Q2 2022 Northrop Grumman Corp Earnings Call

July 28, 2022

[music].

Yeah.

Good day, ladies and gentlemen, and welcome to the Northrop Grumman's second quarter 2022 Conference call. Today's call is being recorded my name is Victor and I'll be your operator today at this time all participants are in a listen only mode I would now like to turn the call over to your house.

Mr. Todd Ernst Treasurer, and Vice President Investor Relations Mr. Ernst. Please proceed.

Thank you Victor and good morning, everyone and welcome to Northrop Grumman's second quarter 2022 conference call, we'll refer to a Powerpoint presentation that is posted to our IR web page. This morning.

Before we start matters discussed on today's call, including 2020 guidance and beyond including our outlooks reflect the company's judgment based on information available at the time of this call may constitute forward looking statements pursuant to safe Harbor provisions of Federal Securities laws.

Forward looking statements involve risks and uncertainties, which are noted in today's press release and in our SEC filings. These risks and uncertainties may cause actual company results to differ materially.

Today's call will include non-GAAP financial measures that are reconciled to our GAAP results in our earnings release on the call today are Kathy Warden, our chair CEO and President and Dave Keffer, Our CFO at this time I would like to turn the call over to Kathy Kathy. Thanks, Todd Good morning, everyone and thank you again for joining us.

I'd like to start today's call by highlighting the James Webb space telescope and the incredible images released just a few weeks ago.

This extraordinary telescope represents countless Northrop Grumman Engineers technician Sciences, and cross functional team working in partnership with NASA for over two decades.

In addition to leading the industry team, we designed and built the deployable. Some shield provided the spacecraft develop the observatory subsystem.

Integrated the total system.

The advanced technology, we've created images that captures will inspire the next generation of innovators and scientists and we believe will be one of web many legacy.

Well the exemplifies the defining characteristic of our business strategy to develop and produce innovative technology solutions to address our customers' toughest challenges.

This strategy differentiates us and aligns our portfolio with our customers' priorities and as a result, we strengthened our position in the market.

As a reminder, the four core focus areas of our strategy our technology leadership.

Favorably and profitably growing our business keeping a laser focus on performance and deploying capital in value creating ways.

This strategy continues to yield results in.

In the second quarter, we saw strong demand across our businesses with a book to Bill ratio of 148, driven by awards for F 35, Gem 63 and restricted program.

All of our businesses had a book to bill ratio above one in the quarter driving a 6% sequential increase in our backlog, which now totals $80 billion.

Given this backlog growth and our continued alignment to customers' budgets and priorities. We are even more confident we can accelerate our revenue in 2023 from the low single digits. We're guiding this year.

In the quarter, we did experience certain challenges from the broader macroeconomic environment, including a tight labor market and supply chain delays, which impacted sales timing.

However, we're pleased with the progress our team continues to make in addressing these challenges and hiring trends improved as we progressed through the second quarter laying the foundation for sales growth in the second half of the year.

As our business growth, we remain focused on performance and driving cost efficiencies across the business.

This continued focus contributed to another quarter of solid margin performance.

Our segment Om rate was a robust 12, 2% in Q2 and stands at 12% year to date.

Dave will cover further details of our quarterly results and guidance update momentarily.

First I'd like to touch on some highlights from the quarter.

The technology developed for James Webb is one example of Northrop Grumman Innovation. Another example is how we are using technology to produce innovative and affordable solutions for our customers.

To that end, we're investing in digital design capabilities and advanced manufacturing facility.

In close partnership with our customer we are digitally transforming how we design and manufacture the next generation of system and you've heard our customers acknowledge the results, particularly with some of the largest programs, including B 21, and GBS CV.

We are marrying our world class engineering talent with the latest digital tools machine learning and agile principles.

And as we announced this quarter. We are also investing in factories of the future, including our state of the art manufacturing facility in West, Virginia, which will incorporate the latest and digital manufacturing automation and modular work cells.

Once operational in 2020 for this facility will support production of up to 600 strike missile per year.

Optimizing quality and reducing cost and cycle times as well as bolstering tactical weapons supply chain capacity for our customers.

For the last few years, we've taken an enterprise wide approach and mission focus areas that are aligned with our customers' priority.

There are areas, where we see opportunity to leverage our technology, knowhow and our domain expertise and tie capabilities from across our businesses.

Today I want to highlight a few of them and the related results. We've seen so far this year.

One example of this is a national security space.

Our customers have made it clear that space underpins many missions vital to our national security.

And we recognize that we need to think about things differently as a rapidly evolving contested domain.

Given us our focus is on providing space based offerings that include a mix of exquisite solutions in combination with proliferated constellations of low Earth orbit satellites also known as <unk>, which together create a more resilient architecture.

We've recently seen the benefits of this approach for example, after the close of the second quarter, we received a $617 million contract for the FCA tracking layer, which is a leo constellation of 14th satellites designed to provide global warning tracking and targeting of advanced missile threats, including hypersonic missiles.

This builds on the SBA transport layer contract. We were awarded in February which is also a leo constellation of 42 satellites, providing resilience low latency high volume data transport and supportive U S military missions around the world.

In addition to these we booked another $700 million in Q2 in restricted space Awards, and now have $11 3 billion of restricted space backlog.

We continue to see the national security space area as one of the strongest growth drivers for our company.

Another focus area, where we are pulling capability and expertise from across the portfolio is missile defense and counter hypersonic.

In the second quarter, we were awarded a contract for the missile Defense Agency to continue development of the glide phase Interceptor program.

GPI will play a central role in ensuring the United States maintains the most reliable and advanced missiles missile defense system capable of outpacing in the CD evolved <unk> missile threats.

This complements our missile defense modernization work already underway on NCI HB TSS Andi Bcf.

We have also been supporting international customers to modernize their missile defense system. For example, last week, we delivered the first of the six production <unk> engagement operation centers for Poland's medium range Air and missile defense system.

Our capital deployment approach is also an important part of the strategy I just laid out for you.

Our first priority is to invest in executing our business strategy by investing in our factories digital design tools and our people who are a key source of our technology leadership, we are creating long term sustainable value.

We also remain committed to returning at least 100% of free cash flow to shareholders. This year.

In the second quarter, we increased our dividend by 10%, marking our 19th consecutive annual increase.

Our new quarterly dividend will be nearly double the level, we paid in the beginning of 2017.

We are also returning capital shareholders through stock repurchases and we continue to target at least one 5 billion in repurchases this year.

Before Dave shares more details about our financial results I'd like to briefly talk about the defense demand environment.

We've seen a fundamental shift in global commitment of resources for defense and National security, particularly in Europe .

This year, we've seen Finland, and Sweden progress their membership in NATO and many European countries increased or state their plans to increase their defense budgets.

The geopolitical environment has highlighted an increase requirement for defense and to turn.

In the U S. This has also resulted in strong bipartisan support for defense spending.

Recently, the congressional armed services Committee marked up their version of the FY 'twenty three defense, though with both providing bipartisan support.

We've been spending above the president's budget.

For Northrop Grumman U S. FY 'twenty three base defense budget request included strong support for key programs like B 21, GBS D. Mci <unk> next generation <unk> and Triton and if there is an opportunity for additional funding for data <unk> F 35 and F.

<unk> that we've seen in proposed plus ups from Congress.

But I will note that as has become the norm in recent years. There is a high probability of starting the fiscal year on a CR. So we have anticipated this in our outlook for 2022.

The budget is a strong reflection of the alignment of our company with our customers and reinforces my confidence that we are well positioned for this environment.

So with that I'll turn the call over to Dave and then I'll have a few closing remarks before we turn to Q&A, Dave Okay. Thanks, Cathy and good morning, everyone. Overall this was another solid quarter with similar themes to Q1.

Near term supply side pressures in a tight labor market have persisted, but the demand.

The environment continues to be quite strong with outstanding awards and backlog growth driven by alignment with our customers' highest priorities setting the stage for longer term success.

We generated $13 billion of New awards in the second quarter, a higher volume than we had expected due to excellent competitive wins and timing of a few large awards, including the latest F 35 block in our aeronautics sector.

Our year to date book to Bill is now one to two.

As a result of our strong bookings, we now expect award volume to be approximately equal to sales for the full year higher than our previous projections.

While these new business metrics position us for growth going forward. Our Q2 sales of $8 8 billion in first half sales in total came in slightly below our expectations as we continue to manage through global supply chain and labor market challenges. These.

These first half results and current trends point toward a full year sales outlook near the low end of our guidance range with Q3 sales slightly over $9 billion.

In Q4 in the mid nine billions.

These figures represent much stronger year over year growth in the second half than the first requiring continued expansion in head count and material receipts.

In Q2, we drove incremental improvements in hiring as the quarter progressed, adding nearly 1000 net employees in Q2 after being down slightly in Q1.

Our material receipts forecast is also weighted towards the second half of the year based on timing of program demand.

These factors along with our growing backlog provides the foundation for faster revenue growth rates in the second half of the year and we expect that momentum to continue into 2023.

Even with temporary top line headwinds our execution remains strong in the quarter.

Margins were 12, 2% in line with the high level from Q2 of last year.

