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Good day, and thanks ladies and gentlemen, and welcome to Northrop Grumman Second Quarter 26 Conference Call. Today's call is being recorded. My name is Josh, and I will be your operator today. At this time, all participants are in a listen-only mode. I would now like to turn the call over to your host, Mr. Todd Ernst, Head of Investor Relations. Mr. Ernst, please proceed.
Good morning, and welcome to Northrop Grumman's Second Quarter 26 Conference Call. Before we begin, please note that matters discussed on today's call, including guidance and outlooks for 2026 and beyond, reflect the company's judgment based on information available at the time of this call. They constitute forward-looking statements under the safe harbor provisions of federal securities laws. Forward-looking statements involve risks and uncertainties, including those noted in today's press release and our SEC filings, which may cause actual company results to differ materially. Today's call will also include non-GAAP financial measures, which are reconciled to our GAAP results in the earnings release. Additionally, we refer to a presentation that has been posted to our Investor Relations website. Joining us on the call today are Kathy J. Warden, our Chair, CEO and President, and John Thomas Greene, our CFO. With that, I will now turn the call over to Kathy.
Thanks, Todd. Good morning, everyone, and thank you for joining us on our second quarter 26 earnings call. As we celebrate America's 250th birthday, we are reminded of the importance of our work in support of preserving freedom and protecting our way of life. It was a moment of pride for our Northrop Grumman team when the B-2 flew over our nation's capital on July 4th, a symbol of American strength and ingenuity. It was also a powerful reminder that many of our technologies have transformed the aerospace and defense industry, from the world's fastest microchip and the James Webb Space Telescope to our signature flying wing technology that epitomizes the B-2 and B-21 stealth bombers. Todd, we operate with a sense of urgency to get these technologies into the hands of our customers with the quality they depend on and the speed to meet today's dynamic threat environment. Our Northrop Grumman team is embracing the call to action from our nation's leadership. We are partnering with our customers to more rapidly develop and deliver the next generation of capabilities while scaling and investing in advanced factories to increase production rates and volumes. We are fully aligned with U.S. government priorities and see significant opportunity and increased demand for our portfolio. There is bipartisan support for defense investment to maintain our nation's competitive edge. Congress is making progress on fiscal year 2027 authorization and appropriations. The House and Senate Armed Services Committees and the House Appropriations Committee each supported $1.1 trillion in the base budget for the Department of Defense, an increase of approximately 10% from fiscal year 2026. Additionally, the administration recently submitted a supplemental request for $67 billion for the Department of Defense to fund recent operational costs, replenishment of weapons, and enhancements to military readiness. Congress is considering the supplemental and the administration's $350 billion reconciliation package, which is intended to expand and modernize the nation's military capabilities by investing in priority programs and the U.S. defense industrial base. While Congress and the administration are still working through the legislative process, Northrop Grumman's core programs remain well supported in the base budget request, which provides us continued confidence in our growth outlook. Around the world, there are unprecedented levels of defense investment as allies accelerate their modernization efforts. Increased global defense spending represents a powerful commitment to our collective security and a recognition of the global threat landscape. At the NATO Summit a few weeks ago, our allies pledged $50 billion in additional investments, including a commitment for Northrop Grumman's Triton autonomous aircraft. In the Middle East, modern missile defense systems remain an essential priority for ensuring national security. Momentum continues to build in numerous countries to acquire our IBCS system, which is proven and operational today. This includes Kuwait, which in May received approval from the State Department for six IBCS systems, and in Australia we were selected to establish an in-country solid rocket motor manufacturing facility. These announcements from the second quarter underscore the breadth of international demand for our production-ready systems. As highlighted in this morning's second quarter release, Northrop Grumman's financial performance reflects continued strong results. We delivered $20 billion in net awards in the quarter, driving a book-to-bill ratio of 1.84x. Backlog continues to grow, including a new record high of $105 billion, and we expect continued strong bookings for the remainder of the year, as well as increased momentum in government outlays. These dynamics strengthen our confidence and outlook for accelerating sales growth in the second half of the year. Sales increased by 5%, supported by growth in all four of our segments, and operating performance has been solid throughout the business. We did have lower operating margin rates in Defense Systems and Space this quarter due to two programs with negative EAC adjustments. In Space, we progressed on the root cause investigation on the GEM 63XL program, and we are implementing corrective actions to address the anomaly we experienced on a launch in the first quarter. These