Q1 2023 Northrop Grumman Corporation Earnings Call

Speaker 2: Good day ladies and gentlemen, and welcome to Northrop Gummins.

Speaker 2: First quarter conference call. Today's call is being recorded. My name is Lisa and I will 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 host, Mr. Todd Earnest, Vice President Investor Relations. Mr. Earnest, please proceed.

Speaker 3: Thanks Lisa. Good morning everyone and welcome to Northrop Grumman's 1st quarter 2023 conference call. We'll refer to a PowerPoint presentation that is posted on our web page this morning. Before we start matters discussed on today's call, including guidance and outlooks for 2023 and beyond.

Speaker 3: reflect the company's judgment based on information available at the time of this call. They constitute forelooking statements pursuant to safe harbor provisions of federal securities laws. Forelooking statements involve risks and uncertainties, including those noted in today's press release and RSCC filings. These risks and uncertainties may cause actual company results to differ materially.

Speaker 3: Today's call will include non-GAAP financial measures that are reconciled to our GAAP results in our earnings release. Thank you for joining us.

Speaker 3: On the call today are Kathy Worden, our Chair, CEO , and President, and Dave Kapperer, our CFO . At this time, I'd like to turn the call over to Kathy. Kathy? Thanks, Todd. Good morning, everyone, and thank you for joining us. Northrop Grumman is off to a solid start to the year. Our team is driving industry-leading growth by executing our strategy.

Speaker 3: In the first quarter, we continued thoughtful investments in the capability and capacity needed to support our customers' operational initiatives, and we initiated a $500 million accelerated share repurchase plan, returning a total of nearly a billion dollars to shareholders through dividends and share repurchases.

Speaker 3: Based on first quarter results and our continued expectations for growth and strong operational performance, we're reaffirming our 2023 segment guidance. We're increasing our EPS guidance based on our continued confidence in our business outlook and to account for the divestiture of a small minority investment signed this week.

Speaker 3: National Defense Strategy.

Speaker 3: which align well with the Northrop Grumman portfolio solution.

Speaker 3: This support was reaffirmed in the administration's budget request, which was released in March. DoD investment accounts are up by nearly 4% for fiscal year 2024. Northrop Grumman programs continue to be well supported in the budget request, particularly in the areas of strategic deterrence.

Speaker 3: space, missile defense, and advanced computing and communication technologies.

Speaker 3: The 2024 budget request also reflects the growing need for weapons capability and capacity, with overall funding increasing more than 20% compared to fiscal year 2023, and significant funding increases to major weapon programs, including many of which we provide key components.

Speaker 3: Two of our franchise programs, GBSC and B21, each saw total investment account funding increase by approximately 10%.

Speaker 3: The future year defense planner FIDUS also prioritizes these programs with funding projected to nearly double from about $8 billion in fiscal year 2023 to $15 billion in 2028.

Speaker 3: Global defense budgets are increasing as many US allies modernize and expand their defense capabilities.

Speaker 3: An important part of our long-term growth strategy is focused on leveraging our portfolio to meet these growing global needs.

Speaker 3: and we continue to make progress in this area.

Speaker 3: In February , Australia issued a request for ARGAM-ER, a high-speed, long-range air-to-ground missile that provides counter air defense capability. Northrop Grumman is a prime contractor for ARGAM-ER, and this recent FMS request has a potential value of over $500 million.

Speaker 3: Australia is one of over a half dozen additional countries expressing interest in this capability.

Speaker 3: In addition, last month the Defense Security Cooperation Agency approved the sale of five additional E-2D Hawkeye aircraft to Japan.

Speaker 3: These aircraft, along with the existing backlog, are expected to extend E2D production well past mid-decade.

Speaker 3: These international opportunities, together with a broad set of others in IBCS, munitions, and sensors, form a strong foundation to grow our international revenue at a double-digit rate over the next several years.

Speaker 3: With its global demand signal as a backdrop, we've been executing a strategy over the past few years to significantly enhance capabilities and capacity in our weapons portfolio.