Driving cost efficiencies and keeping a laser focus on performance are key elements of our strategy.

This will be particularly important efforts and a higher inflationary environment than we've experienced in recent years.

Starts by negotiating good business terms and delivering strong program performance, but it doesn't end there, but also includes driving affordability and our rates, having a disciplined approach to risk management and optimizing our cost structure.

For example in the quarter, we sold a property in best Page, New York and recognized a $38 million gain.

Continuing with our Q2 results diluted earnings per share in the quarter were $6 six.

Down 6% compared to the second quarter of last year EPS.

EPS was lower largely due to non operational items unfavorable returns on our marketable securities and lower net pension income contributed headwinds of 60 <unk>.

Paired to Q2 of last year.

And while our 17, 7% tax rate was lower than last year. It was above Q1, and our full year expectation for 2022.

Turning to full year guidance I'll start with a few updates to our sector estimates.

Our space business continues to deliver excellent sales growth and bookings.

Moving another quarter of record backlog, demonstrating the diversity of capabilities that we bring to market.

As a result, we're again, increasing its sales guidance to the high $11 billion range.

We're tweaking our full year expectation to the mid 5 billion based on a slower ramp on certain programs as well as broader staffing challenges.

For operating margin rate, we are increasing our estimates SaaS DFS and EMS based on their strong year to date results offsetting.

Offsetting these increases are a reduction in the space of Om rate to approximately 10% based on better than expected success in winning new development programs.

And at the company level, we are maintaining our full year guidance ranges for sales segment margin rate EPS and cash.

Within those ranges. We currently expect that any softness in sales is likely to be offset by margin strength.

Embedded in our earnings per share outlook are a few moving pieces.

First our corporate unallocated costs are now projected to be $210 million down $60 million from our prior estimates.

This is due to favorable state tax trends and other lower corporate expenses.

We're also projecting modestly lower net interest expense.

Offsetting these benefits is an unfavorable impact from our marketable securities that we've experienced year to date.

There are no incremental mark to market impacts assumed in our guidance for the second half of the year.

As we noted last quarter regarding corporate unallocated costs, we continue to project a one time spike in state taxes recognized in the quarter in which the R&D tax amortization law is deferred.

With respect to cash second quarter free cash flow was an outflow of $460 million.

The cash taxes paid associated with R&D amortization, our free cash flow would have been roughly breakeven.

Third with the high hundreds of millions of dollars in an average Q2.

A good portion of this delta was due to several large program collections expected toward the end of Q2 that were instead collected in Q3, including about $300 million collected on the first working day of July .

The seasonality of our collections and disbursements as such that the second half of the year is expected to generate much stronger cash flows in the first but as always we will need to keep our focus on execution and drive further working capital efficiencies to offset any ongoing timing issues and achieve our outlook.

Our guidance continues to include two scenarios.

Based on current tax law, and the deferral scenario predicated on receiving refunds for payments made to date.

Next I wanted to take a moment to talk about our pension plans.

Last quarter, I mentioned that while our pension plans contributor component of our GAAP earnings.

<unk> income does not operational and that's something we consider when assessing the company's performance.

Slide 11 in our earnings deck provides an illustration of the pension headwind on GAAP earnings that we've experienced so far this year.

As we look towards next year, we would expect this headwind to grow based on recent volatility in the financial markets year to date, our asset performance has been below our long term expected rate of return and discount rates have had a historic rise of.

Of course, our pension plans arent unique and experiencing these macroeconomic trends.

If we snap the line at quarter end these market conditions would translate to significantly lower net pension income going forward, primarily in the non operating SaaS in July .

Firstly offsetting this GAAP earnings headwind would be a modest increase in projected chaz recoveries, but our required cash contributions would remain very low for the next several years.

Our funded status remains healthy at over 96%.

So while the GAAP earnings impact could be a headwind from a cash or economic perspective, the changes would be modestly favorable.

A lot can change in the financial markets over the course of the year. So we'll wait to provide more specific multiyear projections until later in the year.

Going into the pension sensitivity table that we provided in our January earnings deck for your modeling purposes, and with that I'll turn the call back over to you Cathy.

Dave.

In summary demand remains robust and we saw outstanding bookings and backlog growth in the quarter and year to date.

This demand is creating momentum that supports our expectation for accelerating growth for the remainder of this year and into next additionally.

Additionally, our capital deployment strategy is aimed at supporting long term growth and creating value for our shareholders. We believe the investments we are making today in digital tools and factories of the future are already enabling stronger program performance and contributing to our operating results.

I'm incredibly proud of the Northrop Grumman team as we execute our strategy and position the company for long term success.

So with that we're ready for Q&A.

Ladies and gentlemen, if you wish.

Karen Please press star followed by one one on your Touchtone telephone and.

In the interest of time, please limit yourself to sharepoint and one follow up.

Again.

101 to ask a question one more for questions.

Our first question comes from the line of Ron Epstein from Bank of America. Your line is open.

Yeah.

Hi, everyone. This is mariano pretty smart on for Ron today.

Good morning.

The barn.

Most of the theme of treat experiencing significant pressure from a tight labor market and it seems that you are monitoring these challenges better and even seen some improvement in the second half could you. Please describe some corner what are you doing to navigate.

Thanks.

Well, thanks, Mariana, we absolutely have seen labor headwinds in the first half, but as we noted in our comments we are starting to see those ease in the latter part of the second quarter and even the results that we're seeing in July .

So far and what we're doing is aggressively across the enterprise working both hiring and retention efforts.

Is that all hands on deck strategy to ensure that.

People know that Northrop Grumman is growing and hiring and we are having good success in attracting people to our company. We've also been taking actions to retain the talent that we have and that has really started to take traction I will also say that the market conditions play a significant role and.

Any company's ability to hire and retain and we've seen the market conditions start to soften.

You can't pick up a newspaper read an article online these days without being a company that's talking about hiring.

Freezes or even layoffs and so that will have an impact on the labor market and we expect continued softening as a result of that in the second half, which leads us to feel more confident that the second half will look more like our pre pandemic experience than what we've experienced in the last six to 12 months.

Perfect. Thank you and then on supply chain.

What kind of tools do you have to improve your visibility on multiyear lead times do you have flexibility to reach out long term agreement senior bonds are increasing inventories to Tom with any potential future disruptions.

Well, we do have those tools available to us, but what I would say is I know you've heard from a host of manufacturing, including peers and aerospace and defense industry. This week that we are seeing longer lead times, which impact timing of sale and I believe those are result of numerous factors, but notably the labor availability we were just.

Speaking about so as we noted earlier in the call. We do expect the labor market to soften a bit and while it'll still be a headwind in the second half we don't see it in the same degree that it would be in the first half and then based on the fact that we are deeply embedded with our suppliers, we have Northrop Grumman people on site.

With them and so we believe we have a good handle on material timing delivery for the rest of the year and we've incorporated that into our thinking but of course, it's based on what we know today and as we've seen in the last 12 months Covid flare up component demand fluctuations and a variety of smaller issues can cause enough.

The meeting volatility around timing of supply. So our teams are managing as well I feel like we have done exceptionally well in the first half while we were slightly short of our own revenue projections for Q2, which we said would be about 24, 5% at the midpoint of our guy.

Right.

That was very tight estimating variability in a very challenging market. So we have very detailed reviews of material timing, we're working mitigation strategies on a daily basis.

And we have a handle on what we need to deliver in the second half Dave.

Do you have anything you would add so I think that's well characterized Kathy at a program level. In addition to being confident in our ability to deliver more in the second half the timing of demand is also more weighted towards the second half this year as opposed to last year when the demand timing at a program level happened to be a bit more weighted towards the first half of the year so that to.

That's to the stronger year over year growth outlook for the second half this year.

Thank you.

One more for an excellent question.

Our next question comes from the line of Richard Safran from Seaport Global Your line is open.

Chassis Jade Todd good morning.

Good morning, Brett.

So I wanted to ask you about the news the FTC is making about orbital.

You probably were expecting this at least I would guess.

This was initially brought out win win Lockheed was buying aerojet. So I wanted to know if you could briefly talk to the issues that the FTC is focusing on.

If you could discuss what the range of outcomes might be and.

I know, it's always a bit difficult, but if you could speculate on.

On the impact and any comment you would get there would be appreciated. Thanks.

Yeah. Thanks, Brett So let me start by providing some context on the issue.

We announced our intent to acquire orbital ATK in 2018, and the department of Defense and FTC spent many months looking at the pro competitive aspects of the deal, which there are many and any anti competitive risks before they approve the deal.

So during this period the government identified only one concern and it was around solid rocket motors and so we agreed to a consent order to address that.

Over the past four years, we've executed.

<unk> compliance program and worked with the government very closely in line with the terms of the order. So we believe we've been and we continue to be in compliance with the order.

The FTC did raise one matter they were investigating a few years ago, but to our knowledge that investigation has not concluded.

And we've shared the.

This in our 10-K and 10-Q filings. So you can refer to those for the details of that particular matter and now to the point of your question I know there's been some recent speculation both on the status of that investigation and a broad range of possible next steps that the government might attempt to.

