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Edited Transcript of NOC earnings conference call or presentation 29-Apr-20 12:00pm GMT

Q1 2020 Northrop Grumman Corp Earnings Call

LOS ANGELES Apr 30, 2020 (Thomson StreetEvents) -- Edited Transcript of Northrop Grumman Corp earnings conference call or presentation Wednesday, April 29, 2020 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David F. Keffer

Northrop Grumman Corporation - Corporate VP & CFO

* Kathy J. Warden

Northrop Grumman Corporation - Chairman, CEO & President

* Todd B. Ernst

Northrop Grumman Corporation - VP of IR

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Conference Call Participants

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* Cai von Rumohr

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Carter Copeland

Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense

* David Egon Strauss

Barclays Bank PLC, Research Division - Research Analyst

* Douglas Stuart Harned

Sanford C. Bernstein & Co., LLC., Research Division - SVP and Senior Analyst

* George D. Shapiro

Shapiro Research - CEO and Managing Partner

* Hunter Kent Keay

Wolfe Research, LLC - MD and Senior Analyst of Passenger Airlines, Aerospace & Defense

* Jonathan Phaff Raviv

Citigroup Inc, Research Division - VP & Analyst

* Joseph William DeNardi

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Airline Analyst

* Myles Alexander Walton

UBS Investment Bank, Research Division - MD & Senior Analyst

* Noah Poponak

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Peter J. Arment

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Robert Alan Stallard

Vertical Research Partners, LLC - Partner

* Robert Michael Spingarn

Crédit Suisse AG, Research Division - Aerospace and Defense Analyst

* Ronald Jay Epstein

BofA Merrill Lynch, Research Division - Industry Analyst

* Seth Michael Seifman

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

* Sheila Karin Kahyaoglu

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Northrop Grumman First Quarter 2020 Conference Call. Today's call is being recorded. My name is Josh, and I will be your operator today. (Operator Instructions)

I would now like to turn the call over to your host today, Mr. Todd Ernst, Treasurer and Vice President, Investor Relations. Mr. Ernst, please proceed.

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Todd B. Ernst, Northrop Grumman Corporation - VP of IR [2]

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Thanks, Josh. Good morning, everyone. Welcome to Northrop Grumman's First Quarter 2020 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 2020 guidance, 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 our SEC filings. These risks and uncertainties may cause actual company results to differ materially. Matters discussed on today's call will include non-GAAP financial measures that are reconciled in our earnings release and supplemental PowerPoint presentation. Our earnings release contains a reconciliation of non-GAAP operating measures to our GAAP results.

On the call today are Kathy Warden, our Chairman, CEO and President; and Dave Keffer, our CFO. At this time, I'd like to turn the call over to Kathy. Kathy?

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [3]

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Thank you, Todd. Good morning, everyone, and thank you for joining us today.

Before turning to our quarterly earnings, I'd like to address the COVID-19 impact. I want to thank those who have been working to keep us safe, particularly those on the frontlines in the health care and first responder communities. I also want to thank our Northrop Grumman employees. While each of us faces unique challenges, our team's dedication to the mission is allowing us to continue providing products and services to our customers.

Our first priority is protecting the health, safety and well-being of our team. We are requiring telecommuting for those who can do so, and we've enhanced the safety of workspaces for those who must come to work in person. Our facilities remain open. And we are taking extraordinary measures in an effort to maintain healthy working conditions. These include implementing staggered shifts, health monitoring, social distancing, face coverings and more robust cleaning. In addition, we've expanded employee benefits and well-being programs.

We are also supporting our suppliers with a particular focus on our small and midsized business partners. We are advancing approximately $30 million of payments per week to critical small and midsized suppliers, and we expect these payment advances will exceed $200 million.

In addition, with the actions taken by the Department of Defense to increase progress payments, we are flowing that full supplier benefit to our suppliers in a timely fashion. While we've not had a material supply chain disruption, some are being impacted more than others, and our global supply chain team continues to actively engage with our suppliers to address issues and find new opportunities to help them.

And we are supporting our local communities. We are donating to organizations involved in COVID-19 relief efforts, supporting frontline health care workers, first responders and service members, providing funds to food banks, and helping students get access to technology for virtual learning. We're also providing in-kind donation. One example is a company-wide initiative to produce headbands and assemble thousands of face shields for hospitals.

Turning to first quarter performance, as a result of our employees' efforts, our company did not experience a material operating impact from the pandemic in the first quarter. We delivered a good operating quarter with 5% sales growth, solid operating margin and a strong backlog.

Looking ahead to the remainder of the year, we are adjusting our guidance to reflect our estimate of the pandemic's impact as we understand it today. We are updating our 2020 guidance for sales to between $35 billion and $35.4 billion, a little less than 1% lower than prior guidance at the midpoint. Our update to sales guidance reflects expected COVID-19 related impacts primarily at Aeronautics, including their exposure to commercial aerospace markets.

