Northrop Grumman Corporation (NOC) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to Northrop Grumman's Third Quarter 2026 Conference Call. Today's call is being recorded. My name is Josh, and I will be your operator today. [Operator Instructions]. I would now like to turn the call over to your host, Mr. Randy Sinclair, Vice President of Investor Relations. Mr. Sinclair, please proceed.

Good morning, and welcome to Northrop Brummin's Third Quarter 2026 Conference Call. Before we begin, please note that matters discussed on today's call, including guidance and outlooks for 2026 and beyond, reflect the company's judgment based on information available at the time of this call. They constitute forward-looking statements under the safe harbor provisions of federal securities laws. Forward-looking statements involve risks and uncertainties, including those noted in today's press release and our SEC filings, which may cause actual company results to differ materially. Today's call will also include non-GAAP financial measures, which are reconciled to our GAAP results in the earnings release. Additionally, we will reference a presentation that has been posted on our Investor Relations website. Joining us on the call today are Kathy Warden, our Chair, CEO and President; and John Greene, our CFO. With that, I'll now turn the call over to Kathy.

Thanks, Randy, and good morning, everyone. Northrop Grumman's third quarter results reflect strong and disciplined execution across the company. We're delivering on our commitments, and we're doing it with innovation and urgency. Our execution is based on an enduring strategy and adaptive approach, meeting our customers' needs through technology innovation, a laser focus on performance and value-driven capital deployment. Guided by that strategy, we've deliberately and continuously shaped our portfolio to align with our customers' top priorities, and I'm confident our investments and industry-leading performance will enable durable sales and earnings growth for the foreseeable future. As the threat environment evolves, maintaining America's advantage requires significant and balanced investments in both the attributable mass that supports resilience and the exquisite capabilities that remain the backbone of deterrence and power projection. In a complex world with growing needs for solutions that scale and perform in contested environments, our customers continue to turn to Northrop Grumman. We have leading roles in the strategic triad, space superiority, microelectronics and homeland defense. We also offer innovative and cost-effective solutions in emerging market segments, including counter UAS and autonomous systems. And we are investing to rapidly expand our munitions and missile capacity to meet operational needs and increased demand. Our company's portfolio breadth matched with our execution, turn strategic alignment into delivered capability and value creation, as demonstrated in our third quarter results. In the quarter, our book-to-bill was 1.5x, which drove a new record backlog of $110 billion, reflecting robust demand and years of durable sales. Performance across the portfolio was exceptional, with a segment operating margin rate over 12%. These outcomes are built on disciplined program execution, and our team continues to deliver many significant accomplishments. On Sentinel, all aspects of the program are progressing as planned as we complete multiple tests and achieve our milestones on this complex development effort. In the quarter, we completed the first full vertical assembly of an inert missile at Vandenberg Space for Space and gained approval from the U.S. Air Force on Sentinel Design Maturity for first flight to proceed in 2027. We -- this program is a key growth driver this year and throughout the 2030s as we complete the development and transition into production. In Space Systems, we provide space vehicles and ground systems for the Space Development Agency's proliferated war fighter space architecture. We recently launched and deployed our first 21 satellites for the tranche 1 transport layer, a critical step in the execution of unparalleled space-based communication for the U.S. base force. In the next 6 months, we expect a sustained cadence of launches with nearly 50 of our 150 satellites planned for deployment to support transport and tracking missions. Across our company, we see a sustainable and profitable growth trajectory. As John will share in more detail, we are exceeding our own expectations and increasing our 2026 guidance for segment operating income, margin rate and earnings per share. We expect to drive that momentum into 2027 as we ramp B-21 testing and production Advanced Sentinel, continue our leadership in national security space and meet increased demand for missile and munition production. Our confidence in program execution is reflected in our 2027 outlook where we expect to accelerate growth and expand margins and cash to offset increased capital investments for the B-21 acceleration, maintaining our previously communicated cash flow range. Beyond 2027, we expect growth to again accelerate and margins to further expand as we ramp on franchise programs, increased production volumes and grow international sales. Our outlook reflects both the depth and promise of our premier portfolio with new sources of growth already taking shape. One example of our response to growing market demand is Rate Hunter our latest addition to our counter UAS portfolio. Rate Hunter is a cost-effective product line that's designed to close a critical short-range defense gap as drone swarms and cruise missiles become more