Speaker 3: This portfolio includes components such as electronics, propulsion systems, warheads and fuses, as well as missiles, armaments, and interceptors.

Speaker 3: And as a result, we have multiple positions on key programs as both a supplier and a prime contractor.

Speaker 3: Let me share a few examples of progress we've made on this strategy. In the first quarter, we received awards for nearly $350 million for medium and large caliber ammunition, Bushmaster cannons, and propulsion products for the guided multiple launch rocket system, or GM LRS.

Speaker 3: In addition, we're developing smarter, more advanced weapons required for future high-end fight, with innovations in next-generation strike weapons, high-speed propulsion, and smart ammunition.

Speaker 3: One example of this advancement is the Air Force's Stand-In Attack Weapon, also known as SAWL, a high-speed, longer-range air-to-ground missile.

Speaker 3: During the first quarter, we received an award that takes us to the next phase of this competitive program.

Speaker 3: To meet our customers' growing demand in this area, we have invested nearly $1 billion since acquiring Orbital ATK, building our capacity for weapons and missile components.

Speaker 3: Our investments significantly increased capacity to produce solid rocket motors.

Speaker 3: supporting our expectation for continued demand for this capability, as well as increased capacity for GEM63 boosters, which supports the growing launch needs of our civil and commercial customers. We're also investing to increase capacity at our Missile Integration Facility, located at the Allegheny Ballistics Laboratory in West Virginia.

Speaker 3: Our newest 113,000 square foot facility is a factory of the future.

Speaker 3: It is designed to support production of up to 600 strike missiles per year. Production operations will commence with the second lot of low-rate initial production for ARGAM-ER, adding to other programs that we currently support at this complex, including GMLRS, TOE, Hellfire, and Precision Strike Missile, among several others.

Speaker 3: In addition, we're building a new hypersonic center of excellence in Elston, Maryland.

Speaker 3: Plated to open this summer, this new production facility is designed to provide full life-cycle production for hypersonic weapons from design and development to production and integration, using the latest digital engineering and smart manufacturing technologies.

Speaker 3: The Elkins facility supports programs like hypersonic attack cruise missile, known as HACM, an air-launched, scramjet-powered hypersonic weapon that we're producing in partnership with Raytheon Technologies. We're not only a provider of missile systems, we're also a provider of air-launched missiles.

Speaker 3: We also are a leading provider of Missile Defense Systems. This is a rapidly growing area within our business and includes a diverse set of franchise programs. Our work in Missile Defense is now approaching 10% of company revenue, and we see an opportunity to expand that in the years ahead.

Our broad end-to-end missile defense portfolio includes sensors, interceptors, and command and control systems.

One example is our prime contractor role on the next generation overhead persistent infrared or OPIR polar segment.

This OPIR satellite constellation will operate at a highly elliptical orbit and provide critical strategic missile defense warning capabilities. Importantly, we also provide proliferated low-Earth orbit missile defense capabilities on programs like HVTSS.

and recent awards for SDA tracking TronCH1. In addition, we're a prime integrator on next-generation intercept capabilities, including NGI and glide phase interceptor.

They protect against advanced ballistic and hypersonic missile threats.

Shortly after the close of the quarter, we received approval for full rate production for IDCS, an integrated air and missile defense system.

This key milestone allows the US Army to set the fielding schedule for IBCS to its Air Defense Unit, which will significantly bolster regional defense capabilities.

Over the fight of period, domestic deliveries of IBCS units are expected to increase by 40%.

And as a reminder, Poland selected IBCS to serve as the centerpiece of its air and missile defense modernization, and a number of other allies are also evaluating the system.

Before turning the call over to Dave, I'd like to touch on a couple of key program updates, starting with B21.

The program remains on the government's baseline for cost and schedule, and we're continuing to work toward first flight, which will be informed by events and data and remains on track for this year.

There are no material changes in our EACs this quarter for the EMD nor the ELRIP phases of the program, and we continue to expect to receive the first ELRIP award later this year.