We are maintaining our guidance for segment operating margin rate, and we continue to expect our segment operating margin will range between 11.3% and 11.5%. Although we now expect a margin rate of approximately 10% at AS, this is being offset by an increase in Mission Systems outlook. We now expect Mission Systems will have a low to mid 14% margin rate. So as a result to the revenue impact, first quarter marketable securities impact and interest related to the first quarter bond offering, we now expect our EPS will range between $21.80 and $22.20. And Dave will discuss each of these items in more detail.

Cash from operations and free cash flow were negative in the quarter as is our typical pattern. We continue to expect 2020 free cash flow will range between $3.15 billion and $3.45 billion after capital spending of approximately $1.35 billion. With additional measures in place to help protect our employees, we continue to execute on our programs. And I want to highlight a few of our quarter's achievements.

At Aeronautics, through the end of the first quarter, we have delivered 656 F-35 center fuselages. AS delivered 2 E-2D Advanced Hawkeyes to Japan in mid-March and 2 Global Hawks to the Republic of Korea shortly after the end of the quarter. And our MQ-4C Triton was deployed to U.S. military commanders in the Pacific to provide greater maritime intelligence, surveillance and reconnaissance.

At Defense Systems, we completed the critical design review for the EMD phase of AARGM-ER. The program remains on track with a successful CDR and initial testing of subsystems including the new extended range rocket motor. In addition, DS supported the CDC's COVID-19 response effort by creating over 400 web pages in 3 languages that have received over 900 million page views providing important information about the pandemic spread.

At Mission Systems, our SABR radar upgrade program for F-16s continues to expand. SABR now has production contracts for approximately 670 systems across multiple customers. The Air Force recently exercised an option for 105 radars under their $1 billion SABR ID/IQ contract. This order included 33 radars for air combat command jets which establishes SABR as the system of record for the active Air Force.

And in February, the Marine Corps ordered 2 additional G/ATOR systems to complete their Lot 2 awards. G/ATOR replaces 5 legacy systems with a single system, providing significant performance improvement in each of its modes while reducing training, logistics and maintenance costs.

At Space Systems, we were awarded 2 small but strategically significant DARPA contracts. The first is Glide Breaker, an R&D and demonstration program to develop components for a lightweight interceptor to defeat hypersonic boost glide weapons at very long range. We previously discussed the successful docking of our first mission extension vehicle to the Intelsat 901 spacecraft. This marked the first time 2 commercial satellites docked in-orbit and the first time that satellite extension services are being provided to a satellite in geosynchronous orbit. This accomplishment laid the groundwork for the second DARPA award which establishes a partnership between DARPA and Northrop Grumman for the next-generation of remote servicing of geosynchronous satellites.

Under the agreement, DARPA will provide an advanced robotic payload to integrate with the Northrop Grumman provided spacecraft. This disruptive technology could significantly expand on-orbit servicing capability to include robotic services. Under the agreement, we will retain the spacecraft, payload and IP for commercial use.

In the quarter, Space Systems was also awarded restricted competitive prime contracts totaling multiple billions of dollars in aggregate.

While we and the nation are keenly focused on defeating COVID-19, we must also continue to address a myriad of other national security threats. Our portfolio and investments continue to be closely aligned with the national defense strategy and our customers' long-term priorities. This is evident in the President's budget request for fiscal year 2021, which proposes increased funding for strategic deterrence, hypersonic weapons, missile defense, advanced networks, cyber and space systems.

The Department of Defense, our primary customer, is seeking robust fiscal 2021 funding, which will be the subject of congressional debate later this year. The DoD budget request supports investments in our current capabilities including B-21, SABR, E-2D, advanced weapons, OPIR and other space programs, while also increasing funding for future opportunities aligned with our investments including GBSD, JADC2 and missile defense program like IBCS and Next Generation Interceptor.

Turning to capital deployment, first quarter share repurchases totaled approximately $350 million, and we retired approximately 1 million shares. In April, under an established repurchase program, we bought approximately 400,000 shares for $130 million. Combining first quarter repurchases with April amounts, we have met our approximate target for the year. We remain committed to offering a competitive dividend. In addition, deleveraging the balance sheet remains a priority, and we expect to retire the $1 billion in maturing debt this fall.

In closing, we remain well-positioned to create value going forward. We are fortunate that through the first quarter, our operations have not been materially disrupted. While future impacts of the pandemic remain uncertain, we have a robust pipeline of opportunity, including GBSC, which continues on track for an award later this year. We also continue to lay the foundation for the future. We are actively recruiting for 10,000 open positions, and we hired more than 3,500 people in the first quarter, which included more than 1,300 new hires in March.

We appreciate the government's actions to support the industry's most vulnerable businesses, including increasing progress payments, COVID-related cost recovery through the CARES Act, accelerated and timely awards and support for essential work designation.

Despite the challenges that COVID-19 has presented for every business and individual, through the dedication of our talented workforce, we remain committed to investing for the future, delivering value to our shareholders and meeting our commitments to our customers and all of our stakeholders.

Now I'll turn it over to Dave.