common. This gut-based air defense system combines our proven Bushmaster Changan technology and new precision-guided 50-millimeter ammunition to deliver powerful protection against high volume rates. We're receiving clear demand signals for Rate Hunter from key allies and expected to drive incremental growth for an already rapidly growing defense systems portfolio. We also definitize the Virginia Class Block V submarine procurement for an additional 12 ship sets of main propulsion units and ship service turbine generators. The award value adds $1.4 billion to backlog, supporting our partnership with the Navy through 2032. Additionally, we had multiple competitive strategic award wins in our restricted space portfolio associated with our leadership role in space sensing and superiority. Each advancement adds to breadth and future growth sectors and we are investing in delivering products to capture it. We deploy capital with discipline, investing first to profitably grow and meet our customers' needs. In the last 3 months, we've opened or expanded facilities in Utah, Maryland, Arizona and Florida, adding over 1 million square feet of manufacturing and engineering space and creating more than 2,000 new jobs at these sites. These investments support key customer priorities, including the accelerated production of the B-21 Raider, increased capacity for solid rocket motors and hypersonic propulsion systems, advanced space systems, design and manufacturing and aircraft design and manufacturing. Each is a continuation of our strategy to invest and perform. Today, our investments have provided the capacity necessary to deliver durable growth as we expand our product offerings and capacity. Staying ahead of tomorrow's threats takes leadership in technology. And this quarter, we extended that leadership in several areas. In Aeronautics, Talon Blue completed its first fully autonomous light with the aircraft handily taxi, take-off, flight maneuvers and landing on its own. -- designed and built in 24 months, Talon Blue demonstrates how we're accelerating modular design with manufacturing innovations to deliver real results with speed. After the successful test flight, we used Talon Blue to rapidly test and mature new autonomous capabilities, moving them into the field faster and at lower cost. Building on 7 decades of autonomous leadership, we expect this product line to be a competitive entry in a market with clear growing demand signals, both in the U.S. and internationally. We also introduced Fortitude, a significant advancement in microelectronics technology. This single chip, the size of a grain of rice, uses patented technology to deliver up to 3x the power and 20x the signal quality of comparable solutions in the market today. It can replace dozens of individual components while reducing the weight and power demands of the system it serves. It's a capability with broad application from RADAR to GPS, electronic warfare and future 6G networks, and we're building it for both defense and commercial applications. Fortitude is just one example of our unmatched microelectronics capability. For more than a decade, we've leveraged our expertise in cutting-edge semiconductors and our secure U.S. foundries to pioneer leading quantum computing technologies. Today, we see a significant opportunity to scale this transformative technology for commercial and government customers. To fully realize its potential, we are actively evaluating strategic alternatives and believe we are uniquely positioned to lead in this field. We'll share more details on our approach to scale this capability in the coming months. Turning to the budget and starting with the U.S. We remain optimistic about the strong bipartisan support in Congress for national security. We are operating under a continuing resolution, and we're hopeful that an agreement for appropriations will be reached in the coming months. We understand how to navigate this environment, and we've done so effectively in the past. Importantly, our portfolio includes a set of prioritized growth drivers firmly anchored in the U.S. base budget request, including full coverage of our prime program and solid support across the rest of our business. As a result, we believe we're relatively insulated from incremental funding uncertainty, leaving us well positioned and confident in our outlook. Globally, we continue to witness unprecedented levels of demand for defense capabilities. Allied Defense budgets are in the midst of a multiyear secular upswing and we are responding by providing a range of ready-now capabilities, including munitions, missile defense, sensors as well as crude and uncrewed aircraft. These demand signals give us confidence in our goal to double international sales by 2031. In closing, I'm proud of our team and our ability to execute and innovate with speed. This quarter extended our reputation for driving performance through a strategy fundamentally aligned to our customers' highest priorities. For decades, Northrop Grumman has been solving the world's most difficult challenges including those that require staying ahead of advanced and evolving adversaries. While we continue to adapt and innovate, the core of our advantage is in the technology leadership and our portfolio that underpins deterrence and power projection. We will continue to deliver unmatched capabilities that serve to protect the United States and our allies around the world. That is why I'm excited about our future and confident in our performance trajectory in the years ahead. Now I'll turn it over to John for a review of our quarterly results and updated guidance. John?

