optimistic outlook for the future, both in the U.S. and globally based on the strong demand signals that we're receiving.

That's great. So the demand signals are very powerful, both from domestic and international. But one of the other things that are also just we've seen a lot of growth in sort of the competitive landscape, whether it's attributable or expandable systems, gaining traction. And obviously, you've leaned in on a lot of things. I think there's -- but I'm wondering how you see some of those different things shaping the market.

Yes. Our portfolio is really well aligned to what both the U.S. and our allies need right now. The idea that each need to be able to protect the homeland and the work that we do from missile tracking to interceptors as well as the ability to command and control those assets to have good situational awareness of the threats that exist and how to mitigate those threats. We also have been building up, as you know, capacity in our solid rocket motor business, fuse heads -- fuses and warheads, all of which support the tremendous growth that we're seeing in tactical missiles. And we are at the core of all three legs of the triad being a prime on two of the three legs, which is key to strategic deterrence, which the U.S. provides for our partners around the globe. And so as you look at that complete portfolio, we already have significant work in backlog, over $90 billion of backlog in the company, and we have production awards on many of those areas that I just talked about that are still into the future. They're not in our backlog yet. They are future phases on existing programs. So we see that clear pathway to continued solid growth. We have had approximately 5% growth a year for the last 6. It's obviously not been 5% each year, but on average, that compound annual growth has resulted in a 5% growth. And we see that mid-single-digit growth continuing even without some of the things that we've recently discussed that are additional upside opportunities for our company. For instance, the Navy Fighter Award that is still pending or the B-21 being produced faster. Those opportunities sit on top of that foundation that I just spoke to.

Yes. So Northrop Grumman, I mean, is involved in some exquisite programs, but you've also leaned in on some of these more attributable. I think one of the things that we saw like recently low-cost systems like Lumberjack. Maybe could you talk a little bit about like that, just like you kind of balancing the portfolio?

Yes. And it's a good point. We are balancing the portfolio. We are often thought of as an exquisite developer of technology, and we pride ourselves in that. And that technology sits at the core of many of the solutions that I've already mentioned, but it also can be scaled to more affordable solutions, and we have product lines that enable us to use the technology that we develop for more exquisite purposes, scale it down, and Lumberjack is a great example of that. It is a much lower cost system that can be added with payloads that provide the kind of configurable solution that both the U.S. and our allies need on the battle lines to be able to defend against lower cost threats. Today, very expensive weapons are being used to take down threats that are low cost that asymmetry is not sustainable. And so Lumberjack is a response to that. It gives you the affordability, the configurability against the threat that you are facing in a forward-deployed situation, and it's still leveraging that tech base that I talked about. So it is able to operate in high threat environments.

Great. Let's switch over to the international demand for a second just because it's -- Northrop, I think, for a long time, had a lower percentage of international, but that is changing quite a bit. In the most recent quarter, I think your international sales were up 32% for the quarter. They were up 20% year-to-date. And obviously, they've seen an uptick and what NATO's plans are? How are you thinking the structural changes are affecting Northrop for you?

Yes. We believe that those changes that we're seeing in Europe are going to sustain. And even as more European companies are able to build capabilities and scale those for capacity, the demand is outpacing the new entrants of supply. So we believe that U.S. companies are going to continue to see this market grow and our share grow. Certainly, our company is seeing that. We have a number of product lines that have significant interest that we are working to convert from pipeline into awards and sales over these next several years. But as you've noted, the results of that in this last 1.5 years have been very strong. Our backlog internationally has outpaced our domestic and our growth rate, as you noted, has also outpaced. We see double-digit growth in that international business for the foreseeable future. And I would also say that it's not just Europe. The Middle East has really opened up as a marketplace, again, for the kinds of capabilities that we provide. We also -- I just got back from the President's visit with the Prime Minister in Japan, talking to the Japanese about how their increase in defense spending can be deployed, and they certainly have an appetite to continue to work with U.S. companies like ours.

Terrific. Big inflection and global demand for sure. Let's move over a little bit to maybe the couple of segments, Aeronautics and the always popular B-21 questions that you get. But you've invested heavily in digital engineering, advanced manufacturing for the B-21. How should we think about these innovations kind of translating into the long-term cost efficiency that you've kind of talked about in the past, the production scalability? And how do we think about that kind of cost management side of things?

