Good morning, everyone. My name is Peter Arnold, Senior Aerospace Defense Analyst here at Baird. We are delighted to have with us Northrop Grumman Corporation. With us from Northrop Grumman, we have Kathy Warden, who's Chair, CEO, and President. Northrop Grumman is an $82 billion market cap company. It's had a terrific year, a strong 2025, recently reported 5% organic growth, healthy margin expansion, robust free cash flow growth, and they've highlighted some mid-single digit organic growth. I think that's above peers for next year, and they're on a path to double their free cash flow by 2028. Kathy, thank you again for supporting the conference. Really appreciate it. Kathy's going to make a quick safe harbor statement, and then we'll jump into Q&A.
Thank you, Peter, for that introduction. It's terrific to be back with you again. I would like to remind you that I may make some forward-looking statements, and those come with risks and uncertainties. For more details on those risks and uncertainties, you can reference our SEC filings. With that, you did a fantastic job of summarizing the company's performance through the year. We absolutely are looking for the government shutdown to get resolved this week and to head into the rest of the fourth quarter strong. I look forward to turning it over to you and answering the questions you have.
Yes. Maybe we'll just start with the current landscape. I think maybe if you could set the stage, kind of the big picture, how you're seeing from a, you've just mentioned the shutdown, but also there's been a lot of memos that have been circulating coming out of the Pentagon and how actionable you see this. Maybe you could set the stage, state the state from there.
Absolutely. There is a good bit of transformation going on within the Department of Defense. We are seeing new acquisition strategies, a focus on a national defense strategy that now is much more inclusive of a homeland security emphasis and the budget to go with that. We are seeing a department that wants to move at speed with our industry partners. All of this, to me, is incredibly encouraging. We came into the year knowing that the demand environment was very strong, both in the U.S. and globally. Now what we're seeing is a department that is looking to make acquisition reform to help expend those dollars in the right ways more quickly and to partner with industry and open up the aperture for us to bring forward solutions to help them do that. It is an exciting time in the industry.
As you know, there are a few things that we are working through. The government shutdown, certainly, as we talked a few weeks ago in our earnings call, we were looking forward to that getting resolved by this time so that we could see some of the delays that we were experiencing break free. We had seen some slowment in payments, so we're looking to get that issue behind us as we complete this year. We still believe that our guidance ranges hold with a resolution within these next few days and the six or so weeks left in the year to get that behind us. As we look into 2026, though, a really optimistic outlook for the future, both in the U.S. and globally, based on the strong demand signals that we're receiving.
That's great. The demand signals are very powerful, both from domestic and international. One of the other things that have also just, we've seen a lot of growth in sort of the competitive landscape, whether it's attributable or expendable systems, gaining traction. Obviously, you've leaned in on a lot of things, I think. I'm wondering how you see some of those different things shaping the market.
Yeah. Our portfolio is really well aligned to what both the U.S. and our allies need right now. The idea that each need to be able to protect the homeland and the work that we do from missile tracking to interceptors, as well as the ability to command and control those assets, to have good situational awareness of the threats that exist and how to mitigate those threats. We also have been building up, as you know, capacity in our solid rocket motor business, fuse heads or fuses and warheads, all of which support the tremendous growth that we're seeing in tactical missiles. We are at the core of all three legs of the triad, being a prime on two of the three legs, which is key to strategic deterrence, which the U.S. provides for our partners around the globe.
As you look at that complete portfolio, we already have significant work in backlog, over $90 billion of backlog in the company. We have production awards on many of those areas that I just talked about that are still into the future. They're not in our backlog yet. They're future phases on existing programs. We see that clear pathway to continued solid growth. We have had approximately 5% growth a year for the last six. It's obviously not been 5% each year, but on average, that compound annual growth has resulted in a 5% growth. We see that mid-single digit growth continuing, even without some of the things that we've recently discussed, the traditional upside opportunities for our company. For instance, the Navy Fighter Award that is still pending or the B-21 being produced faster.
Those opportunities sit on top of that foundation that I just spoke to.
Yeah. So Northrop Grumman, I mean, is involved in some exquisite programs, but you've also leaned in on some of these more attritable. I think one of the things that we saw recently, low-cost systems like Lumberjack. Maybe could you talk a little bit about that, just like you're kind of balancing the portfolio?