Thank you, Kathy, and good morning, everyone. I'll start with our third quarter financial results, as shown on Slide 4. Momentum continues to build throughout our portfolio. As Kathy shared, backlog increased 20% to $110 billion compared to the third quarter of last year, driven by bookings of over $16 billion. This performance reflects a book-to-bill ratio of 1.5 for the quarter and 1.45 on a year-to-date basis. Key awards in the quarter include $4.6 billion on restricted programs and additional $2 billion on Sentinel and 3 additional E-2D production aircraft for $1 billion. Third quarter sales were $11.1 billion, up 7% year-over-year, driven by higher sales at all 4 segments. Operating performance was outstanding. Segment operating income grew 5% with a margin rate of 12.1%. From a year-over-year comparison standpoint, the prior year benefited from a favorable $68 million EAC adjustment at MS. Earnings per share increased to $7.89 and up 3%, driven by higher top line segment operating income expansion and additional tax benefits. Capital expenditures were $306 million, reflecting continued investment in our business to enable long-term profitable growth. And adjusted free cash flow was $1.8 billion in the period, up over 40% compared to the prior year, driven by improvements in working capital and $371 million of proceeds from the sale of a test asset on the B-21 program. Overall, it was an outstanding quarter of disciplined program execution that demonstrated the strength of our portfolio. Moving to segment performance, starting with Aeronautics on Slide 5. AS continues to fire on all cylinders with backlog, sales and operating income all up meaningfully from the prior year. sales increased by 14%, driven by higher production volumes and sustainment volumes on the F-35 program. We're also seeing higher volumes in our strike portfolio, driven by the continued ramp on B-21 and higher sustainment sales on the B2 program. Operating margins improved to 10.5%, enabled by product mix and disciplined program execution throughout the portfolio. Defense Systems third quarter sales accelerated to $2.3 billion, up 12% compared to the prior year. Higher sales were driven by continued ramp on Sentinel as well as higher volumes on tactical solid rocket motor programs. Operating income increased to $250 million with third quarter segment operating margin rate of 10.8% supported by good execution on tactical missile programs. Mission Systems delivered another quarter of exceptional bottom line performance. Sales increased 2%, primarily due to the ramp up on restricted airborne radar programs and higher volumes on Marine Systems. Segment operating income was outstanding at 15.8%, driven by continued excellent portfolio execution. And at space, sales increased by 2%, driven by strength on national security programs, including restricted efforts and GPI, partially offset by timing of revenue on the commercial resupply service contract. Margins improved to 11.3%, including stable performance on GEM 63 XL. We resumed delivery of rocket motors in the third quarter. Turning to earnings per share on Slide 9. Third quarter diluted EPS was $7.89, up 3% compared to the prior year. Strong segment operating performance and tax benefits were partially offset by lower returns on marketable securities. The improvement in the third quarter effective tax rate was driven by the recognition of higher research credits. These past 2 quarters have reflected ongoing efforts to optimize our tax positions, both federally and at the state level. We'll continue to assess our positions in future periods and expect the cash benefits associated with these efforts to land over the next several years. Moving to company level guidance on Slide 10. We continue to expect full year sales of $43.75 billion to $44.25 billion. Similar to last year, we expect higher fourth quarter sales throughout the portfolio driven by production throughput, material volumes and normal seasonality. We expect continued strong awards in the fourth quarter and a full year book-to-bill ratio of at least 1.3 on due to continued strong operating performance throughout the portfolio and our confidence in the fourth quarter, we are increasing the midpoint of our segment operating income by $65 million. The updated guidance range of $4.94 billion to $5.04 billion, reflect a full year segment operating margin rate of approximately 11.3% at the midpoint. We are increasing EPS guidance by $0.70 driven by higher segment performance and a lower tax rate, partially offset by higher corporate unallocated costs and interest expense. And we are maintaining our adjusted free cash flow guidance at $3.1 billion to $3.5 billion for the year. Turning to segment level guidance on Slide 11. We are reaffirming our sales guidance at all segments. For operating income, we are increasing our guidance at AES to high 9% and at MS to mid-15% due to their excellent program execution. Collectively, this implies a fourth quarter segment operating margin rate of mid- to high 11%, driven by production mix and continued strong operating performance. Before concluding my prepared remarks, I'll take a few moments to build on Kathy's comments regarding our 2027 outlook. Given the strong support for our key programs and the enduring global demand for our capabilities, we continue to expect robust sales growth next year and well into the next decade. For 2027, we project sales growth between 5% and 7%, representing further acceleration from the growth expected this year with higher sales in all 4 segments. Beyond 2027, we are confident that sales growth will continue to accelerate. We expect segment operating income will grow faster than sales with 10 to 20 basis points of margin expansion beyond the current 2026 guidance midpoint. Capital expenditures continue to be projected at 4.5% of sales as we build out the capacity to support a higher B-21 production rate. In total, we expect approximately $2.1 billion in 2027 CapEx. We also expect a 2027 adjusted free cash flow in the range of $3.3 billion to $3.7 billion. Relative to the previous outlook, higher capital intensity for B-21 acceleration is being offset with stronger operating performance, disciplined working capital management and cash tax optimization. In closing, the results and the outlook we've discussed today are not the product of a single quarter, but the output of the strategy that Kathy described at the onset of the call. That strategy is translating directly into our financial results and it provides a visible runway for durable long-term growth. We expect that growth to come with expanding margins driven by strong program execution, cost efficiency growing international sales and a mix shift towards more production as our development programs mature. Our pairing of intentional strategy and the combination of accelerating growth, expanding margins and capital discipline underpins our confidence in the years ahead. Lastly, we'll continue to be guided by our consistent balanced and disciplined capital allocation priorities, which drive value to our shareholders through strategic investments in our business and shareholder distributions. With that, let's open the call for Q&A.

