Northrop Grumman Corporation

Good day, ladies and gentlemen, and welcome to Northrop Grumman's second quarter 2021 conference call. Today's call is being recorded. My name is Nicole, and I will be your operator today. At this time, all participants are in a listen-only mode. If at any time during the call you require assistance, please press star zero, and an operator will be happy to assist you. I would now like to turn the call over to your host, Mr. Todd Ernst, Treasurer and Vice President, Investor Relations. Mr. Ernst, please proceed.

Thanks, Nicole. Good morning, everyone, and welcome to Northrop Grumman's second quarter 2021 conference call. We'll refer to a PowerPoint presentation that is posted on our IR webpage this morning. Before we start, matters discussed on today's call, including 2021 guidance and beyond, reflect the company's judgment based on information available at the time of this call. They constitute forward-looking statements pursuant to safe harbor provisions of federal securities laws. Forelooking statements involve risks and uncertainties, which are noted in today's press release and our SEC filing. 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 today's call are Kathy Worden, our Chairman, CEO, and President, and Dave Keffer, our CFO. At this time, I'd like to turn the call over to Kathy. Kathy.

Thank you, Todd. Good morning, everyone, and thank you for joining us. Today we are very pleased to announce another strong quarter. I'll begin by recognizing our Northrop Grumman employees for their continued focus on operational excellence. Our results represent the successful execution of our strategy, the strength of our portfolio, and the commitment of our team to deliver for our customers and shareholders. As the global threat environment continues to rapidly evolve, and other nations gain more complex and sophisticated capabilities, our customers need innovative and affordable solutions to be delivered with increasing speed and agility. With the investments we've made in advanced technologies, combined with our talented workforce and adoption of digital transformation capabilities, Northrop Grumman is well positioned to meet our customers' needs and continue to strengthen our position for the future. This quarter, we once again delivered strong growth and operating performance. Our sales increased by 3% to $9.2 billion. Adjusting for the effects of our first quarter divestiture of the IT services business, organic sales increased 10%. While we do expect this growth rate to moderate in the second half of the year, we continue to have a robust pipeline of opportunities in 2021 and beyond. Additionally, program execution across the portfolio was exceptional, which drove our segment operating margins to exceed 12%. This follows on strong Q1 performance, resulting in a year-to-date segment operating margin of 12.1%, and we continue to expect solid performance for the remainder of the year. Earnings per share increased 7% this quarter, and transaction-adjusted EPS has increased 16% year to date. Transaction adjusted free cash flow is also trending favorably and has increased 26% year to date. As a result, we ended the quarter with just under $4 billion in cash on the balance sheet. This provides us continued flexibility for capital deployment. We completed the $2 billion accelerated share repurchase in Q2 and continue to expect to repurchase over $3 billion for the year. Additionally, we increased our dividend by 8% in May. We are executing a balanced capital deployment strategy, which includes investing in the solutions our customers need and also returning cash to investors. Over the next couple of years, we continue to expect to return the majority of our free cash flow to shareholders through share repurchases and dividends. In terms of budget updates from Washington, The Biden administration issued its budget request for fiscal year 2022 in May, and it reinforces the administration's statements around investing in capabilities to maintain U.S. national security advantages. The request aligns well with the investments we've made at Northrop Grumman as we've positioned our portfolio for the future. And while it's still relatively early in the budget process, were pleased to see strong support for national security from the Congress, including a $25 billion increase to the President's budget request approved last week by the Senate Armed Services Committee. Both the House Appropriations Committee and SASC have voiced strong support for many of our programs, including B-21, GBSD, Triton, and F-35, to name a few. We look forward to working with the Congress and the administration as they make progress on the fiscal year 2022 budget. NASA was also well supported in the budget, with a 7% year-over-year increase in proposed funding. NASA priorities include returning to the moon via the Artemis program, where we are a key supplier of critical technologies, including the Habitation and Logistics Outpost, or HALO, and the solid rocket boosters for the Space Launch System, also known as SLS. This provides meaningful opportunity for the company, and it demonstrates the diverse nature of our space business. Turning to business highlights from the quarter, I'll share a few examples that