Take but I'll say that we don't see merit or precedent for most of those scenarios and we continue to maintain that we don't believe this matter will have a material adverse impact to our company.

I won't speculate on what the sites will be because we believe.

It could be zero and certainly isn't material.

Okay that helps thanks, a quick follow up here.

On your comments about international Wonder if you could expand a little bit on that.

What type of equipment are you getting the most interest for.

Could you discuss a little bit about the timing, how thats going to translate to the <unk> and flow into the P&L and then just good old school here with increasing international demand, we should expect more higher margin commercial contract I just wanted to know if that's if you think that's the case thanks.

Thanks Rich this is Dave.

Take that one.

We've gotten a lot of questions in the last few months given the evolving geopolitical global situation.

About near term impacts I think the reality is in our business is long cycle as ours. These things take time to.

<unk> have an impact.

We are certainly engaged with U S and international customers talking about areas of particular demand.

We mentioned.

Products like ABC us on the call today, I would say mission areas like missile defense or a particular international interest as you would expect.

But it will take time for those things to have a financial.

Impact and so I would hesitate to project in any specifics what that may be in the near term. It's something we will keep you apprised of over the next several years as those opportunities.

It'll become reality.

Thank you.

Our next question.

Our next question will come from the line of Doug Barnett from Bernstein, you may begin.

Thank you good morning.

When you look at Aeronautics. This has been complicated given a lot of mature programs ramping down be 'twenty, one going up F 35.

But in Q2, if we take out the land sale gain and margins were well below 10% revenues were low as well which really.

It looks like it makes 82 pretty challenging can you talk about.

How you see the path to guidance and it's too.

Sure I'm happy to touch on that one Doug.

In the first quarter, we had an unusually high volume of favorable net EAC fees in the second quarter net Eac's were light this is the.

Typical nature of a business like Aeronautics, where there is quarterly fluctuation.

But in aggregate we have.

Even a slightly stronger outlook for the year as we described earlier on the margin rate side than we did previously so you need to look through and look past quarterly fluctuations in net EAC and towards the overall outlook on the sales side.

Net EAC fluctuation rolls through sales as well and so I would note that it was relatively stable in the first and second quarter.

Another business as we described earlier in our comments, where we see a higher volume of material receipts projected in the second half than the first.

And so.

I think a reasonable.

Half ramp from where we are today and very consistent with the <unk>.

Projections, we've been providing for a couple of quarters now.

And as a follow up if I switch over to space.

Your backlog there is down $39 billion I mean, it's a huge backlog.

And I know you've got.

Some pretty good revenue growth forecast here, but how should we look at the conversion of that backlog in terms of timing.

Should we see that conversion move to revenues over over the years here.

Sure as you mentioned, we're incredibly pleased with the backlog growth The award volume that we've had in space.

Programs like both the transport and tracking layers of the Fda's.

Architecture are great examples there.

Of work, we're doing really at multiple layers with multiple products.

Supporting multiple mission areas in <unk>.

The national security and civilian space markets in terms of how that backlog then breaks down in terms of award volume overtime sales volume over time.

It's been our fastest growing business and we anticipate that it will continue to be our fastest growing business.

Just an excuse me in any one program GBS D is obviously, a large contributor to its growth last year and this year, but the growth is much broader based and so well GBS D has grown about $5 billion in R. 22 estimates and should show similar growth in 'twenty three we would anticipate a similar volume of.

Growth outside of GBS D going forward in our growth outside of <unk> for this year is actually exceeding <unk> growth.

On a dollar basis in space, So really broad based outstanding growth not just in backlog, but to your point and converting to sales as well.

Thank you our next question.

Our next question comes from the line of Cai.

That bond rumor from Cowen Your line is open.

Yes. Thank you so much so.

You and your partner and GI were selected for the glide phase interceptor.

That's an interceptor and Gis in their sector are there any read across in terms of having won this that would make you better positioned for MDI. If it goes sole source and what do you think the chances are it goes dual source. Thank you.

Okay, very insightful question as always and I would say certainly.

It's beneficial to be supporting multiple like commissions and understanding therefore, how these systems can draw from a common technology base given both certain competition.

I'd say anything more than that and then I'm sure you respect that.

In terms of what the.

Yes.

I mean more broadly I would simply say that missile defense is an area of great importance not only in the U S, but internationally and as I outlined in my comments, we're taking a broad enterprise approach to thinking about how we best spring capabilities with Northrop Grumman to bear on all of these.

City.

So we feel we're positioned well.

To support with the government needs.

I do think there is a balance view, however that we need a broad industrial base in all of our missile defense programs and so I expect that there is some appetite to carry forward multiple providers for longer as we are seeing in mci that down select won't happen and.

So 2025 likely enter your point may extend even further or dual sourced.

And so we think that is.

Supportive if Northrop Grumman growth no matter how it goes.

And we just support the governments in making those decisions about what's best for their industrial base capacity.

Thanks, So much and secondly, you also had a number of wins you alluded to in the Leo.

Area can you.

Look at the second half are there any major opportunities, we should keep our eye on competitive bids.

There are a few mostly what we see in the second half of New awards and as Dave pointed out we do expect to now book to Bill to be close to one which is.

Proven over our outlook at the beginning of the year, because we've been having more success in competitive awards like the two I mentioned with SBA than we had anticipated, but as we look to the second half of the year not as much.

But as we look to the second half of the year not as much competitive.

To be awarded more sole sourced to see about 1 billion and a half of new.

New awards in restricted within.

About the same in space we.

We do have a fairly significant competitive award that we're expecting any day in space within the $1 billion cloth.

And then a lot of smaller things that add up to our full year expectation that cluster.

Hey, Bill.

Thank you one moment for our next question.

Our next question comes from the line of Cristina <unk> from Morgan Stanley . Your line is open.

Hey, good morning Kathy.

Good morning.

You mentioned earlier that theres been a fundamental shift in U S and European support for defense spending and historically when the economic environment is weaker than other federal budgets emerge defense budgets have come under pressure. So what's different this time and how long do you think the support for defensible.

<unk>.

Okay.

Thanks for the question Christine I was just in Europe , two weeks ago, and I would say that I see it truly a fundamental shift in recognizing the threat environment.

Israel.

It is now alright, I think in recent years with in Europe , there's been a sense of we're working toward a longer term threat horizon and perhaps the pace of national.

In defense security spending would have been appropriate in that environment, but the fact that the threat is more eminent is addressed and what youre seeing as planned or committed increases in defense spending across most of the European nations.

That does take several years, so to translate into specific needs by plan.

And fail for companies like ours, So I do expect that there might be some modulation based on broader economic factors and other spending priorities, but I don't see there being another inflection point back to our view that defense spending.

It's a high priority.

CSP fairly enduring.

Thanks, Kathy and as a follow up.

How much urgency is there from your conversations with customers to address the security landscape and when do you think these demand signals might translate to revenue growth.

Yes, so as I noted.

Despite the urgency does take generally at least 18 to 24 months to translate intent into specific program.

For Asia.

Customer wanting to buy X quantity of certain systems in production and it takes even a little longer if it's something that is not in production. If it's a developmental program and so that can be 345 years. So as I think about the landscape in Europe , obviously the time.

It is now to be advising and sharing insights on what can address their highest priority demands just as we do with U S customers, but I don't see it having a material impact on revenues.

For us our other E&P companies in the next.

18 months, so I'd say, it's more in the 2024 time horizon that we would look for it to have a more material impact.

Thank you we'll move for our next question.

Yes.

Our next question comes from the line of Rob Stallard from vertical your line is open.

Thanks, so much good morning.

Good morning, Rob.

Cathy just like to follow up on the question asked you three months ago about inflation and fixed price contracts I was wondering how things have evolved over the last quarter versus your expectations and whether you are making any structural changes to the way you do business considering we are in this higher inflation environment.

Good question so.

Our today view is very much in line with what it was in the first quarter and we certainly are not immune to impacts of inflation. So we're working with the government to quantify those impacts and work with them to mitigate them.

This includes ensuring the appropriate funding is available for the government program managers to acquire the systems needed to support National defense in this inflationary environment and to that end. We're very pleased to see that Congress does including funding to offset inflation in their FY 'twenty three budget markup.

There are some structural characteristics of our business, but naturally mitigate some of these impact Dave talked about the importance of deal structure.

These are things like our mix of cost plus work versus fixed price the relatively short contract duration of our fixed price contracts that allow us to renegotiate based on current condition within one to two years and in some cases escalation clauses that allow us to reprice.

We are looking now at new deals that we're entering we are being more forceful and including those escalation clauses in our contract term, making sure that we're matching our supplier terms with our overall contract terms as some example of what we're doing differently to mitigate the impact.

And then we also within our organization are working to offset the impacts. So this include managing supply chain affordability looking at second suppliers, where we feel suppliers are not addressing affordability, reducing costs in our own areas of overhead costs.

Including the real estate footprint as we noted earlier today.

While inflation is something that we are managing on a daily basis.

I'd say, we haven't seen a material impact to our financial so far this year, but we have to continue to be diligent to make sure that it doesn't become an impact.

And we're watching very closely to see if inflation is starting to modulate our indications would be that that is starting to happen, but we're watching the data just as you are.