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David F. Keffer, Northrop Grumman Corporation - Corporate VP & CFO [4]

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Thanks, Kathy, and good morning, everyone. Before I begin my comments, I'd call your attention to this morning's 8-K filing that recast certain sections of our 2019 Form 10-K to reflect our new sector alignment. We also provided a schedule in our earnings release that provides recast sales and operating income by sector for the last 3 years and each of the quarters in 2019.

My comments begin with first quarter highlights on Slide 3. Excluding the impacts of the pandemic, our first quarter results were about as expected. Sales were up 5%, reflecting top line growth in all 4 of our businesses. Segment OM was solid at 11.1% and net awards totaled $7.9 billion. Awards were particularly strong at Space, where total backlog increased 3%. Earnings per share increased 2% to $5.15.

Slide 4 provides a bridge between first quarter 2019 EPS and first quarter 2020 EPS. While we did not have material COVID-19 operational impacts in Q1, and our businesses performed largely as expected, the volatility in capital markets did impact earnings as losses on marketable securities and the related tax impacts reduced this year's first quarter earnings.

I'll begin a review of sector results on Slide 5. Aeronautics sales were up 1% for the quarter with higher volume at both Autonomous Systems and Manned Aircraft. Higher volume on restricted programs and Global Hawk drove the increase partially offset by ramp-downs in B-2 DMS and NATO AGS as those programs near completion. While not a significant factor in first quarter results, later in March we did begin to see COVID-19 related volume pressure in the supply chain and in employee attendance, particularly at certain manufacturing facilities. I'll talk more about this when we cover guidance.

At Defense Systems, sales rose 6% due to higher volume in both its business areas. Battle Management and Missile Systems growth was driven by higher volume for GMLRS, AARGM and other missile products. Higher sales at Mission Readiness reflect higher volume on an international training program and higher volume on SEMA, an aircraft sustainment program.

Mission Systems sales were also up 6%. Higher volume for airborne radar programs including F-35 and SABR drove higher sales in our Airborne Sensors & Networks business. Maritime/Land Systems & Sensors also grew sales due to higher volume on marine systems and restricted programs.

Space Systems sales rose 8% due to higher volume on restricted programs and other space programs like next-generation OPIR and the Arctic Satellite Broadband Mission program. Increases in Space programs were partially offset by lower volume in Launch & Strategic Missiles. Trends in that business reflect lower volume for the Ground-based Midcourse Defense program and SLS Booster, partially offset by increases in hypersonic activities and the GBSD Technology Maturation Risk Reduction program.

Turning to segment operating income on Slide 6, Aeronautics operating income declined 16%, and margin rate declined to 9.1%. Lower net positive EAC adjustments in Autonomous Systems programs as well as the timing of F-35 risk retirements and contract mix in Manned Aircraft programs were the primary drivers of the operating income trend at Aeronautics.

At Defense Systems, operating income decreased 3%, and operating margin rate declined to 10.4%. This trend reflects a difficult comparison to the prior year's quarter in which we had favorable adjustments on certain small caliber ammunition programs.

Operating income at Mission systems rose 9% and operating margin rate increased 40 basis points to 14.8%. Higher operating income reflects higher sales as well as improved performance on Airborne Sensors & Networks programs partially offset by contract mix at Maritime/Land Systems & Sensors and the timing of risk retirements for Navigation, Targeting & Survivability programs.

Space Systems operating income rose 6% and operating margin rate was comparable to last year at 10.2%. In addition to higher sales, Space operating income also reflects the timing of favorable negotiations on certain commercial contracts in 2019.

Turning to Slide 7, you can see that we've updated guidance for Aeronautics and Mission Systems. The volume impacts we're projecting at AS are associated with commercial aerostructures customers, risks in our supply chain, and changes in employee attendance and productivity in certain areas. We expect that the supply chain and employee attendance impacts of COVID-19 that we began to see toward the end of March will be significant enough to impact our financial performance in certain production areas, particularly in Q2. We are also now planning for weakened commercial aerostructure demand. Commercial aerostructures represent about 1% of total company revenue, and demand has declined as global travel has been impacted by the pandemic.

The decrease in total company sales guidance is driven by the expected COVID-19 related impacts at AS. I would also note that our guidance continues to contemplate growth in restricted activities in manned aircraft partially offset by lower growth in F-35 due to the pandemic. We now expect sales in the low $11 billion range at Aeronautics.

Regarding AS 2020 margin rate guidance, we do expect their margin rate to return to the 10%-plus range in the second half of the year. We currently expect a margin rate of approximately 10% at Aeronautics this year. Based on strong Q1 performance at Mission Systems, we now expect their 2020 margin rate will be in the low to mid 14% range and will offset much of the decline in Aeronautics. Our prior guidance for Defense Systems and Space Systems sales and margin rates is unchanged.

Moving to consolidated guidance on Slide 8, the update to sales guidance reflects the AS impacts we've discussed. We are reaffirming our segment operating margin rate guidance of 11.3% to 11.5% as we expect better performance at MS will largely offset margin pressure at AS. We also continue to expect total operating margin rate in the 10.8% to 11% range with no change to unallocated corporate expense and other items.