Yes. It is a good point. We are balancing the portfolio. We are often thought of as an exquisite developer of technology, and we pride ourselves in that. That technology sits at the core of many of the solutions that I have already mentioned, but it also can be scaled to more affordable solutions. We have product lines that enable us to use the technology that we develop for more exquisite purposes, scale it down. Lumberjack is a great example of that. It is a much lower-cost system that can be added with payloads that provide the kind of configurable solution that both the U.S. and our allies need on the battle lines to be able to defend against lower-cost threats. Today, very expensive weapons are being used to take down threats that are low-cost. That asymmetry is not sustainable. Lumberjack is a response to that.
It gives you the affordability, the configurability against the threat that you are facing in a forward-deployed situation. It is still leveraging that tech base that I talked about. It is able to operate in high-threat environments.
Great. Let's switch over to international demand for a second, just because Northrop, I think for a long time had a lower percentage of international, but that is changing quite a bit. In the most recent quarter, I think your international sales were up 32% for the quarter. They were up 20% year- to- date. Obviously, they've seen an uptick in what NATO's plans are. How do you think the structural changes are affecting Northrop for you?
We believe that those changes that we're seeing in Europe are going to sustain. Even as more European companies are able to build capabilities and scale those for capacity, the demand is outpacing the new entrants of supply. We believe that U.S. companies are going to continue to see this market grow and our share grow. Certainly, our company is seeing that. We have a number of product lines that have significant interest that we are working to convert from pipeline into awards and sales over these next several years. As you've noted, the results of that in this last year and a half have been very strong. Our backlog internationally has outpaced our domestic and our growth rate, as you noted, has also outpaced. We see double-digit growth in that international business for the foreseeable future. I would also say that it's not just Europe.
The Middle East has really opened up as a marketplace again for the kinds of capabilities that we provide. We also, I just got back from the president's visit with the prime minister in Japan, talking to the Japanese about how their increase in defense spending can be deployed. They certainly have an appetite to continue to work with U.S. companies like ours.
Terrific. Big inflection and global demand, for sure. Let's move over a little bit to maybe a couple of segments, aeronautics and the always popular B-21 questions that you get. But you've invested heavily in digital engineering, advanced manufacturing for the B-21. How should we think about these innovations kind of translating into the long-term cost efficiency that you've kind of talked about in the past, the production scalability? And how do we think about that kind of cost management side of things?
We think about that every day. It is not just isolated to the B-21. We are on a margin improvement path that has three major tenets to it. One is performance, driving through the disruption that we saw during the pandemic. Largely, macroeconomic factors have now stabilized to where labor is solid. Our negotiations with our represented workforce have gone very well this year. We have now longer-term agreements in place, CBUs in place. We also have seen that the labor market is more conducive to hiring across our whole spectrum of hiring needs, from engineering to technicians on the manufacturing floor. That has allowed us to really stabilize production lines and get back to the kind of productivity that we saw pre-pandemic.
The second element of our improvement plan was the investments that we're making in digital and the cost efficiencies that we're driving across the organization as a result of those investments. Those are both back-office digital enablers as well as digital enablers on the factory floor in design, engineering, and production. We are seeing those on programs like the B-21 yield phenomenal results. When we talk about how the airplane, as it's now flying in test, is matching the models, the predictive models that we had in design, that means you've reduced the possibility of rework. You are building your first unit to meet those criteria that's required. You don't have to do redesign, which is often very costly if it comes late in the program. That's what's then yielding us the kind of performance that we're seeing on the B-21.
It is important to note, we have done that across the enterprise. We did not do that specifically for the B-21 program. We are doing it company-wide. We are seeing those same results play out elsewhere as well. Of course, the third piece of our strategy we have already touched on a bit, and that is mix shift. As we have more international business, that is accretive generally margin-wise to the rest of the portfolio. As we are moving out of cost-plus development toward more fixed-price production, as our programs mature, that too is a tailwind to margin rate. Those three elements are very much a part of the strategy that we have been executing, and they are executing as we expected them to.