include a component redesign, which has now been proven in a successful static fire test. We expect to begin delivering the redesigned motors by the end of the year. This additional work and the needed material are reflected in our updated EAC position. In Defense Systems, we continue to invest in our strategy to design and produce tactical missiles. We are executing this strategy through investments in two related programs: Stand-in Attack Weapon, or SAW, for the U.S. Air Force, and ARGEM extended range for the Navy. In the quarter, we recognized higher projected costs to complete qualification testing on SAW. Despite the negative performance reflected on GEM 63XL and SAW in the quarter, we are confident in our team's ability to complete qualification and successfully deliver these products. They each provide necessary capability for our customers and represent billions of dollars of potential sales at accretive margins over the next decade. Based on our strong Q2 results and accelerating momentum, we are increasing our financial guidance for 2026. Robust bookings are continuing, and we now expect a full year book-to-bill ratio of at least 1.25x. Sales are now projected at $44 billion at the midpoint, which is over 5% organic growth. We are maintaining our expectations for segment margin performance and we raised EPS estimates by $1.20. A rapidly expanding backlog provides a strong foundation for growth this year and beyond. I highlighted new international opportunities a few minutes ago, which support our multiyear goal to double annual international sales to $10 billion by 2031. Now, I would like to spend a few minutes outlining developments from this quarter which further bolster our U.S. growth outlook. We continue to make progress on the Sentinel program in partnership with the Air Force. This led to further definitization and authorization for us to add additional elements of the program plan, resulting in a $7.6 billion increase in program backlog. During the second quarter, we achieved contract incentives which improved overall profitability and delivered program milestones as scheduled. Let me share a few important examples of this progress. We completed an acoustic test of the Sentinel missile, which validated the system can withstand the intense conditions of a silo launch, another crucial step towards achieving first flight of the integrated missile, which is expected in 2027. The solid rocket motors for the first five flight tests are already in production, and last week we broke ground on yet another advanced facility at our campus in Utah, adding to the existing 1.1 million square feet of purpose-built space for Sentinel. This new facility will support the production phase which starts later this decade. We are seeing firsthand the Department of Defense embrace the use of multiyear agreements to achieve some of its top priorities, particularly on tactical missile programs. When you couple our proven performance as a supplier of solid rocket motors with the additional production capacity we have already brought online, we are positioned to be a qualified rocket motor provider on new programs. Last month, we completed qualification activities to become a supplier on PAC-3, and we reached a $2 billion framework agreement with the Department of Defense and Lockheed Martin. We expect the PAC-3 SRM production awards later this year. In total, we have 10 multiyear agreements for missile acceleration in work across the portfolio with up to $10 billion of sales opportunity over the next seven years. These agreements provide a clear demand signal to industry and Northrop Grumman while delivering greater value and efficiency for our customers. Another area of increasing budget priority is national security space. Modern warfare is driving demand in this market, with every service now depending on space-to-space capabilities, leading to historic increases to the U.S. space budget. Todd, our national security space backlog stands at over $61.6 billion with programs like GPI, GWS, and restricted efforts. For the full year, our national security space business is projected to grow high single digits and generate over $7 billion in sales, accounting for more than 15% of company revenues, driven by areas like space security, space resilience, and missile defense. The proven innovative solutions we develop for government customers, grounded in our engineering expertise and mission knowledge, are also being applied to commercial opportunities, like our in-space satellite servicing. As part of our satellite servicing portfolio, we have developed the first commercial robotic spacecraft capable of repairing, relocating, and servicing satellites in geosynchronous orbit via two robotic arms. It can also install life-extension jet packs onto other satellites for government or commercial customers, prolonging their useful life for up to eight years. The spacecraft is known as the Mission Robotic Vehicle, or MRV, and our first MRV is scheduled to launch later today, weather permitting. Before I turn the call over to John, I want to emphasize that we continue to see an opportunity-rich environment for our company. We are investing in our business, bringing continued rigor and program execution discipline for which we are known, and moving with speed to bring innovative solutions to our customers. These innovations are core to the security of our nation, the protection of our allies, and the preservation of freedom for generations to come. With growing demand, a robust backlog, and disciplined execution, we are confident in our ability to deliver accelerated growth and enduring value for all our stakeholders. So with that, I will ask John to provide a detailed review of our quarterly results and forward guidance.
