Northrop Grumman Corporation

Good day, ladies and gentlemen, and welcome to Northrop Grumman's second quarter conference call. Today's call is being recorded. My name is Josh, 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 Ernst, Vice President, Investor Relations. Mr. Ernst, please proceed.

Thanks, Josh, and good morning, and welcome to Northrop Grumman's second quarter 2023 conference call. We will refer to a PowerPoint presentation that is posted to the IR website on the call this morning. Before we get started, matters discussed on today's call, including guidance and outlooks for 2023 and beyond, reflect the company's judgment based on information available at the time of this call. They constitute four looking statements pursuant to safe harbor provisions of federal securities laws. Four looking statements involve risks and uncertainties, including those noted in today's press release and 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. And on today's call are Kathy Worden, our Chair, CEO, and President, and Dave Keffer, 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. As you saw from this morning's earnings release, global demand for Northrop Grumman Solutions is driving exceptional growth. In the second quarter, our sales were up 9%, with solid contributions from each of our four business segments. Our ability to hire and retain talent and improving supplier deliveries are strengthening our top line. Given our year-to-date sales increase of 7% and an improved outlook, we're increasing our full-year sales guidance range by $400 million. In addition, award volume in the quarter was robust, with a book-to-bill ratio of 1.14. As a result, we're increasing our full-year book-to-bill projection to approximately 1.0. Our $79 billion backlog continues to be more than two times our expected 2023 sales, supporting our long-term growth outlook. We delivered solid second quarter earnings per share of $5.34, and we're increasing the lower end of our full year guidance range by 20 cents. And free cash flow was healthy in the quarter, more than a billion dollars higher than Q2 of last year, positioning us well for our full year target. Turning to the budget environment and starting with the U.S., we're encouraged by the continued bipartisan support for national security funding to implement the administration's national defense strategy. The FY24 budget and recent congressional committee bills prioritize modernization, including areas of strength in our portfolio, such as the triad, the space domain, information superiority, and advanced weapons. We also anticipate continued support for Ukraine and related emergency spending, which would represent even further increased demand. Global demand for our products also continues to grow, as our allies increase defense spending to address evolving threats. We are well positioned in multiple markets to meet this demand, with programs such as Argonne, IBCS, and E2D, as well as munitions. With a robust backlog and a leading growth outlook, I'd like to now spend a few minutes outlining our path to margin expansion, which is a key element of our earnings and cash flow growth plan. Our 2023 operating margin dollar guidance is in the range we've previously provided. This guidance implies a segment margin rate in the mid-11% range in the second half of 2023, having delivered a rate of 10.9% in the first half. We also see an opportunity to increase our year-over-year margin rate in 2024 and get to a 12% target in the longer term. Achieving this margin improvement is built on three key drivers. First is the stabilization of temporal macroeconomic factors that have driven higher costs and impacted our supply chain and labor efficiency. Second is the ongoing implementation of cost management programs across the company that help drive affordability, competitiveness, and performance. And third is our business mix, which we see shifting to more international and production contracts as international demand grows and many of our current development programs mature over the next several years. With regard to the macroeconomic factors, supply chain disruptions rooted in the pandemic and the subsequent labor market tightness have created program delays in cost growth. To reduce this disruption, we're buying ahead of schedule, pursuing second sources where it makes sense, and placing more of our people as suppliers to facilitate timely material delivery. We see signs of progress across our supply chain from these actions, and we are seeing fewer new issues emerge. We've had exceptional performance in growing our headcount since the second half of 2022, and attrition rates are down to pre-pandemic levels. Our focus now is on optimizing labor efficiency, which is an important driver of profitability. To accelerate the learning curve for our employees, we're leaning forward with innovative training programs and standardizing work instruction. Inflation has been a challenge for our industry as well as others. Cost growth has now begun to moderate, but the last 18 months of inflation continue to have a higher base effect on our costs, especially in labor. If you look at our year-end 2021 fixed price backlog, it was largely priced before we began to experience elevated levels of inflation. However, of that backlog, approximately 70% will have been converted into sales by the end of this year. And for new bids, we are factoring higher inflation expectations into our contracts. We're also working to drive additional discipline in our bid approaches, particularly on fixed price contracts, to help protect against these types of dynamics in the future. Overall, we anticipate that these macroeconomic impacts have stabilized and now have largely been incorporated into our margins or risk factors. The second key driver of margin opportunity is cost management, which benefits both affordability and competitiveness. We are laser focused on overhead cost reduction. A foundational element of these reductions is our implementation of digital solutions across our business, which will help to drive performance and productivity. For example, we've built a digital ecosystem that focuses on program execution, bringing together employees, customers, and partners into an integrated environment so they can seamlessly work together. This accelerates design, integration, testing, and deployment across programs, helping us to deliver with quality, speed, and efficiency. We're increasing the number of programs that are operating in this ecosystem, and today we have over 100 active programs that are doing so. We're also investing in and advancing the technologies and digital systems in our factories. We're scaling this across the enterprise to drive efficiencies that should benefit all of our stakeholders. For example, on the B21, we successfully demonstrated the use of this digital thread tied to advanced manufacturing technologies to realize over 15% labor efficiencies in one area of the build. And in June, we launched the expansion of this approach across the whole build process. We're extending this digital thread into our business operations to deliver further benefits across the company. This includes how we're managing our supply chain. where we've broadly centralized procurement, and we're working to leverage our purchasing power to reduce costs. We have over 20,000 suppliers, and we've begun securely connecting them into our digital ecosystem. Over the next several years, we expect to have the majority of our supply base fully integrated. This is expected to lower supplier costs and significantly improve productivity. The third key area of margin opportunity is our business mix. For several years, we've had one of the highest cost plus development contract mixes in the industry, reflecting our significant early stage position on key franchise programs, which will transition to production throughout this decade. This cost plus mix has been increasing, with our first house revenue at 55% cost plus, up from about 50-50 last year. Looking forward, we see this shifting toward more fixed price revenue, rising to approximately 60% of sales by 2027, as a number of large programs in all four of our sectors transition to production. Production program margins are typically a few points higher than development margins, so mix shift can contribute meaningfully to our segment operating margin rates. And we are making good progress on moving programs through development and into production. For example, Argonne ER completed its fifth consecutive test flight in the second quarter. This program is nearing completion of its development phase and is on track to ramp production volumes next year. And on B21, we successfully powered on the first flight test aircraft in the quarter, another important milestone in our campaign to achieve first flight and transition to production. We also expect our international business to grow at a double-digit rate over the next few years, improving our margin opportunity as global sales become a larger percentage of our mix. In the second quarter, we demonstrated our IBCS solution for eight potential international customers, reflecting growing demand for this advanced air and missile defense capability. We also signed a memorandum of agreement with Rheinmetall to expand capacity for F-35 center fuselage production in Europe. We expect these three drivers to result in improved affordability, even better performance, and higher margins. When combined with the strength of our backlog and increasing global demand, these operating margin improvements should provide the foundation for strong future free cash flow growth. Now, with respect to capital deployment, we're executing a strategy that prioritizes investments to support our business plan and returns cash to shareholders. In May, we increased our dividend for the 20th consecutive year by 8%. Year to date, we have returned $1.5 billion to shareholders and are on track to meet our goal of returning more than 100% of free cash flow this year. Overall, the global defense budget outlook and our alignment with customer priorities give us confidence in our growth trajectory. We are focused on margin expansion opportunities and converting this to free cash flow growth to deliver value both for our customers and our shareholders. So with that, I'll hand it over to Dave and he'll cover details of the second quarter financial results and updates to our full year outlook.