And then just a quick follow up there was a news report yesterday that the Air Force is looking to retire on its global Hawks, and I think 2027 I think is this in line with your expectations.

And this is what we've been talking about for a while that the global Hawk franchise would be phased out over time.

Yes, we were expecting and as you note about 40 don't retire until 2027, so that's a bit out in the future and doesn't have an impact on any projections that we have outlined for this year.

But it is in line with our longer term expectation.

Thank you we'll move next question.

Our next question Sheila.

Sheila <unk> from Jefferies. Your line is open.

Good morning, everyone. Thank you.

Maybe if we could just talk about the F 35 program Kathy how big is it today and given some of the reset on production how does that impact the cadence and outlook for Northrop and what are some of the puts and takes just thinking about shifts some content and lead times within mission versus a F.

Mhm.

It continues to be about 10% of our annual sales in total across all aspects of our contribution to the program.

We have worked through our new contract for lot 15 through 17.

We have factored in the demands that Lockheed has for our components and we still see our outlook for 'twenty, two and even into 'twenty three intact as a result of the new expectations around demand as well.

Look over a longer period of time, we still see production being the lion's share of our revenue volume, but sustainment is the fastest growing element of our contribution to the program and in mission systems, We have a combination of development and production because we're supporting the block four upgrades.

And that most notably is revenue support for emission system, even as we phase out of the Das program, which also was in mission systems, We see mission systems revenue being fairly stable because of that increased volume around block four.

Great and then maybe just a follow up you had some positive movement around ABC App I think first deliveries to Poland in the quarter, maybe if you could remind us how you're sizing that program and timing to the army versus other potential international opportunities mhm.

Uh-huh.

Sure happy to jump in on that one Sheila.

In aggregate you can think of that franchise in the 1% of sales range, but as you pointed out they're important domestic and international components to that today and equally importantly international opportunity going forward as well certainly it's a critical mission set that rbcs capability.

Bye.

Attaching.

Previously disconnected.

There's an shooters and bringing new capability to disparate systems, which is really central to the modern mission set both domestically and abroad. So we'd look for that to be a growing franchise. We were really pleased with the competitive awards over the past year.

Should be some second half growth in the program and again, it's a critical part of our defense systems franchise.

Thank you.

Our next question.

Our next question comes from the line of David Strauss from Barclays. Your line is open.

Thanks, Good morning, everyone.

Good morning.

Kathy I think on the last call you.

You kind of endorsed the current consensus revenue estimate for 2023, which I think is around 38 billion.

Is that still the right way to think about.

The revenue trajectory next year.

Would seem like you would be able to get there pretty much on b 21 in GBS the growth so.

Are you assuming what does the rest of the portfolio will look like next year.

B 21 in GBS in terms of growth.

Sure.

So we continue to believe we can accelerate our growth rate next year towards mid single digit range switches.

Consensus is being developed and so I would affirm that and the demand environment is strong as I outlined on the call. So that would provide some tailwind however.

I would caution you just since I am thinking about this as we prepare to give your outlook and trends in October when we will provide more detail that the supply side supply side challenges that we are facing this year are real and it depends on how they mitigate throughout the second half as to what that looks like going.

Into 2023, and we certainly could be delivering higher revenue growth. This year, if not for those supply side constraints. So it really isn't a demand question and to your point. The budgets are strong enough for us to have even further accelerated growth into 2023, so we need to be able to deliver on that.

Both with the labor and the material and so we're monitoring that very closely and we'll have a better sense of what that looks like in October to be able to give you a trend data into 2023.

Okay, Thanks, and Dave Thanks for the color on pension.

Obviously with you guys a lot of moving pieces with the with the mark to market and all of that.

You had previously said Fas has.

Relatively I think in total relatively flat.

Flat in 'twenty three versus 22.

Based on where things today I mean, you helped us at all or are we looking at like a couple of hundred million dollars.

Headwind 23 versus <unk> 22.

Yes, I appreciate you raising that topic for a follow up.

We noted on the call that.

We direct your attention to the pension sensitivity slide we provide every January so to give you a feel for the approximate impact of an increase or decrease in the discount rate or a level of asset returns of a certain degree.

Discount rate increases the most significant effect that we would see on Vasquez income if the year were to end today, we've seen well over 100, perhaps even approaching 200 basis points of discount rate increase since the year began and so.

As we noted in that sensitivity slide every 25 basis points can have a $1 billion or more.

<unk>.

On Mark to market at the end of the year and a substantial impact on.

The Fas has.

Income going forward again these are non operating GAAP earnings.

Amounts, they're not cash flow drivers if anything as we noted the kaz reimbursements are expected to tick up slightly and so from an economic perspective, there's a small benefit there from a GAAP earnings perspective, we would draw your attention to the.

Discount rate and asset returns sensitivities and of course, we will see where the market moves over the next six months to give you a more final sense of the 23 does kind of the outlook.

Thank you our next question.

Our next question comes from the line of Seth Sparkman from Jpmorgan. Your line is open.

Okay. Thanks very much.

Good morning, everyone.

Maybe just to keep everyone riveted I'll ask a follow up question on pension and <unk>.

I Wonder if you could talk about just thinking big picture and conceptually, we've seen Lockheed and their defined benefit plan and they're offloading a lot of their liability onto your insurance companies you guys still have DB. It's not it's not huge I think service costs. This year should be under 400 million box.

But when you think about what you want to do longer term, what makes most sense for Northrop, particularly as a government contractor and with the allowable cost framework.

What do you want to do long term.

Sure. Thanks Seth.

So.

I would point out a few things one we've had outstanding returns on our pension assets over any period do you look at historically over the last 20 years, well above market return expectations really proud of the value that is generated and the benefit that that has both to the company.

So our government customers.

As a result, we are very well funded today, we've talked about a 96% funded status level that fluctuates day to day given market movements, but again, we're in slightly better funded position today than we were even as the first of this year.

Given the changes in the interest rate environment.

Set by the changes in the asset returns that you would expect so there is a lot of moving pieces under the surface, but in aggregate we don't today fuel.

Burning need to make a change to our long term strategy. It has been working it's been a value to the company to the participants and to the government.

And as a result, it is certainly something we'll continue to assess over time, but at this point, we're pleased with asset returns over any long period of time pleased with the funded status that results from that.

We will continue to keep you apprised if there are any changes along the way.

Great.

And then maybe to follow up just on.

On Aeronautics I know you talked earlier about the kind of the absence of EAC user in the quarter I think they were a slight negative I guess, if we look back over the last several.

<unk>.

Given the size of the segment. The EAC is in this segment team relatively light.

Relative to others, what programs kind of give you visibility on that picking up in the coming years and when we think about how.

Margin expansion in this segment over time.

How to how does the framework of underlying margin versus EAC is playing into that.

Sure.

In aggregate for our sector like we.

Would expect in a typical year to have.

Healthy underlying.

Om rate and in a typical year, we would have some volume a favorable net EAC adjustments of course at any given time, we don't know which programs those may come from because.

We've factored our risks and opportunities into our current eac's than we do.

Need to perform well and retire risks.

In order to drive those improvements in an EAC, so I'd be reticent to be able to point to any particular program that we think will be a key or once was the key driver of.

EAC benefits over time, but certainly within our restricted and unrestricted portfolios, we need to continue to execute well drive efficiencies.

Every one of those programs and again continued to have some volume of net EAC pickups on top of the healthy underlying segment AUM right in the business.

Segment, whose execution, we're proud of with some critical programs and we will look to continue to build on that.

Thank you one more for next question.

Our next question comes from the line of Noah <unk> from Goldman Sachs. Your line is open.

Hi, good morning, everyone.

Good morning, good morning.

Why is there.

Currently such a large variance between the pace of Dod budget outlay versus Vod budgeted authorization.

Okay.

Yes.

So no I.

I honestly don't know why I can speculate a few things that may be happening one.

We are seeing these supply chain constraints contracts may just not need additional funding that could just be a temporal issue of timing.

Another is that the labor constraints that were facing the government faces as well. So we have seen where some just shortage of people to get work done.

Impacted anything from outlays to invoice payment timing, but that would be speculation on my part I can't tell you. What I can tell you is that for Northrop Grumman, we did not see that as a.

Actor in second quarter, we had exceptionally strong book to Bill as I noted at 140, <unk>, we have seen acquisition staying relatively on time and awards and outlay has been in line with our expectations.

Okay, Yes.

Yes, it's just a strange dynamic it's uncommon to see.

Authorization humming, along and then being plus stop in discussions of higher in the future and then the outlet is down double digits.

But so for you that it's really supply chain thats.

The bigger factor and then it sounds like you think maybe it's possible that the customer.

Customer knows their supply chain issue so isn't.

Isn't cutting checks as fast as they normally would right without lids, we generally see on existing programs.

Let the government know when we're reaching a certain threshold of spending against the funds that they've outlaid and that will trigger them to provide the next funding increment it could just be that many.

<unk> and programs are trailing what their timing expectation would have been you're seeing that in the results across the industry and so they didn't have the need to do the outlays in the quarter. Obviously, that's a trend we all want to see reverse.

Because to your point the funding is there.

Thank you.