Terrific. Maybe just for the audience, can you remind us on kind of the contract kind of update where kind of which stage the LREP is in for B-21, including the number of units under contract and then the timing of Lot 3 award as well as the advanced procurement of Lot 5?
Yes. To unpack the B-21 program, for those of you who do not follow it as closely as I do, which I hope none of you do, it really is a program that has three major phases. We are still completing the development phase, but we are in test, meaning we are getting toward the end of that development phase of the program. We have two aircraft flying. As I just said, they are performing very well in test. We are already started on low-rate initial production. Those are the lots that Peter was just referring to. We were under contract for the first two lots. We expect to be under contract for the third lot later this year and then about one a year. Those lots are what were priced in the original bid. Those will be executing largely through the end of this decade.
We move into higher-rate production. That is outside of the original bid. Those are subject to future awards. Also, generally on that same timeline, expecting about a lot a year to be awarded until we get to the program of record, which is 100 aircraft. Of course, there is some discussion by the department and the Air Force about wanting more. Right now, the program of record is 100.
Right. I was going to ask that. I mean, you're stealing my thunder, but I'll ask it a different way. 100 . Is it that above 100, is it that they're increasing the mission capability or their mission opportunity for the B-21?
Yes. The B-21 was already envisioned to be a multi-mission aircraft. Its primary mission is to be a bomber with access to environments that are very hard to penetrate because of enemy air defenses and to be able to carry both nuclear and conventional bombs. It has tremendous sensor capability to be an ISR aircraft. Because of its penetrating nature, it can clear the way for less stealth platforms. It really can play more roles than just delivering a bomb for effect, as the B-2 just did. The B-2 really was designed just to be a bomber.
As the Air Force begins to think about force structure and what they need, the idea of taking an aircraft like the B-21 that is now well through development and will be in production and is relatively affordable, despite it being a more expensive platform and exquisite for the capability that the Air Force gets, it is much more affordable than previous versions of bomber aircraft. They are looking to leverage that. We think it makes a lot of sense. We need to get into production, demonstrate the ramp on production. We think this debate about how many are needed will come back to the fore.
Awesome. Thank you for that. Let's move over to defense here. Defense systems could be the fastest-growing segment, maybe in Northrop. You've talked a little bit about most recently in the third quarter, you had 250 basis point margin expansion. When you think about the margins as sustainability, but we also have a very big program in there with Sentinel, but you also have IBCS scaling up. So maybe talk about how you view that mix together.
Our defense system segment really is at the cornerstone of many of the trends I've just talked about. Their international growth has been exceptional. That is driven by the munitions demand increase around the globe that we've already referenced. They also have product lines like our Integrated Battle Command System that are in high demand from our partners for their homeland defense missions. It was originally designed for the Army to use and protect our bases that are forward deployed and our troops that are in harm's way. As other allies now look at how to protect their own homeland, it's an incredible solution. Of course, the U.S. under Golden Dome is looking at that solution as well for our homeland.
They are at the center of many of the trends we've talked about, in addition to leading the Sentinel program, which is one of the three legs of the Triad. They are seeing growth across all dimensions of their portfolio. They are seeing the mix shift over time as we progress through this decade to more high-volume product lines that come with those higher margins and more international work, which also creates those tailwinds. We expect their growth to continue to be accretive to the overall corporation, one of our fastest-growing segments, if not the fastest, and to continue on this trend of margin improvement as well.
Yeah. Part of that is Sentinel moving from kind of cost-plus eventually to fixed price. How do you see that transition? I do not know if timing is something you have visibility on, but.
It's still several years away before we would transition into production on the Sentinel program. We are in the development phase of the program. We are in the middle of a restructure with the Air Force where we are working to accelerate the timeline. In accelerating the timeline, we could see production move to the left from where it was coming out of the Nunn-McCurdy breach a year ago, but it's still several years away. In the meantime, we're working on many risk reduction activities. The reconciliation bill included about $2.5 billion of incremental funding for the Sentinel program to do that. Those risk reduction activities are actually what will help to build the confidence to pull some of those timelines left. This is a high priority for both our company and the Department of Defense.
It's something that I talk to the Deputy Secretary about frequently.