help to demonstrate the strength of our portfolio and our technology leadership across key markets. In partnership with the Air Force, The B-21 program remains on track with two test aircraft in production today, and we continue to make solid progress toward first flight. This program leverages the confluence of Northrop Grumman's long history in aircraft development and advanced low observability capabilities. The Air Force recently published an artist's rendering and a B-21 fact sheet that provides additional insights into the program. The fact sheet highlights that the B-21 is being designed with open systems architecture to reduce integration risk and enable future modernization efforts to allow for the aircraft to evolve as the threat environment changes. As we've discussed on many of these calls, Northrop Grumman is a leader in communications and networking solutions, providing the connective tissue for military platforms, sensors and systems, that weren't designed to communicate with one another, passing information and data using secure, open systems, similar to how we use the internet and 5G in our day-to-day lives. Our systems played an important role in the Northern Edge 2021 Joint Exercise, which was held in May, and showcased how we enabled warfighters to easily communicate and securely share actionable information regardless of platform. As part of the exercise, Northrop Grumman systems were validated on three separate platforms. Our Freedom Pod was the part of a demonstration with the Air National Guard, and our Freedom Radios were a key part of two demonstrations centered on advanced fifth-generation communications. And as a reminder, the Freedom Radios equip both the F-35 and F-22. We are also enabling joint all-domain command and control through our Integrated Air and Missile Defense Battle Command System, or IBCS. In July, the U.S. Army successfully engaged a cruise missile target in a highly contested electronic attack environment during a developmental flight test using Northrop Grumman's IBCS. This latest flight test integrated the widest variety of sensors to date. including a Marine Corps Gator radar, which is our fan-based expeditionary radar that entered full-rate production last year, as well as F-35 and other ground sensors and interceptors. This was the eighth successful flight test performed with the IBCS program, and the program is on track for a competitive down select of full-rate production later this year. In addition, we are making great progress on the GBSV program, In the second quarter, the team officially closed out the EMD baseline review with our Air Force customer, and we completed the integrated baseline review. The IVR is a critical step in setting cost and schedule baselines and is an important milestone for the program. And earlier this month, we were awarded a contract to continue our support of the Minuteman III ground subsystems until their successful transition to the GBSD system. So taking a step back, the examples that I just provided highlight our strong performance, technology leadership, and broad portfolio, and its tight connection to national security priorities, from modernizing our strategic deterrence to breakthrough technologies that connect our forces. Based on the strong results and performance of our company year to date and our latest outlook for the remainder of the year, we are increasing our 2021 revenue, segment OM rate, and transaction-adjusted EPS guidance. Additionally, after two years of book-to-bill over 1.3, we expect our book-to-bill for the full year to be close to 1 this year, with key booking opportunities in the second half of the year that include HALO, SLS, F35, and several restricted programs, laying the foundation for continued growth. Before I turn the call over to Dave, I'd like to talk about ESG. We are very proud of our ESG record and the high marks we've received in many environmental and social rankings. We have built an organization with a robust governance structure, diverse and inclusive working environment, and an ongoing and evolving focus on responsible environment stewardship. In May, we published our most recent sustainability report. It provides transparency into the progress and actions we've taken in these areas and more. To help ensure we adhere to these priorities every day, key components of our ESG goals are reflected in non-financial metrics that are incorporated into the leadership team's annual incentive compensation. And just last week, we announced the appointment of a Chief Sustainability Officer who will report to me and drive further enhancements to our ESG program. I want to again thank all of our employees for stepping up to the challenges our nation is facing and for remaining focused on delivering for our customers and our shareholders. Our second quarter results and enhanced 2021 outlook demonstrate that our strong fundamental trends continue. Over the long term, we are well positioned to provide our customers innovative and affordable solutions to help address national security threats while driving profitable growth and value creation for our shareholders. So with that, I'll turn the call over to Dave, who will provide more detail on our sector results and our updated 2021 guidance. Dave?