As you're aware, we issued $2.25 billion in debt in March, and we now expect interest expense of $590 million. No change to expected tax rate or year-end weighted average share count. Based on the first quarter results and expectations for the remainder of the year, we expect mark-to-market adjusted EPS to range between $21.80 and $22.20.

Slide 9 summarizes our expected COVID-19 impacts on our outlook. While there can be no assurances as to the future impacts of the pandemic, our guidance assumes that we're able to offset higher COVID-19 related costs with other cost reductions. It also assumes that supply chain and labor impacts are greatest in the second quarter, and that operational pace recovers in the second half of the year. This means we currently expect that second quarter sales and margin rate will be more impacted by COVID-19 related factors than the other quarters of 2020. As Kathy said, we are maintaining our free cash flow guidance as we assume our government customers and other prime contractors will continue to make timely payments. We expect the positive impacts of higher progress payments and payroll tax benefits to offset currently anticipated COVID-19 related impacts and higher interest expense.

Slide 10 provides a bridge between our January guidance and today's full year EPS outlook. Operational impacts represent approximately $0.35, driven by the expected COVID-19 related revenue decline. We're assuming that the marketable securities loss in Q1 carries through the year and reduces our EPS by approximately $0.30. And higher interest expense as a result of our recent debt offering is expected to add another $0.30. The debt offering should give us some additional flexibility to support our customers, employees and suppliers during the pandemic and to position our company well for the long term. We have upcoming debt maturities, including $1 billion later this year and $700 million in early 2021, and we expect to utilize excess cash to retire these.

In closing, while we didn't experience significant COVID-19 impacts in Q1, our outlook contemplates our current estimate of the potential impact for the balance of the year. We'll continue to monitor the situation closely.

Overall, our portfolio is well-aligned with evolving customer priorities, we continue to execute to deliver value for our shareholders while managing the COVID-19 risk, and we continue to invest in the future.

With that, Todd, I think we're ready to open the call up for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Robert Stallard with Vertical Research.

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Robert Alan Stallard, Vertical Research Partners, LLC - Partner [2]

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A question I have on GBSD, there's been some talk that the Air Force may move a bit quicker in awarding this contract. I was wondering if this might make any sort of material impact on your results in 2020 or does this really flow through in later years?

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [3]

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So Rob, yes, we are working with the Air Force and negotiating the contract now. And we are prepared through actions we've been taking to move if the Air Force is able to accelerate this award. But it would be a modest acceleration we anticipate. The award was already planned for third quarter of this year. And what we see is that it would likely be only a month or 2 of acceleration if acceleration happens. So we don't expect that to have a material impact on 2020, but certainly getting started more quickly derisks the program to some extent and allows us to be more confident in meeting those milestones along the path to the 2029 IOC dates for the program.

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Operator [4]

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Our next question comes from Jon Raviv with Citi.

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Jonathan Phaff Raviv, Citigroup Inc, Research Division - VP & Analyst [5]

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Just kind of big, big picture here. How are you guys thinking about the business positioning, not only in the current environment, but sort of what the environment's going to be going forward understanding you have a lot of products and capabilities that's still aligned with current national defense strategy requirements. But anyway, how would you align to maybe future government spending priorities? You mentioned your work with the CDC, for example, in recent weeks. How do you think about where you align -- where you put a line elsewhere going forward?

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [6]

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Well, certainly, Jon, we see the demand for our products remaining strong. And that's primarily driven by the threat environment. And I noted a few areas where there we are seeing the presidential budget for '21 reflect significant increases, areas like space, missile defense, hypersonics and other advanced weapons. And so those areas we expect to continue to be in focus as well as the deterrent strategy of our nation which depends on the triad and has obviously modernization happening across all 3 legs of the triad. So those areas are going to continue to be areas of both strength in our portfolio, but areas of importance as we look at demand, near and long term.

We are very pleased to be supporting the government in other areas that have become increasingly important in dealing with the pandemic. I noted the work that we're doing currently for the CDC, and we're very proud of that work. We've been doing that for a number of years. And while it has been relevant previously, it's never been as relevant as it is today and the amount of information that we're able to share around the globe to help people make informed decisions about this pandemic spread and how to reduce the spread is certainly something that we'll continue to do and work that we're very proud of.

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Operator [7]

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Our next question comes from Robert Spingarn with Crédit Suisse.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [8]

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Kathy, I wanted to ask you just a high-level question about the budget now that we've had it and what you might be hearing from the Hill in terms of your programs and how they're doing. And specifically, if you could touch on Triton and the fact that, that program was zeroed out at least from a procurement quantity perspective.