Our next question.

Our next question comes from the line of Rob Spingarn from Melius. Your line is open.

Hey, good morning.

Good morning Kathy.

And as you've held the revenue guide despite the pressure in the first half as you and Dave noted earlier, but the margins are coming down just slightly.

And you've talked about catching up in the second half.

Wanted to ask if the labor to do that is going to be a little more expensive and maybe thats whats behind the margin.

And to what extent the palmdale might be of particular labor pinch point because it does seem like you and Lockheed are competing pretty intensely out there for talent mhm.

Let me start with the second half of the question and then Dave can chime in on the first half we are not seeing palmdale to be more competitive than other labor market labor markets across the country, where we're operating are all competitive palmdale is no different but we have been able to get the staffing there that we need.

To execute on our program, what we've seen more so and we talked about this towards the end of last year, particularly as it impacted the F. 35 line is absenteeism that ebbs and flows with Covid has been a bigger challenge for us. So we have the workforce, we need but if they arent.

As productive because they aren't able to be there consistently that with creating more disruption for us that has started to even out even with this latest set of COVID-19 disruptions, we've not seen the same level of impact because we've taken some mitigating that.

Other thing that we've done in Palmdale is put our own training facility in place. So that we can more quickly onboard people to our production programs and provide them. The training they need it allows us to hire lesser skilled labor coming and we provide the skills needed and that has opened up the pool from which.

We can recruit so we arent just taking talent from other.

People's production lines and vice versa. So those are some of the things that we've done and we're seeing good results.

Helpful and just.

I'm, sorry, I was going to just ask a high level one if it's okay go ahead.

I just wanted to ask you to characterize your positioning for that.

Yeah. So as we think about six generation aircrafts, we are in the process of building. The first of those the B 21, and that's given us some fantastic experience and lessons that we believe we can apply to other sixth generation aircrafts and so were positioned.

A competitor I think our government desires to have as broad industrial base able to prime these large opportunities as possible and we have been clear that we are investing and building our own capabilities and capacities to be able to be a contender.

Alright ill leave it there this morning, Kathy I'll turn it over to you for closing remarks, great. Thanks, Todd and thank you all for joining our call today I again want to acknowledge the extraordinary accomplishments by our team already this year and the momentum that I feel is creating for the future. So I hope each of you enjoy the remainder of.

Of your summer and we look forward to speaking with you in October .

Thanks again.

Ladies and gentlemen, this concludes.

Everyone have a great day.

[music].

Your host Mr. Todd Ernst Treasurer, and Vice President Investor Relations Mr. Ernst. Please proceed thank.

And in our SEC filings these risks and uncertainties may cause actual company results to differ materially.

I'd like to start today's call by highlighting the James Webb space telescope and the incredible images released just a few weeks ago.

This extraordinary telescope represents countless Northrop Grumman Engineers technician Sciences, and cross functional team working in partnership with NASA for over two decades.

In addition to leading the industry team, we designed and built the deployable Sun Shield provided the spacecraft develop the observatory subsystem and integrated the total system.

The advanced technology, we've created images that captures will inspire the next generation of innovators and sciences, and we believe will be one of web many legacy.

Well it exemplifies the defining characteristic of our business strategy to develop and produce innovative technology solutions to address our customers' toughest challenges.

This strategy differentiates us and aligns our portfolio with our customers' priorities and as a result, we strengthened our position in the market.

As a reminder, the four core focus areas of our strategy our technology leadership.

<unk> and profitably growing our business keeping a laser focus on performance and deploying capital in value creating ways.

This strategy continues to yield results.

In the second quarter, we saw strong demand across our businesses with a book to Bill ratio of 148, driven by awards for F 35, Gem 63 and restricted programs.

All of our businesses had a book to bill ratio above one in the quarter driving a 6% sequential increase in our backlog, which now totals $80 billion.

Given this backlog growth and our continued alignment to customer budgets and priority. We are even more confident we can accelerate our revenue in 2023 from the low single digits. We're guiding this year.

In the quarter, we did experience certain challenges from the broader macroeconomic environment, including a tight labor market and supply chain delays, which impacted sales timing.

As our business grows we remain focused on performance and driving cost efficiencies across the business.

This continued focus contributed to another quarter of solid margin performance.

Our segment Om rate was a robust 12, 2% in Q2 and stands at 12% year to date.

Dave will cover further details of our quarterly results and guidance update momentarily.

First I'd like to touch on some highlights from the quarter.

The technology developed for James Webb is one example of Northrop Grumman Innovation. Another example is how we are using technology to produce innovative and affordable solutions for our customers.

To that end, we're investing in digital design capabilities and advanced manufacturing facility.

In close partnership with our customers we are digitally transforming how we design and manufacture the next generation of system and you've heard our customers acknowledged the results, particularly with some of the largest programs, including B 21, and GBS fee.

We are marrying our world class engineering talent with the latest digital tools machine learning and agile principle.

Once operational in 2020 for this facility will support production of up to 600 strike missile per year.

Optimizing quality and reducing costs and cycle times as well as bolstering tactical weapons supply chain capacity for our customers.

For the last few years, we've taken an enterprise wide approach and mission focus areas that are aligned with our customers' priority.

Other areas, where we see opportunity to leverage our technology, knowhow and our domain expertise and tie capabilities from across our businesses.

Today I want to highlight a few of them and the related results. We've seen so far this year.

One example of this is a national security space.

Our customers have made it clear that space underpins many missions vital to our national security.

And we recognize that we need to think about things differently as a rapidly evolving contested domain.

Given this our focus is on providing space based offerings that include a mix of exquisite solutions in combination with proliferated constellations of low Earth orbit satellites also known as <unk>, which together create a more resilient architecture.

In addition to these we booked another $700 million in Q2 in restricted space Awards, and now have $11 3 billion of restricted space backlog.

We continue to see the national security space area as one of the strongest growth drivers for our company.

Another focus area, where we are pulling capability and expertise from across the portfolio is missile defense and counter hypersonic.

In the second quarter, we were awarded a contract for the missile Defense Agency to continue development of the glide phase Interceptor program.

GPI will play a central role in ensuring the United States maintains the most reliable and advanced missiles missile defense system capable of outpacing in the seeding of all in missile threat.

This complements our missile defense modernization work already underway on NCI HB TSS Andi Vcs.

Our capital deployment approach is also an important part of the strategy I just laid out for you.

We also remain committed to returning at least 100% of free cash flow to shareholders This year and.

In the second quarter, we increased our dividend by 10%, marking our 19th consecutive annual increase.

Our new quarterly dividend will be nearly double the level, we paid in the beginning of 2017.

We are also returning capital shareholders through stock repurchases and we continue to target at least $1 5 billion in repurchases this year.

Before Dave shares more details about our financial results I'd like to briefly talk about the defense demand environment.

We've seen a fundamental shift in global commitment of resources for defense and National security, particularly in Europe .

This year, we've seen Finland, and Sweden progressed their membership in NATO and many European countries increased or state there are plans to increase their defense budgets.

The geopolitical environment has highlighted an increased requirement for defense and deterrence.

In the U S. This has also resulted in strong bipartisan support for defense spending recently.

Recently, the congressional armed services Committee marked up their version of the FY 'twenty three defense, though with those providing bipartisan support for further increases in defense spending above the president's budget.

For Northrop Grumman the U S. FY 'twenty three base defense budget request included strong support for key programs like B 21, GBS D. Mci <unk> next generation <unk> and Triton.

And there is an opportunity for additional funding for data <unk> F 35 F 18 that we've seen in proposed plus ups from Congress.

But I will note that <unk> has become the norm in recent years. There is a high probability of starting the fiscal year on a CR. So we have anticipated this in our outlook for 2022.

The budget is a strong reflection of the alignment of our company with our customers and reinforces my confidence that we are well positioned for this environment.

So with that I'll turn the call over to Dave and then I'll have a few closing remarks before we turn to Q&A Steve.

Thanks, Kathy and good morning, everyone. Overall this was another solid quarter with similar themes to Q1.

Near term supply side pressures in a tight labor market have persisted, but the demand environment continues to be quite strong with outstanding awards and backlog growth driven by alignment with our customers' highest priorities setting the stage for longer term success.

We generated $13 billion of New awards in the second quarter.

They're volume than we had expected due to due to the excellent competitive wins.

Timing of a few large awards, including the latest F 35 block in our aeronautics sector or.

Year to date book to Bill is now one to two.

As a result of our strong bookings, we now expect award volume to be approximately equal to sales for the full year higher than our previous projections.

These first half results and current trends point toward a full year sales outlook near the low end of our guidance range with Q3 sales slightly over $9 billion.

In Q4 in the mid nine billions.

These figures represent much stronger year over year growth in the second half than the first requiring continued expansion in head count and material receipts.

In Q2, we drove incremental improvements in hiring as the quarter progressed, adding nearly 1000 net employees in Q2 after being down slightly in Q1.

Our material receipts forecast is also weighted towards the second half of the year based on timing of program demand.

These factors along with our growing backlog provides the foundation for faster revenue growth rates in the second half of the year and we expect that momentum to continue into 2023.

Even with temporary topline headwinds our execution remains strong in the quarter.

