Good day ladies and gentlemen and welcome to the Northrop Grumman's Second Quarter 2022 Conference Call. Today's call is being recorded. My name is Victor and I will be your operator today. [Operator Instructions] I would now like to turn the call over to your host, Mr. Todd Ernst, Treasurer and Vice President, Investor Relations. Mr.

Ernst, please proceed..

Thank you, Victor and good morning, everyone and welcome to Northrop Grumman's second quarter 2022 conference call. We'll refer to a PowerPoint presentation that is posted to our IR web page this morning.

Before we start, matters discussed on today's call, including 2022 guidance and beyond, including our outlooks reflect the company's judgment based on information available at the time of this call. They constitute forward-looking statements pursuant to Safe Harbor provisions of federal securities laws.

Forward-looking statements involve risks and uncertainties which are noted in today's press release and in 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.

On the call today are Kathy Warden, our Chair, CEO and President; and David 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 again for joining us. I'd like to start today's call by highlighting the James Webb space telescope and the incredible images released just a few weeks ago.

This extraordinary telescope represents countless Northrop Grumman engineers, technicians, scientists and cross-functional teams working in partnership with NASA for over 2 decades.

In addition to leading the industry team, we designed and built the deployable Sun Shield, provided the spacecraft, develop the Observatory subsystems and integrated the total system.

The advanced technology we've created and the images it captures will inspire the next generation of innovators and scientists and we believe will be one of Webb's many legacies. Webb exemplifies the defining characteristic of our business strategy to develop and produce innovative technology solutions to address our customers' toughest challenges.

This strategy differentiates us and aligns our portfolio with our customers' priorities. And as a result, we strengthened our position in the market.

As a reminder, the 4 core focus areas of our strategy are technology leadership, sustainably and profitably growing our business, keeping a laser focus on performance and deploying capital in value-creating ways. This strategy continues to yield results.

In the second quarter, we saw strong demand across our businesses with a book-to-bill ratio of 1.48, driven by awards for F-35, GEM 63 and restricted programs. All of our businesses had a book-to-bill ratio above 1 in the quarter, driving a 6% sequential increase in our backlog which now totals $80 billion.

Given this backlog growth and our continued alignment to customers' budgets and priorities, we are even more confident we can accelerate our revenue in 2023 from the low single digits we're guiding this year.

In the quarter, we did experience certain challenges from the broader macroeconomic environment, including a tight labor market and supply chain delays which impacted sales timing.

However, we're pleased with the progress our team continues to make in addressing these challenges and hiring trends improved as we progressed through the second quarter, laying the foundation for sales growth in the second half of the year. As our business grows, we remain focused on performance and driving cost efficiencies across the business.

This continued focus contributed to another quarter of solid margin performance. Our segment OM rate was a robust 12.2% in Q2 and stands at 12% year-to-date. Dave will cover further details of our quarterly results and guidance update momentarily but first, I'd like to touch on some highlights from the quarter.

The technology developed for James Webb is one example of Northrop Grumman's innovation. Another example is how we are using technology to produce innovative and affordable solutions for our customers. To that end, we're investing in digital design capabilities and advanced manufacturing facilities.

In close partnership with our customers, we are digitally transforming how we design, test and manufacture the next generation of systems. And you've heard our customers acknowledge the results. particularly with some of the largest programs, including B-21 and GBSD.

We are marrying our world-class engineering talent with the latest digital tools, machine learning and agile principles.

And as we announced this quarter, we are also investing in factories of the future, including our state-of-the-art manufacturing facility in West Virginia which will incorporate the latest in digital manufacturing, automation and modular work sells.

Once operational in 2024, this facility will support production of up to 600 strike missiles per year, optimizing quality and reducing cost and cycle time as well as bolstering tactical weapon supply chain capacity for our customers.

For the last few years, we've taken an enterprise-wide approach in mission-focused areas that are aligned with our customers' priorities. These are areas where we see opportunity to leverage our technology know-how and our domain expertise and high capabilities from across our businesses.

Today, I want to highlight a few of them and the related results we've seen so far this year. One example of this is in national security space. Our customers have made it clear that space underpins many missions vital to our national security. And we recognize that we need to think about space differently as a rapidly evolving contested domain.