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [9]

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Thanks, Rob. So we are overall pleased with the '21 budget request. As I noted in the previous question, there are areas of significant budget increase that are well-aligned with our priorities and certainly, we were pleased to see that. We also have a number of programs that are well-supported in the budget. I noted a few of those in my opening comments, areas like SABR, E-2D, certainly F-35 continues to be well supported as well. As we look at areas where we saw some perturbation on our programs, Triton being an example, what we see in the budget request is the pause in production with the intent of putting resources toward R&D on a new sensor. And we had anticipated that. So it will be somewhat of an offset to the production pause, the work that we'll do in the R&D. We also have the sale in Triton, which will provide some quantity that bridge the U.S. production pause as well. And of course, we continue to work with Congress as they deliberate on the budget to determine if we can get those 2 aircraft added back. So those are some of the actions that we're taking with Triton. But we do see that it is not just a production pause. This is a continued commitment to the program and investment in additional sensors to make the program and the Hill platform more robust.

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Operator [10]

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Our next question comes from Seth Seifman with JPMorgan.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [11]

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I was wondering if you could talk a little bit about -- you mentioned higher second half margins in Aeronautics and it's implied by the guidance as well. So I was wondering if you could talk a little bit more specifically about what gives you the confidence after the kind of 9-ish percent in Q1 and what seems like operationally will be more challenging in Q2 because of the virus, kind of what gives you that confidence in the second half?

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David F. Keffer, Northrop Grumman Corporation - Corporate VP & CFO [12]

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Hey, Seth, it's Dave. I'll get started on that one. The -- our outlook for the year for AS margins and for total company margins is that we expect the second half to be stronger than the first, largely because of the easing of COVID impacts on the second half, particularly compared to Q2. In AS, in particular, a lot of the margin rate movement from quarter-to-quarter in that business is timing-related. On a year-over-year basis, we saw that the timing of some risk reductions particularly around F-35 made for a tough compare year-over-year. And we do see opportunity for greater margins going forward in that business, both near and long-term than those that it delivered in the first quarter. And so we expect that kind of strength in the second half of the year to materialize in AS. Think of it as largely timing-driven around key program profit milestones and risk reductions that we see more likely coming in the second half than the first.

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Operator [13]

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Our next question comes from Peter Arment with Baird.

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Peter J. Arment, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [14]

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Kathy, you just mentioned some of the supplier disruptions or you're starting to see that a little bit from COVID-19. Maybe you just give us a little more color on kind of your assessment of the supply chain and your confidence around whether there's alternative sources or what kind of audits you went through to kind of assess the impacts going forward.

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [15]

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Yes, thank you, Peter. As I mentioned, our supply chain management team has been very active in monitoring our supply chain for risks and mitigation strategies that can counter those risks. We have not seen significant disruption to this point, but every supplier has unique circumstances. With some, we have worked to enable them to continue operations by sharing best practices for social distancing and other safety protocols. With others, we have advanced payment to help with liquidity concerns as I noted in my script. And then in addition, we have continued to monitor for disruption in the supply chain to our production lines. We've seen a few modest impacts at this point in time, nothing that is causing us considerable program interruption. But we -- as I said, the Q2 impact is where we expect to see the most significant so we're not through the disruption at this point in time. But we are seeing positive trends, both in our own facilities and with our suppliers. We are starting to see absenteeism reduced and more people coming to work in the production facilities. We are seeing small businesses that had to pause operations for a short period of time resuming their operations. And so I would say that the trajectory is positive but we still have uncertainty ahead.

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Operator [16]

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Our next question comes from Sheila Kahyaoglu with Jefferies.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [17]

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Kathy, a question for you, please. Your overall business is set to grow 3% to 5% this year. And given restricted is a higher proportion relative to peers, how do you think about the trajectory of restricted growth? And are there areas, specific areas outside of space that you have higher confidence in the growth outlook, irrespective of what happens with the budgets?

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [18]

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Sheila, thank you for the question. We do see restricted continuing to grow faster than the remainder of our business. And in the first quarter, as just an indicator, we saw 1.3 book-to-bill in our restricted portfolio. This was largely driven by Space awards. As you know, we have significant restricted work across the portfolio. We've in the past talked a good deal about the Aeronautics-restricted business. But Space is also growing rapidly as is Mission Systems. And so it really is widespread that we are seeing that restricted growth. And we anticipate that continuing. As we look forward at opportunities that we have for the remainder of the year as well as programs in the portfolio today and their growth rate, we anticipate that share of restricted business to continue to grow. It's up to about 28% now. And as we have previously said, we expect that to go even higher.

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Operator [19]

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Our next question comes from David Strauss with Barclays.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [20]

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Kathy, I wanted to ask you. So your comment on the impacts from commercial aerospace. I assume that's all A350. Could you just touch on that? And then on GBSD, I think you talked about $250 million in revenue this year. Can you give us some color on how that's going to ramp over the course of next couple of years? And when does that program become bigger than B-21?

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [21]

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So David, I'll start on the question about commercial aero. Our commercial aero work is actually spread over 3 different efforts, the largest of which is the A350. And we are expecting impact across all of those efforts. And we will begin to see that in Q2 but it will persist. It's largely driven by the demand in commercial aero. And so that is why, in particular, aeronautics sector is contributing to the slight decline that we have in our revenue guide for the year.