Thanks, Kathy, and good morning, everyone. My comments begin with second quarter highlights on slide three. We delivered another quarter of excellent organic sales growth, an outstanding segment operating margin rate, and higher EPS. Our year-to-date transaction adjusted free cash flow increased 26%, and we continued to return cash to shareholders through our buyback program and our quarterly dividend, which we increased by 8% in Q2. As a result of our outstanding first half performance and enhanced outlook for the year, We're pleased to be raising our sales, segment operating margin rate, and EPS guidance. Slide four provides a bridge between second quarter 2020 and second quarter 2021 sales. Normalizing for the IT services divestiture, which was a $585 million headwind in the second quarter of 2021, our organic sales increased 10% compared to last year. Working days were the same in both periods. Moving to slide 5, which compares our earnings per share between Q2 of 2020 and Q2 2021, our EPS increased 7% to $6.42. Operational performance contributed $0.60 of growth, and lower unallocated corporate costs driven by state tax changes added another $0.22. Our marketable securities performance was a modest earnings benefit in Q2 of But compared to the even more favorable equity markets experienced in the same quarter last year, it represented a year-over-year headwind of 18 cents. Lastly, we experienced a higher federal tax rate in the period due to a change in tax revenue recognition on certain contracts for years prior to the 2017 Tax Cuts and Jobs Act. Next, I'll begin a review of sector results on slide six. Aeronautics sales were roughly flat for the quarter and up 2% year-to-date. Sales in both periods were higher in manned aircraft, principally due to higher volume on restricted programs and E2D, partially offset by lower production activity on A350, and lower volume in autonomous systems. At defense systems, sales decreased by 24% in the quarter and 21% year-to-date, and on an organic basis, sales were down roughly 3% in both periods. Lower organic sales were driven by the completion of our Lake City activities, which represented a headwind of $120 million in the quarter and $260 million year-to-date. This was partially offset by higher volume in both periods on GMLRS, as well as ramp up on the Global Hawk Contractor Logistics Support Program for the Republic of Korea. Mission system sales were up 6% in the second quarter and 8% year-to-date. On an organic basis, MS delivered another double-digit sales increase in the quarter of almost 12%, and organic sales were higher in all four of its business units in both periods. Turning to space systems, sales continued to grow at a robust rate, rising 34% in the second quarter and 32% year-to-date. Sales in both of its business areas were higher in the quarter and year-to-date periods, reflecting continued ramp-up on GBSD and NGI, as well as higher volume on Restricted Programs, Artemis, and Next Generation OPIR. Moving to segment operating income and margin rate on slide 7, we had an outstanding operational quarter with segment margin rate at 12.2%. Aeronautics Q2 operating income decreased 3%, due to a benefit of $21 million recognized in the second quarter of 2020 from the resolution of a government accounting matter. Operating margin rate was consistent at 10.3% in Q2 and the year-to-date period. At Defense Systems, operating income decreased by 18% in the quarter and 15% year-to-date, primarily due to the impact of the IT services divestiture. Operating margin rate increased to 12.4% in the quarter and 11.8% year-to-date. The increase in operating margin rate was largely driven by improved business performance and business mix in battle management and missile systems programs. Operating income and mission systems rose 18% in the quarter and 15% year-to-date due to higher sales volume and improved performance. Operating margin rate increased to 15.8% in the quarter and benefited from the favorable resolution of certain cost accounting matters, as well as changes in business mix as a result of the IT services divestiture. Year-to-date, operating margin rate increased to 15.5%. Space systems operating income rose 44% in the quarter and 40% year-to-date, and operating margin rate was 11% in both periods. Higher operating income is primarily a result of the higher sales volume, along with the timing of risk retirements contributing to higher net favorable earnings adjustments in both periods. Now turning to sector guidance on slide 8, you'll note that we are now providing quantified ranges for sales and OM rates instead of the broader descriptions such as low to mid or mid to high, given the improved visibility that we have as we pass the midpoint of this fiscal year. we're increasing the sales outlooks of our defense, mission systems, and space sectors, given the strong volume they each produced in the first half and solid outlooks for second half performance. We're slightly reducing sales guidance for aeronautics, reflecting the continued plateauing of several of our production programs after years of outsized growth. For operating margin rate, we're increasing our guidance at defense, MS, and space, and the margin rate at AS remains unchanged. Moving to consolidated guidance on slide nine, we're raising our 2021 outlook for several key metrics. For sales, we're increasing the midpoint of our guide by $500 million to a range of $35.8 billion to $36.2 billion. This translates to full-year organic growth of over 4% and over 5% excluding the 2020 equipment sale at AS. As you review our sales trends, keep in mind that the first half benefited from one month of the IT services business and had seven more working days than the second half will have. We expect the company to have higher organic sales per working day in the second half of the year than the first. We're also increasing both our segment operating margin rate and our overall operating margin rate ranges. by 10 basis points to 11.6% to 11.8% and 15.5% to 15.7% respectively. Keep in mind that the gain from the IT services divestiture contributed approximately five points of our overall operating margin benefit. We're proud of our profit performance in the first half and continue to expect strong results in the second half of the year. First half net favorable EAC adjustments were particularly strong, with lower rates driving Q1 outperformance and program risk retirements contributing to Q2 strength. For unallocated corporate expense, our updated guidance reflects a $30 million reduction associated with state tax changes, and we now foresee an effective federal tax rate in the high 17% range, excluding the effects of the divestiture, which is an increase from our prior guidance. we project a federal tax rate of approximately 22.5% on a GAAP basis. Finally, we're raising our EPS guidance, which I'll highlight on slide 11. The increase in guidance is driven by 40 cents of segment operational improvement. Lower unallocated corporate costs almost fully offset the headwind from the higher federal tax rate, leading to an increase in our transaction-adjusted EPS guidance of 35 cents at the midpoint. Next, I'd like to take a moment to talk about cash. Since our call in January, we've raised the midpoint of our sales guide by $700 million. With those additional sales come additional working capital needs to fuel the growth. But in light of our outstanding first half cash flow performance, we project that we can absorb that additional working capital in our existing transaction-adjusted free cash flow guidance of $3 to $3.3 billion. We believe this range reflects continued strength in cash conversion, balanced with prudent investments in key growth segments of our market. I also wanted to provide more information on the projected impact on our 2022 CAS pension recoveries from the American Rescue Plan Act, which was passed this spring. While asset returns and actuarial assumptions will continue to influence the final number, Our current estimate is approximately $185 million of CAS recoveries in 2022, down $55 million from our January guide, and down about $300 million from our expected 2021 level. We continue to expect minimal required pension contributions over the next several years. Regarding cash deployment, as Kathy mentioned, we completed our $2 billion accelerated share repurchase in the second quarter. retiring over 6 million shares and an average price of around $327 per share. And we continue to target over $3 billion of total buybacks in 2021. At the end of the second quarter, we had approximately $3.7 billion of remaining share repurchase authorization. In conclusion, we're very pleased to have delivered another quarter of rapid growth, outstanding program performance, strong cash flow, and accretive cash deployment. And with that, Todd, I think we're ready to open up the call for Q&A.