Given this, our focus is on providing space based offerings that include a mix of exquisite solutions in combination with proliferated constellations of low earth orbit satellites, also known as LEO which together create a more resilient architecture. We've recently seen the benefits of this approach.

For example, after the close of the second quarter, we received a $617 million contract for the SDA tracking layer which is a LEO constellation of 14 satellites designed to provide global warning, tracking and targeting of advanced missile threats, including hypersonic missiles.

This builds on the SDA transport layer contract we were awarded in February which is also a LEO constellation of 42 satellites, providing resilience, low latency, high volume data transport in support of U.S. military missions around the world.

In addition to these, we booked another $700 million in Q2 in restricted space awards and now have $11.3 billion of restricted space backlog. We continue to see the national security space area as one of the strongest growth drivers for our company.

Another focus area where we are pulling capability and expertise from across the portfolio is missile defense and Counter Hypersonics. In the second quarter, we were awarded a contract from the Missile Defense Agency to continue development of the glide phase interceptor program.

GPI will play a central role in ensuring the United States maintains the most reliable and advanced missile defense systems capable of outpacing and defeating evolving missile threats. This complements our missile defense modernization work already underway on NGI, HBTSS and IBCS.

We have also been supporting international customers to modernize their missile defense system. For example, last week, we delivered the first of the 6 production IBCS engagement operation centers for Poland's medium-range air and missile defense system. Our capital deployment approach is also an important part of the strategy I just laid out for you.

Our first priority is to invest in executing our business strategy. By investing in our factories, digital design tools and our people who are a key source of our technology leadership, we are creating long-term sustainable value. We also remain committed to returning at least 100% of free cash flow to shareholders this year.

In the second quarter, we increased our dividend by 10%, marking our 19th consecutive annual increase. Our new quarterly dividend will be nearly double the level we paid in the beginning of 2017. We are also returning capital to shareholders through stock repurchases and we continue to target at least $1.5 billion in repurchases this year.

Before Dave shares more details about our financial results, I'd like to briefly talk about the defense demand environment. We've seen a fundamental shift in global commitment of resources for defense and national security, particularly in Europe.

Just this year, we've seen Finland and Sweden progress their membership in NATO and many European countries increase or state their plans to increase their defense budget. The geopolitical environment has highlighted an increased requirement for defense and deterrent.

In the U.S., this has also resulted in strong bipartisan support for defense spending. Recently, the Congressional Arm Services Committee has marked up their version of the FY '23 defense bill with both providing bipartisan support for further increases in defense spending above the president budget. For Northrop Grumman, the U.S.

FY '23 base defense budget request included strong support for key programs like T21, GBSD, NGI, IBCS, next-generation OPIR and Triton. And there is an opportunity for additional funding for GATOR, E-2D, F-35 and F-18 that we've seen in proposed plus ups from Congress.

But I will note that as has become the norm in recent years, there is a high probability of starting the fiscal year on a CR, so we have anticipated this in our outlook for 2022. The budget is a strong reflection of the alignment of our company with our customers and reinforces my confidence that we are well positioned for this environment.

So with that, I'll turn the call over to Dave and then I'll have a few closing remarks before we turn to Q&A.

Dave?.

1 based on current tax law and the deferral scenario predicated on receiving refunds for payments made to date. Next, I wanted to take a moment to talk about our pension plans.

Last quarter, I mentioned that while our pension plans contribute a component of our GAAP earnings, the FAS/CAS income is non-operational and not something we consider when assessing the company's performance. Slide 11 in our earnings deck provides an illustration of the pension headwind on GAAP earnings that we've experienced so far this year.

As we look toward next year, we would expect this headwind to grow based on recent volatility in the financial markets. Year-to-date, our asset performance has been below our long-term expected rate of return and discount rates have had a historic rise. Of course, our pension plans aren't unique in experiencing these macroeconomic trends.

If we snap the line at quarter end, these market conditions would translate to a significantly lower net pension income going forward, primarily in the nonoperating FAS pension line.

Partially offsetting this GAAP earnings headwind would be a modest increase in projected CAS recoveries but our required cash contributions would remain very low for the next several years and our funded status remains healthy at over 96%.