Segment margins were 12, 2% in line with the high level from Q2 of last year.

Driving cost efficiencies and keeping a laser focus on performance are key elements of our strategy.

This will be particularly important efforts and a higher inflationary environment than we've experienced in recent years.

It starts by negotiating good business terms and delivering strong program performance, but it doesn't end there. It also includes driving affordability and our rates, having a disciplined approach to risk management and optimizing our cost structure.

For example in the quarter, we sold a property in that page, New York and recognized a $38 million gain.

Continuing with our Q2 results diluted earnings per share in the quarter were $6 six.

Down 6% compared to the second quarter of last year EPS was lower largely due to non operational items unfavorable returns on our marketable securities and lower net pension income contributed headwinds of 60 <unk>.

Compared to Q2 of last year.

While our 17, 7% tax rate was lower than last year. It was above Q1, and our full year expectation for 2022.

Turning to full year guidance I'll start with a few updates to our sector estimates.

Our space business continues to deliver excellent sales growth and bookings.

Moving another quarter of record backlog, demonstrating the diversity of capabilities that we bring to market.

As a result, we're again, increasing its sales guidance to the high $11 billion range.

We're tweaking our full year expectations to the mid 5 billion based on a slower ramp on certain programs as well as broader staffing challenges.

For operating margin rate, we are increasing our estimates SaaS DFS and EMS based on their strong year to date results.

Offsetting these increases are a reduction in this space Om rate to approximately 10% based on better than expected success in winning new development programs.

And at the company level, we're maintaining our full year guidance ranges for sales segment margin rate EPS and cash.

Within those ranges. We currently expect that any softness in sales is likely to be offset by margin strength.

Embedded in our earnings per share outlook are a few moving pieces.

First our corporate unallocated costs are now projected to be $210 million down $60 million from our prior estimates.

This is due to favorable state tax trends and other lower corporate expenses.

We're also projecting modestly lower net interest expense.

Offsetting these benefits is an unfavorable impact from our marketable securities that we've experienced year to date.

There are no incremental mark to market impacts assumed in our guidance for the second half of the year.

As we noted last quarter regarding corporate unallocated costs, we continue to project a one time spike in state taxes recognized in the quarter in which the R&D tax amortization law is deferred.

With respect to cash second quarter free cash flow was an outflow of $460 million absent.

Absent the cash taxes paid associated with R&D amortization, our free cash flow would have been roughly breakeven compared with the high hundreds of millions of dollars in an average Q2.

A good portion of this delta was due to several large program collections expected towards the end of Q2 that were instead collected in Q3, including about $300 million collected on the first working day of July .

The seasonality of our collections and disbursements as such that the second half of the year is expected to generate much stronger cash flows than the first but as always we will need to keep our focus on execution and drive further working capital efficiencies to offset any ongoing timing issues and achieve our outlook.

<unk> continues to include two scenarios one based on current tax law and the deferral scenario predicated on receiving refunds for payments made to date.

Next I wanted to take a moment to talk about our pension plans last quarter I mentioned that while our pension plans contributor component of our GAAP earnings.

Fas income as non operational and that's something we consider when assessing the company's performance.

Slide 11 in our earnings deck provides an illustration of the pension headwind on GAAP earnings that we've experienced so far this year.

Of course, our pension plans arent unique and experiencing these macroeconomic trends.

If we snap the line at quarter end these market conditions would translate to significantly lower net pension income going forward, primarily in the non operating pension line.

Partially offsetting this GAAP earnings headwind would be a modest increase in projected Cas recoveries, but our required cash contributions would remain very low for the next several years and our funded status remains healthy at over 96%.

So while the GAAP earnings impact could be a headwind from a cash or economic perspective, the changes would be modestly favorable.

A lot can change in the financial markets over the course of the year. So we'll wait to provide more specific multiyear projections until later in the year.

Going into the pension sensitivity table that we provided in our January earnings deck for your modeling purposes, and with that I'll turn the call back over to you Cathy.

Dave.

In summary demand remains robust and we saw outstanding bookings and backlog growth in the quarter and year to date.

This demand is creating momentum that supports our expectation for accelerating growth for the remainder of this year and into next Additionally, our capital deployment strategy is aimed at supporting long term growth and creating value for our shareholders. We believe the investments, we're making today in digital tools and factories of the future.

Are already enabling stronger program performance and contributing to our operating results.

So I'm incredibly proud of the Northrop Grumman team as we execute our strategy and position the company for long term success.

So with that we're ready for Q&A.

Ladies and gentlemen, if you wish to ask question. Please press star followed by one one on your Touchtone telephone.

In the interest of time, please limit yourself to one and one follow up again on <unk>.

Want to ask a question one loan for questions.

Our first question comes from the line of Ron Epstein from Bank of America. Your line is open.

Yeah.

Hi, everyone. This is mariano bringing smart on for Ron today.

Good morning.

Labor.

Thank you.

So far and what we're doing is aggressively across the enterprise working both hiring and retention efforts.

Is that all hands on deck strategy to ensure that.

Any company's ability to hire and retain and we've seen the market conditions start to soften.

You can't pick up a newspaper article online these days without being a company that's talking about hiring.

<unk> or even layoffs and so that will have an impact on the labor market and we expect continued softening as a result of that in the second half, which leads us to feel more confident that the second half will look more like our pre pandemic experience than what we've experienced in the last six to 12 months.

Far from claims the Hampden and supply chain.

What kind of tools do you have to improve your visibility on multiyear lead times you have flexibility to reach out long term agreement senior bonds are increasing inventories to talk about any potential future disruptions.

Well, we do have those tools available to us, but what I would say is I know you've heard from a host of manufacturing, including peers and aerospace and defense industry. This week. It we're seeing longer lead times, which impact timing of sale and I believe those are result of numerous factors, but most notably the labor availability we were just.

Speaking about so as we noted earlier in the call. We do expect the labor market to soften a bit and while it'll still be a headwind in the second half we don't see it to the same degree that it would be in the first half and I'm basing. This on the fact that we are deeply embedded with our suppliers, we have Northrop Grumman people on site.

Debating volatility around timing of supply. So our teams are managing as well I feel like we have done exceptionally well in the first half while we were slightly short of our own revenue projections for Q2, which we said would be about 24, 5% at the midpoint of our guide.

Right.

That was very tight estimating variability in a very challenging market.

We have very detailed reviews of material timing, we're working mitigation strategies on a daily basis.

And we have a handle on what we need to deliver in the second half Dave.

That's to the stronger year over year growth outlook for the second half this year.

Thank you.

One more for our next question.

Our next question comes from the line of Richard Safran from Seaport Global Your line is open.

Kathy Dave Todd Good morning.

Good morning, Brett.

So I wanted to ask you about the news the FTC is making about orbital.

<unk>.

You probably were expecting this.

Yes.

This was initially brought out win win Lockheed was buying aerojet. So I wanted to know if you could briefly talk to the issues that the FTC is focusing on.

If you could discuss what the range of outcomes might be.

Yes.

I know, it's always a bit difficult, but if you could speculate on.

On the impact and any comment you would get there would be appreciated. Thanks.

Yeah. Thanks, Brett So let me start by providing some context on the issue we announced our intent to acquire orbital ATK in 2018, and the department of Defense and FTC spent many months looking at the pro competitive aspects of the deal which there are many.

And any anti competitive risks before they approve the deal and so during this period the government identified only one concern and it was around solid rocket motors and so we agreed to a consent order to address that concern over.

Over the past four years, we've executed.

<unk> compliance program and worked with the government very closely in line with the terms of the order. So we believe we've been and we continue to be in compliance with the order.

The FTC did raise one matter they were investigating a few years ago, but to our knowledge that investigation has not concluded.

And we've shared this.

In our 10-K and 10-Q filings. So you can refer to those for the details of that particular matter.

And now to the point of your question I know there's been some recent speculation based on the status of that investigation.

Broad range of possible next steps that the government might attempt to take but I will say that we don't see merit or precedent for most of those scenarios.

We continue to maintain that we don't believe this matter will have a material adverse impact to our company. So I won't speculate what the sites will be because we believe.

It could be zero and certainly isn't material.

Okay that helps thanks, a quick follow up here on your comments about international Wonder if you could expand a little bit on that.

<unk>.

What type of equipment are you getting the most interest for.

Could you go to discuss a little bit about the timing, how thats going to translate to the flow into the P&L and then just look a bit old school here with increasing international demand, we should expect more higher margin commercial contract I just want to know if that's if you think that's the case. Thanks.

Thanks, Rich this is Dave I'll take that one we've gotten a lot of questions in the last few months given the evolving geopolitical global situation.

Near term impacts I think the reality is in our business is long cycle as ours. These things take time to.

Have an impact.

We are certainly engaged with U S and international customers talking about areas of particular demand.

Mentioned.

<unk> like ABC us on the call today, I would say mission areas like missile defense or a particular <unk>.

International interest as you would expect.

But it will take time for those things to have a financial.

Impact and so I'd hesitate to project in any specifics what that may be in the near term. It's something we'll keep you apprised of over the next several years as those opportunities.

Become reality.

Thank you.

For next question.

