Northrop Grumman Q4 2021 Earnings Call Transcript

Quartr
Provided by Quartr
January 27, 2022

There are 14 speakers on the call.

Operator

Good day, ladies and gentlemen, and welcome to Northrop Grumman's 4th Quarter Year End 2021 Conference Call. Today's call is being recorded. My name is Natalia, 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.

Operator

Todd Ernst, Treasurer and Vice President, Investor Relations. Mr. Ernst, please proceed.

Speaker 1

Thank you, Natalia, and good morning, everyone, and welcome to Northrop Grumman's Q4 2021 conference call. We'll refer this morning to a PowerPoint presentation that is posted on our IR webpage. But before we start, I'd just like To go through a couple of comments here, the matters discussed on today's call, including 2022 guidance and beyond, including our outlooks, reflect the company's judgment based on information available at the time of this call. They constitute forward looking statements pursuant to Safe Harbor and provisions of federal securities laws. Forward looking statements involve risks and uncertainties, which are noted in today's press release and our SEC filings.

Speaker 1

These risks and uncertainties may cause actual company results to differ materially. Today's call will include non GAAP financial measures that are reconciled to our GAAP results in our earnings release. And on today's call are Kathy Warden, our Chairman, CEO and President and Dave Keffer, our CFO. At this time, I'd like to turn the call over to Kathy. Kathy?

Speaker 2

Thank you, Todd. Good morning, everyone, and thank you for joining us. We delivered another year of solid operating performance in 2021 and positioned our business for continued growth in 2022. We are executing our strategy, which is to grow the business today and into the future, maintain excellent performance and reduce costs to deliver strong margin rate and deploy our capital to create value. We made significant progress in executing this strategy again in 2021.

Speaker 2

Our organic sales growth for the year was 3%. Our segment operating margin was strong 11.8 percent, which increased 40 basis points compared to 2020 with performance more than offsetting mixed and COVID related headwinds. We grew our transaction adjusted EPS by 8% and generated a 3.1 1,000,000,000 of transaction adjusted free cash flow. Regarding capital deployment, we returned a record $4,700,000,000 to shareholders through dividends and share repurchases, including a $500,000,000 accelerated share repurchase that we announced in November of 2021. We strengthened our balance sheet, retiring over $2,200,000,000 of debt during the year and achieving an increased credit rating in the process.

Speaker 2

And we continue to invest in our business with over $1,400,000,000 in capital expenditures to create new technologies and support franchise programs. We also continue to add to our portfolio of franchise programs with competitive wins on programs like the Integrated Battle Command System or IVCS as well as hypersonic and ballistic tracking space sensor and Next Generation Interceptor. As we look forward to 'twenty two and beyond, we expect our organic growth will continue as we win new business and convert the robust backlog we've built over the past several years into sales growth. And while we'll know more about the President's budget request in the coming weeks, we continue to believe that our portfolio is strongly aligned with the threat environment and the key investment priorities of our customers. Further, we expect strong margin performance as well as double digit free cash flow growth from 2022 through 2024.

Speaker 2

2022 guidance reflects our confidence in our strategy, our broad portfolio and our ability to deliver continued growth and strong performance. As reported, the COVID pandemic We have felt these effects and the challenges of both our supply chain and our own labor availability. We will continue to take proactive steps to address such COVID risks, both to our employees and our business. And looking forward, our current guidance reflect the factors we know today and our best estimates for the remainder of the year. Dave is going to provide more details on the quarter, the full year and our guidance in just a few minutes.

Speaker 2

But turning now to the budget environment, the federal government Two appropriations bills are continuing and we remain optimistic that Congress will reach an agreement by the end of the first quarter. The National Defense Authorization Act contained a $25,000,000,000 increase to the defense budget that represents 5% growth compared to fiscal year 2021, which we expect to also be supported in the appropriations bill. In the NDAA, there is continued support for our major programs and several of our programs received incremental funding above the President's budget request, including Triton, E-2D, F-thirty 5, F-eighteen and Gator among others. And finally, we expect the FY 'twenty three President budget to be delivered to Congress in March of this year, reflecting this administration's priorities in areas such as Mission Systems, Space, Missile Defense, Advanced Weapons and Deterrence. Focusing now on highlights in the quarter, one of our proudest moments was the launch of the Webb Space Telescope on December 25.

Speaker 2

Northrop Grumman is the prime contractor for NASA on Webb and we're honored to have partnered with NASA to provide the world with its revolutionary technology. Webb will peer more than 13,500,000,000 years into the past when the first stars and galaxies were formed, ushering in an exciting new era of space observation and expanding our understanding of the universe. In addition to Webb, we're also supporting NASA's Artemis mission by producing the largest solid rocket motors ever built for the Space Launch Vehicle System, which is being developed to send the first woman and next man to the moon. In the Q4, the space sector received a $3,200,000,000 award to support Artemis Missions 4 through 8. Another important milestone in the quarter was the competitively awarded IBCS in our Defense Systems sector.