So while the GAAP earnings impact could be a headwind, from a cash or economic perspective, the changes would be modestly favorable. A lot can change in the financial markets over the course of the year, so we'll wait to provide more specific multiyear projections until later in the year.

I'd point you to the pension sensitivity table that we provided in our January earnings deck for your modeling purposes. And with that, I'll turn the call back over to you, Kathy..

Thanks, Dave. So in summary, demand remains robust and we saw outstanding bookings and backlog growth in the quarter and year-to-date. This demand is creating momentum that supports our expectation for accelerating growth for the remainder of this year and into next.

Additionally, our capital deployment strategy is aimed at supporting long-term growth and creating value for our shareholders. We believe the investments we are making today in digital tools and factories of the future are already enabling stronger program performance and contributing to our operating results.

So I'm incredibly proud of the Northrop Grumman team as we execute our strategy and position the company for long-term success. So with that, we're ready for Q&A..

[Operator Instructions] Our first question will come from the line of Ron Epstein from Bank of America..

This is Mariana Perez Mora on for Ron today. So on labor. Most of the industry is experiencing significant pressure from a tight labor market. And it seems that you are managing these challenges better and even seen some improvements in the second half.

Could you please describe and give us some color on what are you doing to navigate these challenges?.

Well, thanks, Mariana. We absolutely have seen labor headwinds in the first half. But as we noted in our comments, we are starting to see those ease in the latter part of the second quarter and even the results that we're seeing in July so far. And what we're doing is aggressively across the enterprise, working both hiring and retention efforts.

It is an all-hands-on-deck strategy to ensure that people know that Northrop Grumman is growing and hiring. And we are having good success in attracting people to our company. We've also been taking actions to retain the talent that we have and that has really started to take traction.

I will also say that the market conditions play a significant role in any company's ability to hire and retain -- and we've seen the market conditions start to soften. You can't pick up a newspaper or read an article online these days without seeing a company that's talking about hiring freezes or even layoffs.

And so that will have an impact on the labor market and we expect continued softening as a result of that in the second half which leads us to feel more confident that the second half will look more like our prepandemic experience than what we've experienced in the last 6 to 12 months..

Perfect.

And then on supply chain, how -- or what kind of tools do you have to improve your visibility or material lead times? Do you have flexibility to reach out long-term agreements in advance or increasing inventories to provide any potential future disruptions?.

Well, we do have those tools available to us. But what I would say is, I know you've heard from a host of manufacturing, including peers in aerospace and defense industry this week. That we're seeing longer lead times which impact timing of sales.

And I believe those are a result of numerous factors but notably the labor availability we were just speaking about -- so as we noted earlier in the call, we do expect the labor market to soften a bit. And while it will still be a headwind in the second half, we don't see it being the same degree that it would be in the first half.

And I'm basing this on the fact that we are deeply embedded with our suppliers. We have Northrop Grumman people on site with them. And so we believe we have a good handle on material timing delivery for the rest of the year and we've incorporated that into our thinking but of course, it's based on what we know today.

And as we've seen in the last 12 months, COVID flare up, component demand fluctuations and a variety of smaller issues can cost an estimating volatility and around timing of supply. So our teams are managing this well. I feel like we have done this exceptionally well in the first half.

while we were slightly short of our own revenue projections for Q2 which we said would be about 24.5% at the midpoint of our guide, that was very tight estimating variability in a very challenging market. So we have very detailed reviews of material timing.

We're working mitigation strategies on a daily basis and we have a handle on what we need to deliver in the second half.

Dave, anything you would add?.

I think that's well characterized, Kathy, at a program level, in addition to being confident in our ability to deliver more in the second half, the timing of demand is also more weighted toward the second half of this year as opposed to last year when the demand timing at a program level happened to be a bit more weighted toward the first half of the year.

So that too contributes to the stronger year-over-year growth outlook for the second half of this year..

Our next question will come from the line of Richard Safran from Seaport Global..

So, I wanted to ask you about the news, the FTC is making about Orbital. You probably were expecting this, at least I would guess. This was initially brought out when Lockheed was buying Aerojet. So I want to know if you could briefly talk to the issues that the FTC is focusing on.

If you could discuss what the range of outcomes might be? And I know it's always a bit difficult but if you could speculate on the impact. Any comment you would give there would be appreciated..