Hey, Nicole, we remind everyone how to get into the queue.

Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touchtone phone. Again, that's star one to ask a question. If your question has been answered or you wish to exit the question queue, press the pound key. We ask that you please limit yourself to one question and a follow-up. One moment while we compile the roster. The first question will come from the line of Doug Horne with Bernstein.

Good morning.

Good morning, Doug.

You know, space is now such a big area for you. I wondered if you could give us a sense of how you look at this sort of the broader environment because We're seeing many new entrants in space, commercial players, some doing smallsats, launch vehicles, other things. So when you look at this evolution for Northrop Grumman, where do these players present competition for you? Where can they present partnership opportunities? How do you see this world evolving?

Thanks for the question, Doug. Because as we look at our portfolio, as I've said before, it's quite broad, both in terms of the technologies that we offer, the integration capabilities that we provide. And so in each segment of the market, we follow a strategy of both partnering and leading and combining partner capabilities into our own team. In national security space, for example, We are operating as both a strategic partner to many other primes while also being able to lead efforts on our own that integrate our technologies and others. In the case of civil space, in particular NASA with space exploration, the same is true. Our HALO program is an example of where we're leading. We were awarded that sole source, but we do have partners on that program that are bringing differentiating technologies. While at the same time, on Human Lander, we chose to partner in that case with Blue Origin. So in each case, we look at the capabilities that our team has to bring to the overall mission requirements and whether it's best for us to lead or follow. In order to do that, we need to have strong partnerships, both with the more traditional space companies in our industry, as well as some of the new entrants like SpaceX and blue that are of a larger scale. And I also don't want any of us to forget that there are a number of smaller companies that also have been very good partners for us in this area and will continue to be in the future. And there are dozens of them. We tend not to go forward with singular and focused partnerships in one particular company, but instead have a wide variety of partners that we work with in this area. And that's what we plan to continue to do as the space evolves.

Well, you know, when you look at this, one area is small sats, for example, where I think a lot of aspects of that people now look at is becoming more commoditized, and there's a number of small players. You know, Raytheon made the decision to acquire you know, Blue Canyon. I mean, how do you look at that part of the universe here in terms of what you see as a differentiated capability at Northrop Grumman that clearly your position is going to be very strong for a long time? And then perhaps some other areas, you know, and a small set bus could be one where, you know, you could own it or not own it. How do you think of the division between those two?

Well, as I was noting, we believe that we should own what is most important to a fully integrated offering that meets mission requirements. And we particularly are focused in our case on national security space and space exploration. And so we don't feel we need to own everything. Our acquisition of Orbital ATK rounded out our portfolio nicely. We now have both bus offerings as well as the ability to develop satellites on small scale rapidly, as well as more exquisite payloads for more sophisticated missions. And we like that breadth of our portfolio as it exists today. That's not to say we have everything we need, which is where partnering comes in. but we don't feel we need to take an equity stake or acquire companies to get access to those capabilities.

Okay, very good. Thank you.

The next question will come from the line of Ron Epstein with Bank of America.

Hey, good morning. Kathy, I was just wondering about maybe two things. Could you remind us what's on the horizon in terms of competitions latter half of this year into next year? And then the second point, in terms of capital deployment itself, is there any areas that you're looking, or how are you thinking about that?

Thanks, Ron. So I'll start with the competitions that we see in the latter half of this year. Most of our second half awards are actually non-competitive. We're looking at F-35, SLS awards in the latter half of the year. There are several restricted programs, which are competitive, that we are looking to book in the second half. And we also have IBCS, which I mentioned earlier on the call, which will be selected for full rate production in the second half of this year. As we look longer term, there are aircraft development programs in the pipeline, but those are a bit further out. And so those are areas to the second part of your question that we are investing to position for but are not necessarily evident in our short-range plan. The other areas that we're investing in, when I became CEO in 2019, we defined mission campaigns. And I've talked about several of them in the past. They include areas like national security space, strategic missiles, where we've made significant progress in the last couple of years, executing those campaign strategies, booking new awards, and moving our position in those market segments materially. We continue with that focus. And so looking forward, major areas include future manned aircraft and unmanned aircraft. We also see continued growth in our advanced weapons portfolio, and our advanced networking and communications portfolio, just to name a few.

Great. Thank you. Thank you very much.

The next question will come from the line of Sheila Kayagu with Jefferies.