The B-21 program is expected to be the centerpiece of the Air Force's long-range strike portfolio for decades to come.

With steady growth in the projected funding across the FIDUS, as I outlined, and strong customer demand for its unmatched range, stealth, and survivability, the long-term outlook for the B21 program remains robust. On GDST, we achieved two key milestones in the quarter.

This includes its first full-scale static test fire of the Stage 1 solid rocket motor and the successful completion of a series of wind tunnel tests, which tested the system in both subsonic and hypersonic environments.

The comprehensive test campaign validated our digital modeling and simulations and proved design maturity of the missile.

And earlier this month, the James Webb Space Telescope Industry Team, led by Northrop Grumman, won the prestigious Collier Trophy for revolutionizing the field of astrophysics.

I want to congratulate the team for a pioneering design and unwavering commitment, which were instrumental in winning our industry's highest honor. Overall, our strong start to the year is a clear indicator of this team's performance.

We see continued robust demand for our solutions in the US and abroad, and we believe we're well positioned to maintain our industry leading profitable growth and deliver value creation for shareholders and customers alike.

With that said, I'll hand the call over to Dave to cover the details of our financial results and our outlook. Dave? Okay, thanks Kathy and good morning everyone. As Kathy noted, our first quarter results provide further evidence that our strategy is working.

The strategic investments that we're making in franchise programs and key customer priority areas have positioned us to deliver differentiated growth.

And our team continues to do an outstanding job of managing through challenges in the macroeconomic environment. We added substantially to our headcount again this quarter. With respect to the supply chain, we saw signs of modest progress in Q1, but continue to believe that our supply base will experience areas of pressure for some time.

and inflation levels have begun to moderate, we continue to have a higher base effect on our costs over time, especially on longer-term programs. As we've discussed on prior earnings calls, we've been experiencing impacts from inflation-related cost increases over the past year. We continue to drive efficiencies in our business and partner with our customers in an effort to reduce those impacts going forward.

Now turning to Q1 results, bookings of roughly $8 billion were in line with our expectations, including $3.2 billion in restricted awards.

Our backlog remains solid at more than two times our annual sales, including nearly $24 billion in restricted backlog. At the segment level, our Q1 sales were particularly strong at Space Systems, which grew 17% year-over-year.

Aeronautics sales were slightly below the projected full year run rate, primarily due to timing of volume on a few of our large programs.

MS was up 3% in the quarter, driven by expansion and restricted sales in the Network Information Solutions business.

and defense system sales were up 7%.

Its battle management and missile systems business, several components of which Kathy described earlier, is experiencing particularly strong customer demand given the global threat environment. Segment margins were 10.8% in Q1 in line with our expectations.

and included roughly 50 basis points of unfavorable impact associated with higher CAS pension costs that were incorporated into our rates in Q1. Those impacts were spread relatively evenly across the four segments.

AS margins were down from the first quarter of 2022 primarily because of the 67 million dollar favorable EAC change on the B-21 EMD phase last year. DS margins were about in line with our full year outlook adjusting for the CAS pension impacts.

MS was slightly under its 2023 projection due in part to a loss recognized on an unconsolidated joint venture.

and space margins were solid in the quarter, with lower EAC adjustments partially offset by the sale of a license to a customer.

At the enterprise level, we generated sales volume of $9.3 billion, representing growth of 6% compared to the first quarter of 2022.

Consistent with what we communicated last quarter, our Q1 sales were just over 24% of the midpoint of our full year estimate, and were driven by both our hiring trends and supplier deliveries.

Our first quarter operating income also grew 6% due to lower corporate unallocated expense and intangible asset amortization.

Our diluted earnings per share were $5.50 and included a headwind of over $1.00 per share compared to the first quarter of 2022 from lower net pension income.

EPS comparisons throughout 2023.

And based on current estimates, we expect pension income to begin to increase next year.

We also had a few Q1 benefits below the segment line that contributed to our earnings per share.