Yes. Thanks, Rich. So let me start by providing some context on the issue. We announced our intent to acquire Orbital ATK in 2018 and the Department of Defense and FTC spent many months looking at the pro-competitive aspects of the deals, of which there are many and any anticompetitive risk before they approve the deal.

And so during this period, the government identified only 1 concern and it was around solid rocket motors. And so we agreed to a consent order to address that concern. Over the past 4 years, we've executed an extensive compliance program and worked with the government very closely in line with the terms of the order.

So we believe we've been and we continue to be in compliance with the order. The FTC did raise 1 matter. They were investigating a few years ago. But to our knowledge, that investigation has not concluded. And we've shared the -- this in our 10-K and 10-Q filings. So you can refer to those for the details of that particular matter.

And now to the point of your question, I know there's been some recent speculation both on the status of that investigation and a broad range of possible next steps that the government might attempt to take. But I'll say that we don't see merit or precedent for most of those scenarios.

And we continue to maintain that we don't believe this matter will have a material adverse impact to our company. So I won't speculate on what the size will be because we believe it could be 0 and certainly isn't material..

Okay, that helps. As a quick follow-up here. On your comments about international, I want to know if you could expand a little bit on that. What type of equipment are you getting the most interest for? Could you discuss a little bit about the timing, how that's going to translate to the -- and flow into the P&L.

And then just look a bit old school here with increasing international demand, we should expect more higher-margin commercial contract? I just want to know if that's -- if you think that's the case?.

Thanks, Rich. This is Dave. I'll take that one. We've gotten a lot of questions in the last few months given the evolving geopolitical global situation about near-term impact. I think the reality is in a business as long cycle as ours, these things take time to have an impact. And we are certainly engaged with U.S.

and international customers talking about areas of particular demand -- we mentioned products like IBCS on the call today. I would say mission areas like missile defense or a particular international interest, as you'd expect. But it will take time for those things to have a financial impact.

And so I'd hesitate to project in any specifics what that may be in the near term. It's something we'll keep you apprised of over the next several years as those opportunities become reality..

Our next question comes from the line of Doug Harned from Bernstein..

When you look at Aeronautics, this has been complicated given a lot of mature programs ramping down B-21 going up F-35 but in Q2, if we take out the land sale gain, margins were well below 10%, revenues were low as well which really -- it looks like it makes H2 pretty challenging.

Can you talk about how you see the path to guidance in H2?.

Sure, I'm happy to touch on that one, Doug. In the first quarter, we had an unusually high volume of favorable net EACs in the second quarter net EACs were light. This is the typical nature of a business like Aeronautics, where there is quarterly fluctuation.

But in aggregate, we have even a slightly stronger outlook for the year, as we described earlier on the margin rate side than we did previously. So you need to look through and look past quarterly fluctuations in net EACs and toward the overall outlook. On the sales side, that net EAC fluctuation rolls through sales as well.

And so I'd note that it was relatively stable in the first and second quarter. AS is another business, as we described earlier in our comments where we see a higher volume of material receipts projected in the second half than the first.

And so I think, a reasonable second half ramp from where we are today and very consistent with the projections we've been providing for a couple of quarters now..

And well, as a follow-up, if I switch over to space, I mean your backlog there is now $39 billion. I mean it's a huge backlog. And I know you've got some pretty good revenue growth forecast here.

But how should we look at the conversion of that backlog in terms of timing? How should we see that conversion move to revenues over the years here?.

Sure.

We're -- as you mentioned, we're incredibly pleased with the backlog growth, the award volume that we've had in space programs like both the transport and tracking layers of the FDA architecture are great examples there of work we're doing, really at multiple layers with multiple products supporting multiple mission areas in the national security and civilian space markets.

In terms of how that backlog then breaks down in terms of award volume over time -- or sales volume over time, it's been our fastest-growing business and we anticipate that it will continue to be our fastest-growing business and not just any 1 program, GBSD is obviously a large contributor to its growth last year and this year.

But the growth is much broader based. And so while GBSD has grown about $0.5 billion in our '22 estimates and should show similar growth in '23, we would anticipate a similar volume of growth outside of GBSD going forward. and our growth outside of GBSD for this year is actually exceeding GBSD's growth on a dollar basis in space.

