Good day, ladies and gentlemen and welcome to the Northrop Grumman’s Second Quarter 2020 Conference Call. Today’s call is being recorded. My name is Shelby and I will be your operator today. At this time all participants are in a listen-only mode. [Operator Instructions]. I would now like to turn the call over to your host today, Mr. Todd Ernst, Treasurer and Vice President, Investor Relations. Mr. Ernst, please proceed.

Thanks, Shelby. Good morning, everyone. Welcome to Northrop Grumman’s second quarter 2020 conference call. We will refer to a PowerPoint presentation that is posted to our IR webpage this morning. Before we start, matters discussed on today’s call, including 2020 guidance and beyond reflect the company’s judgment based on the information available at the time of this call. They constitute forward-looking statements pursuant to Safe Harbor provision of Federal Securities Laws. Forward-looking statements involve risks and uncertainties, which are 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 also include non-GAAP financial measures that are reconciled to our GAAP results in our earnings release. On the call today are Kathy Warden, our Chairman, CEO and President; and Dave Keffer, our CFO. At this time, I would like to turn the call over to Kathy. Kathy?

Thank you, Todd. Good morning everyone and thank you for joining us today. We hope you and your families are safe and healthy. I want to start by thanking our employees and recognizing their resiliency and dedication in driving strong second quarter performance in the midst of the COVID pandemic. Along with our customers and suppliers we quickly stood up new work processes and safeguards that allowed us to continue fulfilling customer commitments while strengthening our foundation for the future. And now, as we see new outbreaks of coronavirus in our communities, we continue to prioritize the safety and well-being of our team. This includes flexible work schedules, teleworking, child care assistance, and stringent operating protocols aligned with CDC guidelines to help protect our employees and their loved ones. We also continue to support our suppliers, health care providers, and communities through volunteer time, supplies, and financial resources. Turning to the results for the quarter, despite the challenges of the coronavirus, we delivered a very strong second quarter operationally and financially. Sales grew 5%, driven by 15% top line growth in space and continued growth at aeronautics and mission systems. Segment operating income grew 4% in line with sales growth, and we generated an 11.6% segment operating margin rate. Cash generation was particularly strong. Cash from operations increased 45% to 2.3 billion and free cash flow increased 53% to 2.1 billion after capital spending of 269 million. Our cash results reflect solid operational performance and benefited from actions taken by our customers to support the industrial base. We have the full supplier benefit of higher progress payments to our suppliers, and we have also instituted our own acceleration of payments to many of our most vulnerable suppliers totaling nearly $500 million year-to-date. In addition to those financial highlights in the…

Thanks, Kathy and good morning everyone. I'd also like to thank our employees for their strong performance this quarter. My comments begin with second quarter highlights on Slide 3. We delivered excellent bookings, sales, operating income, EPS, and cash. And we're pleased to be increasing our sales, EPS and free cash flow guidance for the year. I'd also note that as of April 1st, certain unallowable compensation and other costs that we previously reflected in segment results are now in unallocated corporate expense. These are costs that are managed at the corporate level and we made this change as we began to operate within the new sector structure. The Q2 impact of the change was minimal, only increasing second quarter segment operating income by about $1 million. This change has been applied retrospectively and recast results are presented in schedule seven of our earnings release. Slide 4 provides a bridge between second quarter 2020 and second quarter 2019 earnings per share. EPS increased 19% to $6.01. Operational performance drove $0.26 of the increase. During the quarter we recovered $0.23 of the negative return on marketable securities that we incurred in the first quarter and year-over-year this translated to a $0.17 benefit. Pension also contributed $0.49 of the year-over-year improvement. I'll begin a review of sector results on Slide 5. Aeronautic sales were up 7% for the quarter and 4% year-to-date. Sales in autonomous systems and manned aircraft were higher in both periods. Higher volume on restricted programs and the E2D drove higher sales in both periods, along with higher Triton volume in the second quarter. Higher volume in these areas was partially offset by lower volume on the F-35 program due to COVID-19 impacts in both periods. At defense systems, sales decreased by 2% for the quarter and are up…

[Operator Instructions]. Your first question comes from Ron Epstein of Bank of America.