Speaker 2

This program is a centerpiece of the U. S. Army's modernization strategy for air and missile defense and all domain command and control. It's a prime example of our capabilities to integrate assets in the battle space regardless of source, service or domain. This is one of many examples of how we are helping our customers share data between systems and improve command and control in support of their JADC2 vision.

Speaker 2

In the area of missile defense, we had several milestones in the quarter, which position us to help our customers track and defend against hypersonic and ballistic missile threats. In the 4th quarter, We announced that HBTSF had passed its critical design review. These satellites are planned to be part of a multilayered network of spacecraft that will detect and track hypersonic missiles. Also in the quarter, we were selected by the Missile Defense Agency to design a glide phase interceptor for regional hypersonic missile defense. In our Mission Systems sector, we continue to see our customers development of capabilities that will increase the effectiveness and survivability of legacy systems as well as new technologies for next generation systems.

Speaker 2

In the Q4, MS received an accelerated award for F-sixteen Savers for approximately $200,000,000 and full year awards of approximately $700,000,000 We have now received total contract awards for nearly 1,000 radars for this program in support of the U. S. Air Force and National Guard as well as several international customers. In addition, Our Network Information Systems business area within Mission Systems received approximately $1,000,000,000 in award for Advanced Processing Solutions. This portfolio delivers strategic microelectronics focused on high performance computing and security, which helps our customers with connectivity and processing solutions.

Speaker 2

We anticipate additional awards in this segment of the portfolio for the next few years, and we expect it will be a significant growth driver for MS in 2022. Finally, in Aeronautics, The military aircraft market is undergoing a transition as our customers focus their investment in next generation program while divesting some legacy platforms. As we've discussed, certain programs in our portfolio at Aeronautics Systems are maturing and experiencing headwinds. There are also a number of exciting new opportunities that are emerging. This includes next generation manned aircraft as well as new unmanned opportunities, which U.

Speaker 2

S. Air Force Secretary Kendall recently announced. In addition to pursuing these longer term opportunities, is our strategy for sustainability. We strongly believe that our environmental, social and governance programs play an important role in sustainable, profitable growth and in long term value creation for our shareholders, customers and employees. Northrop Grumman is a leader in conservation activity with a 44% reduction in greenhouse gas emissions since 2010.

Speaker 2

In the Q4, S and P released its Global Corporate Sustainability Assessment scores and we ranked in the 96 percentile. We were included on the Dow Jones Sustainability Index North America for the 6th consecutive year, and we were included in the Dow Jones Sustainability World Index for the first time. Our ESG strategy also includes portfolio management actions. As we've discussed on earnings calls last year, we committed to transition out of the small aging and surveillance contract that we have for cluster munitions and that contract is complete. And while we continue to be an ammunition supplier as both a prime and a merchant supplier, we have made the decision to transition our prime role in depleted uranium ammunition to another provider following one final single production year contract.

Speaker 2

We are currently working to establish our next set of sustainability goals and priorities, specifically as they relate to greenhouse gas emissions, water conservation and solid waste diversion with a stronger emphasis on renewable energy. Overall, We're making substantial progress in our ESG journey and we look forward to sharing more in our upcoming sustainability and TCFD reports. So with that, I'll turn it over to Dave to provide more detail on our sector results and guidance and then I have a few additional comments before we move on

Speaker 3

Okay. Thanks, Kathy, and good morning, everyone. 2021 was another strong year of performance for the company. Before going through the details of our results and guidance, I'd like to note a few items to keep in mind when comparing Q4 to the same period last year. As we previewed in prior quarters, the divested IT Services business, the equipment sale at AS and 4 more working days in Q4 2020 represented over $1,600,000,000 of sales when compared to Q4 2021.

Speaker 3

With that said, sales per working day in 2021 were at their highest level in Q4. Moving to sector results, we continued to see certain COVID related effects Turning to Defense Systems, sales declined in Q4 2021 primarily due to the IT Services divestiture. Organic sales were down 9% in Q4 and 4% for the full year, driven by the completion of our contract at the Lake City ammunition plant, which generated almost $400,000,000 of sales in 2020. Mission Systems organic sales were down 3% in the 4th quarter, primarily due to the reduction in working days and up 6% for the full year. Higher 2021 sales were driven by increased volume on GATOR, GBSD, SABRE, J Crew and restricted programs among others.

Speaker 3

And lastly, Space Systems Q4 and full year organic sales rose by 6% and 24% respectively. We continued to ramp significantly on franchise programs, including a $1,100,000,000 increase on GBSD in 2021. Growth was also driven by restricted space programs as well as NGI and Artemis. Moving to segment operating income and margin rate, AS operating margin rate decreased to 8.4% in the quarter and 9.7% for the full year due to the unfavorable EAC adjustment on F-thirty 5. In our other three sectors, Segment operating margin rates met or exceeded the high ends of our prior 2021 guidance ranges.