Thank you, Kathy, and good morning, everyone. I will begin by covering the company's second quarter financial results summarized on Slide 4. Overall, it was a solid quarter with increasing momentum. The robust demand environment we outlined on our last call continues to be converted into new bookings and sales. Second quarter awards totaled $20 billion, driving backlog up 17% year over year to $105 billion. Sales in the quarter accelerated to $10.9 billion with sequential sales up 10% and year-over-year sales up 5%. Segment operating income decreased slightly compared to the prior year. Keep in mind, the second quarter of 25 benefited from a $76 million favorable EAC adjustment on Sentinel. Earnings per share was $7.68, benefiting from a lower effective tax rate. Capital expenditures totaled $320 million and continue to ramp as we invest to expand our facilities to support customer demand. Q2 adjusted free cash flow was nearly $1 billion, a significant increase compared to the prior year. Turning to segment performance, I will start with Aeronautics on Slide 5. Aeronautics delivered outstanding performance in the second quarter with double-digit sales and margin growth. Sales increased 13%, driven by higher volumes on B-21, TacAmo, and mature production programs. On the bottom line, Aeronautics delivered a margin rate of 10.3% driven by strong performance across production and sustainment programs. Turning to Defense Systems. Second quarter sales increased 2% on an organic basis. Higher sales were driven by the continued ramp on Sentinel and missile defense programs. Operating margin was 7.5%. Strong performance across the portfolio was partially offset by a $68 million unfavorable adjustment on SAW related to an increase in projected cost to support the design and qualification of the system. Apart from SAW, the rest of the Defense Systems portfolio contributed an OM rate of 11% in the second quarter, which gives us confidence in delivering improved returns in the second half. Backlog at Defense Systems increased to nearly $35 billion, driven by an increase of $7.6 billion on Sentinel. Our Mission Systems business continued to generate outstanding bottom-line performance, with strong execution across the portfolio. Sales were up 3% in the quarter, supported by higher volumes on marine programs, F-35 sensors, and increases on restricted airborne radar programs. Margin rates improved to 15.4% driven by strong performance and favorable EAC adjustments across the business. At Space, sales increased by 4%, driven by higher volume on NASA's commercial resupply service missions and missile defense programs. Second quarter operating margins were 8.6%. This included an unfavorable EAC adjustment on GEM 63XL related to increases in the estimated cost and quantity of materials needed to complete the program. The rest of the Space portfolio contributed an OM rate of over 11%, supporting our ability to deliver second-half results north of 11%. On Slide 9, you will see our second quarter diluted EPS was $7.68. The prior period included a benefit of $1.00 associated with the training services divestiture. Normalizing for this transaction, Q2 EPS increased by $0.57. This improvement was largely driven by the remeasurement of uncertain tax positions given recent developments with the IRS and from a gain associated with the sale of an equity investment. Turning to company-level guidance on Slide 10. As Kathy outlined earlier in the call, we are increasing our sales guidance to a range of $43.75 to $44.25 billion. This outlook reflects a second-half step-up in sales that is similar to the profile we experienced last year. With this in mind, we anticipate mid- to high-single-digit year-over-year sales growth in Q3. We are increasing our mark-to-market adjusted EPS guidance to a range of $28.60 to $29.10, an increase of $1.20. This reflects solid segment performance in the second half and an effective tax rate of mid-14%. We are reaffirming our outlook for segment operating income, which we are confident will improve in the second half. And we are reaffirming our guidance range for adjusted free cash flow of $3.1 billion to $3.5 billion. Adjusted free cash flow includes several hundred million dollars we expect to collect this year from the B-21 asset sale. This event accelerated cash receipts associated with the sale but shifted other payments on the program out beyond this year. Net, it does not change our