In response to your question about GBSD and the ramp, we expect that to be a gradual ramp as is the case when you start an EMD contract, the engineering phase tends to be very labor-driven. And so we will be adding headcount and rising activity over the next several years. And we wouldn't see a peak in that program for a while. I'm not going to specifically address the part of the question about when it becomes larger than B-21. I know what you're trying to do there, getting us to disclose a little bit more information on B-21 than I can do. But certainly, GBSD will be a significant program in our portfolio as will B-21.

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Operator [22]

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Our next question comes from Joe DeNardi with Stifel.

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Joseph William DeNardi, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Airline Analyst [23]

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Kathy, can you just talk a little bit about the opportunity for the in-orbit servicing work that you're doing? I think that's -- that was a program or an opportunity that Orbital was pretty excited about longer term. Are there certain milestones that you're looking for there? And then just kind of what's the optimistic scenario for what that could look like eventually?

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [24]

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Yes. So -- and we continue to be excited about that opportunity. And as I noted, this award from DARPA that we received in the first quarter now will add capability to what we can do with the servicing mission. So at this point, we are able to do life extension as we're doing on the Intelsat 901 satellite with our first operation. But the robotic servicing will allow us to provide other servicing functionality. So it opens up the market in that regard and clearly is an indicator that we would be able to service, not only commercial, but potentially government satellites as well. So when we look at the market, we are bullish but cautious in that this is the first of a kind. And we want to continue to march through milestones of succession that would lead us to believe that we can accomplish this much broader set of servicing missions. But certainly life extension servicing, which we have already accomplished with the Intelsat satellite, is something we feel comfortable, will be a robust and growing market for us.

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Operator [25]

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Our next question comes from Doug Harned with Bernstein.

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Douglas Stuart Harned, Sanford C. Bernstein & Co., LLC., Research Division - SVP and Senior Analyst [26]

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You're now in the new organization structure and I'm interested in understanding what -- how this looks now. In other words, both in terms of any costs you're still working through on integration. But then also, in this structure, what should we now see as the benefits going forward? And I would say that on 2 sides. One, in revenue synergies and the other in the ability to actually improve margins a little bit as you look at the next couple of years.

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [27]

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So Doug, certainly, with the integration that we're doing, we have already met our cost targets for the integration of Orbital ATK. And the next logical step that we took at the beginning of this year was realigning the sector structure. We see continued opportunity for cost reduction through the new sector alignment, and that is a clear objective that we had for doing the realignment at the beginning of this year. One of the other. And I would say, the more important, is the ability to capture the revenue synergy and successfully execute on those programs. So that was the primary reason why we did the new sector alignment but certainly cost reduction was also a part of our objective for the team. And I'm pleased with the progress that we're making there. As a matter of fact, as we look at this year, we have some increased COVID-19 related costs, as any company does as we do more of the safety protocols, cleaning, social distancing. And we fully expect as we said in our guidance, that we can offset those through other cost reduction measures that we anticipate taking this year. So we are looking ahead and believe that not only the sector realignment but actions that we will continue to take as the sectors operate in this new structure will allow us some cost reduction opportunity. Dave, anything else you'd like to add?

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David F. Keffer, Northrop Grumman Corporation - Corporate VP & CFO [28]

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As you mentioned, Doug, we're going through the standard process now around realigning systems and rate pools and such kind of on the administrative side of the realignment. But I think the bigger picture Kathy mentions is the important one, which is that the realignment enables both top line synergy going forward as well as further improvements in cost management around the business and that those are timely given the environment we find ourselves in, in 2020.

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Operator [29]

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Our next question comes from Myles Walton with UBS.

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Myles Alexander Walton, UBS Investment Bank, Research Division - MD & Senior Analyst [30]

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Kathy, I wanted to hone in on a comment you made about hiring, actually, which was 10,000 jobs unfilled that were posted and 3,500 hires in the first quarter. On a 90,000 employee base, I'm just wondering how much of this is going to be net growth and should we use that as a calibration as to the speed of revenue growth as you look into 2021?

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [31]

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Thanks, Myles. So as we look at our hiring, we have a number of open positions, both to support existing business but also anticipation of future awards. So I would tell you that we only do that hiring if we indeed get those awards as we look forward. So open positions are not necessarily a direct correlation to the number of hires that we'll ultimately make. And as we look at this year, in particular, we go into a year with an assumption around attrition. So that gets us to net heads. And the labor market was very tight at the beginning of this year. As we are working through the last 2 months, we're seeing that attrition is dropping, as you might expect, as other opportunities are becoming more scarce. And so we are in the process of looking at what that may present as both challenge and opportunity for us going forward. And so we are actively working on hiring and being very successful in hiring, as I noted. Still, even as we were dealing with the challenges of the pandemic in March, we saw 1,300 plus hires, and April continues to also be strong. We've moved virtual, as you might expect, to accommodate most of that hiring. And so as we look forward, the net heads, I wouldn't put a number on it but we do expect significant headcount growth this year because of the program volume increases that we have, the sales growth as well as the anticipated awards in the latter half of this year.