Speaker 3

Defense Systems operating margin rate increased 90 basis points to 12.1% in the quarter and 80 basis points to 12% for the full year. Higher operating margin rate was largely due to improved performance as well as recent contract completions. At Mission Systems, operating income and rate grew in both periods. As a result of higher EAC adjustments and business mix changes, Operating margin rate grew to 15.9% in the 4th quarter and 15.6% for the full year. In the Space Systems, operating margin rate was 9.6% in the quarter and 10.6% for the full year.

Speaker 3

Favorable EAC adjustments from strong performance on commercial space programs helped offset mix pressures for the year. And keep in mind that space along with AS and MS benefited from the pension related overhead benefits that we recognized in the Q1 of 2021. At the total company level, segment operating margin rate in the 4th quarter was the same as Q4 2020 even with the F-thirty five charge in 2021 and it increased 40 basis points for the full year to 11.8%. Turning to EPS, our transaction adjusted EPS declined 9% from Q4 2020 to Q4 2021, primarily due to lower sales volume from the factors I described earlier. For the full year EPS, we exceeded the High end of the EPS guidance range we provided in October.

Speaker 3

Transaction adjusted EPS grew 8% in 2021 due to strong segment Performance and lower corporate unallocated costs. Lower corporate unallocated was driven by 2 items we've discussed in prior quarters, The $60,000,000 benefit from an insurance settlement related to the former Orbital ATK business and lower state taxes. Regarding our pension plans, asset performance was strong again in 2021 at nearly 11%, The 3rd year in a row of double digit asset returns. Our FAS discount rate increased 30 basis points to 2.98%. These factors resulted in a mark to market benefit of roughly $2,400,000,000 in 2021.

Speaker 3

In addition, our net pension funding status has improved by over $3,000,000,000 and on a PBO basis is now over 93% funded. We continue to project minimal cash pension contributions over the next several years. Also summarized are our pension cost estimates for the years 2022 through 2024. CAS recoveries are projected Continued declining over the planning period. And while this causes an EPS headwind, particularly in 2022, It makes our rates more competitive and our products more affordable.

Speaker 3

Our CAS prepayment credit is approximately $1,700,000,000 as of January 1 this year. Now turning to cash, we generated nearly $3,600,000,000 of operating cash flow and $3,100,000,000 of transaction adjusted free cash flow in 2021, in line with our expectations. In the Q4, we made our final federal and state tax payments associated with the IT Services divestiture of almost $200,000,000 We also made our first payment of roughly $200,000,000 of deferred payroll taxes from the CARES Act legislation. The remaining payment of the same amount will occur this December. Looking ahead to 2022, Our sector guidance is shown on Slide 9.

Speaker 3

This outlook assumes that appropriation bills are passed by the end of Q1, and it assumes a relatively consistent level of impact from the effects of COVID that we experienced in 2021. At Aeronautics, We expect sales in the mid to high $10,000,000,000 range. As we noted last quarter, we're projecting headwinds in our Haile portfolio as well as lower sales on JSTAR's F-eighteen in our restricted business. Sales on F-thirty five are expected to be slightly higher in 2021 due to the EAC adjustment we booked in Q4. We expect an AS margin rate of approximately 10%, which is up 30 basis points year over year.

Speaker 3

For Defense Systems, we expect sales to be in the high $5,000,000,000 range As this business returns to modest organic growth following the IT Services divestiture and the completion of our Lake City contract. Operating margin rate is expected to remain very strong in the high 11% range. Mission Systems sales are projected to be in the mid-ten $1,000,000,000 range, up from $10,100,000,000 of organic sales in 2021, reflecting Continued strength in demand for our products. Operating margin rate is expected in the low 15% range. Space Systems is expected to remain our fastest growing business and to become our largest segment in 2022.

Speaker 3

Sales are projected in the mid $11,000,000,000 range, up from up about $1,000,000,000 from 2021 with a margin rate in the low 10% range. Turning to slide 10, our total revenue guidance is $36,200,000,000 to $36,600,000,000 representing a range of 2% to 3% organic growth, consistent with the rate we estimated in October 2021. This growth is enabled by our strong backlog, which stands at over $76,000,000,000 and covers more than 2 years of annual sales. The 2021 book to bill of 0.9x was lower than our prior expectation due to the ASF-thirty five award shift to 2022. More importantly, our 3 year trailing average book to bill is 1.22 and remains the foundation of our current and future growth.

Speaker 3

As COVID related headwinds that we experienced late in 2021 continue into early 2022, we anticipate that Q1 2022 sales will be less than 25% of the full year. We have increased the segment operating margin rate outlook that we provided in October as we now expect a rate roughly consistent with 2021 in the range of 11.7% to 11.9%. This projection reflects our continued disciplined approach to cost management and our efforts to offset mix headwinds with strong program performance. Altogether, we expect transaction adjusted earnings per share to be between $24.50 $25.10 based on approximately 155,000,000 weighted shares outstanding. As shown on Slide 11, this includes roughly $2 of year to year EPS headwinds from lower net pension benefits driven by the reduction in CAS recoveries and higher corporate unallocated expense due to the one time benefits in 2021.