I bet. All right. Let's move over to something a little more different, but on mission systems, but microelectronics, the foundries. I don't think a lot of people are aware of that business that's inside Northrop Grumman. Maybe you could talk a little bit about the foundry business, microelectronics business. How do you see that business evolving today?
This is an area where we have seen increased demand for our products that rely on our foundries. As we are growing our own product lines increasingly, we are miniaturizing our electronics. That is part of our differentiation in the solutions we provide, whether in space, in the air, or on the ground. Now what we're seeing is a desire for domestic source of microelectronics in other applications that have traditionally relied on foreign source. Today, we're already in 90% of the nation's national security satellites, not because Northrop builds all of those. Many other companies do. Our foundries are providing the microelectronics that go into those satellites. It is because of the pedigree of source and the specificity of what we're building in the U.S. We do everything from design to fab to packaging in those foundries.
Today, we're producing over a million microchips a year. It is not a small business. We certainly have invested hundreds of millions of dollars to expand that capacity, not just for our own needs, but as we've recently announced, we have opened up to support others as well. We see a tremendous growth path as a result of the convergence of that trend I just noted of needing domestic supply for additional national security applications as well as our own demand.
Is there an opportunity to open up additional foundries, or is it more just expanding what the base that you have?
We certainly know how to build and run a foundry. We know how to scale it. In terms of the business case, we have focused on those higher price point applications where people are willing to pay for the hardening that we do and the U.S. source, which is more expensive than foreign source. We will see that get to an equilibrium. It would be hard for me to sit here today and project how much of that demand is going to shift to the U.S. We are confident enough that it is a tremendous growth opportunity for us that we have gone ahead and invested to build out that capacity. We have two foundries, one on the East Coast and one on the West. They do slightly different things, different materials. The point being, both of them give that pedigree of U.S.-based source of supply.
Terrific. Let's move over to space. Maybe we can weave in Golden Dome on top of that. You've been fighting a little bit of lower volumes, kind of some restricted work and NGI wind down. There's also been some delays. Obviously, SDA is kind of going through its own changes with Golden Dome and things. How do you think you can offset that with the space segment with some of those headwinds?
Space is an area where we have seen some specific headwinds, as you have noted, a couple of programs that we were not successful in capturing. Yet, we have also seen areas of tremendous growth in space resiliency and the modernization of new architectures in everything from missile tracking to ISR to communications. We saw a period of hypergrowth. Our space business nearly doubled. Now we are seeing a period of slower growth. When you look at it over the longer term and you zoom back and look from 2020 to 2030, over a decade, it has not been a steady growth, but it continues to likely be a very significant growth segment of our business. It is in the areas that we think are going to be most enduring into the 2030s.
We have transitioned our space business from low volume, handful of very exquisite satellites a year to where we are on order for 400 satellites this decade. We are producing at that rate. Now over 60% of those satellites are lower cost, low Earth orbit, resilient architecture assets. Our mix has shifted in a way that sets us up very well going into the end of this decade and into the next based on the trends that we see in space.
Related to space, General Guetlein hasn't come out with his architecture yet, but it should be out maybe at the end of the month or sometime, maybe in December. How do you think Northrop plays in? I mean, obviously, you've got a very strong business in solid rocket motors. And it's a duopoly, but there's other players too. At the end of the day, how do you fit into the Golden Dome kind of architecture that's yet to be revealed?
It's an important point that you make that the architecture has not been publicly released. I won't comment on any specifics on it. We have talked before about to provide homeland defense, there are some key attributes that an architecture would need. It needs a space layer to be able to identify, detect, and track threats. It needs a set of interceptors to engage that threat. It requires command and control to be able to link our knowledge from disparate assets into a single operating picture to oversee the response to that threat and inform decision makers for their ability to engage and respond. If you think of those major areas, Northrop Grumman has capability in each of those. This is a big architecture. This is a significant undertaking. My view is there is work for all comers in this area.
It will not be a single company or even a couple of companies that build out this architecture. It will be a large number of us in different pockets. We are just fortunate to have a portfolio that is well positioned to help our country build out this capability at this moment.