Good morning. Kathy, could you just give us a quick update if you can on where we stand with the GBSD and when you might expect that decision to come?

Yes Ron, thanks. We still expect that the Air Force will meet its schedule of making the award for the EMD phase of the program in late August of this year. And we are in the process of discussions with them to meet that objective.

Your next question is from Sheila Kahyaoglu of Jefferies.

Good morning everyone and thank you. Kathy, maybe for you. You talked about moving pieces within aeronautics margins, you had a settlement in the quarter but overall profitability was better. Can you talk about some of the puts and takes maybe risk around COVID versus the offsets and then I think you mentioned continued top line pressure in commercial aero which is obvious there and some budget tightening, so if you could elaborate on that?

Sure, I'm happy to kick that one off, Sheila. So a few of the points you mentioned, I think are worth talking about now. In As we did have a very strong operational Q2 we talked on our last call about the COVID impacts on the business at the time of the call on a Q2 to date basis. Following that timeline, there was quicker than expected recovery from the business impacts of COVID on our AS business. And as the quarter progressed, we also had favorable timing on some materials that boosted results of the quarter. And the non-operational item that we talked about in our scripted comments and mentioned in our filings around the government accounting matter helped Q2 and we thought that may occur later in the year. So a very strong operational quarter combined with those other factors I mentioned. On an ongoing basis to your point, there are obviously continued pressures on the commercial portion of the business, but we're certainly pleased with the Q2 results of AS.

Your next question is from Peter Arment of Baird.

Good morning, Kathy and David, nice quarter. Kathy, can I ask a bigger picture question on the space segment, just kind of touching upon the kind of long-term trends on the margin front. I mean, you're getting all this growth. I assume you're going to have GBSD kind of work flowing through here in a significant way. And given that over 70% of the mix is cost plus, is this a segment that can hold the kind of a 10% margin or how should we think about it just given all the growth and success you've got here?

So Peter, as we think about the margins for space, you're hitting on the right point, the mix will be the biggest driver of margins. Great over time but we do expect to see significant growth in that segment. The margin dollar expansions we're expecting to be quite solid. But on the race itself, as you noted, as we see that mix already a heavy preponderance towards cost type contracts and then adding GBSD, which will also be a cost type program for the EMD. For quite a while, we will have a mix that lends itself to a lower margin rate than what we would experience if we had a higher volume of that business in production. But many of the programs in that business will move to production sooner than GBSD. So GBSD is one of the longest cycles of the programs in that portfolio, it will be in EMD through 2029. But with other programs that we are booking into space as we've seen our bookings grow quite nicely, we'll transition to production in a shorter period of time. So we'll see that mix certainly evolve in the near-term, but over the long-term we will still have a considerable amount of cost plus business in that portfolio.

Your next question is from Seth Seifman of J.P. Morgan.

Thanks very much and good morning. Dave you mentioned the headwinds on the top line in aero next year. And just to -- is there a way to calibrate that a little more, should we expect growth in this segment next year and it just will be more moderate because of those headwinds or did those headwinds prevent growth in the segment?

So as we think about aero on a go forward basis, I would point to our year-to-date growth of about 4% in that business, which is in line with what we had expected for the year and what we're guiding. And although we're not guiding into next year at this point, to tell you the longer-term trajectory for that business is that it won't be one of our fastest growing segments. We've seen a good bit of that portfolio begin to shift also to cost type work that grew significantly. And now it's leveling out and production also on our key programs there is more in a steady state. So the fastest growing segments in our portfolio will certainly be space, but aero will be a nice contributor to the portfolio in terms of some stable and steady programs that are large contributors not only to growth, but solid margin rate performance.