Speaker 3

Earnings volume from sales growth, strong operating margin performance and the lower share count will help to offset those non operational items. We project 2022 transaction adjusted free cash flow of $2,500,000,000 to $2,800,000,000 Assuming the R and D tax amortization law is deferred or repealed, we continue to project about $1,000,000,000 of higher cash taxes should current tax law remain in effect. As I mentioned, our cash tax outlook includes the final payroll tax payment from the CARES Act of approximately $200,000,000 CapEx is expected to remain roughly consistent with 2021 on an absolute dollar basis and slightly lower as a percentage of sales. Slide 12 provides our longer term outlook on cash. The midpoint of our 2022 transaction adjusted free cash flow guidance is $2,650,000,000 and includes roughly $375,000,000 of lower CAS recoveries than 2021.

Speaker 3

From there, we expect a double digit free cash flow CAGR through 2024 driven by operational performance, lower CapEx and the absence of the payroll tax headwind. Our base case again assumes deferral of the R and D tax for all periods. Speaking of taxes, for mark to market pension effects. Also, we anticipate the resolution of an appeals process for certain open years of legacy OATK tax filings in 2022. Audit and appeals processes are underway, but in earlier stages for certain Northrop tax years.

Speaker 3

We refer you to our 10 ks for additional details on the key items, both timing related and permanent in nature to be resolved in those processes. In closing, we're proud of our 2021 performance and we're focused on continuing to execute well on our business and financial strategy in 2022. With that, I'll turn the call back over to you, Kathy.

Speaker 2

Thanks, Dave. In summary, we have strong franchise programs that are well aligned to budget priorities. We are focused on capturing and investing in new growth opportunities, while also executing to drive earnings and cash flow growth. We delivered a solid set of results in 2021 and we are well positioned to continue growing and performing in 2022 and beyond. Our top priority for cash deployment remains shareholder return, including a competitive dividend and share With that in mind, our Board of Directors recently approved an increase in our share repurchase authorization of $2,000,000,000 And based on our outlook today, we plan on returning at least $1,500,000,000 to shareholders via share repurchase in 2022.

Speaker 2

Before turning to your questions, I'd like to thank the Northrop Grumman team for delivering solid operational results with dedication and perseverance. We have extraordinary talent and this includes our leadership team. As we announced in November, Blake Larson is retiring after a 40 year career with Northrop Grumman and its heritage companies. Blake has helped to position our space business for incredible growth and as important, a focus on performance and quality. We are grateful for his contributions to our company and our country.

Speaker 2

And I'd also like to welcome Tom Wilson to my leadership team as he Tom brings strong experience in the space market. He was part of the space team and I'm confident in his ability to lead this business. So with that, we'll go ahead and open the call up for questions. Natalia, back to you.

Operator

Your first question is from the line of Christine Liwag with Morgan Stanley.

Speaker 2

Thanks. Kathy,

Speaker 4

can you elaborate more on the labor and supply chain issues experienced in the quarter at Aeronautics? Are these the same issues like last year? How long do you expect these issues to persist?

Speaker 2

Yes. Thank you, Christine. They are similar issues to what we flagged as well as what we're seeing in our suppliers. And when I talk about labor availability, that's really with the delta variant In the late part of Q3, early part of Q4 and then Omicron again in the late part of Q4 and now early part of 2020 2, we see higher levels of absenteeism. Employee safety is our first priority.

Speaker 2

We encourage people to be out of work if they're experiencing And it has an impact particularly in our high rate, high volume production lines where people are in closer proximity and Where whole work sales might be impacted if we have one person sick or out. And so that's why you see it more pronounced in our aeronautics Because that's where we have really only one high rate, high volume production program, the F-thirty five. And we've talked specifically about the about the impact to that program. Across the rest of the business, it's not that we aren't experiencing these same conditions, but we're able to mitigate them better And you see less of a pronounced impact in any one period. But certainly, we would have expected to see A stronger 4th quarter top line had we not experienced those 2 surges.

Speaker 4

Great. That's very helpful color. And also you outlined what sounds like a fairly comprehensive ESG strategy. When you look at your portfolio, are there other areas where you

Speaker 2

Our portfolio and access assessed with that exposure is. I do want to be clear, we are a defense contractor. And so we are supporting global security mission largely in areas of deterrents, but Also inclusive of weapon systems and we expect to continue in those businesses because we believe they actually promote global security, Human rights proliferation, not the contrary. But with that said, we have evaluated some portions of our portfolio that I've talked about in the past like cluster And today, making the confirmation that we plan to exit depleted uranium ammo as parts of the portfolio That we no longer wanted to support directly.

Operator

Your next question is from the line of Seth Seifman with JPMorgan.

Speaker 5

Thanks very much and good morning. I wonder if You could talk a little bit about where Aeronautics goes from here and how much The headwinds that are coming in 2022 persist into the out years. And then, at the risk of asking about a classified program, When we think further out towards the middle of the decade and beyond, if every place that you're a prime contractor gets up Kind of the expected full rates of production in very rough and Qualitative terms, what that means in terms of the aeronautics top line several years down the line?

Speaker 2

Thanks, Seth. So I'll start and then ask Dave to provide a little more color and specificity. I see our aeronautics sector as having headwinds this year that will dissipate going into 2023. So we don't expect Same levels of decline as we move into next year. And then that trend reversing in the 2024 timeframe.

Speaker 2

And I won't point to any particular program, but it is at that point in time that we expect Some of the headwinds that we've discussed to be largely behind us and the opportunities for growth in higher volume of production And aeronautics to start to kick in. And so that would have both an upward trajectory for Top line, but we also see their margin rate progressively improving over that period as well. So that gives you the macro view. Dave, anything you'd like

Speaker 3

I think you covered it well, Kathy. I think our 'twenty two outlook is consistent both in the mid single digit decline and the sources of that With what we talked about in recent calls, as you pointed out we expect 23 to be more stable and have growth opportunities beyond that. The other thing I'd point out is we're very focused on managing the business well in the meantime, cost management, Managing our capital expenditures and so we're focused on execution and delivery every day in that business and looking to optimize that outlook.

Speaker 5

Okay, great. I'll stick to one this morning. Thanks very much.

Speaker 2

Thanks, Seth.

Operator

Your next question is from the line of Sheila Kahyaoglu with Jefferies.

Speaker 6

Hey, good morning everyone and thank you. Kathy, thanks for the aeronautics color. I was wondering if we maybe we could transition to space and if you could bridge us on the growth for space. It seemed like GBSD was maybe more additive In 2021 than prior expectations, so how do we think about that growth cadence and how do we think about the balance of growth across the other space portfolio?

Speaker 2

So GBSD has been a significant component of space business growth in the last two years, And we expect that to start to level out, but JVSC to continue to be a growth element in space for the foreseeable But with that said, you're right to point out that there was significant growth in the rest of the space portfolio as well, balancing about fifty-fifty with GBSD and contributing last year and we expect that same trend to continue This year with the $1,000,000,000 or so of sales growth that we're projecting in space. And that really is broad based growth. It's coming from All areas of the business, so propulsion, satellites as well as components, it's coming from both restricted and classified work as Well, it's unclassified work and it's coming from a variety of customers, the new Space Force, the U. S. Air Force, as well as NASA as I highlighted today.

Speaker 2

So we really are seeing space growth be quite balanced even in 2023 or 2022, but even more so as we look forward to 2023 and we expect it to continue to be 1 of, if not the fastest growing sector for the foreseeable future.

Speaker 6

Great. Thank

Operator

you. Your next question is from the line of Ron Epstein with Bank of America.

Speaker 7

Yes. Good morning. Kathy, I was wondering if you could speak to you've seen some of the your Hale portfolio Assets, maybe some of the legacy stuff start to fade away. Are there opportunities to replace that? What's out there in that world?

Speaker 7

It's hard to believe that asset class is just going to go away. So if you could speak to other opportunities for Northrop Grumman to replace those assets in the future?

Speaker 2

Yes, Ron. And thanks for that question because we've talked a good bit about the headwinds in our Hill portfolio and that's And then the Global Hawk phasing out, but the reality is autonomous systems are still an important part of both the U. S. Air Force and U. S.

Speaker 2

Navy strategies going forward as well as an important asset in the portfolio for our international customers. So we see that market is continuing to evolve. With some specificity to your question, I mentioned earlier in this call that the U. S. Air Force Secretary Kendall has recently been more specific about launching some new efforts in unmanned systems within the Air Force.

Speaker 2

And we do see those as opportunities that we will pursue. So there is starting to be some more meat on the bones as to what those specific We do see the market as continuing to be attractive.

Speaker 7

Great. Thank you.

Operator

Your next question is from the line of Doug Harned with Bernstein.

Speaker 8

Thank you. Good morning. You gave guidance today for cash, free cash flow in 2022, 2023, 2024. And I guess cash, I mean, I understand you can project some things around pension, but cash is really the most volatile quantity here. And Can you give us a sense of what type of sales and earnings profile actually drives those numbers in 2023 2024?

Speaker 3

Doug, it's Dave. I'm happy to dig into that. I appreciate the question. I think you'll find today's outlook is consistent again with what we It's projected at a higher level on our October call. I think it's important to provide some context when we talk about our Free cash flow outlook over these next few years, our CAS pension reimbursements were over $800,000,000 just 2 years ago in 2020 And we were projecting them to reach $1,000,000,000 by this point in 2022.

Speaker 3

After new legislation and a couple of years of fantastic asset returns that CAS reimbursement is now really just a de minimis benefit to us along with much improved funded status on the pension side and that's the primary driver of the Over the last couple of years, but what that does for us is create a great foundation for us in 2022 to build off of and grow More rapidly over the next few years and that supports that 10 plus percent CAGR we've been talking about. So 2021 free cash flow was around 3,100,000,000 As we talked about CAS reimbursement is down almost $400,000,000 in 'twenty two from 'twenty one. The working capital assumption over the next year is Roughly unchanged, similar in 'twenty three before creating more opportunity in 'twenty four and beyond. We talked a bit about the payroll tax deferral that ends with a payment in late 2022, so that too creates a tailwind as we enter 2023 and 24. And the other is around lower CapEx as we get into particularly 'twenty four and beyond.

Speaker 3

So That combined with the working capital opportunities we see from performance based payment timing and incentive timing really make us optimistic about that really strong CAGR over the next Couple of years. And of course the corollary there is that puts us in a nice position to be able to return a healthy volume of cash to our shareholders. And we've noted on this call and others that That remains our top priority for cash deployment over the next couple of years with $1,500,000,000 as our repo target in 2022 for example. So while I wouldn't read too carefully into a specific sales or margin target in these out years Related to cash, we'll get more into that guidance as we get closer to those years. Certainly, we'll look to continue to grow the company and deliver strong performance along the way.

Speaker 8

Okay. Go ahead.

Speaker 2

Sorry. I guess part of what you are asking is what is our outlook. And while we're not going to provide specific numbers, as Dave said, I'll point you to some of the comments that I made. We expect continued top line growth in this business beyond 2022 and we expect earnings expansion. And so those are factored in both to our 2023 2024 expectations for cash.

Speaker 2

You can draw some conclusions that we see an accelerated growth profile going from 23 into 2024 on earnings and that would be a fair assumption to make as well based on what we've outlined for you.

Speaker 9

And then just as

Speaker 8

a follow-up, one piece of this. If I go back a few years, missiles was one of the hottest areas in the budget. And I know we had this discussion around really Northrop Grumman working to become a 3rd missile supplier. But over that time period, We've seen essentially missile budgets turnover and legacy certainly a lot of the large legacy programs Demand is considerably less. You've got some important programs now in missiles development But how do you see that market?

Speaker 8

Is this still the same kind of opportunity you were looking at a few years ago?

Speaker 2

Doug, when we were looking at this a few years ago, I would say our expectations were balanced between Space And missiles and what we've seen is space has outperformed our expectations. Missiles has been More in line to date with expectations, maybe not as much opportunity as we project Into the out years, the space is more than offsetting that and we feel we've gotten a return on investment. I will say that we continue to be a strong merchant supplier in the missile space. And so as that market We do expect it will particularly in hypersonic. We are partnered with the larger weapon Providers to provide them important components of those weapon systems.

Speaker 2

And so we by no means Believe that our return on investment is not maturing in the weapon space. It's just maturing more quickly and more significantly in space.

Speaker 8

Okay, great. Thank you.

Operator

Your next question is from the line of Robert Stallard with Vertical Research.

Speaker 10

Thanks so much. Good morning.

Speaker 2

Good morning.

Speaker 10

I'd like to follow-up on Doug's question really and Slide 12, and you've got that projected large pickup in free cash flow in 2024. I was wondering if you could maybe qualitatively walk through what

Speaker 3

Sure. Happy to. Like I mentioned, The 10 plus percent CAGR over the next couple of years really shows up particularly strongly in that 2024 timeline and it's for a couple of the reasons that we've described. I'll go into a bit more detail on those. One is around our expectation of lower CapEx in 20 We've talked about that coming down gradually as a percentage of sales and we start to see that in our 'twenty two and 'twenty three guidance.

Speaker 3

As we get to 'twenty four, we expect that to continue to come down on a dollar basis and a percentage of sales as we see The level of demand for CapEx beginning to decline a bit further in 2024. On the working capital side, We have quite a few programs, obviously none of them of too much significance in the overall Sales or balance sheet of the company, but when we aggregate all of that, we see more opportunity for working capital Efficiency drives in that 'twenty four timeline than we do in 'twenty two or 'twenty three given the Timing of some particular performance based payments and milestones and incentives. So we're excited about the opportunity as we look at 2024 and beyond For free cash improvement and of course for the flexibility that that provides us on the deployment side as well. I mentioned the other Back to earlier, which is more just the timing of the payroll tax deferral that we had as a benefit In 2020 that we're now paying half of in 'twenty one and 'twenty two. So that's the only kind of unique item I'd add to that mix.

Speaker 3

Hope that helps.

Speaker 10

Okay. Yes, it's helpful. So it doesn't sound like anything really on the operation side that's massively accelerating in 2024 sort of non operating items then?

Speaker 3

I think that's a good way to characterize it. I think Kathy covered well our expectations for growth and performance over the next couple of years and these Cash flow timing issues are layered on to that outlook.

Speaker 10

Yes. Okay. And then just a quick follow-up on the cash. You mentioned that the if they don't sort out this R and D tax credit It could be $1,000,000,000 hit in 'twenty two. What's your latest thinking on the potential hit in 'twenty three and 'twenty four if this legislation doesn't get changed?

Speaker 3

Yes, thanks for the follow-up question on that. I should note, it's approximately 20% lower Per year after 2022, not exactly given some of the idiosyncrasies and the timing and such, but think of that $1,000,000,000 in 'twenty two potential Coming down to about $800,000,000 $600,000,000 over the next 2 years. As you can imagine, it eventually levels off and normalizes when we get to 2026 or so. So we are certainly still optimistic about resolving Section 174 through deferral or repeal. In the meantime, there Continues to be good broad bipartisan support for doing so.

Speaker 3

It's really just a matter of finding the right legislative vehicle and of course that has proven challenging so far. So that's why we wanted to give you a sense for that volume on today's call.

Operator

Your next question is from the line of Noah Poponak with Goldman Sachs.

Speaker 9

Hi, good morning everybody.

Speaker 2

Good morning.

Speaker 9

The profit margins in space have come down as you've layered in a significant amount of new revenue. As the growth rate sort of transitions there, how should we think about how much recovery you could see in the profitability in that business?

Speaker 2

So Noah, if I look at that business, we continue to layer in new development work. We talked about So things today, the Glyphase interceptor, the NGI program. And so it's not just the GBSD phenomena that is causing that mix headwind. But as GBSD transitions from a development phase Even into the early stages of production, we would expect to see that be the biggest driver in Tailwinds to margin rate and that happens around the middle of the decade. In the meantime, our business to others.

Speaker 2

So we're really pleased with that performance as we ingest all of this development work and believe that we can maintain those rates in line with what we have projected for 2022 and see increases towards the middle of the decade.

Speaker 9

Great, understood. And then Dave, just quickly following up on that on the free cash flow math. If I take each of the years you've now provided back out the CapEx and then back out all the pension inputs you've provided, which sort of gets to a clean number relative to the business segments, excluding anything with cash tax or working capital. That number, as a ratio of the business segments is pretty low compared to where you've been in the past. So that would indicate that you are specifically assuming, a working capital headwind Or some other headwind outside of the business segments.

Speaker 9

Is that the case or is my math wrong?

Speaker 3

Sure. Happy to get into those details another time if you'd like to Dig further.

Speaker 9

Yes, it could be easier with the same numbers in front of us.

Speaker 3

Right, exactly. In aggregate, I think the important Headline here is we've had great working capital performance over the last couple of years. We project more stable working capital performance over the next Couple of years before seeing that opportunity expand again in 2024. And I think that may be the summary of What you're seeing is after a couple of years of just outstanding working capital performance, especially in 2020 when we had things like the progress payment improvement And other tailwinds from the kind of industry perspective on cash, We're in a more normalized period in 20222023 before seeing that opportunity expand again in 2024. So again, happy to follow-up on that.

Speaker 3

Think that gives you a feel for it.

Speaker 9

It does. But it's not you're not assuming an actual incremental working capital headwind 'twenty two, 'twenty three, it's just sort of relatively no change year over year?

Speaker 3

Yes, that's correct.

Speaker 9

Okay. Okay, thanks so much.

Speaker 3

Thank you.

Operator

Your next question is from the line of Kajan Rumohr with Cowen and Company.

Speaker 11

Yes. Thank you so much. So I mean, it's pretty clear that in space, your mix is shifting toward GBSD and MGI. And so I assume that's because they're in the development stage means lower margins, 22%, probably 23%, and therefore Maybe 2024 they move up, but that would be the profile for space. And you mentioned in aeronautical that you saw a reversal In 'twenty four, but you mentioned dissipation in 'twenty three of headwinds.

Speaker 11

I read dissipation meaning that margins can get Better in 'twenty three, but does dissipation mean it's just going to go down, but not quite at the same level. So I guess the bottom line is Looking at the total company, 24, 25, we can see the margins maybe getting better, But maybe they're flat to down over the next 2 years. Is that a fair assessment?

Speaker 2

At the company level, Cai, what we are seeing is continued growth on the top line and margin expansion opportunity. But just as we've demonstrated, right, we've seen 40 basis points of improvement Going from 2020 to 2021, as we look at 2022, we're holding that range constant with where we ended And that's largely because we have offset these mix pressures as we've brought more development work into the portfolio. And so what we are suggesting That would continue to be the case until we move the mix more in the direction of production, But we are having performance improvements and cost efficiencies that are providing tailwinds on margin rates. So You would expect us to continue to work those levers even with this current mix. And We see opportunities for margins even as we look into 2023.

Speaker 12

Thank you very much.

Operator

Your next question is from the line of Myles Walton with UBS.

Speaker 12

Hey, good morning. Kathy, I was wondering if you could comment on the backlog and bookings opportunities in 'twenty two and 35 NGI, I imagine are big movers there, but do you expect the year to end at a higher backlog? And then Dave, just a clarification on the $1,700,000,000 of Prepaid credit, it's not clear that you ever recover that based on the slide of funding and CAS recoveries. Can you just clarify?

Speaker 2

Thanks, Myles. I'll start with your question about year 2022 awards and backlog expectations. We do not expect to have book to bill of 1 in 2022. We see fewer new competitive opportunities The ASF 35 award, which has pushed into this year. We tend not to focus so much on singular year Book to bill, but instead a longer term view because we have so many multiyear awards.

Speaker 2

And as Dave mentioned, when we look at the last 3 years, our average book to bill was 1.22. So it established a really strong Foundation for us to continue to grow. As we look at this year, we still expect to end this year with 4 years and trailing average of over 1.1. So it just gives you a sense that we expect to not only have a Strong backlog, but an average book to bill that continues to support the growth that we are outlining into the future.

Speaker 3

And just briefly on the $1,700,000,000 CAS prepayment credit, we show you the next 3 years of

Speaker 9

current projections in

Speaker 3

a multi decade future for our In a multi decade future for our pension plans both from a FAS and CAS perspective and so Wouldn't indicate that we'd expect that to be final or resolved over the next 3 years in this particular forecast We've got many, many years ahead of us there, a lot of market movement ahead of us there. But I think the bottom line on the pension side is we're really enthusiastic About the continued double digit return performance in 2021 and that has put us at a better funded position than we've been at in many years. So Really a good news story as of today on the pension side of things.

Speaker 12

All right. Thank you.

Operator

Your next question is from the line of Richard Safran with Seaport Global.

Speaker 13

Kathy, David, Todd, good morning. I wanted to ask you, if I could, a capital deployment question. In 2021, you had adjusted free cash flow of $3,100,000,000 but you paid $4,700,000,000 in dividends and repurchases. With respect to the long term free cash flow guide and expectations to return majority of free cash flow to shareholders, I'm trying to get a sense of what And if your actions in 2021 reflect how you're thinking long term about capital deployment, for example, could you draw down the balance sheet cash a Further, given the recent credit upgrade, are you planning any on retiring any more debt? Just was curious about, Given your long term cash flow guide, how you might be thinking about capital deployment over the longer term?

Speaker 2

Yes. Thanks, Rich. And let me just start with this past year, we had the IT Services divestiture, which Generated cash that we also deployed back into the business as we committed we would. And so that's what drove that higher level of capital opportunity even above our free cash flow in 2021. As we're looking forward when we talk about majority Of our cash being returned to shareholders, we talked about at least $1,500,000,000 of share repurchase this year and that is against 2.6% is the midpoint or so of our guide in free cash flow.

Speaker 2

So and Of course, dividends on top of that, which we have committed to continue paying competitive dividends, which will take up again early this year. So That gives you a sense of what we mean by majority. There's also opportunity in that we have I paid down debt and really solidified our balance sheet. So we currently have a cash balance that's higher than what we have 2020 2, but beyond as well. And we really don't have any major debt tranches coming due.

Speaker 2

We have 1 in 2023 that we've outlined, But we have flexibility on whether to refinance or to pay that at this point based on where our credit rating sits. So that's how we're thinking about capital deployment.

Speaker 13

Okay. And just real quick, Your contract mix right now, roughly fifty-fifty cost plus fixed price. I'm just wondering, if you Again, thinking longer term, how you think that might trend? When you start might start thinking about when the portfolio starts leaning towards more Fixed price contracting, is that something that's a 23 or possibly 2024 event?

Speaker 2

It gets a little higher over The next couple of years never significantly out of balance with that fifty-fifty ratio and then in 2025 is when we expect it to start to shift in the

Speaker 13

Thanks very much for all that. Appreciate it.

Speaker 4

Of course.

Speaker 1

All right. We have time for one more question.

Operator

Your last question is from the line of Robert Spingarn with Melius Research.

Speaker 12

Hi, good morning. This actually touches on contract type. Seth asked about the longer term end of decade aeronautics revenues. I wanted to ask about the risk profile in classified aeronautics near term As certain programs transition from development to LRIP and just especially in light of the cost pressure supply chain and so forth. Thank

Speaker 2

you. So as we look at our classified portfolio, Just as we do on all of our programs, we incorporate those low rate initial production Lots that were priced into our estimate and complete process. And so we're looking at that on Ongoing basis that risk is not only being monitored but reflected in our financial statements based on expectations as we know them today. And so the production experience that we have even early on in test aircraft and such all inform How we think about those low rate initial production lot?

Speaker 12

Is there a way to talk about how the revenues transition in 2022 From cost plus to fixed price? Or is this all in 23?

Speaker 2

So not at a particular program level, But we do talk about that in aggregate. And so as I said, our balance, even in aeronautics being specific to the sector, is about fifty-fifty, and we expect that to continue to be the case in 2022. So I think we are at a I'm going to go ahead and wrap up. Thanks again for joining us today. Again, I wanted to thank our team also Another strong year in 2021 and for positioning us so well for 2022 and beyond.

Speaker 2

We have solid performance And our innovation and investments are positioning us to continue delivering the products that our customers want with the urgency that they need. So thanks again for your support. We look forward to talking to you in April.

Operator

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

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Earnings Conference Call
Northrop Grumman Q4 2021
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