And while our forecast for corporate unallocated was already weighted toward the second half of the year, this created a timing benefit of roughly 10 cents per share in the quarter.

Our marketable securities were favorable in the period and contributed roughly 10 cents to earnings.

And our Q1 estimated tax rate of 15.6% was lower than our full year forecast, contributing another 10 cents of upside.

items contributed approximately 30 cents of benefit to our Q1 EPS.

but they are primarily timing related in nature. Turning to cash, as is our typical pattern, we experienced an outflow of cash in the first quarter due primarily to working capital timing. Capital expenditures totaled 309 million dollars and our first quarter operating cash flow was a usage of approximately 700 million dollars.

consistent with historical trends.

Q2 last year was a period of cash outflow also, but we're currently forecasting a modest inflow in Q2 this year.

In April , we made our first cash tax payment of the year, including the R&D taxes owed associated with Section 174.

For the full year, we're projecting over $700 million in cash taxes associated with Section 174, and we continue to be hopeful that Congress will find a way to amend or repeal the law.

Moving to guidance, given that the first quarter was roughly in line with our expectations, we have not changed any of our full year segment guidance ranges.

We continue to project a book to bill ratio just under 1.0 for the year. We expect our second quarter sales to be in line with or slightly higher than Q1 and less than 25% of our full year estimate.

We expect many of the timing items I mentioned previously to normalize over the course of the year, including interest expense. With respect to capital deployment, we remain committed to returning more than 100% of our free cash flow to shareholders this year via dividends and share repurchases. As Kathy mentioned, we will continue to provide additional resources to shareholders to help them save money.

we initiated a $500 million accelerated share repurchase in the first quarter, including our open market repurchases.

We were purchased roughly $720 million of stock in the period. We also raised $2 billion in new notes in the first quarter at attractive rates.

which we anticipate using in part to retire the $1 billion of notes that are maturing in Q3.

Over the long term, we've demonstrated our ability to generate strong and stable cash flows in our underlying business.

And based on the durable growth in several areas of our business that Kathy highlighted, we continue to expect our free cash flow to expand at a robust rate, not just through 2025, but through the second half of the decade as well, providing flexibility for our long-term capital deployment plan.

And as we noted in our 10-Q this morning, we just signed an agreement to sell our minority equity investment in a small international business.

Closing is expected to occur later this year, most likely in Q3, subject to government approvals and closing conditions.

We have increased our EPS guidance by 40 cents, consistent with our estimated gain from the transaction.

and additive to our strong business outlook.

In conclusion, we're pleased with our start to the year, certain improvements in the macro environment, and robust demand signals from our customers domestically and abroad. And with that, let's open up the call for questions.

Thank you. If you would like to ask a question, please press star 11 on your telephone. Again, please press star 11 on your telephone if you would like to ask a question. As well, as a reminder, we ask that you limit yourself to one question and one follow up. One moment for the first question.

And the reason is in the last quarter you all raised the possibility that you could see the first five L-Rips not be profitable in a sense because of inflation. What my question is, is

that presumably when you originally won the contract back in 2015, you made inflation assumptions in the pricing that I would assume made the L-Rips profitable.

And since that time we've seen mostly low inflation years with a couple recent high inflation years just recently here.

And first, how has inflation progressed relative to your original assumptions over that eight year period? And is there an inflation level we should watch for going forward? Where those costs become the issue that you were concerned about? Just trying to really see what the assumptions you're making are.

and how we should think about ultimate profitability here. Thanks for the question. So to talk about the assumptions that we made then on inflation and even that we're making now, I would look to publicly available information. We tend to use indices and we tend to use publicly available information.

to think about long-term projections on macroeconomic conditions. So if you roll the clock back to 2015 and look at what the Fed was doing, they were managing inflation to a 2% target and doing that pretty effectively. So you can imagine that that's the set of assumptions that we would have been...

particularly as it relates to labor, is it doesn't tend to come back down on labor once salaries are elevated. They tend to set a new labor benchmark and so as we think about the future, we're expecting those costs at least to remain elevated over the remainder of the execution of the cost.

to think about that as well.