Your next question is from Robert Stallard of Vertical Research.

Thanks so much. Good morning. You had a very good quarter for order intake in Q2. And I was wondering if any of these awards will result in an increase in self-funded R&D or CAPEX in terms of seed funding at the start?

Hey Rob it is Dave. So it was a really strong quarter, particularly for restricted awards and particularly for awards in our space sector. So we're really pleased with the backlog growth in those portions of the business. We haven't changed our CAPEX outlook for the year. Longer term we've said in the past that we expect a similar volume of CAPEX in 2021 before that begins to decline as a percentage of revenue thereafter. We think that CAPEX outlook remains our best information as of today and we'll continue to really focus those CAPEX investments on the portion of our business, the portions of our business with the strongest growth potential, key customers, key capabilities to drive differentiated capability in areas that are consistent with the national defense strategy.

Your next question is from Jon Raviv of Citi.

Thank you and good morning. Kathy, just kind of going back to the big picture here, obviously a lot of conversation that you addressed also in terms of pressured budget environment. But what is your perspective on accelerating growth, not just sales but really EBIT dollar growth segment, EBIT dollar growth going forward, just as the budget slows down, I think that's a little sort of digression that that is not always appreciated that you guys can actually accelerate growth while the market might slow?

Thanks. Yes, as our backlog is growing quite nicely, we see that providing a strong foundation for growth. We also are encouraged by our portfolio of alignment with the priorities in the national defense strategy. And I would tell you that goes beyond the defense strategy as it's written today. It really is a look at our portfolio compared to the threats that our nation and our allies are facing. And we certainly see space as a domain where there will continue to be an evolution of capability to address increasingly advanced threats from other nations and just the steps for space as a domain that now can offer much more war fighting capability to our nation and its allies. That's one example. But I could give you the same as we talk about weapons and the evolution of weapon systems or the importance of networking in all of these war fighting assets for advanced commands and control. And so that type of alignment of our portfolio says that if the threat continues to evolve in the way that it is today, there would be durability in our ability to continue to grow. And I would point to one other thing, which is the innovation that we are driving as a company that addresses some of the nation's most critical threats and is allowing us to win the work that you're showing us -- that you're seeing show up in our booking. That innovation is as Dave alluded to, targeted investments that we're making in our R&D and our CAPEX to be able to demonstrate for our customers the maturity of technology to address these evolving threats. And I'm quite proud of how our team is doing that. And it will be an increasingly part of the -- increasing part of the selection process that the government uses to determine the partners they will work with on a go forward basis. So those three elements of how we're executing gives me confidence that this business can continue to thrive even in a flat or slightly declining budget environment if, I think the primary if is the threat vector continues to be aligned with what it is today and we expect that to be the case.

Your next question is from Doug Harned of Bernstein.

Good morning, thank you. I wanted to go to aeronautics and specifically on F-35. And if you think about F-35 as now basically new production, upgrades, sustainment, a lot of this would appear that you'll be topping out kind of a new production, but the upgrades and sustainment are going to be growth opportunities. How does Northrop Grumman play in those three and how do you see that collectively contributing to growth over the next few years?

Doug this is Kathy. The F-35 program will continue to be a really important part of our portfolio. We are involved in all three stages of the life cycle on the program and I would characterize those as production, modernization, and sustainment. And for production, as we've noted before we tend to run about 18 months ahead of Lockheed Martin in delivering a center fuselage and ahead also in the delivery of Mission Systems. So we will reach peak production sooner than Lockheed. But if you look at the quantities that they're projecting, we don't reach peak for a while on that program. Modernization is interesting and that for the mission systems, we actually will go back to retrofitting old platforms so the production volume there, once we get through the development stage of the upgrade program, will increase production once again in mission system. And then of course in sustainment, we're seeing that part of the portfolio grow as we get more aircraft fielded. And that's not just in the U.S., but as our global partners are also taking possession of the aircraft. So each of the stages of the program presents opportunity for us in the near-term. In the longer term, it's the modernization and sustainment spaces that will support growth.