We think about that every day, and it's not just isolated to the B-21. We are on a margin improvement path that has 3 major tenets to it. One is performance driving through the disruption that we saw during the pandemic and largely macroeconomic factors have now stabilized to where labor is solid. Our negotiations with our represented workforce have gone very well this year. And we have now longer-term agreements in place, CBUs in place. We also have seen that the labor market is more conducive to hiring across our whole spectrum of hiring needs from engineering to technicians on the manufacturing floor. So that has allowed us to really stabilize production lines and get back to the kind of productivity that we saw pre-pandemic. The second element of our improvement plan was the investments that we're making in digital and the cost efficiencies that we're driving across the organization as a result of those investments. And those are both back office digital enablers as well as digital enablers on the factory floor in design, engineering and production. And we are seeing those on programs like the B-21 yield phenomenal results. When we talk about how the airplane as it's now flying in test is matching the models, the predictive models that we had in design, that means you've reduced the possibility of rework. You are building your first unit to meet those criteria that's required and you don't have to do redesign, which is often very costly if it comes late in the program. And that's what's been yielding us the kind of performance that we're seeing on the B-21. But it's important to note, we've done that across the enterprise. We did not do that specifically for the B-21 program. We are doing it company-wide. So we are seeing those same results play out elsewhere as well. And then, of course, the third piece of our strategy, we've already touched on a bit, and that's mix shift. As we have more international business that is accretive, generally margin-wise to the rest of the portfolio. And as we are moving out of cost-plus development toward more fixed-price production as our programs mature, that too is a tailwind to margin rate. So those three elements are very much a part of the strategy that we've been executing and they're executing as we expected them to.

Terrific. Maybe just for the audience, can you remind us on kind of the contract kind of update where kind of which stage the LRIP is in for B-21, including the number of units under contract and then the timing of Lot 3 award as well as the advanced procurement of Lot 5?

Yes. So to unpack the B-21 program, for those of you who don't follow it as closely as I do, which I hope none of you do, it really is a program that has three major phases. We are still completing the development phase, but we are in test, meaning we're getting toward the end of that development phase of the program. We have two aircraft flying. And as I just said, they're performing very well in test. We are already started on low rate initial production. And those are the lots that Peter was just referring to. We were under contract for the first 2 lots. We expect to be under contract for the third lot later this year and then about one a year. And those lots are what were priced in the original bid and those will be executing largely through the end of this decade. And then we move into higher rate production, that's outside of the original bid. Those are subject to future awards, also generally on that same time line, expecting about a lot a year to be awarded until we get to the program of record, which is 100 aircraft. Of course, there is some discussion by the department and the Air Force about wanting more. But right now, the program of record is 100.

Right. I was generally asked that, so I mean you're stealing my thunder, but I'll ask it a different way, 100. Is it that above 100, is it that they're increasing the mission capability or their mission opportunity for the B-21?

Yes. So the B-21 was already envisioned to be a multi-mission aircraft. Its primary mission is to be a bomber with access to environments that are very hard to penetrate because of enemy air defenses and to be able to carry both nuclear and conventional bombs. But it has tremendous sensor capability to be an ISR aircraft. Because of its penetrating nature, it can clear the way for less stealth platforms. And so it really can play more roles than just delivering a bomb for effect as the B2 just did, but the B2 really was designed just to be a bomber. And so -- as the Air Force begins to think about force structure and what they need, the idea of taking an aircraft like the B-21 that is now well through development and will be in production and is relatively affordable despite it being a more expensive platform and exquisite for the capability that the Air Force gets, it is much more affordable than previous versions of boomer aircraft, and so they're looking to leverage that. And we think it makes a lot of sense. We need to get into production, demonstrate the ramp on production and then we think this debates about how many are needed will come back to the...

Awesome. Thank you for that. Let's move over to Defense Systems. It could be the fastest-growing segment maybe in Northrop. You've talked a little bit about most recently in the third quarter, you had 250 basis point margin expansion. When we think about the margins as sustainability, but we also have a very big program in there with Sentinel, but you also have IBCS scaling up. So maybe talk about how you view that mix together?

Our Defense Systems segment really is that the cornerstone of many of the trends I've just talked about. Their international growth has been exceptional, and that's driven by the munitions demand increase around the globe that we've already referenced. They also have product lines like our Integrated Battle Command System that are in high demand from our partners for their homeland defense missions. It was originally designed for the Army to use and protect our bases that are forward deployed and our troops that are in harm's way, but it's other allies now look at how to protect their own homeland. It's an incredible solution. And of course, the U.S. under Golden Dome is looking at that solution as well for our homeland. And so -- they are at the center of many of the trends we've talked about in addition to leading the Sentinel program, which is one of the three legs of the triad. So they're seeing growth across all dimensions of their portfolio. And they are seeing the mix shift over time as we progress through this decade to more high-volume product lines that come with those higher margins and more international work, which also creates those tailwinds. So we expect their growth to continue to be accretive to the overall corporation, one of our fastest growing segments, if not the fastest, and to continue on this trend of margin improvement as well.

