Q3 2020 Northrop Grumman Corp Earnings Call

October 22, 2020

[music].

At this time all participants are in a listen only mode. If at any time during the call you require assistance. Please press star zero and an operator will be happy to assist you.

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

I think it Italia good morning, everyone and welcome to Northrop Grumman's third quarter 2020 conference call. This morning, we will refer to a powerpoint presentation that is posted on our website.

Before we start matters discussed on today's call, including 2020 guidance and remarks regarding 2021 and beyond reflect the company's judgment based on information available at the time of this call. They constitute forward looking statements pursuant to safe Harbor provisions of the federal Securities laws forward looking statements involve risks and uncertainties, which are noted in today.

Its press release, and our SEC filings 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 financial results in our earnings release on the call today are Kathy Warden, our chairman CEO, and President and Dave Casper, Our CFO at this time I'd like to turn the call over to Kathy Kathy. Thank you Todd.

Good morning, everyone and thank you for joining US today, we hope you and your families are well.

Well no we continue to operate.

I'm done.

Our focus remains on the safety and well being of our people delivering on our customer commitments and supporting our suppliers.

Okay.

As the pandemic continues we are operating under protocols that we instituted earlier in the year, so well being of our employees.

And these are helping us to meet our commitments to customers and deliver strong operating results. While also continuing to strengthen our foundation for the future.

In addition to come in 19, we have experienced locally devastating natural disasters. This summer.

Specially want to recognize our Northrop Grumman employees in Lake, Charles Louisiana, who have persevered through to hurricane in the last two months.

Despite experiencing personal a negative return to work and continue to support the U.S. Air Force through Sustainment of the J stars aircraft.

Their resiliency embodies the spirit Northrop Grumman employees everywhere.

Also before I discuss this quarters results I want to take this opportunity to thank you all.

Who is retiring as president Aeronautics system.

In his more than 34 years with Northrop Grumman. He has made significant contributions to the business.

Leadership, and unwavering commitment to our employees and.

Summers.

And I want to congratulate Tom Jones, who will.

On January Onest.

Currently leased airborne sensors and networks emission system.

Business delivered large scale mission critical for our system and complex hardware and software products for airborne platform, including many in Aeronautics.

Thomas a seasoned executive with 30 years of aerospace and defense experience and were fortunate he will be leading our aeronautics business as it continues to deliver critical national security solution.

Now focusing on our third quarter results.

I want to thank our employees for their dedication to delivering for our customers and shareholders. We.

We had a strong third quarter and based on year to date results, we are raising our guidance for the year.

Our sales grew 7% in the quarter and 6% year to date, driven by sales growth and state mission systems and Aeronautics.

Dave continues to be our most robust growth driver with sales increasing 17% in the third quarter and 13% year to date and mission systems with our second fastest growing sector.

Strong performance for all of our sectors generated segment operating income growth of 10% in the quarter and 4% year to date, and we delivered an 11.5% segment operating margin rate in both periods.

Earnings per share grew 7% in the third quarter and 9% year to date.

Third quarter free cash flow increased 22% to 1.1 billion after capital spending of $287 million.

Year to date free cash flow has increased 80% to 1.9 billion, reflecting solid operational performance as well as the benefit of customer actions to support the industrial base.

Our new business awards are again, a highlight third.

Third quarter bookings totaled more than 20 billion or 2.2 times sales and year to date, we've captured $43 billion and do business, which brings our year to date book to Bill to 1.6.

As of the ended the quarter, our total backlog stood at more than $81 million, a 25% increase from year end and a new record for Northrop Grumman.

This year's New awards demonstrate our portfolios alignment within nations highest priority global security mission, including state nuclear deterrent.

He asked weapon electronic warfare, and all domain command and control.

Turning to sector highlights I'll begin with space.

In early September the Air Force awarded Northrop Grumman up 13.3 billion dollar contracts for the engineering and manufacturing development phase of the ground based strategic deterrent I want to.

I want to congratulate the members of our nationwide team for their exceptional work on this program.

This next phase of our nation's program to replace the Minuteman three Cbm, which were first fielded in 1970 combination more than 10 years of planning across two presidential administration as well as a series of competition.

The empty award includes weapon system design qualification test and evaluation and nuclear certification and.

And we expect to see where it's for the production phases of the program.

Now the DMD phase has been awarded GBSD ramp quickly for.

For 2021, we expect GBSD to contribute nearly $1 billion of incremental growth and space systems are.

Our nation wide team looks forward to delivering secure reliable and effective nuclear deterrence capability to our nation.

And award of that size impact business mix by increasing cost type development work as a percent of sales, particularly at the state and to a lesser extent the entire company.

While we expect this mix shift will pressure next year's margin rate. It's Dave we will work to offset this pressure across the company from program performance and cost management.

In addition to GBSD States also captured one of three evolved strategic sat com or FSS award to rapidly prototype a strategic communications payload with enhanced resilience and cyber security capabilities.

Yes, thats will be designed to seamlessly inter operate with and eventually replace the advanced extremely high frequency system.

This effort is critical to extending our nation's secure satellite communications infrastructure and we expect will represent a multibillion dollar competitive opportunity.

Program milestones achieved in states. This quarter included the successful test of the space launch system to serve for Nasa's arguments program and the NPV to launch in August.

And shortly after the end of the third quarter, our Cygnus spacecraft was launched aboard and targets rocket to complete our 14th resupply mission to the international space station.

At the Aeronautics sector. In addition to higher restricted volume F 35 deliveries to recover to first quarter levels.

We ended the third quarter. We've now delivered 719 F 35 center fuselage units and we are continuing to manufacture at a pace that supports our scheduled deliveries.

On the two D program, we've now delivered 44 of the 75 aircraft under contract.

Navy has it improved 11 plane increase to that program of record and is now working to identify funding for this additional aircraft.

I would also note that international opportunities for you to see continued to be promising in.

In addition to Japan 13, due to eat to de France, and Taiwan are expected to procure two deals in the coming year.

In autonomous systems treatments inaugural deployment to Guam occurred in January and led to an early operational decision by the Navy in May.

Following these critical milestone Triton is quickly becoming an invaluable asset in the seventh sleeps maritime patrol and reconnaissance command.

Despite the likely budget pressure on our health portfolio beyond this year, we have a promising set of future autonomous opportunities, including skyward any into nine replacement among others.

Turning to defense systems in.

In the third quarter, the U.S. Army conducted like higher tests of our Dcs system and successfully engaged multiple targets.

These exercises conducted as part of the IBCM limited user test demonstrated our system's ability to maintain continuous track of the targets. Despite contested environment conditions by fusing data from multiple sensors.

If successful tests have the ability to share data across platforms and sensors are significant demonstration of our underlying architecture, which is applicable to join all domain operation and increases the value and power of our customers' legacy platform and weapons system.

Yes also completed the first environmental tests of our from our new extended range rocket motor a major milestone toward motor qualification and first fly Fi our flight test in 2021.

And in Hypersonics, we successfully completed captive carry tests in support of the DARPA and US Therefore Hawk program.

With a prime contractor we are on track to proceed to free flight testing and we are now establishing manufacturing plants to meet initial low rate production quantity.

And finally at mission systems, we continue to meet or exceed prior year deliveries for the F 35 program.

In the third quarter and Thats delivered 41 radars consistent with 2019 quantities and delivered 47 dash Shipsets and 50, Cnine shipsets year over year increases of 30% and 40% respectively.

Mission systems also received a task order contract valued at $690 million for the Defense Intelligence Agency Tallow system.

Penford focuses on the build of new Big data systems for the DNA, including Mars mission assisted rapid repository system.

Transforming current databases into multi dimensional flexible and rigorous data environments.

Ours is expected to create a military intelligence environment accessible for up to date information by the intelligence community and war fighters.

And DARPA awarded US a contract for his game recur program is.

This innovative program seeks to develop and apply artificial intelligence to existing real time strategy game.

The gamebreak or effort gives us an opportunity to evaluate and develop artificial intelligence technology to improve flexible planning optimization and discovery in products that operate dynamic environment.

Looking ahead, we believe our customers were caught will require integrated artificial intelligence and machine learning capabilities in the same way cyber resiliency is now broadly required in products and system.

And Northrop Grumman is well positioned to support this emerging customer requirements.

We're extremely proud of our team's results for the third quarter and year to date and I will.

And I want to recognize the rebound in productivity our workforce has demonstrated since late March and early April.

As we look ahead to the remainder of the year, our guidance assumes that our teams productivity as well as the operations of our customers and suppliers remain at or near current levels.

It also reflects the strength of year to date results and our expectations for a strong fourth quarter.

Based on our current assumptions, we now expect 2020 sales of $35.7 billion to $36 billion, which is 6% topline growth at the midpoint.

EPS should grow to between $22.25 and $22 and 65 them, which is also 6% growth at the midpoint.

And we now expect free cash flow to increase to between 3.3 and $3.6 billion, a 14% increase over 2019 at the midpoint.