[Operator Instructions]. Our first question comes from Kristine Liwag with Morgan Stanley.

I guess Kathy and John, you've previously talked about acceleration in growth in 2028. But I think when we think about the potential range of outcomes in 2 -- can you just give us an understanding of what drives the low end versus the high end of your outlook? And also with this meaningful step-up in 2028 of acceleration, what are the key operating milestones or potential enablers that could potentially bring forward some of this 2020 growth into 2027? Is that a possibility?

Okay. Kristine, it's good to hear your voice. So let me phrase '27 this way and I'm going to move it back to '26 and talk about our execution here this year. We talked about in the last quarter that we're building momentum. And what you saw in this quarter building momentum, and that momentum continues into 2027. So as we pulled the guide together for 2027, we considered a number of factors. Certainly, the strong backlog that we have, the great execution, the the placement of our programs in the national defense priorities all giving us confidence that we're going to be able to execute strongly into '27 and out beyond into 2028. So the low end reflects frankly, where we are in the budgeting cycle for ourselves. So we've got some more work to do internally to get a greater level of confidence. The high end reflects our belief that we're going to continue to execute very, very strongly and be able to deliver great outcomes for our customers. So it's probably a little bit wider than you would like. And I hear the read in terms of '28, what can we pull in. Certainly, we've got some marquee programs, B-21, Sentinel and the multiyear programs that we're all working on. So 5% to 7% is where we are today. And in our fourth quarter call, we'll tighten that range. And if there's some more upside on it, we'll certainly share.