So really broad-based outstanding growth, not just in backlog but to your point in converting to sales as well..

Our next question comes from the line of Cai von Rumohr from Cowen..

Yes. So you and your partner on MGI were selected for the glide phase interceptor that's an interceptor, NGI is an interceptor.

Are there any read acrosses in terms of having one list that would make you better positioned for NGI if it goes sole source? And what do you think the chances are it goes to all source?.

So Cai, a very insightful question as always. And I would say that certainly, it is beneficial to be supporting multiple like missions and understanding, therefore, how these systems can draw from a common technology base. Given both are in competition I won't say anything more than that and I'm sure you respect that.

In terms of what does this mean more broadly, I would simply say that missile defense is an area of great importance, not only in the U.S. but internationally. And as I outlined in my comments, we're taking a broad enterprise approach to thinking about how we best spring the capabilities of Northrop Grumman to bear on all of these opportunities.

And so we feel we're positioned well to support what the government needs. I do think there is a balanced view, however, that we need a broad industrial days in all of our missile defense programs.

And so I expect that there is some appetite to carry forward multiple providers for longer as we are seeing in NGI that down-select won't happen until 2025 likely and to your point, may extend even further or go sole-source. And we think that is supportive of Northrop Grumman growth no matter how it goes.

And we just support the government in making those decisions about what's best for their industrial base capacity..

And secondly, you also had a number of wins you alluded to in the LEO area.

Can you -- as you look at the second half, are there any major opportunities we should keep our eye on competitive bids?.

There are a few, mostly what we see in the second half of new awards. And as Dave pointed out, we do expect now book to bill to be close to one which is improvement over our outlook at the beginning of the year because we've been having more success in competitive awards like the 2 I mentioned with FDA than we had anticipated.

But as we look to the second half of the year, not as much competitive to be awarded more sole source to see about $1.5 billion of new awards in restricted within AS about the same in states.

We do have a fairly significant competitive award that we're expecting any day in space, it's in the $1 billion class and then a lot of smaller things that add up to our full year expectation of close to one book to bill..

Our next question comes from the line of Kristine Liwag from Morgan Stanley..

You mentioned earlier that there's been a fundamental shift in U.S. and European support for defense spending. And historically, when the economic environment is weaker and other federal budgets emerge defense budgets have come under pressure.

So what's different this time? And how long do you think the support for defense will persist?.

Thanks for the question, Kristine. I was just in Europe a few weeks ago.

And I would say that I see truly a fundamental shift in recognizing the threat environment is real and it's now, right? I think in recent years, within Europe, there's been a sense that we're working toward a longer-term threat horizon and perhaps the pacing of national and defense security spending would have been appropriate in that environment but the fact that the threat is more imminent is addressed in what you're seeing is planned or committed increases in defense spending across most of the European nations.

That does take several years so to translate into specific needs, by plan and sales for companies like ours. So I do expect that there might be some modulation based on broader economic factors and other spending priorities. But I don't see there being another inflection point back to a view that defense spending isn't a high priority.

So I just see it fairly ensuring..

And as a follow-up, how much urgency is there from your conversations with the customers to address the security landscape? And when do you think these demand signals might translate to revenue growth?.

Yes. So as I noted, despite the urgency, it does take generally at least 18 to 24 months to translate intent into specific programs aspirations, customer wanting to buy x quantity of certain systems in production. And it takes even a little longer if it's something that is not in production if it's a developmental program.

And so that can be 3, 4, 5 years. So as I think about the landscape in Europe, obviously, the time is now to be advising and insights on what can address their highest priority demands just as we do with U.S. customers but I don't see it having a material impact on revenues for us or other AMC companies in the next 18 months.

So I'd say it's more in the 2024 time horizon that we would look forward to have a more material impact..

Our next question comes from the line of Rob Stallard from Vertical..

Kathy, I just like to follow up actually on the question I asked you 3 months ago about inflation and fixed price contracts.

I was wondering how things have evolved over the last quarter versus your expectations? And whether you are making any structural changes to the way you do business, considering we are in this higher inflation environment?.