Just maybe let's double-click on the solid rocket motor side of things, just because it's been a duopoly, but there has been a lot of upstarts. The demand signals are obviously moving, inflecting significantly higher. How do you see kind of the Northrop positioning against some of these upstarts that are coming in the solid rocket? There's a lot of kind of Silicon Valley dollars that are flowing. We see that. How do you think about that?
Yeah. What I have said before, and I still believe it to be true, is that it takes at least three years to start from a clean sheet design to get to producing solid rocket motors for a particular weapon system. Because one needs to build out the infrastructure. One needs to develop the capability, meaning the people who have the expertise. You have to design it. You have to qualify it. Today, that qualification happens one weapon system at a time. That is a multi-year process. When I say three years, that is an expedited multi-year process. Five years ago, I would have said five. Even with the department wanting to move fast and new entrants investing and wanting to come into that space, it is going to take a little while. In the meantime, Northrop has expanded our capacity.
We are getting qualified on these weapons. We are becoming a second source where we are not one today. We have increased our market share where we are the source to be providing more of the solid rocket motors. My goal has been, and I think we have accomplished it now, we have showed the Department of Defense solid rocket motors are not a constraint in the supply chain. We have the capacity today. If we get qualified on additional missiles, we can provide the SRMs to support them at the growth rates that the department is talking about. That is my focus. New entrants can come in. I am not afraid of competition. Our company is not afraid of competition. Our goal is to be positioned to take share now, perform, demonstrate, come down our cost curve, be very price competitive. That is what we are on a path to do.
Thank you for that. Last couple of minutes here. Let's talk a few numbers. Think about margin outlook. When you think about the longer-term trajectory, how do you think what are the key drivers for you to get some margin expansion?
Yeah. So I've talked about the key drivers for margin expansion. And they are performance. They are our digital transformation that drives cost efficiencies. And they are our mix. What I foresee is that that trend in each of those three continues over the decade. Mix becomes the more important element of that shift toward the end of the decade.
Is that part of that? Because we've always tracked, and you guys disclose it all, the cost-plus versus fixed price. Is that part of that mix that you're talking about changing?
That's part of the mix. Then the international also is part of that mix. If you look at our disclosures, our international business tends to run a couple hundred basis points above our average as a company. It too is accretive to our margin rate as we grow that as a percentage of our whole.
Great. Let's finish with free cash flow and capital deployment. You've been very vocal. You're on a path to double your free cash flow, as I said in my opening comment. Talk maybe about a few of the key drivers you're seeing there to help you do that.
Yeah. We have met those commitments. We put those longer-range cash targets out a couple of years ago. Each year, we are hitting those commitments with 20% on average growth in our free cash flow year- over- year. We are expecting that a few trends support that. One, we just talked about, as we increase our operating margins, that is contributing to increased free cash flow from operations, which we love. We also are on a path to reduce CapEx as a percentage of sales, not because we are not going to continue to invest in the business, but we have been at a very elevated level for our industry. We have been around 4%, which is double the industry average for the last several years. That has actually set us up quite well with this administration because we have been investing in our business.
It's also set us up with the capacity I just talked about so that we can build out share now. We don't have to continue to invest at that rate to support the business in our base book of business. If we were to be very successful in new awards, capture a significant amount of Golden Dome, capture the Navy Fighter program, accelerate the B-21 program, these would require increased CapEx. They also would come with more operating cash. Those tend to offset each other as we think about the long term. That's how we're thinking about the business and driving our free cash flow performance. We have been hitting our marks for the last three years since we put those out and are committed to continue to do that as well.
I do not think anyone would complain about growth CapEx, for sure. And then just on buybacks, can you just finish on that? Your thoughts on that?
Yeah. We've been returning about 100% of our free cash flow to investors over the last couple of years as we look. We've been doing that with that priority set that I talked about, investing first in ourselves. When we see the growth opportunities, that's always where we first want to put our resources. We have paid a competitive dividend, but we've also had double-digit increases in our dividend over the last several years and 22 consecutive dividend raises. We are committed to continuing to pay a competitive dividend. With the excess, share repurchase has been our way of returning that. I expect that to continue.
Kathy, thank you so much for supporting the conference. Thank you, everyone. The breakout room is in the Oak Room next. Thanks so much, everyone.
Thank you for joining us.