Good morning, Kathy, Dave, and Todd. So going back to space, Kathy, hot topic right now, you know, 37% growth in the quarter, very good. How do we kind of think about this business over the medium term? Does it continue at double digits outside of GBSD growth? Maybe if you could talk about that given the deceleration you have in for the second half with high single digits and just the margin contraction. Is that related to some of the new programs that you're starting in space?

Yes, Sheila. Why don't I start and then I'm going to ask Dave to walk through a few of the specific structural items. But there is no doubt that our space business is performing exceptionally. There are some structural items to consider when you look at the first half compared to the second half. We walked through a few of those. Working days, the timing of our pension cost reductions that flowed through our program, EACs and the impact on margin. And then timing of particular programs like GBSD, which started to ramp in the second half of last year and therefore create a tougher compare in the second half of this. But with that said, this business has exceeded our expectations, frankly, since it was stood up 19 months ago. And we aren't betting against it in the second half, but generally we don't forecast that kind of success that the business is having. but we certainly strive to deliver it. And that's what the team has been doing all year to this point. So I'm going to turn it over to Dave because he can walk you through some of the structural items that I mentioned as you model the second half compared to the first. But I want to leave you with the impression that we still have significant opportunity in the pipeline for this business. I've talked about some of the second half awards and great momentum that will enable this business to continue to grow.

Thanks, Kathy. I think that's a great summary. The first half of the year was just an outstanding half for space, and we continue to see a strong second half in store. You mentioned the working day impact on organic growth in the first quarter. As we noted, that was three extra working days for a 5% or so benefit to growth. In Q4, it's four fewer working days for a 6% to 7% headwind for growth. But of course, those are just timing items. More broadly speaking, we had the GBSD and NGI programs ramping up in the first half, and that will continue going forward. In the second quarter, we noted that we had really strong program performance, in particular on some commercial programs where we had net EAC benefits in the quarter that contributed to that really strong margin rate performance you saw from space in the first half, in addition to the first quarter indirect rate improvements that we talked about on our April call. So in aggregate, a really strong first half for the business. In the second half, we expect continued strong performance. We had originally guided this business to be about a 10% margin rate business for this year. We're outperforming that number this year. We continue to see that as a reasonable expectation in that 10% margin rate range after this year. And so it's a really strong business in a great part of the market, and we intend to continue gaining share there.

Thank you.

Our next question will come from the line of Seth Seisman with J.P. Morgan.

Thanks very much, and good morning, everyone. Kathy, you mentioned HALO as an award coming up for, I think you probably will, it seems like you'll have it in the third quarter, and I noticed it was a firm fixed price contract, I guess, and for something in space where we all know how much risk there can be involved in space programs, how do you think about taking on a firm fixed price contract for an important space opportunity, and what does it say about the way that you and your customers are looking at risk in the space area more broadly?

Thanks, Seth. The HALO program is a firm fixed price contract. We don't see it as a development effort per se. It's building off of the habitats that we have built in the past. And so a lot of commonality with prior efforts and strong experience in this area. And that goes to how we think about bidding more generally. You know that we have a track record of not bidding when we assess the risk as too great to be able to mitigate prior to putting in a fixed price proposal. And we have walked away in the past from opportunities as a result to finding ourselves in that situation. We are getting more sophisticated in being able to shape these opportunities and do risk reduction prior to the bid so that we can get comfortable that those risks are well understood and that we have a plan to mitigate them. And that indeed is the case with Halo. With that said, we have very little firm fixed price development work in our portfolio. And so as we look across the portfolio and think about that risk exposure, I think part of your question is going to are we doing more of that? And the reality is that we are not doing more fixed price development work today than we have in the past, and we don't see that as a broad trend in the industry.

Great. Thanks very much.

The next question will come from the line of Richard Safran with Sea Park Global.

Kathy, David, Todd, good morning. How are you?

Good morning.

You know, either Kathy or David, with a number of programs advancing from development to production, I thought now might be a good time to ask how you're managing cost and cost takeout, both internally and with the supply chain. So I'm just wondering how you're incentivizing and challenging the business segments and suppliers to take out cost and drive productivity improvements. I know it's a general question, but any insight into how you think about this would be helpful as we just consider how to model Northrop longer term.

Thanks, Rich. It is an important question at this point in time as we do see a transition to more production work. We continue to focus on cost control across the company, and it is aided now by our digital transformation effort. It is an enterprise-wide effort led out of my office, and we are streamlining and automating processes both for our product development, so taking cost out of the product development cycle and manufacturing, as well as the back office, both of which contribute to margin improvement opportunity And those will evolve over the next several years as we implement different phases of that digital transformation. We're also monitoring labor costs, something that you didn't ask specifically about. But we have not yet seen significant pressure upward on labor costs. But we're tracking it because, as you all know, nationwide attrition and movement is upward trending and we have not seen that in our company. Our attrition is fairly similar to what it was pre-COVID, but we do continue to monitor that and expect to be able to fully offset that with the efficiencies I referenced in our digital transformation. And so that's part of what we're thinking about as we're setting those goals. With regard to supplier pricing, We have seen some modest pressure in supplier pricing. It's mostly related to areas where there are supply bottlenecks, think semiconductors, certain commodities. But we expect those to be transitory and to be more than offset by the internal efficiencies I spoke about. And in Dave's team, where we manage our enterprise supplier work, they're doing some really good things to get ahead both contractually and through supplier management of those pressures. So, Dave, why don't I turn it to you for any additional comments you'd like to make?