expectations for 2026 cash on the program for the company. Our adjusted free cash flow non-GAAP metric is consistent with our prior treatment from a few years ago when we had a similar event. We continue to expect $1.85 billion of CapEx in 2026 and as we previously shared, we expect CapEx investments of around 4.5% of sales in 2027 and 2028 as we invest in infrastructure to support the B-21 production ramp. Turning to segment-level guidance. At Aeronautics, we are increasing both our top- and bottom-line estimates for the year. We now anticipate sales of approximately $14 billion. This outlook reflects higher B-21 sales as the program continues to ramp as well as higher volumes on mature production programs. On the bottom line, we are raising the operating margin rate to the mid-to-high-9% range, reflecting strong performance in the first half of the year and continued positive expectations for the second half. For Defense Systems, we are maintaining our outlook for sales in the mid- to high-$8 billion range and margins of approximately 10%. Second-half revenues are expected to step up more than $700 million, driven by higher ammunition sales and production timings in our weapons portfolio, as well as continued growth in Sentinel and IBCS. Second-half margin rates are expected to improve to over 11%, consistent with our first-half performance excluding EACs associated with our missile prime investments. At Mission Systems, we are maintaining our guidance of high-$12 billion in 2026 sales while raising our margin rate expectations to approximately 15%. This outlook is underpinned by a sequential second-half sales increase of more than $100 million, driven by higher sales volumes on production programs and new awards. Turning to Space, we continue to expect approximately $11 billion in sales for the year. Following the pattern in the other businesses, second-half sales are expected to increase significantly. This growth is primarily driven by higher volumes on national security space programs, new awards and improved performance on GEM 63XL. On the bottom line, we are lowering our expectation for margin rate to the low-10% range to reflect the margin pressure experienced to date. Performance remains strong across the majority of the Space portfolio, and we are confident in delivering improved second-half performance. Our last guidance update for the quarter relates to intersegment eliminations, which we expect to be approximately $2.7 billion, driven by increased volumes of restricted work at Mission Systems and Sentinel support in the Space segment. We anticipate the intersegment OM rate to be in the mid-13% range. In summary, building on the momentum established in the first half, we remain on track to deliver on our updated full-year projections. Our confidence is underpinned by the enduring demand for our capabilities, record backlog and alignment of our portfolio to global defense priorities. We have made significant investments in our business that position the company for accelerated growth, and we continue to be disciplined in our capital deployment strategy, creating value for all of our stakeholders. With that, let's open the call for Q&A.
分析師問答
Thank you. Your telephone will be unmuted and wait for your name to be announced. To withdraw your question, please press one. Please limit yourself to one question and one follow-up. One moment for questions. Our first question comes from Ronald Epstein with Bank of America. You may proceed.
Hi, Kathy, John and Todd. Congrats on the quarter. This is Andrew on for Ronald. Thank you for taking our questions. Just unpacking the tax impact from the quarter. Is the $1.20 EPS increase in the updated full-year guidance driven entirely by a combination of lower taxes in the quarter and higher sales expectations for the year?
Thanks for the question. I will take it. The tax had an impact on the quarter, certainly, but the higher EPS for the year will be driven by sales execution, increasing sales, strong second-half margins, and a tax benefit. We are going to continue to manage operating costs in the business to ensure that we are as efficient as possible. It is a balance of factors. Certainly in the current quarter, as we did make that adjustment to the uncertain tax position, it did pull forward a benefit, but really what we are trying to get across on this call is the operations are strong, and we expect to deliver a really strong second half of the year.