Your next question is from Carter Copeland of Melius Research.

Hey, good morning. Kathy, I wanted to ask you about the reimbursement of COVID costs and whatnot. I noted that in the industry's letter on the reimbursement of those costs and Northrop wasn't -- didn't participate in that. And I just wondered, do you guys have a lower COVID impact or you have better ability to absorb those costs, I just found that interesting and wondering if you can give us some color on it? Thanks.

So yes, it's true that I chose not to sign onto those letters. I want to make it clear though that we are supportive of a strong national defense and recognize that funds need to be appropriated to support that objective and we are directly engaged in supporting that cause. However, we did see that our impacts from COVID were less significant than we are seeing projected elsewhere. And therefore we have continued to focus on that very issue, making these impacts as small as possible so that we are not in a position where we have an additional bill for taxpayers to get capability delivered and will continue to be focused on that as our primary objective. And that includes everything from keeping our workplaces safe so that our employees can continue to come to work and feel that they can be productive. It is continuing to partner with our suppliers to ensure they have what they need to continue operating effectively and continuing to work with our customers to be innovative in how we continue to get work done even in light of constraints and how we would normally conduct operations. And I would say on all fronts, our team has been both innovative as well as strong partners to our teammates and customers to be able to navigate their way through. And that's allowed us to have this lesser impact than we anticipated as we sat here a quarter ago.

Your next question is from David Strauss of Barclays.

Thanks. Good morning. Hi, Kathy. It sounded like in the prepared remarks, you highlighted the headwinds that you're seeing as we look out the 2021 in aerospace systems. Anything else, Kathy as we think about modeling 2021, we should think about in terms of modeling headwinds, I think you might still have a bit of a headwind from Lake City and James Webb Space Telescope, just trying to think about that as we look out the 2021? Thanks.

So I'll start and then Dave can walk you through some of the details. As we look forward into 2021 there's nothing additional that we haven't already spoken about that present significant headwinds that we know of as we sit here today. The three things that I would point you to and then Dave can walk you through them is Lake City. As you said, the James Webb Space Telescope will launch next year. And so we have expected the volume to continue to decline as we near completion on that satellite. You may have noticed that the dates of the launch moved slightly next year from March to October based on some COVID related impacts. That program is in final integration and test. And as a result, there are a number of observers from NASA and the testing was impacted slightly by people's inability to travel and work full shifts during COVID. So we did see a slight movement there in schedule, but we do still anticipate it to launch next year and as a result, that program will continue to decline in year-over-year sales. And then the third thing that I would point you to that we've spoken about on prior calls are some headwinds in the HALE portfolio with both Triton and Global Hawk. And as we work through this year's budget, we are -- we'll get better clarification on what those headwinds might be. They don't present risk in 2020, but as we look forward into 2021 they could start to present some headwinds. So Dave anything you would like to add on any of those three or anything additional.

Sure just a little more color on each of those topics, on Lake City, just to quantify that a bit further, we think the 2021 headwind is likely to be around 1% of revenue. That's consistent within range we've given in the past or an estimate we've provided before. James Webb, as Kathy mentioned, I think we'll end up being more of a 2022 headwind than a 2021 headwind given the timing. That program is smaller in its annual revenue than Lake City. And then on the HALE portfolio, I think there are more moving pieces and budget determinations to be made and such so I wouldn't begin to quantify that challenge next year or beyond. And of course, all of this should be cast as well with the light of the space program, which is expected -- or the space business expected to be our largest -- I am sorry, our fastest growing business not only this year but beyond the large new development programs in that business that have bolstered its backlog this year and should continue to do so or sources of nice top line opportunity in 2021 and beyond.

Your next question is from Joseph DeNardi of Stifel.