Sure. Thanks, Kathy. We have a keen focus on the supply chain these days. Certainly, we were looking at COVID-driven pressures over the past year and felt those were mitigated well, continuing to track that, of course. On the inflationary side, I think those pressures have been modest so far and focused on a few particular commodities, but have not been anything we haven't been able to mitigate. As Kathy mentioned, contract structures do reduce that risk. About half of our work is cost-type work, and of the remainder, the majority is priced over short durations, and so we get to reprice those frequently enough to mitigate that pressure. On the semiconductor side, we've seen In certain areas and pockets, I would say we've seen extended lead times, but nothing we haven't been able to mitigate broadly by partnering with our suppliers, by sharing demand signals well in advance, and being in tight communication with those in the challenging pockets of that semiconductor community. We're also continuing to make use of our own foundry where appropriate and where in the best interest of our customers. So, you know, taking a step back and kind of summarizing, certainly the supply chain is critical to our cost management efforts and to our execution efforts in general. And more broadly speaking, cost management is a keen focus of ours every day. We don't talk about it a lot on these calls, but certainly it's something that is part and parcel to everything we do, our IT costs, our real estate costs. As Kathy mentioned, we're careful about labor and semiconductor costs and other key elements of our supply chain as well. So these are areas that we're keenly focused on. Certainly digital transformation is the next key initiative that will have a significant beneficial impact. But broadly speaking, it's something that's high on our radar.

That was really great, Kohler. Thanks.

The next question comes from the line of Kai Von Lerner with Cowen & Company.

Yes, thank you. Excellent results again. Space margins. You know, I think we've always talked about, you know, is the mix becoming more production? Is it more development? And obviously, with all the wins you've had in space, GBSD and GI, it looks like the mix is becoming more development. So I'm a little surprised by the very strong margin that you delivered in space. I mean, it looks like in the second half, you're looking at about 10 or a little bit under. But maybe talk to us is that, you know, by your sectors, mainly space, mission, and aeronautics, is the net shift in the mix toward production or toward development, or is it essentially balanced going forward?

Sure, I can start on that, Kai. It's a good question. On the space side, We've touched on some of this, but certainly, to your point, we've been really pleased to be able to increase the margin rate guide there from 10% to start the year to 10.2% to 10.4% in our latest guidance. That's driven by the strength of our first half performance across programs in that portfolio. I mentioned that on the commercial side of the portfolio, there was particular strength in Q2. The indirect rate reductions in the first quarter were also beneficial there. And the second half margin rate continues to look solid. And longer term, you know, we continue to think of it as about a 10% business, though there is that mixed pressure that you described. And so that 10% margin is in the face of that pressure and really driven by the strength of operating performance that we continue to see in the business to include direct and indirect cost performance as well as program execution milestones and such. So it's certainly been a favorable story as we've seen the cost type development work begin to grow in space and one that we expect to continue. MS and AS have a bit of a different picture moving forward that is to some degree offset the cost type increase in space. MS in particular has had a mixed shift toward a bit more fixed price this year, partially driven by the divestiture, which removed a portion of its cost-type portfolio. And in AS, the broader long-term trend would shift a bit more toward fixed price as well. So again, this is one of those scenarios where it's helpful to have a broad portfolio with different types of business at different phases of their life cycles, and that's what we see unfolding in the coming years.

Great answer. Thanks so much.

The next question will come from the line of Christine with Morgan Stanley.

Hi. Good morning, everyone. Good morning. Kathy, circling back on the Artemis Lunar Lander program, Blue Origin has proposed to NASA to waive $2 billion of fees. How does this affect your partnership with Blue Origin? And what's your appetite to support a loss leader approach in space?

Thanks, Christine. So this gets back to the question Doug was asking as well when we think about partnerships. Clearly, when we lead an effort, we will choose to make sizable investments to protect that program and increase our probability of win over its life. because of the advantage that you get when you are the leader, the prime on the effort. And that's exactly what Blue Origin is doing. And it's important to also note that the business case for Blue extends well beyond the NASA program as they think about their aspirations for commercial space travel. In the case of Northrop Grumman, we'd have to do that similar business case assessment, and we'd come to different answers in terms of what our contribution should be to the overall program financials. And that's expected in any good partnership that you lay out the clear expectations of each party, but also the benefits to be gained by each party in aligning those expectations for financial investment.