Gotcha. That is very helpful color. And I guess just pivoting in a different direction here, relating to the unfavorable EACs on Stand-in Attack Weapon, what exactly is driving the higher expected development costs on that program?
As we mature production, the ARGEM ER program, which is the basis of the technology for Stand-in Attack Weapon, we have had some delays in testing that have resulted in a flow-through to the schedule for design and qualification on the Stand-in Attack Weapon. We look at those two programs collectively as part of our tactical missile growth strategy, and we have been investing more resources in the team, including better integration and lab facilities, so that we can accelerate through the testing and deliver these capabilities. They are very much in high demand—one program for the U.S. Navy, the other for the U.S. Air Force—and we have international customers that are looking to get these missiles in their hands. So we want to make sure that we are doing everything we can to drive through the performance challenges and deliver. I will pass it back.
Our next question comes from Seth Seifman with JPMorgan.
Thanks very much, and good morning. Maybe a little bit bigger-picture question about investment. You have invested more than peers over the past decade. Can you talk a little bit more about the returns you have seen on that investment, how it compared to your targets, and how you think about the return on investment for the increased CapEx moving forward? Maybe how that compares to what you have looked for historically.
I will start. I view the investments we have made in the last several years as both investing in capability for new product lines—we have talked about two already this morning, GEM 63XL and Stand-in Attack Weapon are good examples of those investments—and capability on programs like the B-21. Our offerings really position us for the increased top-line growth that we are starting to see. As I talked about earlier on the call, we now expect book-to-bill this year to be 1.25x, which I see as a direct correlation to the investments we have made in capability. We have also been investing in capacity and that has positioned us to win work we otherwise would not have been in a position to deliver upon. Good examples of that are in the munitions portfolio—I talked about having qualified on PAC-3 MSE—and we also have production capacity so that we can start building right away. That allows us to pull those revenues in sooner than we otherwise would have had we not made those investments. We are consistently investing with discipline, making sure that we have strong business cases that are coming to fruition. Our programs are not without technical risk, but once we get through development, having that production in place is serving us well to generate strong return and accelerate revenue and return.
Great. Thanks. Maybe one more detailed question about HALO. The release mentioned some revenue pressure from that program. Is that related to timing, or is that related to NASA's decision to move away from Gateway? If that is the case, are there further sales pressures from HALO expected that we should be aware of?
As you noted, NASA is moving away from their original Gateway plans. We are working with NASA to take the technology that we were developing under the HALO program and still have that contribute to their future Gateway plans. We are in the process of restructuring the contract to do that. It will reduce revenue this year as we outlined in our filings, but it will extend it over a longer period of time as we work deliverables into the new NASA plan.
Our next question comes from Sheila Kahyaoglu with Jefferies. You may proceed.
Good morning, Kathy and John. Maybe, Kathy, just on the last line of question can you talk about—you recently completed qualification activities on solid rocket motors for PAC-3. Maybe on PAC-3 and more broadly on the Sentinel framework, how you are thinking about the timing. Is that in line with plan? How should we think about capacity expansion, and how that impacts profitability?
Yes. We first needed to get through qualification, which we did in this quarter. We have production capacity, and we are starting to build, and we are doing that even ahead of definitized contracts later this year so that we can support the increased demand for the program. We do expect to be definitized for a larger production contract later this year as the funding becomes available through the appropriations from the FY 2027 budget. As we think about Defense Systems drivers in the second half, that is mainly Sentinel and the weapons programs coming into fruition. I will say we are seeing strength in top line across all four of our businesses. You compare first half to second half, some of that is just the natural seasonality of the businesses we saw last year. We have achieved 5% growth in each of the first two quarters over last year and expect that same trend in the second half to get to the midpoint of our guidance of 5%. Last year it was accelerating growth through the year and we are expecting the same trend to occur this year.
Our next question comes from Gavin Parsons with UBS. You may proceed.
Good morning. Kathy, as you progress toward expanding the production capacity for Sentinel, have you had any additional conversations with customers about increasing the program of record beyond 100 units?