Yeah, good morning. Kathy, can you just give us an update on the space logistics, the mission extension vehicle opportunity that you kind of acquired through Orbital maybe what some of the conversations are like there with the customers, I think that's kind of a unique capability for you all? And then could you be a little bit more specific on when peak is for F-35, you said it's a while, can you be any more specific? Thank you.

Sure. Let me start with our mission extension vehicle. As some of you may recall, we returned the customer satellite Intelsat 901 to service in April of this year. And it was the first docking of a life extension vehicle to an active satellite ever accomplished. And I'm very proud of the team for that. First of a kind, it's opening up a whole new set of opportunities and mission extension. And under the terms of that contract, we are going to be working with this through space logistics, four or five years to provide the services. At the same time, we have been working on our second mission extension vehicle and it has arrived at its launch site in French Guyana. And we actually expect that launch to occur in the next few days. And then in MEV 2 will dock with another Intelsat satellite to provide life extension services for it. That docking should occur in early 2021, and this just gives you a little color on what's happening on the program. But to the broader point, this is a market area that we are pioneering first in commercial and the application of it also into military grade satellite as the future holds. And this is something that our Orbital ATK team had started, but as we have integrated into Northrop Grumman has continued and we're leveraging the expertise and experience of the whole team as we look at the future set of opportunity. You also asked about F-35. Really, I would not provide any additional color or guidance. As we do 2021 guidance we'll share some more insight into what we planned for the three components of the program that I spoke about production, sustainment, and modernization. I would say that each of those three pieces of the program and in the two sectors, the two sectors that primarily support the program, and then that there are a number of moving parts on those assumptions due to COVID-19 impact. We're working very closely with Lockheed Martin to understand what those quantities are, and we'll be able to provide you more insight as we guide for 2021.

Your next question is from Myles Walton of UBS.

Thanks, good morning. First one is a clarification, Kathy on the 5.9 billion of classified awards in space, was that dominated by a single award and I'm not sure you've ever got one quite that size before? And then the other is, if you can just make a comment on the national security space launch contract outcome or competition outcome and what your intention is for Omega if it doesn't go your way? Thanks.

Sure, so the large award in restricted space is indeed driven by a single award and it is quite significant. I can't provide any color on what it is, but suffice it to say, this is a long term program as a result of the size of the effort. And in answer to your second question on national security space launch, we are expecting that award to come later this quarter. And we have been progressing, as you know, to prepare our Omega rocket for the requirements of the award, which would be to launch next year in 2021. We are on track. We would be able to meet those requirements through our offering. And if we are not successful, we would continue to leverage that investment that we and the Air Force have made through the first two phases of the program into other propulsion activities in our GMD business. So this is an area that we like many selected to make this investment not only for the potential of a single contract award, it represented a national security space launch. But because it was a way to share our research and development investments across the product line that we can now utilize for other endeavors.

Your next question comes from Robert Spingarn of Credit Suisse.

Hi, good morning. Kathy, I want to try to phrase this question in a way that you can hopefully answer but typically, when you go from EMD to production unmanned aircraft do you tend to see margins on those first few l-RIP plots below equal to or above the margins that you saw towards the end of EMD and is there any reason to think that that behavior would change in the future? Thank you.

So Robert it depends on the contract on any given manned aircraft as to whether those first production units are incorporated into what's already been negotiated or whether they are indeed part of a new contract. And so, if they were contracted as part of the initial award, you would not expect to see the booking rate change because their cost for development would already be incorporated into the booking rate of that effort.

Your next question comes from Cai von Rumohr of Cowen.

Yes, thank you. Thank you very much. So Kathy started kind of highlighting all the news in space and you also mentioned the GBSD is still expected in August and I think on the first part of the call you said it might be about 200 million added to this year. Given holdings [ph] wins is there a decent chance that we will see space following in the second half and so instead of being a low $8 billion revenue number it could be closer to a mid-$8 billion number?

