Northrop Grumman Corp. (NOC)
Cowen 44th Annual Aerospace/Defense & Industrials Conference
February 15, 2023 09:15 AM ET
Company Participants
David Keffer - CFO
Conference Call Participants
Cai Von Rumohr - Cowen and Company
Presentation
Cai Von Rumohr
We're delighted to have -- I think it's our 45th (ph) A&D conference. And as many of you know, we used to do it in New York, but we decided to move to DC, so that Mohammed (ph) can come to the mountain as opposed to vice versa. And we're delighted to kick-off with Northrop Grumman, and we have from Northrop Dave Keffer, CFO. And Dave is going to make a couple of comments, and then we're going to have the discussion. David?
David Keffer
Thanks, Cai. Good morning, everyone. Good to see everyone down here in Northern Virginia where we call home. A couple of quick statements I need to make upfront. First, we're going to make some forward-looking statements today and those statements involve risks and uncertainties. Information about these risks and uncertainties can be found in our SEC filings. We may also discuss certain non-GAAP financial measures, and you can find a reconciliation of those measures to GAAP measures within our most recent earnings release.
Okay. So with that, let me just provide a quick overview and then happy to jump into questions, Cai. So I'm sure many of you saw our recent results for Q4 and 2022 in aggregate. Certainly, we were proud of the year that we delivered in 2022, and we're excited about the year we're kicking off in '23.
Just a couple of quick metrics there. In '22, we delivered another year of book-to-bill over 1.0 this time at 1.07, trailing four year book-to-bill is about 1.2%. And you can see the underlying backlog growth that is supporting what we see as really industry-leading growth rates for us over the last two years and now in the '23 outlook as well. And in the face of the macro pressures in '22, we delivered 3% organic growth. We're projecting an acceleration of 4% to 5% growth in '23.
A good portion of that is also driven by the careful alignment we have with our customers and their budget priorities these days. Of course, recapitalization of the nuclear triad is a source of a number of our largest franchise programs, but there are many areas of our business that are showing growth because of close alignment with budget priorities. I put our whole national security space business, high on that list.
Certainly, domestically and internationally, we see opportunities for growth that we can talk more about today in our weapons business, munitions business, some of the work we're doing around battle management and command and control. So these areas are all very well aligned with the threat environment we see today, which continues to drive budget growth in '23, and we expect the President's budget request for ‘24 to show growth as well.
I mentioned macro forces. We can talk more about those as we go today. But certainly, we overcame a number of those to deliver headcount growth, 7% increase in our overall company headcount in 2022, which I think is just a phenomenal figure in the hiring environment we are facing, particularly in the first half of the year. So good momentum then into this year.
And so we were able to deliver a year of earnings per share in excess of our guidance as we started the year, even well above the high end and free cash flow in the range that we started the year with. We're deploying that cash productively already. We generated another $2 billion through a bond offering early in February, a portion of which is to pay down debt due this coming summer, a portion of which is also to provide us additional flexibility throughout the year.
To that end, we engaged in an accelerated share repurchase already of $500 million in February, on track to return over 100% of our free cash flow this year to our shareholders. So we're excited about 2023, certainly, growth acceleration very much underway and strong bottom line and free cash flow performance as a result. We've projected over 20% growth in our free cash flows over the next three years with continued shareholder friendly deployment plans for that cash.
So with that, why don't I hand it over to you, Cai. Happy to jump into questions.
Question-and-Answer Session
Q - Cai Von Rumohr
Thank you very much. So you mentioned you're coming-off of 1.07 book-to-bill that was better than you expected. I think you were looking for about one going into the year. So what are the potential key driver -- bookings drivers we have for this year and could book-to-bill again be over one?
David Keffer
I guess I can't -- for a second straight year to say it's impossible for it to exceed one only to and exceed when all is said and done. That's certainly the pattern we had in 2022. But we see fewer of the multiyear procurements this year that would lead to large unexpected bookings or even projected bookings this year that would, again, have the book-to-bill above one. We think this is a year where timing-wise, across our portfolio, there are fewer of those multiyear buys and as a result, we'll see a book-to-bill slightly below one. That's not though representative of a decline in demand.