Yes, good question. So I would -- our today view is very much in line with what it was in the first quarter and we certainly are not immune to impacts of inflation. So we're working with the government to quantify those impacts and work with them to mitigate them.

And this includes ensuring that appropriate funding is available for the government program managers to acquire the system needed to support national defense in this inflationary environment. And to that end, we're very pleased to see that Congress is including funding to offset inflation in their FY '23 budget markup.

There are some structural characteristics of our business that naturally mitigate some of these impacts. Dave talked about the importance of deal structure.

These are things like our mix of cost plus work versus fixed price, the relatively short contract duration of our fixed price contracts that allow us to renegotiate based on current conditions within 1 to 2 years and in some cases, escalation clauses that allow us to reprice.

As we are looking now at new deals that we're entering we are being more forceful in including those escalation clauses in our contract terms, making sure that we're matching our supplier terms with our overall contract terms as some examples of what we're doing differently to mitigate the impact.

And then we also, within our organization are working to offset the impact.

So this includes managing supply chain affordability, looking at second suppliers where we feel suppliers are not addressing affordability, reducing costs in our own areas of overhead costs, including the real estate footprint as we noted earlier today, so while inflation is something that we are managing on a daily basis, I would say we haven't seen a material impact to our financials so far this year but we have to continue to be diligent to make sure that it doesn't become an impact.

And we're watching very closely to see if inflation is starting to modulate. Our indications would be that, that is starting to happen but we're watching the data just as you are..

Okay. And then just a quick follow-up. There was a news report yesterday that the Air Force is looking to retire all its Global Hawks in, I think, 2027.

I think is this in line with your expectations?.

It is and this is what we've been talking about for a while that the Global Hawk franchise would be phased out over time. And we -- yes, we were expecting this. And as you note, the Block 40s don't retire until 2027.

So that's a bit out in the future and doesn't have an impact on any projections that we've outlined for this year or next but it is in line with our longer-term expectations..

Our next question from Sheila Kahyaoglu from Jefferies..

Maybe if we could just talk about the F-35 program, Kathy. How big is it today? And given some of the reset on production, how does that impact the cadence and outlook for Northrop? And what are some of the puts and takes just thinking about shifts on content and lead times within Mission versus AS..

So Sheila, it continues to be about 10% of our annual sales in total across all aspects of our contribution to the program.

As we have worked through our new contract for Lot 15 through 17, we have factored in the demand that Lockheed has for our components and we still see our outlook for '22 and even into '23 intact as a result of the new expectations around demand.

As we look over a longer period of time, we still see production being the lion's share of our revenue volume. The sustainment is the fastest-growing element of our contribution to the program. And in Mission Systems, we have a combination of development and production because we're supporting the Block IV upgrades.

And that most notably is revenue support for Mission Systems even as we phase out of the DAS program which also is in Mission Systems. We see Mission Systems revenue being fairly stable because of that increased volume around Block IV..

Great. And then maybe just a follow-up. You had some positive movement IBC, I think, first deliveries to Poland in the quarter. Maybe if you could remind us how you're sizing that program and timing to the Army versus other potential international opportunities..

Sure. Happy to jump in on that one, Sheila. In aggregate, that you can think of that franchise in the 1% of sales range. But as you point out, they are important domestic and international components to that today and equally importantly, international opportunity going forward as well.

Certainly, it's a critical mission set that our IBCS capability can meet by attaching a kind of previously disconnected sensors and shooters and bringing new capability to disparate systems which is really central to the modern mission set, both domestically and abroad. So we look for that to be a growing franchise.

We're really pleased with the competitive awards of the past year. There should be some second half growth in the program. And again, it's a critical part of our Defense Systems franchise..

Our next question comes from the line of David Strauss from Barclays..

Kathy, I think on the last call, you kind of endorsed the current consensus revenue estimate for 2023 which I think is around $38 billion. Is that still the right way to think about the revenue trajectory next year? And it would seem like you would be able to get there pretty much on B-21 and GBSD growth.

So are you assuming, what does the rest of the portfolio look like next year ex B-21 and GBSD in terms of growth?.

So we continue to believe we can accelerate our growth rate next year toward the mid-single-digit range which is how consensus is being developed. And so it would affirm that. And the demand environment is strong, as I outlined on the call. So that would provide some tailwinds.