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Operator [32]

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Our next question comes from Carter Copeland with Melius Research.

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Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [33]

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I wondered if you could just expand briefly on the hiring. It looks like obviously that the classified portion of the business is increasing in its share. And I wondered if you might just speak to what portion of that hiring that you mentioned, the 10,000 jobs is cleared personnel? And maybe just give us a sense of if there's a challenge, given the growth in restricted work that you expect in terms of getting either cleared personnel on or getting folks hired and then getting them cleared. Just help us understand kind of that dynamic and how you're dealing with it.

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [34]

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Thanks, Carter. Yes, a significant portion of that hiring is for cleared personnel. We don't always hire an individual who is already cleared. We have other opportunities that we're able to put people on while they await their clearance. And we've also seen the department take actions that have accelerated clearance processing. And those have been very helpful. We still obviously have a waiting period for those individuals but it is getting shorter through the actions that the government is taking. And so what we do is we do both hiring of individuals who already have clearance directly onto those restricted programs as well as pipelining through our unclassified work with the intention of moving those individuals on restricted programs once their clearance come through. And we've been doing that for years, and it's worked well for us. It's not something that's driving an inordinate amount of increased cost to our business because we have this portfolio that has so much, both unclassified and classified work. And I'll note that classification is relative, too. There are different levels of clearances required, and so people can step through those clearance levels as well.

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Operator [35]

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Our next question comes from Cai von Rumohr with Cowen and Company.

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Cai von Rumohr, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [36]

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So could you give us any color on the significant classified Space awards in the first quarter? And secondly, it was a little stronger for the first quarter in terms of total bookings than maybe some of us expected. Where do you see the backlog going by year-end? And what are the key drivers to get it there?

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [37]

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So Cai, in terms of backlog for the year, we still anticipate it to be above 1 even without GBSD. Clearly in GBSD we expect to be a sizable award if we receive it and so that would drive book-to-bill well above 1. If we look at the first quarter, we did have less than 1 book-to-bill but we had anticipated that as you said and it signals that we expected most of our significant awards to happen later in the year. We did have the large Space restricted awards that we noted. And while we can't provide any detail about what they are, who they're for or the value of them, they were ones that we had been working for a period of time and did anticipate getting but they were competitive. So we clearly had factored them to some extent in our plans for the year, and we're very pleased to be selected and awarded those contracts this quarter.

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Operator [38]

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Our next question comes from Hunter Keay with Wolfe Research.

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Hunter Kent Keay, Wolfe Research, LLC - MD and Senior Analyst of Passenger Airlines, Aerospace & Defense [39]

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So I was wondering if you could follow-up to the exchange we had with Doug earlier. I'm kind of curious about can you maybe give me some examples or even better quantify the amount of costs you're taking out specifically from coronavirus? And this is obviously primarily an aerospace conversation. How many of those -- how much of those costs can you actually keep out once you resume normal production rates? And again, if you could maybe quantify the margin potential. Just basically trying to figure out if you can use this as an opportunity to take out cost that you wanted to take out before and maybe keep them out, if you understand.

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David F. Keffer, Northrop Grumman Corporation - Corporate VP & CFO [40]

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Sure. I'll be happy to start on that one, Hunter. It's tough to quantify the specific volumes of cost takeout that are possible, both near-term and then on a permanent basis. As you mentioned, certainly, there's an opportunity to reduce costs during the pandemic related to travel and conferences and trade shows and other kind of low-hanging fruit like that, that are naturally declining in the business. And we'll look to harvest those cost savings and continue to manage those areas throughout the rest of the year. But then we're also taking this opportunity to look around at the business and find other areas of efficiency. Kathy has been clear over the past year about driving increased efficiency, strong performance around the business, being an agile company that moves quickly and reduces bureaucracy. And so that's part and parcel of what we're looking at today, and that's not in any one sector more than others more than at the corporate level. At all levels, we're taking a look at those opportunities.

The margin impacts will depend to a degree on the business mix by segment. And so those that have more cost-plus work have less margin impact, but greater impact on the competitiveness of their businesses as we look for opportunities to take out costs. So there's a different impact depending on the segment, but a broad company effort to drive that efficiency this year.

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Operator [41]

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(Operator Instructions) The next question comes from Noah Poponak with Goldman Sachs.

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Noah Poponak, Goldman Sachs Group Inc., Research Division - Equity Analyst [42]

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Just want to make sure I fully understand all the moving pieces in the Aeronautics margin in the quarter. In the release you cite the EAC move in Autonomous, F-35 risk retirement and then some mix. Is it maybe possible to size those in terms of how much of the year-over-year change came from each of them? Was there any onetime kind of charge related to the commercial aerospace pieces? I just want to fully understand that year-over-year change. And then if you have any thoughts you could share on where that segment's profitability can go longer term, 3 to 5 years out, I would love to hear that.