I guess two things, I mean, is it possible for us to think of inflation levels that could be of a concern, but then also shouldn't you have the opportunity, at least on labor and materials to get some sort of an equitable adjustment on cost?

Well, we certainly believe so. And as I noted in our last call, that is what we're working toward. And so we continue to have discussions with the government, both congressionally with the dollars that they have appropriated for inflation relief for contracts just like this and the Department of Defense as they think about how to allocate those funds.

and we'll continue to work that very actively. And of course, wouldn't expect that relief to come all at once, but in the annual appropriations associated with the program or a separate fund like we saw in 2023 for inflation relief.

Now with that said, we also are working to offset these increases with other elements inside of our control, our overhead rates, the other costs that flow into segment operating margin that can have a beneficial effect as well. We're not relying solely on actions the government will take, although we do believe that the government will take a lot of the resources that are available to the public.

that both the government and Northrop Bremen should be working to mitigate these impacts and share this risk together. Okay, thank you. That's very helpful. Thanks.

Thank you. One moment for the next question. Our next question will be coming from Seth. Sethman of JC Morgan. Your line is open.

Thanks very much and good morning. I wonder if you could talk a little bit about aeronautics and kind of, you know, other than our restricted programs, you know, I assume B21.

We saw a number of declines in the quarter, and that's not very surprising. Those are kind of mature programs. But where do you see, excluding B21, where we have the budget documents, when do you see the rest of the aeronautics portfolio sort of stabilizing? And then if you could talk about the potential for any other.

term view of Arrow top line. And so while not guiding for 2024, we have said that we do expect revenue to be flattish this year and then begin to grow again next.

And that's driven by a few factors. The first is the programs you noted and that we noted in the queue, like Joint Stars, Global Hawk, that have been putting pressure on our year-for-year comparison arrow do become minimal from this point forward in terms of year-for-year sales decline.

We also have programs that are fairly stable like F-35 that will continue. And then we have growth drivers like B-21. And in addition to that, I would add the Air Force's operational imperatives, as well as some new program activity that's happening for the Navy and aviation as well.

So all of those create modest, but some apply for us as we look in the compared 24 to 23.

the investments that you're making in your prepared remarks. And I thought that was very helpful and it kind of plays into this idea that we're in sort of a different world where the customer needs kind of more spare capacity. How do you think about return on investment?

So as we're thinking about the investments we're making, we look at what we believe a stable long-term capacity level is that will be supported by government expenditures. And we've made those investments, we got ahead of that curve because we believe that we can gain share by being ready for that demand signal as it comes.

forward to the government to get their funding to support what would be that additional capacity. So in the example that I gave today, I talked about us investing nearly a billion of our own dollars in expanding solid rocket motors, both for tactical missiles, which was really the focus of my commentary today, but all the way to strategic missiles as well.

funding to complement it.

Great. Thank you very much.

Our next question will come from Sheila Cailo of Jefferies. Your line is open. Good morning. Thank you, Kathy, Dave, and Todd. Kathy, you mentioned GBSB and B21 funding nearly doubling through the FITA. How do we think about this relative to your plan?

large programs like B21 and Sentinel, you are right to point out that all of that doesn't come to Northrop Grumman and our suppliers. Some of that is government funding. And that's particularly true with the Sentinel program because there is a significant set of government activities associated with the work that will go on in the missile field.

and the coordination and collaboration across government to enable that construction scope. So when we look at our profile on these programs, it is a subset of the overall budget growth, but it tends to follow in terms of relative year-over-year growth.

what we will experience, not necessarily in that year, because those appropriated funds are for what will be expended, it then takes us time to expend those funds, sometimes 18 to 24 months, depending on the scope of work on a program like D21 and Sentinel. So not all of what I just said.