Thanks, Kathy. And maybe switching gears to your nuclear business, we saw the nuclear enterprise get solid support in the fiscal year 22 budget. But now the new administration is undertaking its own nuclear posture review, and it sounds like it's going to be integrated with a new national defense strategy as well. With your exposure with the two legs of the nuclear triad with B-21 and GPSC, what are you watching for when you get a document like this, and do you anticipate to see any major changes?

Well, first, I'm very pleased that the administration is looking at the National Defense Strategy and the Nuclear Pasture Review in an integrated way, because it is the threat environment that should define the overall defense strategy and the role of the strategic deterrent and the nuclear programs as part of that strategy. So it's an indication to me that that's exactly how the administration is thinking about it. They've been clear that their assessment of the threat, particularly with Russia being the pacing threat with regard to nuclear, and China being an emerging but very rapidly growing threat, and recent intelligence just further supports that, that with that basis they will look at what each administration before them has done, overall nuclear posture review, and ensure that the programs and the modernization plans indeed measure up against that threat. we are very confident that, once again, the threat assessment, the affordability of these programs, and the requirements being met by these programs will line up well to both the NDS and the NPR, and that should play out over the next six months or so.

Great. Thank you very much. The next question will come from the line of Robert Spengart with Credit Suisse.

Hey, good morning.

Good morning.

Hi, Dave. I've got one for you on just cash flow cadence and just the smoother cash flow we saw this year. I think last quarter you talked about some of the working capital improvements that drove a smaller outflow there. So now with the first half in the books, how does the second half shake out Q3 to Q4 in terms of free cash flow? Is it going to be flatter or do we have a bigger Q4 situation? that we typically see. And if it is flat, or is that something you can hold on to long term?

Sure. Thanks for the question, Rob. You know, we don't give quarterly guidance, but we do talk about the general trends. And I think you should expect our second half trends this year to be similar to prior years. We had a smoother first half than usual, as you mentioned. We're pleased with that, and that's something we'll strive for going forward. As we look at the second half, overall, as I mentioned, we're driving for the $3 to $3.3 billion free cash flow target that we've had since we started the year. As we mentioned at the beginning of the year, and as you alluded to, that required some working capital enhancements given the growth that we were seeing. And in order to offset the lower pension reimbursements, the outflow associated with payroll tax deferral this year, and a couple hundred million dollars of divestiture-related free cash flow that we had been generating each year prior. And so in aggregate, it required substantial working capital improvements. We've now delivered on those in the first half of the year, and we're really pleased with the progress through the first half. Without giving a quarterly outlook for the second half, we expect continued strength in the third and fourth quarters. that leads to a strong $3 to $3.3 billion, as we mentioned in our guidance for the year. I'd also note, I think of that as a purer free cash flow number than we've had in prior years, given the CAS pension dynamics, which, as we noted on the call, will continue into next year. So that purification of the cash flow, the strength in working capital, I think are good news stories as it relates to free cash.

Thanks, Dave.

The next question comes from the line of Robert Scholar with Vertical Research.

Thanks so much. Good morning.

Good morning.

Dave, it's very wonderful for you. Can you elaborate on what the programs are in aerospace that are going to be plateauing out going forward from here?

Sure. I'll be happy to start on that one, Rob. We would have noted if there were one or two programs driving that. It's really broader-based than that. We've been talking about the trends and the life cycles of various AS programs on the unrestricted side over the last couple of years, and our comments today will be consistent with that. On the F-35 program, we've noted in the past that we deliver ahead of the prime's timeline, and so in this case, we would expect to plateau ahead of our prime on that. And so that's among the programs we'd note here. On the unmanned side, you know, in the hail portfolio, we've talked about the budget dynamics associated there. And so there's still some ongoing budget decision-making to occur for both Global Hawk and Triton. But certainly I would include those in the plateauing list. I'd include F-18 as well. And so, you know, broadly speaking, it's not any one program but a series of them. On the commercial side of our aerostructures business, there's been pressure really over the last year since the COVID dynamics occurred. And so there's a long-term growth opportunity there as the commercial market recovers. But in the nearer term, that smaller portion of our portfolio has faced some pressure as well.

Okay, that's very helpful. And Kathy, maybe one for you. You mentioned JAN-C2 in your commentary. It seems to be the buzzword in the DOD these days. I was wondering how you think this program's gonna evolve. Are we gonna see one sort of mega program or lots of smaller efforts contributing to this theme and what could be the opportunities for Northrop Grumman?