Great. And as a follow-up, Kathy, on Fortitude, you called out your microelectronics, the size of a grain of rice, delivering 3x the power and 20x the signal quality of comparable solutions. It's also particularly interesting that you called out the commercial opportunity for this product. So first, can you give us more context on how differentiated the technology is and how we should think about the growth opportunity for Northrop Grumman for this kind of a defense and commercial TAM?

Yes. Thanks, Kristine. So as we have for decades been at the forefront of microelectronics technology, we've largely focused that technology development on miniaturized processing power. I've talked before about having the most powerful chip in terms of processing speed. And that geared toward military applications has meant that in very small form factors that are power efficient, we are able to deliver extreme processing capability. We recognize that there's commercial applications for those underlying technologies as well. And with Fortitude, and I also mentioned Quantum Technology, we are sitting on patent that have relevance outside of the defense space. So we have been doing a strategic review of our microelectronics capability and looking at how do we bring some of these out to a more both defense. We're not strained from our defense core, but also commercial applications for this underlying technology in our business. So we are optimistic about what that could look like. We are doing some strategic reviews. Fortitude clearly is mature technology. Quantum is progressing towards some very important technical milestones in the next couple of years, but we see both of them as addressing very large both defense and commercial markets.

Our next question comes from John Godyn with Citi.

I also wanted to just ask for a little bit more color on the 2027 comments. This quarter, we saw relative strength in Aeronautics and Defense Systems, while Mission Systems and Space lagged. I know you're going to give sort of segment detail later on. But just in terms of the shape when we're thinking about the drivers of '27, are the leading segments accelerating further? Are the laggards sort of snapping back a bit? Any color you can give us just to give us a little bit of a better sense would be helpful.

Sure, John. So all 4 segments, we will see positive year-over-year growth. So we expect that growth to come from both new programs as well as backlog. And certainly, our 2 leading franchise in terms of growth will be DS. It approaching 10% this year. We expect AES continued growth on the back of B-21. And then Mission Systems, certainly, that business has generated year-over-year growth on average somewhere between 3 and 5, we're going to continue to take a look at that and see if that can be accelerated. And in Space, this year, it's been -- we're looking at relatively muted growth. We expect next year to that to accelerate a bit from where we are this year. So hopefully, that's helpful color.

Yes. That's great. And just sort of a similar question on the margins improving comment. Any puts and takes or leaders and laggers that you'd call out just as we're trying to visualize the upcoming year?

Yes. So AS had a really, really strong margins this year. So as B-21 becomes a larger percent of sales, we're going to certainly expect that program to deliver continued profitability. But certainly, as that becomes a larger percent of sales, that will put some level of basis points pressure on on the AES margin. DS, we expect strong execution, but we have a similar situation with Sentinel, but also growing international sales and program execution that will be helpful. space, relatively consistent margins. And then MS, it's been a banner year in terms of execution there. So we're looking to see if we can repeat that, but where we are today, is likely on the upper end, and I would expect that to fall in a bit. And just one other point on overall margins. We're still early in the planning process here. So the takeaway should be that we're early. We've got strong program performance. We're going to have a slight contract mix shift And then relative to Kathy's comments on Quantum, we haven't included any specific investment dollars for Quantum yet. What we're trying to do is work out the strategic alternatives and make sure we can maximize shareholder value in whatever way we take that initiative.

Our next question comes from Ronald Epstein with Bank of America.

Kathy, can you speak a little bit to the ramp of B-21, you're ramping up production by, what, 25%, how that's going?

Sure, Ron. Thanks for the question. As you know, it is a ramp that will happen over time. We will be investing in that acceleration capacity over the next couple of years and then expect to see the translation into higher volumes later in the decade. We, of course, are ramping beyond production as well. We have sustainment starting to come into the program. We also have modernization that is ongoing in the program. As we've talked about top line drivers for the B-21 is beyond that production acceleration to other elements of the full program life cycle support. But as you pointed to the capacity expansion, that really starts to take effect once we get through the large part of the facilitization, which is through 2028.