However, I would caution you just as I am thinking about this as we prepare to give you outlook and trends in October when we'll provide more detail that the supply side challenges that we are facing this year are real.

And it depends on how they mitigate throughout the second half as to what that looks like going into 2023 and we certainly could be delivering higher revenue growth this year, if not for those supply side constraints. So it really isn't a demand question.

And to your point, the budgets are strong enough for us to have even further accelerated growth into 2023 but we need to be able to deliver on that growth with the labor and the materials. And so we're monitoring that very closely and we'll have a better sense of what that looks like in October to be able to give you trends data into 2023..

Okay. And Dave, thanks for the color on pension. Obviously with you guys, a lot of moving pieces with the mark-to-market and all of that. I think you had previously said FAS has relatively, I think, in total, relatively flat in '23 versus '22.

I mean are based on more things today, I mean, can you help us at all? Are we looking at like a couple of hundred million dollar headwind '23 versus '22..

I appreciate you raising that topic for a follow-up. We noted on the call that we direct your attention to the pension sensitivity slide we provide every January. So to give you a feel for the approximate impacts of an increase or decrease in a discount rate or a level of asset returns of a certain degree.

The discount rate increase is the most significant effect that we would see on FAS/CAS income if the year were to end today, we've seen well over 100, perhaps even approaching 200 basis points of discount rate increase since the year began.

And so as we noted in that sensitivity slide, every 25 basis points can have $1 billion or more impact on mark-to-market at the end of the year and a substantial impact on the FAS/CAS income going forward. Again, these are nonoperating GAAP earnings amounts. They're not cash flow drivers.

If anything, as we noted, the CAS reimbursements are expected to tick up slightly. And so from an economic perspective, there's a small benefit there. From a GAAP earnings perspective, would draw your attention to the discount rate and asset return sensitivities.

And of course, we'll see where the market moves over the next 6 months to give you a more final sense of the '23 FAS/CAS outlook..

Our next question will come from the line of Seth Seifman from JPMorgan..

Maybe just to keep everyone riveted, I'll ask a follow-up question on pension. And Dave, I wonder if you could talk about just thinking big picture and conceptually, we've seen Lockheed and their defined benefit plan and they're offloading a lot of their liability on to insurance companies. You guys still have DB. It's not huge.

I think the service cost this year should be under $400 million.

But when you think about what you want to do longer term, what makes most sense for Northrop, particularly as a government contractor and with the allowable cost framework, what do you want to do long term?.

Sure. Thanks, Seth. So I would point out a few things. One, we've had outstanding returns on our pension assets over any period you look at historically, over the last 20 years, well above market return expectations.

We're really proud of the value that, that has generated and the benefit that, that is both to the company and to our government customers. As a result, we are very well funded today. We talked about a 96% funded status level that fluctuates day-to-day, given market movements.

But again, we're in slightly better funded position today than we were even as of the first of this year, given the changes in the interest rate environment offset by the changes in the asset returns that you'd expect. So there's a lot of moving pieces under the surface.

But in aggregate, we don't today feel a burning need to make a change to our long-term strategy. It has been working. It's been a value to the company, to the participants and to the government. And as a result, it's certainly something we'll continue to assess over time.

But at this point, we're pleased with asset returns over any long period of time, Pleased with the funded status that results from that and we'll continue to keep you apprised if there are any changes along the way..

Great. And then maybe to follow up, just on Aeronautics, I know you talked earlier about the kind of the absence of EACs in the quarter. I think they were a slight negative. I guess if we look back over the last several quarters. Given the size of the segment, the EACs in this segment team relatively light relative to others.

What programs kind of give you visibility on that picking up in the coming years.

And when we think about how margin expansion in the segment over time, how does the framework of underlying margin versus EACs play into that?.

Sure. In aggregate, for a sector like AS, we would expect, in a typical year, to have a healthy underlying OM rate. And in a typical year, we would have some volume of favorable net EAC adjustments.

Of course, at any given time, we don't know which programs those may come from because we've factored our risks and opportunities into our current EACs and we need to perform well and retire risks in order to drive those improvements in EACs.

So I'd be reticent to be able to point to any particular program that we think will be a key or much less the key driver of EAC benefits over time.