The agreement we reached with the Air Force does allow them to consider accelerating production into a larger program of record, and we are working with them in that analysis. They are undertaking it now. I expect that by year-end they will come to a conclusion on that, and we will keep you updated.
Thank you. And on Aeronautics margins, can you give a bit more detail on the strength? Has it been better B-21 performance, legacy programs, or a mix of both?
It has been a mix. B-21 has had good execution throughout the year, which has enabled overall program profitability to trend upward. Mature production programs' EACs have been favorable across the board. Manufacturing processes and delivering key milestones have been strong within this segment, which has enabled margins to be stable and on an upward trend.
Our next question comes from John Gottem with Citi. You may proceed.
Hi, guys. This is Jeremy on for John. Since we last spoke, we saw the largest IPO in history. From a space perspective, what is your overall broad assessment of demand for space as it relates to defense?
In my prepared remarks I talked about our space business in particular national security space, inclusive of our space resiliency offering, our intelligence, surveillance and reconnaissance efforts, and missile defense. We see it as one of the strongest areas of U.S. budget growth and one of our projected growth areas. We see it growing to be a more sizable part of our overall portfolio, generating about 15% of revenues for the company as that area grows double-digit. We also are starting to see increased demand internationally for space, with different export constraints, but a growing pipeline outside the U.S. for our space portfolio as well.
Thanks. Quick follow-up: can you go over your plans for MRV and your involvement in more commercial markets?
Our MRV offering is part of our larger satellite servicing market that provides life extension to satellites. This offering brings robotic arms that allow us to do more servicing operations for satellites. We expect both commercial and government clients to be interested in this capability because it extends the life of high-value assets and reduces maintenance and replenishment costs. We have taken a commercial model: we have invested, we will deploy the capability, and in 2027 it will become operational. It takes time to get it into the right orbit, test it and begin servicing, but next year we expect this to be part of our service offering.
Our next question comes from Scott Deuschle with Deutsche Bank.
Hi, good morning. Kathy, would you be able to share any detail with respect to what your market share on this upcoming PAC-3 contract might look like? Is this a small share position you are pursuing, or do you see a path for Northrop to play a substantial role in this program?
Because we are a new supplier on PAC-3, we will start at a smaller scale, and that will grow over time. I am not at liberty to share exact quantities, but we are focused on performing in these early production deliveries and believe that by doing so we will gain credibility to continue to scale.
John, consensus is forecasting about a 7% revenue CAGR at Defense Systems over the next three years. Across the segment—with awards this quarter like Sentinel, IBCS, international orders—do you see a path to deliver growth better than that 7%?
I'll speak to the current year and avoid too many specifics on the outer years. Execution in the quarter, the strong book-to-bill, and marquee programs like Sentinel, B-21 and weapons demand provide growth drivers that should enable the company over time to accelerate revenue relative to what it has done historically.
Our next question comes from David Strauss with Wells Fargo.
Good morning. Kathy, in recent public forums you have spoken of acceleration in growth at Space next year as well as Mission Systems where growth is relatively low this year. Taking that with expected strong growth at Defense Systems and Aeronautics moving into 2027, is it possible revenue growth could be in the high-single-digit range next year?
As John said, we will refrain from putting a specific number around 2027 growth, but we are outlining reasons for optimism. You heard the book-to-bill of 1.25. We have talked about international growth being double-digit. We have noted not only tailwinds to top line but tailwinds to margin as we start to shift mix away from development toward more production, which are higher-margin businesses. There's a lot to be optimistic about as we look forward to 2027, and I will also note the U.S. budget supports our programs well in the base budget, so we are not dependent on significant supplemental funding above the base to drive growth into 2027.
As a follow-up on free cash flow—given the higher CapEx profile than you may have thought earlier—can you update thoughts on whether prior free cash flow guidance holds even with higher CapEx?