Our next question comes from the line of Doug <unk> from Bernstein, you may begin.

Thank you.

Good morning.

Yes.

When you look at Aeronautics. This has been complicated given a lot of mature programs ramping down be 'twenty, one going up F 35.

But in Q2, if we take out the land sale gain and margins were well below 10% revenues were low as well which really.

It looks like it makes H two pretty challenging can you talk about.

How you see the path to guidance it's too.

Sure I'm happy to touch on that one Doug.

Yes.

In the first quarter, we had an unusually high volume of favorable net EAC is in the second quarter net Eac's were light. This is the.

Typical nature of a business like Aeronautics, where there is quarterly fluctuation.

But in aggregate we have.

Net EAC fluctuation rolls through sales as well and so I would note that it was relatively stable in the first and second quarter.

Another business as we described earlier in our comments, where we see a higher volume of material receipts projected in the second half than the first.

And so.

I think a reasonable.

Half ramp from where we are today and very consistent with the <unk>.

Projections, we've been providing for a couple of quarters now.

Well and as a follow up if I switch over to space.

Your backlog there is now $39 billion I mean, it's a huge backlog.

And I know you've got.

Some pretty good revenue growth forecast here, but how should we look at the conversion of that backlog in terms of timing.

Should we see that conversion move to revenues over over the years here.

Sure as you mentioned, we're incredibly pleased with the backlog growth The award volume that we've had in space.

Programs like both the transport and tracking layers of the Fda's.

Architecture are great examples there.

Of work, we're doing really up multiple layers with multiple products.

Supporting multiple mission areas in <unk>.

The national security and civilian space markets in terms of how that backlog then breaks down in terms of award volume overtime sales volume over time.

It's been our fastest growing business and we anticipate that it will continue to be our fastest growing business.

Just an excuse me in any one program GBS D is obviously, a large contributor to its growth last year and this year.

The growth is much broader based and so well GBS D has grown about $5 billion in R. 22 estimates and should show similar growth in 'twenty three we would anticipate a similar volume of growth outside of GBS D going forward in our growth outside of GBS D. For this year is actually exceeding <unk> growth.

On a dollar basis in space, So really broad based outstanding growth not just in backlog, but to your point and converting to sales as well.

Thank you our next question.

Our next question comes from the line of Cai von rumor from Cowen Your line is open.

Yes. Thank you so much so.

You and your partner and GI were selected for the glide phase interceptor.

That's an interceptor and GI is in their sector are there any read across in terms of having won this that would make you better positioned for MDI. If it goes sole source and what do you think the chances are it goes tool source. Thank you.

Okay, very insightful question as always and I would say certainly.

It's beneficial to be supporting multiple like commissions and understanding therefore, how these systems can draw from a common technology base given both certain competition I won't say anything more than that and then I'm sure you respect that.

In terms of what does this mean.

More broadly.

Simply say that missile defense is an area of great importance not only in the U S, but internationally and as I outlined in my comments, we're taking a broad enterprise approach to thinking about how we best spring capabilities with Northrop Grumman to bear on all of these opportunities.

So we feel we're positioned well.

To support with the government needs.

Do think there is a balance view, however that we need a broad industrial base.

In all of our missile defense programs and so I expect that there is some appetite to carry forward multiple providers for longer as we are seeing in NCI that down select won't happen until 2025 likely enter your point may extend even further or go.

Dual source.

And so we think that is.

Reported if Northrop Grumman growth no matter how it goes.

And we support the governments in making those decisions about what's best for their industrial base capacity.

Thanks, So much and secondly, you also had a number of wins you alluded to in the Leo.

Can you as you look at the second half are there any major opportunities, we should keep our eye on competitive bids.

There are a few mostly what we see in the second half of New awards and as Dave pointed out we do expect to now book to Bill to be close to one which is.

<unk> over our outlook at the beginning of the year, because we've been having more success in competitive awards like the two I mentioned with FCA than we had anticipated, but as we look to the second half of the year not as much.

But as we look to the second half of the year not as much competitive.

To be awarded more sole sourced to see about 1 billion and a half of our.

New awards in restricted within.

About the same in space we.

We do have a fairly significant competitive award that we're expecting any day in space within the $1 billion cloth.

And then a lot of smaller things that add up to our full year expectation that close to one book to bill.

Thank you one moment for our next question.

Our next question comes from the line of Cristina <unk> from Morgan Stanley . Your line is open.

Hey, good morning Kathy.

Good morning.

So what's different this time and how long do you think the support for defense will persist.

Thanks for the question Christine I was just in Europe , two weeks ago, and I would say that I see it truly a fundamental shift in recognizing the threat environment.

Is real and it is now right I think in recent years with in Europe , There's been a sense of we're working toward a longer term threat horizon.

And perhaps the pace of national.

In defense security spending would have been appropriate in that environment, but the fact that the threat is more eminent.

<unk> addressed in what Youre seeing as planned or.

<unk> increases in defense spending across most of the European Nations.

That does take several years, so to translate into specific needs by plan.

Is it a high priority.

So I do see it seemed fairly enduring.

Thanks, Kathy and as a follow up.

How much urgency is there.

From your conversations with customers to address the security landscape and when do you think these demand signals might translate to revenue growth.

Yeah, So as I noted.

Despite the urgency does take generally at least 18 to 24 months.

Ill translate intent into specific program.

For Asia.

Customer wanting to buy X quantity of certain systems in production and it takes even a little longer if it's something that is not in production if it's a developmental program.

So that can be 345 years, so as I think about the landscape in Europe . Obviously, the time is now to be advising and sharing insights on what can address their highest priority demands just as we do with U S customers, but I don't see it having a material impact.

On revenues.

For us our other E&P companies in the next.

18 months, so I'd say, it's more in the 2024 time horizon that we would look for it to have a more material impact.

Thank you we'll move for our next question.

Our next question comes from the line of Rob Stallard from vertical your line is open.

Thanks, so much good morning.

Good morning, Rob.

Cathy just wanted to follow up on the question asked you three months ago about inflation and fixed price contracts I was wondering how things have evolved over the last quarter versus your expectations and whether you are making any structural changes to the way you do business considering we are in this higher inflation environment.

Yes.

Good question so.

Our today, our view is very much in line with what it was in the first quarter and we certainly are not immune to impacts of inflation. So we're working with the government to quantify those impacts and work with them to mitigate them and this includes ensuring the appropriate funding is available for the government program managers to acquire the cyst.

<unk> needed to support National defense in this inflationary environment and to that end. We're very pleased to see that Congress is including funding to offset inflation in their FY 'twenty three budget markup.

There are some structural characteristics of our business, but naturally mitigate some of these impact Dave talked about the importance of deal structure.

We are looking now at new deals that we're entering we are being more forceful and including those escalation clauses in our contract term, making sure that we're matching our supplier terms with our overall contract terms as some examples of what we're doing differently to mitigate the impact.

And then we also within our organization are working to offset the impact. So does include managing supply chain affordability looking at second suppliers, where we feel suppliers are not addressing affordability, reducing costs in our own areas of overhead costs.

Including the real estate footprint as we noted earlier today.

While inflation is something that we are managing on a daily basis.

I'd say, we haven't seen a material impact to our financials. So far this year, but we have to continue to be diligent to make sure that it doesn't become an impact.

And we're watching very closely to see if inflation is starting to modulate our indications would be that that is starting to happen, but we're watching the data sets as you are.

And then just a quick follow up there was a news report yesterday that the Air Force is looking to retire on its global Hawks in I think 2027 I think is this in line with your expectations.

And this is what we've been talking about for a while that the global Hawk franchise would be phased out over time.

Yes, we were expecting and as you note. The block 40 don't retire until 2027, so that's a bit out in the future and doesn't have an impact on any projections that we have outlined for this year.

But it is in line with our longer term expectation.

Thank you we'll move next question.

Our next question Sheila.

Sheila <unk> from Jefferies. Your line is open.

Good morning, everyone. Thank you.

Maybe if we could just talk about the F 35 program Kathy how big is it today and given some of the reset on production how does that impact the cadence on outlook for Northrop and what are some of the puts and takes just thinking about shifts some content and lead times within mission versus a F.

Mhm.

It continues to be about 10% of our annual sales in total across all aspects of our contribution to the program.

We have worked through our new contract for lot 15 through 17.

We have factored in the demand that Lockheed has for our components and we still see our outlook for 'twenty, two and even into 'twenty three intact. As a result of the new expectations around demand as we look over a longer period of time, we still.

See production being the lion's share of our revenue volume, but sustainment is the fastest growing element of our contribution to the program and in mission systems, We have a combination of development and production because we're supporting the block for upgrades and that most notably is revenue.

Support for emission system, even as we phase out of the Das program, which also as emission system, we see mission systems revenue being fairly stable because of that increased volume around block four.

Mhm.

Sure happy to jump in on that one Sheila.

In aggregate.

You can think of that franchise in the 1% of sales range, but as you pointed out they're important domestic and international components to that today and equally importantly international opportunity going forward as well certainly it's a critical mission sets that our abcs capability can meet by.

Attaching.

Kind of previously disconnected sensors, and shooters and bringing new capability to disparate systems.