But certainly, within our restricted and unrestricted portfolios, we need to continue to execute well, drive efficiencies in every one of those programs and again, continue to have some volume of net EAC pickups on top of the healthy underlying segment OM rate in the business.

It's a segment whose execution we're proud of with some critical programs and we'll look to continue to build on that..

Our next question comes from the line of Noah Poponak from Goldman Sachs..

Why is there currently such a large variance between the pace of DoD budget outlay versus DoD budget authorization?.

So no, I honestly don't know why. I can speculate a few things that may be happening. One, as we are seeing these supply chain constraints, contracts may just not need additional funding, so it could just be a temporal issue of timing. Another is the labor constraints that we're facing, the government faces as well.

So we have seen where some just shortage of people to get work done has impacted anything from outlays to invoice payment timing but that would be speculation on my part. I can't tell you why. What I can tell you is that for Northrop Grumman, we did not see that as a factor in second quarter.

We had exceptionally strong book-to-bill, as I noted, at 1.48. We have seen acquisitions staying relatively on time and awards and outlays being in line with our expectations..

Okay. Yes, it's just a strange dynamic. It's uncommon to see authorization humming along and then being pulsed up and discussions of higher in the future and then the outlays down double digits. But so for you, that's -- it's really a supply chain that's the bigger factor.

And then it sounds like you think maybe it's possible that the customer knows their supply chain issue. So isn't cutting checks as fast as they normally would..

Right. Without lays, we generally see on existing programs that we let the government know when we're reaching a certain threshold of spending against the funds that they've outlaid and that will trigger them to provide the next funding increment.

It could just be that many companies and programs are trailing with their timing expectation would have been. You're seeing that in the results across the industry. And so they just didn't have the need to do the outlays in the quarter. Obviously, that's a trend we all want to see reverse, because to your point, the funding is there..

Next question will come from the line of Rob Spingarn from Melius..

In AS, you've held the revenue guide despite the pressure in the first half, as you and Dave noted earlier but the margins are coming down just slightly. And you've talked about catching up in the second half but I wanted to ask if the labor to do that is going to be a little more expensive and maybe that's what's behind the margin.

And to what extent that Palmdale might be a particular labor pinch point because it does seem like you and Lockheed are competing pretty intensely out there for talent..

Let me start with the second half of the question and then Dave can join in on the first half. We are not seeing Palmdale to be more competitive than other labor market. Labor markets across the country where we're operating are all competitive.

Palmdale is no different but we have been able to get the staffing there that we need to execute on our program. What we've seen more so and we talked about this towards the end of last year, particularly as it impacted the F-35 line is absenteeism that ebbs and flows with COVID has been a bigger challenge for us.

So we have the workforce we need but if they aren't as productive because they aren't able to be there consistently that was creating more disruption for us. That has started to even out. Even with this latest set of COVID disruptions, we have not seen the same level of impact because we've taken some mitigating steps.

The other thing that we've done in Palmdale is put our own training facility in place so that we can more quickly onboard people to our production programs. and provide them the training they need. It allows us to hire lesser skilled labor coming in. We provide the skills needed and that has opened up the pool from which we can recruit.

So we aren't just taking talent from other people's production lines and vice versa. So those are some of the things that we've done and we're seeing good results..

And very helpful. And just -- I'm sorry, I was going to just ask a high-level one, if it's okay..

Go ahead..

I just wanted to ask you to characterize your positioning for NGAD?.

Yes. So as we think about sixth-generation aircraft, we are in the process of building the first of those to B-21 and that's given us some fantastic experience and lessons that we believe we can apply to other sixth-generation aircraft. And so we're positioned as a competitor.

I think our government desires to have a broad industrial base, able to prime these large opportunities as possible. And we have been clear that we are investing and building our own capabilities and capacities to be able to be a contender..

I have to leave it there this morning. Kathy, turn it over to you for closing remarks..

Great. Thanks, Todd and thank you all for joining our call today. I again want to acknowledge the extraordinary accomplishments by our team already this year and the momentum that I feel is creating for the future. So I hope each of you enjoy the remainder of your summer and we look forward to speaking with you in October. Thanks again..

Ladies and gentlemen, this concludes today's conference call. Everyone, have a great day..