Yes. So part of that is Sentinel moving from kind of cost plus eventually to fixed price. How do you see that transition? And when -- and I don't know if timing is something you have visibility on, but...

So it's still several years away before we would transition into production on the Sentinel program. We are in the development phase of the program. We are in the middle of a restructure with the Air Force, where we are working to accelerate the time line. And in accelerating the time line, we could see production move to the left from where it was coming out of the Nunn-McCurdy breach a year ago, but it's still several years away. In the meantime, we're working on many risk reduction activities and the reconciliation bill included about $2.5 billion of incremental funding for the Sentinel program to do that. And those risk reduction activities are actually what will help to build the confidence to pull some of those time lines left. This is a high priority for both our company and the Department of War. It's something that I talked to the Deputy Secretary about frequently.

I bet. All right. Let's move over to something a little more different, but on Mission System, but microelectronics, the foundries, I don't think a lot of people are aware of that business that's inside Northrop Grumman. Maybe you could talk a little bit about the foundry business, microelectronics business. How do you see that business evolving today?

This is an area where we have seen increased demand for our products that rely on our foundries. As we are growing our own product lines increasingly, we are miniaturizing our electronics, and that is part of our differentiation in the solutions we provide, whether in space, in the air or on the ground. But now what we're seeing is a desire for domestic source of microelectronics in other applications that have traditionally rely on foreign source. So today, we're already in 90% of the nation's national security satellites, not because Northrop builds all of those, many other companies do, but our foundries are providing the microelectronics that go into those satellites. And it's because of the pedigree of source and the specificity of what we're building in the U.S. We do everything from design to fab to packaging in those foundries. Today, we're producing over 1 million microchips a year, so it's not a small business. But we certainly have invested hundreds of millions of dollars to expand that capacity, not just for our own needs, but as we've recently announced, we have opened up to support others as well. And we see a tremendous growth path as a result of the convergence of that trend I just noted of needing domestic supply for additional national security applications as well as our own demand.

Is there an opportunity to open up additional foundries? Or is it more just expanding what the base that you have?

So we certainly know how to build and run a foundry, and we know how to scale it. In terms of the business case, we have focused on those higher price point applications where people are willing to pay for the hardening that we do and the U.S. source, which is more expensive than foreign source. We will see that get to an equilibrium. It would be hard for me to sit here today and project how much of that demand is going to shift to the U.S. But we're confident enough that it's a tremendous growth opportunity for us that we have gone ahead and invested to build out that capacity. And we have two foundries, one on the East Coast and one in the West. They do slightly different things, different materials, but the point being both of them give that pedigree of U.S.-based source of supply.

Terrific. Let's move over to space and maybe -- and we can weave in Golden Dome on top of that. But you've been fighting a little bit of lower volumes, kind of some restricted work and NGI wind down. And there's also been some delays, obviously, SDA is kind of going through its own changes with Golden Dome and things. How do you think you can offset that with the space segment with some of those headwinds?

Space is an area where we have seen some specific headwinds, as you've noted, a couple of programs that we were not successful in capturing. And yet, we've also seen areas of tremendous growth in space resiliency and the modernization of new architectures in everything from missile tracking to ISR to communications. And so we are -- we saw a period of hyper growth. Our space business nearly doubled and now we are seeing a period of slower growth. But when you look at it over the longer term, and you zoom back and look from 2020 to 2030 over a decade, it hasn't been a steady growth, but it has -- it continues to likely be a very significant growth segment of our business. And it's in the areas that we think are going to be most enduring into the 2030s. We have transitioned our space business from low volume, handful of very exquisite satellites a year to where we are on order for 400 satellites this decade, and we are producing at that rate. And now over 60% of those satellites are lower cost, low Earth orbit resilient architecture assets. So our mix has shifted in a way that sets us very well going into the end of this decade and into the next based on the trends that we see in the space.

So related to space, so General Glynn hasn't come out with this architecture yet, but it should be up maybe at the end of the month or sometime maybe in December. How do you think Northrop plays in? I mean, obviously, you've got a very strong business in solid rocket motors, and it's a duopoly, but there's other players, too. But at the end of the day, how do you fit into the Golden Dome kind of architecture that's yet to be revealed?

Well, it's an important point that you make that the architecture has not been publicly released. So I won't comment on any specifics on it. But we have talked before about to provide homeland defense, there are some key attributes that an architecture would need. It needs a space layer to be able to identify, detect and track threats. It needs a set of interceptors to engage that threat. It requires command and control to be able to link our knowledge from disparate assets into a single operating picture to oversee the response to that threat and inform decision makers for their ability to engage and respond. And if you think of those major areas, Northrop Grumman has capability in each of those, but this is a big architecture. This is a significant undertaking. So my view is there is work for all comers in this area, and it will not be a single company or even a couple of companies that build out this architecture. It will be a large number of us in different pockets. And we're just fortunate to have a portfolio that is well positioned to help our country build out this capability at this moment.

Just maybe let's double click on the solid rocket motor side of things, just because you've been -- it's been a duopoly, but there has been a lot of upstarts, but the demand signals are obviously moving -- inflecting significantly higher. How do you see kind of the Northrop positioning against some of these upstarts that are coming in the solid rocket because there's a lot of kind of Silicon Valley dollars that are flowing and we see that. How do you think about that?

Yes. What I have said before and I still believe it to be true, is that it takes at least 3 years to start from a clean sheet design to get to producing solid rocket motors for a particular weapon system. Because one needs to build out the infrastructure. One needs to develop the capability, meaning the people who have the expertise, who have to design it, you have to qualify it. And today, that qualification happens one weapon system at a time. And so that is a multiyear process. And when I say 3 years, that's an expedited multiyear process because 5 years ago, I would have said 5. So even with the department wanting to move fast and new entrants investing and wanting to come into that space, it's going to take a little while. In the meantime, Northrop has expanded our capacity. We are getting qualified on these weapons. We are becoming a second source where we aren't one today. And we have increased our market share where we are the source to be providing more of the solid rocket motors. My goal has been, and I think we've accomplished it now, we have showed the Department of War solid rocket motors are not a constraint in the supply chain. We have the capacity today. If we get qualified on additional missiles, we can provide the SRMs to support them at the growth rates that the department is talking about. And that's my focus. So new entrants can come in. I'm not afraid of competition. Our company isn't afraid of competition. But our goal is to be positioned to take share now, perform, demonstrate, come down our cost curve, be very price competitive, and that's what we're on a path to do.

Thank you for that. The last couple of minutes here, let's talk a few numbers. Like when you think about margin outlook, when you think about the longer-term trajectory, how do you think of like what are the key drivers for you to get some margin expansion?

Yes. So I've talked about the key drivers for margin expansion, and they are performance, they are our digital transformation that drives cost efficiencies and they are our mix. What I foresee is that, that -- that trend in each of those 3 continues over the decade. Mix becomes the more important element of that shift towards the end of the decade.

Is that part of that because we've always tracked and you guys disclosed it all, the cost plus versus fixed price. Is that part of that mix that you're talking about changing?

That's part of the mix and then the international also is part of that mix. If you look at our disclosures, our international business tends to run a couple of hundred basis points above our average as a company. And so it too is accretive to our margin rate as we grow that as a percentage of our whole.

Great. And let's finish with free cash flow and capital deployment, and you've been very vocal and you're on a path to double your free cash flow, as I said in my opening comment. Talk maybe about a few of the key drivers you're seeing there to help you do that.

Yes. Well, we've met those commitments. We put those longer-range cash targets out a couple of years ago. And each year, we are hitting those commitments with 20% on average growth in our free cash flow year-over-year. We are expecting that few trends support that. One we just talked about as we increase our operating margins, that's contributing to increased free cash flow from operations, which we love. We also are on a path to reduce CapEx as a percentage of sales, not because we aren't going to continue to invest in the business, but we've been at a very elevated level for our industry. So we've been around 4%, which is double the industry average for the last several years. That's actually set us up quite well with this administration because we have been investing in our business. It's also set us up with the capacity I just talked about so that we can build out share now. But we don't have to continue to invest at that rate to support the business in our base book of business. If we were to be very successful in new awards, capture a significant amount of Golden Dome, capture the Navy fighter program, accelerate the B-21 program. These would require increased CapEx, but they also would come with more operating cash. So those tend to offset each other as we think about the long term. So that's how we're thinking about the business and driving our free cash flow performance. And we have been hitting our marks for the last 3 years since we got those out and are committed to continue to do that.

I don't think anyone would complain about growth CapEx for sure. And then just on buybacks, can you just finish on that and where your thoughts on that?

Yes. We've been returning about 100% of our free cash flow to investors over the last couple of years. As we look -- and we've been doing that with that priority set that I talked about, investing first in ourselves. When we see the growth opportunities, that's always where we first want to put our resources. We have paid a competitive dividend, but we've also had double-digit increases in our dividend over the last several years and 22 consecutive dividend raises. So we are committed to continuing to pay a competitive dividend. And then with the excess share repurchase has been our way of returning that, and I expect that to continue.

Kathy, thank you so much for supporting the conference. Thank you, everyone. The breakout room is in the Oak Room next. Thanks so much, everyone.

Thank you for joining us.