To the contrary, there are, like, as I mentioned earlier, parts of our business that are showing really significant growth in demand. And we look at bookings and book-to-bill over a multiyear period because of these kind of timing issues in expansion of our backlog. And it's that three and four year backlog growth that we're continuing to target, again, 1.2 over the last four years, that's a lofty level, but certainly keeping that number well above one is our objective going forward, and we think that will lead to healthy growth.
In this environment, certainly, space as an example, kind of a microcosm of this environment where there's great healthy demand, but it could be a year where even our space business shows book-to-bill below one, because we're in a period now where we're ramping up on some key development programs, preparing for future production on other programs and the large block buys that we've had in multiyear procurements that have resulted in very large awards over the last couple of years are now in an execution phase.
And some of those cases will also have down selects over the next couple of years, and we can talk more about those as we go as well. But it's overall just a timing year where we anticipate to build to be a bit below one, but no dearth of opportunities out there. We're certainly looking across our businesses to have a strong year for growth.
Cai Von Rumohr
So one area that look it has opportunity in defense. I mean you've expected it to be about flat this year. But I have to thank you going to benefit from the Ukraine conflict for ICBS (ph), weapons replenishment. Maybe walk us through some of the opportunities you have in defense on the booking side.
David Keffer
Sure. You've touched on a few of the keys, and I'll elaborate a bit on those. As you're aware, over the last couple of years, we've seen a decline in our Defense Systems sector sales as particularly the more serv-oriented side of that portfolio around sustainment and logistic support for air platforms has come down as some of those platforms have retired the Joint Stars and Global Hawk fleets among them. And some of that modest decline in that portion of the business will continue in '23 before leveling off. But that's offset by growth in some of the areas you mentioned.
IBCS is a portfolio of technologies that integrate previously kind of un-integratable disparate sensor and shooter systems, both for the U.S. We have a large Army program of record there as well as other foreign customers where Poland is certainly the largest early kind of flagship adopter, but there are 10 other countries expressing in-house and some of which are very near term.
You can imagine that the ability for foreign country that's seeing an increased threat environment to connect previously disparate radars and other sensor systems to affect our systems to manage their own battle management and missile defense systems, this is an incredible upgrade in their capability. And so IBCS is a great fit for that over time. And it's a great example of Northrop Grumman software technology leading to better integration of existing platforms and future platforms as well. So IBCS is key to the domestic and international growth opportunity. We will also enter a full rate production phase for the U.S. Army domestic portion of IBCS later this year.
On the weapons side, certainly, the unfortunate events internationally have led to growth in demand, both domestically and internationally for everything from smaller scale munitions up through larger-scale weapons systems where we are both the prime and the key supplier of propulsion technology. And so, we began to see that surge in demand signal at this time last year and talked about the fact that, that was kind of an 18 to 24 month cycle through which you'd see orders and then sales volume resulting particularly on the international side.
And now, as we approach the 12 month point and get closer to those 18 and 24 month milestones, we're starting to see evidence of orders activity again, both as a supplier and the prime and then of the resulting sales growth. You saw some of that even in the fourth quarter, where our Defense Systems business grew at a double-digit rate. A lot of that was in the weapons portion of that business. We're a critical and growing supplier on programs like GMLRS. It can perform as a second source alternative on some of the key programs that the U.S. government is reentering production on. So we're actively involved in some of those discussions.
And then there are large weapons programs where we're a prime as well and showing great promise programs like the stand in attack weapon for the U.S. government. So when you aggregate all of that, there's a healthy uplift in demand in those portions [Technical Difficulty] Right. So we haven't provided multiyear sales guidance much less for an individual sector, but those are the types of seeds of growth that we'll look to sell this year in the weapons business, in both domestically and internationally and on the IBCS side to the degree that we can continue to have particularly international growth opportunity materialize there, those should lead to a good foundation for growth in that business. And we'll see the puts and takes in that business over time, but we're excited about the DS portfolio as a result.