I'll go back to operating cash flows first. From 2023 through the current year operating cash flow has increased about 30%. The business continues to generate a great deal of cash quarter over quarter. For the outer years, we provided a view on CapEx at about 4.5% of sales. We will continue to work and manage that to turn operating cash flow into free cash flow. The 2027 and 2028 numbers will be refined through this quarter; we will be prepared to give a view in Q3 and an updated view in Q4. We understand how important free cash flow is and how effectively we use it. Right now we are investing to support customer demand, and at the right time we will evaluate CapEx to ensure it makes sense. First and foremost is to continue to invest to meet the demand signals we are seeing.
Our next question comes from Matt Akers with BNP Paribas.
Good morning. Kathy, I wanted to ask about unmanned demand. We saw the recent NATO order for Triton. What are you seeing there, and could that contribute to doubling international business as you discussed?
We are pleased that NATO has expressed interest in buying up to five Tritons. We expect to work with them through the remainder of this year to get on contract next year, and we see this as an endorsement for products like Triton that are mature production programs we can deliver from our production line with relative speed. Triton supports an important surveillance mission in the High North. Unmanned systems will continue to contribute to our international growth, but we have numerous growth drivers internationally—munitions, IBCS, manned platforms like E-2D—so it is a broad-based set of international offerings driving our overall growth.
If I could do one more, any update on Golden Dome and space-based interceptors? Any sense of how much that will contribute this year?
Golden Dome is a collection of programs that create homeland missile defense architecture. It includes competitions as well as sole-source additions to contracts we already have in place. We started seeing reconciliation dollars be allocated earlier this year; that was slow coming into the year but opened up as we entered the second quarter. We are seeing those funds being put onto contract and expect more selection decisions and contract actions throughout the remainder of this year and into early next. Revenues from Golden Dome-related activity will continue to scale.
Our next question comes from Kristine Liwag with Morgan Stanley.
Hi. This is Justin on for Kristine. Thanks for taking the question. Wanted to ask about the microelectronics business. Kathy, you have given great color in the past around this business and the work you are doing at the foundry. Can you update us on how that business is faring and how the growth outlook there might compare to the rest of the Mission Systems portfolio given both internal and external demand?
We continue to offer solutions for government and commercial customers in microelectronics. We are experiencing some program life cycle dynamics, so growth in that business has been lower this year, particularly in our restricted microelectronics area, but we expect demand to increase over time. This is an important enabler not only to our products where we vertically integrate microelectronics into Mission Systems and Aeronautics as well as weapon systems in Defense Systems, but also where we sell them to other customers for secure processing. The underlying demand fueling the microelectronics business is still robust; it is just a temporary year-over-year comparison after growing very strongly last year.
Our next question comes from Scott Mikus with Melius Research.
Good morning, Kathy and John. John, I appreciate the color on what gives you line of sight to low-11% margins at both Defense Systems and Space in the second half. Is that low-11% margin rate for both segments the right jumping-off point for 2027?
We are focused on 2027, and I understand the modeling question. The businesses have strong backlogs. Pulling out the one program-specific issue at Defense Systems, margins are about 11% excluding that. We've given detail on the rest of the segment. I won't be prescriptive about exactly how to model beyond that, but we have confidence in the firm's execution capabilities to continue to drive strong margins through the second half of this year and into next year.
Quick one for Kathy: on MRV, from a qualitative perspective, what is the potential market for an offensive version of that spacecraft that could be used to disable adversary satellites?
I appreciate the question. I'll leave it to the U.S. government to decide how that capability might fulfill mission objectives. It is our objective to offer clients options for technology deployment and for them to determine policy for when and how they might deploy that technology.
Our next question comes from Scott Deuschle with BTIG.
Kathy, John, good morning. I know you mentioned marine as a growth driver at Mission Systems, an area that often doesn't get highlighted. Can you share more about your marine business today and where it is going? Is this a mission area in which you might invest more organically or inorganically?