Regarding capital deployment, we continue to focus on a balanced strategy the call for robust investment strengthening of the balance sheet through debt reduction and funding of our pension plan and returning cash to shareholders, which we will do by resuming share repurchases and maintaining a competitive dividend.

We believe our strong cash flow and current cash balances will allow us to drive address all of these value creating deployment opportunities.

Turning to the U.S. budget environment, we expect to see continued strong bipartisan support for national security in the future as indicated by the $740 billion targeted for us like 2021 appropriations.

We are pleased that Congress and the administration agreed to a continuing resolution that funds. The government through December 11, and avoids disruption in the execution of critical National security missions.

And I will note that funding under continuing resolutions supports our programs, including GBSD, even if the continuing resolution is extended into early next year.

We continue to believe that bipartisan support for defense spending will endure and that our portfolio is well aligned to support our national defense strategy.

While we plan for various budget scenarios defense spending is largely threat driven and today's threat environment warrants a strong defense.

Emerging threats are intensifying and we believe both political parties are committed to effectively countering these threats.

While there are many external uncertainties Northrop Grumman has a strengthening foundation for growth and the capabilities and people necessary to address our nation's most challenging problems.

We are investing for the future delivering value to our shareholders and meeting our commitments to our customers and all of our stakeholders.

So now I'll turn it over to Dave to provide more detail on our sectors results.

2020 guidance updates as well as a preview of certain trends in 2021.

Dave.

It's Kathy and good morning, everyone I'd also like to thank our employees for their strong performance this quarter.

My comments, beginning with the third quarter highlights on slide three.

We delivered excellent bookings sales operating income EPS and cash and we're pleased to be increasing our 2020 guidance for sales EPS and free cash flow would be assumptions, we kept the articulated.

Slide four provides a bridge between third quarter 2020, and third quarter 2019 earnings per share higher sales and segment operating income grew 51 cents for the increase.

Net pension contributed 40 cents these Paul.

These positives were partially offset by a higher corporate unallocated, which was primarily driven by a 50 million dollar increase in state taxes as well as higher net interest expense federal income taxes and other items.

I would also note that COVID-19 related expenses are reflected in our current results.

Well begin a review of sector results on slide five there are unaudited sales rose, 5% for the quarter and 4% year to date.

Sales in autonomous systems amend aircraft were higher in both periods for the.

For the quarter and year to date restricted activities and the Etwo D contributed to sales growth and for the quarter F. 35 volume was also higher.

Defense system sales decreased 4% in Q3 and year to date sales were comparable to last year.

Third quarter trends included lower volume for mission readiness.

Hunter you may be Sustainment program nears completion.

And in Battle management missile systems.

Third quarter sales reflect lower volume at Lake City and on an international weapons program as both of those activities neared completion.

Declines in these areas were partially offset by higher volume on GM in Florida, and our year to date results reflect similar program threats.

Mission systems sales were up 10% in the third quarter and 6% year to date all.

All four MNS business areas contributed to this quarter's sales growth.

Third quarter results reflect higher airborne radar volume for the Mesa and the F 35 programs higher.

Higher volume on self protection and targeting systems.

And higher volume on marine systems and Gator.

Year to date sales growth reflects higher volume for airborne radars marine systems restricted programs and self protection avionics and targeting programs.

Space system sales rose, 17% in the third quarter and 13% year to date due to higher volume in both business areas.

Higher volume on restricted programs and other space programs like next generation, OPI or and NASA artemus contributed to higher sales in both periods strong.

Stronger volume a launch vehicle and Hypersonics programs drove higher launching strategic missile sales in both periods.

Now turning to segment operating income on slide six.

Aeronautics operating income increased 9% and margin rate increased to 10.1%.

Year to date this margin rate is 10% in both.

In both periods as recorded lowered net EA see adjustments in the third quarter lower positive vcs were more than offset by favorable overhead rate performance and year to date results were helped by the second quarter 21 million dollar government accounting benefit.

Defense systems operating income increased by 8% in the quarter and 2% year to date operating margin rate increased 130 basis points in the quarter to 11.7% and 20 basis points year to date margin.

Margin rate expansion in both periods is due to improved performance in Battle management and Ms missile systems programs.

Operating income at mission systems rose, 5% in the quarter and 6% year to date third.

Third quarter operating margin was 14.5% and year to date margin rate was comparable to the prior year at 14.6%.

Space systems operating income rose, 17% in the quarter and 11% year to date.

Third quarter operating margin rate improved to 10.2% and year to date operating margin rate declined slightly to 10.3% principally due to lower net you see adjustments.

Turning to slide seven.

We've updated guidance at all four sectors based on our current assumptions and better than expected year to date results.

At this we now expect sales to grow to the mid $11 billion range with some potential upside related to additional lower margin sales that may be booked in the fourth quarter for Doug.

For defense systems, we are increasing margin rate to approximately 11%. We're also increasing our margin rate guidance permission systems, we now.

We now expect a mid 14% margin rate this year at Emmis.

In that space based on the increase in development work at the sector. We expect sales will increase to the mid $8 billion range with a low 10% margin rate for the year.

Moving to consolidated guidance on slide eight we're raising 2020 sales adjusted EPS and free cash flow guidance to reflect the strength of year to date results.

2020 sales are now expected to range between 35.7 and $36 billion.

$400 million increase over prior guidance with topline growth of 6% at the midpoint.

We've also increased our total net Fas pension adjustment by $25 million.

In part to reflect the updated demographic study that we completed in the third quarter of each year.

No change to our expected federal tax rate or year end weighted average share count.

Based on year to date results and expectations for the remainder of the year, we're increasing mark to market adjusted EPS to a range of $22.25 to $22 and 65 sets for free cash flow. We now expect to between 3.3 and $3.6 billion for the year.

We're about $20 per share at the midpoint.

Slide nine provides a bridge between july's guidance in today's full year EPS outlook.

Increasing guidance reflects 25 cents of third quarter Upper racial improvement.

Regarding capital deployment capital expenditures year to date total $828 million and as we indicated we retired $1 billion in debt that matured on October 15th.

As we look ahead to next year on slide 10, we.

We expect three of our four sectors space mission systems and defense systems to have top line trends consistent with 2020.

Space should continue low to mid teen percent top line growth supported by a backlog that has more than doubled this year due to GBSD and robust restricted awards.

Mission systems should generate mid single digit sales growth.

Including higher volume from restricted and airborne and ground radar programs.

Defense systems topline growth will be impacted by the Lake City wind down which will be a headwind of approximately $400 million next year. This is a little more than we originally anticipated and reflects the fact, we had more than more sales than expected in 2020 as we transition these activities over to the new contractor.

We expect the US 2021 sales to be comparable to this year.

Regarding aeronautics systems, we expect several factors.

Will lead to a deceleration from this year's mid single digit growth in.

In 2021, we believe COVID-19, we will continue to impact our commercial programs.

35 production will begin to plateau, and our hill portfolio will likely experience defense budget funding pressures. These factors lead us to an expectation of low single digit growth at Aeronautics in 2021 from the mid $11 billion range. This year.

Given these secular trends, we expect 2021 sales at the company level will be in the low to mid $37 billion range, which includes intercompany eliminations of approximately $2 billion.

Looking at segment margin trends GBSD will pressure the margin rate at space, but we expect margin rate performance from the other three businesses will be generally consistent with 2020 as.

As Kathy said, we have opportunities to offset mix pressure at space systems through program performance and cost reductions across the company.

We will aggressively drive to capture these opportunities we do.

We do continue to expect higher segment margin dollars in 2021, and we expect next year's segment margin rate will likely trend toward the low end of the 2020 guidance range of 11.3% to 11.5%.

Our outlook assumes current productivity levels and although we are actively pursuing the recovery of cobot related costs or outlook does not include significant recoveries.

Turning to cash we continue to expect strong cash flow there will be a 2021 headwind related to the reversal of about half of this year is $300 million to $400 million deferred payroll tax related benefit, but we expect to have opportunities to offset that with improvements in working capital or 2021 capital.

Expenditures are expected to be about $1.35 billion.

Regarding 2021 pension items I would note that in addition to updates for changes in the discount rate at the end of this year and actual 2020 plan asset returns were evaluating our pension assumptions, including our long term expected rate of return which is currently 8%.

For your modeling purposes, we believe the net effect of these and other pension assumption updates effective 12, 31 is likely to lower our annual net vasquez pension adjustment by approximately $150 million to $250 million in both 2021 and 2022 versus estimates of one point so.

Having 5 billion and $1.8 billion, respectively, which we provided on January Thirtyth we.

We will provide our detailed outlook on pension items on our fourth quarter call in January.

As discussed more fully in our earnings release, and our SEC filings or guidance for 2020, and our outlook for 2021 assume no significant changes to our productivity to support for our programs or to the federal corporate tax rate. In addition, our guidance and outlook do not reflect any potential discretionary pension plan.

Contributions that we may choose to make in either year.

In closing, we're very pleased with our third quarter and year to date results, particularly new awards and our record backlog over.

Overall, our portfolio is well aligned with evolving customer priorities, we continue to execute to deliver value for our shareholders and we continued to invest in the future.

With that said I think we're ready to open the call up for queuing it.