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David F. Keffer, Northrop Grumman Corporation - Corporate VP & CFO [43]

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Sure. Thanks, Noah. I'll get started on that one. The 2 buckets you mentioned were approximately even in overall size. What I think is important to note is that no one specific program had a material enough impact to be called out individually. And so year-over-year, it was a tough compare quarter for AS given that there was -- the timing of some of those risk reductions in last year's Q1 created a tough compare. But in this year's Q1, there were pressures on a few programs, fewer upsides on others than we might typically see in a given quarter. Again, much of that is timing-related and we try to take that into account as we look at the rest of the year.

I think the other thing that's important to note there is in a more typical year, we would have expected to see more opportunity to mitigate those Q1 challenges in Q2 through Q4. But of course, our timing is increasingly short there given the impacts of the COVID pandemic on Q2 particularly in the volume pressures that we're seeing in AS. And so that makes it more difficult to mitigate those Q1 pressures than a typical year would provide.

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [44]

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And Noah, on your question about the longer-term and where we think AS margins can go, certainly all things being equal, we expect 3 to 5 years out to have a higher production mix than we have today because we have some significant development programs in Aeronautics as we sit here today. And that would naturally create opportunity for margin improvement during that period.

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Operator [45]

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Our next question comes from George Shapiro with Shapiro Research.

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George D. Shapiro, Shapiro Research - CEO and Managing Partner [46]

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I had wanted to know, the expectation has been that your sales would grow faster than other people, but it hasn't happened that way. Can you point to some inflection point or what quarter or year we might start to see the sales growth do better than others or much better than the budget that's going to decline over the next several years?

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [47]

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So George, I wouldn't want to try to predict a quarter at which point we would see an inflection compared to peers because we don't have the insight into our peers. I do feel like we've performed well relative to the market. We have increased our competitive win rate, and that's a strong indicator of performance in the competitive marketplace. We have also shown significant improvement in our backlog, and we're pleased with where it sits and also have a number of opportunities that we've outlined to build that backlog this year and we anticipate doing so. So what I really focus on is looking forward, how are we positioned regardless of what defense budgets do in this country and around the globe? Do we have a portfolio that's well-aligned to the highest growth areas? And the answer to that is, yes, as we sit here today, and we believe we'll continue to be. Areas of exposure like the strategic deterrent program that, in the case of B-21, we've already captured. In the case of GBSD, we anticipate being awarded later this year. In the case of Space, which is the fastest-growing in the President's '21 budget for this year, we certainly have good exposure with hypersonics and other advanced weapons now in the portfolio and expect that we can continue to grow off of what is today a small base, but an area where we expect to have significant demand. And we believe those areas of demand will be key regardless of what the top line budget looks like because they're based on the advancement of our adversary's capabilities and the threats that they impose. So based on that, we feel positive about how our portfolio is positioned for growth. And we anticipate that we can continue to create strong shareholder value through that growth, successful execution and turning that into earnings.

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Todd B. Ernst, Northrop Grumman Corporation - VP of IR [48]

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Operator, we have time for one more question.

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Operator [49]

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Our last question comes from Ron Epstein with Bank of America.

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Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [50]

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Kathy, there's been discussion in the industrial policy office in the DoD about accelerating progress payments and then getting that pushed down in the supply chain. How is that impacting you? And when you think about your supply base, particularly those suppliers who have significant commercial aerospace businesses, do you worry about disruptions there? And how are you handling that?

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [51]

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Yes, Ron, we have seen the impact of the increase in progress payments to 90% that the department has offered. And we are flowing that full supplier benefit down to our suppliers in a timely fashion. And as I noted earlier in my comments, in addition to that, we are also doing some advances for suppliers paying in advance because we want to help them with the challenges they are having, particularly those suppliers that straddle both defense programs and commercial aerospace programs. And so we believe that our suppliers are well supported by us today. But we monitor that on a daily basis because it's an evolving situation for them, particularly those that are exposed on that demand side to the commercial aero market.

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David F. Keffer, Northrop Grumman Corporation - Corporate VP & CFO [52]

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And what I'd add to that is we have fewer progress payment contracts than some of our similarly sized peers do. And that we are being sure to quickly flow through to our suppliers, their portion of that benefit. So when you aggregate the net benefit to Northrop Grumman, certainly we appreciate the work of our customers to increase that benefit. But it doesn't change our cash flow guidance for the year. On the upside, we have some additional benefit from the progress payments as well as potential tax benefits we mentioned on the call. And offsetting those, we have the impacts of COVID that we discussed to include the interest on the new bond. So that keeps us in the same range of cash flow that we were projecting previously.

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Todd B. Ernst, Northrop Grumman Corporation - VP of IR [53]

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All right, great. Well, thank you, and I'll turn it over to Kathy for closing remarks.

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Kathy J. Warden, Northrop Grumman Corporation - Chairman, CEO & President [54]

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Thanks, Todd.

Well, I'm very pleased to have Dave on our team and helping to lead through the challenges of the pandemic. We and the entire Northrop Grumman team remain resolute in managing through these challenges and being well positioned for the future.

We look forward to speaking with you again in July. And until then, please stay well.

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Operator [55]

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