Cai Von Rumohr
Right. So last year you did a good job of winning competitive down select. You mentioned not a whole lot this year, but as we look out to '24, maybe early '25, there are a number of programs that look like we should reach a decision point NGI and NGAD Loyal Wingman. What can you tell us about, what the potential there is and where you feel good or what the ones we should watch for and when?
David Keffer
Sure. You've touched on a couple that, that it's hard to watch for because they'll be in the restricted domain for a while, certainly, as some of the services look at next-generation air platforms that creates opportunity for Northrop Grumman, both as a potential prime and as a supplier of key technologies in that overall domain. But with regard to specifics around program opportunities, there's a limited amount we can address there, but you also touched on a few that we can talk through.
And NGI is in that category, the Next Generation Interceptor, a critical missile defense capability for our country, and we're one of two down selected parties. Later this year, that will reach a preliminary design review phase. We've made great progress and are targeting that PDR for great demonstration of that progress. And obviously, there's continued competition there. But to your point, as we get to the middle of the decade, it looks like we'll know more about the future outlook for NGI.
I'd put the SiAW (ph) program that I mentioned earlier in that same category, multiple down selected parties there on the stand-in attack weapon. But we think the legacy of great execution we have on the AARGM and AARGM-ER programs give us a great offering around the stand-in attack weapon and a great prime opportunity in the weapons business. There are a number of others across government, many of which are in our space business, where they will -- they're going through important demonstrations of capability today and engineering phases today to reach either next phases of production or down selects in the coming years.
I'd also put the Space Development Agency's Tranche 1 wins that we had in '22 in that same category, both for the transport and tracking layers in LEO there. The Tranche 1 volumes are just a small subset of the overall constellations expected over time. And so performing well, delivering on time, on cost to our customers is critical in these Tranche 1 opportunities to earn the right to be an awardee in Tranche 2 and beyond. So those two are on our list of opportunities for growth in the coming years.
Cai Von Rumohr
And so you mentioned the good hiring, but maybe give us an update, supply chain, hiring inflation, what are you seeing?
David Keffer
Sure. That's the trio of macro topics we've been covering in some detail over the last year and with good reason. It's a unique set of circumstances particularly around supply chain inflation factors that we've been addressing as an industry among most other industries over the past year. I think I'd separate the labor market a bit from those in that while we were talking about that as a pressure on us in the first several months of 2022, in particular, our performance in gross and net hiring really improved substantially in the second half of 2022.
And we ended up adding about 6,500 net hires in 2022, about 7% increase in the company's headcount in a year that, across the industry, was known as a very difficult year to just to kind of meet demand much less increase your headcount. And so we're really proud of the work that's going in across our business. And I think a portion of that is macro driven, certainly around the technology side of the market.
There has been some softness in recent months around companies laying-off software developers, systems engineers and other capabilities that are in high demand in Northrop Grumman. But I also think the internal capability is important to talk about the culture, the employer of choice, kind of niche in our market that we look to deliver, I think, is important here, having key capabilities rolled out very publicly in 2022, like, first images from the James Webb Space Telescope for which we were the prime contractor as well as the rollout of the B-21 Raider.
I think these are great examples of ways that our current employee base and new employees alike can kind of coalesce around the criticality of these missions and the uniquenesses of the technologies we're creating. So I think all of that leads to improving labor situation over the last year. that's not the impediment for us now towards growth than it was a year ago.
On the supply chain side, there continue to be disruptions and perturbations in the supply chain. Certainly, we were able to deliver great growth in Q4 year-over-year, in part because of improvements in our timing and volume of deliveries in the supply chain, but I hesitate to draw a trend line there and say, okay, the supply chain challenges are behind us. Certainly, they continue to exist.
And as an industry and certainly as a company, we're looking to continue to mitigate those pressures. And that flows through to the inflation side of the equation as well. Obviously, we're tracking inflation indices just as others are, and we're seeing it in real time in our business. Perhaps there's been some modest improvements in recent months in those indices, but we're still working through the process of pricing inflationary factors into all of our programs and gradually getting that -- the latest set of macroeconomic conditions factored into all of our contracts, and that's a process that we set a year ago would take time.
And so we're making good progress through it certainly every day. I think having half of our business on the cost side and half of it on the fixed price side means there are different impacts on different parts of our business. And even on the fixed price side, only a subset of our fixed price work is multiyear in nature, and the majority of that tax price work is repriced on an annual basis. So we're looking to mitigate cost increases wherever we can, drive efficiencies through our programs, work with our customers to mitigate those impacts program-by-program, case-by-case basis around the company, but it's a key focus for us every day.
Cai Von Rumohr
So you've guided 5% revenue growth this year, and that's up from where you were in October. How should we think about growth accelerating into '24 and '25? You've got B-21, GBSD, Space Ukraine impact kicking in. How should we -- maybe walk us through what we should be looking for?
David Keffer
Sure. We're really pleased with the level of growth we've delivered over the last couple of years. Again, think of it as industry-leading growth. And again, to your point, accelerating from 3% in '22 up to the 4% to 5% level in '23. With that said, it seems every time we accelerate it, we're asked why we can't accelerate it even faster. And there are a number of forces that will affect the final sales growth figures for '24 and '25. Certainly, to your point, the demand for our products, the demand for our capabilities remains very strong.
And so there are opportunities if macro conditions permit to continue to accelerate sales growth over time. We're balancing that in our outlook, and we haven't provided guidance for those years, but we've provided a cash flow outlook for the multiyear period. We're balancing in our outlook for that multiyear view, the clear demand signal we're getting both domestically and internationally, with the macro environment, as we've talked about, around continued disruptions in the supply chain, I think, that will be a process that takes time to work through.
Labor availability, as I mentioned, has improved, and we're optimistic that, that will continue at current levels. But then there are also inflationary pressures to work through as well. And then certainly, in terms of the funding environment, we understand the President's budget will involve defense budget growth for 2024, coming off a strong growth year in defense budgets in 2023, but it remains to be seen exactly when 2024 budgets will be passed and in what construct how long we're dealing with a continuing resolution? Whether there are any last minute dynamics around debt ceiling or overall deficit concerns from one side of the aisle or the other that lead to challenges there. So we're trying to take a balanced view of these opportunities and risks and work that into an overall outlook. Certainly, to your point, the demand signals continue to be strong, and we're working the supply side as well.
Cai Von Rumohr
So let's turn to margins. Your 10-K indicates a possible, but not probable loss on the fixed price B-21 LRIP options. Where are you in negotiating LRIP 1? And given you're underrunning the ICE estimates on which funding is based, what sort of relief do you think you can get?
David Keffer
It's a question we've been asked often over the last couple of weeks, and it's early to gauge the likely outcome here. But I think the big picture is important to have in mind. The B-21 is the contract for which the engineering and manufacturing development phase in which we're executing now and a set of early fixed price low rate initial production options were both awarded in 2015 originally and then subsequently in 2016.
And so the work for these phases was priced many years ago, and it's at a scale that's different from other programs as well. So it's unique in our portfolio and having been priced that long ago and being at a meaningful scale. And that's why through the macroeconomic pressures we've seen over the last couple of years, we determined it was appropriate based on the set of conditions we were looking at in Q4 to note the potential risk there around this initial -- low rate initial production phase of the program given that it is fixed price.
With that said, we're working every day to mitigate those pressures to generate production cost efficiencies, both internally and with our suppliers, work with our customer to address ways to mitigate those macroeconomic impacts as well. But over time, I think the important thing here is that this is a critical capability and that the EMD phase has gone exceptionally well.
You hear the comments from leaders all the way through the secretary of defense himself at the rollout ceremony in December about just how critical and unique this capability is across multiple missions as we look at the threat environment that is to come over the next couple of decades, rolling out this capability and then scaling it up over time is important to our customer set. The way we've generated the capability and the early testing all indicate that it's going to be a strong and important program for a number of years. So we'll work through this initial -- low rate initial production phase as lots begin to be awarded later this year and over the next several years.
Also important to note that over time, not only will we have the expectation of full rate production, which is yet to be priced, but also any modernization work and sustainment work that would typically go along with a program like this. So that's the big picture. Again, we'll be updating folks as we have new information in the coming quarters.
Cai Von Rumohr
It's a fixed price option. So in theory, you don't negotiate on the price. However, to make the point that nobody expected this kind of inflation when you sign the contract and the ICE estimates are above where the funding is. So how does it work? I mean, I assume you go to the government and you say, gosh, we didn't expect inflation muted. How does that -- how do you go about getting relief on something that was out of everyone's control and can you?
David Keffer
I agree these are unique circumstances. And as a result, I don't think there is a playbook for government or industry to manage through situations like this, and we're addressing it in real time. As I mentioned, our focus is really on executing well on the program, performing as efficiently as we can, and then we'll work with the customer to address any impacts that they deem appropriate, but it would be preliminary for me to try to project exactly how those discussions might go. And it is a restricted program, and so there's a limited amount we can say, in general.
But I think, broadly speaking, as an industry, we're working with our customers to address what is a unique macroeconomic environment that we faced over the last couple of years and make sure there are equitable outcomes as a result. And broadly speaking, we have good partnerships with our customers to address in reasonable ways those factors. And they affect every contract differently, whether it's a cost type incentive fee or award fee program, or in this case, fixed-price phase of a program. And it differs in every case, and we'll work through it in this case.
Cai Von Rumohr
Looking at the budget, the fit up, it looks like LRIP is basically five years about $19 billion give or take. So it looks like this would get to about $4 billion a year roughly and got to be a big portion of your aeronautical revenues, say, close to 30%. If the margins are lower, let's say, they're near breakeven, even if they're lack (ph), I mean, it would look like this would be highly dilutive to aeronautical margins. Is there a way you can really offset that to stabilize those margins.
David Keffer
Sure. So a few points I'd make there. One is, we're talking about budget numbers, and those are both multiyear budgets when you talk about a production phase like this. And their government dollars, not just contractor dollars included in the production costs that you're looking at there. And to your earlier point, those are based on government cost estimates and not contractor prices. And so a lot of factors would lead to disconnects and just trying to identify a single budget year and associating that with sales in that year. So I think that's important context.
With that said, lower profitability on the LRIP phase would, of course, be an influence on aeronautics margins and on enterprise margins overall. I think in terms of offsets, within aeronautics, we're going to look to continue to drive really strong performance over the next few years. We've gone through phases of economic disruption on a number of programs over the last couple of years in really across our business, but within aeronautics in particular. And over the next couple of years, we'll look to generate -- continue to generate efficiencies.
The labor market and supply chain should both be in continually improving conditions over the next few years. And so this -- the kind of broader environment should lead to opportunities for more efficiency. Certainly, we're also looking to manage costs as efficiently as we can within aeronautics, but I think it's an example where we have a much larger company than just any one sector. We have four sectors all of generally comparable size.
And at the scale of the overall company, there will be parts of the business at any given time that are facing margin pressure or cash upside or sales growth or contraction. And across the entirety of the company, we see great opportunity to both grow sales and grow earnings and cash flow over the next few years. I talked about the set of conditions on the cash flow side, in particular, that should lead to a healthy environment for growth, not just over the next couple of years, but really into the second half of the decade.
And so to look at any one particular program, I think misses some of the broader point. We'll look to address individual programs and sector challenges and opportunities alike. But I think in aggregate, we're upbeat about the growth profile that we see for the company as a whole.
Cai Von Rumohr
Got it. So one of the things in their Q4 release is that it looks like there's now an indicated uptrend in CAS recovery, which is basically helps your cash flow. But CAS also is basically part of your overhead in terms of calculating sector margins. So what kind of pressure does that put on the sector margins, although, I know all in it’s also [indiscernible].
David Keffer
That's a great question. Interestingly, it's going to be inverse situation to what we faced two years ago, though in smaller numbers this time. A couple of years ago, primarily because of strong asset returns as well as some legislative items. And otherwise, we had a decline in our CAS pension cost recoveries that led to a combination of both lower cash flows and as well as a single year, single quarter catch-up, in particular, on our EACs because of the lower indirect rates. As you mentioned, as we roll out those lower cost projections from pension.
We're now in the opposite scenario where because of a challenging year for asset returns in 2022, our cost projections for CAS pension that we recover from -- through our rates from our government contracts is now projected to increase. And so we'll have a bit of the inverse scenario where cash flows gradually rise from those related to pension over the next couple of years. And conversely, we have an impact on the cumulative catch-up on our EACs in the quarter in which we roll out those higher pension costs. And so that will be early this year.
We talked on our earnings call about rolling those through our rates in the first quarter of the year. And so we had a $100 million pickup through our EACs in the first quarter of 2021. This is a smaller and more gradual impact, but we've told investors to expect something on the order of half of that magnitude in the first quarter of 2023. And as we've noted, economically speaking, it has an impact on margins. But economically speaking, it is accretive to cash flow over the next several years. And really, over the life of the pension plans, all of this balances out. It just becomes a timing issue from year-to-year.
Cai Von Rumohr
So turning to GBSD, you negotiated it later than the B1. I think you negotiated it in 2020, and you didn't have quite the same kind of competitive environment, but you do have five LRIP options. Can you help us understand, are those fixed price and could those represent [Technical Difficulty]
David Keffer
[Technical Difficulty] cost projections for production in the coming years as opposed to the past years. And so we still have an opportunity ahead of us to negotiate those production units and intend to do so with the maximum amount of information available to us and the customer at that time. So a very different scenario in that way from B-21 where they were priced years ago.
Cai Von Rumohr
So on the press side, Kathy mentioned your transition to digital solutions, there's a potential offset to inflation. Like, what sort of impact could it have? And with the acceleration big tech layoffs, are you starting to benefit that you're seeing it's a whole lot easier to get folks to join Northrop?
David Keffer
I'd stop short of saying it's easy to find especially cleared software developers, systems engineers. Certainly, there is a tight and we've made great strides in that department. And certainly, those continue to be challenging areas for the market overall, but we've made a lot of improvements. And I think some of that is driven by layoffs and hiring freezes in the tech community to your point.
In terms of digital transformation, overall, it is a critical process that we're going through in our business today. And we're kind of in the middle innings, if you will, of that process started a few years ago and continues in earnest and will for a few more years. And it's the kind of process you're never completely finished with. But for us, it's around the digitization of everywhere from the design through the development and manufacturing and then sustainment phases of the life cycle of all of our key programs.
And so you can imagine the amount of cost reduction, risk management, risk mitigation, early identification that you get in a digitally enabled program with great underlying data and management of that information and ways of visualizing and conceptualizing that information that didn't exist five, 10, 20 years ago and should enable us to be more efficient also in the way we oversee and manage the business.
So if that sounds like a great opportunity, I think it's because it is, but it doesn't -- it's not easy and it's not overnight. Through the adoption of these tools and processes, there are opportunities for efficiency for us over a period of years, both in the way we bid and execute programs and the way we manage the business overall. So I do think that's an important lever in our ability to manage costs and drive cost efficiencies across the business in a period where we need that efficiency to mitigate inflation to your point.
Cai Von Rumohr
Also talked of your greater vertical integration than peers like you make your own semiconductors. What impact could this have on your ability to offset inflation?
David Keffer
Certainly, we have some unique capabilities in our foundries and our ability to produce some of our own chips. But in the grand scheme of things, it is niche capability that supports certain of our government contracts with certain unique requirements. And it's not the answer to the overall kind of macro chip question around long-term sources of semiconductors.
So I'd stop short of saying it's a game changing internal capability in that way, but I do think it's an exemplary of the uniqueness of the company. We are a technology company, first and foremost, and we have depth in technologies. We're not just a lean kind of integrator of other tools and techniques, but really have depth in our own internal capabilities, and that leads to unique kind of payloads that get adopted in our overall space platforms and air platforms.
Our mission systems technologies are leading edge and lead to great opportunities for growth, both in our Mission Systems business and elsewhere. So having technology depth and understanding, I think, is a real help for some of our [indiscernible] technology application programs, but also for large franchise flywheel programs as well.
Cai Von Rumohr
So I think you've talked revenue should be growing the next several years. You've talked about earnings moving up, but you didn't talk about margins. And if we look at the mix is shifting toward GBSD, cost plus B-21 LRIP looks like it's probably going to be somewhat below average. Is it fair to say that there's less certainty in terms of the trend in margins than there is in earnings and revenues?
David Keffer
Certainly, from a margin rate perspective, we had targeted 12% margin rates at the segment level kind of before the macroeconomic impacts of the last 12 to 24 months became so acute, and so we've had an easing of segment margins over that period along with the rest of the industry. I think now the question is, at what point we'll get back to that kind of trajectory on pace for the 12% target? The underlying business fundamentals are the same. It's just a matter of when we're able to price the broader kind of macroeconomic environment that exists today into our full contract base.
And I think there are indications that the macroeconomic factors are improving now, such that, that will not take too many years, but the pace of that recovery is what we'll guide in many ways, the pace of our margin improvement opportunity. Because you mentioned GBSD will continue as a cost type program for the next several years and B-21 and other factors. But I'd also say, there are a number of other programs that will move from cost type development work into fixed price production with opportunity for margin expansion as a result.
And some of our fixed price work that has been affected by the macroeconomic factors over the last couple of years should provide opportunity for margin stability or even expansion over the next several years. So there's a mix of influences really, in this environment where we see net EAC improvements being lower than usual because of the macroeconomic factors as we work them into our contract pricing across the board. That's the environment we'd expect to see normalize over the next couple of years and lead to that mitigating increased opportunity in our margins. So the pace of that is yet to be determined.
Cai Von Rumohr
All right. So cash flow, you've talked about it doubles by 2025. But clearly, that's off a depressed base and, of the $1.6 billion mid-point cash lift. It looks -- I mean, we just did back at the envelope, it looks like about $1 billion of that comes from what I call non-operating Section 174, CAS, CapEx minus depreciation. So is that remaining $600 million over that three year period? Is that conservative or is that really...
David Keffer
So it's our best estimate as we stand today. It's a couple of hundred million dollars of underlying free cash flow expansion in the business in each of those years. I agree with your broader point, which is some of these kind of unique headwinds over the last couple of years will become tailwinds over the next few years CAS. Pension cost declines and now gradual increases, again, Section 174 R&D tax impacts, which will lead, which have, of course, been a headwind for the industry and will now be a tailwind for the next five years.
I'd put our capital intensity on that list as well. We're in a unique period right now where we're capitalizing this large suite of franchise programs, B-21 GBSD and others on top of all the growth we had in 2022. We looked about programs like the Amazon Kuiper launch support. And so we're in a uniquely high capital intensity period right now. That will ease also by the middle of the decade. And so that leads to underlying growth in the kind of operational and free cash flow trajectory over the next few years. And we've only provided three years of growth outlook.
But when you think about the foundation that creates for the second half of the decade, where you have continued declines in cash taxes around $174 million, continued moderation of capital intensity and these programs moving to production, creating opportunity for strong cash flow streams, it's a healthy environment for continued growth in free cash flow through the rest of the decade.
Cai Von Rumohr
Terrific. I see that we're out of time, but that was great. Thank you very much. Really appreciate it.
David Keffer
Thanks, Cai.
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Northrop Grumman Corp. (NOC) Cowen 44th Annual Aerospace/Defense & Industrials Conference (Transcript)