I am pleased that remind everyone how to get into queue and ask questions.

Ladies and gentlemen, if you wish to ask a question. Please press star followed by one on your Touchtone telephone again press Star one to ask a question. If your question has been answered or if you wish to exit the questions can you press the pound key to exit the Q.

Star Zero at anytime for operator assistance.

Your first question comes from the line of Robert Stallard with vertical research.

Hi, Thanks, so much good morning.

Good morning.

Thanks for all the detail there on that 2021 beds Kathy just on another topic on non GBSD I was wondering if you could comment about how confident you are at.

That said this program stay on track because there has been some commentary could be at risk or the change in administration and the tough budget environment and in relation to that as the program progresses do you think come 2021 will be this across the full space margins. Thank you.

Thanks, Rob.

Every new administration has conducted an analysis of the triad and we expect that to happen again, if after the election, we are working with the new administration, but I'll also note that each have reaffirmed it has a critical role to play in our national security since the night.

Since 1994 video D. has had a formal nuclear posture review process and in that they evaluate the nation's strategic deterrent posture and have validated all three legs of the Tri Ed as being critically important and I'll note that the two most recent nuclear pasture is one which was in 2010.

We've conducted by the Obama administration and of course, the one and 2018 was conducted by the Trump, Hence administration, but again, both confirm the need for the Tri Ed to include Gbpfifty Anthony 21.

And historically, if we look back when defense spending decline and conventional military forces come under budget pressure you asked them. The allies have relied even more heavily upon nuclear deterrents to ensure global stability. So we think that the triad is going to be viewed as even more import.

And from a budgetary priority perspective, if those.

If those conditions exist.

So we are confident that a new administration would recognize that value and continue to support the modernization efforts that are well underway for both GTSP and B 21.

Your next question.

And then just before we move on you had a second part to the question Rob. So let me address that quickly you asked about the margins in one or 2021 would be the trough given the mix pressure that we will have from the GBSD program.

I will remind you that we're expecting nearly a billion dollars of incremental growth from GBSD next year, but we also expect significant growth going from 21 to 22, so that mix pressure will persist, but as Dave noted in his commentary we are working to offset that pressure as a company.

With strong cost reduction program performance.

And then how is now we are ready for that question. Thank you.

Your next question is from the line of Carter Copeland with Melius research.

Hey, good morning, everyone.

Good morning Carter.

Kathy I Wonder if you could talk about what you expect in terms of bad.

Backlog growth opportunities in 2021, given that 2019 and 2020 were so strong with some big lumpy award seat.

You can still grow backlog next year or is that going to be tougher given the comparison. Thanks.

We certainly see the opportunity to continue to grow backlog for next year, we have a number of opportunities that we're pursuing across all sectors I'll point to a few next gen jammer and mission.

While assessing dealer replacement of dealer.

Also in mission system, we have in CCI. The next generation interceptor, which would be in phase. So these are just a few examples of large potential awards.

Newstar.

We would look to to bolster our book to Bill next year.

Certainly we expect that book to Bill.

Be as robust as this year, just given the singular effect of the GBSD Award and the strong backlog that we have across our sectors and initiatives to provide a little bit of color on that we don't tend to look at awards and book to Bill on a quarterly basis, we look at on a longer term and we are well.

About a year of sales and backlog is safe.

Our thing products and mission systems defense systems tends to run at the short cycle business more with the backlog about equal to sales, but that's typical so we see strong backlog in all of our sectors and the opportunity to continue to build backlog.

Any level.

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

Hi, good morning.

I was interested in trying to get a sense for where services are headed they've had some very good topline growth in product sales, but services have really been flat at best and perhaps you could talk about why that is and do you expect to see that services revenues grow from here.

And do you expect the F 35, sustainment to be a significant part of that.

I think Doug let me start with the last part of the question first and then I'll talk more generally about services, we do see F 35, sustainment growth as a contributor to our overall.

Services business, but I'll also note that I'm about F 35, Sustainment growth runs through our Aeronautics business and our mission systems business, when we're talking about spares and repairs to the Sun visor businesses that produce the pros.

Products themselves not necessarily for our defense systems business, where our aircraft modernization that that team is involved in the sustainment.

Program for the F 35, so we see sustainment spread across the company and we see that growth contribute to all three of the sectors that I noted in terms of services growth within defense systems, we have seen that business to be relatively flat.

And we've talked about some of the headwinds there that had been running off over the last couple of years based on strategic decisions Weve made about business to not pursue.

And that's certainly slowed even into our 2021 result, but we've also seen some nice new program wins in that business, we talked about a large restricted program earlier in the year, we had a significant award.

In our services IP services business in the third quarter. So we are seeing growth. Its just offset by those headwinds that we've been talking about and as you know we've been executing on that strategic repositioning for our services business in tee up to now see us for several years.

For several years.

Your next question is from the line of Jon Raviv with Citigroup.

Thank you and good morning, Kathy in your repair prepared remarks, excuse me you talked about how there is uncertainty, but north or kind of strengthening foundation for growth what about.

Condition for strengthening strengthening growth and ask in the context of what is the prospect for growth rate to accelerate after 21 as new programs ramp up you overcome some headwinds like Lake City.

In July we talked about Aero being on a remarkable 21 and 22, but just thinking about growth ahead in sustaining that number as you point to maybe call it 3% to 5% and 21.

Thanks, John well as you note our outlook for 21 represents another solid year of growth for us beyond 2021, who will be somewhat dependent on the topline defense budget outlook, but also on our portfolios ability to offer the solutions the U.S. government and our allies.

He'll are necessary for their most pressing for us and.

And our recent success in capturing new work indicates that we do have a strong alignment to those high priority item, but the combination of the budget and portfolio are certainly what will drive our outlook for 2002 and beyond.

Seems strong bipartisan support for our key programs like the 21 GB as the F 35, and these two will be key to continuing to see growth beyond 2021, but given the threat environment. We expect that support to continue for those large program and.

We have really.

Really nice visibility as a result of being on the early end of programs like the 21 ingenious team, which go for for many years as you know and have a growth profile in that period.

I will acknowledge that flattening budget could lead to fewer new start.

But we feel well positioned in that our backlog has been building over the last couple of years very nicely and as I noted earlier in response to a question we see the potential to continue building that backlog at least into next year.

Your next question is from the line of David Strauss with Barclays.

Thanks, Good morning.

Good morning, David.

Kathy Dave wanted to ask on on free cash flow or I guess first of all on on pension, how you're thinking about that and maybe the potential to front end load some of the pension contributions you're thinking about in the out years, given the given the cash balance you're going to you're going to have here.

And then thinking about the cash profile from here it looks like despite everything this year that working capital based on your guidance for the full year. It looks like working capital capital is going to be fairly neutral.

Does that benefit you from here and then a last part a bit your capex profile do you still see that stepping down pretty meaningfully and in 2022. Thank you.

Sure, Thanks, David and I'm happy to dig into two each of those pieces as we look at the cash flows in the.

Years, 2021, and beyond I think you're right that that we've generated a healthy cash balance at this point with $5 billion at the end of Q.

Q3 that certainly enabled us to pay down the billion dollars of debt that we talked about earlier in October we do continue to plan for a gradual.

The leveraging of the balance sheet. So that's one element of our capital deployment strategy investing in the business is certainly cannot.

Continues to be the hallmark of our capital deployment strategy on the Capex side that you asked about our outlook. There is unchanged at 1.35 billion this year and next with.

With a gradual decline in terms of percentage of sales thereafter.

We don't see anything that would cause us to change that outlook at this point.

Returning cash to shareholders remains a priority as well and as Kathy talked about.

Earlier, we do anticipate a restart.

Restarting our share repurchase program in 2021, and continuing to make me team.

Competitive dividend.

On the pension side. It is something that we look at in terms of the timing of pension contributions that are anticipated to pick up a bit in 2022.

As we noted earlier those are not incorporated into our free cash flow guidance for this year or next but the opportunity to to make voluntary early pension contributions remains a possibility in in either of those years.

So the bottom line is our intent is not to sit on the current high levels of cash that we have.

Generated over the last couple of years for longer than we believe it's necessary.

And you should expect a nice balanced approach to capital deployment over the next call.

Couple of years to continue for us.

Digging into the free cash flow question for 2021, a bit further I think that to as an important topic.

And I think one to look at on a multiyear basis. So our 2019 cash free cash flow was up 20 up 18% from 2018 or 2020 higher guide that we provided today goals for about 14% growth at the mid point from 2019, so exceptional growth from that too.

Two year period.

2020, free cash flow benefits about $3 million to $400 million from the payroll tax deferral also benefits a bit from progress payment changes.

And then we have some headwinds related to covert related delays and the supplier payment accelerations that we've done this year, which on an aggregate year to date basis total over $800 million. So we continue to support those those critical suppliers.

As we look at 21, we'll have.

The headwind related to the payroll tax deferral from this year, that's about 50% of that.

I don't.

But we'll work to offset that to your point through continued working capital management and do feel like we can can create a bit of a.

Can create a bit of a tailwind there.

And with comparable Capex removed 20 to 21, when you aggregate all that we think the net result for 21 free cash will be continued strong free cash flow on that multiyear basis, but potentially below the higher 2020 free cash flow guide that we provided today because of that a combination of factors.

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

Hi, Thanks, very much and good morning, Tom.

I Wonder if maybe if you could talk a little bit more about the job the autonomous portfolio and kind of.

Mechanics and timeframe.

Starting to get growth to pick up there and in particular, maybe the Skype or award and.

How you guys think about that given that it's kind of a different a different type of program in terms of being a low cost solution that kind of the system.

The more high end stock that Northrop has been focused on a traditionally.

Thanks, Seth I'd be happy to so let me start by talking about our current.

Thomas portfolio.

And looking at tail in particular, so the combination of our global Hawk and Triton program. We have talked about some budget pressures. There you may be familiar that for Triton. The Navy has discussed that production pause for the next two years and that is what is currently.

Programmed into the Navy 2021 budget request, we are working with the Navy in Congress to see what that prediction pause actually entails in terms of aircraft for next year.

But with Australia, we also see some offsets to that production.

Gap that we would experience otherwise with the Navy Hot we do believe the Navy is committed to the program in the long term. It's on all of the statements that they've made and so this really is a opportunity for the air vehicle to pause and wait for some government provided sensors that we can.

Integrated into the production vehicles going forward.

With regard to global Hawk. The Air Force is contemplating a reduction in their fleet from largely block 20 and block Thirtys.

And well they signaled that that is not formal direction at this point. So we really don't have more color on what those pressures might look like for global Hawk, but.

We do anticipate that over the next several years the that will become more clear and we will have a stronger production and that leads to the question that you asked about Sky Morgan other analysis of alternatives that are being considered in this case, particularly by the Air Force, but I would note.

That all of the services strategic plan call for a significant contribution by unmanned systems in particular aerial unmanned systems, including not only the air force that the Navy and the Marine Corps. So Skype weren't in particular, we look at it as an opportunity because of its architecture.

Sexual component more so than just the air vehicle alone. The Skyworks vision is the system will be operating together instead of on a single platform, having the capability to.

Really operate on aided which is Howard Hill platform developed today that broader range of requirement as you point will be in a lower price point, but have some very sophisticated requirements that need to be interest in areas like connectivity vehicle management, all things that across the Northrop Grumman.

We have strong capabilities to contribute so we're actually quite excited about opportunities that looks beyond the platform itself to the conductivity of other sensors and aircraft because it starts to engage some of the integration that we can do with our mission system.

Our platform our programs and our products as well so really as we look forward. This is an evolution of Ondemand and one that we think is very consistent with what the services have been discussing in systems and systems operating together and the work that we've been doing.

Lead the way and not all of them and I command and control of system on manned and unmanned.

Your next question is from the line of Cai von Rumohr with Cowen.

Thank you very much so cash.

Kathy you mentioned the backlog could grow and why they just looking at it it doesn't look like the new opportunities are that huge maybe I'm wrong, there, but but so what would it take to get you were at our existing programs those are big increases coming you've already gotten your money.

G B C, but other restricted areas what are the key elements that could get to a higher backlog next year.

Yes.

So I I noted a few program, but as you I'm sure appreciate across our programs that the timing of award.

Some large like F 35, we expect a another production.

Lot of award next year, but there are many smaller efforts as well that tool to have their natural annual increment, particularly production program that will flow into next year that create a significant base and foundation of award and I just referred to a few of the new.

The new business that we would see contributing to an ability to get to a one or greater of till next year, but certainly there are lots of awards that are anticipated in just our normal course of business across all four sectors.

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

Hi, Good morning, Cathy gave and Todd and just given 10% growth in Michigan This quarter and the promotion of Tom Jones to lead Aeronautics Your largest segment from a subsegment admissions how do we think about actual growth drivers admission growth over the next few years, because I've got to GBS. It is your most most significant growth country.

Peter in your portfolio.

Yes, Sheila and thank you for recognizing that has certainly Tom Jones, and his leadership and airborne sensors and networks and sinus mission system has contributed to very strong growth for mission systems that have them of the four businesses inside of mission systems. The most.

Significant contributor to growth for a couple of years, but I would also note that all of the businesses and mission systems contributed to its growth. This year. So we have been pleased to see that it isn't just one of the divisions driving that growth I'm speaking to Tom Jones in particular I one of the reasons that I'm very pleased to.

Hi him stepping into the role at Aeronautics sector is that in addition to leading our airborne sensors and networks. He was leading our crops company campaign for next generation Air dominance, which looks at all next generation aircraft and mission systems that would meet the requirements of the Gulf.

Women for their next generation fleet.

Fleet and so in that role he was already working very closely between our aeronautics and our mission systems sector on how we bring these capabilities together to accomplish the mission that our customers have laid out both the air Force and the Navy for their next generation of aircraft.

And mission program.

So that synergy between those two businesses will only get stronger as we have Tom transition into Aeronautics I'd also note that the team the team under Tom and Airborne sensors and networks is a very strong team sorry fully expects that the growth that we've seen there we'll continue onto their leadership.

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

Hey, good morning, guys. Thanks.

So when Cathy.

Bigger picture question for you.

They are classified programs have become such an important piece of it.

Northrop's business and <unk>.

I guess report reasons right, there sort of a black box.

How do you want.

Investors to think about it and.

I have a follow on to that or a bend them that up.

With the announcement of and.

And the or the wanting to do more rapid aircraft programs prototype in the whole digital century series thing.

What kind of opportunity does that present for north or because presumably that's all in the classified world as well.

Thanks, Brian So one of the most important thing for our performance as the company is program performance.

And so what I want our investors to know first and foremost about our classified and restricted word is that we have the same level of governance over the programs that we do any other program. The appropriate people are cleared into the details of those programs reviewing them regularly understanding what they need to perform.

And providing the resources to them and to execute successfully and so that goes to our ability to continue to have a track record of disciplined and focused performance in our restricted portfolio, even though we can't share as much of that.

Ill with our Investor community as we could on our unclassified portfolio.

And the second part of your question around digital engineering and the important role that our digital enterprise transformation is going to have on all of our program going forward I'd actually start by pointing to JV and see where we are using the digital enterprise.

As the base for executing that program. The work that we have done with the customer already even under the tech maturation and risk reduction phase of the program was done in a digital environment. We delivered artifact for review in a fully digital environment, where they were actually looking.

And things that model not documents produced this is the first time in a program with a size where that's been the case.

We're very pleased to be pioneering away in partnership with the Air force to make that a reality on the GBSD program, but those investments that were making for GBS C are being utilized across our entire portfolio. So as we think about next generation air dominance in the program, but are part of that overall.

All I campaign, a phone call it they too will benefit from a full digital engineering thread of.

Fired by our customers and even in areas like state and mission systems. In addition to aeronautics each new start is looking at implementing not only the design in a digital way, but a full thread it looks that the producibility and maintainability.

Thank you so much.

Of models and the digital environment.

Your next question is from the line of Pete Skibitski with Olympic Global.

Yeah. Thanks, good morning.

Okay, just a follow up on Sascar earlier question regarding hail you Avi is I know you touched on Australia, but but in general that was a domestic discussion we talked about you Avi export policy because I thought maybe there has been some changes made to the mtc are about I don't know how radical or not those changes have than that can you give us your up.

Hey that view there on regulation around around exports for hotels.

And maybe whether or not it goes far enough to help exports just given I think a lot of market share has been ceded to some competitors out there. Thanks.

I think the thing there were changes to the Mtc are and they are very encouraging changes. They will open up more international customers to have potential access of course, they still go through the same approval process, but now it looks more favorable upon Uh huh.

Part of this technology, because it hasn't caught up in the missile technology regime as tightly and so when we look at the process. We are really pleased the department of state and the department of Defense and the U.S. has worked together into makes it possible it will take us some time.

Fine to work with nations that are now eligible for this technology and get through processes of them requesting it and up to engaging with them, but it is opening a door that had not been opened before so over a multiyear period, we do expect us to open up more international sales.

Just for health platform, which is what we produce today so for unmanned systems overall, including ones, we might develop in the future.

I'm going to tell you we have time for one more question.

Your last question is from the line of Myles Walton with the B S.

Thanks. Good morning, Thanks for squeezing me in maybe a clarification on the pension cash assumptions are 21, and 22 did did only Fas move forward to CASM and funding respectively change and then on on space. Your growth. There for 21 I think this year you grew space more.

Than 10% without GBSD.

So why the implied deceleration to virtually no growth in 21 X GBSD. Thanks.

Hey, Myles I'll start on the on the pension question.

We still have a lot of assumptions to.

Assumptions to finalize their and review internally and so that's why it doesn't make sense for us at this space to get into a line by line.

A detailed review of those assumptions before they are fully baked in of course, we have to see where discount rates end up as well as a full year asset performance for this year, it's possible that there will be movement, both the Fas and the cows lines, but those are as I mentioned still in the works. The net result that were.

Talking through 150, 250 would cover both of those.

From a cash perspective, I don't think you should think of this as.

Think of this as being a meaningful change to our 21.

We're 22 outlook, but again, we'll have more details and we'll be able to update that on the January call.

And I'd say, just very quickly with strategic space, we've seen a tremendous amount of growth. This year as you pointed to many of those program ramps throughout this year and she is more of a steady state growth into next.

Next year and strategic missile as its transitioning from she'd be GMT to enjoy guy well see a little bit of flatness until we get.

Through the other side, but all of that is being more than offset by TBSI and.

Additional growth and in strategic they just not quite as much there in 2021 on a year over year comparison, we saw in 2020.

So why don't I go ahead, and close todays call by reiterating our thanks to the Northrop Grumman team for another outstanding quarter of performance.

This is especially impressive in light of the challenging conditions that we all face. This year. We are successfully executing on our strategy with solid results through the first three quarters and we're well positioned to have a strong finish to this year and continue that momentum into 2021. So.

So thank you for joining us today, we look forward to speaking to you again in late January when we'll report on our full year results and to provide 2021 Titan.

That concludes our call.

<unk>.

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

[music].

Good day, ladies and gentlemen, and welcome to the Northrop Grumman's third quarter 2020 conference call.

This 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. If at any time during the call you require assistance. Please press star zero and an operator will be happy to assist you.

I would now like to turn the call over to your host Mr., Todd <unk> Treasurer, and Vice President Investor Relations Mr. Art. Please proceed.

I think in a tight yeah. Good morning, everyone and welcome to Northrop Grumman's third quarter 2020 conference call. This morning, we will refer to a powerpoint presentation that is posted on our website.

Its press release, and our SEC filings 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 financial results in our earnings release on the call.

On the call today are Kathy Warden, our chairman CEO, and President and Dave copper our CFO at this time I'd like to turn the call over to Kathy Kathy.

Thank you Todd.

Morning, everyone and thank you for joining US today, we hope you and your families are well.

Well no we continue to operate in the month.

On a global pandemic.

Our focus remains on the safety and well being of our people delivering on our customer commitments and supporting our supplier community.

As the pandemic continues we are operating under protocols that we instituted earlier in the year to help preserve and well being of our employees.

These are helping us to meet our commitments to customers and deliver strong operating results. While also continuing to strengthen our foundation for the future.

In addition to come in 19, we have experienced locally devastating natural disasters in the summer.

Specially want to recognize our Northrop Grumman employees in Lake Charles Louisiana.

Persevere through to hurricane in the last two months.

Despite experiencing personal lot. They can return to work and continue to support the U.S. Air Force for Sustainment of the day it starts aircraft.

Their resiliency embodies the spirit Northrop Grumman employees everywhere.

Also before I discuss this quarter's results I want to take this opportunity to thank John Oh, Yeah. It was retiring as president Aeronautics system.

In his more than 34 years with Northrop Grumman. She has made significant contributions to the business through his leadership and unwavering commitment to our employees and customers.

And I want to congratulate Tom Jones, who will succeed yada on January 1st.

Tom currently leaves airborne sensors and networks in mission systems.

This business delivered large scale mission critical for our system and complex hardware and software product for airborne platforms, including many in Aeronautics.

Tom is a seasoned executive with 30 years of aerospace and defense experience and were fortunate he will be leading our aeronautics business.

We continue to deliver critical national security solution.

Now focusing on our third quarter results I want to thank our employees for their dedication to delivering for our customers and shareholders.

We had a strong third quarter and based on year to date results, we are raising our guidance for the year.

Our sales grew 7% in the quarter and 6% year to date, driven by sales growth and state mission systems and Aeronautics.

Dave continues to be our most robust growth driver with sales increasing 17% in the third quarter and 13% year to date and mission systems with our second fastest growing sector.

Strong performance for all of our sectors generated segment operating income growth of 10% in the corner and 4% year to date, and we delivered an 11.5% segment operating margin rate in both periods.

Earnings per share grew 7% in the third quarter and 9% year to date.

Third quarter free cash flow increased 22% to 1.1 billion after capital spending of $287 million.

Year to date free cash flow has increased 80% to $1.9 billion, reflecting solid operational performance as well as the benefit of customer actions to support the industrial base.

Our new business awards are again a highlight.

Third quarter bookings totaled more than 20 billion or 2.2 times sales and year to date, we've captured $43 billion and do business, which brings our year to date book to Bill to 1.6.

As of the ended the quarter, our total backlog stood at more than $81 million, a 25% increase from year end and a new record for Northrop Grumman.

This year's New awards demonstrate our portfolios alignment with the nations highest priority global security mission, including state nuclear deterrent advanced weapons electronic warfare, and all domain command and control.

Turning to the sector highlights I'll begin with thanks.

In early September the Air Force awarded Northrop Grumman 13.3 million dollar contract for the engineering and manufacturing development phase of the ground based strategic deterrent.

I want to congratulate the numbers aren't nationwide team for their exceptional work on this program.

This next phase of our nation's program to replace the Minuteman three I see the.

Which were first yielded a 1970 combination more than 10 years of planning across two presidential administration as well as the series of competition.

The M.D. award includes weapons system design qualification test and evaluation and nuclear certification.

We expect it works for the production phases of the program.

Now the DMD phase has been awarded GBSD ramp quickly for Htwo.

For 2021, we expect GTSP to contribute nearly $1 billion of incremental growth based system.

Our nationwide team looks forward to delivering secure reliable and effective nuclear deterrent capability to our nation.

And award of this size impact business mix by increasing cost type development work as a percent of sales, particularly in Spain and to a lesser extent the entire company.

While we expect this mix shift will pressure next year's margin rate in space, We will work to offset this pressure across the company from program performance and cost management.

In addition to GBSD space also captured one of three a halt strategic sat com or NSS Award.

Rapidly prototype a strategic communications payload with enhanced resilience and cyber security capabilities.

Yes that will be designed to seamlessly inter operate with and eventually replace the advanced extremely high frequency system.

Effort is critical to extending our nation's secure satellite communications infrastructure and we expect will represent a multibillion dollar competitive opportunity.

Program milestones achieved in space. This quarter included the successful test of the space launch system booster for Nasa's arguments program and the MPV to launch in August.

And shortly after the end of the third quarter. Our Cygnus spacecraft was launched aboard inventories rocket to complete our 14 resupply mission to the international space station.

At the Aeronautics sector. In addition to higher restricted volumes F 35 deliveries to recover to first quarter levels.

End of the third quarter. We've now delivered 719 F 35 center fuselage units and we are continuing to manufacture at a pace that supports our scheduled deliveries.

On the two deep program. We've now delivered 44 of the 75 aircraft under contract.

Navy has an improved 11 plane increase to that program of record and is now working to identify funding for this additional aircraft.

I would also note that international opportunities for Intuity continue to be promising and into.

In addition to Japan 13 into de France, and Taiwan are expected to procure duties in the coming year.

In autonomous systems titles inaugural deployment to Guam occurred in January and led to an early operational decision by the Navy in May.

Following these critical milestone Triton is quickly becoming an invaluable asset in the seven sleep Maritime patrol and reconnaissance command.

Despite the likely budget pressure on our health portfolio beyond this year, we have a promising set of future autonomous opportunities, including Skyworks any into nine replacement among others.

Turning to defense systems.

In the third quarter. The US Army conducted like fire tests of our IBCM system and successfully engaged multiple targets.

These exercises conducted as part of the IBCM limited user test demonstrated our system's ability to maintain continuous track of the targets despite contested environment conditions by few.

Using data from multiple sensors.

If successful test of the ability to share data across platforms and sensors are significant demonstration of our underlying architecture, which is applicable to join all domain operation and increases the value and power of our customers' legacy platform and weapons system.

Yes also completed the first environmental testing arc of our new extended range rocket motor.

Her milestone toward motor qualification and first like fire flight test in 2021.

And in Hypersonics, we successfully completed captive carry test in support of the DARPA and US Therefore Hawk program.

With a prime contractor we are on track to proceed to free flight testing and we are now establishing manufacturing plants to meet initial low rate production quantity.

And finally admissions system, we continue to meet or exceed prior year deliveries for the F 35 program.

In the third quarter and Thats delivered 41 radars consistent with 2019 quantities and delivered 47 dash obsessed and 50 Cnine Shipsets.

Year over year increases of 30% and 40% respectively.

Mission systems also received a task order contract valued at $690 million for the defense intelligence agencies talents system.

This effort focuses on the build of new Big data systems for the DNA included Mars mission assistant rapid repositories system.

Transforming current databases into multi dimensional flexible and rigorous data environments.

Ours is expected to create a military intelligence environment accessible for up to date information by the intelligence community and war fighters.

And DARPA awarded US a contract for his team record program is.

Innovative program seeks to develop and apply artificial intelligence to existing real time strategy game.

Gamebreak or effort gives us an opportunity to evaluate and develop artificial intelligence technology to improve flexible planning optimization and discovery and products that operate dynamic environment.

Northrop Grumman is well positioned to support this emerging customer requirements.

We're extremely proud of our team's results for the third quarter and year to date.

And I want to recognize the rebound in productivity our workforce has demonstrated since late March and early April.

As we look ahead to the remainder of the year, our guidance assumes that our teams productivity as well as the operations of our customers and suppliers remain at or near current levels.

It also reflects the strength of year to date results and our expectations for a strong fourth quarter.

Based on our current assumptions, we now expect 2020 sales of $35.7 million to $36 million.

Which is 6% topline growth at the midpoint.

EPS should grow to between $22.25 and $22.65, which is also 6% growth at the midpoint.

And we now expect free cash flow to increase to between 3.3 and $3.6 billion, a 14% increase over 2019 at the midpoint.

We believe our strong cash flow and current cash balances will allow us to directly address all of these value creating deployment opportunities.

Turning to the U.S. budget environment, we expect to see continued strong bipartisan support for national security in the future.

Indicated by the $740 million targeted for like 2021 appropriation.

We are pleased to the Congress and the administration agreed to a continuing resolution funds. The government through December 11, and avoids disruption in the execution of critical National security missions.

And I will note that funding under continuing resolutions supports our programs, including GBSD, even if the continuing resolution is extended into early next year.

We continue to believe that bipartisan support for defense spending will endure and that our portfolio is well aligned to support our national defense strategy.

While we plan for various budget scenarios defense spending is largely threat driven and today's threat environment warrants a strong defense.

Emerging threats are intensifying and we believe those political parties are committed to effectively countering these threats.

While there are many external uncertainties Northrop Grumman has a strengthening foundation for growth and the capabilities and people necessary to address our nation's most challenging problems.

We are investing for the future delivering value to our shareholders and meeting our commitments to our customers and all of our stakeholders.

So now I'll turn it over to Dave to provide more detail on our sectors results too.

2020 guidance updates as well as a preview of certain trends in 2021.

Dave.

Thanks, Kathy and good morning, everyone I'd also like to thank our employees for their strong performance this quarter.

So let's begin with the third quarter highlights on slide three.

We delivered excellent bookings sales operating income EPS and cash and we're pleased to be increasing our 2020 guidance for sales EPS and free cash flow would be.

Assumptions, we kept the articulated.

Slide four provides a bridge between third quarter 2020, and third quarter 2019 earnings per share higher sales and segment operating income growth 51 cents for the increase.

Pension contributed 40 cents.

These positives were partially offset by higher corporate unallocated, which was primarily driven by a 50 million dollar increase in state taxes as well as higher net interest expense federal income taxes and other items.

Also note that could make team related expenses are reflected in our current results.

Well begin a review of sector results on slide five there and audit sales rose, 5% for the quarter and 4% year to date.

Sales in autonomous systems, a manned aircraft were higher in both periods for the call.

For the quarter and year to date restricted activities and the two d. contributed to sales growth and for the.

And for the quarter of 35 volume was also higher.

Defense system sales decreased 4% in Q3 and year to date sales were comparable to last year.

Third quarter trends included lower volume permission readiness.

Hunter you would be Sustainment program nears completion.

And in Battle management missile systems third quarter sales reflect lower volume at Lake City and on an international weapons program.

Both of those activities neared completion design.

Lines in these areas were partially offset by higher volume on GML or us and our year to date.

Year to date results reflect similar program trends.

Mission systems sales were up 10% in the third quarter and 6% year to date.

For MSS business areas contributed to this quarter's sales growth.

Third quarter results reflect higher airborne radar volume for the Mesa and the F 35 programs.

Higher volume on self protection and targeting system manpower.

And higher volume on marine systems and Gator.

Year to date sales growth reflects higher volume for airborne radars marine systems restricted programs and self protection avionics and targeting programs.

Space system sales rose, 17% in the third quarter and 13% year to date due to higher volume in both business areas.

Volume on restricted programs and other space programs like next generation, OPI or and NASA artemus contributed to higher sales in both periods straw.

Stronger volume a launch vehicle and Hypersonics programs drove higher launching strategic missile sales in both periods.

Now turning to segment operating income on slide six.

Aeronautics operating income increased 9% and margin rate increased to 10.1%.

Year to date EPS margin rate is 10%.

In both periods recorded lower net see adjustments in the third quarter lower positive vcs were more than offset by favorable overhead rate performance and year to date results were helped by the second quarter $21 million government accounting benefit.

Defense systems operating income increased by 8% in the quarter and 2% year to date operating margin rate increased 130 basis points in the quarter to 11.7% and 20 basis points year to date margin.

Margin rate expansion in both periods is due to improved performance in Battle management and mission missile systems programs.

Operating income at mission systems rose, 5% in the quarter and 6% year to date third.

Third quarter operating margin was 14.5% and year to date margin rate was comparable to the prior year at 14.6%.

Space systems operating income rose, 17% in the quarter and 11% year to date.

Third quarter operating margin rate improved to 10.2% and year to date operating margin rate declined slightly to 10.3% principally due to lower net see adjustments.

Turning to slide seven.

We've updated guidance at all four sectors based on our current assumptions and better than expected year to date results.

Yes, we now expect sales to grow to the middle of $1 billion range with some potential upside related to additional lower margin sales that may be booked in the fourth quarter.

For defense systems, we are increasing margin rate to approximately 11%. We're also increasing our margin rate guidance permission systems.

We now expect a mid 14% margin rate this year at MFS.

And that space based on the increase in development work at the sector. We expect sales will increase to the mid $8 billion range with a low 10% margin rate for the year.

Moving to consolidated guidance on slide eight we are raising 2020 sales adjusted EPS and free cash flow guidance to reflect the strength of year to date results.

2020 sales are now expected to range between 35.7 and $36 billion.

$400 million increase over prior guidance with topline growth of 6% at the midpoint.

We've also increased our total net pension adjustment by $25 million.

In part to reflect the updated demographic study that we completed in the third quarter of each year.

No change to our expected federal tax rate for year end weighted average share count.

Based on year to date results and expectations for the remainder of the year, we're increasing mark to market adjusted EPS to a range of $22.25 to $22.65 for free cash flow. We now expect to between 3.3 and $3.6 billion for the year.

About $20 per share at the midpoint.

Slide nine provides a bridge between july's guidance in today's full year EPS outlook.

Increasing guidance reflects 25 cents of third quarter operational improvement.

Regarding capital deployment capital expenditures year to date total $828 million and as we indicated we retired $1 billion in debt that matured on October 15th.

As we look ahead to next year on slide 10, we.

We expect three of our four sectors space mission systems and defense systems to have top line trends consistent with 2020.

Space should continue low to mid teen percent topline growth support.

Supported by a backlog that has more than doubled this year due to GBSD and robust restricted awards.

Mission systems should generate mid single digit sales growth incur.

Including higher volume from restricted and airborne and ground radar programs.

Defense systems top line growth will be impacted by the Lake City wind down which will be a headwind of approximately $400 million next year. This is a little more than we originally anticipated and reflects the fact, we had more than more sales than expected in 2020 as we transition these activities over to the new contractor.

We expect 2021 sales to be comparable to this year.

Regarding aeronautics systems, we expect several factors.

Will lead to a deceleration from this year's mid single digit growth.

In 2021, we believe COVID-19, we will continue to impact our commercial programs.

35 production will begin to plateau, and our hill portfolio will likely experience defense budget funding pressures.

These factors lead us to an expectation of low single digit growth at Aeronautics in 2021 from the mid $11 billion range. This year.

Given these secular trends, we expect 2021 sales at the company level will be in the low to mid $37 billion range, which includes intercompany eliminations of approximately $2 billion.

Looking at segment margin trends GBSD will pressure the margin rate of space, but we expect margin rate performance from the other three businesses will be generally consistent with 2020.

As Kathy said, we have opportunities to offset mix pressure at space systems through program performance and cost reductions across the company.

We will aggressively drive to capture these opportunities.

We do continue to expect higher segment margin dollars in 2021, and we expect next year's segment margin rate will likely trend towards the low end of the 2020 guidance range of 11.3% to 11.5%.

Our outlook assumes current productivity levels.

Although we are actively pursuing the recovery of coated related costs or outlook does not include significant recoveries.

Turning to cash.

We continue to expect strong cash flow there will be a 2021 headwind related to the reversal of about half of this year is $300 million to $400 million deferred payroll tax related benefit, but we expect to have opportunities to offset that with improvements in working capital or 2021 capital expenditures are expected to be about.

About $1.35 billion.

Regarding 2021 pension items I would note that in addition to updates for changes in the discount rate at the end of this year and actual 2020 plan asset returns, we are evaluating our pension assumptions, including our long term expected rate of return which is currently 8%.

Seven 5 billion and $1.8 billion, respectively, which we provided on January thirtyth.

We will provide our detailed outlook on pension items on our fourth quarter call in January.

As discussed more fully in our earnings release, and our SEC filings or guidance for 2020, and our outlook for 2021 assume no significant changes to our productivity.

Support for our programs.

Or to the federal corporate tax rate. In addition, our guidance and outlook do not reflect any potential discretionary pension plan contributions that we may choose to make in either year.

In closing, we're very pleased with our third quarter and year to date results, particularly new awards and our record backlog over.

Overall, our portfolio is well aligned with evolving customer priorities, we continue to exit.

We continue to execute to deliver value for our shareholders and we continue to invest in the future.

Thats right I think we're ready to open the call up for Q in it.

I am pleased that remind everyone how to get into queue and ask questions.

Ladies and gentlemen, if you wish to ask a question. Please press star followed by line on your Touchtone telephone again press Star one to ask a question. If your question has been answered for if you wish to exit the question skew press the pound key to exit the Q Press Star zero at any time for operate.

Peter assistance.

Your first question comes from the line of Robert Stallard with vertical research.

Hi, Thanks, so much good morning.

Good morning.

Thanks truly at the detail there on that 2021, but some Kathy just on another topic on GBSD I was wondering if you could comment about how confident you are.

This program staying on track there has been some commentary could be at risk with the change of administration and the tough budget environment and in relation to that as the program progresses do you think come 2021 will be this trough year.

Space margins. Thank you.

Thanks, Rob.

Every new administration has conducted an analysis of the Tri Ed and we expect that to happen again, it's after the election or working with the New administration, but I'll also note that each have reaffirmed in how the critical role to play in our National security.

Since 1994 video he has had a formal nuclear posture review process and in that they evaluate the nation's strategic deterrent posture and have validated all three legs of the Tri Ed as being critically important and I'll note that the two most recent nuclear pasture reviews, one witness in 2010.

With conducted by the Obama Biden administration and of course, the one and 2018 was conducted by the Trumps administration, but again, both confirm the need for the Tri Ed to include GBSD Anthony 21.

Historically, if we look back when defense spending decline and conventional military forces come under budget pressure.

Than the allies have rely more heavily upon nuclear deterrents to ensure global stability and we think that.

Triad is going to be viewed as even more important from a budgetary priority perspective.

Those conditions exist.

So we are confident that a new administration when recognize that value and continue to support the modernization efforts that are well underway for both GBS C and B 21.

Your next question Adam.

Just before we move on you had a second part to the question Rob. So let me address that quickly you asked about margins and one or 2021 would be in a trough given the mix pressure that we will have from the GBSD program.

I'll remind you that we are expecting nearly a billion dollars of incremental growth from TBSI next year, but we also expect significant growth going from 21 to 22.

The mix pressure will persist, but as Dave noted in his commentary we are working to offset that pressure at the company level with strong cost reduction program performance.

And then how is now ready for next question. Thank you.

Your next question is from the line of Carter Copeland with Melius research.

Hey, good morning, everyone.

Good morning Carter.

Kathy I Wonder if you could talk about what you expect in terms of backlog.

Backlog growth opportunities in 2021, given that 2019 and 2020 were so strong with some big lumpy Awards.

I think you can still grow backlog next year or is that going to be tougher given the comparison. Thanks.

We certainly see the opportunity to continue to grow backlog for next year, we have a number of opportunities that we're pursuing across all sectors. All point to you all next Gen Jammer and mission.

Well as the dealer replacement deal.

Yeah.

Also in mission systems, we have in CCI. The next generation interceptor, which would be in base. So these are just a few examples of large potential awards.

Newstar.

We could.

Look to to bolster our book to Bill next year.

Certainly we expect that book to Bill.

Don't be as robust this year, just given the singular attempt of the GTSP Award and the strong backlog that we have across our sectors and interest and provide a little bit of color on that we don't tend to look at awards and book to Bill on a quarterly basis, we look at on a longer term and we are.

Well above a year of sales and backlog.

Hey.

Our same products and mission systems.

Systems tends to run at the short cycle business more when the backlog about equal to sales, but that's typical so we see strong backlog in all of our sectors and the opportunity to continue to build backlog at the company level.

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

Hi, good morning.

I was interested in trying to get a sense for where services are headed.

Some very good topline growth in product sales, but services have really been flat at best and perhaps you could talk about why that is and do you expect to see that services revenues grow from here at.

And do you expect the F 35, sustainment to be a significant part of that.

Thanks, Doug So let me start with the last part of your question first and then ill talk more generally about services, we do see F 35, sustainment growth as a contributor to our overall.

Services business, but I'll also note that some of that F 35, Sustainment growth runs through our Aeronautics business and our mission systems business when we're talking about there.

And repairs.

John viable businesses that produce the pros.

Products themselves not necessarily for our defense systems business, where our aircraft modernization.

That team is involved in the Sustainment.

Program for the F 35, so we see some statements right across the company and we see that growth contributing to all three of the sectors that I did in terms of services growth within defense systems, we have seen that business to be relatively flat.

And we've talked about some of the headwinds there that have been running off over the last couple of years based on strategic decisions Weve made about business to not pursue.

For several years.

Your next question is from the line of Jon Raviv with Citigroup.

Thank you and good morning, Kathy in your repair prepared remarks, excuse me you talked about how there is uncertainty, but Northrop strengthening foundation for growth what about the foundation for strengthening strengthening growth and ask in the context of what is the prospect for growth rate to accelerate after 21 as new programs ramp up your comms.

Headwinds like Lake City.

I know in July we talked about Aero being on a remarkable 21 and 22, but just thinking about growth ahead and sustaining that number as you point to maybe call it 3% to 5% and 21.

Thanks, John well as you note our outlook for 2001 represents another solid year growth for us beyond 2021 will be somewhat dependent on the topline defense budget outlook, but also on our portfolios ability to offer them solutions, the U.S. government and our allies appeal.

Our necessary for their most pressing for us and.

Seems strong bipartisan support for our key programs like 21 genius C. F 35, and these two will be key to continuing to see growth beyond 2021, but given the threat environment. We expect that support to continue for those large program.

We have really.

Really nice visibility as a result of being on the early end of programs like the 21 ingenious team, which go for for many years as you know and have a growth profile in that period.

I will acknowledge that flattening budget could lead to fewer newstar.

Your next question is from the line of David Strauss with Barclays.

Thanks, Good morning.

Good morning, David.

Kathy Dave wanted to ask on on free cash flow or I guess first of all on on pension, how you're thinking about that and maybe the potential of up front end load.

Some of the pension contributions you're thinking about in the out years, given the given the cash balance you're going to you're going to have here.

And then thinking about the cash profile from here it looks like despite everything this year that working capital based on your guidance for the full year looks like working capital capitals can be fairly neutral.

Does that benefit you from here and then last part a bit your capex profile, you still see that stepping down pretty meaningfully and in 2022. Thank you.

Sure. Thanks, David I'm happy to dig into each of those pieces as we look at the cash flows in the.

Years, 2021, and beyond I think you're right that that we've generated a healthy cash balance at this point $5 billion at the end of Q.

Q3 that certainly enabled us to pay down the billion dollars of debt that we talked about earlier in October we do continue to plan for a gradual.

Deleveraging of the balance sheet. So thats, one element of our capital deployment strategy investing in the business is certainly continues to be.

Continues to be the hallmark of our capital deployment strategy on the Capex side that you asked about.

Our outlook there is unchanged at 1.35 billion this year and next with.

With a gradual decline in terms of percentage of sales thereafter.

We don't see anything that would cause us to change that outlook at this point.

Returning cash to shareholders remains a priority as well and as Kevin talked about early.

Earlier, we do anticipate restart.

Restarting our share repurchase program in 2021, continuing to maybe maintain.

Competitive dividend.

On the pension side. It is something that we look at in terms of the timing of pension contributions that are anticipated to pick up a bit in 2022.

As we noted earlier those are not incorporated into our free cash flow guidance for this year and next but.

Opportunity to to make voluntary early pension contributions remains a possibility in.

There are those years.

So the bottom line is our intent is not to sit on the current high levels of cash that we have.

Generated over the last couple of years for longer than we believe it's necessary.

And you should expect to.

Nice balanced approach to capital deployment over the next.

Couple of years to continue for us.

Digging into the free cash flow question for 2021, a bit further I think that two is an important topic.

Two year period.

2020, free cash flow benefits about $3 million to $400 million from the payroll tax deferral also benefits a bit from progress payment changes.

And then we're we have some headwinds related to the cobot related delays and those supplier payment accelerations that we've done this year, which on an aggregate year to date basis total over $800 million. So we continue to support those.

Those critical suppliers.

As we look at 21, we'll have.

The headwind related to the payroll tax deferral from this year, that's about 50% of that amount.

But we will work to offset that to your point through continued working capital management and do feel like we can create a bit of a.

Can create a bit of a tailwind there.

And with comparable Capex remove 20 to 21 when you aggregate all of that we think the net result for 21 free cash will be continued strong free cash flow on that multiyear basis, but potentially below the higher 2020 free cash flow guide that we've provided today because of that combination of factors.

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

Thanks very much.

Good morning, Tom.

I Wonder if maybe if you could talk a little bit more about the job the autonomous portfolio at cost.

Mechanics and timeframe.

Starting to.

Great to pick up there and in particular, maybe the Skype or award and.

How you guys think about that given that it's kind of a different a different type of program in terms of being a low cost solution.

The more high end stuff that Northrop has been focused on traditionally.

Thanks, Seth I'd be happy to so let me start by talking about our current autonomous polio and looking at retail in particular, so the combination of our global Hawk and Triton program, we have talked about some budget pressures there.

Maybe familiar that for Triton. The Navy has discussed that production pause for the next two years and that is what is currently program into the Navy 2021 budget request, we are working with the Navy and Congress to see what that.

Production pause actually entails in terms of aircraft for next year.

But with Australia, we also see some offsets to that production.

We would experience otherwise with the Navy Hot we do believe the Navy is committed to the program in the long term based on all of the statements that they've made and so this really is a opportunity for air vehicle to pause and wait for some government provided sensors that we get in and.

Great it into the production vehicle.

With regard to global Hawk. The Air Force is contemplating a reduction in their fleet from largely block 20 and block Thirtys.

And while they've signaled that that is not formal direction at this point. So we really don't have more color to add.

On what those pressures might look like for global Hawk, but.

We do anticipate that over the next several years that will become more clear and we will have a stronger projection and that leads to the question that you asked about skyward. Other analysis of alternatives that are being considered in this case, particularly by the air Force, but I would note.

All of the services strategic plan calls for a significant contribution by.

In particular aerial unmanned system, including not only the air force that the Navy and the Marine Corps, So skyward in particular.

We look at as an opportunity because of its architectural component more so than just the air vehicle alone. The Skyworks vision systems will be operating together instead of on a single platform, having the capability to really.

Really operate on aided which is Howard Hill platform developed today that broader range of requirements. As you point will be in a lower price point, but have some very sophisticated requirements that need to be interest in areas like connectivity vehicle management, all things across the Northrop Grumman ports.

Folio, we have strong capabilities to contribute so we're actually quite excited about opportunities that look beyond the platform itself to the conductivity of other sensors and aircraft because it starts to engage some of the integration that we can do with our mission system.

Our platform programs and products as well so.

Really as we look forward. This is an evolution of unmanned and one that we think is very consistent with what the services have been discussing in systems and some operating together and the work that we've been doing to lead the way in that all domain command.

And control of.

On manned and unmanned.

Your next question is from the line of Cai von Rumohr with Cowen.

Thank you very much so.

Kathy you mentioned the backlog could grow and why they just looking at it it doesn't look like the new opportunities.

Our that huge maybe I'm wrong, there, but but so what would it take to get to it.

Existing programs.

Increases coming you've already gotten your money on GBS, Steve, but any other restricted areas what are the key elements jet to a higher backlog next year.

So I noted a few program, but as you I'm sure.

Im sure appreciate across our programs that.

The timing of awards.

Some large like F 35, we expect another production.

Lot of award next year, but there are many smaller efforts as well that we'll just have their natural annual increment, particularly production program that will flow into next year that create a significant base and foundation of award and I just referred to a few of the new.

The new business that we would see contributing to an ability to get to a one or greater of till next year and certainly there are lots of awards that are anticipated in just our normal course.

Business across all four of our sectors.

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

Hi, Good morning, Cathy Bhavan Todd.

Just given 10% growth in Michigan this quarter and the promotion of Tom Jones to lead Aeronautics Your largest segment from a sub segment in Michigan.

How do we think about actual growth drivers admission growth over the next few years.

'cause outside of GBS is your most most significant growth contributor in your portfolio.

Yes, Sheila and thank you for recognizing that as certainly Tom Jones and his leadership at airborne sensors and networks and sinus mission systems has contributed to very strong growth for.

Four emission system that have them of the four businesses inside his mission systems. The most significant contributor to growth for a couple of years, but I would also note that all of the businesses and mission systems contributed to growth. This year. So we have been pleased to see that it isn't just one of the divisions driving that growth.

Speaking to Tom Jones in particular, I, one of the reasons that I'm very pleased to have him stepping into the role aeronautics sector is that in.

And to leading our airborne sensors and networks.

Cross Company campaign for next generation Air dominance, which looks at all next generation aircraft and mission systems that would meet the requirements of the government for their next generation fleet.

Fleet and so in that role he was already working very closely between our aeronautics on our mission systems sector.

We bring these capabilities together to accomplish the mission that our customers have laid out both the air Force and the Navy for their next generation of aircraft.

And mission program, so that synergy between those two businesses will only get stronger as we have Tom transition into airing on it.

Also note that the.

Under Tom and airborne sensors in networks as a very strong team sorry fully expect that the growth that we've seen there we'll continue onto their leadership.

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

Hey, good morning, guys. Thanks.

So kathryn.

Bigger picture question for you.

They are classified programs have sort of become such an important piece of.

Northrop's business and.

I guess report reasons right, there sort of a black box.

How do you want to invest.

Investors to think about it and kind of as a follow on to that or abandon it up.

With the announcement of and.

In the third the wanting to do more rapid.

Aircraft programs prototype in the whole digital century series thing.

What kind of opportunity does that present for north or because presumably that's all classified world as well.

Thanks, Ron So one of the most important thing for our performance of the company is the program performance and so what I want our investors to know first and foremost about our classified and restricted work is that we have the same level of governance over the program.

We do any other program the appropriate people are cleared into the details of those programs reviewing them regularly understanding what they need to perform and providing the resources to them to execute successfully and so that goes to our ability to continue.

To have a track record of disciplined and focused performance in our restricted portfolio, even though we can't share as much of that detail with our investor community as we could on our unclassified portfolio.

I think that model not documents produced this is the first time on a program of this size or that's been the case and we're very pleased Sydney pioneering the way in partnership with the Air Force to make that a reality on the GBSD program, but those investments that were making for GBM C are being utilized across our.

Our entire portfolio. So as we think about next generation air dominance in the program, but are part of that overall campaign is I'll call. It they too will benefit from a full digital engineering Rad.

Acquired by our customers and even in areas like space and mission systems. In addition to aeronautics.

When you start looking at implementing not only the design in a digital way, but a full thread it looks that the producibility and maintainability.

So.

Models and the digital environment.

Your next question is from the line of Pete Skibitski with Olympic Global.

Yeah. Thanks, good morning.

Just a follow up on SaaS earlier question regarding the hail you Avi is I know you touched on Australia, but but in general that was a domestic discussion we talk about you Avi export policy because I thought maybe there had been some changes made to the mtc are but I don't know how radical or not those changes have been but can you give us your updated.

View there on on regulation around around exports for health and.

Maybe whether or not it goes far enough to help exports just given I think a lot of market share has been ceded to some competitors out there. Thanks.

Yeah. Thanks.

The changes to the Mtc are and they are very encouraging changes that will open up more international customers to have potential access of course, they still go through the same approval process, but now it looks more favorable upon.

As part of this technology, because it isn't caught up in the missile.

Balance sheet machine as tightly and so when we look at this process. We are really pleased with the department of state and the department of Defense and the U.S. has worked together.

To make this possible it will take us some time to work with nations that are now eligible for this technology and get through processes of them requesting it and engaging with them, but it is opening a door that had not been opened before so over a multiyear period, we do expect us.

So not more international sales not just for health platform, which is what we produced today for unmanned systems overall, including ones, we might develop in the future.

Tell you we have time for one more question.

Your last question is from the line of Myles Walton with the B S.

Thanks. Good morning, Thanks for squeezing me in maybe a clarification on the pension cash assumption is 21 and 22 did did only Fas move forward did CASM and funding respectively change and then on on space. Your growth. There for 21 I think this year you grew space.

More than 10% without GBSD.

So why the implied deceleration to virtually no growth in 21 X GBSD. Thanks.

Hey, my although I'll start on the on the pension question.

We still have a lot of.

Assumptions to finalize their and review internally and so that's why it doesn't make sense for us at this phase to get into a line by line.

Detailed review of those assumptions before they are fully baked and of course, we have to see where discount rates end up as well as a full year asset performance for this year, it's possible that there will be movement, both the Fas and mcos loans, but those are as I mentioned still in the works. The net result that were.

Talking through 150 to 250 would cover both of those.

From a cash perspective, I don't think you should.

Think of this as being a meaningful change to our 21.

Were 22 outlook, but again, we will have more details will be able to update that on the January call.

And I'd say, just very quickly with strategics days, we've seen a tremendous amount of growth. This year as you pointed to many of those program ramps throughout this year and she is more of a steady state growth into.

Next year and strategic missile as is transitioning from TV.

Okay.

Hi, well see a little bit of flatness until we get.

The other side, but all of that is being more than offset by TBSI and.

Funnel growth and strategic save just not quite as much there in 2021 on a year over year compare as we saw in 2020.

So why don't I go ahead and close todays call.

Reiterating our thanks to the Northrop Grumman team for another outstanding quarter of performance. It is especially impressive in light of the challenging conditions that weve all faced this year.

We are successfully executing on our strategy with solid results through the first three quarters, and we're well positioned to have a strong finish to this year and continue that momentum into 2021.

So thank you for joining us today, we look forward to speaking to you again in late January when we'll report on our full year results and to provide 2021 that concludes.

That concludes our call.

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

Q3 2020 Northrop Grumman Corp Earnings Call

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