We have exposure to multiple aspects of the marine marketplace. The work we are doing on propulsion for the modernization of the nuclear navy is the biggest growth driver in our Marine business and we expect it to continue to be so as we move through the early stages delivering our first low-rate initial production units, scaling production over time. We are pleased that this set of programs has come out of development and now is in production. Our team is executing well to drive schedule improvement and improve overall performance, thus improving margins on that business. We expect it to be a key growth driver and a key performance driver for the foreseeable future.
On the international pipeline, you mentioned Kuwait. How is the Middle East looking as a broader market? Are you seeing meaningful reforms around the FMS process that could speed things up?
We announced the Kuwait order for six systems this quarter. We also have Letters of Request from the UAE and Qatar for our IBCS system and are in discussions with multiple other Middle East countries. This is a result of the importance of missile defense as demonstrated in recent conflicts for cruise missiles and drones—both detection and interception—and IBCS is designed for that integrated air and missile defense mission. We have seen a real improvement in how quickly FMS cases are being approved; they are being approved at a much more rapid rate than in prior years. The administration has placed focus on cross-agency work that expedites FMS cases, and we are significantly ahead of prior years in approvals.
Our next question comes from Peter Arment with Baird. You may proceed.
Good morning, Kathy and John. On Defense Systems' EAC adjustment and investment spending on tactical missiles, how do you handicap cost growth from here? Are we in the mid innings or late innings, and confidence around the double-digit margin guidance in the second half for Defense Systems?
We brought in independent resources to scrub our assumptions behind that EAC, and I have confidence that we have an executable plan and the team in place. We have added resources—not just people but infrastructure—to allow us to execute that plan and we have agreements with our customer that give me confidence we are in lockstep on what needs to be delivered. Those risks are well understood, which generally is key to having confidence in the go-forward plan and estimated cost, and we are there. With that said, we are not done with qualification; until we are, there is risk, but we will keep you updated and I feel confident we have a good plan to execute.
Our next question comes from Gautam Khanna with TD Cowen.
Good morning. Could you elaborate on the $10 billion of SRM opportunity over seven years and how we should think about the company's protection against inflation and pricing over such a long period? What might that mean for profitability of that business over time?
Those negotiations are ahead of us. What we have now is a set of opportunities and we are working with the Department of Defense and prime customers to identify negotiation points on price, fee and investments needed to recover costs over time. The framework agreements lay out a construct for those and as we work through this year and likely into early next, as funding becomes available we will work through the finer points to definitize contracts. We will be disciplined as we do on all contracts. In many cases we have invested so that capacity is available now and we have completed qualification, which means we understand what we need to build and these will look more like mature production programs. We will ensure we incorporate any risk into our pricing assumptions.
Our final question comes from Myles Walton with Wolfe Research.
Thanks. John, I just wanted to ask about the size of the positive adjustment on Sentinel in the quarter. That effectively offset the higher investment on ARGEM, and is that why we should think about the 11% ex the Stand-in Attack Weapon?
That is a good way to think about it. It was not material enough to break out separately, so we did not. We don't want to create a precedent of identifying low-dollar items because it would lead to many breakout requests. But your description is a reasonable way to think about it.
Kathy, on space-based AMTI, the largest new start program in the FY27 submission went quickly to a large award to another supplier. Can you describe where Northrop is planning to compete either as a prime or supplier within space-based AMTI or GMTI space-based offerings?
It is an attractive segment where we do have capability. We are looking at future tranches of requirements we could respond to. We will not get out ahead of ourselves on any bid decisions at this point, but it is a market where we believe we have opportunity to compete. Well, thank you all for joining our call today. As you have heard from both John and me, we see robust demand for our products around the globe, and we are optimistic that U.S. budgets will continue to fully support our programs. We are confident we are on a path for improved margin performance in the second half. Our team is fully committed to addressing the two program items we spoke about today and delivering strong performance on those in the second half while continuing the excellent performance we had in the rest of the portfolio. Company margins are nearing a high 11% without those two EAC adjustments. That performance needs to continue, and we are committed to making it so that we can drive the increase in sales and EPS that we have committed to in our updated guide. John and Todd look forward to following up with you on any additional questions. Thank you.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation.