Aviation Week editors discuss Northrop Grumman’s exit from the U.S. Air Force’s competition to replace the F-22 Raptor and the implications of L3Harris Technologies’ acquisition of Aerojet Rocketdyne.

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Rush Transcript

Jen DiMascio:               Hello and welcome to the Check 6 Podcast, an addition coming to you during the sleepy days of summer. But we're staying wide awake. Last week, Northrop Grumman and L3Harris Technologies provided their quarterly earnings reports and delivered some industry changing news. Northrop Grumman, for example, revealed that it would not be competing for the US Air Force's 6th generation Next Generation Air Dominance Fighter program. And L3Harris Technologies has completed its merger of Aerojet Rocketdyne. I'm Jen DiMascio, the executive editor for Defense & Space, here with Defense Editor Steve Trimble, and Executive Editor for Business, Michael Bruno. And we are here to discuss what these changes might mean. Steve, were you surprised by Northrop's decision to sit out this F-22 replacement competition?

Steve Trimble:              Well, I don't know if surprise is the right word. Just because the entire Next Generation Air Dominance program has been so secret, it makes it difficult to be very prescriptive about what should or should not be happening. But I mean, there have been some mitigating steps along the way that made it sound like one of the three teams that were competing for the NGAD program for the Air Force anyway, originally, that had been whittled down. And that's because, I mean, usually what happens with these competitions is you start with a large number of companies. In this case, there were three that we were aware of specifically. Because the Air Force awarded a contract to three companies to study integrating a next generation adapter propulsion system into a next generation fighter. That happened in August of 2022. So we knew that there were three companies going for the prime role in the Air Force NGAD program.

But usually what happens is that they start there and then they go into a prototype fly off. Just like we saw with YF-22 and the YF-23, a Lockheed and Northrop airplane and the Advanced Tactical Fighter Competition 33 years ago or so. And also as we saw with the Boeing X-32 and the Lockheed X-35, 25 years ago, for what became the Joint Strike Fighter and Lockheed's F-35. Now in this case, Northrop, Lockheed, and Boeing were involved. Now we know that Northrop is out, that leaves the two competitors for the Joint Strike Fighter Competition, still at least putatively involved in Next Generation Air Dominance. That's Lockheed and Boeing. So not necessarily a surprise, but just with everything with NGAD, we are reading tea leaves for the most part.

Jen DiMascio:               So Steve, continuing to read the tea leaves, what does this mean for Northrop?

Steve Trimble:              Well, there's a few points we should consider. So we have to remember, there's actually two NGAD programs. There's the one for the Air Force, one for the Navy. And based on all of our understanding so far, we think that these are two different aircraft. They may have common systems, but they're going to be two different aircraft designs. And on the Air Force one, we know Northrop is no longer competing as the prime contractor. But Kathy Warden, the Northrop CEO specifically said that they are still responding to the other bidders' request for proposal as a supplier. And so that's interesting. But she also said with that, that it would be from their mission systems portfolio. So then you're thinking about sensors, their radars, their electronic warfare systems. And that's interesting because it seems to kind of rule out their role as an airframe structures provider. As they do for the center fuselage for Lockheed for the F-35 and the center fuselage for the Super Hornet for Boeing. Super Hornet and the Growler.

So we know in the Air Force program, they're now going to be a mission system supplier, at least compete for a role as a mission system supplier. But they're not going to be a structured supplier or of course the prime contractor. But they still have other opportunities. And Kathy Warden was explicit about keeping the door open to competing for the Navy version of the Next Generation Air Dominance program. As well as being a player in the collaborative combat aircraft market, which is just starting to develop around the NGAD family of systems, as they call it. These are the uncrewed aircraft that would fly with the crewed next generation fighters, both for the Air Force and the Navy. And so far, Northrop released two different concepts for crewed combat aircraft. They have the SG-1, which is sort of a flying-wing. Looks very similar to what we saw with the X-47 if you go back several years.

And then they also have the Model 437, which is essentially just an uncrewed version of their Model 401 Sierra. Also known as the Son of Aries in sort of popular world. But Northrop actually calls it the Model 401 Sierra. That's their role now in the NGAD program. And it is interesting with the Navy concept because we don't know a whole lot about the Navy concept, but what we have reported... This goes back to I think it was May of 2019, where the one time the Navy opened up about what the requirements were, they told us that it was explicitly that they do not have the same requirement for penetrating stealth as the Air Force. So they don't have the same requirement for a Tailless Supersonic planned form that the Air Force is looking at. They're fine with vertical tails on their aircraft. And it was hard to know exactly how to parse that.

But what that means is that might actually help Northrop in that competition, right? Because one of the hardest things to do has come up with a Tailless Supersonic design that you can control and still be agile. And Northrop's legacy with Subsonic flying-wing aircraft makes that even a harder push for them. Because they haven't done a new fighter since the early 1980s really. So the Navy requirement may fit better with Northrop's technology profile. Although certainly Boeing are also very competent in that area as well. So that'll be the interesting competition now. And it's not clear at all what the Navy's timing is, but it's going to be at least a few years down the road.

Jen DiMascio:               Wow. Well, Michael, this is not the first time that Northrop has chosen to sit out a competition, correct?

Michael Bruno:             Yeah. This is kind of status quo for Northrop Grumman when it comes to how Wall Street views them. And their corporate history, going back to when Wes Bush was chairman and CEO, the predecessor to current CEO, Kathy Warden. The company has a strong history for better for worse, for choosing relatively early in programs whether to continue forward or whether to get out. Whether to cut bait and move on to some other pond to go fishing, or to keep going with the program. And just a couple that come to mind really quick, are T-7, MQ-25. There are a couple of others. On the other hand, they pursued B-21, they pursued GBSD, ground-based strategic deterrence. When they decide that there is a, I think the term is capital franchise. But when there is a major, major program that they think they are both expert at, that they can bring in eventually on time and close to budget, that's always relative terms in defense contracting.

But more importantly, something that they think over the long-term when they get to production rate, they can really hit it out of the park and make money. That's what their corporate DNA drives them to do, is to cut losses early and go for the big prizes and bring them in. And so Steve is much smarter about the whole NGAD and who's a good competitor and how does that play out. I have no clue about that. But again, from a Wall Street perspective, nobody's necessarily surprised when you see a headline that says Northrop has decided not to pursue something. Just a final point on that. One reason they do this compared to others such as Boeing, if you notice that T-7 and MQ-25, those are both programs Boeing has. And Boeing's having a lot of trouble with. And so Northrop's kind of been like the anti-Boeing on the other end of the spectrum. And one of the reasons they do that is Northrop is very, very sensitive to what's called the contract mix in their portfolio.

They've had to spend a whole lot of money on what I'll call R&D. The B-21s, the GBSD, those are the minuteman threes. When you're in R&D, you're spending a lot of money to get the program going. You got to prove the technology, you got to stand up the infrastructure. That's a lot of money going out the door that you don't get a return on quickly. So Northrop's been trying to fight this balance of having enough programs in production past the development stage where they're cashing in. Everybody in the business world knows long rate production is where you make the money. That's where you can really get a return and all the investments upfront. And where you can start squeezing out costs on a yearly basis to generate more and more profit, and increase your operating margin.

So Northrop is really sensitive to trying to keep a balance because if you go into any quarterly teleconference and you listen to the analysts, they're always asking about this contract mix. "Hey Northrop, when you going to make more profit? When are you going to raise your operating margins?" This is how they do it.

Jen DiMascio:               So Northrop in its earnings report also said that the B-21 Bomber program has completed a key test in the run-up to its first flight. What was the test, Steve? And when will it achieve the next milestone that we're all waiting for?

Steve Trimble:              There was the Power on Milestone they said was completed in the second quarter. So we know it happened sometime between March and June. This is when they turn on the electrical systems on the airplane. It may seem mundane, but it's a really big step for a first aircraft of a new type. And it's always a key milestone in the process that leads to a first flight. Now we've been waiting quite a while now for first flight, because the rollout was on December 2nd. I actually went back and counted the number of days between the rollout of the B-2 and the first flight of their B-2, and that was 238 days from November 22nd, 1988 to July 17th, 1989. We have now exceeded that 238 day total before the B-21 development program.

So what does that mean? We do know that the B-21 is moving at a slower development pace than the B-2. Because the other comparison is B-21 program completed critical design review in November, early December of 2018, and they got to roll out four years later. They might get to first flight five years later. That would be by the end of this year. The B-2 program went from critical design review to first flight in three years and eight months. And even that was 18 months behind the original schedule for the program. So clearly B-21, up to this point, is moving at a slower pace than the B-2. That doesn't mean that it's going to continue moving at a slow pace. One of the things the Air Force has argued is that they're taking a bit more time before first flight to make sure that the program is solid, and they've got the major engineering and technical challenges figured out. So that when they can flight test, it's a very smooth process. And it sort of flows right into production without any major delays or cost overruns, or anything like that.

So this could still be good news for the program, but it's something that we're watching. It's just that the pace has gone a bit slower than we expected it to go, especially because it came from the Rapid Capabilities Office.

Jen DiMascio:               Interesting. Well, we've been talking a lot about the biggest defense companies in the US and the world, Northrop. We've talked a little bit about Lockheed and Boeing. But L3Harris has been aiming to be the sixth prime contractor in the US and it has just completed its acquisition of Aerojet Rocketdyne. Michael, does this merger provide L3Harris with that distinction that it's CEO, Chris Kubasik has so coveted?

Michael Bruno:             It definitely lends more credibility to his argument. And it gets, I think, L3Harris Technologies reasonably in the realm of being called the Sixth Defense Prime and people not really snickering at that. Not that people were laughing at Chris Kubasik. But the question of how you were going to get there, we always knew in order for L3Harris to get that big, they were going to have to keep acquiring and get a lot bigger. And for a very long time after L3 Technologies and Harris Core came together, they were very much in the divestiture mood. They were cutting off parts of the business that were low margin. These were parts of the business that weren't making a lot of money. And the leaders of L3 and Harris had to raise money in order to pay for the merger costs. So you fast-forward and you're wondering, "What are they going to go buy in order to be a very large defense prime?"

And now we know it's something like Aerojet Rocketdyne. And what is so different is that the roots of L3 and Harris were very much on the defense electronics side. These are what we would call a light footprint type of defense niches. It's not like where you own a big foundry or a manufacturing site, you're not building huge aircraft or missiles or whatever. But now L3Harris is. It is providing a massive amount of hardware to the Pentagon and NASA through its acquisition of Aerojet Rocketdyne, and really does make it a big player one way or another. Just to put this into perspective one more way, Aerojet Rocketdyne was the last large independent provider of missile and rocket propulsion in the United States defense industry. And you could very much say very much one of the last ones in the western world. And so for it to be swallowed up by somebody, would automatically make that somebody so much bigger.

Jen DiMascio:               You talked a little bit about where L3 and Aerojet would be the prime that's sort of on those electronic programs, right?

Michael Bruno:             Yeah, you do definitely see a desire by any mid-size defense company to get into the upper realm of being a large defense prime. And they do it for market reasons. They do it for good business reasons. When you are the prime, you become the immediate company getting paid by the Pentagon or NASA. You get to control the costs underneath you. So you can determine what the supply chain is going to look like and where you're going to optimize. Where you're going to make margin, additive profit on top of whatever the supply chain costs before you deliver it to the end customer. When you're inside the supply chain like Aerojet Rocketdyne always was, they were a provider mostly to some other large program. They're getting told what costs and expectations are going to be. They are prime on many programs, don't get me wrong. Prime just means that you're directly selling to the Pentagon or NASA. But you want to be a large prime because when you're a large prime, you get to start setting the economic terms of the contracts.

And this makes a lot of sense. All the major companies we talk about now that are the five or six major primes, most of them have roots in being much smaller companies. And over time they built up and acquired to take on that heft. Part and parcel to that is the Pentagon's wariness with allowing companies to become so big that they get to decide what the terms are that the taxpayers have to spend when the Pentagon or NASA comes along and says, "We want a project. We want to go to the moon. Or we want a new aircraft." The taxpayers want to be the one in charge in the end of that, of course is set through Congress and the defense acquisition officials. And so when a company gets so big, like Lockheed is the top large defense prime by annual sales, and they made a play to try to buy Aerojet Rocketdyne couple of years ago. And that got shut down by antitrust regulators.

And there was a lot of talk at the time because the Biden Administration was new in office, about whether this was Biden making a stamp about, "I'm going to stop consolidation in the defense industry." Well, I mean, when you go back and you look at that antitrust complaint that was raised against Lockheed, and Aerojet. It was a very standard, a very traditional, very historic antitrust complaint where there would've been too much vertical integration within Lockheed. Which is the major customer, maybe the single largest customer for Aerojet. I could be wrong on that, but I know they were one of the biggest. That's different from L3Harris, which was not a customer of Aerojet. So you're not quite seeing that vertical integration and those concerns come up. So this is one way for Aerojet to survive and thrive, and it's a way for L3Harris to become a large defense prime.

Jen DiMascio:               What are the risks or the potential rewards for L3Harris in bringing in Aerojet?

Michael Bruno:             Huge risk and huge reward. That's how it works in the business world, is you basically can't have one without the other. So I'll start with the rewards first, the good news. The good news is if they pull this off, they really are the sixth large defense prime. They are a key long-term, and I mean decades. Generations. They are a key provider to NASA and the Pentagon in a century that is becoming defined by the peer competition, not near peer anymore. It's a peer competition between China and the United States. The West and the East, led by China. Which China now includes Russia within its orbit. That's something Steve can probably talk a lot smarter than I can about. But the fact being is that L3 is making a strategic move, and that's how Chris Kubasik sold this all along. He had shareholders who were really, really apprehensive about him spending $4.7 billion to go buy Aerojet Rocketdyne.

They certainly would've rather seen that as returns to shareholders. Checks that come in the mail for owning the stock. But he convinced most of them on... In fact, he convinced almost all of them, I think, basically that this was a way to guarantee the company would not only survive but thrive in the coming century. And that's a great, great play. If it turns out, now here's the if. The if is, anytime companies come together, it's a risk to integrate. Anytime large companies come together, it's a huge risk to integrate. The integration is everything from cost-cutting. Where do you save a few dollars, but you don't shoot yourself in the foot and stop yourself from being able to provide either contracts, or to go out and get new ones? And then there's just the intangibles, like cultural integration. How do you get two companies...? Which companies all the time like to say that they're very culturally aligned. But the fact is companies are different, different personalities like different people.

And when you try to bring them in together 2, 3, 5 years down the line, and you're trying to be a functional business. And you're still like saying, "Oh, those Aerojet guys over there, or those L3 women over here. And they just do things a little differently and they can't quite see how we do it." It's not something that L3 and Aerojet are going to be confronted with that is any different from what any other large company goes through. And many large companies have seen the entire value of their acquisition, of their proposed merger, basically get erased because they couldn't integrate and they couldn't make it work in the end. So integration remains to be seen. It's a huge, huge risk, but if they pull it off, it's a large reward.

Jen DiMascio:               Well, unfortunately, that's all we have time for today. Don't miss a single episode by subscribing to Check 6 in your podcast app of choice. One last request. If you're listening to us in Apple Podcasts and want to support us, please leave us a five star rating and good review. Thanks a lot for listening. Bye-bye.