Which is really central to the modern mission set both domestically and abroad. So we'd look for that to be a growing franchise. We were really pleased with the competitive awards over the past year.

There should be some second half growth in the program and again, it's a critical part of our defense systems franchise.

Yes.

Thank you.

First just a question.

Our next question comes from the line of David Strauss from Barclays. Your line is open.

Thanks, Good morning, everyone.

Good morning.

Kathy I think on the last call you you.

You kind of endorsed the current consensus revenue estimate for 2023, which I think is around 38 billion.

Is that still the right way to think about.

The revenue trajectory next year.

It seemed like you would be able to get there pretty much on b 21 in GBS the growth so.

Are you assuming what does the rest of the portfolio will look like next year.

B 21 in GBS in terms of growth.

Yes.

So we continue to believe we can accelerate our growth rate next year towards mid single digit range, which is how consensus is being developed and so I would affirm that and the demand environment is strong as I outlined on the call. So that would provide some tailwind how's.

However.

I would caution you just since I am thinking about this as we prepare to give your outlook and trends in October when we will provide more detail that the supply tight supply side challenges that we are facing this year are real and it depends on how they mitigate throughout the second half as to what that looks like going.

Growth with the labor and the material and so we're monitoring that very closely and we'll have a better sense of what that looks like in October to be able to give you a trend data into 2023.

Okay, Thanks, and Dave Thanks for the color on pension.

Obviously with you guys a lot of moving pieces with the with the mark to market and all of that.

You had previously said Fas has.

Relatively I think in total relatively flat.

Flat in 'twenty three versus 22.

Based on where things today can you help us at all or are we looking at like a couple hundred million dollar headwind.

Headwind.

<unk> three versus 22.

I appreciate you raising that topic for a follow up.

We noted on the call that.

We direct your attention to the pension sensitivity slide we provide every January so to give you a feel for the approximate impact of an increase or decrease in the discount rate or.

Our level of asset returns of a certain degree the discount rate increases the most significant effect that we would see on Fas income.

Income if the year were to end today.

We've seen well over 100, perhaps even approaching 200 basis points of discount rate increase since the year began and so as we noted in that sensitivity slide every 25 basis points can have a $1 billion or more.

<unk>.

The mark to market at the end of the year and a substantial impact on.

The Fas.

Income going forward.

These are non operating GAAP earnings.

Mounts theyre not cash flow drivers if anything as we noted because reimbursements are expected to tick up slightly and so from an economic perspective, there's a small benefit there from a GAAP earnings perspective, we would draw your attention to the.

The discount rate and asset returns sensitivities and of course, we will see where the market moves over the next six months to give you a more final sense of the 'twenty three vasquez outlook.

Thank you Omar for next question.

Our next.

<unk> comes from the line of Seth Sparkman from Jpmorgan. Your line is open.

Okay. Thanks, very much Anna good morning, everyone.

Maybe just to keep everyone riveted I'll ask a follow up question on pension and Dave I Wonder if you could talk about just thinking big picture and conceptually, we've seen Lockheed and their defined benefit plan and they're offloading a lot of their liability onto insurance companies you guys still have DB.

It's not huge I think service costs this year should be under 400 million box.

But when you think about what you want to do longer term, what makes most sense for Northrop, particularly as a government contractor and with the allowable cost framework.

What do you want to do long term.

Sure. Thanks, Seth so.

I would point out a few things one we have had outstanding returns on our pension assets over any period do you look at historically over the last 20 years, well above market return expectations really proud of the value that is.

Is generated and the benefit that that has both to the company and to our government customers.

Given the changes in the interest rate environment.

Offset by the changes in the asset returns that you would expect so there is a lot of moving pieces under the surface, but in aggregate, we don't today feel a.

Burning need to make a change to our long term strategy. It has been working it's been a value to the company to the participants and to the government.

And as a result, it's certainly something we'll continue to assess over time, but at this point, we're pleased with asset returns over any long period of time pleased with the funded status that results from that.

We will continue to keep you apprised if there are any changes along the way.

Great.

And then maybe to follow up just on.

On Aeronautics I know you talked earlier about the kind of the absence of EAC is in the quarter I think there were a slight negative I guess, if we look back over the last several quarters.

Given the size of the segment. The EAC is in this segment team relatively light.

Relative to others, what programs kind of give you visibility on that picking up in the coming years and when we think about how.

Margin expansion in this segment over time.

How to how does the framework of underlying margin versus eac's play into that.

Sure.

In aggregate for our sector like Aaas.

We would expect in a typical year to have.

The underlying AUM rate and in a typical year, we would have some volume a favorable net EAC adjustments of course at any given time, we don't know which programs those may come from because we've factored our risks and opportunities into our current eac's them, we need to perform well and retire risks.

In order to drive those improvements in an EAC, so I'd be reticent to be able to point to any particular program that we think will be a key months was the key driver of <unk>.

See benefits over time, but certainly within our restricted and unrestricted portfolios, we need to continue to execute well drive efficiencies.

And every one of those programs and again continue to have some volume of net EAC pickups on top of the healthy underlying segment AUM right in the business.

Segment, whose execution, we're proud of with some critical programs.

To continue to build on that.

Thank you one more for our next question.

Our next question comes from the line of Noah <unk> from Goldman Sachs. Your line is open.

Hi, good morning, everyone.

Good morning, good morning.

Why is there.

Currently such a large variance between the pace of Dod budget outlay versus Dod budget authorization.

So no I.

I honestly don't know why I can speculate a few things that may be happening one as we are seeing these supply chain constraints contracts may just not need additional funding that could just be a temporal issue of timing.

Another is that the labor constraints that were facing the government faces as well so we have seen some.

Just shortage of people to get work done.

Impacted anything from outlays.

Our payment timing.

That would be speculation on my part I can't tell you why what I can tell you is that for Northrop Grumman, we did not see that as a factor in second quarter. We had exceptionally strong book to Bill as I noted at 140, <unk> Athene acquisition, staying relatively on time and awards and outlay has been in <unk>.

Line with our expectations.

Okay.

It's just a strange dynamic it's uncommon to see.

No.

Authorization humming, along and then being plus stop in discussions of higher in the future and then the outlet is down double digits.

But so for you that it's really supply chain thats.

The bigger factor and then it sounds like you think maybe it's possible that the.

Customer knows their supply chain issue so isn't.

Isn't cutting chucks as fast as they normally would right without lids, we generally see on existing programs that we let the government know when we're reaching a certain threshold of spending against the funds that they've outlaid and that will trigger them to provide the next funding increment it could just be that.

Many.

Companies and programs are trailing what their timing expectation would have been and youre seeing that in the results across the industry and so.

Have the need to do the outlays in the quarter, obviously, that's a trend we all want to see reverse.

Because to your point the funding is there.

Thank you.

Our next question.

Our next question comes from the line of Rob Spingarn from Melius. Your line is open.

Hey, good morning.

Good morning Kathy.

And as you've held the revenue guide despite the pressure in the first half as you and Dave noted earlier, but the margins are coming down just slightly.

And you've talked about catching up in the second half.

Wanted to ask if the labor to do that is going to be a little more expensive and maybe thats whats behind the margin.

And to what extent the palmdale might be of particular labor pinch point because it does seem like you and Lockheed are competing pretty intensely out there for talent mhm.

Let me start with the second half of the question and then Dave can chime in on the first half we are not seeing palmdale to be more competitive than other labor markets labor markets across the country, where we're operating are all competitive palmdale is no different but we have been able to get the staffing there that we need.

To execute on our program, what we've seen more so and we talked about this towards the end of last year, particularly as it impacts would be up 35 line is absenteeism that ebbs and flows with Covid has been a bigger challenge for us. So we have the workforce, we need but if they arent.

As productive because they aren't able to be there consistently that was creating more disruption for us that has started to even out even with this latest set of COVID-19.

Since we have not seen the same level of impact because we've taken some mitigating that.

The other thing that we've done in Palmdale is put our own training facility in place. So that we can more quickly onboard people to our production programs and to provide them. The training they need it allows us to hire lesser skilled labor coming and we provide the skills needed and that has opens up the pool from which.

We can recruit so we arent just taking talent from other.

People's production lines and vice versa. So those are some of the things that we've done and we're seeing good results.

Helpful and just.

So I was going to just ask a high level one if it's okay go ahead.

I just wanted to ask you to characterize your positioning for that.

Yeah, So as we think about sixth generation aircrafts.

We're in the process of building the first of those.

The B 21, and that's given us some fantastic experience than lessons that we believe we can apply to other sixth generation aircrafts and so.

So we're positioned as a competitor I think our government desires to have as broad industrial base able to prime these large opportunities as possible and we have been clear that we are investing and building our own capabilities and capacities to be able to be a contender.

Alright, and what has to leave it there this morning, Kathy I'll turn it over to you for closing remarks, great. Thanks, Todd and thank you all for joining our call today I again want to acknowledge the extraordinary accomplishments by our team already this year and the momentum that I feel is creating for the future. So I hope each of you enjoy the remainder.

Of your summer and we look forward to speaking with you in October .

Thanks again.

Q2 2022 Northrop Grumman Corp Earnings Call

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