Well look I'm really comfortable with our guide which is approximately 8. And so if you take first half revenue you get to a number that is slightly below 8. So to your point there is some growth that needs to occur in the second half but as I said we are very comfortable with the guidance that growth is reasonable based on what we know today.

Your next question is from Richard Safran of Seaport Global.

Good morning Kathy, Dave, and Todd, how are you doing? Listen, I would like to ask you to if you could expand on your comments on contract mixed with space. For the company overall given your knowledge of new programs could you discuss how you see the overall and long-term contract mix changing in terms of fixed price and cost plus, how that might impact margins? And in your answer could you also update us on the expected long-term growth of classified versus unclassified contracts?

Sure, it is Dave. I will be happy to provide that answer. Today as we talked about in the past we are around 50:50 in terms of fixed price versus cost plus in our mix. And that as you know is heavily determined by the phase of lifecycle programs that we happen to be in at any given time and the key drivers of that mix. On a going forward basis given some of the awards we've talked about to date and those that are expected in the second half of the year, in particular those large development efforts in the space business, we would anticipate that the cost plus mix would increase above the 50% level and that the fixed price would decline. These are our figures at the company level as opposed to any particular segment level. Of course cost plus business as well as perhaps more predictable and stable in margin rates in a typical scenario does tend to be at lower margin rates than their overall fixed price business. And so as that mix shifts certainly we are expected to lead to margin dollar growth and we will look to offset a portion of that impact on overall margins through really strong contract performance, program performance, careful management of our costs, etc. So that's the overall kind of trend that I think you should be expecting as we have these large new development programs entering the portfolio.

Your next question is from Hunter Keay of Wolfe Research.

Hi everybody, good morning. Kathy can you talk about the potential long-term opportunity for NGAD. I realize this is not a new program concept but it feels like it is kind of coming into form with the air force's digital century series initiative, so can you help me frame how you're thinking about NGAD opportunity through that lens? Thank you.

So if we think about any new development program through a couple of lens; one, do we have the capability that we can offer a value add to the government and two, should we prime the effort or should we partner with the effort. And with our business and the opportunity for us to do work both on the platform itself and to the Mission Systems we sometimes make those decisions together and sometimes make them separately. I would say for digital century series because of the way it is developing and it's meant to be incremental and rapid, we continue to look at each increment and make the determination of where we conduct that value. So both our Mission Systems and our aeronautics sector are engaged in meaningful dialogue with the Air Force on the program and have work associated with the effort. But these increments will each represent different opportunities based on the requirements and whether we would play as the prime at the platform level or as primarily a Mission Systems provider.

Your next question is from George Shapiro of Shapiro Research.

Yes, good morning. Kathy if you can I wanted some more color on the F-35, it was kind of surprising to me that your revenue was down and Lockheed showed double-digit gain. So is that reflecting the 18 months that you are ahead of them or this quarter was just unique to COVID or any additional color you could provide contrasting the two different numbers?

Sure, we won't go so far as to talk about anyone else's results but we'll give you a sense for ours in the quarter. There were some COVID impacts on the program in the quarter. We talked about the impacts on F-35 among other similar programs on our last call. And experienced those impacts in the quarter which did affect the year-over-year growth rate for the program in the quarter. As Kathy mentioned earlier, the timing of our business related to F-35 in both the aeronautics segment and the Mission Systems segment are different than the prime timing given the nature of the work and so I think you can expect slightly different kind of trends in those businesses over time as we've had in the past. I think COVID impacts were the primary Q2 items of note there.

Alright and we're at the end of the time here, so I would like to turn it over to Kathy for some closing comments.

Thanks Todd. I would like to conclude by thanking the Northrop Grumman team for their dedication and perseverance which enabled us to continue to operate so well during the global pandemic. It has taken innovation, partnership with our suppliers and customers, and just sheer determination and I am really proud of what they have accomplished this quarter and expect they will continue. I want to wish you and your family’s continued good health and thanks for joining us on the call today. I really look forward to engaging with you in the weeks and months ahead. Take care.

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