And then maybe as a follow-on to B-21, a question we frequently get from investors, how should they think about potential risk of another charge the future around the fixed price low rate initial production months.

The program is performing very well. We are continuing to progress through test and as we are testing the aircraft, it is performing against our key performance parameters. That's the largest risk in any development program, which is that you would find discoveries late and particularly the later you get in test, we are knocking down that risk with each program day and test milestone that is successful. We also are working our way through the production learning curve. And so again, there each and every day that we perform, we are improving our performance cadence and retiring risk. It is not without risk because we still have a ways to go clearly in production of our remaining LRIP units, but our confidence continues to grow in the team's ability to execute on that program.

Our next question comes from Scott Deuschle with Deutsche Bank.

Kathy, just to be more explicit, when you talk about the strategic review for the foundry business, are you suggesting you might sell it or spin it? Or is there a broader landscape of strategic alternatives than just those 2 outcomes?

It's a broader landscape clearly to the degree that we and others see value in that business. We could continue to solely invest in it ourselves with the support of our current shareholders. We could think about broadening that base of investment or we could think as you noted, about separating the business, all of those options are on the table and certainly the degree to which we do that and the timing are all the things that we would be taking under advisement here in the coming months.

Can you quantify at all what the size of the investment might be required if you were to go it alone?

It would be premature to do that because it depends on how quickly we want to scale to particular technical milestones and our appetite for that. So we really shared this with you today to just give you the broader purview of what is happening in our microelectronics business with several technologies, like the RQL, which is our unique advantage in quantum. It stands for reciprocal quantum logic and it's an ultra-efficient superconducting chip technology. And as we said, we believe it has applicability not only for us scale a quantum computer, but that others might also be able to leverage this technology. So that's what we are exploring.

Okay. And then, John, when the B-21 charges were first books, I believe the expectation on cash timing was that 60% of the cash impact would hit buyer before 2026. I think the remaining 40% was 2027 or later. Is that still the kind of rough cadence and timing expectation for those cash losses? Or has that actually moved at all?

Yes. So the way to think about that is on the loss burn down. And what we've said is about $100 million a quarter is what we'll typically burn down. This quarter, the number happened to be $70 million. So -- you can just do the math on that to have a better estimate of the cash impact.

Our next question comes from Sheila Kahyaoglu with Jefferies.

I thought the slide was super helpful in terms of the program funding that highlights the base request pending for almost 70% of the portfolio. and the 5% to 7% growth for 2027. How do you think about the major drivers of that 5% to 7%? And I guess, where are areas of potential acceleration that might move the needle as you suggested potentially for 2028 growth.

Sheila, certainly, the programs that we outlined on that chart are key drivers of growth, areas like B-21, Sentinel, our support to shipbuilding and in addition, things that are not fully represented on the chart like our weapons portfolio scaling into new munitions acceleration counsel weapons where we have not been a key provider, but we now are entering into contracts become a key provider. Those would scale over the course of 2027. International is obviously not represented on this chart. It's meant to be a U.S. base budget analysis, but international is also a key driver of acceleration of our growth in 2027 and beyond. And international, as always is more difficult to pin down in time in terms of exact timing for getting under contract. So it becomes a driver of question as to how much of that falls into '27 and how much falls more into 2028. And then the other area that isn't significantly called out on this chart, but we expect to be a key growth driver is our restricted base portfolio. About 2/3 of our space portfolio falls into the category of national security space and both the base budget and the reconciliation package has pretty significant increases that could drive further growth. So when you think about what will drive us towards the bottom end versus the top end of our growth range for 2027, it's the rate at which we get these areas on contract and can scale our production rate at which international contracts are awarded and begin to have a meaningful impact in 2027. And probably most importantly, is the level of appropriation and the timing of appropriations, the amount of time we stay in a continuing resolution, certainly, could impact 2027. But the point being, we expect acceleration throughout the year with further acceleration into 2028.