The signal from the budget tells you there is continued and sustained growth in both of those programs through the FIDUS. That that growth will come and be sustained not just through that 2028 period, but you could expect it to continue both when you look at what the government has said about quantities on B21 and how they ran.

you raised around free cash flow growth. What we were touching on there is really beyond the three-year outlook period that we've provided with specifics. The second half of the decade provides an opportunity for continued free cash flow growth and that's driven by returns on some of the investments Kathy's been describing throughout this call. It'll be a period of less heavy capital intensity.

and more in the way of opportunity for returns on those investments we have been and are currently making. And then of course some of the less operational items like cash taxes will be lower in the second half of the decade as we get through the Section 174 amortization period.

And the opportunity exists for CAS pension recoveries to continue to be higher in that second half of the decade. So, all told, that's what gives us optimism about that period from a pre-cash flow expansion perspective also.

Hey, good morning.

Good morning. Maybe changing gears just, excuse me, getting over a cold. Maybe changing gears just a little bit.

Cathy, can you talk a bit about, and you mentioned it a little bit in your opening remarks, but Northrop'spounder, trying to enforce the standards to civil rights.

the whole architecture of space is changing. You guys had a huge presence there and there's some pretty interesting stuff going on with your partnership with Firefly and so on and so forth. But if you could just kind of walk us through your vision on Northrop in space.

defense commercial.

Certainly. So you're right to point out that our strategy in space is broad-based. The cornerstone of it is as the cornerstone of our business tied to national security and supporting the U.S. and our allies to operate effectively and freely in space.

But we also have a significant strategic pillar in space exploration, as evidenced in our work in James Webb and more scientific missions, but also our work in the Artemis program in space exploration. And our commercial ventures are largely tied to enabling those two strategic pillars within our space business.

So when we are looking at the technologies that we need in space, we are well integrated across all elements of a solution. Meaning we think about launch, even if we're not the launch provider, having partnerships with companies that can provide us the ability.

to launch and thus the relationship we have with Firefly. Being able to build the satellites that provide value and that's both being a bus provider as well as the payloads. Then being able to operate command and control those assets in space so that's more of a JADC2 contribution with the space domain in mind.

And then of course, that means being able to operate on the ground as well as be able to have these satellites able to communicate and share data. So this ties to the core competencies we have across this company and other domains. And we are working to bring all of that to the space domain. And the space domain is the fastest growing area, not only of our business, but our customers' budgets. So.

A huge growth driver for you. Do you foresee that continuing into the next couple of years? How should we think about the growth of that business?

I do and I've said that we shouldn't get wedded to double digit growth that we've been experiencing consistently for the last several years because we have been in the position of winning significant new programs and seeing those programs ramp and the business itself has nearly doubled. It's pretty amazing to see what's happened in the last few years. So I don't expect that.

to be the growth profile for the next several years, but I do expect it to continue to be a growth engine in our company. And as we just talked about programs like Sentinel, the most significant growth on some of these is yet to come because many of the programs are in the development phase where we are just building the first of.

The opportunity is when those transition into production for both higher volumes and higher margins. That's still very much ahead of us. Great. Thank you very much. Thanks.

Thank you. One moment for the next question. The next question will be coming from Robert Spingarn of Milius. Your line is open.

Hones our skills makes us stronger. And so we we see this as a positive for the industry overall Thanks, Kathy Thank you one moment for the next question

P.

What.

The next question will be coming from Jason Gursky of Citi. Your line is open. Good morning. Kathy did a nice job of outlining some of the recent wins and developments in the investments that you're making. You touched a little bit about aeronautics and space growth in the out years. I wonder if you might do the same for…

systems. It's been a steady grower. We anticipate that it will continue to be. It hasn't been our fastest grower, but it's just really consistent. And I expect that to be the position mission systems finds itself in going forward. And that's not to say there aren't a lot of changes happening within that business. It is a highly competitive business and one where technical differentiation is critical.

But at the same time, they are competing for next generation technologies. And you see this even playing out on the F-35 where we talked about the new radar development award that we got as that platform is being modernized with Block IV upgrades. And so I'm really pleased with that team's competitive position to stay at the forefront of technology and continue to win new work, but that will be necessary.