So I absolutely see this being a collection of smaller efforts rather than one large program and that supports the ability for the government to make this architecture a reality, digesting it by upgrading platforms and sensors with the ability to communicate with one another or share data and be part of an architecture is a much better solution in my view than trying to go with a single party or a single platform to be the network of choice because the mission requirements vary so greatly. When you think about a contested space and the kind of architecture that you need, it's very different than when you're operating in an uncontested environment like we have been for the last 20 years in the Middle East. So there will be many architectures to be able to support different theaters and mission requirements in JADC2, and therefore an opportunity for all of industry to participate. Where Northrop Grumman is particularly strong is in our advanced networking, as those capabilities are the core of helping platforms and systems that were not designed to share data to be able to do so in the future. And I would also note that's a much more affordable answer to getting a platform modernized to be part of a JADC2 architecture than completely redesigning or replacing the platform itself.

That makes sense. Thank you very much.

The next question will come from the line of Miles Walton with EBS.

Thanks. Good morning. Dave, back to cash for a second. The working capital headwind you absorbed, can you maybe just size that? And also, after a couple of years of elevated growth and likely some moderation in the growth next year, should we expect the working capital to start to flow out in 22 and 23 in a more measurable sense?

Thanks for the question, Miles. It's tough to size exactly the nature of the pressure from the increased growth this year. As we mentioned, we've increased our guidance now by 700 million in sales since the beginning of the year. And so you can apply a reasonable days of working capital metric there. And, you know, it's maybe 100 million or so of pressure on that metric that we're able to overcome in part due to the strong first half performance and the strength and outlook that that gives us as a result. As we look at 22 and beyond, You know, we're certainly not finished in our efforts to drive working capital efficiency and effectiveness. That's, you know, like we talked about earlier with cost management, that's something we wake up every day and focus on, and that focus will continue. So I'll look for continued opportunities in 22 and 23. More broadly, as we think about pre-cash in 22 and beyond, You know, we have the pension dynamic I mentioned earlier that we'll need to overcome. And then on the tax side, everyone is awaiting news on legislative environment there as it relates to the R&D amortization issues and such. So we're focused, as you'd imagine, on the things we can control, which are around working capital efficiency, being prudent with our capital expenditures, focusing those on key growth areas of the market. And at this point, we feel confident that we're doing a good job in both of those areas.

All right. Thank you.

The next question comes from the line of David Strauss with Barclays.

Thanks. Good morning, everyone. Hi, David. base Kathy so it looks like you know with your revised revenue guidance you're talking about two billion dollar revenue increase year over year you know adjusting for the divested revenues as well I think previously you had said GBSD was 800 900 million does that still hold within that or is that improved and then you know that if you could just break out the big chunks that are driving that extra you know billion or so revenue growth this year

Yes, so GBSD is still close to a billion dollars of incremental revenue this year as we anticipated, and about 60% of the growth is non-GBSD in the midpoint of our guide as we project out for the remainder of the year. So healthy growth across the entirety of the portfolio, not just GBSD. And I will note, and I've spoken about this before, GBSD will continue to grow into next year and 2023. So it has a long ramp, if you will. But it's just amazing to hear you repeat it. $2 billion of growth in that segment is just tremendous. The team is executing and winning work at a rate that I haven't seen in my time in this industry. Kudos to them.

And Kathy, that non-GBSD portion, I think you said 60%, does that bucket grow next year as well?

We expect it to. Again, we will provide more color on our 22 guidance, but we expect space to continue to be our fastest growing segment. It'll modulate from this year, certainly. There just aren't the same number of opportunities going into 2022 that there are in 2021. We still have confidence in this team's ability to win, but we do see that modulating a bit, but still plenty of growth drivers for 2022. Terrific.

Thanks very much for the call.

Thank you.

We have time for one more question.

The final question will come from the line of Mike Maggiore with Youth Research.

Hey, good morning. Thank you. Kathy, I'd be curious to get your thoughts on the cyber domain, maybe just how you see that trending relative to the budget at a high level, where you see Northrop in the landscape, how big it is for you, and then how it trends for Northrop relative to the rest of Northrop.

So, cyber continues to be an important standalone market segment, when we think about the work we're doing for customers to enable secure processing, secure communications, oftentimes those programs are wrapped up under those umbrellas when we talk about a processing program or a communications program. In addition, now the ability to securely command and control or communicate is a differentiator in many of the programs that we're bidding and winning. It was true on GBSD. Secure command and control was an essential requirement, and we were able to bring forward a solution to that requirement based on the strength of our cyber expertise that we gained largely from our direct work with the government on securing their assets, but then apply internally as we build new weapons systems. So a lot of synergy with our standalone cyber portfolio, even though it, in and of itself, is not that large, it does drive opportunity and differentiation across the entirety of the business. And we see it continuing to grow. It has been growing for a decade, and we expect that trend to continue as just about every weapon system now has requirements for security.

Great. All right, we'll leave it there and turn it over to Kathy for some closing remarks.

Thank you, Todd. Well, again, this quarter, we demonstrated our ability to execute our strategy and deliver growth, operational excellence, and balanced capital deployment. So our strong performance, all the credit goes to the team, and I want to thank them again for their hard work and continued efforts as we look forward. I have great confidence in our future. Thanks for joining us today. I look forward to our next call in October.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation.